10-K

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-K

(Mark One)
þ	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the fiscal year ended December 31, 2006
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from          to          .

Commission File Number 000-26785

PACKETEER, INC.

(Exact name of Registrant as specified in its charter)

DELAWARE	77-0420107
(State of incorporation)	(I.R.S. Employer Identification No.)

10201 NORTH DE ANZA BLVD.
CUPERTINO, CALIFORNIA 95014
(Address of principal executive offices)

Registrant’s telephone number, including area code:

(408) 873-4400

Securities registered pursuant to Section 12(b) of the Act:

Title of Class	Name of Each Exchange on Which Registered
Common Stock, $0.001 Par Value	The Nasdaq Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o     Accelerated filer þ     Non accelerated filer o

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

Based on the closing sale price of the common stock on the Nasdaq Global Select Market (formerly the Nasdaq National Market) on June 30, 2006, the aggregate market value of the voting common stock held by non-affiliates of the Registrant was $347,995,297. Shares of common stock held by each officer and director and by each person known by the Registrant to own 10% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

The number of shares outstanding of Registrant’s common stock, $0.001 par value, was 35,968,876 at March 11, 2007.

DOCUMENTS INCORPORATED BY REFERENCE

Information required by Part III, Items 10, 11, 12, 13 and 14 of this Form 10-K is incorporated by reference from the Registrant’s definitive Proxy Statement for the Registrant’s 2007 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after December 31, 2006.

TABLE OF CONTENTS

PART I
	Item 1.	Business	3
	Item 1A.	Risk Factors	9
	Item 1B.	Unresolved Staff Comments	19
	Item 2.	Properties	19
	Item 3.	Legal Proceedings	19
	Item 4.	Submission of Matters to a Vote of Security Holders	20
PART II
	Item 5.	Market For Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities	21
	Item 6.	Selected Financial Data	23
	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24
	Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	36
	Item 8.	Financial Statements and Supplementary Data	38
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	74
	Item 9A.	Controls and Procedures	74
	Item 9B.	Other Information	75
PART III
	Item 10.	Directors and Executive Officers of the Registrant	75
	Item 11.	Executive Compensation	75
	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	75
	Item 13.	Certain Relationships and Related Transactions	75
	Item 14.	Principal Accountant Fees and Services	75
PART IV
	Item 15.	Exhibits and Financial Statement Schedules	75
Signatures			77
EXHIBIT 10.32
EXHIBIT 10.33
EXHIBIT 10.34
EXHIBIT 21.1
EXHIBIT 23.1
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

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PART I

ITEM 1.   BUSINESS

In addition to historical information, this Annual Report on Form 10-K contains forward-looking statements regarding our strategy, financial performance and revenue sources that involve a number of risks and uncertainties, including those discussed under the title “RISK FACTORS” in Item 1A. Forward-looking statements in this report include, but are not limited to, those relating to future revenues, revenue growth and profitability, markets for our products, our ability to continue to innovate and obtain patent protection, operating expense targets, liquidity, new product development, the possibility of acquiring complementary businesses, products, services and technologies, the geographical dispersion of our sales, expected tax rates, our international expansion plans and our development of relationships with providers of leading Internet technologies. While this outlook represents our current judgment on the future direction of the business, such risks and uncertainties could cause actual results to differ materially from any future performance suggested below due to a number of factors, including the perceived need for our products, our ability to convince potential customers of our value proposition, the costs of competitive solutions, our reliance on third party contract manufacturers, continued capital spending by prospective customers and macro economic conditions. Readers are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this Annual Report. Packeteer undertakes no obligation to publicly release any revisions to forward-looking statements to reflect events or circumstances arising after the date of this document, except as required by law. See “RISK FACTORS” appearing in Item 1A. Investors may access our filings with the Securities and Exchange Commission including our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and amendments to such reports on our website, free of charge, at www.packeteer.com, but the information on our website does not constitute part of this Annual Report.

OVERVIEW

Packeteer is a leading provider of wide area network, or WAN, Application Delivery systems designed to deliver a comprehensive set of visibility, Quality of Service, or QoS, control, compression, application acceleration and branch office service capabilities. Our product family includes PacketShaper, iShared, SkyX and Mobiliti Client products that can be deployed within large data centers, smaller branch office sites and software clients on PCs for mobile and Small Office/Home Office, or SOHO, users throughout a distributed enterprise. We deliver superior application performance and end user experience using an “intelligent overlay”, which bridges applications and IP networks, adapts to our customers’ existing infrastructure and addresses the demands created by a changing application environment in order to deliver high performance applications across all WAN and Internet links.

INDUSTRY BACKGROUND

Networked computing has created new challenges for Information Technology, or IT, managers. As more core business applications, such as SAP and Oracle, become distributed and Web-enabled, and the use of video over IP and voice over IP, or VOIP, increases, the amount of network data increases dramatically. This increase in data makes it difficult for businesses to ensure the performance of their applications. Further, enterprise users access graphic-intensive web sites, download large files, view streaming media presentations, monitor news and stock quotes and access peer-to-peer applications, instant messaging and other critical and non-critical information over the Internet. The resulting traffic deluge impacts network resources that serve point-of-sale, order processing, enterprise resource planning, supply-chain management and other vital business functions.

Further, changes in application delivery and networking technologies present additional issues for enterprises. Server consolidation, which involves removing of branch office servers and consolidating files and storage into data centers, exposes limitations in application protocols like common internet file system, or CIFS, and network file system, or NFS. These file access protocols require a large number of round trips across the WAN to accomplish their tasks, slowing performance. In addition, consolidation centralizes certain services, creating new traffic types from services that were once delivered locally.

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The WAN/Application Bottleneck

The adoption of Fast Ethernet and Gigabit Ethernet technologies has reduced network congestion on the local area network, or LAN. Simultaneously, the deployment of fiber infrastructure in the service provider backbone has also reduced bandwidth contention in that portion of the network. However, the bridge between the two, the WAN access link, is often constrained, expensive and difficult to upgrade, resulting in a bandwidth bottleneck.

Today’s enterprise networks require solutions that ensure mission-critical application performance, increase network efficiency, and enable the convergence of data, voice and video traffic. Superior application performance, good user experience and high user productivity, especially at branch locations, are primary focus areas for IT departments. At the same time, they seek to leverage investments in application software and proactively control recurring network costs by optimizing bandwidth utilization.

The Packeteer Solution

For enterprise customers, our systems are designed to enable IT organizations to effectively deliver applications and performance while providing measurable cost savings in WAN investments. For service providers, our systems are designed to provide a platform for delivering application-intelligent network services that provide application level visibility and QoS control, expanding revenue opportunities.

Our products are designed to enable businesses and service providers to realize the following key benefits:

•  gain application and network performance visibility and insight,

•  ensure proper performance for mission-critical applications,

•  permit easy deployment,

•  increase effective and available bandwidth,

•  enable time-sensitive interactive services,

•  enable server consolidation,

•  increase network efficiency and

•  reduce operational cost.

OUR KEY STRATEGIES

Our objective is to be the leading provider of WAN Application Delivery systems that give enterprises and service providers a new layer of control for applications delivered across intranets, extranets and the Internet. Key elements of our strategy include:

Focus on Enterprise Performance Needs for Distributed Enterprises.  We are focused on providing high performance, easy-to-use and cost-effective solutions to distributed enterprises whose businesses rely on networked applications. For these businesses, managing mission-critical application performance user experience and productivity will continue to be competitive requirements. We believe we have established a differentiated market position based on our development of a comprehensive solution and our early market leadership and brand awareness. We intend to continue to direct our development, sales and marketing efforts toward addressing the application performance needs of large, distributed enterprises.

Continue to Build Indirect Distribution Channels.  We currently have over 600 value-added resellers, distributors and systems integrators that sell our products in over 50 countries. We intend to continue to develop and support new reseller and distribution relationships, as well as to establish additional indirect channels with service providers and systems integrators. We believe this strategy will enable us to increase the worldwide deployment of our products.

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Expand Presence in Telecommunications Service Provider Market.  We are actively pursuing opportunities in the telecommunications service provider market and currently have a variety of telecommunications service provider customers. We believe service providers are under increasing pressure to attract new subscribers, reduce subscriber turnover, improve operating margins and develop new revenue streams. Specifically, service providers seek to differentiate themselves through value-added service offerings, such as web hosting, application outsourcing and application service-level management. We believe our solutions enable service providers to deliver these higher value services by enhancing network and application performance and better managing and allocating network resources. Our goal is to increase demand for our solutions with service providers by leveraging our strong enterprise presence.

Extend Product Scope beyond WAN Equipment into Adjacent Infrastructure.  We are actively pursuing opportunities to expand the scope of value-added services that our product solutions provide beyond our traditional networking equipment focus into new markets that involve storage and servers. Through our 2006 acquisition of Tacit Networks, Inc., or Tacit, we have been able to consolidate new, value-added products into our existing solutions. The Tacit iShared product set provides alternative methods for branch office storage, branch office server infrastructure and branch office backup systems. We can also expand into these new areas through technology and distribution partnerships with third parties, such as our relationship with Microsoft and Brocade Communications.

Extend WAN Application Performance Technology Leadership.  Our technological leadership is based on our sophisticated traffic classification, flexible policy setting capabilities, precise rate control expertise, compression and acceleration technologies and ability to measure response time and network performance. We intend to invest our research and development resources to increase performance by handling higher speed WAN connections, increase functionality by identifying and managing additional applications or traffic types and increase system modularity. We also plan to invest our research and development resources to develop new leading-edge technologies for emerging markets. These development plans include extending our solutions to incorporate in-depth application-management techniques that will improve performance and heighten internal network security.

PRODUCTS

Our WAN Application Delivery products are designed to solve network and application performance problems through a family of appliances with multiple software options that provide visibility into application performance and network utilization, control over network performance and network utilization, compression and protocol acceleration to accelerate performance and increase WAN capacity.

PacketShaper is designed to provide application traffic monitoring that builds on our industry-leading Layer 7 traffic classification, analysis and reporting technology to provide visibility into network utilization and application performance. PacketShaper ISP is designed to enable service providers to create differentiated services through fast and efficient bandwidth provisioning and management. The PacketShaper family currently includes the 1400, 1700, 3500, 7500, and 10000 models.

The Shaping Module for PacketShaper is a software option designed to provide application-based traffic and bandwidth management to deliver predictable, efficient performance for applications running over the WAN and Internet. This module provides QoS using state-of-the-art bandwidth, traffic, service-level and policy management technology.

The Compression Module for PacketShaper is a software option designed to provide increased throughput for application traffic through compression technology. Combining Layer 7 classification, traffic shaping and application-intelligent compression raises the level of control customers have over the performance of their network applications and associated bandwidth costs.

The Acceleration Module for PacketShaper is a software option designed to overcome the latency issues associated with transmission control protocol, or TCP, and hypertext transfer protocol, or HTTP, over the WAN. Targeted at higher latency environments, this module provides significant improvements in throughput and performance for bulk applications like file transfer and large web applications.

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PolicyCenter is a directory-based policy management application that is designed to enable our enterprise and service provider customers to broadly deploy, scale and manage application QoS throughout the network. PolicyCenter is a lightweight directory access protocol, or LDAP, directory-enabled application running under Windows that enables customers to centrally administer and update policies, software versions, and device status for Packeteer-based networks.

ReportCenter is an application that is designed to aggregate metrics from large deployments and create organization — wide reports to manage trends and provide support for capacity planning and usage analysis. ReportCenter lowers the cost of ownership for large deployments of PacketShaper appliances, improves the quality of information and eases administrative overhead.

iShared is suited for environments with large amounts of collaborative traffic (files, email, and large documents) and/or undergoing server consolidation. The iShared product not only provides Wide Area File Services, or WAFS, with CIFS acceleration, but includes general WAN optimization technologies that include compression, byte caching, Web object caching and TCP acceleration. Moreover, iShared has the ability to deliver Microsoft-based branch office services like print services, domain name system/dynamic host configuration protocol, or DNS/DHCP, and Domain Controller, as well as acting as a distribution point or secondary server for SMS. iShared’s capabilities integrate natively with Microsoft security and management frameworks, ensuring compatibility that disables many other products in the space. iShared is available both in an appliance version, as well as an installable software package known as FlexInstall that delivers WAFS, optimization and service delivery on existing server infrastructure.

SkyX^® products and technologies enhance the performance and efficiency of Internet and private network access, accelerating applications for high capacity data center to data center links, often found in disaster recovery architectures, as well as over satellite and long-haul networks. The product line includes the PX 250 and PX750 models.

Mobiliti software products provide solutions for the mobile and SOHO users. Combining acceleration technologies with offline file access and backup services, Mobiliti delivers a software-based client solution installed on laptops and PCs.

CUSTOMERS

We sell all of our products primarily through an established network of more than 600 distributors, value-added resellers and system integrators in more than 50 countries, complemented by our direct sales organization. In 2006, sales to Alternative Technology, Inc. and Westcon, Inc. accounted for 23% and 18% of net revenues, respectively. These customers are distributors, who in turn sell to a large number of value-added resellers, system integrators and other resellers.

MANUFACTURING

We outsource all of our manufacturing, including warranty repair. Outsourcing our manufacturing enables us to reduce fixed costs and to provide flexibility in meeting market demand. We currently rely on our longstanding contract manufacturer, SMTC Manufacturing Corporation, or SMTC, located in San Jose, California, and to a lesser extent, three additional manufacturers for all of our manufacturing requirements. The manufacturing processes and procedures for these manufacturers are ISO certified.

MARKETING AND SALES

We target our marketing and sales efforts at channel sales partners, enterprises and service providers. Marketing and sales activities focus on reaching the corporate information technology organization managers responsible for the performance of mission-critical applications and maintenance of network performance in the enterprise. We also focus on reaching resellers and service providers that provide valued-added service offerings, such as application performance monitoring and management.

We have a number of marketing programs to support the sale and distribution of our products and educate existing and potential enterprise and service provider customers about the benefits of our products. Our marketing

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efforts include publication of technical, educational and business articles in industry magazines, participation in tradeshows, conferences and technology seminars, electronic marketing, including web site-based communication programs, electronic newsletters and on-line end user seminars; and focused advertising, direct mail, public relations and analyst outreach.

As of December 31, 2006, our worldwide sales and marketing organization consisted of 164 individuals, including managers, sales representatives and technical and administrative support personnel. We have domestic sales offices located throughout the United States. In addition, we have international sales offices located throughout Europe, the Asia Pacific region and Japan.

We believe there is a strong international market for our products. Our international sales are conducted primarily through our overseas offices. Sales to customers outside of the Americas accounted for 53%, 54%, and 59% of net revenues in 2006, 2005, and 2004, respectively.

RESEARCH AND DEVELOPMENT

As of December 31, 2006, our research and development organization consisted of 146 employees providing expertise in different areas of our software: control and compression technologies, classification, central management, user interface, platform engineering and protocol acceleration. Since inception, we have focused our research and development efforts on developing and enhancing our WAN Application Delivery solutions. In 2006, 2005, and 2004, we spent $30.6 million, $21.8 million, and $15.0 million, respectively, on research and development efforts. During 2006, our major research and development programs included adding new Restriction of Hazardous Substances compliant hardware platforms for many of our PacketShaper and SkyX products and major upgrades to our PacketShaper products that integrate application acceleration technology gained through our acquisition of Mentat, Inc, or Mentat, in December 2004. In addition, we released new versions of the Tacit iShared and Mobiliti products, which included new features and capabilities.

CUSTOMER SERVICE AND TECHNICAL SUPPORT

Our customer service and support organization provides technical support services. Our technical support staff provides our customers with 24/7 support services and is strategically located in five regional service centers: in California, New Jersey, Japan, Malaysia, and The Netherlands. These services, which may include telephone/web support, next business day advance replacement and access to all software updates and upgrades, are typically sold as single or multi-year contracts to our resellers and end users. In addition, we have formal agreements with two third-party service providers to facilitate next business day replacement for end user customers located outside the United States covered by maintenance agreements providing this service level. We also provide our customers with a warranty, which is typically twelve months from the date of shipment to the end user. We believe that these programs improve service levels and lead to increased customer satisfaction.

COMPETITION

The WAN Application Delivery market in which we compete is a rapidly evolving and highly competitive sector of the WAN Application Optimization market. We expect competition to persist and intensify in the future as our sector becomes subject to increasing industry focus. Increased competition could result in reduced prices and gross margins for our products and could require increased spending by us on research and development, any of which could harm our business. We compete with Cisco Systems, Juniper Networks, other switch/router vendors, Riverbed Technology in the wide area file systems market segment, Citrix System through their Orbital Data acquisition, security vendors and several small private companies that sell products that utilize competing technologies to provide monitoring or bandwidth management, compression and acceleration. Although none of these companies currently offer an integrated visibility, control and compression solution such as our WAN Application Delivery system, Cisco and other network equipment providers have announced products or strategies which, if released, could be directly competitive with our products. Our products compete for information technology budget allocations with products that offer monitoring technologies, such as probes and related software. Lastly, we face indirect competition from companies that offer enterprise customers and service providers

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increased bandwidth and infrastructure upgrades that increase the capacity of their networks, which may lessen or delay the need for WAN Application Delivery solutions.

We believe the principal competitive factors in the WAN Application Delivery market are:

•  ability to address the broad range of applications that enterprises must deliver, including ERP, to financial transactions, voice, video, file access and many more

•  products to suit every required delivery point

•  expertise and in-depth knowledge of applications;

•  ability to ensure end user performance in addition to aggregate performance of the WAN access link;

•  ability to integrate in the existing network architecture without requiring network reconfigurations or desktop changes;

•  timeliness of new product introductions;

•  ability to compress traffic without decreasing throughput, performance or network capacity;

•  ability to integrate traffic classification, management, reporting and acceleration into a single platform; and

•  compatibility with industry standards;

INTELLECTUAL PROPERTY

We rely on a combination of patent, copyright and trademark laws, and on trade secrets, confidentiality provisions and other contractual provisions to protect our proprietary rights. These measures afford only limited protection. As of December 31, 2006, we have 36 issued U.S. patents and 70 pending U.S. patent applications. We cannot assure you that our means of protecting our proprietary rights in the U.S. or abroad will be adequate or that competitors will not independently develop similar technologies. Our future success depends in part on our ability to protect our proprietary rights to the technologies used in our principal products. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use trade secrets or other information that we regard as proprietary. In addition, the laws of some foreign countries do not protect our proprietary rights as fully as do the laws of the U.S. We cannot assure you that any issued patent will preserve our proprietary position, or that competitors or others will not develop technologies similar to or superior to our technology. Our failure to enforce and protect our intellectual property rights could harm our business, operating results and financial condition.

From time to time, third parties, including our competitors, have asserted patent, copyright and other intellectual property rights to technologies that are important to us. We expect that we will increasingly be subject to infringement claims as the number of products and competitors in the market grows and the functionality of products overlaps. The results of any litigation matter are inherently uncertain. In the event of an adverse result in any litigation with third parties that could arise in the future, we could be required to pay substantial damages, including treble damages if we are held to have willfully infringed, to cease the manufacture, use and sale of infringing products, to expend significant resources to develop non-infringing technology, or to obtain licenses to the third-party technology. Licenses may not be available from any third-party that asserts intellectual property claims against us on commercially reasonable terms, or at all. In addition, litigation frequently involves substantial expenditures and can require significant management attention, even if we ultimately prevail.

EMPLOYEES

As of December 31, 2006, we employed a total of 421 full-time equivalent employees. Of the total number of employees, 146 were in research and development, 142 in sales and system engineering, 22 in marketing, 76 in customer support and operations and 35 in administration. Our employees are not represented by any collective bargaining agreement with respect to their employment by us.

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ITEM 1A.   RISK FACTORS

You should carefully consider the risks described below before making an investment decision. If any of the following risks actually occur, our business, financial condition or results of operations could be materially and adversely affected. In such case, the trading price of our common stock could decline, and you may lose all or part of your investment.

IF THE WAN APPLICATION DELIVERY SYSTEMS MARKET FAILS TO GROW, OUR BUSINESS WILL FAIL

The market for WAN Application Delivery systems is still developing and its success is not guaranteed. Therefore, we cannot accurately assess the size of the market, the products needed to address the market, the optimal distribution strategy, or the competitive environment that will develop. In order for us to be successful, our potential customers must recognize the value of more sophisticated bandwidth management solutions, decide to invest in the management of their networks and the performance of important business software applications and, in particular, adopt our bandwidth management solutions.

OUR FUTURE OPERATING RESULTS ARE DIFFICULT TO PREDICT AND MAY FLUCTUATE SIGNIFICANTLY, WHICH COULD ADVERSELY AFFECT OUR STOCK PRICE

We believe that period-to-period comparisons of our operating results cannot be relied upon as an indicator of our future performance, and that the results of any quarterly period are not necessarily indicative of results to be expected for a full fiscal year. We have experienced fluctuations in our operating results in the past and may continue to do so in the future. Our operating results are subject to numerous factors, many of which are outside of our control and are difficult to predict. As a result, our quarterly operating results could fall below our forecasts or the expectations of public market analysts or investors in the future. If this occurs, the price of our common stock would likely decrease. Factors that could cause our operating results to fluctuate include variations in:

•  the timing and size of orders and shipments of our products;

•  the mix of products we sell;

•  the mix and effectiveness of the channels through which those products are sold;

•  the timing and success of new product and upgrade introductions;

•  the geographical mix of the markets in which our products are sold;

•  the average selling prices of our products;

•  the amount and timing of our operating expenses;

•  the impact of changes in effective tax rates; and

•  the impact of acquisitions.

In the past, revenue fluctuations resulted primarily from variations in the volume and mix of products sold and variations in channels through which products were sold. For example, for the three months ended September 30, 2005 we deferred recognition of revenue on approximately $3.6 million in product sales due to channel inventory levels, which contributed to our revenues being below analyst expectations. In addition, as an increasing portion of our revenues is derived from larger unit sales, the timing of such sales can have a material impact on quarterly performance. As a result, a delay in completion of large deals at the end of a quarter can result in our missing analysts’ forecasts for the quarter. Total operating expenses may fluctuate between quarters due to the timing of spending. For example, research and development expenses, specifically prototype expenses, consulting fees and other program costs, have fluctuated relative to the specific stage of product development of the various projects underway. Sales and marketing expenses have fluctuated due to the timing of specific events such as sales meetings or tradeshows, or the launch of new products. Additionally, operating costs outside the United States are incurred in local currencies, and are remeasured from the local currency to the U.S. dollar upon consolidation. As exchange rates vary, these operating costs, when remeasured, may differ from our prior performance and our expectations.

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Tax rates can vary significantly based upon the geographical mix of the markets in which our products are sold and may also cause our operating results to fluctuate. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for detailed information on our operating results.

WE MAY BE UNABLE TO COMPETE EFFECTIVELY WITH OTHER COMPANIES IN OUR MARKET SECTOR WHO OFFER, OR MAY IN THE FUTURE OFFER, COMPETING TECHNOLOGIES

We compete in a rapidly evolving and highly competitive sector of the networking technology market. We expect competition to persist and intensify in the future from a number of different sources. Increased competition could result in reduced prices and gross margins for our products and could require increased spending by us on research and development, sales and marketing and customer support, any of which could harm our business. We compete with general switch/route vendors such as Cisco Systems, Inc. and Juniper Networks, Inc. We also compete with more specialized vendors such as Riverbed Technology, which we compete with in the wide area file systems market segment. We also compete with security vendors and several small private companies that utilize competing technologies to provide bandwidth management, compression and acceleration. We expect this competition to increase particularly due to the anticipated requirement from enterprises to consolidate more functionality into a single appliance. In addition, our products and technology compete for information technology budget allocations with products that offer monitoring capabilities, such as probes and related software. Also, merger and acquisition activity by other companies can and has created new perceived competitors. Additionally, we face indirect competition from companies that offer enterprise customers and service providers increased bandwidth and infrastructure upgrades that increase the capacity of their networks, which may lessen or delay the need for WAN Application Delivery solutions.

Many of our competitors and potential competitors are substantially larger than we are and have significantly greater financial, sales and marketing, technical, manufacturing and other resources and more established distribution channels. These competitors may be able to respond more rapidly to new or emerging technologies and changes in customer requirements or devote greater resources to the development, promotion and sale of their products than we can. We have encountered, and expect to encounter, prospective customers who are extremely confident in and committed to the product offerings of our competitors, and therefore are unlikely to buy our products. Furthermore, some of our competitors may make strategic acquisitions or establish cooperative relationships among themselves or with third parties to increase their ability to rapidly gain market share by addressing the needs of our prospective customers. Our competitors may enter our existing or future markets with solutions that may be less expensive, provide higher performance or additional features or be introduced earlier than our solutions. Given the market opportunity in the WAN Application Delivery solutions market, we also expect that other companies may enter or announce an intention to enter our market with alternative products and technologies, which could reduce the sales or market acceptance of our products and services, perpetuate intense price competition or make our products obsolete. If any technology that is competing with ours is or becomes more reliable, higher performing, less expensive or has other advantages over our technology, then the demand for our products and services would decrease, which would harm our business. Similarly, demand for our products could decrease if current or prospective competitors make prospective product release announcements claiming superior performance or other advantages regardless of the market availability of such products.

IF WE DO NOT EXPAND OR ENHANCE OUR PRODUCT OFFERINGS OR RESPOND EFFECTIVELY AND ON A TIMELY BASIS TO TECHNOLOGICAL CHANGE, OUR BUSINESS MAY NOT GROW OR WE MAY LOSE CUSTOMERS AND MARKET SHARE

Our future performance will depend on the successful development, introduction and market acceptance of new and enhanced products and features that address customer requirements in a cost-effective manner. We cannot assure you that our technological approach will achieve broad market acceptance or that other technologies or solutions will not supplant our approach. The WAN Application Delivery solutions market is characterized by ongoing technological change, frequent new product introductions, changes in customer requirements and evolving industry standards. The introduction of new products, market acceptance of products based on new or alternative technologies, or the emergence of new industry standards, could render our existing products obsolete or make it

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easier for other products to compete with our products. Developments in router-based queuing schemes or alternative compression technologies could also significantly reduce demand for our product. Our future success will depend in part upon our ability to:

•  develop and maintain competitive products;

•  enhance our products by adding innovative features that differentiate our products from those of our competitors and meet the needs of our larger customers;

•  bring products to market and introduce new features on a timely basis at competitive prices;

•  integrate acquired technology into our products;

•  successfully negotiate and integrate acquisitions;

•  identify and respond to emerging technological trends in the market; and

•  respond effectively to new technological changes or new product announcements by others.

We have experienced such delays in the past, including a delay in the integration of certain technology we acquired from Mentat. If we are unable to effectively perform with respect to the foregoing, or if we experience delays in product development, we could experience a loss of customers and market share.

ANY ACQUISITIONS WE MAKE COULD RESULT IN DILUTION TO OUR EXISTING STOCKHOLDERS AND DIFFICULTIES IN SUCCESSFULLY MANAGING OUR BUSINESS

We have made, and may in the future make, acquisitions of, mergers with, or significant investments in, businesses that offer complementary products, services and technologies. For example, in May 2006 we announced our acquisition of Tacit Networks, and in December 2004 we announced our acquisition of Mentat. There are risks involved in these activities, including but not limited to:

•  difficulty in integrating the acquired operations and retaining acquired personnel;

•  limitations on our ability to retain acquired distribution channels and customers;

•  diversion of management’s attention and disruption of our ongoing business;

•  difficulties in managing product development activities to define a combined product roadmap, ensuring timely development of new products, timely release of new products to market, and the development of efficient integration and migration tools;

•  the potential product liability associated with selling the acquired company’s products; and

•  the potential write-down of impaired goodwill and intangible and other assets. In particular, we recorded approximately $49.1 million in goodwill related to the acquisition of Tacit and $9.5 million in goodwill related to the acquisition of Mentat. Goodwill will be subject to impairment testing rather than being amortized over a fixed period. To the extent that the business acquired in that transaction does not remain competitive, some or all of the goodwill related to that acquisition could be charged against future earnings.

These factors could have a material adverse effect on our business, results of operations or financial position, especially in the case of a large acquisition. In particular, we may complete acquisitions, which we believe will substantially contribute to our future revenues and profits, but may have an adverse impact on our profitability in the shorter term. Furthermore, we may incur indebtedness or issue equity securities to pay for future acquisitions. The issuance of equity or convertible debt securities could be dilutive to our existing stockholders.

IF OUR INTERNATIONAL SALES EFFORTS ARE UNSUCCESSFUL, OUR BUSINESS WILL FAIL TO GROW

The failure of our indirect partners to sell our products internationally will harm our business. Sales outside of the Americas accounted for 53%, 54%, and 59% of net revenues in 2006, 2005, and 2004, respectively. Our ability

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to grow will depend in part on the expansion of international sales, which will require success on the part of our resellers, distributors and systems integrators in marketing our products.

We intend to expand operations in our existing international markets and to enter new international markets, which will demand management attention and financial commitment. We may not be able to successfully sustain and expand our international operations. In addition, a successful expansion of our international operations and sales in foreign markets will require us to develop relationships with suitable indirect channel partners operating abroad. We may not be able to identify, attract, manage or retain these indirect channel partners.

Furthermore, to increase revenues in international markets, we will need to continue to establish foreign operations, to hire additional personnel to run these operations and to maintain good relations with our foreign indirect channel partners. To the extent that we are unable to successfully do so, or to the extent our foreign indirect channel partners are unable to perform effectively, our growth in international sales may be limited.

Our international sales are currently all U.S. dollar-denominated. As a result, an increase in the value of the U.S. dollar relative to foreign currencies could make our products less competitive in international markets. In the future, we may elect to invoice some of our international customers in local currency. Doing so will subject us to fluctuations in exchange rates between the U.S. dollar and the particular local currency and could negatively affect our financial performance. Additionally, operating costs outside the United States are incurred in local currencies, and are remeasured from the local currency to the U.S. dollar upon consolidation. As exchange rates vary, these operating costs, when remeasured, may differ from our prior performance and our expectations. Tax rates can vary significantly based upon the geographical mix of the markets in which our products are sold and may also cause our operating results to fluctuate.

IF WE ARE UNABLE TO FAVORABLY ASSESS THE EFFECTIVENESS OF OUR INTERNAL CONTROL OVER FINANCIAL REPORTING, OR IF OUR INDEPENDENT AUDITORS ARE UNABLE TO PROVIDE AN UNQUALIFIED ATTESTATION REPORT ON OUR ASSESSMENT, OUR STOCK PRICE COULD BE ADVERSELY AFFECTED

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, our management is required to report on the effectiveness of our internal control over financial reporting in each of our annual reports. In addition, our independent auditor must attest to and report on management’s assessment of the effectiveness of our internal control over financial reporting. The rules governing the standards that must be met for management to assess our internal control over financial reporting are new and complex, and require significant documentation, testing and possible remediation. As a result, our efforts to comply with Section 404 have required the commitment of significant managerial and financial resources. As we are committed to maintaining high standards of public disclosure, our efforts to comply with Section 404 are ongoing, and we are continuously in the process of reviewing, documenting and testing our internal control over financial reporting, which will result in continued commitment of significant financial and managerial resources.

Management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2006 is included under the title “CONTROLS AND PROCEDURES” in Item 9A, and our independent registered public accounting firm’s attestation is included under the title “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” in Item 8. Management’s assessment, and our registered public accounting firm’s attestation, concluded that our internal control over financial reporting as of December 31, 2006 was not effective due to material weaknesses related to our (i) accounting for income taxes and (ii) rebate reserves. Specifically, (i) we did not maintain effective controls to provide for the reconciliation of the income taxes payable account to supporting detail and the review of the income taxes payable account reconciliation by someone other than the preparer; and (ii) we did not maintain effective controls over the review of the rebate reserves as the review performed was not appropriately designed, nor was the review conducted in sufficient detail. Although we intend to diligently and regularly review and update our internal control over financial reporting in order to ensure compliance with the Section 404 requirements, in future years we may discover additional areas of our internal controls that need improvement, and our management may encounter problems or delays in completing the implementation and maintenance of any such improvements necessary to make a favorable assessment of our

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internal controls over financial reporting. We may not be able to favorably assess the effectiveness of our internal controls over financial reporting as of December 31, 2007 or beyond, or our independent auditors may be unable to provide an unqualified attestation report on our assessment. If this occurs, investor confidence and our stock price could be adversely affected.

IF WE ARE UNABLE TO DEVELOP AND MAINTAIN STRONG PARTNERING RELATIONSHIPS WITH OUR INDIRECT CHANNEL PARTNERS, OR IF THEIR SALES EFFORTS ON OUR BEHALF ARE NOT SUCCESSFUL, OR IF THEY FAIL TO PROVIDE ADEQUATE SERVICES TO OUR END USER CUSTOMERS, OUR SALES MAY SUFFER AND OUR REVENUES MAY NOT INCREASE

We rely primarily on an indirect distribution channel consisting of resellers, distributors and systems integrators for our revenues. Because many of our indirect channel partners also sell competitive products, our success and revenue growth will depend on our ability to develop and maintain strong cooperative relationships with significant indirect channel partners, as well as on the sales efforts and success of those indirect channel partners.

We cannot assure you that our indirect channel partners will market our products effectively, receive and fulfill customer orders of our products on a timely basis or continue to devote the resources necessary to provide us with effective sales, marketing and technical support. In order to support and develop leads for our indirect distribution channels, we plan to continue to expand our field sales and support staff as needed. We cannot assure you that this internal expansion will be successfully completed, that the cost of this expansion will not exceed the revenues generated or that our expanded sales and support staff will be able to compete successfully against the significantly more extensive and well-funded sales and marketing operations of many of our current or potential competitors. In addition, our indirect channel agreements are generally not exclusive and one or more of our channel partners may compete directly with another channel partner for the sale of our products in a particular region or market. This may cause such channel partners to stop or reduce their efforts in marketing our products. Our inability to effectively establish or manage our distribution channels would harm our sales.

In addition, our indirect channel partners may provide services to our end user customers that are inadequate or do not meet expectations. Such failures to provide adequate services could result in customer dissatisfaction with us or our products and services due to delays in maintenance and replacement, decreases in our customers’ network availability and other losses. These occurrences could result in the loss of customers and repeat orders and could delay or limit market acceptance of our products, which would negatively affect our sales and results of operations.

SALES TO LARGE CUSTOMERS WOULD BE DIFFICULT TO REPLACE IF LOST

A limited number of indirect channel partners have accounted for a large part of our revenues to date and we expect that this trend will continue. Because our expense levels are based on our expectations as to future revenue and to a large extent are fixed in the short term, any significant reduction or delay in sales of our products to any significant indirect channel partner or unexpected returns from these indirect channel partners could harm our business. In 2006, sales to two customers, Alternative Technology, Inc. and Westcon, Inc. accounted for 23% and 18% of net revenues, respectively. In 2005, sales to Alternative Technology, Inc. and Westcon, Inc. accounted for 22% and 13% of net revenues, respectively. At December 31, 2006, Alternative Technologies and Westcon accounted for 18% and 23% of accounts receivable, respectively. These customers are indirect channel partners, who in turn sell to a large number of value-added resellers, system integrators and other resellers. In addition, as an increasing portion of our revenues is derived from larger unit sales, the timing of such sales can have a material impact on quarterly performance. As a result, a delay in completion of large deals at the end of a quarter can result in our missing analysts forecasts for the quarter. We expect that our largest customers in the future could be different from our largest customers today. End users could stop purchasing and indirect channel partners could stop marketing our products at any time. We cannot assure you that we will retain our current indirect channel partners or that we will be able to obtain additional or replacement partners. The loss of one or more of our key indirect channel partners or the failure to obtain and ship a number of large orders each quarter could harm our operating results.

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WE FACE RISKS RELATED TO INVENTORIES OF OUR PRODUCTS HELD BY OUR DISTRIBUTORS

Many of our distributors maintain inventories of our products. We work closely with these distributors to monitor channel inventory levels so that appropriate levels of products are available to resellers and end users. However, if distributors reduce their levels of inventory or if they do not maintain sufficient levels to meet customer demand, our sales could be negatively impacted.

Additionally, we monitor and track channel inventory with our distributors in order to estimate end user requirements. Overstocking could occur if reports from our distributors about expected customer orders are inaccurate, if customer orders are not fulfilled in a forecasted quarter or the demand for our products were to rapidly decline due to economic downturns, increased competition, underperformance of distributors or the introduction of new products by our competitors or ourselves. This could cause sales and cost of sales to fluctuate from quarter to quarter.

OUR RELIANCE ON SALES OF OUR PRODUCTS BY OTHERS AND THE VARIABILITY OF OUR SALES CYCLE MAKES IT DIFFICULT TO PREDICT OUR REVENUES AND RESULTS OF OPERATIONS

The timing of our revenues is difficult to predict because of our reliance on indirect sales channels and the variability of our sales cycle. The length of our sales cycle for sales through our indirect channel partners to our end users may vary substantially depending upon the size of the order and the distribution channel through which our products are sold.

We generally ship product upon receipt of orders and as a result have limited unfulfilled product orders at any point in time. Substantially all of our revenues in any quarter depend upon customer orders that we receive and fulfill in that quarter. To the extent that an order that we anticipate will be received and fulfilled in a quarter is not actually received in time to fulfill prior to the end of that quarter, we will not be able to recognize any revenue associated with that order in the quarter. If revenues forecasted in a particular quarter do not occur in that quarter, our operating results for that quarter could be adversely affected. The greater the volume of an anticipated order, the lengthier the sales cycle for the order and the more material the potential adverse impact on our operating results if the order is not timely received in a quarter. In addition, as an increasing portion of our revenues is now derived from larger sales, the risk of delayed sales having a material impact on quarterly performance has increased. Furthermore, because our expense levels are based on our expectations as to future revenue and to a large extent are fixed in the short term, a substantial reduction or delay in sales of our products or the loss of any significant indirect channel partner could harm our business.

WE HAVE RELIED AND EXPECT TO CONTINUE TO RELY ON A LIMITED NUMBER OF PRODUCTS FOR A SIGNIFICANT PORTION OF OUR REVENUES

Most of our revenues have been derived from sales of our WAN Application Delivery systems and related maintenance and training services. We currently expect that our system-related revenues will continue to account for a substantial percentage of our revenues for the foreseeable future. Our future operating results are significantly dependent upon the continued market acceptance of our products and enhanced applications. Our business will be harmed if our products do not continue to achieve market acceptance or if we fail to develop and market improvements to our products or new and enhanced products. A decline in demand for our WAN Application Delivery systems as a result of competition, technological change or other factors would harm our business.

INTRODUCTION OF OUR NEW PRODUCTS MAY CAUSE CUSTOMERS TO DEFER PURCHASES OF OUR EXISTING PRODUCTS WHICH COULD HARM OUR OPERATING RESULTS

When we announce new products or product enhancements that have the potential to replace or shorten the life cycle of our existing products, customers may defer purchasing our existing products. These actions could harm our operating results by unexpectedly decreasing sales, increasing our inventory levels of older products and exposing us to greater risk of product obsolescence.

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THE AVERAGE SELLING PRICES OF OUR PRODUCTS COULD DECREASE RAPIDLY, WHICH MAY NEGATIVELY IMPACT GROSS MARGINS AND REVENUES

We may experience substantial period-to-period fluctuations in future operating results due to the erosion of our average selling prices. The average selling prices of our products could decrease in the future in response to competitive pricing pressures, increased sales discounts, new product introductions by us or our competitors or other factors. Therefore, to maintain our gross margins, we must develop and introduce on a timely basis new products and product enhancements and continually reduce our product costs. Our failure to do so could cause our revenue and gross margins to decline.

