10-K

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

þ	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the year ended December 31, 2005
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 000-27723

SonicWALL, Inc.

(Exact name of registrant as specified in its charter)

California	77-0270079
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

1143 Borregas Avenue

Sunnyvale, CA 94089

(Address of Principal Executive Offices, including zip code)

(408) 745-9600

(Registrant’s Telephone Number, including area code)

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

None

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

Common Stock, no par value

      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 (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     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 Rule 12b-2 of the Act).     Yes o          No þ

      As of June 30, 2005, the aggregate market value of Common Stock held by non-affiliates of the registrant (based upon the closing sale price on the NASDAQ National Market on that date) was approximately $345,586,755. Shares held by each executive officer, director and by each person who owns 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.

      As of February 28, 2006, there were 64,531,435 shares of the Registrant’s Common Stock outstanding. This is the only outstanding class of common stock of the Registrant.

DOCUMENTS INCORPORATED BY REFERENCE

      Certain portions of the registrant’s proxy statement for its 2005 annual meeting of shareholders are incorporated by reference into Part III of this Form 10-K.

TABLE OF CONTENTS

PART I
	ITEM 1. Business
	ITEM 1A. Risk Factors
	ITEM 1B. Unresolved Staff Comments
	ITEM 2. Properties
	ITEM 3. Legal Proceedings
	ITEM 4. Submission of Matters to a Vote Of Security Holders
PART II
	ITEM 5. Market For Registrant’s Common Equity And Related Stockholder Matters
	ITEM 5c. Issuer Purchases of Equity Securities (in thousands, except per-share amounts)
	ITEM 6. Selected Consolidated Financial Data
	ITEM 7. Management’s Discussion And Analysis Of Financial Condition And Results Of Operations
	ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk
	ITEM 8. Financial Statements And Supplementary Data
	ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
	ITEM 9A. Controls and Procedures
PART III
	ITEM 10. Directors and Executive Officers of the Registrant
	ITEM 11. Executive Compensation
	ITEM 12. Security Ownership of Certain Beneficial Owners and Management
	ITEM 13. Certain Relationships and Related Transactions
	ITEM 14. Principal Accountant Fees and Services
PART IV
	ITEM 15. Exhibits and Financial Statement Schedules
SIGNATURES
Schedule II
EXHIBIT 3.2
EXHIBIT 10.36
EXHIBIT 23.1
EXHIBIT 23.2
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1

CAUTIONARY NOTE ON FORWARD-LOOKING STATEMENTS

      This Annual Report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the 1934 Act. We intend that the forward-looking statements be covered by the safe harbor provisions for forward-looking statements in these sections. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “intend” or “continue,” the negative of such terms or other comparable terminology. These statements are only predictions, reflecting our expectations for future events or our future financial performance. Actual events or results may differ materially. In evaluating these statements you should specifically consider various factors, including the risks outlined under “Risk Factors.” These factors may cause our actual results to differ materially from any forward-looking statement.

      Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Annual Report.

PART I

ITEM 1. Business

Overview

      SonicWALL designs, develops, manufactures and sells integrated network security, mobility, and productivity solutions for small to medium size networks used in enterprises, e-commerce, education, healthcare, retail point-of-sale, and government markets. Our Internet security infrastructure products are designed to provide secure Internet access to both wired and wireless broadband customers, enable secure Internet-based connectivity for distributed organizations, and process secure transactions for enterprises and service providers. We believe our access security appliances provide high-performance, robust, reliable, easy-to-use and affordable Internet firewall security and virtual private networking (“VPN”) functionalities. Additionally, our Internet security products are designed to make our customers more productive and more mobile, while still maintaining a high level of security. As of December 31, 2005, we have sold more than 759,000 of our Internet security appliance platforms worldwide. We also sell value-added services for our security appliances, including content filtering, anti-virus protection and intrusion prevention on a subscription basis. We also license software packages such as our Global Management System (“GMS”) and our Global VPN Client. Our GMS enables distributed enterprises and service providers to manage and monitor a large number of SonicWALL Internet security appliances and deploy our security software and services from a central location to reduce staffing requirements, speed deployment and lower costs. Our Global VPN Client provides mobile users with a simple, easy-to-use solution for securely accessing the network. On November 28, 2005 we completed the acquisition of Lasso Logic, Inc. (“Lasso”), an early stage company providing continuous data protection for backup and recovery solutions and acquired certain assets from enKoo, Inc. (“enKoo”) associated with its secure remote access technology. We are in the process of integrating the Lasso Logic products into our family of security solutions and integrating the key features of enKoo’s technology into our SSL-VPN products. Our products and services are primarily sold, and our software licensed, on an indirect basis through two-tiered distribution, first to distributors and then to value-added resellers, who then sell to end-customers.

      SonicWALL was initially incorporated in California in 1991 as Sonic Systems. In August 1999, we changed our name to SonicWALL, Inc. References in this report to “we,” “our,” “us,” and “the Company” refer to SonicWALL, Inc. Our principal executive offices are located at 1143 Borregas Avenue, Sunnyvale, California 94089, and our telephone number is (408) 745-9600.

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Industry Background

Growth of Internet Usage and Acceptance

      Businesses and consumers access the Internet for a wide variety of uses including communications, information gathering and commerce. Businesses and enterprises of all sizes have accepted the Internet as a critical yet affordable means of achieving global reach and brand awareness, allowing access and shared information among a large number of geographically dispersed employees, customers, suppliers and business partners. The Internet has become a particularly attractive solution for small and medium size businesses due to its cost effectiveness and ease-of-use. Larger enterprises also connect their internal networks to the Internet allowing for greater and quicker communications and expanded operations. Many of today’s larger enterprises also have branch offices, mobile workers and telecommuters who connect electronically to the corporate office and each other. The Internet has also become a vital tool of information access and communication for schools, libraries, government agencies and other institutions.

Increasing Use of Broadband Access Technologies

      The connection speed by which individuals and businesses and enterprises of all sizes connect to the Internet is increasing. Small to medium enterprises, branch offices and consumers are shifting from dial-up connections to substantially faster, always connected broadband technologies such as digital subscriber lines (“DSL”) and cable Internet access. Larger enterprises are moving from T1 connectivity to T3 connectivity and in some cases to OC-3 connectivity. These broadband connections allow for substantially faster Internet access among many simultaneous users. Additionally, as Internet access speeds increase, both network bandwidth and network traffic speeds have significantly increased, further reflecting the ubiquity and the importance of the Internet to business operations.

Importance of Internet Security

      We believe Internet security is essential for businesses and enterprises due to the large amount of confidential information transmitted or accessible over the Internet. Broadband technologies, including DSL and cable, are always connected to the Internet. This constant connectivity increases the risk that confidential information and other proprietary or otherwise sensitive information might be compromised by computer hackers, identity thieves, disgruntled employees, contractors or competitors. In addition, business or enterprise data and networks become increasingly vulnerable to security threats and sophisticated attacks as the number of connections to the Internet increase, through satellite offices or telecommuters, and the volume of confidential information accessible through the Internet increases. Breaches of network security are costly to a business, both financially and as a source of lost productivity resulting from network and computer down-time. We believe that many enterprises are aware of the need to increase their network security budget to address these concerns; thereby increasing the confidence of users that transactions over the Internet are secure.

      The market for Internet security products includes a variety of applications to address network vulnerabilities and protect confidential data during transmission and access. These applications include, among others, firewalls, VPN access products, anti-virus solutions, intrusion prevention, content filtering and SSL encryption.

Integrated Solutions for Internet Security

      As network connection speeds and bandwidth have increased, and as more complex forms of data are transmitted by and within enterprises, reliable security solutions have developed that emphasize high rates of data transfer while maintaining the integrity and security of network data. Enterprises of all sizes require a broad array of high performance, cost-effective products to secure their networks, delivering firewall protection and VPN connectivity to both the central office headquarters and for the perimeter branch offices and telecommuters.