OUR PRODUCTS MAY HAVE ERRORS OR DEFECTS THAT WE FIND AFTER THE PRODUCTS HAVE BEEN SOLD, WHICH COULD INCREASE OUR COSTS AND NEGATIVELY AFFECT OUR REVENUES AND THE MARKET ACCEPTANCE OF OUR PRODUCTS

Our products are complex and may contain undetected defects, errors or failures in either the hardware or software. In addition, because our products plug into our end users’ existing networks, they can directly affect the functionality of those networks. Furthermore, end users rely on our products to maintain acceptable service levels. We have in the past encountered errors in our products, which in a few instances resulted in network failures and in a number of instances resulted in degraded service. To date, these errors have not materially adversely affected us. Additional errors may occur in our products in the future. In particular, as our products and our customers’ networks become increasingly complex, the risk and potential consequences of such errors increases. The occurrence of defects, errors or failures could result in the failure of our customers’ networks or mission-critical applications, delays in installation, product returns and other losses to us or to our customers or end users. In addition, we would have limited experience responding to new problems that could arise with any new products that we introduce. These occurrences could also result in the loss of or delay in market acceptance of our products, which could harm our business. In particular, when a customer experiences what they believe to be a defect, error or failure, they will often delay additional purchases of our product until such matter is addressed or consider products offered by competitors.

We may also be subject to liability claims for damages related to product errors. While we carry insurance policies covering this type of liability, these policies may not provide sufficient protection should a claim be asserted. A material product liability claim may harm our business.

OUR RELIANCE ON THIRD-PARTY MANUFACTURERS FOR ALL OF OUR MANUFACTURING REQUIREMENTS COULD CAUSE US TO LOSE ORDERS IF THESE THIRD-PARTY MANUFACTURERS FAIL TO SATISFY OUR COST, QUALITY AND DELIVERY REQUIREMENTS

We currently rely on SMTC, our longstanding contract manufacturer, and to a lesser extent, three additional manufacturers for all of our manufacturing requirements. Either we or SMTC and our other third-party manufacturers may terminate our contract with them without cause at any time. Third-party manufacturers may encounter difficulties in the manufacture of our products, resulting in product delivery delays. Any manufacturing disruption could impair our ability to fulfill orders. Our future success will depend, in significant part, on our ability to have these third party manufacturers, or others, manufacture our products cost-effectively and in sufficient volumes. We face a number of risks associated with our dependence on third-party manufacturers including:

•  reduced control over delivery schedules;

•  the potential lack of adequate capacity during periods of excess demand;

•  decreases in manufacturing yields and increases in costs;

•  the potential for a lapse in quality assurance procedures;

•  increases in prices; and

•  the potential misappropriation of our intellectual property.

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We have no long-term contracts or arrangements with our manufacturers which guarantee product availability, the continuation of particular payment terms or the extension of credit limits. We have experienced in the past, and may experience in the future, problems with our contract manufacturers, such as inferior quality, insufficient quantities and late delivery of product. To date, these problems have not materially adversely affected us. We may not be able to obtain additional volume purchase or manufacturing arrangements with these manufacturers on terms that we consider acceptable, if at all. If we enter into a high-volume or long-term supply arrangement and subsequently decide that we cannot use the products or services provided for in the agreement, our business will be harmed. In the future, we may seek to shift manufacturing of certain products from one manufacturer to another. We cannot assure you that we can effectively manage our third-party manufacturers or any such transition or that our third-party manufacturers will meet our future requirements for timely delivery of products of sufficient quality or quantity or facilitate any such transition efficiently. Any of these difficulties could harm our relationships with customers and cause us to lose orders.

In the future, we may seek to use additional contract manufacturers. We may experience difficulty in locating and qualifying suitable manufacturing candidates capable of satisfying our product specifications or quantity requirements, or we may be unable to obtain terms that are acceptable to us. The lead-time required to identify and qualify new manufacturers could affect our ability to timely ship our products and cause our operating results to suffer. In addition, failure to meet customer demand in a timely manner could damage our reputation and harm our customer relationships, resulting in reduced market share.

MOST OF THE COMPONENTS AND SOME OF THE SOFTWARE USED IN OUR PRODUCTS COME FROM SINGLE OR LIMITED SOURCES, AND OUR BUSINESS COULD BE HARMED IF THESE SOURCES FAIL TO SATISFY OUR SUPPLY REQUIREMENTS

Almost all of the components used in our products are obtained from single or limited sources. Our products have been designed to incorporate a particular set of components. As a result, our desire to change the components of our products or our inability to obtain suitable components on a timely basis would require engineering changes to our products before we could incorporate substitute components. Any such changes could be costly and result in lost sales.

We do not have any long-term supply contracts with any of our vendors to ensure sources of supply. If our contract manufacturer fails to obtain components in sufficient quantities when required, our business could be harmed. Our suppliers also sell products to our competitors. Our suppliers may enter into exclusive arrangements with our competitors, stop selling their products or components to us at commercially reasonable prices or refuse to sell their products or components to us at any price. Our inability to obtain sufficient quantities of single-sourced or limited-sourced components, or to develop alternative sources for components or products could harm our ability to maintain and expand our business.

Similarly, the software for our ReportCenter product and certain of the software components for our iShared products are developed by single sources. We rely upon these providers for resolving software errors, developing software for product updates and providing certain levels of customer support for these products. It would be time-consuming and costly to replace these providers if they failed to provide quality services in an efficient manner, or if our relationships with them were interrupted or terminated. We are currently involved in litigation with Valencia Systems, Inc., the sole provider of the software for our ReportCenter product, as described further in the Risk Factor entitled “THE PENDING LITIGATION TO WHICH WE ARE A PARTY, INCLUDING ANY ADVERSE RESOLUTION OF SUCH LITIGATION, MAY ADVERSELY IMPACT OUR BUSINESS.” An adverse outcome to that litigation, as well as any disruption in our access to the software development and maintenance services provided by our single source providers or our inability to develop alternative sources for these services, would adversely affect our business.

THE PENDING LITIGATION TO WHICH WE ARE A PARTY, INCLUDING ANY ADVERSE RESOLUTION OF SUCH LITIGATION MAY ADVERSELY IMPACT OUR BUSINESS

On June 22, 2006, we filed a lawsuit in Santa Clara Superior Court against Valencia Systems, Inc., or Valencia, alleging Valencia’s breach of a Software License and Development Agreement pursuant to which Valencia provides

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certain software development and maintenance services for us. This complaint followed an earlier arbitration demand from Valencia pursuant to which Valencia claimed damages of $3,000,000. We were granted injunctive relief in our action prohibiting Valencia from disparagement or discontinuing maintenance or support services. The court has ordered the matter to arbitration and the parties have not yet formally responded to the other’s allegations. Valencia’s motion for a preliminary injunction was denied by the arbitrator. We believe Valencia’s claims to be without merit and intend to defend this matter vigorously. However, this matter is in the early stages and we cannot reasonably estimate an amount of potential loss, if any, at this time. The results of litigation are inherently uncertain, and there can be no assurance that we will prevail. The costs and disruptions associated with the litigation with Valencia could have a material adverse effect on our business, financial condition and results of operations. Because Valencia is the sole provider of software development and maintenance services for our ReportCenter products, any disruption in our access to the development and maintenance services provided by Valencia could have a material adverse affect on us. For additional information regarding certain of the lawsuits in which we are involved, see Item 3, “Legal Proceedings.”

CHANGES IN FINANCIAL ACCOUNTING STANDARDS ARE LIKELY TO IMPACT OUR FUTURE FINANCIAL POSITION AND RESULTS OF OPERATIONS

New laws, regulations and accounting standards, as well as changes to and varying interpretations of currently accepted accounting practices in the technology industry might adversely affect our reported financial results, which could have an adverse effect on our stock price. Furthermore, guidance related to the expensing of the fair value of equity instruments provided to employees in SFAS No. 123(R), “Share Based Payments,” has materially adversely affected operating and net income for the year ended December 31, 2006, and may affect our stock price.

CHANGES IN OR INTERPRETATIONS OF, TAX RULES AND REGULATIONS MAY ADVERSELY AFFECT OUR EFFECTIVE TAX RATES.

As a global company, we are subject to taxation in the United States and various other countries. Unanticipated changes in our tax rates could affect our future results of operations. Our future effective tax rates could be unfavorably affected by changes in tax laws or the interpretation of tax laws, by unanticipated decreases in the amount of revenue or earnings in countries with low statutory tax rates, or by changes in the valuation of our deferred tax assets and liabilities or changes in our reserves.

In addition, we are subject to examination of our income tax returns by the Internal Revenue Service and other domestic and foreign tax authorities, including a current examination by the Internal Revenue Service for our 2003 and 2004 tax returns, primarily related to our intercompany transfer pricing. We regularly assess the likelihood of outcomes resulting from these examinations to determine the adequacy of our provision for income taxes, and believe such estimates to be reasonable. However, there can be no assurance that the final determination of any of these examinations will not have an adverse effect on our operating results and financial position.

OUR INABILITY TO ATTRACT, INTEGRATE AND RETAIN QUALIFIED PERSONNEL COULD SIGNIFICANTLY INTERRUPT OUR BUSINESS OPERATIONS

Our future success will depend, to a significant extent, on the ability of our management to operate effectively, both individually and as a group. We are dependent on our ability to attract, successfully integrate, retain and motivate high caliber key personnel. Competition for qualified personnel and management in the networking industry, including engineers, sales and service and support personnel, is intense, and we may not be successful in attracting and retaining such personnel. There may be only a limited number of persons with the requisite skills to serve in these key positions and it may become increasingly difficult to hire such persons. Competitors and others have in the past and may in the future attempt to recruit our employees. With the exception of our CEO and CFO, we do not have employment contracts with any of our personnel. Our business will suffer if we encounter delays in hiring additional personnel as needed. In addition, if we are unable to successfully integrate new key personnel into our business operations in an efficient and effective manner, the attention of our management may be diverted from growing our business or we may be unable to retain such personnel. In January 2006, we hired a new Vice President, Engineering, and, in February 2007, we hired a new Vice President, Marketing.

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IF WE ARE UNABLE TO EFFECTIVELY MANAGE OUR GROWTH, WE MAY EXPERIENCE OPERATING INEFFICIENCIES AND HAVE DIFFICULTY MEETING DEMAND FOR OUR PRODUCTS

In the past, we have experienced rapid and significant expansion of our operations. If further rapid and significant expansion is required to address potential growth in our customer base and market opportunities, this expansion could place a significant strain on our management, products and support operations, sales and marketing personnel and other resources, which could harm our business.

In the future, we may experience difficulties meeting the demand for our products and services. The use of our products requires training, which is provided by our channel partners, as well as us. If we are unable to provide training and support for our products in a timely manner, the implementation process will be longer and customer satisfaction may be lower. In addition, our management team may not be able to achieve the rapid execution necessary to fully exploit the market for our products and services. We cannot assure you that our systems, procedures or controls will be adequate to support the anticipated growth in our operations.

We may not be able to install management information and control systems in an efficient and timely manner, and our current or planned personnel, systems, procedures and controls may not be adequate to support our future operations.

FAILURE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY WOULD RESULT IN SIGNIFICANT HARM TO OUR BUSINESS

Our success depends significantly upon our proprietary technology and our failure or inability to protect our proprietary technology would result in significant harm to our business. We rely on a combination of patent, copyright and trademark laws, and on trade secrets, confidentiality provisions and other contractual provisions to protect our proprietary rights. These measures afford only limited protection. As of December 31, 2006, we have 36 issued U.S. patents and 70 pending U.S. patent applications. Currently, none of our technology is patented outside of the United States. Our means of protecting our proprietary rights in the U.S. or abroad may not be adequate and competitors may independently develop similar technologies. Our future success will depend in part on our ability to protect our proprietary rights and the technologies used in our principal products. Despite our efforts to protect our proprietary rights and technologies unauthorized parties may attempt to copy aspects of our products or to obtain and use trade secrets or other information that we regard as proprietary. Legal proceedings to enforce our intellectual property rights could be burdensome and expensive and could involve a high degree of uncertainty. These legal proceedings may also divert management’s attention from growing our business. In addition, the laws of some foreign countries do not protect our proprietary rights as fully as do the laws of the U.S. Issued patents may not preserve our proprietary position. If we do not enforce and protect our intellectual property, our business will suffer substantial harm.

CLAIMS BY OTHERS THAT WE INFRINGE ON THEIR INTELLECTUAL PROPERTY RIGHTS COULD BE COSTLY TO DEFEND AND COULD HARM OUR BUSINESS

We may be subject to claims by others that our products infringe on their intellectual property rights. These claims, whether or not valid, could require us to spend significant sums and amount of time in litigation and customer relations, pay damages, delay product shipments, reengineer our products or acquire licenses to such third-party intellectual property. We may not be able to secure any required licenses on commercially reasonable terms, or at all. We expect that we will increasingly be subject to infringement claims as the number of products and competitors in the WAN Application Delivery systems market grows and the functionality of products overlaps. Any of these claims or resulting events could harm our business.

IF OUR PRODUCTS DO NOT COMPLY WITH EVOLVING INDUSTRY STANDARDS AND GOVERNMENT REGULATIONS, OUR BUSINESS COULD BE HARMED

The market for WAN Application Delivery systems is characterized by the need to support industry standards as these different standards emerge, evolve and achieve acceptance. In the United States, our products must comply with various regulations and standards defined by the Federal Communications Commission and Underwriters

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Laboratories. Internationally, products that we develop must comply with standards established by the International Electrotechnical Commission as well as with recommendations of the International Telecommunication Union. To remain competitive we must continue to introduce new products and product enhancements that meet these emerging U.S. and international standards. However, in the future we may not be able to effectively address the compatibility and interoperability issues that arise as a result of technological changes and evolving industry standards. Failure to comply with existing or evolving industry standards or to obtain timely domestic or foreign regulatory approvals or certificates could harm our business.

OUR GROWTH AND OPERATING RESULTS WOULD BE IMPAIRED IF WE ARE UNABLE TO MEET OUR FUTURE CAPITAL REQUIREMENTS

We currently anticipate that our existing cash and investment balances will be sufficient to meet our liquidity needs for the foreseeable future. However, we may need to raise additional funds if our estimates of revenues, working capital or capital expenditure requirements change or prove inaccurate or in order for us to respond to unforeseen technological or marketing hurdles or to take advantage of unanticipated opportunities.

In addition, we expect to review potential acquisitions that would complement our existing product offerings or enhance our technical capabilities. Any future transaction of this nature could require potentially significant amounts of capital. These funds may not be available at the time or times needed or available on terms acceptable to us. If adequate funds are not available, or are not available on acceptable terms, we may not be able to take advantage of market opportunities to develop new products or to otherwise respond to competitive pressures.

CERTAIN PROVISIONS OF OUR CHARTER AND OF DELAWARE LAW MAKE A TAKEOVER OF PACKETEER MORE DIFFICULT, WHICH COULD LOWER THE MARKET PRICE OF THE COMMON STOCK

Our corporate documents and Section 203 of the Delaware General Corporation Law could discourage, delay or prevent a third- party or a significant stockholder from acquiring control of Packeteer. In addition, provisions of our certificate of incorporation may have the effect of discouraging, delaying or preventing a merger, tender offer or proxy contest involving Packeteer. Any of these anti-takeover provisions could lower the market price of the common stock and could deprive our stockholders of the opportunity to receive a premium for their common stock that they might otherwise receive from the sale of Packeteer.

ITEM 1B.   UNRESOLVED STAFF COMMENTS

Not applicable

ITEM 2.   PROPERTIES

We lease approximately 69,000 square feet of administrative and research and development facilities in Cupertino, California under a lease that expires in December 2014. In December 2007, the premises subject to the lease will be expanded to approximately 105,000 square feet. We also lease sales offices in various locations throughout the United States, as well as an additional research and development facilities in Los Angeles, California and South Plainfield, New Jersey. Our international leased offices include a research and development facility located in Canada and sales and support offices throughout Europe, the Asia Pacific region and Japan. We believe that our future growth can be accommodated by current facilities or by leasing the necessary additional space.

ITEM 3.   LEGAL PROCEEDINGS

In November 2001, a putative class action lawsuit was filed in the United States District Court for the Southern District of New York against us, certain of our officers and directors, and the underwriters of our initial public offering. An amended complaint, captioned In re Packeteer, Inc. Initial Public Offering Securities Litigation, 01-CV-10185 (SAS), was filed on April 20, 2002.

The amended complaint alleges violations of the federal securities laws on behalf of a purported class of those who acquired our common stock between the date of our initial public offering, or IPO, and December 6, 2000. The

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amended complaint alleges that the description in the prospectus for our IPO was materially false and misleading in describing the compensation to be earned by the underwriters of our IPO, and in not describing certain alleged arrangements among underwriters and initial purchasers of our common stock. The amended complaint seeks damages and certification of a plaintiff class consisting of all persons who acquired shares of our common stock between July 27, 1999 and December 6, 2000.

A special committee of the board of directors has authorized us to negotiate a settlement of the pending claims substantially consistent with a memorandum of understanding negotiated among class plaintiffs, all issuer defendants and their insurers. The parties have negotiated a settlement, which is subject to approval by the Court. On February 15, 2005, the Court issued an Opinion and Order preliminarily approving the settlement, provided that the defendants and plaintiffs agree to a modification narrowing the scope of the bar order set forth in the original settlement agreement. The parties agreed to a modification narrowing the scope of the bar order, and on August 31, 2005, the Court issued an order preliminarily approving the settlement. On December 5, 2006, the United States Court of Appeals for the Second Circuit overturned the District Court’s certification of the class of plaintiffs who are pursuing the claims that would be settled in the settlement against the underwriter defendants. Plaintiffs informed the District Court that they intend to seek further appellate review of this decision, and that they would like to be heard by the District Court as to whether the settlement may still be approved even if the the decision of the Court of Appeals is not reversed. The District Court indicated that it would defer consideration of final approval of the settlement pending plaintiffs’ request for further appellate review. We do not currently believe that the outcome of this proceeding will have a material adverse impact on our financial condition, results of operations or cash flows. No amount has been accrued as of December 31, 2006, as we believe a loss is neither probable nor estimable.

On June 22, 2006, we filed a lawsuit in Santa Clara Superior Court against Valencia Systems, Inc., or Valencia, alleging Valencia’s breach of a Software License and Development Agreement pursuant to which Valencia provides certain software development and maintenance services for us. This complaint followed an earlier arbitration demand from Valencia pursuant to which Valencia claimed damages of $3,000,000. We were granted injunctive relief in its action prohibiting Valencia from disparagement or discontinuing maintenance or support services. The court has ordered the matter to arbitration and the parties have not yet formally responded to the other’s allegations. Valencia’s motion for a preliminary injunction was denied by the arbitrator. We believe Valencia’s claims to be without merit and intends to defend this matter vigorously. However, this matter is in the early stages and we cannot reasonably estimate an amount of potential loss, if any, at this time. The results of litigation are inherently uncertain, and there can be no assurance that we will prevail.

In addition, we are subject to examination of its income tax returns by the Internal Revenue Service and other domestic and foreign tax authorities, including a current examination by the Internal Revenue Service for our 2003 and 2004 tax returns, primarily related to our intercompany transfer pricing. We regularly assess the likelihood of outcomes resulting from these examinations to determine the adequacy of our provision for income taxes, and believe such estimates to be reasonable.

We are routinely involved in legal and administrative proceedings incidental to its normal business activities and believe that these matters will not have a material adverse effect on its financial position, results of operations or cash flows.

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

Not applicable.

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PART II

ITEM 5.   MARKET FOR REGISTRANT’S COMMON STOCK, RELATED STOCKHOLDER MATTERS AND ISSUER REPURCHASES OF EQUITY SECURITIES

Our common stock has been quoted on the Nasdaq Global Select Market (formerly the Nasdaq National Market) under the symbol “PKTR” since our initial public offering on July 28, 1999. Prior to this time, there was no public market for our common stock. The following table shows the high and low closing prices per share of our common stock as reported on the Nasdaq Global Select Market for the periods indicated:

	High		Low
2006:
Fourth Quarter	$	13.85	$	8.55
Third Quarter		11.81		7.91
Second Quarter		14.18		10.15
First Quarter		13.80		8.01
2005:
Fourth Quarter	$	12.19	$	7.36
Third Quarter		14.78		11.05
Second Quarter		15.63		10.99
First Quarter		17.18		13.03

As of March 11, 2007, there were approximately 307 holders of record of our common stock. We have never declared or paid any dividends on our capital stock. We currently expect to retain future earnings, if any, for use in the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future.

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The graph depicted below shows a comparison of cumulative total stockholder returns for the Company, the Nasdaq Composite Index, the Nasdaq Computer Manufacturers Industry Index and the Standard and Poors 500 Index for the period commencing December 31, 2001 and ending on December 29, 2006. We have included the Nasdaq Computer Manufacturers Index in order to show a comparison of cumulative total stockholder returns for a relevant industry index. We will not provide information for the Standard and Poors 500 Index in the future. The past performance of our Common Stock is no indication of future performance.

COMPARISON OF CUMULATIVE TOTAL RETURN
FROM DECEMBER 31, 2001 THROUGH DECEMBER 29, 2006(1)

Among Packeteer, The S & P 500 Index, The Nasdaq Composite Index

And The Nasdaq Computer Manufacturers Index

	12/31/01		12/31/02		12/31/03		12/31/04		12/30/05		12/29/06
Packeteer		100.00		93.08		230.39		196.07		105.43		184.53
S & P 500		100.00		77.90		100.24		111.15		116.61		135.03
NASDAQ Composite		100.00		69.66		99.71		113.79		114.47		124.20
NASDAQ Computer Manufacturers		100.00		67.48		109.37		115.04		107.28		134.84

(1)  The graph assumes that $100 was invested in the Company at the closing price on December 31, 2001, in our Common Stock and in each index, and all dividends were reinvested. No cash dividends have been declared on our Common Stock.

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ITEM 6.   SELECTED FINANCIAL DATA

The selected consolidated financial data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements of Packeteer, Inc. and the Notes thereto included elsewhere in this report, in order to understand factors that may affect the comparability of the information below. Our actual results in future periods could differ materially from the historical results set forth below as a result of a number of factors, including the risks described under the title “RISK FACTORS” in Item 1A:

	Years Ended December 31,
	2006		2005		2004			2003		2002
	(In thousands, except per share data)
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Net revenues	$	145,123	$	112,941	$	92,437		$	72,723	$	55,014
Product and service costs		36,935		27,738		22,837			17,036		12,852
Amortization of purchased intangible assets		2,150		1,557		38			—		—
Gross profit		106,038		83,646		69,562			55,687		42,162
Operating expenses:
Research and development		30,646		21,778		14,973			12,202		10,877
Sales and marketing		57,889		38,276		35,504			26,433		23,420
General and administrative		13,949		7,222		6,061			5,494		4,636
In-process research and development		1,800		—		—			—		—
Total operating expenses		104,284		67,276		56,538			44,129		38,933
Income from operations		1,754		16,370		13,024			11,558		3,229
Other income, net		3,932		2,913		1,127			701		915
Income before provision (benefit) for income taxes		5,686		19,283		14,151			12,259		4,144
Provision (benefit) for income taxes		782		125		(383	)		1,226		415
Net income	$	4,904	$	19,158	$	14,534		$	11,033	$	3,729
Basic net income per share	$	0.14	$	0.57	$	0.44		$	0.35	$	0.12
Diluted net income per share	$	0.14	$	0.55	$	0.42		$	0.32	$	0.12
Shares used in computing basic net income per share		34,848		33,823		32,994			31,634		30,205
Shares used in computing diluted net income per share		35,740		35,065		34,502			34,364		30,718

	December 31,
	2006		2005		2004		2003		2002
	(In thousands)
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and investments	$	76,557	$	122,677	$	92,197	$	86,707	$	65,474
Working capital		52,379		103,961		73,171		75,273		53,492
Total assets		216,968		168,657		137,792		104,699		79,912
Deferred revenue		29,104		22,115		16,157		9,592		5,968
Long-term debt obligations		—		—		—		—		545
Total stockholders’ equity		159,509		128,607		101,959		83,418		63,401

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

The following discussion, which should be read in conjunction with our Consolidated Financial Statements and the Notes thereto included under the title “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA”, contain forward-looking statements that involve risks and uncertainties. Forward-looking statements can be identified by words such as “anticipates,” “expects,” “believes,” “plans,” “predicts,” and similar terms. Forward-looking statements are not guarantees of future performance and our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed under the title “RISK FACTORS” in Item 1A. We assume no obligation to publicly release any revisions to forward-looking statements to reflect events or circumstances arising after the date of this document, except as required by law.

OVERVIEW

We are a leading provider of WAN Application Delivery systems designed to deliver a comprehensive set of visibility, QoS, control, compression, application acceleration and branch office service capabilities to enterprise customers and service providers. For enterprise customers, our systems are designed to enable IT organizations to effectively deliver applications and performance, while providing measurable cost savings in WAN investments. For service providers, our systems are designed to provide a platform for delivering application-intelligent network services that provide application level visibility and QoS control, expanding revenue opportunities.

Our WAN Application Delivery system consists of a family of scalable appliances that can be deployed within large data centers as well as smaller remote sites throughout a distributed enterprise. Each appliance can be configured with software modules to deliver a range of WAN Application Traffic Management capabilities. Our product family includes PacketShaper, iShared, SkyX and Mobiliti Client products that can be deployed within large data centers, smaller branch office sites and software clients on PCs for mobile and SOHO users throughout a distributed enterprise. We deliver superior application performance and end user experience using an “intelligent overlay”, which bridges applications and IP networks, adapts to our customers’ existing infrastructure and addresses the demands created by a changing application environment in order to deliver high performance applications across all WAN and Internet links.

In May 2006, we completed our acquisition of Tacit for an initial purchase price of $68.0 million in cash, including acquisition costs of $1.7 million. In addition, we assumed all the then outstanding options to purchase Tacit common stock, and converted those into options to purchase approximately 320,000 shares of our common stock. In addition to the cash paid that is included in the initial purchase price, the merger agreement required that $7.85 million of cash be placed in an escrow account to secure Tacit’s obligations under certain representation and warranty provisions. The escrow funds will be released fifteen days following the later of 90 days after completion of the audit of our 2006 financial statements or one year from the closing date of the acquisition, at which time the final purchase price will be adjusted. In connection with the acquisition, we have recorded $49.1 million of goodwill, $8.4 million of other intangible assets, and $11.2 million of net tangible assets. In addition, we wrote off acquired in-process research and development, or IPR&D, of $1.8 million because the acquired technologies had not reached technological feasibility and had no alternative uses. The financial information presented for 2006 includes the results of Tacit subsequent to the acquisition date.

Our results for 2006 reflected an increase in net revenues of $32.2 million, or 28%, from $112.9 million in 2005. Net income for 2006 was $4.9 million compared to net income of $19.2 million for 2005. Included in cost of revenues and operating expenses for 2006 was stock-based compensation expense of $13.3 million related to stock options and Employee Stock Purchase Plan (ESPP) as a result of adopting Statement of Financial Accounting Standards (SFAS) No. 123(R), “Share-Based Payments” (SFAS 123(R)). There was no stock-based compensation expense related to stock options and ESPP recognized during 2005 and 2004.

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We believe that our current value proposition, which enables our enterprise customers to get more value out of existing network resources and improved performance of their critical applications, should allow us to grow our business again in 2007. Our growth rate and net revenues depend significantly on continued growth in the WAN Application Delivery market, our ability to develop and maintain strong partnering relationships with our indirect channel partners and our ability to expand or enhance our current product offerings or respond to technological change. Our growth in service revenues is dependent upon increasing the number of units under maintenance, which is dependent on both growing our installed base and renewing existing maintenance contracts. Our future profitability and rate of growth, if any, will be directly affected by the continued acceptance of our product in the marketplace, as well as the timing and size of orders and shipments, product mix, average selling price of our products and general economic conditions. Our failure to successfully convince the market of our value proposition and maintain strong relationships with our indirect channel partners to ensure the success of their selling efforts on our behalf, would adversely impact our net revenues and operating results. Our future revenue and profitability may also be impacted by future acquisitions.

CRITICAL ACCOUNTING POLICIES

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to allowance for doubtful accounts and sales returns, inventory valuation, rebate and warranty reserves, valuation of long-lived assets, including intangible assets and goodwill, income taxes and stock-based compensation, among others. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

We believe that of our significant accounting policies, which are described in Note 1 of the Notes to Consolidated Financial Statements, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, we believe the accounting policies below are the most critical to aid in fully understanding and evaluating our consolidated results of operations and financial condition.

Revenue recognition.  We apply the provisions of Statement of Position, or SOP, 97-2, “Software Revenue Recognition,” as amended by SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions,” to all transactions involving the sale of hardware and software products. Revenue is generally recognized when all of the following criteria are met, as set forth in paragraph 8 of SOP 97-2:

•  persuasive evidence of an arrangement exists,

•  delivery has occurred,

•  the fee is fixed or determinable, and

•  collectibility is probable.

Receipt of a customer purchase order is persuasive evidence of an arrangement. Sales through our distribution channel are evidenced by an agreement governing the relationship together with purchase orders on a transaction-by-transaction basis.

Delivery generally occurs when product is delivered to a common carrier from Packeteer or its designated fulfillment house. For certain destinations outside the Americas, delivery occurs when product is delivered to the destination country. For maintenance contracts, delivery is deemed to occur ratably over the contract period.

Our fees are typically considered to be fixed or determinable at the inception of an arrangement and are negotiated at the outset of an arrangement, generally based on specific products and quantities to be delivered. In the event payment terms are provided that differ significantly from our standard business practices, which are generally ninety days or less, the fees are deemed to not be fixed or determinable and revenue is recognized as the fees become due and payable.

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We assess collectibility based on a number of factors, including credit worthiness of the customer and past transaction history of the customer.

Generally, product revenue is recognized upon delivery. However, product revenue on sales to major new distributors are recorded based on sell-through to the end user customers until such time as we have established significant experience with the distributor’s product exchange activity. Additionally, when we introduce new product into our distribution channel for which there is no historical customer demand or acceptance history, revenue is recognized on the basis of sell-through to end user customers until such time as demand or acceptance history has been established.

We defer recognition of revenue on inventory in the distribution channel in excess of a certain number of days. On the same basis, we reduce the associated cost of revenues, which is primarily related to materials, and include this amount in inventory. We recognize these revenues and associated cost of revenues when the inventory levels no longer exceed expected supply. No amounts were deferred under this policy as of December 31, 2006 or 2005.

We have analyzed all of the elements included in our multiple element arrangements and have determined that we have sufficient vendor specific objective evidence, or VSOE, of fair value to allocate revenue to the maintenance component of our product and to training. VSOE of fair value is based upon separate sales of maintenance renewals and training to customers. Accordingly, assuming other revenue recognition criteria are met, revenue from product sales is recognized upon delivery using the residual method in accordance with SOP 98-9. Revenue from maintenance is recognized ratably over the maintenance term and revenue from training is recognized when the training has taken place. To date, training revenues have not been material.

Inventory valuation.  Inventories consist primarily of finished goods and are stated at the lower of cost (on a first-in, first-out basis) or market. We record inventory write-downs for excess and obsolete inventories based on historical usage and forecasted demand. Factors which could cause our forecasted demand to prove inaccurate include our reliance on indirect sales channels and the variability of our sales cycle; the potential of announcements of our new products or enhancements to replace or shorten the life cycle of our current products, or cause customers to defer their purchases; loss of sales due to product shortages; and the potential of new or alternative technologies achieving widespread market acceptance and thereby rendering our existing products obsolete. If future demand or market conditions are less favorable than our projections, additional inventory write-downs may be required and would be reflected in cost of sales in the period the revision is made.

Valuation of long-lived and intangible assets and goodwill.  We test goodwill for impairment in accordance with Statement of Financial Accounting Standards (SFAS) 142, “Goodwill and Other Intangible Assets.” SFAS 142 requires that goodwill be tested for impairment at the “reporting-unit” level (“Reporting Unit”) at least annually and more frequently upon the occurrence of certain events, as defined by SFAS 142. Consistent with our determination that we have only one reporting segment as defined in SFAS 131, “Disclosures about Segments of an Enterprise and Related Information,” we have determined that we have only one Reporting Unit. Goodwill is tested for impairment annually on December 1 in a two-step process. First, we determine if the carrying amount of our Reporting Unit exceeds the “fair value” of the Reporting Unit, which would indicate that goodwill may be impaired. If we determine that goodwill may be impaired, we compare the “implied fair value” of the goodwill, as defined by SFAS 142, to our carrying amount to determine if there is an impairment loss. We do not have any goodwill that we consider to be impaired.

In accordance with SFAS 144, “Accounting for Impairment or Disposal of Long-lived Assets”, we evaluate long-lived assets, including intangible assets other than goodwill, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Recoverability of these assets is measured by comparison of the carrying amount of the asset to the future undiscounted cash flows the asset is expected to generate. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset.

Sales return reserve.  In accordance with SFAS 48, “Revenue Recognition When Right of Return Exists,” management must use judgment and make estimates of potential future product returns related to current period product revenue. When providing for sales return reserves, we analyze historical return rates, as we believe they are the primary indicator of possible future returns. Material differences may result in the amount and timing of our

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revenues if for any period actual returns differ from our judgments or estimates. The sales return reserve balances at December 31, 2006 and 2005 were $2.5 million and $1.6 million, respectively.

Rebate reserves.  Certain distributors and resellers can earn rebates under several of our programs. The rebates earned are recorded in accordance with Emerging Issues Task Force 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendors Products)”. For established programs, our estimates for rebates are based on historical usage rates. For new programs, rebate reserves are calculated to cover our maximum exposure until such time as historical usage rates are developed. When sufficient historical experience is established, there may be a reversal of previously accrued rebates if actual rebate claims are less than the maximum exposure. Additionally, there may be a reversal of previously accrued rebate reserves if rebates are not claimed before the expiration dates established for each program. Rebate reserves at December 31, 2006 and 2005 were $2.3 million and $1.6 million, respectively.

Warranty reserves.  Upon shipment of products to our customers, we provide for the estimated cost to repair or replace products that may be returned under warranty. Our warranty period is typically 12 months from the date of shipment to the end user customer. For existing products, the reserve is estimated based on actual historical experience. For new products, the warranty reserve is based on historical experience of similar products until such time as sufficient historical data has been collected on the new product. Factors that may impact our warranty costs in the future include our reliance on our contract manufacturer to provide quality products and the complexity of our products which may contain undetected defects, errors or failures in either the hardware or the software. To date, these problems have not materially adversely affected us. Warranty reserves amounted to $488,000 and $234,000 at December 31, 2006 and 2005, respectively.

Stock Based Compensation.  Effective January 1, 2006, we began accounting for stock options and ESPP shares under the provisions of SFAS 123(R), which requires the recognition of the fair value of equity-based compensation. The fair value of stock options and ESPP shares was estimated using a Black-Scholes option valuation model. This model requires the input of subjective assumptions, including expected stock price volatility and estimated life of each award. The fair value of equity-based awards is amortized over the vesting period of the award, net of estimated forfeitures, and we have elected to use the graded-option method. We make quarterly assessments of the adequacy of the tax credit pool to determine if there are any deficiencies that require recognition in the consolidated statements of operations. Prior to the implementation of SFAS 123(R), we accounted for stock options and Employee Stock Purchase Plan, or ESPP, shares under the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and made pro forma footnote disclosures as required by SFAS No. 148, “Accounting For Stock-Based Compensation — Transition and Disclosure,” which amended SFAS No. 123, “Accounting For Stock-Based Compensation.” Pro forma net income and pro forma net income per share disclosed in the footnotes to the consolidated financial statements were estimated using a Black-Scholes option valuation model. The fair value of restricted shares issued in connection with an acquisition was calculated based upon the fair market value of our common stock at the date of grant. See Note 1 of the Notes to the Consolidated Financial Statements for additional information and related disclosures.

Accounting for Income Taxes.  We utilize the asset and liability method of accounting for income taxes pursuant to SFAS 109. Accordingly, we are required to estimate our income taxes in each of the jurisdictions in which we operate as part of the process of preparing our consolidated financial statements. This process involves estimating our actual current tax exposure, including assessing the risks associated with tax audits, together with assessing temporary differences resulting from the different treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. Due to the evolving nature of tax rules combined with the large number of jurisdictions in which we operate, it is possible that our estimates of our tax liability could change in the future, which may result in additional tax liabilities and adversely affect our results of operations, financial condition and cash flows.

SFAS 109 provides for the recognition of deferred tax assets if it is more likely than not that those deferred tax assets will be realized. Management reviews deferred tax assets periodically for recoverability and makes estimates and judgments regarding the expected geographic sources of taxable income in assessing the need for a valuation allowance to reduce deferred tax assets to their estimated realizable value.

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Factors such as our cumulative profitability in the U.S. and our projected future taxable income were the key criteria in deciding to release a portion of the valuation allowance. If the estimates and assumptions used in our determination change in the future, we could be required to revise our estimates of the valuation allowances against our deferred tax assets and adjust our provisions for additional income taxes.

Quantification of Errors.  In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108 (SAB 108), “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” which addresses how uncorrected errors in previous years should be considered when quantifying errors in current-year financial statements. SAB 108 requires companies to consider both a “rollover” method which focuses primarily on the income statement impact of misstatements and the “iron curtain” method which focuses primarily on the balance sheet impact of misstatements when quantifying errors in current-year financial statements and the related financial statement disclosures. The transition provisions of SAB 108 permit a company to adjust retained earnings (accumulated deficit) for the cumulative effect of immaterial errors relating to prior years. In the three months ended December 31, 2006 we determined that errors had been made in our financial statements related to the recording of rebate reserves, resulting in an overstatement of rebate reserves of $500,000, net of taxes of $150,000.

Historically, we have evaluated uncorrected differences utilizing the rollover approach. We believe the impact of these errors were immaterial to prior years under the rollover method. However, under SAB 108, which we were required to adopt for the year ended December 31, 2006, we must assess materiality using both the rollover method and the iron-curtain method. Under the iron-curtain method, the cumulative impact of the errors are material to our 2006 financial statements and, therefore, we have recorded an adjustment to our opening 2006 accumulated deficit balance in the amount of $350,000 in accordance with the implementation guidance in SAB 108.

The impact on accumulated deficit is comprised of the following amounts (in thousands):

	Years Ended December 31,
	2004			2005			Total
Accumulated deficit
Net revenues	$	(603	)	$	103		$	(500	)
Provision for income taxes		181			(31	)		150
Total, net of tax	$	(422	)	$	72		$	350

RESULTS OF OPERATIONS

The following table includes selected consolidated statements of operations data for all quarters of the periods indicated (in thousands, except per share amounts):

	2006
	Quarter Ended
	December 31,			September 30,			June 30,			March 31,
Net revenues	$	42,683		$	35,986		$	34,169		$	32,285
Gross profit		29,930			26,062			25,580			24,466
Income (loss) from operations		(637	)		(1,357	)		(386	)		4,134
Net income (loss)		894			301			(805	)		4,514
Basic net income (loss) per share		0.03			0.01			(0.02	)		0.13
Diluted net income (loss) per share		0.02			0.01			(0.02	)		0.13

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	2005
	Quarter Ended
	December 31,		September 30,		June 30,		March 31,
Net revenues	$	31,851	$	24,835	$	28,177	$	28,078
Gross profit		23,812		18,206		20,720		20,908
Income from operations		5,837		2,008		4,665		3,860
Net income		9,098		2,255		4,228		3,577
Basic net income per share		0.27		0.07		0.13		0.11
Diluted net income per share		0.26		0.06		0.12		0.10

The following table sets forth certain financial data as a percentage of net revenues for the periods indicated; however, these historical operating results are not necessarily indicative of the results for any future period:

	2006			2005			2004
Net revenues:
Product revenues		76	%		76	%		81	%
Service revenues		24			24			19
Total net revenues		100			100			100
Cost of revenues:
Product costs		18			17			18
Service costs		8			7			7
Amortization of purchased intangible assets		1			2			—
Total cost of revenues		27			26			25
Gross margin		73			74			75
Operating expenses:
Research and development		21			19			16
Sales and marketing		40			34			38
General and administrative		10			6			7
In-process research and development		1			—			—
Total operating expenses		72			59			61
Income from operations		1			15			14
Interest and other income, net		3			2			1
Income before provision (benefit) for income taxes		4			17			15
Provision (benefit) for income taxes		1			—			(1	)
Net income		3	%		17	%		16	%

OVERVIEW OF RESULTS OF OPERATIONS FOR 2006

Net revenues for 2006 were $145.1 million, an increase of 28% over 2005. Gross profit was $106.0 million, or 74% of net revenues, and operating income was $1.8 million. During 2005, net revenues were $112.9 million, gross profit was $83.6 million, or 73% of net revenues, and operating income was $16.4 million. Included in operating income for 2006 was $13.3 million of stock-based compensation expense recognized under SFAS 123(R) related to stock options and ESPP. There was no stock-based compensation expense related to stock options and ESPP recognized during 2005 and 2004.

During 2006, we continued to invest in our operations, with operating expenses of $90.3 million, excluding the $12.2 million impact of stock-based compensation related to stock option plans and the ESPP and $1.8 million from IPR&D expense related to the acquisition of Tacit. This represents an increase of $23.0 million, or 34%, from

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$67.3 million reported in 2005. Headcount at December 31, 2006 increased by 117, or 38% compared to December 31, 2005, primarily in sales and marketing and research and development. The Tacit acquisition accounts for 71 of this additional headcount.

During 2006, we generated $20.4 million of cash from operating activities, compared to $28.9 million generated in 2005. At December 31, 2006 we had cash, cash equivalents and investments of $76.6 million, accounts receivable of $31.7 million and deferred revenues of $29.1 million.

NET REVENUES

Net revenues increased to $145.1 million in 2006 from $112.9 million in 2005 and from $92.4 million in 2004. The increase from 2005 to 2006 was $32.2 million, or 28%, and the increase from 2004 to 2005 was $20.5 million, or 22%. We expect revenue growth in 2007 will meet or exceed the revenue growth we reported for 2006.

We derive our revenue from two sources, product revenues and service revenues. Product revenues consist primarily of sales of our WAN Application Delivery systems. Product revenues accounted for 76%, 76%, and 81% of our net revenues in 2006, 2005 and 2004, respectively. Product revenues increased to $110.1 million in 2006 from $85.6 million in 2005 and from $74.6 million in 2004. The increase in product revenues from 2005 to 2006 of $24.6 million, or 29%, is primarily the result of an increase in the number of units shipped and a slight increase in weighted average selling prices. In addition, we recognized revenue from Tacit products of $6.8 million in 2006. The increase from 2004 to 2005 of $11.0 million, or 15% was primarily due to an increase in the number of units shipped from year to year. There were no significant changes in average selling prices during 2005.

Service revenues consist primarily of maintenance revenues and, to a lesser extent, training revenues. Maintenance revenues, which are included in service revenues, are recognized on a monthly basis over the life of the contract. The typical subscription and support term is twelve months, although multi-year contracts of up to three years are also sold. Service revenues accounted for 24%, 24%, and 19% of net revenues in 2006, 2005 and 2004, respectively. Service revenues increased to $35.0 million in 2006 from $27.4 million in 2005 and from $17.9 million in 2004. The increase from 2006 to 2005 of $7.6 million, or 28%, was due primarily to an increase in the number of units under maintenance contracts, as well as revenue from Tacit maintenance contracts of $955,000. The increase from 2004 to 2005 of $9.5 million, or 53%, was due primarily to increases in the number of units under maintenance contracts.

For 2006, net revenues in the Americas increased to $67.6 million, from $52.6 million in 2005 and $37.9 million in 2004. Sales in the Americas accounted for 47%, 46% and 41% of net revenues for 2006, 2005 and 2004, respectively. Net revenues in Asia Pacific were $35.3 million, $27.7 million and $25.0 million, or 24%, 25% and 27% of net revenues in 2006, 2005 and 2004, respectively. Net revenues in Europe, the Middle East and Africa, or EMEA, of $42.2 million, $32.6 million and $29.5 million, represented 29%, 29% and 32% of net revenues in 2006, 2005 and 2004, respectively. We expect our geographic distribution of net revenues will be approximately the same in 2007 as we experienced in 2006.

In 2006, sales to two customers, Alternative Technology, Inc., or Alternative Technology, and Westcon, Inc., or Westcon, accounted for 23% and 18% of net revenues, respectively. In 2005, sales to Alternative Technology and Westcon accounted for 22%, and 13% of net revenues, respectively. In 2004, sales to Alternative Technology and Westcon accounted for 22%, and 19% of net revenues, respectively. Sales to the top 10 indirect channel partners accounted for 73%, 65% and 71%, of net revenues in 2006, 2005 and 2004, respectively. Alternative Technology and Weston are distributors, who in turn sell to a large number of value-added resellers, system integrators and other resellers. At December 31, 2006, Alternative Technologies and Westcon accounted for 18% and 23% of gross accounts receivable, respectively. At December 31, 2005, Alternative Technologies and Westcon accounted for 20% and 13% of gross accounts receivable, respectively.

COST OF REVENUES

Our cost of revenues consists of the cost of finished products purchased from our contract manufacturers, overhead costs, service support costs and amortization of purchased intangible assets.

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We outsource all of our manufacturing. We design and develop a majority of the key components of our products, including printed circuit boards and software. In addition, we determine the components that are incorporated into our products and select the appropriate suppliers of these components. Our overhead costs consist primarily of personnel related costs for our product operations and order fulfillment groups and other product costs such as warranty and fulfillment charges. Service support costs consist primarily of personnel related costs for our customer support and training groups, as well as fees paid to third-party service providers to facilitate next business day replacement for end user customers located outside the United States. Additionally, we allocate overhead such as facilities, depreciation and IT costs to all departments based on headcount and usage. As such, general overhead costs are reflected in each cost of revenue and operating expense category. We must continue to work closely with our contract manufacturers as we develop and introduce new products and try to reduce production costs for existing products.

Cost of revenues was $39.1 million in 2006, an increase of $9.8 million, or 33%, from $29.3 million in 2005 and from $22.9 million in 2004. Excluding the amortization of intangibles of $2.2 million and stock-based compensation of $1.1 million in 2006, the cost of revenues represented 25% of total net revenues for 2006, compared to 26% in 2005 and 25% in 2004.

Product costs increased $6.5 million, or 33%, to $26.0 million in 2006 from $19.6 million in 2005. In 2005, the increase was $2.8 million, or 17%, from $16.8 million in 2004. The increase in 2006 from 2005 was primarily related to an increase in manufacturing costs of $4.1 million from 2005 due to increases in the number of units shipped, and to a lesser extent an increase in weighted average component cost. Other product costs increased $2.4 million in 2006 from 2005, primarily for overhead costs. Product costs for 2006 also included $414,000 of stock-based compensation related to stock option plans and the ESPP and increase of $460,000 in other personnel related costs due to increased headcount, as well as increases of $479,000 in inventory write-downs, $335,000 in warranty expense and $270,000 in freight costs. The increase in 2005 from 2004 was primarily due to an increase in manufacturing costs of $2.4 million, primarily due to a shift in product mix. Overhead and other product costs increased $427,000, including $287,000 in components costs and $134,000 in freight costs.

Service costs increased $2.7 million, or 26%, to $10.9 million in 2006 from $8.2 million in 2005. The increase in 2006 from 2005 includes $732,000 of stock-based compensation related to stock option plans and the ESPP and increases of $1.2 million in other personnel costs due to increased headcount, $146,000 in travel, $138,000 in shipping costs and $196,000 in expensed support materials. In 2005, service costs increased $2.1 million, or 35%, from $6.1 million in 2004. The increase in 2005 from 2004 was due to a $784,000 increase in personnel costs resulting from increased headcount in our support group, a $379,000 increase in service fees paid to our third party maintenance provider, a $273,000 increase in product used to support our maintenance contracts and a $460,000 increase in royalties related to maintenance contracts. We expect service costs to continue at the higher levels reflected in 2006 as a result of the increase in the number of units under maintenance contracts.

In connection with the acquisition of Tacit, we recorded $3.5 million of purchased intangible assets related to developed technology that are being amortized over their estimated useful lives of three years. In 2006, amortization expense of $735,000 related to these intangibles was included in cost of revenues. In connection with the acquisition of Mentat in 2004, we recorded $7.2 million of purchased intangible assets that are being amortized over their estimated useful lives of one to six years. In 2006, 2005 and 2004, amortization expense of $1.4 million, $1.6 million and $38,000, respectively, related to these intangibles was included in cost of revenues.

To the extent our customer base continues to grow, we intend to continue to invest additional resources in our customer support group and expect that our fees to third-party service providers will continue to increase as our international installed base grows. We expect the cost of revenues in 2007, excluding the impact of stock-based compensation and amortization expenses, to approximate 27% of net revenues.

RESEARCH AND DEVELOPMENT

Research and development expenses consist primarily of salaries and related personnel expenses, allocated overhead, consultant fees and prototype expenses related to the design, development, testing and enhancement of our products and software. We have historically focused our research and development efforts on developing and enhancing our WAN Application Delivery solutions.

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Research and development expenses of $30.6 million in 2006 increased from $21.8 million in 2005 and from $15.0 million in 2004. The increased costs in 2006 from 2005 of $8.9 million, or 41%, were primarily due to increased personnel related expenses of $7.7 million, including amortization of stock-based compensation related to stock option plans and the ESPP of $3.9 million, and $3.8 million related to an increase in headcount from 105 at December 31, 2005 to 146 at December 31, 2006, primarily resulting from the Tacit acquisition. In addition, allocated corporate services and facilities costs increased $764,000 due to increased headcount and consulting fees increased $523,000 from 2005. The increase in 2005 from 2004 of $6.8 million, or 45%, was primarily related to increased salary and related personnel expenses, and to a lesser extent, project material, depreciation and other facilities related expenses. Personnel related expenses increased $5.2 million, including $867,000 in amortization of stock-based compensation related to the Mentat acquisition and $4.3 million related to an increase in headcount, partially resulting from the Mentat acquisition. Depreciation and other facilities related expenses increased $670,000 and were also primarily related to the Mentat acquisition. Research and development expenses represented 21%, 19% and 16% of net revenues in 2006, 2005 and 2004, respectively. As of December 31, 2006, all research and development costs have been expensed as incurred.

We expect that in the future, our research and development spending will increase in absolute dollars as we continue to develop and maintain competitive products and enhance our current products by adding innovative features that differentiate our products from those of our competitors. We believe that continued investment in research and development is critical to attaining our strategic product and cost control objectives. We expect that our research and development expenses in 2007, excluding the impact of stock-based compensation expense, will approximate 19% of net revenues.

SALES AND MARKETING

Sales and marketing expenses consist primarily of salaries, commissions and related personnel expenses for those engaged in the sales, marketing and support of the product, as well as related trade show, promotional and public relations expenses and allocated overhead. Our sales force and marketing efforts are used to develop brand awareness, drive demand for system solutions and support our indirect channels.

Sales and marketing expenses increased to $57.9 million in 2006 from $38.3 million in 2005 and from $35.5 million in 2004. The increase of $19.6 million, or 51%, in 2006 from 2005 included personnel related costs and various marketing program related costs. Personnel related costs in 2006 included an increase in stock-based compensation related to stock option plans and the ESPP of $5.2 million and an increase in salaries, commissions, bonuses and employee benefits of $7.6 million due primarily to the increase in headcount and increased sales commissions. This reflects an increase in sales and marketing headcount from 122 at December 31, 2005 to 164 at December 31, 2006, primarily resulting from the Tacit acquisition. Also included in personnel related costs in 2006 were severance costs of $584,000. The increase in 2006 from 2005 also reflected increases in travel and entertainment of $1.8 million, consulting and outside service costs of $1.6 million, demonstration unit costs of $827,000, and channel marketing program costs of $761,000, resulting from increased headcount and sales and marketing activities. Additionally, in 2006, amortization expense of $791,000 related to intangible assets purchased in the Tacit acquisition was included in sales and marketing expense. The increase of $2.8 million, or 8%, in 2005 from 2004 was primarily attributable to an increase in personnel related costs, and to a lesser extent, to increases in various channel marketing programs and demonstration units. Personnel related costs increased $1.9 million, as headcount increased to 122 at December 31, 2005 from 114 at December 31, 2004. The costs related to various channel marketing programs increased $469,000 and the cost of demonstration units increased $286,000 as a result of the introduction of two new PacketShaper products, as well as Mentat’s SkyX products, to our customer base during 2005. Sales and marketing expenses represented 40%, 34% and 38% of net revenues in 2006, 2005 and 2004, respectively

We intend to continue to invest in appropriate sales and marketing campaigns and therefore expect sales and marketing expenses in absolute dollars to increase in the future. We expect that sales and marketing expenses in 2007, excluding the impact of stock-based compensation expense, will approximate 33% of net revenues.

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GENERAL AND ADMINSTRATIVE

General and administrative expenses consist primarily of salaries and related personnel expenses for administrative personnel, professional fees, allocated overhead and other general corporate expenses.

General and administrative expenses increased to $13.9 million in 2006 from $7.2 million in 2005 and from $6.1 million in 2004. The increase in 2006 of $6.7 million, or 93%, from 2005 was primarily due to personnel related costs, including an increase in stock-based compensation related to stock option plans and the ESPP of $3.0 million, and an increase in salaries and employee benefits of $1.2 million, due primarily to an increase in headcount from 28 at December 31, 2005 to 35 at December 31, 2006. In addition, professional fees increased $2.0 million, primarily for accounting, legal and tax related matters. In addition, depreciation and other facilities related expenses increased $730,000. The $1.2 million, or 19%, increase in expenses in 2005 from 2004 was primarily attributable to increased personnel related expenses and professional service fees. Personnel related costs, including salaries and recruiting fees increased $687,000 and professional service fees, primarily for accounting and tax related services increased $586,000. General and administrative expenses represented 10%, 6% and 7% of net revenues in 2006, 2005 and 2004, respectively.

We expect general and administrative expenses in 2007, excluding the impact of stock-based compensation expense, will approximate 6% of net revenues.

IN-PROCESS RESEARCH AND DEVELOPMENT

Our methodology for allocating the purchase price relating to acquisitions to IPR&D was determined through established valuation techniques in the high-technology networking product industry. IPR&D expense for 2006 was $1.8 million for acquired IPR&D related to the acquisition of Tacit. IPR&D was expensed upon the closing of the acquisition during the three months ended June 30, 2006 because technological feasibility had not been established and no future alternative uses existed. The fair value of the existing purchased technology, as well as the technology under development, was determined using the income approach, which estimates the present value of future economic benefits such as cash earnings, cost savings, tax deductions, and proceeds from disposition. The present value calculations were developed by discounting expected cash flows to the present value at a rate of return that incorporates the risk-free rate for the use of funds, the expected rate of inflation, and risks associated with the particular investment. The discount rate of 19% selected was generally based on rates of return available from alternative investments of similar type and quality.

The IPR&D expense for 2006 related primarily to projects associated with Tacit’s iShared WAN optimization technology (including the hardware appliance and the related software) enhancements and upgrades. The projects identified as in-process technology are those that were underway at the time of the Tacit acquisition and, at the date of acquisition, required additional effort to establish technological feasibility. The successful completion of these projects was a significant risk at the date of acquisition due to the remaining efforts to achieve technical viability, rapidly changing customer markets, uncertain standards for new products, and significant competitive threats. If an identified project is not successfully completed, there is no alternative future use for the project and the expected future income will not be realized.

INTEREST AND OTHER INCOME, NET

Interest and other income, net, consists primarily of investment income from our cash, cash equivalents and investments. Interest and other income, net increased to $3.9 million in 2006 from $2.9 million in 2005 and from $1.2 million in 2004. The increase in 2006 from 2005 was due to increased investment yields, partially offset by lower average balances of invested funds. The increase in 2005 from 2004 was due to increases in yields and higher balances of invested funds.

INCOME TAX PROVISION (BENEFIT)

We recorded a tax provision of $782,000 for 2006, reflecting an effective tax rate for the year of 14%. Included in the tax provision for 2006 was a $2.6 million increase in income tax reserves relating to transfer pricing exposure, the impact of $1.8 million of IPR&D related to the Tacit acquisition, and a $1 million tax benefit resulting from the

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revision of original estimates of the prior year tax provision upon preparation of the related tax return, partially offset by other adjustments. Absent these items, we would have recorded a tax benefit of approximately $1.4 million, which is primarily related to the utilization of tax credits. For 2005, we recorded a tax provision of $125,000 reflecting the release of $3.2 million of our valuation allowance on deferred tax assets. Without the release, our effective rate would have been approximately 17% instead of the 1% provision that we reported. Our tax provision in 2006 was also impacted by a relative decrease in earnings subject to taxation in countries that have lower statutory tax rates and an increase in non-deductible stock compensation, compared to 2005. For 2004, we realized a tax benefit of $383,000 reflecting the release of a portion of our valuation allowance on our deferred tax assets. Without the release, our effective rate would have been approximately 14% instead of the 3% benefit that we reported. Our future effective income tax rate depends on various factors, such as tax legislation, the geographic composition of our pre-tax income, and non-tax deductible stock compensation expenses. We carefully monitor these factors and timely adjust the effective income tax rate accordingly.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109”, (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return that results in a tax benefit. Additionally, FIN 48 provides guidance on de-recognition, statement of operations classification of interest and penalties, accounting in interim periods, disclosure, and transition. This interpretation is effective for fiscal years beginning after December 15, 2006. We are evaluating the effect that the adoption of FIN 48 will have on our results of operations and financial condition and are not yet in a position to determine such effects.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurement”, (SFAS 157). This Standard defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. We have not determined the effect that the adoption of SFAS 157 will have on our consolidated results of operations, financial condition or cash flows.

See Note 1 in our Notes to Consolidated Financial Statements for information regarding other recent accounting pronouncements.

LIQUIDITY AND CAPITAL RESOURCES

Balance Sheet and Cash Flows

Cash and Cash Equivalents and Investments.  The following table summarizes our cash and cash equivalents and investments, which are classified as “available for sale” and consist of highly liquid financial instruments (in thousands):

	December 31,
					Increase
	2006		2005		(Decrease)
Cash and cash equivalents	$	39,640	$	36,221	$	3,419
Investments		36,917		86,456		(49,539	)
Total	$	76,557	$	122,677	$	(46,120	)

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The cash and cash equivalents balance increased $3.4 million and the combined balance decreased by $46.1 million during 2006 due to activities in the following areas (in thousands).

Net cash provided by operating activities	$	20,428
Net cash used in investing activities		(25,084	)
Net cash provided by financing activities		8,075
Net change in cash and cash equivalents	$	3,419

The decrease was primarily due to $74.8 million used in the acquisition of Tacit, net of cash and investments acquired, including $7.9 million held in escrow, partially offset by net cash provided by operating activities of $20.4 million and proceeds from the issuance of stock through option exercises and the ESPP totaling $7.1 million. In addition, $3.6 million was used for purchases of property and equipment. In 2006, although we recorded net income of $4.9 million, we generated $20.4 million in cash from operations primarily due to adjustments for non-cash items (primarily depreciation, amortization and stock-based compensation). Our uses of cash for net working capital included increases of accounts receivable, partially offset by an increase in deferred revenue.

We expect that cash provided by operating activities may fluctuate in future periods as a result of a number of factors, including fluctuations in our operating results, shipment linearity, accounts receivable collections, and excess tax benefits from stock-based compensation. Shipment linearity is a measure of the level of shipments throughout a particular quarter.

Accounts receivable, net.  The following table summarizes our accounts receivable, net (in thousands).

	December 31,
					Increase
	2006		2005		(Decrease)
Accounts receivable, net	$	31,743	$	15,759	$	15,984

The increase in net accounts receivable was due to increased sales and a decreased shipment linearity in the three months ended December 31, 2006. Days sales outstanding (DSO) as of December 31, 2006 and 2005 was 68 days and 46 days, respectively. Our DSO is primarily impacted by shipment linearity and collections performance. A steady level of shipments and good collections performance will result in reduced DSO compared with a higher level of shipments toward the end of a quarter, which will result in a shorter amount of time to collect the related accounts receivable and increased DSO.

Deferred Revenue.  The following table summarizes our deferred revenue, net (in thousands).

	December 31,
					Increase
	2006		2005		(Decrease)
Current deferred revenue	$	23,931	$	18,986	$	4,945
Long-term deferred revenue		5,173		3,129		2,044
Total		29,104		22,115		6,989

The increase in deferred service revenue reflects the impact of the increase in the number of units under maintenance contract and renewals, partially offset by the ongoing amortization of deferred maintenance revenue.

Contractual Obligations

We have contractual obligations in the form of operating leases. These are described in further detail in Note 4 of the Notes to the Consolidated Financial Statements. Additionally, we have purchase obligations reflecting open purchase order commitments, including $800,000 of third party licensing contract commitments.

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The following chart details our contractual obligations as of December 31, 2006 (in thousands):

	Payments Due by Period
			Less Than		1 - 3		3 - 5
Contractual Obligations	Total		1 Year		Years		Years
Cash obligations not reflected in Consolidated Balance Sheet
Operating lease obligations(1)	$	6,095	$	2,871	$	2,228	$	996
Purchase obligations		12,469		11,669		400		400
Total	$	18,564	$	14,540	$	2,628	$	1,396

(1) In January 2007, we entered into an amendment to extend the term of the lease of our Cupertino, California facilities through December 2014 and to expand the premises subject to the lease. The lease payments under the amended lease, which will begin in December 2007, will be approximately $2.6 million per year, with a total commitment of $19 million over the extended lease term. This amount is not reflected in the above chart.

Liquidity and Capital Resource Requirements

During the past three years, we have had sufficient financial resources to meet our operating requirements, to fund our capital spending and to repay our bank line of credit.

We expect to experience growth in our working capital needs for at least the next twelve months in order to execute our business plan. We anticipate that operating activities, as well as planned capital expenditures, will constitute a partial use of our cash resources. In addition, we may utilize cash resources to fund additional acquisitions or investments in complementary businesses, technologies or products. We believe that our current cash, cash equivalents and investments of $76.6 million at December 31, 2006 will be sufficient to meet our anticipated cash requirements for working capital and capital expenditures for at least the next twelve months. However, we may need to raise additional funds if our estimates of revenues, working capital or capital expenditure requirements change or prove inaccurate or in order for us to respond to unforeseen technological or marketing hurdles or to take advantage of unanticipated opportunities. These funds may not be available at the time or times needed, or available on terms acceptable to us. If adequate funds are not available, or are not available on acceptable terms, we may not be able to take advantage of market opportunities to develop new products or to otherwise respond to competitive pressures.

ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Fixed Income Investments

Our exposure to market risks for changes in interest rates and principal relates primarily to investments in debt securities issued by U.S. government agencies and corporate debt securities. We place our investments with high credit quality issuers and, by policy, limit the amount of the credit exposure to any one issuer. Our investment securities are classified as available-for-sale and consequently are recorded on the balance sheet at fair value with unrealized gains and losses reported as a separate component of accumulated other comprehensive income.

We do not use derivative financial instruments. In general our policy is to limit the risk of principal loss and ensure the safety of invested funds by limiting market and credit risk. All highly liquid investments with less than three months to maturity from date of purchase are considered to be cash equivalents; investments with maturities between three and twelve months are considered to be short-term investments; and investments with maturities in excess of twelve months from the balance sheet date are considered to be long-term investments.

At December 31, 2006, our investment portfolio included fixed-income securities with a fair value of approximately $67.1 million, having an average duration of 0.30 years. These securities are subject to interest rate risk and will decline in value if interest rates increase. Based on our investment portfolio at December 31, 2006, an immediate 10% increase in interest rates would result in a decrease in the fair value of the portfolio of approximately $124,000. While an increase in interest rates reduces the fair value of the investment portfolio,

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we will not realize the losses in the consolidated statements of operations unless the individual fixed-income securities are sold prior to recovery or the loss is determined to be other-than-temporarily impaired.

Foreign Exchange

We develop products in the United States and sell in North America, Asia, Europe and the rest of the world. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in worldwide markets. All sales are currently made in U.S. dollars; and as a result, a strengthening of the dollar could make our products less competitive in foreign markets. All operating costs outside the United States are incurred in local currencies, and are remeasured from the local currency to U.S. dollars upon consolidation. As exchange rates vary, these operating costs, when remeasured, may differ from our prior performance and our expectations. We have no foreign exchange contracts, option contracts or other foreign currency hedging arrangements.

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ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following consolidated financial statements, and the related notes thereto, of Packeteer and the Reports of Independent Registered Public Accounting Firm are filed as a part of this Form 10-K.

	Page
	Number
Reports of Independent Registered Public Accounting Firm		39
Consolidated Balance Sheets as of December 31, 2006 and 2005		42
Consolidated Statement of Operations for the years ended December 31, 2006, 2005 and 2004		43
Consolidated Statements of Stockholders’ Equity and Comprehensive Income for the years ended December 31, 2006, 2005 and 2004		44
Consolidated Statements of Cash Flows for the years ended December 31, 2006, 2005 and 2004		45
Notes to Consolidated Financial Statements		46

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

Packeteer, Inc.:

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting appearing under Item 9A(b), that Packeteer, Inc. did not maintain effective internal control over financial reporting as of December 31, 2006, because of the effect of material weaknesses identified in management’s assessment, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Management of Packeteer, Inc. is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a control deficiency, or a combination of control deficiencies, that results in a more than remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weaknesses have been identified and included in management’s assessment as of December 31, 2006: (i) the Company did not maintain effective controls to provide for the reconciliation of the income taxes payable account to supporting detail and the review of the income taxes payable account reconciliation by someone other than the preparer; and (ii) the Company did not maintain effective controls over the review of the rebate reserves as the review was not appropriately designed, nor was the review conducted in sufficient detail.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Packeteer, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2006. The aforementioned material weaknesses were considered in determining the nature, timing and extent of audit tests applied in our audit of the 2006 consolidated financial statements, and this report does not affect our report dated March 15, 2007, which expressed an unqualified opinion on those consolidated financial statements.

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In our opinion, management’s assessment that Packeteer, Inc. did not maintain effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, because of the effect of the material weaknesses described above on the achievement of the objectives of the control criteria, Packeteer, Inc. has not maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

/s/  KPMG LLP

Mountain View, California

March 15, 2007

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

Packeteer, Inc.:

We have audited the accompanying consolidated balance sheets of Packeteer, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Packeteer, Inc. and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.

As discussed in Note 1 to the consolidated financial statements, effective January 1, 2006, Packeteer, Inc. adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 123R, Share-Based Payment. Also, as discussed in Note 1 to the consolidated financial statements, Packeteer, Inc. changed its method of quantifying financial statement errors in 2006.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Packeteer, Inc.’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 15, 2007 expressed an unqualified opinion on management’s assessment of, and an adverse opinion on the effective operation of, internal control over financial reporting.

/s/  KPMG LLP

Mountain View, California

March 15, 2007

41

PACKETEER, INC.

CONSOLIDATED BALANCE SHEETS

	December 31,
	2006			2005
	(In thousands, except per share amounts)
ASSETS
Current assets:
Cash and cash equivalents	$	39,640		$	36,221
Short-term investments		25,681			81,228
Accounts receivable, net of allowance for doubtful accounts and sales returns of $3,010 and $1,800, as of December 31, 2006 and 2005, respectively		31,743			15,759
Other receivables		216			207
Inventories		3,957			4,979
Prepaids and other current assets		3,249			2,148
Total current assets		104,486			140,542
Non-current assets:
Property and equipment, net		3,968			2,681
Long-term investments		11,236			5,228
Goodwill		58,656			9,527
Purchased intangible assets, net		11,045			5,606
Other non-current assets		27,577			5,073
Total assets	$	216,968		$	168,657
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	3,014		$	2,808
Accrued compensation		9,567			6,551
Other accrued liabilities		8,431			4,716
Income taxes payable		7,164			3,520
Deferred revenue		23,931			18,986
Total current liabilities		52,107			36,581
Non-current liabilities:
Deferred revenue, less current portion		5,173			3,129
Deferred rent and other		179			340
Total liabilities		57,459			40,050
Commitments and contingencies (Notes 4 and 5)
Stockholders’ equity:
Preferred stock, $0.001 par value; 5,000 shares authorized; no shares issued and outstanding as of December 31, 2006 and December 31, 2005		—			—
Common stock, $0.001 par value; 85,000 shares authorized; 35,400 and 34,197 shares issued and outstanding as of December 31, 2006 and December 31, 2005, respectively		36			34
Additional paid-in capital		212,961			188,046
Deferred stock-based compensation		—			(567	)
Accumulated other comprehensive loss		(18	)		(182	)
Accumulated deficit		(53,470	)		(58,724	)
Total stockholders’ equity		159,509			128,607
Total liabilities and stockholders’ equity	$	216,968		$	168,657

See accompanying notes to consolidated financial statements.

42

PACKETEER, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

	Years Ended December 31,
	2006		2005		2004
	(In thousands, except per share amounts)
Net revenues:
Product revenues	$	110,164	$	85,590	$	74,557
Service revenues		34,959		27,351		17,880
Total net revenues		145,123		112,941		92,437
Cost of revenues(1):
Product costs		26,028		19,575		16,780
Service costs		10,907		8,163		6,057
Amortization of purchased intangible assets		2,150		1,557		38
Total cost of revenues		39,085		29,295		22,875
Gross profit		106,038		83,646		69,562
Operating expenses(1):
Research and development		30,646		21,778		14,973
Sales and marketing, includes amortization of purchased intangible assets of $791 in 2006, and none in 2005 and 2004		57,889		38,276		35,504
General and administrative		13,949		7,222		6,061
In-process research and development		1,800		—		—
Total operating expenses		104,284		67,276		56,538
Income from operations		1,754		16,370		13,024
Interest and other income, net		3,932		2,913		1,127
Income before provision (benefit) for income taxes		5,686		19,283		14,151
Provision (benefit) for income taxes		782		125		(383	)
Net income	$	4,904	$	19,158	$	14,534
Basic net income per share	$	0.14	$	0.57	$	0.44
Diluted net income per share	$	0.14	$	0.55	$	0.42
Shares used in computing basic net income per share		34,848		33,823		32,994
Shares used in computing diluted net income per share		35,740		35,065		34,502
(1) Stock-based compensation included in the costs and expenses line items:
Product costs	$	414	$	—	$	—
Service costs		732		—		—
Research and development		4,371		867		13
Sales and marketing		5,241		25		1
General and administrative		3,037		9		—

See accompanying notes to consolidated financial statements.

43

PACKETEER, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

												Accumulated			Notes
						Additional			Deferred			Other			Receivable
	Common Stock					Paid-in			Stock-Based			Comprehensive			from			Accumulated						Comprehensive
	Shares			Amount		Capital			Compensation			Income (Loss)			Stockholders			Deficit			Total			Income
	(In thousands)
Balances as of December 31, 2003		32,501		$	32	$	175,820		$	—		$	(12	)	$	(6	)	$	(92,416	)	$	83,418
Issuance of restricted common stock, net of repurchases		110			—		1,624			(1,624	)		—			—			—			—
Issuance of common stock upon exercise of stock options		510			1		2,925			—			—			—			—			2,926
Issuance of common stock pursuant to Employee Stock Purchase Plan		297			—		1,256			—			—			—			—			1,256
Repayments of notes receivable from stockholders		—			—		—			—			—			6			—			6
Amortization of stock-based compensation		—			—		—			14			—			—			—			14
Comprehensive income:
Unrealized loss on investments		—			—		—			—			(195	)		—			—			(195	)	$	(195	)
Net income		—			—		—			—			—			—			14,534			14,534			14,534
Comprehensive income																								$	14,339
Balances as of December 31, 2004		33,418			33		181,625			(1,610	)		(207	)		—			(77,882	)		101,959
Issuance of common stock upon exercise of stock options		490			1		3,033			—			—			—			—			3,034
Issuance of common stock pursuant to Employee Stock Purchase Plan		299			—		2,346			—			—			—			—			2,346
Repurchase of restricted common stock		(10	)		—		(149	)		142			—			—			—			(7	)
Tax benefit from employee stock option plans		—			—		1,191			—			—			—			—			1,191
Amortization of stock-based compensation		—			—		—			901			—			—			—			901
Comprehensive income:
Unrealized gain on investments		—			—		—			—			25			—			—			25		$	25
Net income		—			—		—			—			—			—			19,158			19,158			19,158
Comprehensive income																								$	19,183
Balances as of December 31, 2005		34,197			34		188,046			(567	)		(182	)		—			(58,724	)		128,607
Cumulative effect of adjustments from the adoption of SAB No. 108, net of taxes		—			—		—			—			—			—			350			350
Adjusted balances as of January 1, 2006		34,197			34		188,046			(567	)		(182	)		—			(58,374	)		128.957
Reclassification of deferred stock based compensation upon adoption of SFAS 123(R)		—			—		(567	)		567						—			—			—
Issuance of common stock upon exercise of stock options		888			2		4,581			—			—			—			—			4,583
Issuance of common stock pursuant to Employee Stock Purchase Plan		315			—		2,511			—			—			—			—			2,511
Stock options assumed in acquisition		—			—		2,482			—			—			—			—			2,482
Tax benefit from employee stock option plans		—			—		2,113			—			—			—			—			2,113
Stock-based compensation related to acquisition		—			—		484						—			—			—			484
Stock-based compensation related to stock options and Employee Stock Purchase Plan		—			—		13,311			—			—			—			—			13,311
Comprehensive income:
Unrealized gain on investments		—			—		—			—			164			—			—			164		$	164
Net income		—								—			—			—			4,904			4,904			4,904
Comprehensive income																								$	5,068
Balances as of December 31, 2006		35,400		$	36	$	212,961		$	—		$	(18	)	$	—		$	(53,470	)	$	159,509

See accompanying notes to consolidated financial statements

44

PACKETEER, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

	Year Ended December 31,
	2006			2005			2004
	(In thousands)
Cash flows from operating activities:
Net income	$	4,904		$	19,158		$	14,534
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		2,630			2,414			1,728
Amortization of purchased intangible assets		2,941			1,557			38
Provision for (reversal of) allowance for doubtful accounts		292			(45	)		89
Write-down of inventory		568			89			86
Stock-based compensation related to Mentat acquisition		484			901			14
Stock-based compensation related to stock options and ESPP		13,311			—			—
Excess tax benefit from stock-based compensation plans		(981	)		—			—
Tax benefits from employee stock option plans		2,829			1,191			—
Deferred income taxes		(5,794	)		(2,967	)		(2,375	)
Loss on disposal of property and equipment		9			20			9
In-process research and development		1,800			—			—
Changes in operating assets and liabilities, net of acquired assets and assumed liabilities:
Accounts receivable		(14,324	)		1,114			(5,440	)
Other receivables		(9	)		1,680			475
Inventories		680			(1,962	)		(278	)
Prepaids and other current assets		(522	)		(186	)		(12	)
Accounts payable		206			6			573
Accrued compensation		2,397			84			2,217
Other accrued liabilities		(247	)		(1,163	)		1,896
Income taxes payable		2,846			1,082			1,379
Deferred revenue		6,476			5,958			6,428
Other		(68	)		(50	)		(33	)
Net cash provided by operating activities		20,428			28,881			21,328
Cash flows from investing activities:
Purchases of property and equipment, net		(3,626	)		(2,049	)		(1,931	)
Purchases of investments		(66,834	)		(109,851	)		(93,487	)
Proceeds from sales and maturities of investments		120,156			104,945			72,810
Acquisitions, net of cash acquired		(66,930	)		(1,750	)		(17,304	)
Funds deposited into escrow in connection with acquisition		(7,850	)		—			—
Net cash used in investing activities		(25,084	)		(8,705	)		(39,912	)
Cash flows from financing activities:
Proceeds from issuance of common stock, net of repurchases		4,583			3,027			2,926
Sale of stock to employees under the ESPP		2,511			2,346			1,256
Excess tax benefit from stock-based compensation plans		981			—			—
Proceeds from repayment of notes receivable from stockholders		—			—			6
Payments of notes payable		—			—			(139	)
Principal payments of capital lease obligations		—			—			(457	)
Net cash provided by financing activities		8,075			5,373			3,592
Net increase (decrease) in cash and cash equivalents		3,419			25,549			(14,992	)
Cash and cash equivalents at beginning of year		36,221			10,672			25,664
Cash and cash equivalents at end of year	$	39,640		$	36,221		$	10,672
Non-cash investing and financing activities:
Issuance of restricted common stock, net of repurchases, to former Mentat employees	$	—		$	—		$	1,624
Options assumed in acquisition of Tacit	$	2,482		$	—		$	—
Supplemental disclosures of cash flow information:
Cash paid during period for income taxes, net of refunds	$	348		$	811		$	475
Cash paid during period for interest	$	—		$	—		$	27

See accompanying notes to consolidated financial statements.

45

PACKETEER, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.   DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

DESCRIPTION OF BUSINESS

Packeteer, Inc., along with its subsidiaries (collectively referred to herein as the “Company,” “Packeteer,” “we” and “us”) is a provider of wide area network, or WAN, Application Delivery systems designed to deliver a comprehensive set of visibility, Quality of Service, or QoS, control, compression, application acceleration and application service capabilities. Our product family includes PacketShaper, iShared, SkyX and Mobiliti Client products that can be deployed within large data centers, smaller branch office sites and software clients on PCs for mobile and Small Office/Home Office, or SOHO, users throughout a distributed enterprise. We deliver superior application performance and end user experience using an “intelligent overlay”, which bridges applications and IP networks, adapts to our customers’ existing infrastructure and addresses the demands created by a changing application environment in order to deliver high performance applications across all WAN and Internet links. The Company was incorporated on January 25, 1996, and commenced principal operations in 1997, at which time the Company began selling its products and related services. The Company currently markets and distributes its products via a worldwide network of resellers, distributors and systems integrators.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PREPARATION

The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

USE OF ESTIMATES

The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to allowance for doubtful accounts and sales returns, inventory valuation, rebate and warranty reserves, valuation of long-lived assets, including intangible assets and goodwill, income taxes and stock-based compensation, among others. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

REVENUE RECOGNITION

Product revenues consist primarily of sales of the Company’s WAN Application Delivery systems, which include hardware, as well as software licenses, to distributors and resellers. Service revenues consist primarily of maintenance revenue and, to a lesser extent, training revenue.

The Company applies the provisions of Statement of Position, or SOP, 97-2, “Software Revenue Recognition,” as amended by SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions,” to all transactions involving the sale of hardware and software products. Revenue is generally recognized when all of the following criteria are met, as set forth in paragraph 8 of SOP 97-2:

•  persuasive evidence of an arrangement exists,

•  delivery has occurred,

•  the fee is fixed or determinable, and

•  collectibility is probable.

46

PACKETEER, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Receipt of a customer purchase order is persuasive evidence of an arrangement. Sales through the Company’s distribution channel are evidenced by an agreement governing the relationship together with purchase orders on a transaction-by-transaction basis.