      We believe that security solutions that integrate hardware, software and service elements overcome many of the shortcomings of solutions based upon software alone. Software based security solutions can be difficult

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to install and manage, often requiring dedicated and highly-skilled in-house information technology (“IT”) personnel. Additionally, software only security solutions can also be difficult to integrate within networks, often requiring installation of dedicated server equipment and the use of complex load balancing switches to ensure a reliable, high-speed connection. Our integrated security solution approach can overcome many of these limitations by integrating firewall, VPN, anti-virus, intrusion prevention and content filtering into one easy-to-deploy device that is interoperable with other Internet Protocol Security (“IPSec”) devices. These integrated solutions can remain current through automatic update services.

Importance of Productivity and Mobility

      As security becomes a more visible component of network IT spending, the need to demonstrate a return on investment can influence the relative attractiveness of our solutions. This trend among our end-users has encouraged us to develop and position our solutions to underscore productivity benefits. For example, content filtering can be used in an office environment to prevent employees from surfing or shopping during business hours in addition to blocking objectionable material. As networks become more accessible to vendors, suppliers, customers, partners and employees on the road or at remote locations, the need for mobile solutions that are secure also increases. Our approach to mobility extends from wireless solutions to remote secure access through VPN tunnels.

The Advent of Secure Virtual Private Networks (VPNs)

      Large and small enterprises utilize VPNs in the place of more costly private, dedicated networks or leased lines. VPNs allow for two or more individual networks to be linked creating one large private network. The private network is “virtual” because it leverages the public Internet as the network infrastructure. Enterprises use VPNs to achieve a variety of objectives. Telecommuters and traveling workers can access a corporate network to work from their out-of-office locations using remote access VPN. Satellite and branch offices can connect to the home office network using site-to-site VPNs. An enterprise can connect with its business partners, suppliers and customers utilizing an Extranet VPN. These VPN connections must be secure from unauthorized access and safe from unauthorized alteration. To secure a VPN, information traveling between the locations is encrypted and authenticated. To help deliver the desired quality and security levels, businesses and enterprises can monitor and prioritize network traffic for business-critical applications and allocate bandwidth for specific traffic, typically using customer premise equipment encryption and authentication products.

      In a distributed business model, branch offices and point-of-sale (POS) locations extend a company’s reach into key markets. To realize these benefits, the communication link must be available at all times and be able to support the application. VPN solutions help companies establish centralized control over branch offices, POS locations, or remote kiosks by providing the robust security and performance needed for business continuity. A traditional site-to-site connection often requires the leasing of expensive, dedicated data lines that are difficult to deploy and manage. With the advent of affordable broadband and standards-based VPN, organizations can deploy secure remote access via Internet connections. With today’s VPN technology and broadband connections, enterprises of any size may use the Internet to securely communicate with their multiple locations.

Need for Anti-Virus, Intrusion Prevention and Content Filtering Solutions

      In the Computer Security Institute Computer Crime and Security Survey published in 2004, the two most common forms of attack or abuse reported were virus outbreaks and insider abuse of network access. In addition to lost productivity, companies and their customers and partners are vulnerable to severe financial losses. This reality has been underscored by the rapid infection of many users through widespread and highly publicized virus outbreaks affecting business networks around the globe. At the same time, we believe that issues such as employee productivity, liability concerns and network bandwidth continue to fuel the growth of content filtering. Enterprises are deploying anti-virus protection, content filtering and intrusion prevention solutions across the enterprise and expending technical resources to keep these defenses updated against the latest virus threats and objectionable or inappropriate content.

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Changing Mobile Computing Environment and Demand for SSL-VPN

      In today’s mobile environment, information needs to be accessed by a highly diverse community of users from essentially anywhere an internet connection exists and through access devices that are not always owned or controlled by the IT organization. For large enterprises with in-house IT personnel and higher IT spending budgets, these challenges are more easily addressable than for the more IT-constrained small and mid-sized business (SMBs).

      SSL-VPN is a new approach to connecting any user from anywhere to any resource reliably, conveniently, and with granular levels of security. SSL-VPN does not establish a network-layer connection between users and the VPN gateway. Rather, connections are established at a layer above, at the transport layer. The Web browser on the user’s device represents the pre-existing VPN software client for establishing an encrypted tunnel between the user’s device and the SSL-VPN gateway. Through a Web browser, users can access several categories of applications and resources. Until recently, SSL-VPN solutions have been designed for large enterprises with a feature set and price that exceeded SMB needs and means. This situation is changing with new SSL-VPN product offerings specifically designed to meet the remote access needs of SMBs at affordable prices.

The SonicWALL Solutions

      SonicWALL provides comprehensive Internet security solutions that include access security and transaction security products, value-added security applications, training, consulting and support services. Our access security product line provides cost effective and high performance Internet security solutions to small, medium and large enterprise users in commercial, healthcare, education and government markets. Our transaction security products enable our target enterprise and service provider users to process large volumes of secure transactions using SSL technology without compromising the performance of their e-commerce or e-business applications.

      SonicWALL products are designed to provide comprehensive Internet security for (1) networks ranging in size from one to more than 15,000 users (2) enterprises having branch offices, telecommuting employees or POS locations and (3) e-commerce applications that handle millions of secure transactions daily. Our security appliances span a wide range of requirements, from single-user set-top appliances to rack-mounted enterprise-class units capable of supporting thousands of users. Our products offer functional flexibility to accommodate the number of supported users, the number of transactions handled, the number of ports and feature options such as anti-virus protection, content filtering and intrusion prevention, as well as management tools that enable our customers to easily manage SonicWALL appliances installed throughout their networks. Our transaction security products include appliance-based solutions, which can be deployed in sophisticated networks requiring the highest levels of transaction performance. Our SSL appliances enable web sites to maintain performance levels while processing a growing number of secure transactions.

      In addition to serving the security needs of the small to medium enterprises, SonicWALL access security products are sold as security solutions for large, distributed enterprises and their branch offices, POS locations and telecommuters. Our access security products are designed to be compatible with industry VPN technology standards. We believe SonicWALL transaction security products provide a solution for enterprises and service providers who are deploying high-performance e-commerce applications.

      As of December 31, 2005, we have sold more than 759,000 of our Internet security appliance platforms worldwide. The SonicWALL product line provides our customers with the following key benefits:

•  High-Performance, Scalable and Robust Access Security. The SonicWALL product line provides a comprehensive integrated security solution that includes firewall, VPN, gateway anti-virus, anti-spyware, intrusion prevention and content filtering. Our access security products protect private networks against Internet-based theft, destruction or modification of data, and can automatically notify customers if their network is under certain types of attack. SonicWALL has been awarded the internationally recognized International Computer Security Association (“ICSA”) Firewall Certification. Our SSL-VPN product family provides organizations of all sizes with an affordable, simple and