Delivery generally occurs when product is delivered to a common carrier from Packeteer or its designated fulfillment house. For certain destinations outside the Americas, delivery occurs when product is delivered to the destination country. For maintenance contracts, delivery is deemed to occur ratably over the contract period.

Fees are typically considered to be fixed or determinable at the inception of an arrangement and are negotiated at the outset of an arrangement, generally based on specific products and quantities to be delivered. In the event payment terms are provided that differ significantly from the Company’s standard business practices, which are generally ninety days or less, the fees are deemed to not be fixed or determinable and revenue is recognized as the fees become due and payable.

The Company assesses collectibility based on a number of factors, including credit worthiness of the customer and past transaction history of the customer.

Generally, product revenue is recognized upon delivery. However, product revenue on sales to major new distributors are recorded based on sell-through to the end user customers until such time as the Company has established significant experience with the distributor’s product exchange activity. Additionally, when the Company introduces new product into its distribution channel for which there is no historical customer demand or acceptance history, revenue is recognized on the basis of sell-through to end user customers until such time as demand or acceptance history has been established.

The Company defers recognition of revenue on inventory in the distribution channel in excess of a certain number of days. On the same basis, the Company reduces the associated cost of revenues, which is primarily related to materials, and includes this amount in inventory. The Company recognizes these revenues and associated cost of revenues when the inventory levels no longer exceed expected supply. No amounts were deferred under this policy at December 31, 2006 or 2005.

The Company has analyzed all of the elements included in its multiple element arrangements and has determined that it has sufficient vendor specific objective evidence, or VSOE, of fair value to allocate revenue to the maintenance component of its product and to training. VSOE is based upon separate sales of maintenance renewals and training to customers. Accordingly, assuming other revenue recognition criteria are met, revenue from product sales is recognized upon delivery using the residual method in accordance with SOP 98-9. Revenue from maintenance is recognized ratably over the maintenance term and revenue from training is recognized when the training has taken place. To date, training revenues have not been material.

SALES RETURN RESERVES

Management makes estimates of potential future product returns related to current period product revenue in accordance with Statement of Financial Accounting Standards (SFAS) 48, “Revenue Recognition When Right of Return Exists”. These sales return reserves are recorded as a reduction to revenue. The Company’s estimate for sales returns is based on its historical return rates and is recorded against accounts receivable.

The following provides additional details on the sales return reserves (in thousands):

	Years Ended December 31,
	2006			2005			2004
Balance at beginning of year	$	1,625		$	1,251		$	713
Additions, charged against revenues		5,604			3,400			2,247
Deductions		(4,766	)		(3,026	)		(1,709	)
Balance at end of year	$	2,463		$	1,625		$	1,251

47

PACKETEER, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

ALLOWANCE FOR DOUBTFUL ACCOUNTS

The allowance for doubtful accounts reduces trade receivables to the amount that is ultimately believed to be collectible. When evaluating the adequacy of the allowance for doubtful accounts, management reviews the aged receivables on an account-by-account basis, taking into consideration such factors as the age of the receivables, customer history and estimated continued credit-worthiness, as well as general economic and industry trends.

The following provides additional details on the allowance for doubtful accounts (in thousands):

	Years Ended December 31,
	2006			2005			2004
Balance at beginning of year	$	175		$	229		$	149
Provision for (reversal of) allowance for doubtful accounts receivable		292			(45	)		89
Addition to reserve related to acquisition of Tacit		277			—			—
Amounts written off, net of recoveries		(197	)		(9	)		(9	)
Balance at end of year	$	547		$	175		$	229

COST OF REVENUES

Our cost of revenues consists of the cost of finished products purchased from our contract manufacturers, overhead costs, service support costs and amortization of purchased intangible assets. The Company provides currently for the estimated costs that may be incurred under product warranties when products are shipped.

CASH AND CASH EQUIVALENTS

The Company considers all highly liquid investments with an original maturity of three months or less from date of purchase to be cash equivalents. Cash and cash equivalents consist primarily of cash on deposit with banks, money market instruments and investments in commercial paper that are stated at cost, which approximates fair market value.

INVESTMENTS

Management determines the appropriate classification of investment securities at the time of purchase and reevaluates such designation as of each balance sheet date. As of December 31, 2006 and 2005, all investment securities are designated as “available-for-sale.” These available-for-sale securities are carried at fair value based on quoted market prices, with the unrealized gains (losses) reported as a separate component of stockholders’ equity. The Company periodically reviews the realizable value of its investments in marketable securities. When assessing marketable securities for other-than temporary declines in value, we consider such factors as the length of time and extent to which fair value has been less than the cost basis, the market outlook in general and the Company’s intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value. If an other-than-temporary impairment of the investments is deemed to exist, the carrying value of the investment would be written down to its estimated fair value.

INVENTORIES

Inventories consist primarily of finished goods and are stated at the lower of cost (on a first-in, first-out basis) or market. We record inventory write-downs for excess and obsolete inventories based on historical usage and forecasted demand. If future demand or market conditions are less favorable than our projections, additional inventory write-downs may be required and would be reflected in cost of revenues in the period the revision is made. The Company recorded write-downs of inventory of $568,000, $89,000 and $86,000 in 2006, 2005 and 2004, respectively.

48

PACKETEER, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Inventories consisted of the following at December 31 (in thousands):

	2006		2005
Completed products	$	3,785	$	4,584
Components		172		395
Total inventories	$	3,957	$	4,979

LONG-LIVED ASSETS

Property and equipment, including equipment acquired under capital lease, is recorded at cost. Depreciation and amortization are provided using the straight-line method over the estimated useful lives of the assets, generally 18 months to four years. Leasehold improvements are amortized over the shorter of estimated useful lives of the assets or the lease term, generally five years. During 2004, the remaining leases were fully paid and the equipment under capital lease was transferred to computers and equipment.

Property and equipment consisted of the following at December 31 (in thousands):

	2006			2005
Computers and equipment	$	9,785		$	7,323
Furniture and fixtures		2,142			1,439
Leasehold improvements		2,317			1,582
		14,244			10,344
Less: accumulated depreciation and amortization		(10,276	)		(7,663	)
Property and equipment, net	$	3,968		$	2,681

Goodwill represents the excess purchase price over the estimated fair value of net assets acquired as of the acquisition date. Goodwill of $49.1 million and $9.5 million was recorded in connection with the acquisition of Tacit and Mentat, respectively.

Other intangibles include purchased intangibles recorded in connection with the acquisition of Tacit and Mentat and are amortized using the straight-line method over the estimated useful lives of the assets.

The following table provides additional details on goodwill and acquired intangible assets, net (in thousands):

	December 31,							December 31,
	2005							2006
	Balance		Acquisition		Amortization			Balance
Goodwill	$	9,527	$	49,129	$	—		$	58,656
Other intangibles:
Developed technology		4,053		3,530		(1,755	)		5,828
Customer contracts and relationships		1,421		4,200		(984	)		4,637
Trade name		132		650		(202	)		580
	$	15,133	$	57,509	$	(2,941	)	$	69,701

49

PACKETEER, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following tables set forth the carrying amount of other intangible assets that will continue to be amortized (in thousands):

	December 31, 2006
			Gross
	Amortization		Carrying		Accumulated			Net Carrying
	Life		Amount		Amortization			Amount
Intangibles:
Developed technology		3-5 yrs	$	8,630	$	(2,802	)	$	5,828
Customer contracts and relationships		3-6 yrs		6,100		(1,463	)		4,637
Trade name		3 yrs		850		(270	)		580
			$	15,580	$	(4,535	)	$	11,045

	December 31, 2005
			Gross
	Amortization		Carrying		Accumulated			Net Carrying
	Life		Amount		Amortization			Amount
Intangibles:
Developed technology		5 yrs	$	5,100	$	(1,047	)	$	4,053
Customer contracts and relationships		6 yrs		1,900		(479	)		1,421
Trade name		3 yrs		200		(68	)		132
			$	7,200		(1,594	)	$	5,606

Included in cost of revenues was amortization expense of $2.2 million, $1.6 million and $38,000 for 2006, 2005 and 2004, respectively. Included in sales and marketing expense was amortization expense of $791,000 in 2006 and none in 2005 and 2004.

Based on the purchased intangible assets balance as of December 31, 2006, the estimated related future amortization is as follows (in thousands):

Year	Amount
2007	$	3,803
2008		3,738
2009		2,841
2010		663
	$	11,045

Goodwill is tested for impairment annually on December 1 in a two-step process. First, the Company determines if the carrying amount of its Reporting Unit exceeds the “fair value” of the Reporting Unit, which would indicate that goodwill may be impaired. If the Company determines that goodwill may be impaired, the Company compares the “implied fair value” of the goodwill, as defined by SFAS 142, to its carrying amount to determine if there is an impairment loss. The Company does not have any goodwill that it considers to be impaired.

In accordance with SFAS 144, “Accounting for Impairment or Disposal of Long-lived Assets”, the Company evaluates long-lived assets, including intangible assets other than goodwill, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Recoverability of these assets is measured by comparison of the carrying amount of the asset to the future undiscounted cash flows the asset is expected to generate. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset.

50

PACKETEER, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Other Assets consisted of the following at December 31 (in thousands):

	2006		2005
Deferred tax assets	$	19,210	$	4,622
Amounts held in escrow		7,850		—
Other		517		451
	$	27,577	$	5,073

ADVERTISING COSTS

Advertising costs are expensed as incurred and the amounts were insignificant for all periods presented and are classified under sales and marketing expense. Advertising expenses for 2006, 2005 and 2004 were $470,000, $206,000, and $277,000, respectively.

OTHER ACCRUED LIABILITIES

Other accrued liabilities consisted of the following at December 31, (in thousands):

	2006		2005
Rebate reserves	$	2,311	$	1,634
Warranty reserves		488		234
Other		5,632		2,848
	$	8,431	$	4,716

REBATE RESERVES

Certain distributors and resellers can earn rebates under several Packeteer programs. The rebates earned are recorded in accordance with Emerging Issues Task Force (EITF) 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendors Products)”. For established programs, the Company’s estimates for rebates are based on historical usage rates. For new programs, rebate reserves are calculated to cover the Company’s maximum exposure until such time as historical usage rates are developed. When sufficient historical experience is established, there may be a reversal of previously accrued rebates if actual rebate claims are less than the maximum exposure. Additionally, there may be a reversal of previously accrued rebate reserves if rebates are not claimed before the expiration dates established for each program.

WARRANTY RESERVES

Upon shipment of products to its customers, the Company provides for the estimated cost to repair or replace products that may be returned under warranty. The Company’s warranty period is typically 12 months from the date of shipment to the end user customer. For existing products, the reserve is estimated based on actual historical experience. For new products, the required reserve is based on historical experience of similar products until such time as sufficient historical data has been collected on the new product and is included in other accrued liabilities.

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The following provides a reconciliation of changes in Packeteer’s warranty reserve (in thousands):

	For the Years Ended December 31,
	2006			2005			2004
Balance at beginning of year	$	234		$	315		$	303
Provision for current year sales		586			242			422
Warranty costs incurred		(332	)		(323	)		(410	)
Balance at end of year	$	488		$	234		$	315

RESEARCH AND DEVELOPMENT COSTS

Development costs incurred in the research and development of new products, other than software, and enhancements to existing products are expensed as incurred. Costs for the development of new software products and enhancements to existing products are expensed as incurred until technological feasibility has been established, at which time any additional development costs would be capitalized in accordance with SFAS 86, “Accounting for Costs of Computer Software To Be Sold, Leased, or Otherwise Marketed.” To date, the Company’s software has been available for general release shortly after the establishment of technological feasibility, which the Company defines as a working prototype and, accordingly, capitalizable costs have not been material.

STOCK-BASED COMPENSATION

The Company has adopted a stock incentive plan that provides for the grant to eligible individuals of stock options, stock appreciation rights, restricted stock purchase rights and bonuses, restricted stock units, performance shares and performance units. The Company also has an Employee Stock Purchase Plan, or ESPP, which enables employees to purchase the Company’s common stock.

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including employee stock options and employee stock purchases related to the ESPP based on estimated fair values. SFAS 123(R) supersedes the Company’s previous accounting under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS 123(R). The Company has applied the provisions of SAB 107 in its adoption of SFAS 123(R). Using the modified prospective transition method of adopting SFAS 123(R), the Company began recognizing compensation expense for stock-based awards granted or modified after December 31, 2005 and awards that were granted prior to the adoption of SFAS 123(R) but were still unvested at December 31, 2005. Under this method of implementation, no restatement of prior periods has been made.

Stock-based compensation expense recognized under SFAS 123(R) in the consolidated statements of operations for 2006 related to stock options and ESPP was $12.1 million and $1.2 million, respectively. The estimated fair value of the Company’s stock-based awards, less expected forfeitures, is amortized over the awards’ vesting period using the graded vesting method. In addition, the stock-based compensation expense for 2006 included $484,000 related to restricted stock issued in connection with the Mentat acquisition that would have been included in the Company’s consolidated statements of operations under the provisions of APB 25. For 2005 and 2004, stock-based compensation expense of $901,000 and $14,000, respectively, was related to the Mentat acquisition. There was no stock-based compensation expense related to stock options and ESPP recognized during 2005 and 2004. As a result of adopting SFAS 123(R), the Company’s income before provision (benefit) for income taxes and net income for 2006 were reduced by $13.3 million and $9.2 million, respectively. The implementation of SFAS 123(R) reduced basic and fully diluted earnings per share by $0.26 for 2006. See Note 7 for additional information.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

SFAS 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s statements of operations. Prior to January 1, 2006, the Company measured compensation expense for its employee stock-based compensation plans using the intrinsic value method under APB 25 and related interpretations. In accordance with APB 25, no stock-based compensation expense was recognized in the Company’s statements of operations for stock options granted to employees and directors that had an exercise price equal to the deemed fair value of the underlying common stock on the date of grant.

Stock-based compensation expense recognized in the Company’s statements of operations in 2006 included compensation expense for share-based payment awards granted prior to, but not yet vested as of December 31, 2005, based on the grant date fair value estimated in accordance with the pro forma provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (SFAS 123), as amended, and compensation expense for the share-based payment awards granted subsequent to December 31, 2005 based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). As stock-based compensation expense recognized in the consolidated statements of operations in 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In the Company’s pro forma information required under SFAS 123 for the periods prior to 2006, the Company accounted for forfeitures as they occurred.

Prior to the adoption of SFAS 123R, the Company presented all tax benefits for deductions resulting from the exercise of stock options and disqualifying dispositions as operating cash flows on its consolidated statement of cash flows. SFAS 123R requires the benefits of tax deductions in excess of recognized compensation expense to be reported as a financing cash flow, rather than as an operating cash flow. This requirement reduced net operating cash flows and increased net financing cash flows in 2006. Total cash flow remained unchanged from what would have been reported under prior accounting rules.

On November 10, 2005, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position No. FAS 123(R)-3 “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards.” This FSP provides a practical transition election related to the accounting for the tax effects of share-based payments awards to employees, as an alternative to the transition guidance for the additional paid-in capital pool, or APIC pool, in paragraph 81 of SFAS 123(R). The Company has elected to adopt the alternative transition method provided in the FASB Staff Position for calculating the tax effects of equity-based compensation pursuant to SFAS 123(R).The alternative transition method includes simplified methods to establish the beginning balance of the APIC pool related to the tax effects of employee stock-based compensation, and to determine the subsequent impact on the APIC pool and Consolidated Statements of Cash Flows of the tax effects of employee stock-based compensation awards that are outstanding upon adoption of SFAS 123(R).

Stock Options

The exercise price of each stock option equals the market price of the Company’s stock on the date of grant. Most options are scheduled to vest over four years and expire no later than ten years from the grant date. The fair

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PACKETEER, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model, assuming no expected dividends and the following weighted-average assumptions:

	Year Ended
	December 31,
	2006
Stock Option Grants:
Expected life (years)		4.62
Expected volatility		62	%
Risk-free interest rate		4.88	%

The computation of the expected volatility assumption used in the Black-Scholes calculations for new grants is based on a combination of historical and implied volatilities. When establishing the expected life assumption, the Company reviews historical employee exercise behavior of option grants with similar vesting periods.

The weighted average grant date fair value of options granted during 2006 was $5.83. The weighted average fair value of options assumed in 2006 in connection with the acquisition of Tacit was $12.46. The total intrinsic value of options exercised during 2006 was $5.6 million. The total fair value of options that vested during 2006 was $10.4 million. At December 31, 2006, the Company had $10.1 million of total unrecognized compensation expense, net of estimated forfeitures, related to stock option plans that will be recognized over the weighted average period of 2.73 years. Cash received from stock option exercises was $4.6 million during 2006.

Employee Stock Purchase Plan.

The ESPP permits participants to purchase common stock through payroll deductions of up to 15% of an employee’s compensation, including commissions, overtime, bonuses and other incentive compensation. The purchase price per share is equal to 85% of the fair market value per share on the participant’s entry date into the offering period or, if lower, 85% of the fair market value per share on the semi-annual purchase date. The number of shares issued under the ESPP during 2006 was 315,000. Compensation expense is calculated using the fair value of the employees’ purchase rights granted under the Black-Scholes model, assuming no expected dividends and the following weighted average assumptions:

	Year Ended
	December 31,
	2006
ESPP Rights:
Expected life (years)		1.19
Expected volatility		61	%
Risk-free interest rate		5.07	%

Based on the Black-Scholes option pricing model, the weighted average estimated fair value of purchase rights under the ESPP was $3.75 for 2006.

Restricted Stock Issued in Acquisition

In connection with the acquisition of Mentat, Inc., or Mentat, in December 2004, the Company recorded deferred stock-based compensation of approximately $1.6 million associated with the issuance of restricted shares. Beginning in 2006, stock-based compensation expense related to purchase acquisitions is calculated under SFAS 123(R) and recognized over the remaining vesting periods. During 2006, the Company recorded stock-based compensation expense of $484,000 related to the acquisition and credited additional paid-in capital. Prior to 2006, a portion of the purchase consideration for purchase acquisitions was recorded as deferred stock-based compensation. The balance for deferred stock-based compensation was reflected as a reduction to additional paid-in capital in the consolidated statements of shareholders’ equity. Amortization of stock-based compensation

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PACKETEER, INC.

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associated with these shares totaled $901,000 and $14,000, respectively, for 2005 and 2004. As of December 31, 2006, the Company has $89,000 of unrecognized compensation expense related to these restricted shares, which will be recognized over the remaining vesting period of 12 months.

Pro Forma Information under SFAS 123 for Periods Prior to 2006

Prior to January 1, 2006, the Company followed the disclosure-only provisions under SFAS 123, as amended. The following table illustrates the effect on net income and earnings per share for 2005 and 2004 if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation (in thousands, except per share data):

	Years Ended December 31,
	2005			2004
Net income as reported	$	19,158		$	14,534
Add: Stock-based compensation under APB 25 related to acquisitions, net of tax		599			9
Deduct: Stock-based employee compensation expense determined under fair value-based method for all awards, net of tax		(10,021	)		(8,595	)
Pro forma net income	$	9,736		$	5,948
Earnings per share:
Basic — as reported	$	0.57		$	0.44
Diluted — as reported	$	0.55		$	0.42
Basic — pro forma	$	0.29		$	0.18
Diluted — proforma	$	0.28		$	0.17

Compensation expense for pro forma purposes is reflected over the vesting period, in accordance with the method described in FASB Interpretation (FIN) 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans.”

For pro forma purposes, the fair value of the Company’s stock option grants and ESPP awards was estimated using the Black-Scholes option-pricing model, assuming no expected dividends and the following weighted-average assumptions for the years ended December 31:

	2005			2004
Employee Stock Option Plan:
Expected life (years)		3.34			3.28
Expected volatility		90	%		102	%
Risk-free interest rate		4.03	%		2.64	%

	2005			2004
Employee Stock Purchase Plan:
Expected life (years)		1.25			1.26
Expected volatility		63	%		91	%
Risk-free interest rates		3.90	%		3.62	%

Prior to January 1, 2006, the expected life and expected volatility of the stock options were based upon historical data and implied volatility factors. Forfeitures of employee stock options were accounted for on an as-incurred basis.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Based on the Black-Scholes option pricing model, the weighted average estimated fair value of employee stock option grants was $7.86 and $10.34, respectively, for the years ended December 31, 2005 and 2004, respectively. The total intrinsic value of options exercised during the years ended December 31, 2005 and 2004 was $3.8 million and $4.1 million, respectively. The weighted-average fair value of the purchase rights granted under the ESPP during 2005 and 2004 was $5.30 and $4.84, respectively.

CONCENTRATIONS OF RISK

Financial instruments, which potentially subject the Company to concentrations of credit risk, consist primarily of cash, cash equivalents, investments and accounts receivable. The Company’s cash, cash equivalents and investments are maintained with highly accredited financial institutions and investments are placed with high quality issuers. The Company believes no significant concentration of credit risk exists with respect to these financial instruments. Credit risk with respect to trade receivables is limited as the Company performs ongoing credit evaluations of its customers. Based on management’s evaluation of potential credit losses, the Company believes its allowances for doubtful accounts are adequate.

A limited number of indirect channel partners have accounted for a large part of our revenues to date and we expect that this trend will continue. The following table provides details of sales to individual customers who accounted for 10% or more of total revenues:

	Years Ended December 31,
	2006			2005			2004
Alternative Technology, Inc		23	%		22	%		22	%
Westcon, Inc		18	%		13	%		19	%

At December 31, 2006, Alternative Technologies, Inc. and Westcon, Inc. accounted for 18% and 23% of accounts receivable, respectively. At December 31, 2005, Alternative Technologies and Westcon accounted for 20% and 13% of gross accounts receivable, respectively.

The Company principally relies on one, and to a lesser extent three additional, contract manufacturers for all of its manufacturing requirements. Any manufacturing disruption could impair its ability to fulfill orders. The Company’s reliance on these third-party manufacturers for all its manufacturing requirements could cause it to lose orders if these third-party manufacturers fail to satisfy the Company’s cost, quality and delivery requirements.

INCOME TAXES

The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance for any tax benefits of which future realization is uncertain.

FOREIGN CURRENCY TRANSACTIONS

The Company’s sales to international customers are U.S. dollar-denominated. As a result, there are no foreign currency gains or losses related to these transactions.

The functional currency for the Company’s foreign subsidiaries is the U.S. dollar. Accordingly, the entities remeasure monetary assets and liabilities at period-end exchange rates, while non-monetary items are remeasured at historical rates. Income and expense accounts are remeasured at the average rates in effect during the year.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Remeasurement adjustments are recognized in income as transaction gains or losses in the year of occurrence. To date, the effect of such amounts on net income has not been significant.

OTHER COMPREHENSIVE INCOME (LOSS)

The Company reports comprehensive income or loss in accordance with the provisions of SFAS 130, “Reporting Comprehensive Income.” SFAS 130 establishes standards for reporting comprehensive income and loss and its components in financial statements. Other comprehensive income (loss) consists entirely of unrealized gains (losses) on marketable securities available for sale of $164,000, $25,000 and $(195,000) for 2006, 2005 and 2004, respectively. Accordingly, the accumulated other comprehensive income (loss) as of December 31, 2006 and 2005 related entirely to net unrealized losses on marketable securities available for sale. Tax effects of unrealized losses are not considered material for any periods presented.

NET INCOME PER SHARE

Basic net income per share has been computed using the weighted-average number of common shares outstanding during the period, less the weighted-average number of common shares that are subject to repurchase. Diluted net income per share has been computed using the weighted average number of common and potential common shares outstanding during the period, as calculated using the treasury stock method.

For purposes of computing diluted earnings per share, weighted average common share equivalents do not include stock options with an exercise price that exceeded the average fair market value of the Company’s common stock for the period, as the effect would be anti-dilutive. Additionally, all common share equivalents are excluded from diluted earnings per share for loss periods. Options to purchase shares of common stock that were excluded from the computation were as follows (in thousands):

	Years Ended December 31,
	2006		2005		2004
Shares issuable under stock options		5,199		4,174		2,170

Basic net income per share has been computed using the weighted-average number of common shares outstanding during the period, less the weighted-average number of common shares that are subject to repurchase. Diluted net income per share has been computed using the weighted average number of common and potential common shares outstanding during the period.

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PACKETEER, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following table presents the calculation of basic and diluted net income per share (in thousands, except per share amounts):

	Years Ended December 31,
	2006			2005			2004
Numerator:
Net income	$	4,904		$	19,158		$	14,534
Denominator:
Basic:
Weighted-average common shares outstanding		34,910			33,932			33,104
Less: common shares subject to repurchase		(62	)		(109	)		(110	)
Basic weighted-average common shares outstanding		34,848			33,823			32,994
Diluted:
Basic weighted-average common shares outstanding		34,848			33,823			32,994
Add: potentially dilutive common shares from stock Options and ESPP and shares subject to repurchase		872			1,221			1,485
Add: potentially dilutive common shares from warrants		20			21			23
Diluted weighted-average common shares outstanding		35,740			35,065			34,502
Basic net income per share	$	0.14		$	0.57		$	0.44
Diluted net income per share	$	0.14		$	0.55		$	0.42

QUANTIFICATION OF ERRORS

In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108 (SAB 108), “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” which addresses how uncorrected errors in previous years should be considered when quantifying errors in current-year financial statements. SAB 108 requires companies to consider both a “rollover” method which focuses primarily on the income statement impact of misstatements and the “iron curtain” method which focuses primarily on the balance sheet impact of misstatements when quantifying errors in current-year financial statements and the related financial statement disclosures. The transition provisions of SAB 108 permit a company to adjust retained earnings (accumulated deficit) for the cumulative effect of immaterial errors relating to prior years. In the three months ended December 31, 2006, we determined that errors had been made in our financial statements related to the recording of rebate reserves, resulting in an overstatement of rebate reserves of $500,000, net of taxes of $150,000.

Historically, the Company has evaluated uncorrected differences utilizing the rollover approach. The Company believes the impact of these errors were immaterial to prior years under the rollover method. However, under SAB 108, which the Company was required to adopt for the year ended December 31, 2006, the Company must assess materiality using both the rollover method and the iron-curtain method. Under the iron-curtain method, the cumulative impact of the errors related to the rebate reserve are material to the Company’s 2006 financial statements and, therefore, the Company has recorded an adjustment to its opening 2006 accumulated deficit balance in the amount of $350,000 in accordance with the implementation guidance in SAB 108.

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PACKETEER, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The impact on accumulated deficit is comprised of the following amounts (in thousands):

	Years Ended December 31,
	2004			2005			Total
Accumulated deficit
Net revenues	$	(603	)	$	103		$	(500	)
Provision for income taxes		181			(31	)		150
Total, net of tax	$	(422	)	$	72		$	350

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109”, (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return that results in a tax benefit. Additionally, FIN 48 provides guidance on de-recognition, statement of operations classification of interest and penalties, accounting in interim periods, disclosure, and transition. This interpretation is effective for fiscal years beginning after December 15, 2006. The Company is evaluating the effect that the adoption of FIN 48 will have on its results of operations and financial condition and is not yet in a position to determine such effects.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurement”, (FAS 157). This Standard defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company has not determined the effect that the adoption of FAS 157 will have on its consolidated results of operations, financial condition or cash flows.

2.   BUSINESS COMBINATIONS

Acquisition of Tacit Networks, Inc.

On May 16, 2006, the Company completed its acquisition of Tacit Networks, Inc., or Tacit, a privately held company headquartered in South Plainfield, New Jersey. Tacit was a developer of products that allow enterprises with multiple locations to more efficiently store and transfer data between remote sites and central data storage sites. The acquisition expanded the Company’s product offerings of branch office infrastructure solutions that enable organizations pursuing server, storage and resource consolidation to meet cost, security and regulatory compliance objectives.

Tacit became a wholly owned subsidiary of the Company in a transaction accounted for using the purchase method. The Company acquired 100% of the outstanding shares of Tacit for an initial purchase price of $68.0 million in cash, including acquisition costs of $1.7 million. In addition, the Company assumed all of the then outstanding options to purchase Tacit common stock, and converted those into options to purchase approximately 320,000 shares of the Company’s common stock. In addition to the cash paid that is included in the initial purchase price, the merger agreement required that $7.85 million of cash be placed in an escrow account to secure Tacit’s obligations under certain representation and warranty provisions. The escrow funds will be released fifteen days following the later of 90 days after completion of the audit of the Company’s 2006 financial statements or one year from the closing date of the acquisition, at which time the final purchase price will be adjusted.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The results of operations of Tacit are included in the Company’s Consolidated Statements of Operations beginning May 16, 2006, the closing date of the acquisition. The following table summarizes the initial purchase price (in thousands):

Cash	$	66,358
Fair value of options assumed		2,482
Acquisition related transaction costs		1,655
Total initial purchase price	$	70,495

The fair value of the assumed options, both vested and unvested, was determined using a Black-Scholes valuation model consistent with the Company’s valuation of stock options in accordance with SFAS 123(R). See Note 1. Unrecognized compensation expense associated with the fair value of the unvested options assumed was approximately $1.2 million which is not included in the initial purchase price above.

Under the purchase method of accounting, the initial purchase price as shown in the table above is allocated to Tacit’s net tangible and intangible assets based on their estimated fair values as of the date of the completion of the acquisition. The escrow funds are included in other non-current assets in the accompanying consolidated balance sheets and have not been included in goodwill. When the funds are released to the former stockholders of Tacit, additional goodwill will be recorded. In addition, adjustments may be made to the allocation of the initial purchase price to reflect adjustments to deferred taxes related to the acquisition, as well as future tax benefits related to stock options assumed in the acquisition.

The preliminary allocation of the initial purchase price as of December 31, 2006 is as follows (in thousands):

	Amount
Cash and cash equivalents	$	1,083
Short-term investments		3,620
Accounts receivable		1,952
Inventories		226
Prepaids and other current assets		862
Property and equipment		300
Net deferred tax assets		9,036
Accounts payable and accrued liabilities		(5,380	)
Deferred revenue		(513	)
Goodwill		49,129
Identifiable intangible assets		8,380
In-process research and development		1,800
Total initial purchase price	$	70,495

Identifiable intangible assets

Identifiable intangible assets, which consist primarily of customer relationships, trade names and technology, are amortized on a straight-line basis over their estimated useful lives. The customer relationships intangible relates to Tacit’s ability to sell existing, in-process and future versions of its products to its existing customers. Developed technology intangibles include a combination of patented and unpatented technology, trade secrets, and computer

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PACKETEER, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

software that represent the foundation for current and planned new products. The following table presents details of the purchased intangible assets (in thousands, except years):

	Estimated
	Useful Life		Amount
	(In years)
Intangible Assets
Developed technology		3	$	3,530
Customer relationships		4		4,200
Trade name		3		650
Total			$	8,380

Goodwill

Approximately $49.1 million of the initial purchase price has been allocated to goodwill. Goodwill represents the excess of the purchase price over the fair value of the underlying net tangible and intangible assets. The goodwill was attributed to the premium paid to expand and quicken the combined company’s ability to serve the growing markets for Wide Area File Services and branch office server solutions. Management believes the acquisition positions the combined company as a leading supplier of branch office server solutions delivering network services, network data reductions and file and bulk data caching. None of the goodwill recorded as part of the Tacit acquisition will be deductible for United States federal income tax purposes. Goodwill will be deductible for state income tax purposes in those states in which the Company elects to step up its basis in the acquired assets.

In accordance with SFAS No. 142, goodwill will not be amortized but instead will be tested for impairment at least annually (more frequently if certain indicators are present). In the event that management determines that the value of goodwill has become impaired, the Company would incur an accounting charge for the amount of impairment during the period in which the determination is made.

In-process research and development

The Company estimates that $1.8 million of the purchase price represents in-process research and development, (IPR&D), primarily related to projects associated with Tacit’s iShared network wide area network, or WAN, optimization technology (including the hardware appliance and the related software) enhancements and upgrades that had not yet reached technological feasibility and have no alternative future use. The Company’s methodology for allocating the purchase price of acquisitions to IPR&D was determined through established valuation techniques in the high-technology networking product industry. The fair value of the technology under development, as well as the existing purchased technology, was determined using the income approach, which estimates the present value of future economic benefits such as cash earnings, cost savings, tax deductions, and proceeds from disposition. The present value calculations were developed by discounting expected cash flows to the present value at a rate of return that incorporates the risk-free rate for the use of funds, the expected rate of inflation, and risks associated with the particular investment. The discount rate of 19% selected was generally based on rates of return available from alternative investments of similar type and quality.

Net deferred tax assets

Net deferred tax assets of $9.0 million include tax effects of fair value adjustments primarily related to intangible assets and net operating loss tax carryforwards, net of a valuation allowance of $1.7 million, the benefit from which will be allocated to goodwill when , and if, it is subsequently realized.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Pro forma financial information

The unaudited financial information in the table below summarizes the combined results of operations of Packeteer and Tacit, on a pro forma basis, as though the companies had been combined as of the beginning of each of the periods presented. The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of each of the periods presented. The pro forma financial information for 2006 also includes incremental stock-based compensation expense due to the assumption of Tacit stock options, investment banking fees, and other acquisition related costs, recorded in Tacit’s historical results of operations during May 2006. The pro forma financial information for all periods presented also includes amortization charges from acquired intangibles, adjustments to interest income, and related tax effects.

The unaudited pro forma financial information for 2006 combines the historical results for Packeteer for 2006, which include the results of Tacit subsequent to May 16, 2006, and the historical results for Tacit for the period from January 1, 2006 to May 16, 2006. The unaudited pro forma financial information for 2005 combines the historical results for Packeteer and Tacit. The following table summarizes the pro forma financial information, unaudited, (in thousands, except per share amounts):

	Year Ended
	December 31,
	2006			2005
Total net revenues	$	148,360		$	116,450
Net income (loss)		(2,639	)		879
Net income (loss) per share:
Basic	$	(0.08	)	$	0.03
Diluted	$	(0.08	)	$	0.03

Acquisition of Mentat

On December 21, 2004, Packeteer acquired all of the outstanding common stock of Mentat, a privately held company located in Los Angeles, California. Mentat products are designed to provide high performance networking solutions for satellite and high-latency networks. The acquisition deepens and extends Packeteer’s intellectual property and provides advanced acceleration capabilities for new WAN performance solutions for global customers.

The aggregate purchase price of Mentat was approximately $19.1 million, including acquisition costs. Of the $19.1 million, $17.3 million was paid in cash upon closing and the remaining $1.8 million was paid to the former shareholders of Mentat upon the collection of a non-trade receivable. The non-trade receivable was collected in January 2005 and was immediately paid to the former shareholders of Mentat per the terms of the purchase agreement. Our methodology for allocating the purchase price relating to purchase acquisitions is determined through established valuation techniques in the high-technology networking industry. Goodwill is measured as the excess of the cost of acquisition over the sum of the amounts assigned to tangible and identifiable intangible assets acquired, less liabilities assumed. The following table presents the allocation of the acquisition cost, including professional fees and other related acquisition costs, to the assets acquired and liabilities assumed, based on their fair values (in thousands):

Net tangible assets	$	2,327
Intangible assets		7,200
Goodwill		9,527
Net assets acquired	$	19,054

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Of the $7.2 million acquired intangibles, $5.1 million was assigned to developed technology, $1.9 million to customer contracts and relationships and $200,000 to trade name. These intangible assets have useful lives ranging from one to six years. Both the purchased intangible assets and the goodwill are expected to be deductible for tax purposes.

In March 2005, an OEM customer of Mentat exercised its option to buyout its license agreement. In accordance with the terms of the license, for a total of $3.0 million, the customer was granted a perpetual, non-transferable and non-exclusive binary and source code license to certain Mentat software plus support and maintenance for a period of twelve months. The $3.0 million fee was initially recorded as deferred revenue and revenue was recognized over the following twelve-month period. In 2006 and 2005, Packeteer included $669,000 and $2.3 million, respectively, in revenues under this arrangement, with no balance remaining in deferred revenue at December 31, 2006. A portion of the purchased intangible asset “Customer Contracts and Relationships” was related to this particular customer contract. The estimated useful life on this portion of the intangible asset was reduced from six years to one year and was fully amortized at December 31, 2006.

In addition, under the terms of the agreement, Packeteer was to pay up to $3.7 million in retention bonuses to former Mentat employees including both cash and restricted stock to incent Mentat employees to remain with Packeteer. The cash bonuses, totaling approximately $2.0 million were to be paid to the Mentat employees in equal installments, one half one year from the date of acquisition and the remainder on the two year anniversary of the acquisition, so long as the employee remains employed with Packeteer on each of the installment dates. During 2006 and 2005, $690,000 and $870,000, respectively, was paid to former Mentat employees under the cash retention bonus plan. No amounts remain payable at December 31, 2006.

The restricted stock retention bonuses totaling approximately 114,000 restricted shares were valued at $1.7 million; however, approximately 4,000 shares valued at $59,000 were repurchased on the date of acquisition due to employee terminations. Amortization of stock-based compensation expense associated with these shares totaled $484,000, $901,000 and $14,000 for the years ended December 31, 2006, 2005 and 2004, respectively. See Note 1.

Mentat’s results of operations have been included in the consolidated financial statements since the date of acquisition, December 21, 2004. The results of operations of Mentat were not material for the periods prior to the acquisition.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

3.   FINANCIAL INSTRUMENTS

The Company’s cash equivalents and investments consist of the following at December 31, 2006 and 2005 (in thousands):

	Available-for-Sale Securities
			Gross		Gross
	Amortized		Unrealized		Unrealized			Estimated
	Cost		Gains		Losses			Fair Value
DECEMBER 31, 2006
Commercial paper and money markets	$	31,442	$	1	$	(1	)	$	31,442
Asset and mortgage backed securities		7,514		8		(21	)		7,501
Corporate bonds		11,473		3		(2	)		11,474
Total debt securities		50,429		12		(24	)		50,417
US Treasury and agencies		16,656		2		(8	)		16,650
	$	67,085		14	$	(32	)	$	67,067
Amounts included in cash and cash equivalents								$	30,150
Amounts included in short-term investments									25,681
Amounts included in long-term investments									11,236
								$	67,067
DECEMBER 31, 2005
Commercial paper and money markets	$	17,160	$	—	$	(1	)	$	17,159
Asset and mortgage backed securities		23,987		4		(62	)		23,929
Corporate bonds		19,215		2		(14	)		19,203
Total debt securities		60,362		6		(77	)		60,291
US Treasury and agencies		59,402		2		(113	)		59,291
	$	119,764	$	8	$	(190	)	$	119,582
Amounts included in cash and cash equivalents								$	33,126
Amounts included in short-term investments									81,228
Amounts included in long-term investments									5,228
								$	119,582

The amortized cost and estimated fair values of the Company’s investments as of December 31, 2006, shown by effective maturity date, are as follows (in thousands):

			Estimated
	Amortized		Fair
	Cost		Value
Mature in one year or less	$	55,843	$	55,831
Mature between one year and two years		11,242		11,236
	$	67,085	$	67,067

All variable rate securities, including asset and mortgage backed securities, are classified as short-term investments regardless of the underlying reset date.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following tables show the fair values and gross unrealized losses for those investments that were in an unrealized loss position as of December 31, 2006 and 2005, aggregated by investment category and the length of time that individual securities have been in a continuous loss position (in thousands):

	Less Than 12 Months					12 Months or Greater					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Loss			Value		Loss			Value		Loss
DECEMBER 31, 2006
Security Description
Commercial paper and money markets	$	7,925	$	—		$	149	$	(1	)	$	8,074	$	(1	)
Asset and mortgage backed securities		4,434		(21	)		—		—			4,434		(21	)
Corporate bonds		3,353		(2	)		—		—			3,353		(2	)
US Treasury and agencies		11,526		(8	)		—		—			11,526		(8	)
	$	27,238	$	(31	)	$	149	$	(1	)	$	27,387	$	(32	)

	Less Than 12 Months					12 Months or Greater					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Loss			Value		Loss			Value		Loss
DECEMBER 31, 2005
Security Description
Commercial paper and money markets	$	12,434	$	(1	)	$	—	$	—		$	12,434	$	(1	)
Asset and mortgage backed securities		9,762		(45	)		1,598		(17	)		11,360		(62	)
Corporate bonds		7,370		(2	)		1,325		(12	)		8,695		(14	)
US Treasury and agencies		35,532		(107	)		6,541		(6	)		42,073		(113	)
	$	65,098	$	(155	)	$	9,464	$	(35	)	$	74,562	$	(190	)

The Company invests in investment grade securities. The unrealized losses on these investments were caused by interest rate increases and not credit quality. At this time, we believe that, due to the nature of the investments, the financial condition of the issuers, and Packeteer’s ability and intent to hold the investments through these short-term loss positions, factors would not indicate that these unrealized losses should be viewed as “other-than-temporary.”

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PACKETEER, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

4.   COMMITMENTS AND GUARANTEES

The Company leases its facilities under non-cancelable lease agreements that expire at various dates through 2011. Some of these arrangements contain renewal options, and require the Company to pay taxes, insurance and maintenance costs. Rent expense was $2.6 million, $2.2 million and $2.0 million for the years ended December 31, 2006, 2005 and 2004, respectively. As of December 31, 2006, the future minimum rental payments under operating leases are as follows (in thousands):

	Lease
Years Ending December 31,	Obligations
2007	$	2,871
2008		1,229
2009		999
2010		648
2011		348
Total future minimum lease payments	$	6,095

Additionally, our distributor and reseller agreements generally include a provision for indemnifying such parties against certain liabilities if our products are claimed to infringe a third-party’s intellectual property rights. To date, we have not incurred any costs as a result of such indemnifications and have not accrued any liabilities related to such obligations in the accompanying consolidated balance sheets.

In January 2007, the Company entered into an agreement to amend the lease agreement for its headquarters. See additional information in Note 10.

5.   CONTINGENCIES

In November 2001, a putative class action lawsuit was filed in the United States District Court for the Southern District of New York against the Company, certain officers and directors of the Company, and the underwriters of the Company’s initial public offering. An amended complaint, captioned In re Packeteer, Inc. Initial Public Offering Securities Litigation, 01-CV-10185 (SAS), was filed on April 20, 2002.

The amended complaint alleges violations of the federal securities laws on behalf of a purported class of those who acquired the Company’s common stock between the date of the Company’s initial public offering, or IPO, and December 6, 2000. The amended complaint alleges that the description in the prospectus for the Company’s IPO was materially false and misleading in describing the compensation to be earned by the underwriters of the Company’s IPO, and in not describing certain alleged arrangements among underwriters and initial purchasers of the Company’s common stock. The amended complaint seeks damages and certification of a plaintiff class consisting of all persons who acquired shares of the Company’s common stock between July 27, 1999 and December 6, 2000.

A special committee of the board of directors has authorized the Company to negotiate a settlement of the pending claims substantially consistent with a memorandum of understanding negotiated among class plaintiffs, all issuer defendants and their insurers. The parties have negotiated a settlement, which is subject to approval by the Court. On February 15, 2005, the Court issued an Opinion and Order preliminarily approving the settlement, provided that the defendants and plaintiffs agree to a modification narrowing the scope of the bar order set forth in the original settlement agreement. The parties agreed to a modification narrowing the scope of the bar order, and on August 31, 2005, the Court issued an order preliminarily approving the settlement. On December 5, 2006, the United States Court of Appeals for the Second Circuit overturned the District Court’s certification of the class of plaintiffs who are pursuing the claims that would be settled in the settlement against the underwriter defendants. Plaintiffs informed the District Court that they intend to seek further appellate review of this decision, and that they would like to be heard by the District Court as to whether the settlement may still be approved even if the the

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PACKETEER, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

decision of the Court of Appeals is not reversed. The District Court indicated that it would defer consideration of final approval of the settlement pending plaintiffs’ request for further appellate review. We do not currently believe that the outcome of this proceeding will have a material adverse impact on our financial condition, results of operations or cash flows. No amount has been accrued as of December 31, 2006, as we believe a loss is neither probable nor estimable.

On June 22, 2006, the Company filed a lawsuit in Santa Clara Superior Court against Valencia Systems, Inc., or Valencia, alleging Valencia’s breach of a Software License and Development Agreement pursuant to which Valencia provides certain software development and maintenance services for the Company. This complaint followed an earlier arbitration demand from Valencia pursuant to which Valencia claimed damages of $3,000,000. The Company was granted injunctive relief in its action prohibiting Valencia from disparagement or discontinuing maintenance or support services. The court has ordered the matter to arbitration and the parties have not yet formally responded to the other’s allegations. Valencia’s motion for a preliminary injunction was denied by the arbitrator. The Company believes Valencia’s claims to be without merit and intends to defend this matter vigorously. However, this matter is in the early stages and the Company cannot reasonably estimate an amount of potential loss, if any, at this time. The results of litigation are inherently uncertain, and there can be no assurance that the Company will prevail. No amount has been accrued as of December 31, 2006, as we believe a loss is neither probable nor estimable.

In addition, the Company is subject to examination of its income tax returns by the Internal Revenue Service and other domestic and foreign tax authorities, including a current examination by the Internal Revenue Service for its 2003 and 2004 tax returns, primarily related to its intercompany transfer pricing. The Company regularly assesses the likelihood of outcomes resulting from these examinations to determine the adequacy of its provision for income taxes, and believe such estimates to be reasonable.

The Company is routinely involved in legal and administrative proceedings incidental to its normal business activities and believes that these matters will not have a material adverse effect on financial position, results of operations or cash flows.

6.   INCOME TAXES

Income (loss) before provision (benefit) for income taxes is attributable to the following geographic locations for the periods ended December 31 (in thousands):

	2006			2005		2004
United States	$	(9,736	)	$	6,060	$	2,627
Foreign		15,422			13,223		11,524
Income before provision (benefit) for income taxes	$	5,686		$	19,283	$	14,151

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Our income tax provision (benefit) for 2006, 2005 and 2004 consists of the following (in thousands):

	2006			2005			2004
Current:
Federal	$	3,670		$	1,681		$	1,174
State		149			37			6
Foreign		2,757			1,374			812
Total current		6,576			3,092			1,992
Deferred:
Federal		(3,984	)		(387	)		(2,375	)
State		(1,656	)		(1,910	)		—
Foreign		(154	)		(670	)		—
Total deferred		(5,794	)		(2,967	)		(2,375	)
Provision (benefit) for income taxes	$	782		$	125		$	(383	)

The provision (benefit) for income taxes differs from the amount computed by applying the statutory federal tax rate to income before tax as follows (in thousands):

	For the Years Ended December 31,
	2006			2005			2004
Federal tax at statutory rate	$	1,990		$	6,749		$	4,953
State taxes, net of federal benefit		(980	)		(90	)		6
Change in valuation allowance		—			(3,168	)		(6,117	)
Non deductible in-process research and development		630			—			—
Non deductible stock-based compensation		1,126			—
Other non deductible expenses		110			77			65
Alternative minimum income tax		—			—			1,172
Tax credits		(1,487	)		(1,967	)		(895	)
Foreign tax differential		(607	)		(1,476	)		400
Other		—			—			33
Total provision (benefit) for income taxes	$	782		$	125		$	(383	)

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PACKETEER, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The components of the deferred tax assets at December 31 are set forth below (in thousands):

	2006			2005
Deferred tax assets:
Various accruals, reserves and other temporary differences not deductible for tax purposes	$	7,357		$	3,326
Property and equipment		1,298			540
Net operating loss carryforwards		22,845			10,978
Tax credit carryforwards		9,509			6,864
Gross deferred tax assets		41,009			21,708
Deferred tax liabilities:
Intangible assets related to acquisition		(2,690	)		—
Gross deferred tax liabilities		(2,690	)		—
Total gross net deferred tax assets		38,319			21,708
Valuation allowance		(17,961	)		(16,368	)
Net deferred tax assets	$	20,358		$	5,340

Net current deferred tax assets of $1.1 million and $0.7 million are included in prepaids and other current assets at December 31, 2006 and 2005, respectively. Net long-term deferred tax assets of $19.2 million and $4.6 million are included in other non-current assets at December 31, 2006 and 2005, respectively. A valuation allowance has been provided to reduce the deferred tax asset to an amount management believes is more likely than not to be realized. Expected realization of deferred tax assets for which a valuation allowance has not been recognized is based upon the reversal of existing taxable temporary differences and taxable income expected to be generated in the future. The net change in the total valuation allowance in 2006 was an increase of $1.6 million, which is comprised of an increase in valuation allowance of $1.7 million for deferred tax assets related to the acquisition of Tacit, offset by a $0.1 million release of valuation allowance for deferred taxes attributable to employee stock deductions. The net change in the total valuation allowance in 2005 was a decrease of $2.5 million, which is comprised of a release of valuation allowance of $3.2 million, partially offset by an increase in valuation allowance for deferred tax assets attributable to employee stock option deductions. The net change in the total valuation allowance in 2004 was a decrease of $5.8 million, of which $2.4 million related to release of valuation allowance and $3.7 million related to the utilization of net operating loss carryforwards that previously had valuation allowances established against them.

Approximately $16.3 million of the valuation allowance for deferred tax assets is attributable to employee stock option deductions, the benefit from which will be allocated to additional paid-in capital when, and if, it is subsequently realized. Approximately $1.7 million of the valuation allowance is attributable to Tacit pre-acquisition net operating losses and research credits, the benefit from which will be allocated to goodwill when, and if, it is subsequently realized.

Deferred tax liabilities have not been recognized for undistributed earnings of foreign subsidiaries because it is management’s intention to indefinitely reinvest such undistributed earnings outside the U.S.

At December 31, 2006, the Company has net operating loss carryforwards for federal, California and New Jersey income tax purposes of approximately $58.5 million, $10.0 million and $28.6 million, respectively. If not utilized, the federal net operating loss carryforwards will begin to expire in 2020, and the California net operating loss carryforwards will begin to expire in 2012 and the New Jersey net operating loss carryforwards will begin to expire in 2010. At December 31, 2006, the Company had federal, California, New Jersey and Canadian research credit carryforwards of approximately $4.2 million, $4.2 million, $0.1 million and $0.8 million, respectively. If not

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PACKETEER, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

utilized, the federal research credit carryforwards will begin to expire in 2011. The California research credit carryforwards can be carried forward indefinitely. The New Jersey research credit carryforward will begin to expire in 2020. The Canadian research credits will begin to expire in 2015.

The Company’s income taxes payable for federal, state and foreign purposes have been reduced by the tax benefits from employee stock options. The Company receives an income tax benefit calculated as the difference between the fair market value of the stock issued at the time of exercise and the option price, tax effected. The net tax benefits from employee stock option transactions were $2.8 million in 2006, of which $0.7 million consisted of tax benefits from employee stock option transactions related to fully vested options assumed in the acquisition of Tacit and were reflected as a decrease to goodwill and $2.1 million were reflected as an increase to addition paid-in capital in the Consolidated Statements of Shareholders’ Equity. The net tax benefits from employee stock option transactions were $1.2 million in 2005, all of which were reflected as an increase to additional paid-in capital. No tax benefits from employee stock option transactions were recorded in 2004.

The Company is undergoing an examination by the Internal Revenue Service for its 2003 and 2004 tax returns, primarily related to our intercompany transfer pricing. Management believes that adequate amounts have been accrued for potential adjustments resulting from the examination.

7.   STOCKHOLDERS’ EQUITY

PREFERRED AND COMMON STOCK

The Company’s Board of Directors has authorized 5,000,000 shares of preferred stock. The authorized preferred stock shares are undesignated and the Board has the authority to issue and to determine the rights, preference and privileges thereof.

The Company’s Board of Directors has authorized 85,000,000 shares of common stock.

WARRANTS

As of December 31, 2006, 45,000 warrants to purchase common stock were outstanding and exercisable with a $6.25 exercise price per share and an expiration date in May 2009.

1999 STOCK INCENTIVE PLAN

In May 1999, the Company’s Board of Directors adopted and its stockholders approved the 1999 Stock Incentive Plan (1999 Plan), which became effective on July 27, 1999, and serves as the successor program to its 1996 Equity Incentive Plan (the predecessor plan). All options outstanding under the Predecessor Plan on the effective date were incorporated into the 1999 Plan and were treated as outstanding options under the 1999 Plan. The number of shares reserved under the 1999 Plan automatically increases annually beginning on January 1, 2000 by the lesser of three million shares or 5% of the total number of shares of common stock outstanding. Under the 1999 Plan, the Company may grant incentive or nonstatutory stock options, stock appreciation rights, restricted stock purchase rights and bonuses, restricted stock units, performance shares and performance units to eligible participants, including its officers, other key employees, our non-employee directors and certain consultants. The 1999 Plan is generally administered by the Compensation Committee of the Board of Directors, which sets the terms and conditions of the options and other awards. Non-statutory stock options and incentive stock options are exercisable at prices not less than 85% and 100%, respectively, of the fair value on the date of grant. The options become 25% vested one year after the date of grant with 1/48 per month vesting thereafter and expire at the end of 10 years from date of grant or sooner if terminated by the Board of Directors. As of December 31, 2006, an aggregate of approximately 14.7 million shares have been reserved under the 1999 Plan, of which approximately 3.2 million were available for future grant.

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PACKETEER, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

STOCK OPTIONS ASSUMED IN ACQUISITION

In connection with the acquisition of Tacit, the Company assumed all the then outstanding options to purchase Tacit common stock granted under their 2000 Equity Incentive Plan, and converted those into options to purchase approximately 320,000 shares of the Company’s common stock, of which approximately 90,000 were outstanding and approximately 59,000 were unvested as of December 31, 2006. In most circumstances, these options become fully vested upon involuntary termination.

A summary of stock option activity under stock option plans follows (in thousands, except per share data):

				Options Outstanding
									Weighted
							Weighted		Average
							Average		Remaining		Aggregate
	Available						Exercise		Contractual		Intrinsic
	for Grant			Shares			Price		Term (Years)		Value
	(In thousands, except per share amounts)
Options outstanding as of December 31, 2003		2,174			4,729		$	9.51
Shares made available for grant		1,625			—
Granted		(2,337	)		2,337			16.03
Exercised		—			(510	)		5.74
Cancelled		898			(898	)		14.17
Options outstanding as of December 31, 2004		2,360			5,658			11.80
Shares made available for grant		1,671			—
Granted		(1,750	)		1,750			12.95
Exercised		—			(490	)		6.20
Cancelled		589			(589	)		14.23
Options outstanding as of December 31, 2005		2,870			6,329			12.33
Shares made available for grant		1,710			—
Options assumed(a)					320			1.28
Granted		(2,594	)		2,594			10.68
Exercised		—			(888	)		5.16
Cancelled/forfeited/expired		1,193			(1,206	)		12.98
Options outstanding at December 31, 2006		3,179			7,149			12.01		7.43	$	21,390
Options vested and expected to vest at December 31, 2006					6,553			12.09		7.28	$	19,838
Options exercisable at December 31, 2006					3,768			12.46		6.17	$	12,951

(a) Represents activity related to options that were assumed as a result of the acquisition of Tacit in May 2006. See Note 2 for additional information.

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PACKETEER, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following table summarizes significant ranges of outstanding and exercisable options as of December 31, 2006 (in thousands, except years and per-share amounts):

					Options Exercisable
	Options Outstanding				Weighted-				Weighted-
			Weighted-		Average				Average
			Average		Exercise				Exercise
	Number		Remaining		Price per		Number		Price per
Range of Exercise Prices	Outstanding		Contractual Life		Share		Exercisable		Share
			(In years)
$ 0.19 - 4.71		810		5.51	$	3.67		751	$	3.79
4.75 - 8.36		880		6.12		7.52		695		7.34
8.37 - 9.51		1,125		9.09		9.43		18		9.09
9.54 - 12.03		1,279		8.43		11.53		316		11.07
12.05 - 13.81		727		8.14		12.71		358		12.60
13.87 - 14.00		738		8.07		14.00		384		14.00
14.01 - 18.10		943		6.68		16.03		731		16.05
18.49 - 20.77		517		7.08		19.39		385		19.39
48.06		130		3.07		48.06		130		48.06
Total		7,149		7.43		12.01		3,768		12.46

As of December 31, 2006 and 2005, there were approximately 9,000 non-plan options outstanding with a weighted average exercise price of $0.25 per share, all of which expire in October 2007.

1999 EMPLOYEE STOCK PURCHASE PLAN

In May 1999, the Company’s Board of Directors adopted the 1999 Employee Stock Purchase Plan (ESPP). The ESPP became effective July 27, 1999. The number of shares reserved under the ESPP automatically increases annually beginning on January 1, 2000 by the lesser of one million shares or 2% of the total number of shares of common stock outstanding. The ESPP permits participants to purchase common stock through payroll deductions of up to 15% of an employee’s compensation, including commissions, overtime, bonuses and other incentive compensation. Purchases are limited to a maximum of 1,000 shares for an individual employee for each purchase period. The purchase price per share is equal to 85% of the fair market value per share on the participant’s entry date into the offering period or, if lower, 85% of the fair market value per share on the semi-annual purchase date. As of December 31, 2006, approximately 4.8 million shares had been reserved under the plan and approximately 3.2 million were available for future issuance. During 2006, 2005 and 2004, approximately 315,000, 299,000 and 297,000 shares were issued under the ESPP during 2006.

RESTRICTED STOCK ISSUED IN ACQUISITION

In connection with the acquisition of Mentat, the Company issued approximately 114,000 restricted shares valued at $1.7 million, however, approximately 4,000 shares valued at $59,000 were repurchased on the date of acquisition due to employee terminations. The value of the shares was determined based on the fair value of the Company’s stock at the date of issuance. Under the terms of the related shareholder agreements, the shares vest in equal installments, one-third one year from the date of acquisition, one-third on the second anniversary of the acquisition and one-third on the third anniversary of the acquisition, so long as the employee is still employed by Packeteer on the anniversary date. During 2005, approximately 10,000 of these restricted shares were repurchased by the Company due to terminations, according to the terms of the shareholder agreements. In 2006 and 2005, approximately 48,000 and approximately 34,000 shares vested, respectively, including approximately 29,000 shares in 2006 that became immediately vested upon employee terminations. At December 31, 2006, there were approximately 18,000 restricted shares outstanding.

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PACKETEER, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

8.   401(k) PLAN

In 1997, the Company adopted a 401(k) plan (“401(k)”). Participation in the 401(k) is available to all employees. Entry date to the 401(k) is the first day of each month. Each participant may elect to contribute an amount up to 100% of his or her annual base salary plus commission and bonus, but not to exceed the statutory limit as prescribed by the Internal Revenue Code. The Company may make discretionary contributions to the 401(k). To date, no contributions have been made by the Company.

9.   SEGMENT REPORTING

The Company’s chief operating decision maker is considered to be the Company’s CEO. The CEO reviews financial information presented on a consolidated basis substantially similar to the consolidated financial statements. Therefore, the Company has concluded that it operates in one segment and accordingly has provided only the required enterprise-wide disclosures.

The Company operates in the United States and internationally and derives its revenue from the sale of products and software licenses and maintenance contracts related to the Company’s products. Sales outside of the Americas accounted for 53%, 53% and 59% of net revenues in 2006, 2005, and 2004, respectively.

Geographic information is as follows (in thousands):

	Years Ended December 31,
	2006		2005		2004
Net revenues:
Americas	$	67,614	$	52,604	$	37,934
Asia Pacific		35,284		27,715		24,963
Europe, Middle East, Africa		42,225		32,622		29,540
Total net revenues	$	145,123	$	112,941	$	92,437

Net revenues reflect the destination of the product shipped. The Americas net revenue includes sales into Canada, Latin America and South America, which in total accounted for 3%, 5% and 3% of total net revenues in 2006, 2005 and 2004, respectively.

Long-lived assets are primarily located in North America. Long-lived assets located outside North America are not significant.

10.   SUBSEQUENT EVENT

In January 2007, the Company entered into an amendment to the facility lease for its headquarters in Cupertino, California that extends the term of the lease to December 2014 (with certain options to extend). Under the terms of this amendment, the premises subject to the lease will be expanded in December 2007. The lease payments under the amended lease will be approximately $2.6 million per year, with a total commitment of $19 million over the extended lease term.

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

Not Applicable.

ITEM 9A.   CONTROLS AND PROCEDURES

(a)   Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on this evaluation, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures as of December 31, 2006, were ineffective to ensure that the information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

(b)   Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness (within the meaning of PCAOB Auditing Standard No. 2) is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2006, and this assessment identified material weaknesses in our internal control over financial reporting related to our (1) accounting for income taxes and (2) rebate reserves. Specifically, (i) we did not maintain effective controls to provide for the reconciliation of the income taxes payable account to supporting detail and the review of the income taxes payable account reconciliation by someone other than the preparer; and (ii) we did not maintain effective controls over the review of the rebate reserves as the review was not appropriately designed, nor was the review conducted in sufficient detail. These deficiencies resulted in a material misstatement of our income taxes payable and the rebate reserves, which were adjusted prior to the issuance of our 2006 consolidated financial statements.

In making its assessment of internal control over financial reporting, management used the criteria issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO, in “Internal Control-Integrated Framework”. Because of the material weaknesses described above, management’s conclusion is that we did not maintain effective internal control over financial reporting as of December 31, 2006.

Our independent registered public accounting firm has issued an attestation report on management’s assessment of our internal control over financial reporting. That report is included herein under Item 8.

(c)   Changes in Internal Control Over Financial Reporting

There has been no change in our internal control over financial reporting during the three months ended December 31, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. In order to remediate the material weaknesses described above, we are implementing revised

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policies and procedures pertaining to income taxes payable and rebate accruals and increasing the size and training of our financial staff.

ITEM 9B.   OTHER INFORMATION

Not Applicable.

PART III

Item 10.   Directors and Executive Officers of the Registrant

The information required by this item with respect to identification of directors is incorporated by reference to the information contained in the section captioned “Proposal No. 1: Election of Directors” in the Proxy Statement. For information with respect to identification of our executive officers is incorporated by reference to the information contained in the section captioned “Executive Officers” in the Proxy Statement. Information with respect to Items 405, 406, 407(c)(3), (d)(4) and (d)(5) of Regulation S-K is incorporated by reference to the information contained in the sections captioned “Section 16(a) Beneficial Ownership Reporting Compliance” and “Corporate Governance” in the Proxy Statement.

Item 11.   Executive Compensation

The information required by Item 402 of Regulation S-K is incorporated herein by reference to the information contained in the section captioned “Executive Compensation” in the Proxy Statement. The information required by Items 407(e)(4) and (e) (5) of Regulation S-K is incorporated by reference to the information contained in the sections captioned “Compensation Committee Interlocks and Insider Participation,” and “Compensation Committee Report,” respectively, of the Proxy Statement.

Item 12.   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information required by this Item is incorporated herein by reference to the information contained in the sections captioned “Stock Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information” in the Proxy Statement.

Item 13.   Certain Relationships and Related Transactions

The information required by this Item is incorporated herein by reference to the information contained in the section captioned “Certain Relationships and Related Transactions” “and “Corporate Governance” in the Proxy Statement.

Item 14.   Principal Accounting Fees and Services

The information required by this Item is incorporated herein by reference to the information contained in the section captioned “Proposal No. 2: Ratification of Appointment of Independent Registered Public Accounting Firm” in the Proxy Statement.

PART IV

ITEM 15.   EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a)(1) Financial Statements

See the Consolidated Financial Statements beginning on page 42 of this Form 10-K.

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(2) Financial Statement Schedule

All financial statement schedules are omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes.

(3) Exhibits

See the Exhibit Index at page 79 of this Form 10-K.

(b) See the Exhibit Index at page 79 of this Form 10-K.

(c) See the Consolidated Financial Statements beginning on page 42.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Cupertino, State of California, on this 15^th day of March 2007.

PACKETEER, INC.

By:  /s/  DAVE CÔTÉ

Dave Côté

President and Chief Executive Officer

Date: March 15, 2007

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints, jointly and severally, Dave Côté and David Yntema, and each of them acting individually, as his attorney-in-fact, each with full power of substitution and resubstitution, for him or her in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K (including post-effective amendments), and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact, or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Name	Title	Date
/s/  DAVE CÔTÉ Dave Côté	President and Chief Executive Officer (Principal Executive Officer) and Director	March 15, 2007
/s/  DAVID YNTEMA David Yntema	Chief Financial Officer and Secretary (Principal Financial and Accounting Officer)	March 15, 2007
/s/  STEVEN CAMPBELL Steven Campbell	Chairman of the Board of Directors	March 15, 2007
/s/  CRAIG ELLIOTT Craig Elliott	Director	March 15, 2007
/s/  JOSEPH GRAZIANO Joseph Graziano	Director	March 15, 2007
/s/  L. WILLIAM KRAUSE L. William Krause	Director	March 15, 2007

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Name	Title	Date
/s/  BERNARD MATHAISEL Bernard Mathaisel	Director	March 15, 2007
/s/  PETER VAN CAMP Peter Van Camp	Director	March 15, 2007
/s/  GREGORY MYERS Gregory Myers	Director	March 15, 2007

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EXHIBIT INDEX

Exhibit
Number			Description
	3	.1(2)	Registrant’s Amended and Restated Certificate of Incorporation.
	3	.3(4)	Registrant’s Amended and Restated Bylaws.
	4	.1(2)	Form of Registrant’s Specimen Common Stock Certificate.
	10	.8(2)*	Registrant’s 1996 Equity Incentive Plan.
	10	.9(2)*	Registrant’s 1999 Stock Incentive Plan.
	10	.10(2)*	Registrant’s 1999 Employee Stock Purchase Plan.
	10	.11(2)*	Form of Indemnity Agreement entered into by Packeteer, Inc. with each of its executive officers and directors.
	10	.21(3)*	Amendment dated May 23, 2001 to the 1999 Stock Incentive Plan.
	10	.22(4)*	Amendment dated May 22, 2002 to the 1999 Stock Incentive Plan.
	10	.23(4)	Facilities Lease Agreement dated July 15, 2003, between NMSPCSLDHB, a California Limited Partnership, and Packeteer, Inc.
	10	.24(5)*	Employment Agreement dated September 27, 2002 between Dave Côté and Packeteer, Inc.
	10	.25(6)*	Amendment dated July 16, 2003 to the 1999 Employee Stock Purchase Plan.
	10	.26(7)*	Amendment dated December 15, 2004 to the 1999 Stock Incentive Plan.
	10	.27(7)	Agreement and Plan of Reorganization by and among Packeteer, Inc., P Acquisition Corporation, Mentat Inc. and Certain Shareholders of Mentat Inc.
	10	.29(8)*	Amendment dated February 24, 2005 to the 1999 Employee Stock Purchase Plan.
	10	.30(9)*	Amendment dated May 24, 2005 to the 1999 Stock Incentive Plan.
	10	.31(10)	Agreement and Plan of Reorganization by and among Packeteer, Inc., Oslo Acquisition Corporation, Tacit Networks, Inc. and Vikram Gupta dated May 8, 2006.
	10	.32(1)*	Form of Notice of Grant and Performance Share Agreement under 1999 Stock Incentive Plan.
	10	.33(1)	First Amendment of Lease dated January 31, 2007, between NMSPCSLDHB, a California Limited Partnership, and Packeteer, Inc.
	10	.34(1)*	Amendment dated February 5, 2007 to the 1999 Stock Incentive Plan.
	21	.1(1)	Subsidiaries of Packeteer.
	23	.1(1)	Consent of KPMG LLP, Independent Registered Public Accounting Firm.
	24	.1(1)	Power of Attorney (see page 77).
	31	.1(1)	Sarbanes-Oxley Section 302 Certification — CEO
	31	.2(1)	Sarbanes-Oxley Section 302 Certification — CFO
	32	.1(1)	Sarbanes-Oxley Section 906 Certification — CEO
	32	.2(1)	Sarbanes-Oxley Section 906 Certification — CFO

*	Management contract, or compensatory plan or arrangement.
(1)	Filed herewith.
(2)	Incorporated by reference from Packeteer’s Registration Statement on Form S-1 (Reg. No. 79333-79077), as amended.
(3)	Incorporated by reference from Packeteer’s 10-K dated March 22, 2002.
(4)	Incorporated by reference from Packeteer’s 10-K dated March 29, 2001.
(5)	Incorporated by reference from Packeteer’s 10-K dated March 21, 2003.
(6)	Incorporated by reference from Packeteer’s 10-K dated March 5, 2004.
(7)	Incorporated by reference from Packeteer’s 10-K dated March 16, 2005.
(8)	Incorporated by reference from Packeteer’s 10-Q dated April 29, 2005.
(9)	Incorporated by reference from Packeteer’s 8-K dated May 26, 2005.
(10)	Incorporated by reference from Packeteer’s 10-Q dated August 9, 2006.

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EX-10.32

Exhibit 10.32

PACKETEER, INC.
NOTICE OF GRANT OF PERFORMANCE SHARES
(For U.S. Participant)

The Participant has been granted an award of Performance Shares (the “Award”) pursuant to the Packeteer, Inc. 1999 Stock Incentive Plan (the “Plan”) and the Performance Share Agreement attached hereto (the “Agreement”), each of which represents the right to receive on the Settlement Date one (1) share of Common Stock, as follows:

Participant:		Employee ID:
Grant Date:		Grant No.:
Target Number of Performance Shares:	[_______________], subject to adjustment as provided by the Agreement.
Maximum Number of Performance Shares:	[_______________], subject to adjustment as provided by the Agreement. [Not to exceed 750,000 shares for 3-year Performance Period]
Performance Period:	The three fiscal years of the Corporation beginning January 1, 2007 and ending December 31, 2009.
Performance Measures:	Revenue Growth Percentage, as defined by the Agreement. Average Operating Income Margin Percentage, as defined by the Agreement.
Vesting Date:	[_______________], 2010, except as provided by the Agreement.
Vested Performance Shares:	Except as provided by the Agreement, and provided that the Participant’s Service has not terminated prior to the Vesting Date, on the Vesting Date the number of Vested Performance Shares (not to exceed the Maximum Number of Performance Shares) shall be determined by multiplying the Target Number of Performance Shares by the product of the Revenue Growth Percentage Multiplier (as defined by the Agreement) and the Average Operating Income Margin Percentage Multiplier (as defined by the Agreement).
Settlement Date:	The Vesting Date, except as otherwise provided by the Agreement.

By their signatures below or by electronic acceptance or authentication in a form authorized by the Corporation, the Corporation and the Participant agree that the Award is governed by this Notice and by the provisions of the Plan and the Agreement, both of which are made a part of this document. The Participant acknowledges that copies of the Plan, the Agreement and the prospectus for the Plan are available on the Corporation’s internal web site and may be viewed and printed by the Participant for attachment to the Participant’s copy of this Grant Notice. The Participant represents that the Participant has read and is familiar with the provisions of the Plan and the Agreement, and hereby accepts the Award subject to all of their terms and conditions.

PACKETEER, INC.		PARTICIPANT
By:
		Signature
Its:
		Date
Address:  10201 North de Anza Boulevard
	Cupertino, CA 95014, USA	Address

ATTACHMENTS: 1999 Stock Incentive Plan, as amended to the Grant Date; Performance Share Agreement and Plan Prospectus

PACKETEER, INC.
PERFORMANCE SHARE AGREEMENT
(For U.S. Participants)

     Packeteer, Inc. has granted to the Participant named in the Notice of Grant of Performance Shares (the “Grant Notice”) to which this Performance Share Agreement (the “Agreement”) is attached an Award consisting of Performance Shares subject to the terms and conditions set forth in the Grant Notice and this Agreement. The Award has been granted pursuant to the Packeteer, Inc. 1999 Stock Incentive Plan (the “Plan”), as amended to the Grant Date, the provisions of which are incorporated herein by reference. By signing the Grant Notice, the Participant: (a) acknowledges receipt of and represents that the Participant has read and is familiar with the Grant Notice, this Agreement, the Plan and a prospectus for the Plan (the “Plan Prospectus”) in the form most recently prepared in connection with the registration with the Securities and Exchange Commission of shares issuable pursuant to the Plan, (b) accepts the Award subject to all of the terms and conditions of the Grant Notice, this Agreement and the Plan and (c) agrees to accept as binding, conclusive and final all decisions or interpretations of the Plan Administrator upon any questions arising under the Grant Notice, this Agreement or the Plan.

     1. Definitions and Construction.

          1.1 Definitions. Unless otherwise defined herein, capitalized terms shall have the meanings assigned to such terms in the Grant Notice or the Plan.

               (a) “Average Operating Income Margin Percentage” means a percentage equal to the annual average for the Performance Period of the Pro Forma Annual Operating Income Margin determined for each fiscal year of the Corporation contained in the Performance Period and certified by the Plan Administrator in accordance with Section 4.

               (b) “Average Operating Income Margin Percentage Multiplier” means a number determined as follows:

Average Operating Income	Average Operating Income Margin
Margin Percentage	Percentage Multiplier
Less than 12.0%	0.00
12.0%	0.75
Equal to or greater than 15%	1.00

The Average Operating Income Margin Percentage Multiplier for Average Operating Income Margin Percentages falling between the percentages set forth in the table above shall be determined by linear interpolation.

               (c) “Cause” means the occurrence of any of the following: (1) Participant’s theft, dishonesty, misconduct, breach of fiduciary duty for personal profit, or falsification of any documents or records of the Corporation; (2) Participant’s material failure to abide by the code of conduct or other policies (including, without limitation, policies relating to confidentiality and reasonable workplace conduct) of the Corporation; (3) misconduct by Participant within the scope of Section 304 of the Sarbanes-Oxley Act of 2002 as a result of which of the Corporation is required to prepare an accounting restatement; (4) Participant’s unauthorized use, misappropriation, destruction or diversion of any tangible or intangible asset or corporate opportunity of the Corporation (including, without limitation, Participant’s improper use or disclosure of the confidential or proprietary information of the Corporation); (5) any intentional act by Participant which has a material detrimental effect on reputation or business of the Corporation; (6) Participant’s repeated failure or inability to perform any reasonable assigned duties after written notice from the Corporation of, and a reasonable opportunity to cure, such failure or inability; (7) any material breach by Participant of any employment, non-disclosure, non-competition, non-solicitation or other similar agreement between Participant and the Corporation, which breach is not cured pursuant to the terms of such agreement; (8) Participant’s failure to cooperate in any investigation by the Corporation that has been approved by the Board or the Audit Committee of the Board; or (9) Participant’s conviction (including any plea of guilty or nolo contendere) of any criminal act involving fraud, dishonesty, misappropriation or moral turpitude, or which impairs Participant’s ability to perform his duties with the Corporation.

               (d) “Disability” means either (1) the inability of Participant to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous period of not less than twelve (12) months, or (2) Participant is, by reason of any medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous period of not less than twelve (12) months, receiving income replacement benefits for a period of not less than three (3) months under an accident and health plan covering employees of Participant’s employer accident and health plan covering employees of Participant’s employer.

               (e) “ Involuntary Termination of Service” means the involuntary termination by the Corporation (or its successor) of the Service of the Participant for reasons other than Cause; provided, however, that Involuntary Termination of Service shall not include any voluntary termination or any termination of Participant’s employment which is a result of Participant’s death or Disability.

               (f) “Operating Income” means the operating income of the Corporation for a fiscal year of the Corporation determined in accordance with generally accepted accounting principles but prior to the accrual or payment of any Performance Award (as defined by the Plan) for the Performance Period.

               (g) “Performance Share” means a right to receive on the Settlement Date one (1) share of Common Stock if such Performance Share is then a Vested Performance Share.

               (h) “Plan Administrator” shall mean the Primary Committee (as defined by the Plan).

               (i) “Pro Forma Annual Operating Income Margin” means, for each fiscal year of the Corporation contained in the Performance Period, a percentage determined by dividing the Pro Forma Operating Income for such fiscal year by the Revenue for such fiscal year.

               (j) “Pro Forma Operating Income” means, for each fiscal year of the Corporation contained in the Performance Period, the Operating Income of the Corporation for such fiscal year, adjusted to exclude (i) amortization of purchased intangible assets, (ii) in-process research and development expense, (iii) stock-based compensation expense from acquisitions and (iv) stock-based compensation expense determined in accordance with Statement of Financial Accounting Standards No. 123 (revised 2004).

               (k) “Revenue” means the total revenue of the Corporation for a fiscal year of the Corporation determined in accordance with generally accepted accounting principles.

               (l) “Revenue Growth Percentage” means a percentage equal to the Three-Year Annual Revenue Compound Annual Growth Rate measured over the Performance Period and certified by the Plan Administrator in accordance with Section 4.

               (m) “Revenue Growth Percentage Multiplier” means a number determined as follows:

Revenue Growth Percentage	Revenue Growth Percentage Multiplier
Less than 15.0%	0.00
15.0%	0.75
18.0%	1.00
20.0%	1.25
25.0%	1.50
30.0%	2.00
Equal to or greater than 35%	2.50

The Revenue Growth Percentage Multiplier for Revenue Growth Percentages falling between the percentages set forth in the table above shall be determined by linear interpolation.

2

               (n) “Three-Year Annual Revenue Compound Annual Growth Rate” means a percentage determined by the following formula: [(FY09 Revenue/FY06 Revenue)^(1/3)] — 1, where, “FY09 Revenue” means the Revenue of the Corporation for the fiscal year of the Corporation ending December 31, 2009 and “FY06 Revenue” means the Revenue of the Corporation for the fiscal year of the Corporation ending December 31, 2006.

          1.2 Construction. Captions and titles contained herein are for convenience only and shall not affect the meaning or interpretation of any provision of this Agreement. Except when otherwise indicated by the context, the singular shall include the plural and the plural shall include the singular. Use of the term “or” is not intended to be exclusive, unless the context clearly requires otherwise.

     2. Administration.

          All questions of interpretation concerning the Grant Notice, this Agreement and the Plan shall be determined by the Plan Administrator. All determinations by the Plan Administrator shall be final and binding upon all persons having an interest in the Award. Any officer of the Corporation shall have the authority to act on behalf of the Corporation with respect to any matter, right, obligation, or election which is the responsibility of or which is allocated to the Corporation herein, provided that such officer has apparent authority with respect to such matter, right, obligation, or election. If the Participant is a Covered Employee (as defined by the Plan), compensation realized by the Participant pursuant to the Award is intended to constitute qualified performance-based compensation within the meaning of Section 162(m) of the Code and the regulations thereunder, and the provisions of this Agreement shall be construed and administered in a manner consistent with this intent.

     3. The Award.

          3.1 Grant of Performance Shares. On the Grant Date, the Participant shall acquire, subject to the provisions of this Agreement, a right to receive a number of Performance Shares which shall not exceed the Maximum Number of Performance Shares set forth in the Grant Notice, subject to adjustment as provided in Section 10. The number of Performance Shares, if any, ultimately earned by the Participant, shall be that number of Performance Shares which become Vested Performance Shares.