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	secure clientless remote network and application access solution that requires no pre-installed client software. Our anti-virus services provide comprehensive virus protection with automatic updates and minimal administration. Our gateway anti-virus, anti-spyware and intrusion prevention services prevent malicious code from infecting networks by blocking transmissions through the gateway and disrupt background communications from existing spyware programs that transmit confidential data. Our content filtering service enables customers such as businesses, schools, government agencies and libraries to restrict access to objectionable or inappropriate web sites.
•	Ease of Installation and Use. The SonicWALL product line delivers “plug-and-play” appliances designed for easy installation and use. Installation consists of connecting a SonicWALL device between the private network and the broadband Internet access device for our access security products and in front of the e-commerce web server for our transaction security products. SonicWALL products are easily configured and managed through a web browser-based interface or through our GMS. No reconfiguration of any personal computer application is required. Our access security products are pre-configured to interface with major Internet access technologies, including cable, DSL, Integrated Services Design Network (“ISDN”), Frame Relay and T-1 via Ethernet. Our transaction security products are compatible with major web server and e-commerce software products and are designed to operate in the most sophisticated and highest traffic network architectures.
•	Low Total Cost of Ownership. The SonicWALL product design minimizes the purchase, installation and maintenance costs of Internet security. The suggested retail prices of our access security products begin at $395 and scale up with products and features that span a wide array of customer requirements. Our affordable, easy-to-manage Internet security appliances also enable customers to avoid employee expenses that may otherwise be required to implement and maintain an effective Internet security solution.
•	Reliability. The SonicWALL product design maximizes reliability and uptime. Our products use an embedded single purpose operating system and a solid state hardware design. Some competitive product offerings consist of software installed on general-purpose host computers that use the Windows NT or UNIX operating systems. General-purpose operating systems are designed to run multiple applications, creating an environment less dedicated to security. In such circumstances we believe the probability of random system crashes may increase. Moreover, since general-purpose computers contain many moving parts, such as hard disk drives, floppy drives, fans and switching power supplies, they are more prone to hardware failures over time. Such software and hardware failures may compromise security.

Strategy

      Our goal is to extend our leadership position by continuing the transition to a comprehensive provider of integrated security, productivity and mobility solutions. We plan to accomplish our goal by focusing on Value Innovation, the process whereby we deliver solutions with price-performance advantages.

      Key elements of our strategy include:

•  Global Growth. We plan to focus our investment in those geographical areas that can return the growth rates consistent with a global high-tech organization. Part of the global growth initiative also includes taking advantage of supply chain improvements wherever possible. We believe that this type of alignment of our resources will strengthen our global position.

•  Continue to Bring New Products to the Market. We intend to use our internal product design and development expertise to produce outstanding solutions that deliver value to our end-users.

•  Continuous Cost Reduction. We anticipate that the hardware appliance business will continue to operate under the same economic pressures common to the IT industry generally. The constraints include constant pressure for improved price-performance. We intend to be vigorous in our pursuit to lower costs in all aspects of our business. Supply chain improvements and overall continual business

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	process improvement are key components of this initiative. We believe that the associated cost reductions will strengthen our market position and assist us in penetrating new markets.
•	Strengthen Our Indirect Channel. Our global target markets are generally served by a two-tier distribution channel. We have achieved varying degrees of regional penetration in these markets with large scale distributors at the hub of our model and over 10,000 value-added resellers (“VAR’s”) and systems integrators forming a distribution web that covers over 50 countries. We intend to continue to implement programs designed to enhance our competitive position through distributors and VAR’s.
•	Increase Services and Software Revenue. We intend to continue to develop new service and licensed software offerings to generate additional revenue from our installed base and provide additional functionality ancillary to our product sales. We currently offer a selection of integrated functionality including gateway anti-virus, client anti-virus, anti-spyware, intrusion prevention and content filtering subscription services. We also offer fee-based customer support services and training to our customers. We have dedicated sales and marketing personnel and programs that focus on selling these services, as well as add-on products to our existing base of customers.
•	Inorganic Growth. We intend to continue to explore corporate opportunities to enhance our ability to broaden the product range that we bring to the market. Where appropriate, we may license, OEM, or acquire technologies in order to better address the current and future requirements of our customers.

Products and Services

      SonicWALL provides comprehensive Internet security solutions that include access security and transaction security products, value-added security applications, and training, consulting and support services. Our access security product line provides cost effective and high performance Internet security solutions to small, medium and large enterprise customers in commercial, healthcare, education and government markets.

      Our GMS enables distributed enterprises and service providers to manage and monitor a large number of SonicWALL Internet security appliances and deploy our security services from a central location to speed deployment, reduce staffing requirements and lower costs.

Access Security Features

      SonicWALL access security products include high performance, solid-state Internet security appliances designed to provide integrated security to meet the needs of the individual telecommuter through a large distributed enterprise. SonicWALL Internet security appliances share a common set of Internet security features that have been tailored to meet the needs of our target markets:

      Deep Packet Inspection Firewall Security. Our firewall technology is designed to protect private networks against Internet-based theft, destruction or modification of data, and automatically notify customers if their networks are under attack. SonicWALL has been awarded the internationally recognized ICSA Firewall Certification. In addition, the firewall technology in our products detects and thwarts certain “denial of service” attacks and delivers intelligent, real-time network security protection against sophisticated application layer and content-based attacks. SonicWALL has expanded its Gateway Anti-Virus/ Intrusion Prevention Service to include protection from spyware. Our Gateway Anti-Virus, Anti-Spyware and Intrusion Prevention Service for TZ and PRO Series platforms integrates a configurable, high performance deep packet inspection engine with a dynamically updated database containing thousands of attack and vulnerability signatures. This integrated service offering is designed to protect networks against a comprehensive array of dynamic threats including viruses, spyware, worms, Trojans and software vulnerabilities, such as buffer overflows, as well as peer-to-peer and instant messenger applications, backdoor exploits, and other malicious code.

      Internet Protocol Address Management. SonicWALL products also include Network Address Translation (“NAT”) and Dynamic Host Configuration Protocol (“DHCP”) client and server capabilities. NAT allows a customer to connect multiple users on their private network to the Internet using a single public IP Address. DHCP Client allows the appliance to automatically acquire its IP address

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settings from the Internet Service Provider (“ISP”). DHCP Server allows computers on the private network to automatically acquire IP address settings from the appliance, simplifying client personal computer configuration.

      Web Browser-Based Management. SonicWALL appliances are easily and securely configured and managed through a web browser-based interface. The SonicWALL interface insulates the user from the underlying complexity of Internet security, while providing enough flexibility to meet the diverse needs of our customers.

      Logging and Reporting. SonicWALL appliances maintain an event log of potential security concerns, which can be viewed with a web browser or automatically sent on a periodic basis to any e-mail address. SonicWALL appliances notify the administrator of high-priority security issues, such as an attack on a server, by immediately sending an alert message to a priority e-mail account such as an e-mail pager. SonicWALL appliances also provide pre-defined reports that show different views of Internet usage, such as the most commonly accessed web sites.

Security Appliances

      SonicWALL Internet gateway appliances vary with respect to the number of supported users, the number of ports, product features, processor speed and scalability. During 2004 and 2005 we introduced a new generation of products for both our PRO Series appliances as well as our TZ Series appliances.

      SonicWALL’s current generation line of Internet gateway appliances includes:

      SonicWALL TZ 150 and TZ 150 Wireless. This Internet security appliance delivers layered protection to small and home offices through an integrated deep packet inspection firewall/ VPN in an easy-to-use, low cost platform. Its compact form factor includes a single Ethernet WAN port and four-port LAN switch, allowing multiple devices to connect safely to the network.

      SonicWALL TZ 170 and TZ 170 Wireless. This Internet security appliance is designed to provide a comprehensive security platform, delivering network security, flexibility and reliability to home, small, remote and branch offices. This high performance deep packet inspection firewall/ VPN ships in multiple node configurations and offers a choice between absolute ease-of-use for basic networks and ultimate flexibility for networks with more complex needs. The functionality of the TZ 170 is extended by the integrated 5-port medium dependent interface crossover (“MDIX”) switch allowing multiple computers to be networked together. The TZ 170 Wireless provides all the same features plus wireless connectivity over 802.11b/g standards.