          3.2 No Monetary Payment Required. The Participant is not required to make any monetary payment (other than applicable tax withholding, if any) as a condition to receiving the Performance Shares or shares of Common Stock issued upon settlement of the Performance Shares, the consideration for which shall be past services actually rendered and/or future services to be rendered to the Corporation (or any Parent or Subsidiary) or for its benefit. Notwithstanding the foregoing, if required by applicable state corporate law, the Participant shall furnish consideration in the form of cash or past services rendered to the Corporation (or any Parent or Subsidiary) or for its benefit having a value not less than the par value of the shares of Common Stock issued upon settlement of the Performance Shares.

3

     4. Certification of Plan Administrator.

          4.1 Level of Performance Measures Attained. As soon as practicable following completion of the Performance Period, and in any event prior to the Vesting Date, the Plan Administrator shall certify in writing the level of attainment of the Performance Measures during the Performance Period and the resulting number of Performance Shares which shall become Vested Performance Shares on the Vesting Date, subject to the Participant’s continued Service until the Vesting Date. The Corporation shall promptly notify the Participant of the determination by the Plan Administrator.

          4.2 Adjustment to Performance Measures for Extraordinary Items. The Plan Administrator shall adjust one or both of the Performance Measures, as it deems appropriate, to exclude the effect (whether positive or negative) of any of the following occurring after the grant of the Award: (a) a change in accounting standards required by generally accepted accounting principles, (b) a merger with or acquisition of any other business entity or business assets, (c) restructurings, discontinued operations, extraordinary items or other unusual or non-recurring charges, (d) an event either not directly related to the operations of the Corporation or not within the reasonable control of the Corporation’s management or (e) changes in applicable laws or regulations affecting the Corporation. Each such adjustment, if any, shall be made solely for the purpose of providing a consistent basis from period to period for the calculation of Performance Measures in order to prevent the dilution or enlargement of the Participant’s rights with respect to the Award.

     5. Vesting of Performance Shares.

          5.1 In General. Except as provided by this Section and Section 9, the Performance Shares shall vest and become Vested Performance Shares as provided in the Grant Notice and certified by the Plan Administrator.

          5.2 Effect of Leave of Absence. Unless otherwise required by law, in event that the Participant has taken in excess of thirty (30) days in unpaid leaves of absence during the Performance Period, the number of Performance Shares determined to be Vested Performance Shares, if any, shall be prorated on the basis of the number of days of the Participant’s Service during the Performance Period during which the Participant was not on an unpaid leave of absence.

          5.3 Effect of Involuntary Termination of Service Following a Corporate Transaction. In the event of the Involuntary Termination of Service of the Participant upon or within twelve (12) months following a Corporate Transaction in which the Performance Shares are assumed, continued or replaced by the Acquiror pursuant to Section 9 and prior to the Vesting Date, then a number of Performance Shares equal to the product of the Target Number of Performance Shares, as adjusted pursuant to Section 10 in connection with the Corporate Transaction, and the greater of (a) fifty percent (50%) or (b) the percentage that the number of days elapsed from the commencement of the Performance Period to the date of such Involuntary Termination bears to the total number of days contained in the Performance Period shall be accelerated and shall be deemed Vested Performance Shares effective as of the date of such termination of Service, and the Award shall be settled in full in accordance with Section 7

4

immediately upon the date of such termination of Service, which shall be deemed the Settlement Date for this purpose. This Section 5.3 shall govern exclusively the vesting of the Award in the event of a termination of the Participant’s Service upon or following a Corporate Transaction or Change in Control.

     6. Termination of Service; Forfeiture of Unvested Performance Shares.

          Except as provided by Section 5.3 and Section 9, in the event that the Participant’s Service terminates prior to the Vesting Date for any reason or no reason, with or without cause, the Participant shall forfeit and the Corporation shall automatically reacquire all Performance Shares subject to this Award. On the Vesting Date, the Participant shall forfeit and the Corporation shall automatically reacquire all Performance Shares which have not become Vested Performance Shares. The Participant shall not be entitled to any payment for such forfeited Performance Shares.

     7. Settlement of the Award.

          7.1 Issuance of Shares of Common Stock. Subject to the provisions of Section 7.3 below, the Corporation shall issue to the Participant on the Settlement Date with respect to each Vested Performance Share one (1) share of Common Stock. Shares of Common Stock issued in settlement of Performance Shares shall not be subject to any restriction on transfer other than any such restriction as may be required pursuant to Section 7.3, Section 8 or the Corporation’s Insider Trading Policy.

          7.2 Beneficial Ownership of Shares; Certificate Registration. The Participant hereby authorizes the Corporation, in its sole discretion, to deposit for the benefit of the Participant with any broker with which the Participant has an account relationship of which the Corporation has notice any or all shares acquired by the Participant pursuant to the settlement of the Award. Except as provided by the preceding sentence, a certificate for the shares as to which the Award is settled shall be registered in the name of the Participant, or, if applicable, in the names of the heirs of the Participant.

          7.3 Restrictions on Grant of the Award and Issuance of Shares. The grant of the Award and issuance of shares of Common Stock upon settlement of the Award shall be subject to compliance with all applicable requirements of federal, state law or foreign law with respect to such securities. No shares of Common Stock may be issued hereunder if the issuance of such shares would constitute a violation of any applicable federal, state or foreign securities laws or other law or regulations or the requirements of any stock exchange or market system upon which the Common Stock may then be listed. The inability of the Corporation to obtain from any regulatory body having jurisdiction the authority, if any, deemed by the Corporation’s legal counsel to be necessary to the lawful issuance of any shares subject to the Award shall relieve the Corporation of any liability in respect of the failure to issue such shares as to which such requisite authority shall not have been obtained. As a condition to the settlement of the Award, the Corporation may require the Participant to satisfy any qualifications that may be necessary or appropriate, to evidence compliance with any applicable law or regulation and to

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make any representation or warranty with respect thereto as may be requested by the Corporation.

          7.4 Fractional Shares. The Corporation shall not be required to issue fractional shares upon the settlement of the Award. Any fractional share resulting from the determination of the number of Vested Performance Shares shall be rounded down to the nearest whole number.

     8. Tax Withholding.

          8.1 In General. At the time the Grant Notice is executed, or at any time thereafter as requested by the Corporation, the Participant hereby authorizes withholding from payroll and any other amounts payable to the Participant, and otherwise agrees to make adequate provision for, any sums required to satisfy the federal, state, local and foreign tax withholding obligations of the Corporation, if any, which arise in connection with the Award or the issuance of shares of Stock in settlement thereof. The Corporation shall have no obligation to process the settlement of the Award or to deliver shares until the tax withholding obligations as described in this Section have been satisfied by the Participant.

          8.2 Withholding in Shares. Subject to applicable law, the Corporation shall require the Participant to satisfy its tax withholding obligations by deducting from the shares of Common Stock otherwise deliverable to the Participant in settlement of the Award a number of whole shares having a fair market value, as determined by the Corporation as of the date on which the tax withholding obligations arise, not in excess of the amount of such tax withholding obligations determined by the applicable minimum statutory withholding rates.

     9. Corporate Transaction.

          9.1 Effect of Corporate Transaction on the Award. In the event of a Corporate Transaction, the surviving, continuing, successor, or purchasing entity or parent thereof, as the case may be (the “Acquiror”), may, without the consent of the Participant, either assume or continue the Corporation’s rights and obligations with respect to the outstanding Performance Shares or substitute for outstanding Performance Shares substantially equivalent rights with respect to the Acquiror’s stock. For purposes of this Section, a Performance Share shall be deemed assumed if, following the Corporate Transaction, the Performance Share confers the right to receive, subject to the terms and conditions of the Plan and this Agreement, the consideration (whether stock, cash, other securities or property or a combination thereof) to which a holder of a share of Common Stock on the effective date of the Corporate Transaction was entitled; provided, however, that if such consideration is not solely common stock of the Acquiror, the Board may, with the consent of the Acquiror, provide for the consideration to be received upon settlement of the Performance Share to consist solely of common stock of the Acquiror equal in Fair Market Value to the per share consideration received by holders of Common Stock pursuant to the Corporate Transaction. In the event the Acquiror elects not to assume, continue or substitute for the outstanding Performance Shares in connection with a Corporate Transaction, the vesting of 100% of the Target Number of Performance Shares shall be accelerated and shall be deemed Vested Performance Shares effective as of the date of the Corporate Transaction, and the Award shall be settled in full in accordance with Section 7

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immediately prior to the Corporate Transaction, provided that the Participant’s Service has not terminated prior to such date. The vesting of Performance Shares and settlement of the Award that was permissible solely by reason of this Section shall be conditioned upon the consummation of the Corporate Transaction.

          9.2 Federal Excise Tax Under Section 4999 of the Code.

               (a) Excess Parachute Payment. In the event that any acceleration of vesting the Performance Shares and any other payment or benefit received or to be received by the Participant would subject the Participant to any excise tax pursuant to Section 4999 of the Code due to the characterization of such acceleration of vesting, payment or benefit as an “excess parachute payment” under Section 280G of the Code, the Participant may elect, in his or her sole discretion, to reduce the amount of any acceleration of vesting called for by this Agreement in order to avoid such characterization.

               (b) Determination by Independent Accountants. To aid the Participant in making any election called for under Section 9.2(a), no later than the date of the occurrence of any event that might reasonably be anticipated to result in an “excess parachute payment” to the Participant as described in Section 9.2(a), the Corporation shall request a determination in writing by independent public accountants selected by the Corporation (the “Accountants”). As soon as practicable thereafter, the Accountants shall determine and report to the Corporation and the Participant the amount of such acceleration of vesting, payments and benefits which would produce the greatest after-tax benefit to the Participant. For the purposes of such determination, the Accountants may rely on reasonable, good faith interpretations concerning the application of Sections 280G and 4999 of the Code. The Corporation and the Participant shall furnish to the Accountants such information and documents as the Accountants may reasonably request in order to make their required determination. The Corporation shall bear all fees and expenses the Accountants may reasonably charge in connection with their services contemplated by this Section 9.2(b).

     10. Adjustments for Changes in Capital Structure.

          Subject to any required action by the stockholders of the Corporation, in the event of any change in the Common Stock effected without receipt of consideration by the Corporation, whether through merger, consolidation, reorganization, reincorporation, recapitalization, reclassification, stock dividend, stock split, reverse stock split, split-up, split-off, spin-off, combination of shares, exchange of shares, or similar change in the capital structure of the Corporation, appropriate adjustments shall be made in the number of Performance Shares subject to the Award and/or the number and kind of shares to be issued in settlement of the Award, in order to prevent dilution or enlargement of the Participant’s rights under the Award. For purposes of the foregoing, conversion of any convertible securities of the Corporation shall not be treated as “effected without receipt of consideration by the Corporation.” Any fractional share resulting from an adjustment pursuant to this Section shall be rounded down to the nearest whole number. Such adjustments shall be determined by the Plan Administrator, and its determination shall be final, binding and conclusive.

     11. Rights as a Stockholder or Employee.

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          The Participant shall have no rights as a stockholder with respect to any shares which may be issued in settlement of this Award until the date of the issuance of a certificate for such shares (as evidenced by the appropriate entry on the books of the Corporation or of a duly authorized transfer agent of the Corporation). No adjustment shall be made for dividends, distributions or other rights for which the record date is prior to the date such certificate is issued, except as provided in Section 10. If the Participant is an Employee, the Participant understands and acknowledges that, except as otherwise provided in a separate, written employment agreement between the Corporation or a Parent or Subsidiary and the Participant, the Participant’s employment is “at will” and is for no specified term. Nothing in this Agreement shall confer upon the Participant any right to continue in Service interfere in any way with any right of the Corporation or any Parent or Subsidiary to terminate the Participant’s Service at any time.

     12. Legends.

          The Corporation may at any time place legends referencing any applicable federal, state or foreign securities law restrictions on all certificates representing shares of Common Stock issued pursuant to this Agreement. The Participant shall, at the request of the Corporation, promptly present to the Corporation any and all certificates representing shares acquired pursuant to this Award in the possession of the Participant in order to carry out the provisions of this Section.

     13. Miscellaneous Provisions.

          13.1 Termination or Amendment. The Plan Administrator may terminate or amend the Plan or this Agreement at any time; provided, however, that except as provided in Section 9 in connection with a Corporate Transaction, no such termination or amendment may adversely affect the Participant’s rights under this Agreement without the consent of the Participant unless such termination or amendment is necessary to comply with applicable law or government regulation, including, but not limited to, Section 409A of the Code. No amendment or addition to this Agreement shall be effective unless in writing.

          13.2 Nontransferability of the Award. Prior the issuance of shares of Common Stock on the Settlement Date, neither this Award nor any Performance Shares subject to this Award shall be subject in any manner to anticipation, alienation, sale, exchange, transfer, assignment, pledge, encumbrance, or garnishment by creditors of the Participant or the Participant’s beneficiary, except transfer by will or by the laws of descent and distribution. All rights with respect to the Award shall be exercisable during the Participant’s lifetime only by the Participant or the Participant’s guardian or legal representative.

          13.3 Unfunded Obligation. The Participant shall have the status of a general unsecured creditor of the Corporation. Any amounts payable to the Participant pursuant to the Award shall be an unfunded and unsecured obligation for all purposes, including, without limitation, Title I of the Employee Retirement Income Security Act of 1974. The Corporation shall not be required to segregate any monies from its general funds, or to create any trusts, or establish any special accounts with respect to such obligations. The Corporation shall retain at all times beneficial ownership of any investments, including trust investments, which the

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Corporation may make to fulfill its payment obligations hereunder. Any investments or the creation or maintenance of any trust or any Participant account shall not create or constitute a trust or fiduciary relationship between the Plan Administrator or the Corporation and the Participant, or otherwise create any vested or beneficial interest in the Participant or the Participant’s creditors in any assets of the Corporation. The Participant shall have no claim against the Corporation for any changes in the value of any assets which may be invested or reinvested by the Corporation with respect to the Award.

          13.4 Further Instruments. The parties hereto agree to execute such further instruments and to take such further action as may reasonably be necessary to carry out the intent of this Agreement.

          13.5 Binding Effect. This Agreement shall inure to the benefit of the successors and assigns of the Corporation and, subject to the restrictions on transfer set forth herein, be binding upon the Participant and the Participant’s heirs, executors, administrators, successors and assigns.

          13.6 Delivery of Documents and Notices. Any document relating to participation in the Plan or any notice required or permitted hereunder shall be given in writing and shall be deemed effectively given (except to the extent that this Agreement provides for effectiveness only upon actual receipt of such notice) upon personal delivery, electronic delivery at the e-mail address, if any, provided for the Participant by the Corporation or a Parent or Subsidiary, or upon deposit in the U.S. Post Office or foreign postal service, by registered or certified mail, or with a nationally recognized overnight courier service, with postage and fees prepaid, addressed to the other party at the address shown below that party’s signature to the Grant Notice or at such other address as such party may designate in writing from time to time to the other party.

               (a) Description of Electronic Delivery. The Plan documents, which may include but do not necessarily include: the Plan, the Grant Notice, this Agreement, the Plan Prospectus, and any reports of the Corporation provided generally to the Corporation’s stockholders, may be delivered to the Participant electronically. In addition, the Participant may deliver electronically the Grant Notice to the Corporation or to such third party involved in administering the Plan as the Corporation may designate from time to time. Such means of electronic delivery may include but do not necessarily include the delivery of a link to a Corporation intranet or the internet site of a third party involved in administering the Plan, the delivery of the document via e-mail or such other means of electronic delivery specified by the Corporation.

               (b) Consent to Electronic Delivery. The Participant acknowledges that the Participant has read Section 13.6(a) of this Agreement and consents to the electronic delivery of the Plan documents and Grant Notice, as described in Section 13.6(a). The Participant acknowledges that he or she may receive from the Corporation a paper copy of any documents delivered electronically at no cost to the Participant by contacting the Corporation by telephone or in writing. The Participant further acknowledges that the Participant will be provided with a paper copy of any documents if the attempted electronic delivery of such documents fails. Similarly, the Participant understands that the Participant must provide the

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Corporation or any designated third party administrator with a paper copy of any documents if the attempted electronic delivery of such documents fails. The Participant may revoke his or her consent to the electronic delivery of documents described in Section 13.6(a) or may change the electronic mail address to which such documents are to be delivered (if Participant has provided an electronic mail address) at any time by notifying the Corporation of such revoked consent or revised e-mail address by telephone, postal service or electronic mail. Finally, the Participant understands that he or she is not required to consent to electronic delivery of documents described in Section 13.6(a).

          13.7 Integrated Agreement. The Grant Notice, this Agreement and the Plan shall constitute the entire understanding and agreement of the Participant and the Corporation with respect to the subject matter contained herein or therein and supersedes any prior agreements, understandings, restrictions, representations, or warranties between the Participant and the Corporation with respect to such subject matter other than those as set forth or provided for herein or therein. To the extent contemplated herein or therein, the provisions of the Grant Notice and the Agreement shall survive any settlement of the Award and shall remain in full force and effect.

          13.8 Applicable Law. This Agreement shall be governed by the laws of the State of California as such laws are applied to agreements between California residents entered into and to be performed entirely within the State of California.

          13.9 Counterparts. The Grant Notice may be executed in counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument.

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EX-10.33

Exhibit 10.33

First Amendment of Lease

     This first amendment of lease (“First Amendment”) is made and entered into this 31st day of January, 2007 by and between NMSBPCSLDHB, a California Limited Partnership (“Landlord”) and Packeteer, Inc., a Delaware corporation (“Tenant”) with reference to the following facts:

A.	Landlord and Tenant entered into that certain lease dated July 15, 2002 (“Lease”) pursuant to which the Landlord agreed to lease to Tenant approximately 69,015 square feet of space comprising the first and second floors of a three story building located at 10201 North De Anza Boulevard, Cupertino, California (“Original Premises”).
B.	Landlord and Tenant wish to amend the terms of the Lease so as to provide for 1) an extension of the term of the Lease for a period of seven years (“Extended Term”), 2) an expansion of the Original Premises to include the third floor (the new total square footage is approximately 104,990 square feet) (“Amended Premises”), 3) the tenant improvements to be performed by the Landlord relating to the Original Premises and later the “Amended Premises” and 4) two options to extend the Extended Term.
C.	Landlord warrants that the term of the third floor lease, currently in effect, is coterminous with the term of Tenant’s current lease term and that there are no options to extend the third floor lease beyond the current term.

     NOW THEREFORE, the parties do hereby agree to amend the Lease as follows:

Agreement

1.	Extended Term. The Extended Term will be for seven years commencing December 20, 2007 and terminating December 19, 2014 for the space described in paragraph 2 below.
2.	Amended Premises. That approximately 104,990 square feet comprising the entire three story building located at 10201 North De Anza Boulevard, Cupertino, California.
3.	Rent. The rent for the Amended Premises will be $1.98 per square foot modified net for the first year of the Extended Term with three percent (3%) annual rent escalations to follow.
4.	Operating Expenses. Effective at the commencement of the Extended Term, Tenant will be responsible for the cost of real property taxes, property insurance (fire and extended policy), janitorial and the cost of utilities. All other costs of the Amended Premises will be borne by the Landlord and will not be reimbursed by the Tenant.
5.	Tenant Improvements.

a. Prior to January 31, 2007 Landlord, at Landlord’s sole expense, will perform the following work:

i)	Perform a full survey of the HVAC system that services the Amended Premises by a licensed mechanical contractor.
ii)	Clear the roof of debris and patch the roof where required.
iii)	Provide a new elevator technician.

iv)	Restore the freight elevator to good working condition.
v)	Fix the leak/leaks associated with the third floor balcony.

b.	Prior to February 15, 2007, Landlord, at Landlord’s sole expense, will start the immediately required repairs and replacements of the HVAC system as directed by the findings of the HVAC survey and will complete said work no later than March 15, 2007. Furthermore during the term of the Lease and the Extended Term, Landlord will be very proactive about all required repairs and replacements.
c.	As early as possible during the spring of 2007 but in no event later than May 31, 2007, Landlord will replace the entire roof of the Amended Premises.
d.	Within one week of Vocera vacating the third floor, Landlord will reset lobby elevators so that they open on all three floors and reset the freight elevator so that it services all three floors.
e.	Upon Vocera vacating the third floor, the tenant improvement schedule will be as follows:

i)	Landlord will restore the third floor to the floor plan shown in and attached as Exhibit “A”. Prior to commencing this restoration process Landlord will consult with Tenant to see if Tenant wants to retain any of the improvements marked for restoration. If Tenant does retain some of these improvements, Tenant will have no obligation to restore them at the expiration of Tenant’s Extended Term or any extensions to the Extended Term.
ii)	Once restoration is complete and all of Vocera’s cubicles have been removed, Landlord will clean all carpeted areas and replace carpet where necessary. No patching of carpet, if required, will be visible nor will there be a change of carpet mid-room. In addition Landlord will repaint all interior walls of the third floor.
iii)	Landlord will deliver the third floor to Tenant with all systems in good working order and condition, including but not limited to plumbing, electrical (including panels and outlets), sprinklers, lighting, ceiling tiles, window coverings and mechanical systems.
iv)	During the time Landlord is performing Landlord’s work on the third floor, as described in section 5 of the First Amendment, Landlord will not charge Tenant rent or operating expenses for the third floor. Following completion of Landlord’s work, Landlord will grant Tenant an additional three (3) months of free rent and no operating expenses for the third floor for Tenant’s installation of Tenant’s tenant improvements, cabling and fit up. As long as Tenant does not interfere with Landlord’s work on the third floor, Tenant may also utilize the period of time during which Landlord is performing Landlord’s work for Tenant’s tenant improvements.

f. In the event Landlord does not perform all of the prior described tenant improvements within the time frames called for above, Tenant may contract with appropriate third parties to affect any tenant improvements not yet completed. Any monies paid by Tenant to these third parties will be credited against rent owed by Tenant to Landlord.

6. Options to Extend. Tenant will have two (2) five (5) year options to extend the Extended Term on the same general terms and conditions of Section 35 in said Lease, at the then prevailing market rent.

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7. Parking. During the extended term Tenant shall be entitled to the exclusive use of all parking belonging to the Amended Premises.

All other terms of the Lease will remain unchanged.

Each individual signing this agreement warrants and represents that he or she has been authorized by the appropriate action of the party who he or she represents to enter into this agreement.

IN WITNESS WHEREOF, the parties hereto have executed this agreement as of the date first above written.

Landlord:	Tenant:
NMSBPCSLDHB, a California limited partnership	Packeteer, Inc., a Delaware corporation
/s/ Bob Granum	/s/ David C. Yntema
By: Bob Granum	By: David C. Yntema
Its: General Partner	Its: Chief Financial Officer

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EX-10.34

Exhibit 10.34

PACKETEER, INC.
1999 STOCK INCENTIVE PLAN

Amended and Restated Effective as of February 5, 2007

ARTICLE ONE

GENERAL PROVISIONS

     I. PURPOSE OF THE PLAN

          This 1999 Stock Incentive Plan is intended to promote the interests of Packeteer, Inc., a Delaware corporation, by providing eligible persons in the Corporation’s service with the opportunity to acquire a proprietary interest, or otherwise increase their proprietary interest, in the Corporation as an incentive for them to remain in such service.

          Capitalized terms shall have the meanings assigned to such terms in the attached Appendix.

     II. STRUCTURE OF THE PLAN

          A. The Plan shall be divided into four separate equity programs:

• the Discretionary Option/SAR Program under which eligible persons may, at the discretion of the Plan Administrator, be granted Options and/or Stock Appreciation Rights;

• the Restricted Stock/Restricted Stock Unit Program under which eligible persons may, at the discretion of the Plan Administrator, be granted Restricted Stock Purchase Rights, Restricted Stock Bonuses and/or Restricted Stock Units;

• the Performance Award Program under which eligible persons may, at the discretion of the Plan Administrator, be granted Performance Shares and/or Performance Units; and

• the Automatic Option Grant Program under which eligible non-employee Board members shall automatically receive Option grants at designated intervals over their period of continued Board service.

          B. The provisions of Articles One and Six shall apply to all equity programs under the Plan and shall govern the interests of all persons under the Plan.

     III. ADMINISTRATION OF THE PLAN

          A. The Primary Committee shall have sole and exclusive authority to administer the Discretionary Option/SAR Grant Program, Restricted Stock/Restricted Stock Unit

Program and Performance Award Program with respect to Section 16 Insiders and Covered Employees. Administration of the Discretionary Option/SAR Grant Program, Restricted Stock/Restricted Stock Unit Program and Performance Award Program with respect to all other persons eligible to participate in those programs may, at the Board’s discretion, be vested in the Primary Committee or a Secondary Committee, or the Board may retain the power to administer those programs with respect to all such persons. However, any Awards granted to members of the Primary Committee under the Discretionary Option/SAR Grant Program, Restricted Stock/Restricted Stock Unit Program or Performance Award Program shall be made by a disinterested majority of the Board.

          B. The Board may, in its discretion by resolution adopted by the Board, authorize one or more officers of the Corporation to grant one or more Awards of Options, SARs and/or Restricted Stock Units under the Discretionary Option/SAR Grant Program and the Restricted Stock/Restricted Stock Unit Program, without further approval of the Board or the Primary or Secondary Committee, to any Employee, other than a person who, at the time of such grant, is a Section 16 Insider or a Covered Employee, and to determine the number and vesting terms of the shares of Common Stock or Restricted Stock Units to be subject to such Awards; provided, however, that (1) no Employee shall be granted in any calendar year Option or SAR Awards for more than 50,000 shares of Common Stock or Restricted Stock Unit Awards for more than 25,000 such units, (2) the number of shares of Common Stock or Restricted Stock Units subject to each such Option , SAR or Restricted Stock Unit Award shall comply with guidelines established from time to time by the Board or the Primary Committee, and (3) each such Option, SAR and Restricted Stock Unit Award shall be subject to the terms and conditions of the appropriate standard form of Award Agreement approved by the Board or the Primary Committee and shall conform to the provisions of the Plan and such other guidelines as shall be established from time to time by the Board or the Primary Committee. Any officer or officers so authorized by the Board shall be deemed the Plan Administrator solely for the purpose of granting such Option, SAR and Restricted Stock Unit Awards.

          C. Members of the Primary Committee or any Secondary Committee shall serve for such period of time as the Board may determine and may be removed by the Board at any time. The Board may also at any time terminate the functions of any Secondary Committee and any officer delegated authority pursuant to Section III.B above and reassume all powers and authority previously delegated to such committee or officer.

          D. Except for an officer delegated limited authority pursuant to Section III.B above, each Plan Administrator shall, within the scope of its administrative functions under the Plan, have full power and authority (subject to the provisions of the Plan) to establish such rules and regulations as it may deem appropriate for proper administration of the Discretionary Option/SAR Grant Program, Restricted Stock/Restricted Stock Unit Program and Performance Award Program and to make such determinations under, and issue such interpretations of, the provisions of those programs and any outstanding Awards thereunder as it may deem necessary or advisable. Decisions of the Plan Administrator within the scope of its administrative functions under the Plan shall be final and binding on all parties who have an interest in the Discretionary Option/SAR Grant Program, Restricted Stock/Restricted Stock Unit Program or Performance Award Program under its jurisdiction or any Award thereunder.

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          E. Service on the Primary Committee or the Secondary Committee shall constitute service as a Board member, and members of each such committee shall accordingly be entitled to full indemnification and reimbursement as Board members for their service on such committee. No member of the Primary Committee or the Secondary Committee shall be liable for any act or omission made in good faith with respect to the Plan or any Awards under the Plan.

          F. Administration of the Automatic Option Grant Program shall be self-executing in accordance with the terms of that program, and no Plan Administrator shall exercise any discretionary functions with respect to any Option grants made under that program.

     IV. ELIGIBILITY

          A. The persons eligible to participate in the Discretionary Option/SAR Grant Program, Restricted Stock/Restricted Stock Unit Program and Performance Award Program are as follows:

          (i) Employees,

          (ii) non-employee members of the Board or the board of directors of any Parent or Subsidiary, and

          (iii) consultants and other independent advisors who provide services to the Corporation (or any Parent or Subsidiary).

          B. Except for an officer delegated limited authority pursuant to Section III.B above, each Plan Administrator shall, within the scope of its administrative jurisdiction under the Plan, have full authority to determine with respect to Awards granted under the Discretionary Option/SAR Grant Program, Restricted Stock/Restricted Stock Unit Program and Performance Award Program (i) the type of Award to be granted, (ii) which eligible persons are to receive such Awards, (iii) the time or times when those Awards are to be granted, (iv) the number of shares to be covered by each such Award, (v) the exercise or purchase price, if any, under each such Award, (vi) the timing, terms and conditions of the exercisability or vesting (if any) of each such Award or any shares acquired pursuant thereto, (vii) the maximum term for which the Award is to remain outstanding, (viii) the Performance Measures, Performance Period, Performance Award Formula and Performance Goals applicable to any Award and the extent to which such Performance Goals have been attained, (ix) the effect of the Participant’s termination of Service on any of the foregoing, and (x) all other terms, conditions and restrictions applicable to any Award or Shares acquired pursuant thereto not inconsistent with the terms of the Plan.

          C. The individuals who shall be eligible to participate in the Automatic Option Grant Program shall be limited to (i) those individuals who first become non-employee Board members on or after the Underwriting Date, whether through appointment by the Board or election by the Corporation’s stockholders, and (ii) those individuals who continue to serve as non-employee Board members at one or more Annual Stockholders Meetings held after the Underwriting Date. A non-employee Board member who has previously been in the employ of the Corporation (or any Parent or Subsidiary) shall not be eligible to receive the initial automatic Option grant under the Automatic Option Grant Program at the time he or she first becomes a

3.

non-employee Board member, but shall be eligible to receive one or more annual automatic Option grants under the Automatic Option Grant Program while he or she continues to serve as a non-employee Board member.

     V. STOCK SUBJECT TO THE PLAN

          A. The stock issuable under the Plan shall be shares of authorized but unissued or reacquired Common Stock, including shares repurchased by the Corporation on the open market. The number of shares of Common Stock reserved for issuance over the term of the Plan shall not exceed the sum of (i) 3,845,917 shares plus (ii) the additional shares of Common Stock automatically added to the share reserve each year pursuant to the provisions of Section V.B. of this Article One.

          B. The number of shares of Common Stock available for issuance under the Plan shall automatically increase on the first trading day of January each calendar year during the term of the Plan, beginning with calendar year 2000, by an amount equal to five percent (5 %) of the total number of shares of Common Stock outstanding on the last trading day in December of the immediately preceding calendar year, but in no event shall any such annual increase exceed 3,000,000 shares.

          C. No Participant may be granted Options or Freestanding SARs for more than 1,000,000 shares of Common Stock in the aggregate per calendar year. No Participant may be granted Restricted Stock Awards or Awards of Restricted Stock Units intended, in either case, to result in the payment of Performance-Based Compensation for more than 500,000 shares of Common Stock in the aggregate per calendar year. No Participant may be granted Performance Shares intended to result in the payment of Performance-Based Compensation for more than 150,000 shares of Common Stock in the aggregate for each year contained in the Performance Period with respect to such Award. No Participant may be granted Performance Units intended to result in the payment of Performance-Based Compensation for more than $1,500,000 for each year contained in the Performance Period with respect to such Award.

          D. Shares of Common Stock subject to outstanding Options (including Options incorporated into this Plan from the Predecessor Plan) or Freestanding SARs shall be available for subsequent issuance under the Plan to the extent those Options or Freestanding SARs expire or terminate for any reason prior to exercise in full. Unvested shares issued under the Plan and subsequently forfeited, cancelled or repurchased by the Corporation at the original issue price paid per share and unvested shares subject to Restricted Stock Unit Awards or Performance Share Awards cancelled prior to settlement shall be added back to the number of shares of Common Stock reserved for issuance under the Plan and shall accordingly be available for reissuance through one or more subsequent Awards granted under the Plan. However, should the exercise price of an Option under the Plan be paid with shares of Common Stock or should shares of Common Stock otherwise issuable under the Plan be withheld by the Corporation in satisfaction of the withholding taxes incurred in connection with the exercise, vesting or settlement of an Award under the Plan, then the number of shares of Common Stock available for issuance under the Plan shall be reduced by the gross number of shares for which the Award is exercised, becomes vested or is settled, and not by the net number of shares of Common Stock

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issued to the holder of such Award. Shares of Common Stock underlying one or more SARs exercised under the Plan shall not be available for subsequent issuance under the Plan.

          E. If any change is made to the Common Stock by reason of any stock split, stock dividend, recapitalization, combination of shares, exchange of shares or other change affecting the outstanding Common Stock as a class without the Corporation’s receipt of consideration, appropriate adjustments shall be made by the Plan Administrator to (i) the maximum number and/or class of securities issuable under the Plan, (ii) the maximum number and/or class of securities for which any one person may be granted one or more Awards under the Plan within a specified period of time as provided in Section V.C of this Article One, (iii) the number and/or class of securities for which grants are subsequently to be made under the Automatic Option Grant Program to new and continuing non-employee Board members, (iv) the number and/or class of securities and the exercise price per share in effect under each outstanding Option and SAR under the Plan, (v) the number and/or class of securities in effect under each outstanding Restricted Stock Award, Restricted Stock Unit Award and Performance Share Award under the Plan, (vi) the number and/or class of securities and price per share in effect under each outstanding Option incorporated into this Plan from the Predecessor Plan and (vii) the maximum number and/or class of securities by which the share reserve is to increase automatically each calendar year pursuant to the provisions of Section V.B. of this Article One. Such adjustments to the outstanding Awards are to be effected in a manner which shall preclude the enlargement or dilution of rights and benefits under such Awards. The adjustments determined by the Plan Administrator shall be final, binding and conclusive.

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ARTICLE TWO

DISCRETIONARY OPTION/SAR GRANT PROGRAM

     I. OPTION TERMS

          Each Option shall be evidenced by an Award Agreement in the form approved by the Plan Administrator; provided, however, that the Award Agreement shall comply with the terms specified below. Each Award Agreement evidencing an Incentive Option shall, in addition, be subject to the provisions of the Plan applicable to such Options.

          A. Exercise Price.

               1. The exercise price per share shall be fixed by the Plan Administrator but shall not be less than one hundred percent (100%) of the Fair Market Value per share of Common Stock on the Option grant date.

               2. The exercise price shall become immediately due upon exercise of the Option and shall, subject to the provisions of the Award Agreement evidencing the Option, be payable in one or more of the forms specified below:

               (i) cash or check made payable to the Corporation,

               (ii) shares of Common Stock held for the requisite period (if any) necessary to avoid a charge to the Corporation’s earnings for financial reporting purposes and valued at Fair Market Value on the Exercise Date, or

               (iii) to the extent the Option is exercised for vested shares, through a special sale and remittance procedure pursuant to which the Participant shall concurrently provide irrevocable instructions to (a) a Corporation-designated brokerage firm to effect the immediate sale of the purchased shares and remit to the Corporation, out of the sale proceeds available on the settlement date, sufficient funds to cover the aggregate exercise price payable for the purchased shares plus all applicable Federal, state and local income and employment taxes required to be withheld by the Corporation by reason of such exercise and (b) the Corporation to deliver the certificates for the purchased shares directly to such brokerage firm in order to complete the sale.

          Except to the extent such sale and remittance procedure is utilized, payment of the exercise price for the purchased shares must be made on the Exercise Date.

          B. Exercise and Term of Options. Each Option shall be exercisable at such time or times, during such period and for such number of shares as shall be determined by the Plan Administrator and set forth in the Award Agreement evidencing the Option. However, no Option shall have a term in excess of ten (10) years measured from the Option grant date.

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          C. Effect of Termination of Service.

               1. The following provisions shall govern the exercise of any Options held by the Participant at the time of cessation of Service or death:

               (i) Any Option outstanding at the time of the Participant’s cessation of Service for any reason shall remain exercisable for such period of time thereafter as shall be determined by the Plan Administrator and set forth in the Award Agreement evidencing the Option, but no such Option shall be exercisable after the expiration of the Option term.

               (ii) Any Option held by the Participant at the time of death and exercisable in whole or in part at that time may be subsequently exercised by the personal representative of the Participant’s estate or by the person or persons to whom the Option is transferred pursuant to the Participant’s will or in accordance with the laws of descent and distribution or by the Participant’s designated beneficiary or beneficiaries of that Option.

               (iii) Should the Participant’s Service be terminated for Misconduct, then all outstanding Options held by the Participant shall terminate immediately and cease to be outstanding.

               (iv) During the applicable post-Service exercise period, the Option may not be exercised in the aggregate for more than the number of vested shares for which the Option is exercisable on the date of the Participant’s cessation of Service. Upon the expiration of the applicable exercise period or (if earlier) upon the expiration of the Option term, the Option shall terminate and cease to be outstanding for any vested shares for which the Option has not been exercised. However, the Option shall, immediately upon the Participant’s cessation of Service, terminate and cease to be outstanding to the extent the Option is not otherwise at that time exercisable for vested shares.

               2. The Plan Administrator shall have complete discretion, exercisable either at the time an Option is granted or at any time while the Option remains outstanding, to:

               (i) extend the period of time for which the Option is to remain exercisable following the Participant’s cessation of Service from the limited exercise period otherwise in effect for that Option to such greater period of time as the Plan Administrator shall deem appropriate, but in no event beyond the expiration of the Option term, and/or

               (ii) permit the Option to be exercised, during the applicable post-Service exercise period, not only with respect to the number of vested shares of Common Stock for which such Option is exercisable at the time of the Participant’s cessation of Service but also with respect to one or more additional installments in which the Participant would have vested had the Participant continued in Service.

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          D. Stockholder Rights. The holder of an Option shall have no stockholder rights with respect to the shares subject to the Option until such person shall have exercised the Option, paid the exercise price and become a holder of record of the purchased shares.

          E. Repurchase Rights. The Plan Administrator shall have the discretion to grant Options which are exercisable for unvested shares of Common Stock. Should the Participant cease Service while holding such unvested shares, the Corporation shall have the right to repurchase, at the exercise price paid per share, any or all of those unvested shares. The terms upon which such repurchase right shall be exercisable (including the period and procedure for exercise and the appropriate vesting schedule for the purchased shares) shall be established by the Plan Administrator and set forth in the document evidencing such repurchase right.

          F. Limited Transferability of Options. During the lifetime of the Participant, Incentive Options shall be exercisable only by the Participant and shall not be assignable or transferable other than by will or by the laws of descent and distribution following the Participant’s death. However, a Non-Statutory Option may, in connection with the Participant’s estate plan, be assigned in whole or in part during the Participant’s lifetime to one or more members of the Participant’s immediate family or to a trust established exclusively for one or more such family members. The assigned portion may only be exercised by the person or persons who acquire a proprietary interest in the Option pursuant to the assignment. The terms applicable to the assigned portion shall be the same as those in effect for the Option immediately prior to such assignment and shall be set forth in such documents issued to the assignee as the Plan Administrator may deem appropriate. Notwithstanding the foregoing, the Participant may also designate one or more persons as the beneficiary or beneficiaries of his or her outstanding Options under this Article Two, and those Options shall, in accordance with such designation, automatically be transferred to such beneficiary or beneficiaries upon the Participant’s death while holding those Options. Such beneficiary or beneficiaries shall take the transferred Options subject to all the terms and conditions of the applicable agreement evidencing each such transferred Option, including (without limitation) the limited time period during which the Option may be exercised following the Participant’s death.

     II. INCENTIVE OPTIONS

          The terms specified below shall be applicable to all Incentive Options. Except as modified by the provisions of this Section II, all the provisions of Articles One, Two and Six shall be applicable to Incentive Options. Options which are specifically designated as Non-Statutory Options when issued under the Plan shall not be subject to the terms of this Section II.