      SonicWALL TZ 170 SP and TZ 170 SP Wireless. This Internet security appliance is designed to provide a comprehensive security platform delivering continuous network uptime for critical, secure data connectivity through integrated and automated broadband and analog failover and failback technologies. This high performance deep packet inspection firewall/ VPN offers automated broadband-to-broadband-to-analog WAN redundancy for unparalleled network uptime. The TZ 170 SP Wireless provides all the same features plus secure 802.11b/g wireless connectivity.

      SonicWALL PRO 1260. This Internet security appliance is designed to provide a comprehensive security and switching platform delivering network security and flexibility to small business and remote office networks through an integrated deep inspection firewall/ VPN and wire-speed 24-port, auto-MDIX Layer 2 switch.

      SonicWALL PRO 2040. This Internet security appliance is designed to provide a comprehensive network security, mobility and productivity solution utilizing high performance architecture to deliver business-class firewall and VPN performance, advanced features and configuration flexibility in a rack-mounted appliance. The PRO 2040 includes a high performance architecture with a deep packet inspection firewall and 3DES/ AES VPN.

      SonicWALL PRO 3060. This Internet security appliance is designed to provide a comprehensive security platform for complex networks, utilizing six fully configurable Ethernet interfaces to provide

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cost-effective, enterprise-class firewall throughput and VPN concentration. The PRO 3060 is powered by SonicOS firmware which provides hardware fail-over, wide-area network (“WAN”) ISP fail-over and an automated secondary VPN gateway, providing continuous network uptime. This product can support up to 128,000 concurrent sessions, 25 VPN client sessions for remote users and 500 to 1,000 VPN site-to-site connections.

      SonicWALL PRO 4060. This Internet security appliance is designed to provide all of the features of the PRO 3060, but increases the concurrent sessions to 500,000, VPN client sessions for remote users to 1,000 and VPN site-to-site connections to 3,000.

      SonicWALL PRO 4100. This Internet security appliance provides powerful internal and external network protection across all 10 gigabit interfaces to deliver high-speed gateway anti-virus, anti-spyware, anti-spam and intrusion prevention. The PRO 4100 includes an extensive array of advanced networking and configuration flexibility features in an accessible, affordable platform that is easy to deploy and manage in a wide variety of environments. Its features include 800 Mbps firewall, 300Mbps deep packet inspection and 350 Mbps VPN throughputs.

      SonicWALL PRO 5060. This Internet security appliance is a high performance, multi-service security gateway for medium-to-large networks integrating gigabit-class firewall, VPN, intrusion prevention, anti-virus and content filtering into a single platform that is designed to be easy to install and manage. The PRO 5060 is powered by a high performance architecture delivering 1+ Gbps deep packet inspection firewall and 500 Mbps 3DES/ AES VPN throughput.

      SonicWALL Content Security Manager. We believe our Content Security Management solutions enhance the security of the network and the productivity of the workforce. Built on SonicWALL’s security technology, these appliance-based solutions integrate seamlessly into virtually any network environment to deliver scalable, cost-effective content management. The SonicWALL Content Security Manager 2100 CF delivers appliance-based Internet filtering that enhances security and employee productivity, optimizes network utilization and mitigates liability concerns by managing access to objectionable Web content.

      SonicWALL SSL-VPN 200 and SSL-VPN 2000. The SSL-VPN series provides organizations of all sizes with an affordable, simple and secure clientless remote network and application access solution that requires no pre-installed client software. Utilizing only a standard Web browser, users can easily and securely access e-mail, files, intranets, remote desktops (including both full desktop and individual application access) and other resources on the corporate LAN from any location. With no need for a pre-installed or “fat” VPN client, administrators are freed from the tasks of deploying, configuring and updating software, reducing maintenance and support costs. SonicWALL SSL-VPN Series solutions integrate seamlessly into virtually any network topology to deliver powerful, scalable and affordable remote access to corporate resources.

Security Application and Services

      SonicWALL Internet security appliances integrate seamlessly with our line of value-added security applications to provide a complete Internet security solution. With SonicWALL’s integrated security applications and services, we believe users can reduce the integration and maintenance problems that often result from sourcing, installing, and maintaining security products and services from multiple vendors.

      SonicWALL Global VPN Client. Our virtual private networking capabilities enable affordable and secure communications over the Internet between geographically dispersed offices, workers and partners.

      SonicWALL Content Filtering Service. Our content filtering service enables businesses, families, schools and libraries to control access to objectionable or inappropriate web sites. SonicWALL can filter Internet content by uniform resource locator (“URL”), keyword or application type. We offer a content filtering subscription service that provides a list of objectionable web sites that is automatically updated on an hourly basis.

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      SonicWALL Anti-Virus. Our anti-virus subscription service can ease the challenges of installing and maintaining anti-virus protection throughout an enterprise and across a distributed network. This SonicWALL service integrates with our security appliances to deploy and maintain anti-virus software for each user on the network without the need for desktop-by-desktop installation, configuration and maintenance. Automatic anti-virus updates insulate all network nodes from new virus outbreaks.

      SonicWALL Gateway Anti-Virus, Anti-Spyware and Intrusion Prevention. SonicWALL Gateway Anti-Virus, Anti-Spyware and Intrusion Prevention Service integrate gateway anti-virus, anti-spyware and intrusion prevention to deliver intelligent, real-time network security protection against sophisticated application layer and content-based attacks. Utilizing a configurable, high performance deep packet inspection architecture, SonicWALL Gateway Anti-Virus, Anti-Spyware and Intrusion Prevention Service is designed to secure the network from the core to the perimeter against a comprehensive array of dynamic threats including viruses, worms, Trojans, spyware and software vulnerabilities such as buffer overflows, as well as peer-to-peer and instant messenger applications, backdoor exploits, and other malicious code.

Global Security Management Applications

      Today, enterprises and service providers face an increasing security management challenge resulting from geographically distributed networks. As a distributed network grows and branches into multiple sub-networks linked by the Internet, so does the complexity of managing security policies. A weakness in security implementation at any remote location can expose the entire network infrastructure to attack.

      For network administrators, managing security for distributed networks on a site-by-site basis places a strain on resources. Visits to remote sites to setup security, inspect security installations, or provide training to local personnel is time consuming, expensive and impractical. Administrators cannot be certain that every installation in the distributed network is complying with company security policies. To address these realities, SonicWALL’s Global Management System (“GMS”) is designed to provide global security management. This software application is designed to provide network administrators with configuration and management tools to globally define, distribute, enforce and deploy the full range of security application services and upgrades for thousands of SonicWALL Internet security appliances.

Customer Service and Technical Support

      We offer our customers a complete range of support programs that include electronic support, product maintenance and personalized technical support services on a worldwide basis. We offer direct support to customers in North America, Europe, Japan and selected countries in Asia Pacific. Support services in other locations are provided through SonicWALL distributors. We now have five customer support centers located in Sunnyvale, California; Phoenix, Arizona; Boxtel, The Netherlands; Tokyo, Japan and Bangalore, India. Most of our technical support function in all locations is outsourced to third party service providers under agreements that may be cancelled upon advance written notice of either 90 or 180 days. Outsourcing our technical support enables us to reduce fixed overhead and personnel costs and allows us the flexibility to meet market demand. SonicWALL provides direct support for enterprise customers and certain channel partners who require custom services.

      Our standard service offerings include support which is available during normal business hours, as well as support services with access 24 hours a day, seven days a week. These support offerings provide replacement for failing hardware, telephone or web-based technical support and firmware updates. For certain large customers, SonicWALL also offers custom support agreements that may include additional features like dedicated technical account management, accelerated escalation and logistical support.

Customers

      We sell our products through distributors, resellers and original equipment manufacturers. As of December 31, 2005, we sold more than 759,000 Internet security appliance platforms. The following lists our top international and domestic distributors based on revenues in the year ended December 31, 2005.