          A. Eligibility. Incentive Options may only be granted to Employees.

          B. Dollar Limitation. The aggregate Fair Market Value of the shares of Common Stock (determined as of the respective date or dates of grant) for which one or more Options granted to any Employee under the Plan (or any other Option plan of the Corporation or any Parent or Subsidiary) may for the first time become exercisable as Incentive Options during any one calendar year shall not exceed the sum of One Hundred Thousand Dollars ($100,000).

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To the extent the Employee holds two (2) or more such Options which become exercisable for the first time in the same calendar year, the foregoing limitation on the exercisability of such Options as Incentive Options shall be applied on the basis of the order in which such Options are granted.

          C. 10% Stockholder. If any Employee to whom an Incentive Option is granted is a 10% Stockholder, then the exercise price per share shall not be less than one hundred ten percent (110%) of the Fair Market Value per share of Common Stock on the Option grant date, and the Option term shall not exceed five (5) years measured from the Option grant date.

     III. STOCK APPRECIATION RIGHTS

          Each SAR shall be evidenced by an Award Agreement in the form approved by the Plan Administrator; provided, however, that the Award Agreement shall comply with the terms specified below.

          A. Types of SARs Authorized. A SAR may be a Freestanding SAR granted independently of any Option, a Tandem SAR granted in tandem with all or any portion of a related Option, or a Limited SAR granted to a Section 16 Insider with respect to an outstanding Option. A Tandem SAR or a Limited SAR may be granted either concurrently with the grant of the related Option or at any time thereafter prior to the complete exercise, termination, expiration or cancellation of such related Option.

          B. Terms and Conditions of Freestanding SARs.

               1. Exercise Price. The exercise price per share subject to a Freestanding SAR shall be fixed by the Plan Administrator but shall not be less than one hundred percent (100%) of the Fair Market Value per share of Common Stock on the grant date.

               2. Exercisability and Term of Freestanding SARs. Each Freestanding SAR shall be exercisable at such time or times, during such period and for such number of shares as shall be determined by the Plan Administrator and set forth in the Award Agreement evidencing such Award. However, no Freestanding SAR shall have a term in excess of ten (10) years measured from the grant date.

               3. Exercise of Freestanding SARs and Settlement in Stock. Upon the exercise (or deemed exercise pursuant to paragraph 5 below) of a Freestanding SAR authorizing settlement solely in shares of stock, the Participant (or the Participant’s legal representative or other person who acquired the right to exercise such SAR by reason of the Participant’s death) shall be entitled to receive payment of an amount for each share with respect to which such SAR is exercised equal to the excess, if any, of the Fair Market Value of a share of Common Stock on the Exercise Date of such SAR over the exercise price. Payment of such amount shall be made in whole shares of Common Stock as soon as practicable following the Exercise Date. The number of shares to be issued shall be determined on the basis of the Fair Market Value of a share of Common Stock on the Exercise Date of the Freestanding SAR.

               4. Exercise of Freestanding SARs and Settlement in Cash. Subject to the provisions of Section I of Article Six with respect to Code Section 409A, the Plan

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Administrator may grant Freestanding SARs that provide for payment in cash. The Exercise Date(s) applicable to any such SAR shall be established in compliance with the provisions of Section I of Article Six with respect to Code Section 409A either by the Plan Administrator in granting such SAR, or, if permitted by the Plan Administrator, by an advance election of the Participant in a manner complying with the requirements of Code Section 409A. Upon the exercise (or deemed exercise pursuant to paragraph 5 below) of any such Freestanding SAR, the Participant (or the Participant’s legal representative or other person who acquired the right to exercise such SAR by reason of the Participant’s death) shall be entitled to receive payment of an amount for each share with respect to which such SAR is exercised equal to the excess, if any, of the Fair Market Value of a share of Common Stock on the Exercise Date of such SAR over the exercise price. Payment of such amount shall be made in cash as soon as practicable following the Exercise Date.

               5. Deemed Exercise of Freestanding SARs. If, on the date on which a Freestanding SAR would otherwise terminate or expire, such SAR by its terms remains exercisable immediately prior to such termination or expiration and, if so exercised, would result in a payment to the holder of such SAR, then any portion of such SAR which has not previously been exercised shall automatically be deemed to be exercised as of such date with respect to such portion.

               6. Effect of Termination of Service. Subject to earlier termination of a Freestanding SAR as otherwise provided herein and unless otherwise provided by the Plan Administrator in the Award Agreement evidencing such SAR, a Freestanding SAR shall be exercisable after a Participant’s termination of Service only during the applicable time period determined in accordance with Section I.C of this Article Two (treating the SAR as if it were an Option) and thereafter shall terminate.

          C. Terms and Conditions of Tandem SARs.

               1. One or more Participants may be granted the right, exercisable upon such terms as the Plan Administrator may establish, to elect between the exercise of the underlying Option for shares of Common Stock and the surrender of that Option in exchange for a distribution from the Corporation in an amount equal to the excess of (a) the Fair Market Value (on the Option surrender date) of the number of shares in which the Participant is at the time vested under the surrendered Option (or surrendered portion thereof) over (b) the aggregate exercise price payable for such shares.

               2. No such Option surrender shall be effective unless it is approved by the Plan Administrator, either at the time of the actual Option surrender or at any earlier time. If the surrender is so approved, then the distribution to which the Participant shall be entitled shall be made solely in whole shares of Common Stock valued at Fair Market Value on the Option surrender date.

               3. If the surrender of an Option is not approved by the Plan Administrator, then the Participant shall retain whatever rights the Participant had under the surrendered Option (or surrendered portion thereof) on the Option surrender date and may exercise such rights at any time prior to the later of (a) five (5) business days after the receipt of

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the rejection notice or (b) the last day on which the Option is otherwise exercisable in accordance with the terms of the Award Agreement evidencing such Option, but in no event may such rights be exercised more than ten (10) years after the Option grant date.

          D. Terms and Conditions of Limited SARs.

               1. Subject to the provisions of Section I of Article Six with respect to Code Section 409A, one or more Section 16 Insiders may be granted Limited SARs with respect to their outstanding Options.

               2. Upon the occurrence of a Hostile Take-Over, each individual holding one or more Options with such a Limited SAR shall have the unconditional right (exercisable for a thirty (30)-day period following such Hostile Take-Over) to surrender each such Option to the Corporation. In return for the surrendered Option, the Participant shall receive a cash distribution from the Corporation in an amount equal to the excess of (A) the Take-Over Price of the shares of Common Stock at the time subject to such Option (whether or not the Participant is otherwise vested in those shares) over (B) the aggregate exercise price payable for those shares. Such cash distribution shall be paid within five (5) days following the Option surrender date.

               3. At the time such Limited SAR is granted, the Plan Administrator shall pre-approve any subsequent exercise of that right in accordance with the terms of this Paragraph D. Accordingly, no further approval of the Plan Administrator or the Board shall be required at the time of the actual Option surrender and cash distribution.

          E. Stockholder Rights. The holder of an SAR shall have no stockholder rights with respect to the shares subject to the SAR until such person shall have exercised the SAR and become a holder of record of the shares issued in payment of such SAR.

          F. Limited Transferability of SARs. During the lifetime of the Participant, an SAR shall be exercisable only by the Participant and shall not be assignable or transferable other than by will or by the laws of descent and distribution following the Participant’s death. However, a Tandem SAR related to a Non-Statutory Option or a Freestanding SAR to be settled in shares of Common Stock may, in connection with the Participant’s estate plan, be assigned in whole or in part during the Participant’s lifetime to one or more members of the Participant’s immediate family or to a trust established exclusively for one or more such family members. The assigned portion may only be exercised by the person or persons who acquire a proprietary interest in the Freestanding SAR or both the Tandem SAR and related Non-Statutory Option pursuant to the assignment. The terms applicable to the assigned portion shall be the same as those in effect for the SAR immediately prior to such assignment and shall be set forth in such documents issued to the assignee as the Plan Administrator may deem appropriate. Notwithstanding the foregoing, the Participant may also designate one or more persons as the beneficiary or beneficiaries of his or her outstanding SARs under this Article Two, and those SARs shall, in accordance with such designation, automatically be transferred to such beneficiary or beneficiaries upon the Participant’s death while holding those SARs. Such beneficiary or beneficiaries shall take the transferred SARs subject to all the terms and conditions of the applicable agreement evidencing each such transferred SAR, including (without

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limitation) the limited time period during which the SAR may be exercised following the Participant’s death.

     IV. CORPORATE TRANSACTION/CHANGE IN CONTROL

          A. In the event of any Corporate Transaction, each outstanding Option and SAR shall automatically accelerate so that each such Award shall, immediately prior to the effective date of the Corporate Transaction, become fully exercisable for the total number of shares of Common Stock at the time subject to such Award and may be exercised for any or all of those shares as fully vested shares of Common Stock. However, an outstanding Option or SAR shall not become exercisable on such an accelerated basis if and to the extent: (i) such Award is, in connection with the Corporate Transaction, to be assumed by the successor corporation (or parent thereof) or (ii) subject to compliance with the provisions of Section I of Article Six with respect to Code Section 409A, such Award is to be replaced with a cash incentive program of the successor corporation which preserves the spread existing at the time of the Corporate Transaction on any shares for which the Award is not otherwise at that time exercisable and provides for subsequent payout in accordance with the same exercise/vesting schedule applicable to those Award shares or (iii) the acceleration of such Award is subject to other limitations imposed by the Plan Administrator at the time of the Award grant.

          B. All outstanding repurchase rights shall automatically terminate, and the shares of Common Stock subject to those terminated rights shall immediately vest in full, in the event of any Corporate Transaction, except to the extent: (i) those repurchase rights are to be assigned to the successor corporation (or parent thereof) in connection with such Corporate Transaction or (ii) such accelerated vesting is precluded by other limitations imposed by the Plan Administrator at the time the repurchase right is issued.

          C. Immediately following the consummation of the Corporate Transaction, all outstanding Options and SARs (other than a Limited SAR to the extent provided by Section III.F of this Article Two) shall terminate and cease to be outstanding, except to the extent assumed by the successor corporation (or parent thereof).

          D. Each Option and SAR which is assumed in connection with a Corporate Transaction shall be appropriately adjusted, immediately after such Corporate Transaction, to apply to the number and class of securities which would have been issued to the Participant had such Award been exercised immediately prior to such Corporate Transaction. If the holders of Common Stock receive cash consideration in connection with the Corporate Transaction, the assumed Option or SAR may be adjusted, at the option of the successor corporation, to apply to the number of shares of its common stock with a fair market value equivalent to the cash consideration paid per share of Common Stock in such Corporate Transaction. Appropriate adjustments to reflect such Corporate Transaction shall also be made to (i) the exercise price per share under each outstanding Option and SAR, provided the aggregate exercise price for such securities shall remain the same, (ii) the maximum number and/or class of securities available for issuance over the remaining term of the Plan and (iii) the maximum number and/or class of securities for which any one person may be granted Awards under the Plan per calendar year and (iv) the maximum number and/or class of securities by which the share reserve is to increase automatically each calendar year. All such adjustments shall be made in compliance with the

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requirements of Code Sections 409A, 422 and 424 and any related guidance issued by the U.S. Treasury Department, if applicable.

          E. The Plan Administrator shall have the discretionary authority to structure one or more outstanding Options or SARs under the Discretionary Option/SAR Grant Program so that those Awards shall, immediately prior to the effective date of such Corporate Transaction, become fully exercisable for the total number of shares of Common Stock at the time subject to those Awards and may be exercised for any or all of those shares as fully vested shares of Common Stock, whether or not those Awards are to be assumed in the Corporate Transaction. In addition, the Plan Administrator shall have the discretionary authority to structure one or more of the Corporation’s repurchase rights under the Discretionary Option/SAR Grant Program so that those rights shall not be assignable in connection with such Corporate Transaction and shall accordingly terminate upon the consummation of such Corporate Transaction, and the shares subject to those terminated rights shall thereupon vest in full.

          F. The Plan Administrator shall have full power and authority to structure one or more outstanding Options or SARs under the Discretionary Option/SAR Grant Program so that those Awards shall become fully exercisable for the total number of shares of Common Stock at the time subject to those Awards in the event the Participant’s Service is subsequently terminated by reason of an Involuntary Termination within a designated period (not to exceed eighteen (18) months) following the effective date of any Corporate Transaction in which those Awards are assumed and do not otherwise accelerate. Any Options or SARs so accelerated shall remain exercisable for fully vested shares until the earlier of (i) the expiration of the Award term or (ii) the expiration of the one (1) year period measured from the effective date of the Involuntary Termination. In addition, the Plan Administrator may structure one or more of the Corporation’s repurchase rights so that those rights shall immediately terminate with respect to any shares held by the Participant at the time of his or her Involuntary Termination, and the shares subject to those terminated repurchase rights shall accordingly vest in full at that time.

          G. The Plan Administrator shall have the discretionary authority to structure one or more outstanding Options or SARs under the Discretionary Option/SAR Grant Program so that those Awards shall, immediately prior to the effective date of a Change in Control, become fully exercisable for the total number of shares of Common Stock at the time subject to those Awards and may be exercised for any or all of those shares as fully vested shares of Common Stock. In addition, the Plan Administrator shall have the discretionary authority to structure one or more of the Corporation’s repurchase rights under the Discretionary Option/SAR Grant Program so that those rights shall terminate automatically upon the consummation of such Change in Control, and the shares subject to those terminated rights shall thereupon vest in full. Alternatively, the Plan Administrator may condition the automatic acceleration of one or more outstanding Options or SARs under the Discretionary Option/SAR Grant Program and the termination of one or more of the Corporation’s outstanding repurchase rights under such program upon the subsequent termination of the Participant’s Service by reason of an Involuntary Termination within a designated period (not to exceed eighteen (18) months) following the effective date of such Change in Control. Each Option or SAR so accelerated shall remain exercisable for fully vested shares until the earlier of (i) the expiration of the Award term or (ii) the expiration of the one (1) year period measured from the effective date of Participant’s cessation of Service.

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          H. The portion of any Incentive Option accelerated in connection with a Corporate Transaction or Change in Control shall remain exercisable as an Incentive Option only to the extent the applicable One Hundred Thousand Dollar ($100,000) limitation is not exceeded. To the extent such dollar limitation is exceeded, the accelerated portion of such Option shall be exercisable as a Nonstatutory Option under the Federal tax laws.

          I. The outstanding Options and SARs shall in no way affect the right of the Corporation to adjust, reclassify, reorganize or otherwise change its capital or business structure or to merge, consolidate, dissolve, liquidate or sell or transfer all or any part of its business or assets.

     V. PROHIBITION OF OPTION OR SAR REPRICING WITHOUT STOCKHOLDER APPROVAL

          Without the affirmative vote of holders of a majority of the shares of Common Stock cast in person or by proxy at a meeting of the stockholders of the Corporation at which a quorum representing a majority of all outstanding shares of Common Stock is present or represented by proxy, the Plan Administrator shall not approve a program providing for either (a) the cancellation of outstanding Options or SARs and the grant in substitution therefore of new Options or SARs having a lower exercise price or (b) the amendment of outstanding Options or SARs to reduce the exercise price thereof. This paragraph shall not be construed to apply to “issuing or assuming a stock option in a transaction to which section 424(a) applies,” within the meaning of Code Section 424.

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ARTICLE THREE

RESTRICTED STOCK/RESTRICTED STOCK UNIT PROGRAM

     I. RESTRICTED STOCK AWARDS

          Shares of Common Stock may be issued under the Restricted Stock/Restricted Stock Unit Program through direct and immediate issuances without any intervening Option or SAR Award. Restricted Stock Awards shall be evidenced by Award Agreements specifying whether the Award is a Restricted Stock Bonus or a Restricted Stock Purchase Right and the number of shares of Common Stock subject to the Award, in such form as the Plan Administrator shall from time to time establish. Award Agreements evidencing Restricted Stock Awards may incorporate all or any of the terms of the Plan by reference and shall comply with and be subject to the following terms and conditions:

          A. Types of Restricted Stock Awards Authorized. Restricted Stock Awards may be in the form of either a Restricted Stock Bonus or a Restricted Stock Purchase Right. Restricted Stock Awards may be granted upon such conditions as the Plan Administrator shall determine, including, without limitation, upon the attainment of one or more Performance Goals described in Section I.D of Article Four. If either the grant or vesting of a Restricted Stock Award is to be contingent upon the attainment of one or more Performance Goals and is to result in the payment of Performance-Based Compensation, the Plan Administrator shall follow procedures substantially equivalent to those set forth in Sections I.C through I.E.1 of Article Four.

          B. Purchase Price. The purchase price for shares of Common Stock issuable under each Restricted Stock Purchase Right shall be established by the Plan Administrator in its discretion. No monetary payment (other than applicable tax withholding) shall be required as a condition of receiving shares of Common Stock pursuant to a Restricted Stock Bonus, the consideration for which shall be services actually rendered to the Corporation (or any Parent or Subsidiary) or for its benefit. Notwithstanding the foregoing, if required by applicable state corporations law, the Participant shall furnish consideration in the form of cash or past services rendered to the Corporation (or any Parent or Subsidiary) or for its benefit having a value not less than the par value of the shares of Common Stock subject to such Restricted Stock Award.

          C. Purchase Period. A Restricted Stock Purchase Right shall be exercisable within a period established by the Plan Administrator, which shall in no event exceed thirty (30) days from the effective date of the grant of the Restricted Stock Purchase Right.

          D. Payment of Purchase Price. Payment of the purchase price for the number of shares of Common Stock being purchased pursuant to any Restricted Stock Purchase Right shall be made (a) in cash or cash equivalent or by check made payable to the Corporation or (b) by past services rendered to the Corporation (or any Parent or Subsidiary) or for its benefit.

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          E. Vesting Provisions.

               1. Shares of Common Stock issued pursuant to a Restricted Stock Award may, in the discretion of the Plan Administrator, be fully and immediately vested upon issuance or may vest in one or more installments over the Participant’s period of Service or upon attainment of specified performance objectives, including, without limitation, Performance Goals described in Section I.D of Article Four. The elements of the vesting schedule applicable to any unvested shares of Common Stock issued pursuant to a Restricted Stock Award shall be determined by the Plan Administrator and incorporated into the Award Agreement.

               2. Any new, substituted or additional securities or other property (including money paid other than as a regular cash dividend) which the Participant may have the right to receive with respect to the Participant’s unvested shares of Common Stock by reason of any stock dividend, stock split, recapitalization, combination of shares, exchange of shares or other change affecting the outstanding Common Stock as a class without the Corporation’s receipt of consideration shall be issued subject to (i) the same vesting requirements applicable to the Participant’s unvested shares of Common Stock and (ii) such escrow arrangements as the Plan Administrator shall deem appropriate.

               3. The Participant shall have full stockholder rights with respect to any shares of Common Stock issued to the Participant pursuant to a Restricted Stock Award, whether or not the Participant’s interest in those shares is vested. Accordingly, the Participant shall have the right to vote such shares and to receive any regular cash dividends paid on such shares.

               4. Should the Participant cease to remain in Service while holding one or more unvested shares of Common Stock issued pursuant to a Restricted Stock Award or should the performance objectives or Performance Goals not be attained with respect to one or more such unvested shares of Common Stock, then those shares shall be immediately surrendered to the Corporation for cancellation, and the Participant shall have no further stockholder rights with respect to those shares. To the extent the surrendered shares were previously issued to the Participant for consideration paid in cash or cash equivalent, the Corporation shall repay to the Participant the cash consideration paid for the surrendered shares.

               5. The Plan Administrator may in its discretion waive the surrender and cancellation of one or more unvested shares of Common Stock which would otherwise occur upon the cessation of the Participant’s Service or the non-attainment of the performance objectives or Performance Goals applicable to those shares. Such waiver shall result in the immediate vesting of the Participant’s interest in the shares of Common Stock as to which the waiver applies. Such waiver may be effected at any time, whether before or after the Participant’s cessation of Service or the attainment or non-attainment of the applicable performance objectives or Performance Goals.

     II. RESTRICTED STOCK UNIT AWARDS

          Subject to the provisions of Section I of Article Six with respect to Code Section 409A, shares of Common Stock may be issued under the Restricted Stock/Restricted Stock Unit

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Program on a deferred basis through the grant of Restricted Stock Units. Restricted Stock Unit Awards shall be evidenced by Award Agreements specifying the number of shares of Common Stock subject to the Award, in such form as the Plan Administrator shall from time to time establish. Award Agreements evidencing Restricted Stock Unit Awards may incorporate all or any of the terms of the Plan by reference and shall comply with and be subject to the following terms and conditions:

          A. Grant of Restricted Stock Unit Awards. Restricted Stock Unit Awards may be granted upon such conditions as the Plan Administrator shall determine, including, without limitation, upon the attainment of one or more Performance Goals described in Section I.D of Article Four. If either the grant or vesting of a Restricted Stock Unit Award is to be contingent upon the attainment of one or more Performance Goals, the Plan Administrator shall follow procedures substantially equivalent to those set forth in Sections I.C through I.E.1 of Article Four.

          B. Purchase Price. No monetary payment (other than applicable tax withholding, if any) shall be required as a condition of receiving a Restricted Stock Unit Award, the consideration for which shall be services actually rendered to the Corporation (or any Parent or Subsidiary) or for its benefit. Notwithstanding the foregoing, if required by applicable state corporations law, the Participant shall furnish consideration in the form of cash or past services rendered to the Corporation (or any Parent or Subsidiary) or for its benefit having a value not less than the par value of the shares of Common Stock issued upon settlement of the Restricted Stock Unit Award.

          C. Vesting Provisions. Restricted Stock Units may or may not be made subject to vesting conditions based upon the satisfaction of such Service requirements, conditions, restrictions or performance objectives , including, without limitation, Performance Goals as described in Section I.D of Article Four, as shall be established by the Plan Administrator and set forth in the Award Agreement evidencing such Award.

          D. Voting Rights, Dividend Equivalent Rights and Distributions. Participants shall have no voting rights with respect to shares of Common Stock represented by Restricted Stock Units until the date of the issuance of such shares (as evidenced by the appropriate entry on the books of the Corporation or of a duly authorized transfer agent of the Corporation). However, the Plan Administrator, in its discretion, may grant Dividend Equivalent Rights pursuant to the Award Agreement evidencing any Restricted Stock Unit Award with respect to the payment of cash dividends on Common Stock paid prior to the date on which Restricted Stock Units held by such Participant are settled. A Participant granted Dividend Equivalent Rights shall be credited with additional whole Restricted Stock Units as of the date of payment of such cash dividends on Common Stock. The number of additional Restricted Stock Units (rounded to the nearest whole number) to be so credited shall be determined by dividing (a) the amount of cash dividends paid on such date with respect to the number of shares of Common Stock represented by the Restricted Stock Units previously credited to the Participant by (b) the Fair Market Value per share of Common Stock on such date. Such additional Restricted Stock Units shall be subject to the same terms and conditions and shall be settled in the same manner and at the same time (or as soon thereafter as practicable) as the Restricted Stock Units originally subject to the Restricted Stock Unit Award. In the event of a dividend or

17.

distribution paid in shares of Common Stock or any other adjustment made upon a change to the Common Stock as described in Section V.E of Article One, appropriate adjustments shall be made in the Participant’s Restricted Stock Unit Award so that it represents the right to receive upon settlement any and all new, substituted or additional securities or other property (other than normal cash dividends) to which the Participant would entitled by reason of the shares of Common Stock issuable upon settlement of the Award, and all such new, substituted or additional securities or other property shall be immediately subject to the same vesting conditions as are applicable to the Award.

          E. Effect of Termination of Service. Unless otherwise provided by the Plan Administrator and set forth in the Award Agreement evidencing a Restricted Stock Unit Award, if a Participant’s Service terminates for any reason, whether voluntary or involuntary (including the Participant’s death or disability), then the Participant shall forfeit to the Corporation any Restricted Stock Units pursuant to the Award which remain subject to vesting conditions as of the date of the Participant’s termination of Service.

          F. Settlement of Restricted Stock Unit Awards. The Corporation shall issue to a Participant on the date on which Restricted Stock Units subject to the Participant’s Restricted Stock Unit Award vest or, subject to the provisions of Section I of Article Six with respect to Code Section 409A, on such other date determined by the Plan Administrator, in its discretion, and set forth in the Award Agreement one (1) share of Common Stock (and/or any other new, substituted or additional securities or other property pursuant to an adjustment described in Section II.D above) for each Restricted Stock Unit then becoming vested or otherwise to be settled on such date, subject to the withholding of applicable taxes. If permitted by the Plan Administrator, and subject to the provisions of Section I of Article Six with respect to Code Section 409A, the Participant may elect to defer receipt of all or any portion of the shares of Common Stock or other property otherwise issuable to the Participant pursuant to this Section, and such deferred issuance date(s) elected by the Participant shall be set forth in the Award Agreement. Notwithstanding the foregoing, the Plan Administrator, in its discretion, may provide for settlement of any Restricted Stock Unit Award by payment to the Participant in cash of an amount equal to the Fair Market Value on the payment date of the shares of Common Stock or other property otherwise issuable to the Participant pursuant to this Section.

          G. Nontransferability of Restricted Stock Unit Awards. Prior to the settlement of a Restricted Stock Unit Award, the Award shall not be subject in any manner to anticipation, alienation, sale, exchange, transfer, assignment, pledge, encumbrance, or garnishment by creditors of the Participant or the Participant’s beneficiary, except transfer by will or by the laws of descent and distribution. All rights with respect to a Restricted Stock Unit Award granted to a Participant hereunder shall be exercisable during his or her lifetime only by such Participant or the Participant’s guardian or legal representative.

     III. CORPORATE TRANSACTION/CHANGE IN CONTROL

          A. All of the Corporation’s outstanding repurchase rights under Restricted Stock Awards shall terminate automatically, and all the shares of Common Stock subject to those terminated rights and outstanding Restricted Stock Unit Awards shall immediately vest in full, in the event of any Corporate Transaction, except to the extent (i) those repurchase rights are to be

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assigned to the successor corporation (or parent thereof) in connection with such Corporate Transaction, (ii) substantially equivalent rights for stock of the successor corporation (or parent thereof) are substituted for outstanding Restricted Stock Units in connection with such Corporate Transaction or (iii) such accelerated vesting is precluded by other limitations imposed in the Award Agreement.

          B. The Plan Administrator shall have the discretionary authority to structure one or more of the Corporation’s repurchase rights under Restricted Stock Awards so that those rights shall automatically terminate in whole or in part, and the shares of Common Stock subject to those terminated rights or to Restricted Stock Unit Awards shall immediately vest, in the event the Participant’s Service should subsequently terminate by reason of an Involuntary Termination within a designated period (not to exceed eighteen (18) months) following the effective date of any Corporate Transaction in which those repurchase rights are assigned to the successor corporation (or parent thereof) or substantially equivalent rights for stock of the successor corporation (or parent thereof) are substituted for outstanding Restricted Stock Units in connection with such Corporate Transaction.

          C. The Plan Administrator shall also have the discretionary authority to structure one or more of the Corporation’s repurchase rights under Restricted Stock Awards so that those rights shall automatically terminate in whole or in part, and the shares of Common Stock subject to those terminated rights or to Restricted Stock Unit Awards shall immediately vest, in the event the Participant’s Service should subsequently terminate by reason of an Involuntary Termination within a designated period (not to exceed eighteen (18) months) following the effective date of any Change in Control.

     IV. SHARE ESCROW/LEGENDS

          Unvested shares may, in the Plan Administrator’s discretion, be held in escrow by the Corporation until the Participant’s interest in such shares vests or may be issued directly to the Participant with restrictive legends on the certificates evidencing those unvested shares.

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ARTICLE FOUR

PERFORMANCE AWARD PROGRAM

     I. TERMS OF PERFORMANCE AWARDS

          Subject to the provisions of Section I of Article Six with respect to Code Section 409A, Performance Awards may be granted to Participants in such amount and upon such terms as shall be determined by the Plan Administrator, in its sole discretion. Performance Awards shall be evidenced by Award Agreements in such form as the Plan Administrator shall from time to time establish. Award Agreements evidencing Performance Awards may incorporate all or any of the terms of the Plan by reference and shall comply with and be subject to the following terms and conditions:

          A. Types of Performance Awards Authorized. Performance Awards may be in the form of either Performance Shares or Performance Units. Each Award Agreement evidencing a Performance Award shall specify the number of Performance Shares or Performance Units subject thereto, the Performance Award Formula, the Performance Goal(s) and Performance Period applicable to the Award, and the other terms, conditions and restrictions of the Award.

          B. Initial Value of Performance Shares and Performance Units. Unless otherwise provided by the Plan Administrator in granting a Performance Award, each Performance Share shall have an initial value equal to the Fair Market Value of one (1) share of Stock, subject to adjustment as provided in Section V.E of Article One, on the effective date of grant of the Performance Share. Each Performance Unit shall have an initial monetary value determined by the Plan Administrator at the time of grant. The final value payable to the Participant in settlement of a Performance Award determined on the basis of the applicable Performance Award Formula will depend on the extent to which Performance Goals established by the Plan Administrator are attained within the applicable Performance Period established by the Plan Administrator.

          C. Establishment of Performance Period, Performance Goals and Performance Award Formula. In granting each Performance Award, the Plan Administrator shall establish in writing the applicable Performance Period, Performance Award Formula and one or more Performance Goals which, when measured at the end of the Performance Period, shall determine on the basis of the Performance Award Formula the final value of the Performance Award to be paid to the Participant. Unless otherwise permitted in compliance with the requirements under Code Section 162(m), with respect to each Performance Award intended to result in the payment of Performance-Based Compensation, the Plan Administrator shall establish the Performance Goal(s) and the Performance Award Formula applicable to the Performance Award no later than the earlier of (a) the date ninety (90) days after the commencement of the applicable Performance Period or (b) the date on which 25% of the Performance Period has elapsed, and, in any event, at a time when the outcome of the Performance Goals remains substantially uncertain. Once established, the Performance Goals and Performance Award Formula applicable to a Performance Award intended to result in the

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payment of Performance-Based Compensation shall not be changed during the Performance Period. The Corporation shall notify each Participant granted a Performance Award of the terms of such Award, including the Performance Period, Performance Goal(s) and Performance Award Formula.

          D. Measurement of Performance Goals. Performance Goals shall be established by the Plan Administrator on the basis of targets to be attained (“Performance Targets”) with respect to one or more measures of business or financial performance (each, a “Performance Measure”), subject to the following:

               1. Performance Measures. Performance Measures shall have the same meanings as used in the Corporation’s financial statements, or, if such terms are not used in the Corporation’s financial statements, they shall have the meaning applied pursuant to generally accepted accounting principles, or as used generally in the Corporation’s industry. Performance Measures shall be calculated with respect to the Corporation and each Subsidiary consolidated therewith for financial reporting purposes or such division or other business unit as may be selected by the Plan Administrator. For purposes of the Plan, the Performance Measures applicable to a Performance Award shall be calculated in accordance with generally accepted accounting principles, but prior to the accrual or payment of any Performance Award for the same Performance Period and excluding the effect (whether positive or negative) of any change in accounting standards or any extraordinary, unusual or nonrecurring item, as determined by the Plan Administrator, occurring after the establishment of the Performance Goals applicable to the Performance Award. Each such adjustment, if any, shall be made solely for the purpose of providing a consistent basis from period to period for the calculation of Performance Measures in order to prevent the dilution or enlargement of the Participant’s rights with respect to a Performance Award. Performance Measures may be one or more of the following, as determined by the Plan Administrator:

                    (i) revenue;

                    (ii) sales;

                    (iii) expenses;

                    (iv) operating income;

                    (v) gross margin;

                    (vi) operating margin;

                    (vii) earnings before any one or more of: stock-based compensation expense, interest, taxes and depreciation, and amortization;

                    (viii) pre-tax profit;

                    (ix) net operating income;

                    (x) net income;

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                    (xi) economic value added;

                    (xii) free cash flow;

                    (xiii) operating cash flow;

                    (xiv) the market price of the Common Stock;

                    (xv) earnings per share;

                    (xvi) return on stockholder equity;

                    (xvii) return on capital;

                    (xviii) return on assets;

                    (xix) return on investment;

                    (xx) balance of cash, cash equivalents and marketable securities;

                    (xxi) market share;

                    (xxii) number of customers;

                    (xxiii) customer satisfaction;

                    (xxiv) product development; and

                    (xxv) completion of a joint venture or other corporate transaction.

               2. Performance Targets. Performance Targets may include a minimum, maximum, target level and intermediate levels of performance, with the final value of a Performance Award determined under the applicable Performance Award Formula by the level attained during the applicable Performance Period. A Performance Target may be stated as an absolute value or as a value determined relative to an index, budget or other standard selected by the Plan Administrator.

          E. Settlement of Performance Awards.

               1. Determination of Final Value. As soon as practicable following the completion of the Performance Period applicable to a Performance Award, the Plan Administrator shall certify in writing the extent to which the applicable Performance Goals have been attained and the resulting final value of the Award earned by the Participant and to be paid upon its settlement in accordance with the applicable Performance Award Formula.

               2. Discretionary Adjustment of Award Formula. In its discretion, the Plan Administrator may, either at the time it grants a Performance Award or at any time

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thereafter, provide for the positive or negative adjustment of the Performance Award Formula applicable to a Performance Award granted to any Participant who is not a Covered Employee to reflect such Participant’s individual performance in his or her position with the Corporation or such other factors as the Plan Administrator may determine. If permitted under a Covered Employee’s Award Agreement, the Plan Administrator shall have the discretion, on the basis of such criteria as may be established by the Plan Administrator, to reduce some or all of the value of the Performance Award that would otherwise be paid to the Covered Employee upon its settlement notwithstanding the attainment of any Performance Goal and the resulting value of the Performance Award determined in accordance with the Performance Award Formula. No such reduction may result in an increase in the amount payable upon settlement of another Participant’s Performance Award.

               3. Effect of Leaves of Absence. Unless otherwise required by law, payment of the final value, if any, of a Performance Award held by a Participant who has taken in excess of thirty (30) days in leaves of absence during a Performance Period shall be prorated on the basis of the number of days of the Participant’s Service during the Performance Period during which the Participant was not on a leave of absence.

               4. Notice to Participants. As soon as practicable following the Plan Administrator’s determination and certification in accordance with paragraphs 1 and 2 above, the Corporation shall notify each Participant of the determination of the Plan Administrator.

               5. Payment in Settlement of Performance Awards. Subject to the provisions of Section I of Article Six with respect to Code Section 409A, as soon as practicable following the Plan Administrator’s determination and certification in accordance with paragraphs 1 and 2 above or on such other date(s) determined by the Plan Administrator, in its discretion, and set forth in the Award Agreement, payment shall be made to each eligible Participant of the final value of the Participant’s Performance Award. Payment of such amount shall be made in the form of cash, Shares, or a combination thereof as determined by the Plan Administrator. Unless otherwise provided in the Award Agreement evidencing a Performance Award, payment shall be made in a lump sum. If permitted by the Plan Administrator, and subject to the provisions of Section I of Article Six with respect to Code Section 409A, the Participant may elect to defer receipt of all or any portion of the payment to be made to the Participant pursuant to this paragraph, and such deferred payment date(s) elected by the Participant shall be set forth in the Award Agreement.

               6. Provisions Applicable to Payment in Shares. If payment is to be made in shares of Common Stock, the number of such shares shall be determined by dividing the final value of the Performance Award by the value of a share of Common Stock determined by the method specified in the Award Agreement. Such methods may include, without limitation, the closing market price on a specified date (such as the settlement date) or an average of market prices over a series of trading days. Shares of Common Stock issued in payment of any Performance Award may be fully vested and freely transferable shares or may be subject to vesting conditions as provided in Section I.E.1 of Article Three.

          F. Voting Rights; Dividend Equivalent Rights and Distributions. Participants shall have no voting rights with respect to shares of Common Stock represented by

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Performance Share Awards until the date of the issuance of such shares, if any (as evidenced by the appropriate entry on the books of the Corporation or of a duly authorized transfer agent of the Corporation). However, the Plan Administrator, in its discretion, may grant Dividend Equivalent Rights pursuant to the Award Agreement evidencing any Performance Share Award with respect to the payment of cash dividends on Common Stock paid prior to the date on which the Performance Shares are settled or forfeited. A Participant granted Dividend Equivalent Rights shall be credited with additional whole Performance Shares as of the date of payment of such cash dividends on Common Stock. The number of additional Performance Shares (rounded to the nearest whole number) to be so credited shall be determined by dividing (a) the amount of cash dividends paid on such date with respect to the number of shares of Common Stock represented by the Performance Shares previously credited to the Participant by (b) the Fair Market Value per share of Common Stock on such date. Such additional Performance Shares shall be subject to the same terms, conditions and restrictions and shall be settled in the same manner and at the same time (or as soon thereafter as practicable) as the shares originally subject to the Award. Dividend Equivalent Rights shall not be granted with respect to Performance Units. In the event of a dividend or distribution paid in shares of Common Stock or any other adjustment made upon a change to the Common Stock as described in Section V.E of Article One, appropriate adjustments shall be made in the Participant’s Performance Share Award so that it represents the right to receive upon settlement any and all new, substituted or additional securities or other property (other than normal cash dividends) to which the Participant would entitled by reason of the shares of Common Stock issuable upon settlement of the Performance Share Award, and all such new, substituted or additional securities or other property shall be immediately subject to the same Performance Goals as are applicable to the Award.

          G. Effect of Termination of Service. Unless otherwise provided by the Plan Administrator and set forth in the Award Agreement evidencing a Performance Award, if a Participant’s Service terminates for any reason, whether voluntary or involuntary (including the Participant’s death or disability) before completion of the Performance Period applicable to the Performance Award, then the Participant shall forfeit the Award in its entirety.

          H. Nontransferability of Performance Awards. Prior to settlement in accordance with the provisions of the Plan, no Performance Award shall be subject in any manner to anticipation, alienation, sale, exchange, transfer, assignment, pledge, encumbrance, or garnishment by creditors of the Participant or the Participant’s beneficiary, except transfer by will or by the laws of descent and distribution. All rights with respect to a Performance Award granted to a Participant hereunder shall be exercisable during his or her lifetime only by such Participant or the Participant’s guardian or legal representative.

     II. CORPORATE TRANSACTION/CHANGE IN CONTROL

          The Plan Administrator may, in its discretion, provide in any Award Agreement evidencing a Performance Award that, in the event of a Corporate Transaction or Change in Control, the Performance Award held by a Participant whose Service has not terminated prior to the Change in Control or whose Service terminated by reason of the Participant’s death or Permanent Disability shall become vested and payable effective as of the date of the Corporate Transaction or Change in Control to such extent as specified in such Award Agreement.

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ARTICLE FIVE

AUTOMATIC OPTION GRANT PROGRAM

          The provisions of the Automatic Option Grant Program have been revised as of February 8, 2002, subject to approval by the Corporation’s stockholders at the 2002 Annual Stockholders Meeting.

     I. OPTION TERMS

          A. Grant Dates. Option grants shall be made on the dates specified below:

               1. Each individual who is first elected or appointed as a non-employee Board member at any time on or after the 2002 Annual Stockholders Meeting shall automatically be granted, on the date of such initial election or appointment, a Non-Statutory Option to purchase 30,000 shares of Common Stock, provided that individual has not previously been in the employ of the Corporation or any Parent or Subsidiary.