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Top Domestic and International Distributors

• Tech Data	• Canon Solutions (Japan)
• Ingram Micro	• Tek Data (UK)
• Alternative Technology	• Azlan Group (UK)
• Securematics, Inc.	• Marubeni Solutions (Japan)
	• Softbank BB Corp
	• ComputerLinks AG

End Users

      Our products are sold by our channel partners to end-users such as, financial institutions, professional offices, service providers, healthcare providers and educational and other public entities.

Sales and Marketing

      Our sales and marketing efforts focus on successfully penetrating the small to medium size networks used in enterprises, e-commerce, education, healthcare, and retail/point-of-sale markets. Our marketing programs promote SonicWALL brand awareness and reputation as a provider of reliable, high-performance, easy-to-use, and affordable Internet security appliances as well as a provider of a suite of value added support, service and software offerings. We try to strengthen our brand through a variety of marketing programs which include on-going public relations, our web site, advertising, direct mail, industry and regional trade shows and seminars. We intend to continue expanding and strengthening our indirect channel relationships through additional marketing programs and increased promotional activities.

      We believe that SonicWALL products are ideally suited for the indirect channel business model. We market and sell our products in this indirect channel through a two-tiered distribution structure consisting of distributors and resellers in the United States and over 50 other countries. Distributors and resellers accounted for approximately 97% of our total revenue for the year ended December 31, 2005. Resellers, which include systems integrators, ISPs, dealers, mail order catalogs and online catalogs, generally purchase our products from our distributors and then sell our products to end-users in our target markets.

      We divide our sales organization regionally into the following territories: the Americas; Asia Pacific (APAC); and Europe, the Middle East and Africa (EMEA). Regional sales representatives manage our relationships with our network of distributors, value-added resellers and customers, help our value-added reseller network sell and support key customer accounts, and act as a liaison between our value-added reseller network and our marketing organization. The regional sales representative’s primary responsibility is to help the indirect channel succeed and grow within the territory. We also have an internal sales staff that supports the indirect channel.

      Domestic Channel. In the Americas, the primary distributors of our products to resellers are Ingram Micro and Tech Data. Ingram Micro accounted for approximately 18% of total revenue in 2005, 17% in 2004 and 23% in 2003. Tech Data accounted for approximately 21% of total revenue in 2005, 21% in 2004 and 20% in 2003.

      Domestic resellers receive various benefits and product discounts, generally depending on the level of purchase commitment and achievement. Our standard reseller program offers access to sales and marketing materials. Certain of our resellers qualify for our Medallion program, which extends those benefits by adding access to an expanded set of sales and marketing tools, as well as priority technical support. The top level of that program is the SonicWALL Gold Partner, where additional benefits such as sales leads, access to additional discounted demonstration units and market development funds are available.

      International Channel. We believe there is a strong international market for our products. International sales represented approximately 34% of our total revenue in 2005, 30% in 2004 and 30% in 2003. We direct substantially all of our international resellers to the appropriate distributor in each territory. We support our international distributors by offering customizable marketing materials, sales tools, leads, co-operative

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marketing funds, joint advertising, discounted demonstration units and training. We also participate in regional press tours, trade shows and seminars.

      Original Equipment Manufacturer Channel. From time to time we may enter into select original equipment manufacturer relationships in order to take advantage of opportunities to rapidly penetrate certain target markets. We believe these opportunities expand our overall market while having a minor impact on our own indirect channel sales.

Technology

      We have designed our SonicWALL products using a unique combination of proprietary and non-proprietary hardware and software that delivers Internet security with what we believe is excellent ease-of-use and industry-leading price/performance.

Appliance Platforms

      SonicWALL’s line of appliance platforms is currently based on several architectures.

      SonicWALL’s TZ Series appliances are based on a highly integrated system-on-a-chip architecture which SonicWALL purchases from a third-party. SonicWALL’s PRO Series appliances are based on an industry standard processor architecture coupled to an auxiliary processor purchased from a third party.

      The entire SonicWALL access security product line provides the following core features:

•  Deep Packet Inspection Firewall. The core technology is the deep packet inspection firewall software, a widely recognized method of implementing an Internet firewall. This software examines all layers of the packet (from the physical layer up to application layer) and determines whether to accept or reject the requested communication based on information derived from previous communications and the applications in use. Deep packet inspection dynamically adjusts based on the changing state of the communication running across the firewall and is invisible to users on the protected network.

•  IP Address Management. We have developed tools to manage the complexity of IP addressing. Network Access Transmission (“NAT”) allows networks to share a small number of valid public IP addresses with an equal or larger number of client computers on the LAN. Our DHCP Client and Server tools allow both the firewall and the client computers behind it to obtain their respective IP addresses dynamically from a server and thereby eliminate the need for manual configuration.

      The SonicWALL access security product line offers the following options for device management:

•  Web Browser-Based Management Interface. We believe our products have an intuitive and easy-to-use web-based management interface for rapid installation, configuration, and maintenance, without the need for a dedicated information technology staff to install and maintain the solution. This interface can be easily accessed from any web browser on the internal, private network. This interface can also be accessed remotely in a secure manner using the virtual private networking feature described above.

•  SonicWALL Global Management System. Our global management system, SonicWALL GMS, is an enterprise software application that is designed to enable service providers and distributed enterprises to manage all of their SonicWALL appliances from a central location. SonicWALL GMS is available to use in Windows NT, Windows 2000 and Sun Solaris operating environments. SonicWALL GMS is also compatible with leading relational database management systems such as Oracle and Microsoft SQL Server.

Applications and Services

      SonicWALL Internet Security Appliances are designed to integrate seamlessly with a complete line of value-added security services to provide comprehensive Internet security. With SonicWALL’s integrated security services, we believe that integration and maintenance problems that often result from sourcing,

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installing, and maintaining security products from multiple vendors are minimized. Our security services are easily enabled on the base hardware platform via a software key.

•  Content Filtering. Our Internet content filter blocks objectionable content using a list of prohibited URLs and keywords as well as cookies, Java and ActiveX scripts. Subscribers to this service enable their SonicWALL appliance to automatically download an updated URL list weekly to keep pace with the dynamic nature of Internet content.

•  Gateway Anti-Virus. Our gateway anti-virus subscription service is intended to provide anti-virus protection throughout a business and across a distributed network and delivers protection for high threat viruses and malware by conducting inspections over the most common protocols used in today’s networked environments. This SonicWALL service integrates with our security appliances to deploy and maintain anti-virus software for each user on the network — without the need for desktop-by-desktop installation, configuration and maintenance. Automatic anti-virus updates are available for all network nodes to protect them from new virus outbreaks.

•  Anti-Spyware. Our anti-spyware program blocks spyware delivered through auto-installed ActiveX components, scans and logs spyware threats that are transmitted through the network and alerts administrators when new spyware is detected and/or blocked. This service offering also stops existing spyware programs from communicating in the background with hackers and servers on the Internet thereby preventing the transfer of confidential information, and provides granular control over networked applications by enabling administrators to selectively permit or deny the installation of individual spyware programs. Our spyware offering prevents e-mailed spyware threats by scanning and then blocking infected e-mails transmitted either through SMTP, IMAP or Web-based e-mail.

•  Intrusion Prevention. Our intrusion prevention service utilizes a configurable, ultra-high performance deep packet inspection engine to deliver maximum network protection while preventing known buffer overflow vulnerabilities in software. This service also defends against various worms, Trojans, and backdoor exploits thereby mitigating risk and liability concerns while improving productivity by blocking instant messaging and peer-to-peer applications. The service not only protects networks from attacks originating outside the network (WAN), but also from internal attacks targeting network segments (LANs), and provides a robust database of attack and vulnerability signatures that is dynamically updated as new exploits and vulnerabilities are discovered.

Research and Development

      We believe that our future success will depend in large part on our ability to develop new and enhanced Internet security solutions and our ability to meet the rapidly changing needs of our target customers who have broadband access to the Internet. We focus our research and development on evolving Internet security needs. We have made substantial investments in hardware, firmware, and software, which are critical to drive product cost reductions and higher performance solutions.

      Our research and development activities are conducted at our principal facilities in Sunnyvale, California. In 2005, 2004 and 2003 we incurred expenses, excluding amortization of stock-based compensation, of $22.6 million, $23.3 million and $19.9 million, respectively, on research and development activities.

Competition

      The market for Internet security products is worldwide and highly competitive. Competition in our market has increased over the past year, and we expect competition to further intensify in the future. There are few substantial barriers to entry. Additional competition from existing competitors and new market entrants will likely occur in the future.

      Our competitors may be able to respond more quickly than we can to new or emerging technologies and changes in customer requirements. In addition, our current and future competitors may integrate security products into the infrastructure of their existing product lines, including operating systems, routers, and browsers, in a manner that may discourage users from purchasing the products and services we offer. Many of

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our current and potential competitors have greater name recognition, larger customer bases to leverage and greater access to proprietary technology, and could therefore gain market share to our detriment. In addition, our current and potential competitors may consolidate through mergers or acquisitions or establish cooperative relationships among themselves or with third parties. These actions may further enhance their financial, technical and other resources. We expect additional competition as other established and emerging companies enter the Internet security market and new products and technologies are introduced.

      Principal competitors in our markets include, but are not limited to the following, all of which sell worldwide or have a presence in most of the major markets for such products:

•  enterprise firewall software vendors such as Check Point, Microsoft and Symantec;

•  network equipment manufacturers such as Cisco Systems, Lucent Technologies, Nortel Networks and Nokia;

•  security appliance suppliers such as WatchGuard Technologies and Juniper Networks.

Intellectual Property

      We currently rely on a combination of patent, trademark, copyright, and trade secret laws, confidentiality provisions and other contractual provisions to protect our intellectual property. Our intellectual property program consists of an on-going patent disclosure and application process, the purchase of intellectual property assets from others and the licensing of intellectual property from others. We plan to continue our aggressive plan to build our intellectual property portfolio. Despite our efforts to protect our intellectual property, unauthorized parties may misappropriate or infringe our intellectual property. We plan to aggressively pursue any such misappropriation or infringement of our intellectual property. Our pending patent applications may not result in the issuance of any patents. Even if we obtain the patents we are seeking, that will not guarantee that our patent rights will be valuable, create a competitive barrier, or will be free from infringement. Furthermore, if any patent is issued, it might be invalidated or circumvented or otherwise fail to provide us any meaningful protection. We face additional risk when conducting business in countries that have poorly developed or inadequately enforced intellectual property laws. In any event, competitors may independently develop similar or superior technologies or duplicate the technologies we have developed, which could substantially limit the value of our intellectual property.

U.S. Government Export Regulation Compliance

      Our products are subject to federal export restrictions on encryption strength. Federal legal requirements allow the export of any-strength encryption to designated business sectors overseas, including U.S. subsidiaries, banks, financial institutions, insurance companies and health and medical end users. We have federal export authorization that allows us to export encryption technology to commercial entities in approved countries. In certain instances, we require individual export licenses. With appropriate approvals, we are able to export strong encryption to a wide range of foreign end-users, subject to limitations and record-keeping requirements. We require that our distributors understand these export requirements and comply with them in the sale and distribution of our products.

Manufacturing

      We currently outsource our hardware manufacturing and assembly to contract manufacturers. Flash Electronics manufactures and assembles many of our products at facilities in both the U.S. and China. Our current agreement with Flash Electronics, effective on June 4, 2004, provides for an initial term of one (1) year and automatic renewal terms of one (1) year each unless cancelled by either party upon 90 days prior written notice. SerComm Corporation of Taiwan manufactures and assembles certain of our products at facilities located in Taiwan. Our agreement with SerComm, effective on January 20, 2005, specifies an initial term of one (1) year with automatic yearly renewal terms unless terminated by either party upon 90 days prior written notice. Outsourcing our manufacturing and assembly enables us to reduce fixed overhead and personnel costs and to provide flexibility in meeting market demand.

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      We design and develop the key components for the majority of our products. In addition, we generally determine the components that are incorporated in our products and select the appropriate suppliers of these components. Product testing and burn-in are performed by our contract manufacturer using tests that we typically specify.

      As part of our design and development activity, we constantly review environmental regulations in the jurisdictions in which we do business. Working with our contract manufacturers, we review the applicability of these regulations to our products and the established timetables for implementation of the regulations with the objective of providing compliant products in a timely fashion.

Information about Segments and Geographic Areas

      Financial information relating to our segments and information on revenues generated in different geographic areas are set forth in Note 9, entitled “Segment Reporting,” of the Notes to Consolidated Financial Statements in Part II, Item 8 of this report. In addition, information regarding risks attendant to our foreign operations is set forth under the heading “RISK FACTORS” included later in this report.

Employees

      As of December 31, 2005, we had 404 employees. Of these, 198 were employed in sales and marketing, 49 in finance and administration, 139 in research and development and 18 in operations. We are not party to any collective bargaining agreements with our employees and we have not experienced any work stoppages. We believe we have excellent relations with our employees.

Where You Can Find More Information

      We make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to such reports filed pursuant to Section 13(a) or 15(d) of the Exchange Act, available free of charge on or through our Internet website located at www.sonicwall.com, as soon as reasonably practicable after they are filed with or furnished to the SEC.

      We also make available on our Internet website our Corporate Governance Principles and other corporate governance related documents including the charters of the Audit Committee, Compensation Committee, and Nominations and Corporate Governance Committee of our Board of Directors , the Code of Conduct for all employees and directors, and our Code of Ethics for Principal Executive and Senior Financial Officers. Such information is also available in print to stockholders upon request.

ITEM 1A. Risk Factors

      You should carefully review the following risks associated with owning our common stock. Our business, operating results or financial condition could be materially adversely affected in the event any of the following risks were to be realized. You should also refer to the other information set forth in this report and incorporated by reference herein, including our financial statements and the related notes. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

Rapid changes in technology, regulatory requirements and industry standards could render our products, software and services unmarketable or obsolete, and we may be unable to successfully introduce new products and services.

      To succeed, we must continually introduce new products, software and services and change and improve our products, software and services in response to new competitive product introductions, rapid technological developments, changes in regulatory requirements, and changes in operating systems, broadband Internet access, application and networking software, computer and communications hardware, programming tools, computer language technology and other security threats. Product and service development for Internet security appliances requires substantial engineering time and testing. The disparities between the laws and administrative measures adopted by various jurisdictions in which we do business create uncertainty over the

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applicability, scope and form of the regulations affecting our products and services and the timing for compliance with applicable regulations. Releasing new products, software and services prematurely may result in quality problems, and delays may result in loss of customer confidence and market share. In the past, we have on occasion experienced delays in the scheduled introduction of new and enhanced products, software and services, and we may experience delays in the future. We may be unable to develop new products, software and services or achieve and maintain market acceptance of them once they have come to market. Furthermore, when we do introduce new or enhanced products, software and services, we may be unable to manage the transition from previous generations of products or previous versions of software and services to minimize disruption in customer ordering patterns, avoid excessive inventories of older products and deliver enough new products, software and services to meet customer demand. If any of the foregoing were to occur, our business could be adversely affected.

We depend on two major distributors for a significant amount of our revenue, and if they or others cancel or delay purchase orders, our revenue may decline and the price of our stock may fall.