               2. On the date of each Annual Stockholders Meeting, beginning with the 2002 Annual Stockholders Meeting, each individual who is to continue to serve as a non-employee Board member, whether or not that individual is standing for re-election to the Board at that particular Annual Stockholders Meeting, shall automatically be granted a Non-Statutory Option to purchase 15,000 shares of Common Stock. There shall be no limit on the number of such annual automatic Option grants any one non-employee Board member may receive over his or her period of Board service, and a non-employee Board member who has previously been in the employ of the Corporation (or any Parent or Subsidiary) or who has otherwise received one or more stock Option grants from the Corporation shall be eligible to receive one or more such annual automatic Option grants over his or her period of continued Board service.

               3. Stockholder approval of the amendment contained in this 2002 Restatement at the 2002 Annual Stockholders Meeting shall constitute pre-approval of each Option granted on or after that Annual Meeting pursuant to the express terms of this Automatic Option Grant Program on the basis of the amendments to this program effected by such Restatement and the subsequent exercise of that Option in accordance with its terms.

          B. Exercise Price.

               1. The exercise price per share shall be equal to one hundred percent (100%) of the Fair Market Value per share of Common Stock on the Option grant date.

               2. The exercise price shall be payable in one or more of the alternative forms authorized under the Discretionary Option/SAR Grant Program. Except to the extent the sale and remittance procedure specified thereunder is utilized, payment of the exercise price for the purchased shares must be made on the Exercise Date.

          C. Option Term. Each Option shall have a term of ten (10) years measured from the Option grant date.

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          D. Exercise and Vesting of Options. Each Option shall be immediately exercisable for any or all of the Option shares. However, any shares purchased under the Option shall be subject to repurchase by the Corporation, at the exercise price paid per share, upon the Participant’s cessation of Board service prior to vesting in those shares. The shares subject to each initial automatic Option grant shall vest, and the Corporation’s repurchase right shall lapse, in a series of six (6) successive equal semi-annual installments upon the Participant’s completion of each six (6)-month period of service as a Board member over the thirty-six (36)-month period measured from the Option grant date. The shares subject to each annual automatic Option grant shall vest, and the Corporation’s repurchase right shall lapse, in a series of two (2) successive equal annual installments upon the Participant’s completion of each twelve (12)-month period of service as a Board member over the twenty-four (24)-month period measured from the Option grant date.

          E. Limited Transferability of Options. Each Option under this Article Five may, in connection with the Participant’s estate plan, be assigned in whole or in part during the Participant’s lifetime to one or more members of the Participant’s immediate family or to a trust established exclusively for one or more such family members. The assigned portion may only be exercised by the person or persons who acquire a proprietary interest in the Option pursuant to the assignment. The terms applicable to the assigned portion shall be the same as those in effect for the Option immediately prior to such assignment and shall be set forth in such documents issued to the assignee as the Plan Administrator may deem appropriate. The Participant may also designate one or more persons as the beneficiary or beneficiaries of his or her outstanding Options under this Article Five, and those Options shall, in accordance with such designation, automatically be transferred to such beneficiary or beneficiaries upon the Participant’s death while holding those Options. Such beneficiary or beneficiaries shall take the transferred Options subject to all the terms and conditions of the applicable agreement evidencing each such transferred Option, including (without limitation) the limited time period during which the Option may be exercised following the Participant’s death.

          F. Termination of Board Service. The following provisions shall govern the exercise of any Options held by the Participant at the time the Participant ceases to serve as a Board member:

                    (i) The Participant (or, in the event of Participant’s death, the personal representative of the Participant’s estate or the person or persons to whom the Option is transferred pursuant to the Participant’s will or in accordance with the laws of descent and distribution or by the designated beneficiary or beneficiaries of such Option) shall have a twelve (12)-month period following the date of such cessation of Board service in which to exercise each such Option.

                    (ii) During the twelve (12)-month exercise period, the Option may not be exercised in the aggregate for more than the number of vested shares of Common Stock for which the Option is exercisable at the time of the Participant’s cessation of Board service.

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                    (iii) Should the Participant cease to serve as a Board member by reason of death or Permanent Disability, then all shares at the time subject to the Option shall immediately vest so that such Option may, during the twelve (12)-month exercise period following such cessation of Board service, be exercised for all or any portion of those shares as fully-vested shares of Common Stock.

                    (iv) In no event shall the Option remain exercisable after the expiration of the Option term. Upon the expiration of the twelve (12)-month exercise period or (if earlier) upon the expiration of the Option term, the Option shall terminate and cease to be outstanding for any vested shares for which the Option has not been exercised. However, the Option shall, immediately upon the Participant’s cessation of Board service for any reason other than death or Permanent Disability, terminate and cease to be outstanding to the extent the Option is not otherwise at that time exercisable for vested shares.

     II. CORPORATE TRANSACTION/CHANGE IN CONTROL/HOSTILE TAKE-OVER

          A. In the event of any Corporate Transaction while the Participant remains in Service, the shares of Common Stock at the time subject to each outstanding Option held by such Participant under this Automatic Option Grant Program but not otherwise vested shall automatically vest in full so that each such Option shall, immediately prior to the effective date of the Corporate Transaction, become fully exercisable for all of the shares of Common Stock at the time subject to such Option and may be exercised for all or any portion of those shares as fully-vested shares of Common Stock. Immediately following the consummation of the Corporate Transaction, each automatic Option grant shall terminate and cease to be outstanding, except to the extent assumed by the successor corporation (or parent thereof).

          B. In connection with any Change in Control while the Participant remains in Service, the shares of Common Stock at the time subject to each outstanding Option held by such Participant under this Automatic Option Grant Program but not otherwise vested shall automatically vest in full so that each such Option shall, immediately prior to the effective date of the Change in Control, become fully exercisable for all of the shares of Common Stock at the time subject to such Option and may be exercised for all or any portion of those shares as fully-vested shares of Common Stock. Each such Option shall remain exercisable for such fully-vested Option shares until the expiration or sooner termination of the Option term or the surrender of the Option in connection with a Hostile Take-Over.

          C. All outstanding repurchase rights under this Automatic Option Grant Program shall automatically terminate, and the shares of Common Stock subject to those terminated rights shall immediately vest in full, in the event of any Corporate Transaction or Change in Control.

          D. Subject to the provisions of Section I of Article Six with respect to Code Section 409A, upon the occurrence of a Hostile Take-Over while the Participant remains in Service, the Participant shall have a thirty (30)-day period in which to surrender to the

27.

Corporation each of his or her outstanding Options under this Automatic Option Grant Program. The Participant shall in return be entitled to a cash distribution from the Corporation in an amount equal to the excess of (i) the Take-Over Price of the shares of Common Stock at the time subject to each surrendered Option (whether or not the Participant is otherwise at the time vested in those shares) over (ii) the aggregate exercise price payable for such shares. Such cash distribution shall be paid within five (5) days following the surrender of the Option to the Corporation. No approval or consent of the Board or any Plan Administrator shall be required at the time of the actual Option surrender and cash distribution.

          E. Each Option which is assumed in connection with a Corporate Transaction shall be appropriately adjusted, immediately after such Corporate Transaction, to apply to the number and class of securities which would have been issuable to the Participant in consummation of such Corporate Transaction had the Option been exercised immediately prior to such Corporate Transaction. If the holders of Common Stock receive cash consideration in connection with the Corporate Transaction, the assumed Option may be adjusted, at the Option of the successor corporation, to apply to the number of shares of its common stock with a fair market value equivalent to the cash consideration paid per share of Common Stock in such Corporate Transaction. Appropriate adjustments shall also be made to the exercise price payable per share under each outstanding Option, provided the aggregate exercise price payable for such securities shall remain the same. All such adjustments shall be made in compliance with the requirements of Code Section 409A, if applicable.

          F. The grant of Options under the Automatic Option Grant Program shall in no way affect the right of the Corporation to adjust, reclassify, reorganize or otherwise change its capital or business structure or to merge, consolidate, dissolve, liquidate or sell or transfer all or any part of its business or assets.

     III. REMAINING TERMS

          The remaining terms of each Option granted under the Automatic Option Grant Program shall be the same as the terms in effect for Option grants made under the Discretionary Option/SAR Grant Program.

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ARTICLE SIX

MISCELLANEOUS

     I. COMPLIANCE WITH CODE SECTION 409A

          A. Awards Subject to Code Section 409A. The provisions of this Section I shall apply to any Award or portion thereof that is or becomes subject to Code Section 409A. Awards subject to Code Section 409A include, without limitation:

               1. Any Non-Statutory Option or SAR that permits the deferral of compensation other than the deferral of recognition of income until the exercise of the Award.

               2. Any Restricted Stock Unit Award or Performance Award that either (a) provides by its terms for settlement of all or any portion of the Award on one or more dates following the Short-Term Deferral Period (as defined below) or (b) permits or requires the Participant to elect one or more dates on which the Award will be settled.

          Subject to any applicable U.S. Treasury Regulations promulgated pursuant to Code Section 409A or other applicable guidance, the term “Short-Term Deferral Period” means the period ending on the later of (i) the date that is two and one-half months from the end of the taxable year of the Corporation in which the applicable portion of the Award is no longer subject to a substantial risk of forfeiture or (ii) the date that is two and one-half months from the end of the Participant’s taxable year in which the applicable portion of the Award is no longer subject to a substantial risk of forfeiture. For this purpose, the term “substantial risk of forfeiture” shall have the meaning set forth in any applicable U.S. Treasury Regulations promulgated pursuant to Code Section 409A or other applicable guidance.

          B. Deferral and/or Distribution Elections. Except as otherwise permitted or required by Section 409A or any applicable U.S. Treasury Regulations promulgated pursuant to Code Section 409A or other applicable guidance, the following rules shall apply to any deferral and/or distribution elections (each, an “Election”) that may be permitted or required by the Plan Administrator pursuant to an Award subject to Code Section 409A:

               1. All Elections must be in writing and specify the amount of the distribution in settlement of an Award being deferred, as well as the time and form of distribution as permitted by this Plan.

               2. All Elections shall be made by the end of the Participant’s taxable year prior to the year in which services commence for which an Award may be granted to such Participant; provided, however, that if the Award qualifies as “performance-based compensation” for purposes of Code Section 409A and is based on services performed over a period of at least twelve (12) months, then the Election may be made no later than six (6) months prior to the end of such period.

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               3. Elections shall continue in effect until a written election to revoke or change such Election is received by the Corporation, except that a written election to revoke or change such Election must be made prior to the last day for making an Election determined in accordance with paragraph 2 above or as permitted by Section I.C below.

          C. Subsequent Elections. Any Award subject to Code Section 409A which permits a subsequent Election to delay the distribution or change the form of distribution in settlement of such Award shall comply with the following requirements:

               1. No subsequent Election may take effect until at least twelve (12) months after the date on which the subsequent Election is made;

               2. Each subsequent Election related to a distribution in settlement of an Award not described in Section I.D.2, I.D.3, or I.D.6 below must result in a delay of the distribution for a period of not less than five (5) years from the date such distribution would otherwise have been made; and

               3. No subsequent Election related to a distribution pursuant to Section I.D.4 below shall be made less than twelve (12) months prior to the date of the first scheduled payment under such distribution.

          D. Distributions Pursuant to Deferral Elections. No distribution in settlement of an Award subject to Code Section 409A may commence earlier than:

               1. Separation from service (as determined by the Secretary of the United States Treasury);

               2. The date the Participant becomes Disabled (as defined below);

               3. Death;

               4. A specified time (or pursuant to a fixed schedule) that is either (i) specified by the Plan Administrator upon the grant of an Award and set forth in the Award Agreement evidencing such Award or (ii) specified by the Participant in an Election complying with the requirements of Section I.B and/or I.C above, as applicable;

               5. To the extent provided by the Secretary of the U.S. Treasury, a change in the ownership or effective control or the Corporation or in the ownership of a substantial portion of the assets of the Corporation; or

               6. The occurrence of an Unforeseeable Emergency (as defined below).

          Notwithstanding anything else herein to the contrary, to the extent that a Participant is a “Specified Employee” (as defined in Code Section 409A(a)(2)(B)(i)) of the Corporation, no distribution pursuant to Section I.D.1 above in settlement of an Award subject to Code Section 409A may be made before the date which is six (6) months after such Participant’s date of separation from service, or, if earlier, the date of the Participant’s death.

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          E. Unforeseeable Emergency. The Plan Administrator shall have the authority to provide in any Award subject to Code Section 409A for distribution in settlement of all or a portion of such Award in the event that a Participant establishes, to the satisfaction of the Plan Administrator, the occurrence of an Unforeseeable Emergency. In such event, the amount(s) distributed with respect to such Unforeseeable Emergency cannot exceed the amounts necessary to satisfy such Unforeseeable Emergency plus amounts necessary to pay taxes reasonably anticipated as a result of such distribution(s), after taking into account the extent to which such hardship is or may be relieved through reimbursement or compensation by insurance or otherwise or by liquidation of the Participant’s assets (to the extent the liquidation of such assets would not itself cause severe financial hardship). All distributions with respect to an Unforeseeable Emergency shall be made in a lump sum as soon as practicable following the Plan Administrator’s determination that an Unforeseeable Emergency has occurred.

          The occurrence of an Unforeseeable Emergency shall be judged and determined by the Plan Administrator. The Plan Administrator’s decision with respect to whether an Unforeseeable Emergency has occurred and the manner in which, if at all, the distribution in settlement of an Award shall be altered or modified, shall be final, conclusive, and not subject to approval or appeal.

          F. Disabled. The Plan Administrator shall have the authority to provide in any Award subject to Code Section 409A for distribution in settlement of such Award in the event that the Participant becomes Disabled. A Participant shall be considered “Disabled” if either:

               1. the Participant is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous period of not less than twelve (12) months, or

               2. the Participant is, by reason of any medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous period of not less than twelve (12) months, receiving income replacement benefits for a period of not less than three (3) months under an accident and health plan covering employees of the Participant’s employer.

          All distributions payable by reason of a Participant becoming Disabled shall be paid in a lump sum or in periodic installments as established by the Participant’s Election, commencing as soon as practicable following the date the Participant becomes Disabled. If the Participant has made no Election with respect to distributions upon becoming Disabled, all such distributions shall be paid in a lump sum as soon as practicable following the date the Participant becomes Disabled.

          G. Death. If a Participant dies before complete distribution of amounts payable upon settlement of an Award subject to Code Section 409A, such undistributed amounts shall be distributed to his or her beneficiary under the distribution method for death established by the Participant’s Election as soon as administratively possible following receipt by the Plan Administrator of satisfactory notice and confirmation of the Participant’s death. If the

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Participant has made no Election with respect to distributions upon death, all such distributions shall be paid in a lump sum as soon as practicable following the date of the Participant’s death.

          H. No Acceleration of Distributions. Notwithstanding anything to the contrary herein, this Plan does not permit the acceleration of the time or schedule of any distribution under this Plan, except as provided by Code Section 409A and/or the Secretary of the U.S. Treasury.

     II. TAX WITHHOLDING

          A. The Corporation’s obligation to deliver shares of Common Stock upon the exercise of Options or the issuance or vesting of such shares under the Plan or payment of cash in settlement of any Award shall be subject to the satisfaction of all applicable Federal, state and local income and employment tax withholding requirements.

          B. The Plan Administrator may, in its discretion, provide any or all Participants holding Awards under the Plan (other than the Options granted or the shares issued under the Automatic Option Grant Program) with the right to use shares of Common Stock in satisfaction of all or part of the Withholding Taxes to which such Participants may become subject in connection with the exercise, vesting, issuance of shares or other settlement of their Awards. Such right may be provided to any such holder in either or both of the following formats:

               Stock Withholding: The election to have the Corporation withhold, from the shares of Common Stock otherwise issuable upon the exercise or settlement of an Award, a portion of those shares which are fully vested and which have an aggregate Fair Market Value equal to the percentage of the Withholding Taxes (not to exceed one hundred percent (100%)) designated by the holder, but not in any event in excess of the amount determined by the applicable minimum statutory withholding rates.

               Stock Delivery: The election to deliver to the Corporation, at the time shares of Common Stock previously issued vest, one or more such shares of Common Stock with an aggregate Fair Market Value equal to the percentage of the Withholding Taxes (not to exceed one hundred percent (100%)) designated by the holder, but not in any event in excess of the amount determined by the applicable minimum statutory withholding rates.

     III. EFFECTIVE DATE AND TERM OF THE PLAN

          A. The Plan shall become effective immediately on the Plan Effective Date.

          B. The Plan shall serve as the successor to the Predecessor Plan, and no further Option grants or direct stock issuances shall be made under the Predecessor Plan after the Plan Effective Date. All Options outstanding under the Predecessor Plan on the Plan Effective Date shall be incorporated into the Plan at that time and shall be treated as outstanding Options under the Plan. However, each outstanding Option so incorporated shall continue to be governed solely by the terms of the Award Agreement evidencing such Option, and no provision of the Plan shall be deemed to affect or otherwise modify the rights or obligations of the holders of such incorporated Options with respect to their acquisition of shares of Common Stock.

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          C. One or more provisions of the Plan, including (without limitation) the Option/vesting acceleration provisions of Article Two relating to Corporate Transactions and Changes in Control, may, in the Plan Administrator’s discretion, be extended to one or more Options incorporated from the Predecessor Plan which do not otherwise contain such provisions.

          D. The Plan shall terminate upon the earliest to occur of (i) May 18, 2009, (ii) the date on which all shares available for issuance under the Plan shall have been issued as fully-vested shares or (iii) the termination of all outstanding Options in connection with a Corporate Transaction. Should the Plan terminate on May 18, 2009, then all Option grants and unvested stock issuances outstanding at that time shall continue to have force and effect in accordance with the provisions of the Award Agreements evidencing such grants or issuances.

     IV. AMENDMENT OF THE PLAN

          A. The Board shall have complete and exclusive power and authority to amend or modify the Plan or any Award Agreement in any or all respects. However, except as provided in Section V.B below, no such amendment or modification shall adversely affect the rights and obligations with respect to Awards at the time outstanding under the Plan unless the Participant consents to such amendment or modification. In addition, certain amendments may require stockholder approval pursuant to applicable laws or regulations.

          B. Notwithstanding any other provision of this Plan to the contrary, the Board may, in its sole and absolute discretion and without the consent of any Participant, amend the Plan or any Award Agreement, to take effect retroactively or otherwise, as it deems necessary or advisable for the purpose of conforming the Plan or such Award Agreement to any present or future law relating to plans of this or similar nature (including, but not limited to, Code Section 409A), and to the administrative regulations and rulings promulgated thereunder.

          C. Options to purchase shares of Common Stock may be granted under the Discretionary Option/SAR Grant and shares of Common Stock may be issued under the Restricted Stock Awards that are in each instance in excess of the number of shares then available for issuance under the Plan, provided any excess shares actually issued under those programs shall be held in escrow until there is obtained stockholder approval of an amendment sufficiently increasing the number of shares of Common Stock available for issuance under the Plan. If such stockholder approval is not obtained within twelve (12) months after the date the first such excess issuances are made, then (i) any unexercised Options granted on the basis of such excess shares shall terminate and cease to be outstanding and (ii) the Corporation shall promptly refund to the Participants the exercise or purchase price paid for any excess shares issued under the Plan and held in escrow, together with interest (at the applicable Short Term Federal Rate) for the period the shares were held in escrow, and such shares shall thereupon be automatically cancelled and cease to be outstanding.

     V. USE OF PROCEEDS

          Any cash proceeds received by the Corporation from the sale of shares of Common Stock under the Plan shall be used for general corporate purposes.

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     VI. REGULATORY APPROVALS

          A. The implementation of the Plan, the granting of any stock Option under the Plan and the issuance of any shares of Common Stock pursuant to any Award shall be subject to the Corporation’s procurement of all approvals and permits required by regulatory authorities having jurisdiction over the Plan.

          B. No shares of Common Stock or other assets shall be issued or delivered under the Plan unless and until there shall have been compliance with all applicable requirements of Federal and state securities laws, including the filing and effectiveness of the Form S-8 registration statement for the shares of Common Stock issuable under the Plan, and all applicable listing requirements of any stock exchange (or the Nasdaq National Market, if applicable) on which Common Stock is then listed for trading.

     VII. NO EMPLOYMENT/SERVICE RIGHTS

          Nothing in the Plan shall confer upon the Participant any right to continue in Service for any period of specific duration or interfere with or otherwise restrict in any way the rights of the Corporation (or any Parent or Subsidiary employing or retaining such person) or of the Participant, which rights are hereby expressly reserved by each, to terminate such person’s Service at any time for any reason, with or without cause.

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APPENDIX

          The following definitions shall be in effect under the Plan:

          A. Automatic Option Grant Program shall mean the automatic Option grant program in effect under Article Five of the Plan.

          B. Award shall mean an Option, Stock Appreciation Right, Restricted Stock Purchase Right, Restricted Stock Bonus, Restricted Stock Unit, Performance Share or Performance Unit granted under the Plan.

          C. Award Agreement shall mean one or more written or electronic documents constituting an agreement between the Corporation and a Participant and setting forth the terms, conditions and restrictions of an Award granted to the Participant.

          D. Board shall mean the Corporation’s Board of Directors.

          E. Change in Control shall mean a change in ownership or control of the Corporation effected through either of the following transactions:

                    (i) the acquisition, directly or indirectly by any person or related group of persons (other than the Corporation or a person that directly or indirectly controls, is controlled by, or is under common control with, the Corporation), of beneficial ownership (within the meaning of Rule 13d-3 of the 1934 Act) of securities possessing more than fifty percent (50%) of the total combined voting power of the Corporation’s outstanding securities pursuant to a tender or exchange offer made directly to the Corporation’s stockholders, or

                    (ii) a change in the composition of the Board over a period of thirty-six (36) consecutive months (twelve (12) months in the case of any Award subject to Code Section 409A) or less such that a majority of the Board members ceases, by reason of one or more contested elections for Board membership, to be comprised of individuals who either (A) have been Board members continuously since the beginning of such period or (B) have been elected or nominated for election as Board members during such period by at least a majority of the Board members described in clause (A) who were still in office at the time the Board approved such election or nomination.

          F. Code shall mean the Internal Revenue Code of 1986, as amended, and any applicable regulations promulgated thereunder.

          G. Common Stock shall mean the Corporation’s common stock.

          H. Corporate Transaction shall mean any of the following transactions to which the Corporation is a party:

                    (i) a stockholder-approved merger or consolidation in which securities possessing more than fifty percent (50%) of the total combined voting power of the Corporation’s outstanding securities are transferred to a person or persons different from the persons holding those securities immediately prior to such transaction, or

                    (ii) a merger or consolidation (whether or not stockholder-approved) following a Change in Control in which voting securities of the Corporation are transferred to the person or persons (or affiliates of such persons) who acquired ownership or control of the Corporation pursuant to the Change in Control; or

                    (iii) the sale, transfer or other disposition of all or substantially all of the Corporation’s assets in complete liquidation or dissolution of the Corporation.

          I. Corporation shall mean Packeteer, Inc., a Delaware corporation, and any corporate successor to all or substantially all of the assets or voting stock of Packeteer, Inc.. which shall by appropriate action adopt the Plan.

          J. Covered Employee shall mean any Employee who is or may become a “covered employee,” as defined in Code Section 162(m), or any successor statute, and who is designated, either as an individual Employee or member of a class of Employees, by the Primary Committee no later than the earlier of (i) the date ninety (90) days after the beginning of the Performance Period, or (ii) the date on which twenty-five percent (25%) of the Performance Period has elapsed, as a “Covered Employee” under the Plan for such applicable Performance Period.

          K. Discretionary Option/SAR Grant Program shall mean the discretionary Option and Stock Appreciation Right grant program in effect under Article Two of the Plan.

          L. Dividend Equivalent Right shall mean the right of a Participant, granted at the discretion of the Plan Administrator or as otherwise provided by the Plan, to receive a credit for the account of such Participant in an amount equal to the cash dividends paid on one share of Common Stock represented by an Award held by such Participant.

          M. Employee shall mean an individual who is in the employ of the Corporation (or any Parent or Subsidiary), subject to the control and direction of the employer entity as to both the work to be performed and the manner and method of performance.

          N. Exercise Date shall mean the date on which the Corporation shall have received written notice of the Option or SAR exercise.

          O. Fair Market Value per share of Common Stock on any relevant date shall be determined in accordance with the following provisions:

                    (i) If the Common Stock is at the time traded on the Nasdaq National Market, then the Fair Market Value shall be the closing selling

A-1.

price per share of Common Stock on the date in question, as such price is reported by the National Association of Securities Dealers on the Nasdaq National Market and published in The Wall Street Journal. If there is no closing selling price for the Common Stock on the date in question, then the Fair Market Value shall be the closing selling price on the last preceding date for which such quotation exists.

                    (ii) If the Common Stock is at the time listed on any Stock Exchange, then the Fair Market Value shall be the closing selling price per share of Common Stock on the date in question on the Stock Exchange determined by the Plan Administrator to be the primary market for the Common Stock, as such price is officially quoted in the composite tape of transactions on such exchange and published in The Wall Street Journal. If there is no closing selling price for the Common Stock on the date in question, then the Fair Market Value shall be the closing selling price on the last preceding date for which such quotation exists.

                    (iii) For purposes of any Option grants made on the Underwriting Date, the Fair Market Value shall be deemed to be equal to the price per share at which the Common Stock is to be sold in the initial public offering pursuant to the Underwriting Agreement.

          P. Freestanding SAR shall mean an SAR that is granted independently of any Options, as described in Article Two.

          Q. Hostile Take-Over shall mean the acquisition, directly or indirectly, by any person or related group of persons (other than the Corporation or a person that directly or indirectly controls, is controlled by, or is under common control with, the Corporation) of beneficial ownership (within the meaning of Rule 13d-3 of the 1934 Act) of securities possessing more than fifty percent (50%) of the total combined voting power of the Corporation’s outstanding securities pursuant to a tender or exchange offer made directly to the Corporation’s stockholders which the Board does not recommend such stockholders to accept.

          R. Incentive Option shall mean an Option which satisfies the requirements of Code Section 422.

          S. Involuntary Termination shall mean the termination of the Service of any individual which occurs by reason of:

                    (i) such individual’s involuntary dismissal or discharge by the Corporation for reasons other than Misconduct, or

                    (ii) such individual’s voluntary resignation following (A) a change in his or her position with the Corporation which materially reduces his or her duties and responsibilities or the level of management to which he or she reports, (B) a reduction in his or her level of compensation (including base salary, fringe benefits and target bonus under any corporate-performance based bonus or incentive programs) by more than fifteen percent (15%) or (C) a relocation of such individual’s place of employment by more than fifty (50) miles,

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provided and only if such change, reduction or relocation is effected by the Corporation without the individual’s consent.

          T. Misconduct shall mean the commission of any act of fraud, embezzlement or dishonesty by the Participant, any unauthorized use or disclosure by such person of confidential information or trade secrets of the Corporation (or any Parent or Subsidiary), or any other intentional misconduct by such person adversely affecting the business or affairs of the Corporation (or any Parent or Subsidiary) in a material manner. The foregoing definition shall not be deemed to be inclusive of all the acts or omissions which the Corporation (or any Parent or Subsidiary) may consider as grounds for the dismissal or discharge of any Participant or other person in the Service of the Corporation (or any Parent or Subsidiary).

          U. 1934 Act shall mean the Securities Exchange Act of 1934, as amended.

          V. Non-Statutory Option shall mean an Option not intended to satisfy the requirements of Code Section 422.

          W. Option shall mean an Option to purchase Common Stock granted under the Plan. An Option may be either an Incentive Option or a Non-Statutory Option.

          X. Parent shall mean any corporation (other than the Corporation) in an unbroken chain of corporations ending with the Corporation, provided each corporation in the unbroken chain (other than the Corporation) owns, at the time of the determination, stock possessing fifty percent (50%) or more of the total combined voting power of all classes of stock in one of the other corporations in such chain.

          Y. Participant shall mean any person who has been granted an Award.

          Z. Performance Award shall mean and Award of Performance Shares or Performance Units.

          AA. Performance Award Formula shall mean, for any Performance Award, a formula or table established by the Plan Administrator which provides the basis for computing the value of a Performance Award at one or more threshold levels of attainment of the applicable Performance Goal(s) measured as of the end of the applicable Performance Period.

          BB. Performance-Based Compensation shall mean compensation realized by a Participant under an Award that constitutes performance-based compensation within the meaning of Code Section 162(m) and the applicable treasury regulations thereunder.

          CC. Performance Measures shall mean one or more measures of business or financial performance described in Article Four which are approved by the Corporation’s stockholders pursuant to this Plan in order to qualify compensation payable under Awards based upon the attainment of Performance Goals established with respect to such Performance Measures as Performance-Based Compensation.

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          DD. Performance Period shall mean the period of time at the end of which the attainment of one or more Performance Goals is measured in order to determine the extent of the vesting of an Award or the amount of the payment to be made upon the settlement of an Award.

          EE. Performance Share shall mean a bookkeeping unit granted to a Participant pursuant to an Award described in Article Four, representing the right to receive a value denominated in shares and in an amount, determined at the time such unit becomes payable, which is a function of the extent to which one or more Performance Goals established with respect to the Award have been achieved.

          FF. Performance Unit shall mean a bookkeeping unit granted to a Participant pursuant to an Award described in Article Four, representing the right to receive a value denominated in money and in an amount, determined at the time such unit becomes payable, which is a function of the extent to which one or more Performance Goals established with respect to the Award have been achieved.

          GG. Permanent Disability or Permanently Disabled shall mean the inability of the Participant to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment expected to result in death or to be of continuous duration of twelve (12) months or more. However, solely for purposes of the Automatic Option Grant Program, Permanent Disability or Permanently Disabled shall mean the inability of the non-employee Board member to perform his or her usual duties as a Board member by reason of any medically determinable physical or mental impairment expected to result in death or to be of continuous duration of twelve (12) months or more.

          HH. Plan shall mean the Corporation’s 1999 Stock Incentive Plan, as set forth in this document.

          II. Plan Administrator shall mean the particular entity, whether the Primary Committee, the Board or the Secondary Committee, which is authorized to administer the Plan with respect to one or more classes of eligible persons, to the extent such entity is carrying out its administrative functions with respect to the persons under its jurisdiction. Plan Administrator shall also mean any officer or officers to the extent authorized by the Board pursuant to Section III.A of Article One to grant Options and SARs under the Discretionary Option/SAR Grant Program.

          JJ. Plan Effective Date shall mean the date the Plan shall become effective and shall be coincident with the Underwriting Date.

          KK. Predecessor Plan shall mean the Corporation’s 1996 Equity Incentive Plan in effect immediately prior to the Plan Effective Date hereunder.

          LL. Primary Committee shall mean the committee of two (2) or more non-employee Board members appointed by the Board to administer the Discretionary Option/SAR Grant Program, Restricted Stock/Restricted Stock Unit Program and Performance Award Program with respect to Section 16 Insiders and Covered Employees.

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          MM. Restricted Stock Award shall mean an Award of a Restricted Stock Bonus or a Restricted Stock Purchase Right.

          NN. Restricted Stock Bonus shall mean shares of Common Stock granted to a Participant pursuant to Article Three of the Plan.

          OO. Restricted Stock Purchase Right shall mean a right to purchase shares of Common Stock granted to a Participant to Article Three of the Plan.

          PP. Restricted Stock/Restricted Stock Unit Program shall mean the Restricted Stock Purchase Right, Restricted Stock Bonus and Restricted Stock Unit program in effect under Article Four of the Plan.

          QQ. Restricted Stock Unit shall mean a bookkeeping unit granted to a Participant pursuant to an Award described in Article Three, representing the right to receive one share of Common Stock or its equivalent in cash at a date following the date of grant.

          RR. Secondary Committee shall mean a committee of one or more Board members appointed by the Board to administer the Discretionary Option/SAR Grant Program, Restricted Stock/Restricted Stock Unit Program and Performance Award Program with respect to eligible persons other than Section 16 Insiders and Covered Employee.

          SS. Section 16 Insider shall mean an officer or director of the Corporation subject to the short-swing profit liabilities of Section 16 of the 1934 Act.

          TT. Service shall mean the performance of services for the Corporation (or any Parent or Subsidiary) by a person in the capacity of an Employee, a non-employee member of the board of directors or a consultant or independent advisor, except to the extent otherwise specifically provided in the Award Agreement evidencing an Award. A Participant’s Service shall not be deemed to have terminated merely because of a change in the capacity in which the Participant renders such Service, provided that such change is from Employee to non-employee member of the Board, from non-employee member of the Board to Employee or from consultant or other independent advisor to Employee or non-employee member of the Board, provided that there is no interruption or termination of the Participant’s Service. However, a Participant’s Service shall be deemed terminated upon a change from Employee to consultant or other independent advisor. A Participant’s Service shall not be deemed to have terminated merely because of a change in the entity within the group consisting of the Corporation, any Parent and all Subsidiaries for which the Participant renders Service, provided that there is no interruption or termination of the Participant’s Service. Furthermore, a Participant’s Service shall not be deemed to have terminated if the Participant takes any military leave, sick leave, or other bona fide leave of absence approved by the Corporation. However, if any such leave taken by a Participant exceeds ninety (90) days, then on the ninety-first (91st) day following the commencement of such leave the Participant’s Service shall be deemed to have terminated unless the Participant’s right to return to Service is guaranteed by statute or contract. Notwithstanding the foregoing, unless otherwise designated by the Corporation or required by law, a leave of absence shall not be treated as Service for purposes of determining vesting under the Participant’s Award Agreement. A Participant’s Service shall be deemed to have terminated

A-5.

either upon an actual termination of Service or upon the entity for which the Participant performs Service ceasing to be the group consisting of the Corporation, any Parent and all Subsidiaries. Subject to the foregoing, the Corporation, in its discretion, shall determine whether the Participant’s Service has terminated and the effective date of such termination.

          UU. Stock Appreciation Right or SAR shall mean a bookkeeping entry representing, for each share of Common Stock subject to such Award, a right to receive payment of an amount equal to the excess, if any, of the Fair Market Value of such share on the date of exercise of the Award over the exercise price for such share. A Stock Appreciation Rights may be a Freestanding SAR, a Tandem SAR or a Limited SAR.

          VV. Stock Exchange shall mean either the American Stock Exchange or the New York Stock Exchange.

          WW. Subsidiary shall mean any corporation (other than the Corporation) in an unbroken chain of corporations beginning with the Corporation, provided each corporation (other than the last corporation) in the unbroken chain owns, at the time of the determination, stock possessing fifty percent (50%) or more of the total combined voting power of all classes of stock in one of the other corporations in such chain.

          XX. Take-Over Price shall mean the greater of (i) the Fair Market Value per share of Common Stock on the date the Option is surrendered to the Corporation in connection with a Hostile Take-Over or (ii) the highest reported price per share of Common Stock paid by the tender offeror in effecting such Hostile Take-Over. However, if the surrendered Option is an Incentive Option, the Take-Over Price shall not exceed the clause (i) price per share.

          YY. Tandem SAR shall mean an SAR that is granted in connection with a related Option pursuant to Article Two, the exercise of which shall require forfeiture of the right to purchase a share under the related Option (and when a share is purchased under the Option, the Tandem SAR shall similarly be canceled).

          ZZ. 10% Stockholder shall mean the owner of stock (as determined under Code Section 424(d)) possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Corporation (or any Parent or Subsidiary).

          AAA. Underwriting Agreement shall mean the agreement between the Corporation and the underwriter or underwriters managing the initial public offering of the Common Stock.

          BBB. Underwriting Date shall mean the date on which the Underwriting Agreement is executed and priced in connection with an initial public offering of the Common Stock.

          CCC. Withholding Taxes shall mean the Federal, state and local income and employment withholding taxes to which a Participant may become subject in connection with an Award.

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EX-21.1

EXHIBIT 21.1

SUBSIDIARIES OF REGISTRANT

Name	Jurisdiction of Incorporation
Packeteer Holdings, Inc.	Delaware
Packeteer International Inc.	Delaware
Packeteer Caymans	Cayman
Packeteer Y.K.	Japan
Packeteer Asia Pacific Limited	Hong Kong
Packeteer Europe B.V.	The Netherlands
Packeteer Technologies	Canada
Packeteer Australia Pty Limited	Australia
Packeteer UK Ltd.	United Kingdom
Packeteer GmbH	Germany
Packeteer SAS	France
Packeteer Aps	Denmark
Packeteer Singapore	Singapore
Packeteer Korea	South Korea
Packeteer Iberica	Spain
Packeteer Shanghai	China
Packeteer Beijing	China
Packeteer India	India
Packeteer Malaysia	Malaysia
Packeteer (Thailand) Ltd.	Thailand
Packeteer Italy s.r.l.	Italy

EX-23.1

EXHIBIT 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders
Packeteer, Inc.:

We consent to incorporation by reference in the registration statements (File No. 333-134604, 333-133964, 333-122371, 333-122294,
and 333-102739) on Form S-8 of Packeteer, Inc. of our reports dated March 15, 2007, with respect to the consolidated balance sheets of Packeteer, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2006, management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2006, and the effectiveness of internal control over financial reporting as of December 31, 2006, which reports appear in the December 31, 2006 annual report on Form 10-K of Packeteer, Inc.

As discussed in Note 1 to the consolidated financial statements, effective January 1, 2006, Packeteer, Inc. adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 123R, Share-Based Payment. Also, as discussed in Note 1 to the consolidated financial statements, Packeteer, Inc. changed its method of quantifying financial statement errors in 2006.

Our report dated March 15, 2007, on management’s assessment of the effectiveness of internal control over financial reporting and the effectiveness of internal control over financial reporting as of December 31, 2006, expresses our opinion that Packeteer, Inc. did not maintain effective internal control over financial reporting as of December 31, 2006, because of the effect of material weaknesses on the achievement of objectives of the control criteria and contains an explanatory paragraph that states that (i) the Company did not maintain effective controls to provide for the reconciliation of the income taxes payable account to supporting detail and the review of the income taxes payable account reconciliation by someone other than the preparer; and (ii) the Company did not maintain effective controls over the review of the rebate reserves as the review was not appropriately designed, nor was the review conducted in sufficient detail.

/s/ KPMG LLP

Mountain View, California
March 15, 2007

EX-31.1

Exhibit 31.1

CERTIFICATIONS

I, Dave Côté, CEO of Packeteer, Inc., certify that:

1. I have reviewed this annual report on Form 10-K of Packeteer, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a)	designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)	designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c)	evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d)	disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors:

(a)	all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Dated: March 15, 2007	/s/ Dave Côté
	Dave Côté
	Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATIONS

I, David Yntema, CFO of Packeteer, Inc., certify that:

1. I have reviewed this annual report on Form 10-K of Packeteer, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a)	designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)	designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c)	evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d)	disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors:

(a)	all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Dated: March 15, 2007	/s/ David Yntema
	David Yntema
	Chief Financial Officer

EX-32.1

Exhibit 32.1

Certification of Chief Executive Officer Pursuant to
18 U.S.C. Section 1350,
As Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the Annual Report of Packeteer, Inc. (the “Company”) on Form 10-K for the year ended December 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Dave Côté, as President and Chief Executive Officer of the Company, hereby certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, (“Section 906”) that:

(1)	The Report fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and
(2)	The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: March 15, 2007	/s/ DAVE CÔTÉ
	Dave Côté
	President and Chief Executive Officer

EX-32.2

Exhibit 32.2

Certification of Chief Financial Officer Pursuant to
18 U.S.C. Section 1350,
As Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the Annual Report of Packeteer, Inc. (the “Company”) on Form 10-K for the year ended December 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, David Yntema, as Chief Financial Officer of the Company, hereby certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, (“Section 906”) that:

(1)	The Report fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and
(2)	The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: March 15, 2007	/s/ DAVID YNTEMA
	David Yntema
	Chief Financial Officer