      To date, sales to two distributors, Ingram Micro and Tech Data, have accounted for a significant portion of our revenue. For the fiscal years ended December 31, 2005, 2004 and 2003, substantially all of our sales were to distributors and resellers as shown in the following table, expressed as a percentage of total revenue:

	FY 2005			FY 2004			FY 2003
Distributors/ Resellers		97	%		98	%		96	%

      Sales through Ingram Micro and Tech Data for the fiscal years ended December 31, 2005, 2004 and 2003 represented the following percentages of total revenue:

Customers	FY 2005			FY 2004			FY 2003
Ingram Micro		18	%		17	%		23	%
Tech Data		21	%		21	%		20	%

      In addition, for the fiscal year ended December 31, 2005, our top 10 distributors and resellers accounted for 66% of our total revenue. In each of 2004 and 2003, our top 10 distributors and resellers accounted for 56% or more of total revenue.

      We anticipate that sales of our products to relatively few distributors and resellers will continue to account for a significant portion of our revenue. Although we have renewable one-year agreements with Ingram Micro and Tech Data and certain other large distributors, these contracts are subject to termination at any time. We cannot assure you that any of these distributors or resellers will continue to place orders with us, that orders will continue at the levels of previous periods or that we will be able to obtain large orders from new distributors or resellers. If any of the foregoing should occur, our revenue will likely decline and our business will be adversely affected.

      In addition, Ingram Micro and Tech Data represented the following dollar amount and percentages of our accounts receivable balance (in millions, except for percentages):

	2005
					2004
	December 31,
									2003
Ingram Micro	$	2.0M	15	%	$	.8M	6	%	$	1.3M	14	%
Tech Data	$	1.4M	11	%	$	3.8M	26	%	$	1.4M	15	%

      The failure of distributors and resellers to pay us in a timely manner could adversely affect our balance sheet, our results of operations and our creditworthiness, which could make it more difficult to conduct business.

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If we are unable to compete successfully in the highly competitive market for Internet security products and services, our business could be adversely affected.

      The market for Internet security products is worldwide and highly competitive. Competition in our market continues to increase, and we expect competition to further intensify in the future. There are few substantial barriers to entry and additional competition from existing competitors and new market entrants will likely occur in the future. Current and potential competitors in our markets include, but are not limited to, Check Point, Microsoft, Symantec, Cisco Systems, Lucent Technologies, Nortel Networks, Nokia, WatchGuard Technologies and Juniper Networks, all of which sell worldwide or have a presence in most of the major markets for such products.

      Competitors to date have generally targeted the security needs of enterprises of every size with firewall and VPN products that range in price from approximately $250 to more than $30,000. We may experience increased competitive pressure in some of our product lines as well as some of our software feature sets. This increased competitive pressure may result in both lower prices and gross profits. Many of our current or potential competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical, marketing and other resources than we do. In addition, our competitors may bundle products, software and services that are competitive to ours with other products, software and services that they may sell to our current or potential customers. These customers may accept these bundled offerings rather than separately purchasing our offerings. If any of the foregoing were to occur, our business could be adversely affected.

Difficulty predicting our future operating results or profitability due to volatility in general economic conditions and the Internet security market may result in a misallocation in spending, and a shortfall in revenue which would harm our operating results

      Changes in general economic conditions and the volatility in the demand for Internet security products are two of the many factors underlying our inability to predict our revenue for a given period. We base our spending levels for product development, sales and marketing, and other operating expenses largely on our expected future revenue. A large proportion of our expenses are fixed for a particular quarter or year, and therefore, we may be unable to implement a decrease in our spending in time to compensate for any unexpected quarterly or annual shortfall in revenue. As a result, any shortfall in revenue would likely adversely affect our operating results. For the year ended December 31, 2005, we reported a net income of $6.3 million. For the year ended December 31, 2004, we reported a net loss of $313,000. For the year ended December 31, 2003, we reported a net loss of $17.7 million. Our accumulated deficit as of December 31, 2005 is $118.6 million. We do not know if we will be able to sustain profitability in the future.

The selling prices of our solution-based product, software and services offerings may decrease, which may reduce our gross profits.

      The average selling prices for our solution-based product, software and services offerings may decline as a result of competitive pricing pressures, a change in our mix of products, software and services, anticipation of introduction of new functionality in our products or software, promotional programs and customers who negotiate price reductions in exchange for longer-term purchase commitments. In addition, competition continues to increase in the market segments in which we participate and we expect competition to further increase in the future, thereby leading to increased pricing pressures. Furthermore, we anticipate that the average selling prices and gross profits for our products will decrease over product life cycles. We cannot assure you that we will be successful in developing and introducing new offerings with enhanced functionality on a timely basis, or that our product, software and service offerings , if introduced, will enable us to maintain our prices and gross profits at current levels. If the price of individual products, software or services decline or if the price of our solution-based offerings decline, our overall revenue may decline and our operating results may be adversely affected.

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We offer retroactive price protection to our major distributors and if we fail to balance their inventory with end- user demand for our products, our allowance for price protection may be inadequate. This could adversely affect our results of operations.

      We provide our major distributors with price protection rights for inventories of our products held by them. If we reduce the list price of our products, our major distributors receive refunds or credits from us that reduce the price of such products held in their inventory based upon the new list price. As of December 31, 2005, we estimated that approximately $11.8 million of our products in our distributors’ inventory are subject to price protection. We have issued approximately $700,000 and 98,000 of credits under our price protection policies in 2005 and 2004, respectively. Future credits for price protection will depend on the percentage of our price reductions for the products in inventory and our ability to manage the level of our major distributors’ inventory. If future price protection adjustments are higher than expected, our future results of operations could be materially adversely affected.

We are dependent on international sales for a substantial amount of our revenue. We face the risk of international business and associated currency fluctuations, which might adversely affect our operating results.

      International revenue represented 34% of total revenue for in 2005, 30% of total revenue in 2004, and 30% of total revenue in 2003. We expect that international revenue will continue to represent a substantial portion of our total revenue in the foreseeable future. Our risks of doing business abroad include our ability to structure our distribution relationships in a manner consistent with marketplace requirements and on favorable terms, and if we are unable to do so, revenue may decrease from our international operations. Because our sales are denominated in U.S. dollars, the weakness of a foreign country’s currency against the dollar could increase the price of our products in such country and reduce our product unit sales by making our products more expensive in the local currency. A weakened dollar could increase the cost of local operating expenses and procurement of raw materials. We are subject to the risks of conducting business internationally, including potential foreign government regulation of our technology, geopolitical risks associated with political and economic instability, changes in diplomatic and trade relationships, and changes in foreign countries’ laws affecting such areas as employment relationships, environmental regulation, intellectual property protection and the Internet generally.

Delays in deliveries from our suppliers could cause our revenue to decline and adversely affect our results of operations.

      Our products incorporate certain components, component subassemblies or technologies that are available from single or limited sources of supply. Specifically, our products rely upon components from companies such as Iwill, Intel, Cavium, and Broadcom. We do not have long-term supply arrangements with any vendor, and any disruption in the supply of these products or technologies may adversely affect our ability to obtain necessary components or technology for our products. If this were to happen, our product shipments may be delayed and business lost, resulting in a decline in sales. In addition, our products utilize components that have in the past been subject to market shortages and price fluctuations. If we experience price increases in our product components, we will experience declines in our gross profit.

We license intellectual property, including certain databases and software, and if our licensors experience delays in product updates or provide us with products of substandard quality, the revenue we receive from our products and services that use this intellectual property would be at risk.

      We have agreements to license intellectual property, including databases and software, which we incorporate as part of certain of our products and services. Licensors of such databases and software may fail to provide us with updated products or may experience delays in providing us with updated products. In addition, our licensors may provide us with products of substandard quality. If either of these events happens, we may be unable to provide our customers with the appropriate level of functionality in our solution based offerings. In that event, our customers may purchase similar offerings from one of our competitors, or sales to our customers may be delayed. In either case, our revenue would be adversely affected.

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We rely primarily on contract manufacturers for our product manufacturing and assembly, and if these operations are disrupted for any reason, we may not be able to ship our products.

      We outsource our hardware manufacturing and assembly to contract manufacturers. Flash Electronics manufactures and assembles many of our products at facilities in both the U.S. and China. Our agreement with Flash Electronics, effective June 4, 2004, specifies an initial term of one (1) year with automatic yearly renewal terms unless the agreement is terminated by either party upon 90 days prior written notice. SerComm Corporation of Taiwan manufactures and assembles certain of our products at facilities located in Taiwan. Our agreement with SerComm, effective on January 20, 2005, specifies an initial term of one (1) year with automatic yearly renewal terms unless terminated by either party upon 90 days prior written notice. Our operations could be disrupted if we have to switch to a replacement vendor or if our hardware supply is interrupted for any reason. In addition, we provide forecasts of our demand to our contract manufacturers nine months prior to scheduled delivery of products to our customers. If we overestimate our requirements, our contract manufacturers may have excess inventory, which would increase our costs. If we underestimate our requirements, our contract manufacturers may have an inadequate component inventory, which could interrupt manufacturing of our products and result in delays in shipments and revenue. In addition, lead times for materials and components that we order vary significantly and depend on factors such as the specific supplier, contract terms and demand for each component at a given time. Financial problems of our contract manufacturers or reservation of manufacturing capacity by other companies, inside or outside of our industry, could either limit supply or increase costs. We may also experience shortages of components from time to time, which also could delay the manufacturing of our products. If any of the foregoing occurs we could lose customer orders and revenue could decline.

Sales of our products may be adversely affected by various factors which would adversely affect our revenue.

      Sales of our products may be adversely affected in the future by changes in the geopolitical environment and global economic conditions; sales and implementation cycles of our products; changes in our product mix; structural variations in sales channels; ability of our channel to absorb new product introductions; acceptance of our products in the market place; and changes in our supply chain model. These changes may result in corresponding variations in order backlog. A variation in backlog levels could result in less predictability in our quarter-to-quarter net sales and operating results. Sales of our products may also be adversely affected by fluctuations in demand for our products, price and product competition in the markets we service, introduction and market acceptance of new technologies and products, and financial difficulties experienced by our distributors, resellers or end-users. We may, from time to time, experience manufacturing issues that create a delay in our suppliers’ ability to provide specific components resulting in delayed shipments. To the extent that manufacturing issues and any related component shortages result in delayed shipments in the future, and particularly in periods when we and our suppliers are operating at higher levels of capacity, it is possible that revenue could be adversely affected for a quarter or longer.

Environmental regulations enacted in various jurisdictions in which we do business may increase the component costs of our products and if we experience delays in shipment of complaint products our revenue would decline and our operating results would be adversely affected.

      Various jurisdictions in which we do business are promulgating environmental directives that impact manufacturers doing business in those jurisdictions. The disparities between the regulatory frameworks adopted create uncertainty over the applicability, scope and form of the regulations affecting our products and the timing for compliance with the applicable regulations. Certain of these regulations may necessitate changes to the components used in our products which could result in an increase in product cost and a decrease in our gross profit. Further, while we and our contract manufacturers constantly review environmental regulations in the jurisdictions in which we do business, the timetable for implementation of these regulations may result in delays in our ability to provide compliant products in a timely manner to those markets which would cause our revenues to decline and our operating results to be adversely affected.

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If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results. As a result, current and potential stockholders could lose confidence in our financial reporting which would harm our business and the trading price of our stock.

      Section 404 of the Sarbanes-Oxley Act of 2002 requires our management to report on, and our independent registered public accounting firm to attest to, the effectiveness of our internal control over financial reporting. We have an ongoing program to perform the system and process evaluation and testing necessary to comply with these requirements. We have incurred increased expense and have devoted additional management resources to on going Section 404 compliance activity. Effective internal controls are necessary for us to provide reliable financial reports. If we cannot provide reliable financial reports, our business and operating results could be harmed.

Acquisitions could be difficult to integrate, disrupt our business, dilute shareholder value and the products and services acquired may not be accepted by the market. As a result, our operating results would be adversely affected.

      On November 28, 2005, we announced that we had acquired Lasso Logic, Inc., an early stage company providing continuous data protection for backup and recovery solutions for the small and medium business market. At the same time, we also announced that we had acquired certain assets of enKoo, a developer of remote access technology. On February 8, 2006, we announced that we had acquired Mail Frontier, Inc., a company providing message security solutions to mid-tier businesses. We are continually reviewing possible corporate opportunities and we may announce acquisitions or investments in other companies, products or technologies in the future. As part of each transaction, we will be required to integrate operations, train, retain and motivate the personnel of these entities. We may be unable to maintain uniform standards, controls, procedures and policies across our entire enterprise and if the products and services released as a result of these acquisitions experience quality problems or are otherwise not accepted by the market, we may suffer a loss of confidence by our distributors and resellers and sales of these products and services will not meet expectations. As a consequence, these acquisitions may cause disruptions in our operations and divert management’s attention from day-to-day operations, which could impair our relationships with our current employees, customers and strategic partners.

      We may have to incur debt or issue equity securities to pay for any future acquisitions. The issuance of equity securities for any acquisition could be substantially dilutive to our shareholders. In addition, due to acquisitions made in the past our profitability has suffered because of acquisition-related costs, amortization costs and impairment losses for acquired goodwill and other intangible assets.

We have been unable to predict accurately the costs associated with evaluating our internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002 and may continue to be unable to do so in the future.

      We have been unable to accurately predict the costs, including the costs of both internal assessments and external auditor assessments, associated with complying with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 and in evaluating our internal control over financial reporting. Costs of compliance have been significantly greater than anticipated, and costs of compliance in future periods may continue to be unpredictable, which could have an adverse effect on our financial results.

We cannot be certain that the remediation efforts concerning our internal control over financial reporting will be effective or sufficient.

      In the course of our ongoing evaluation and testing of our internal controls over financial reporting, we have identified areas requiring improvement. We either have implemented, or are in the process of implementing, enhanced processes and controls designed to address the issues identified during our ongoing evaluation and testing process. We cannot be certain that our remediation efforts will be effective or sufficient for us to conclude that such remediation efforts are successful.

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Our Financial Statements could be affected by the need to restate previously issued annual or interim financial statements.

      In the event an error in our financial statements requires us to report that previously reported financial statements should no longer be relied upon, amended financial statements for such previously reported periods would be required. Furthermore, we may be unable to certify the adequacy of our internal controls over financial reporting and our independent registered public accounting firm may be unable to attest thereto. In such circumstances, investors could lose confidence in our internal controls over financial reporting, our disclosure controls and the reliability of our financial statements, which could result in a decrease in the value of our common stock and could cause serious harm to our business, financial condition and results of operations.

We cannot be certain that our internal controls over financial reporting will be effective or sufficient when tested by increased scale of growth or the impact of acquisitions.

      It may be difficult to design and implement effective internal controls over financial reporting for combined operations and differences in existing controls of acquired businesses may result in weaknesses that require remediation when internal controls over financial reporting are combined. Our ability to manage our operations and growth will require us to improve our operations, financial and management controls, as well as our internal reporting systems and controls. We may not be able to implement improvements to our internal reporting systems and controls in an efficient and timely manner and may discover deficiencies and weaknesses in existing systems and controls; especially when such systems and controls are tested by increased scale of growth or the impact of acquisitions.

We must attract and retain qualified financial personnel to maintain effective controls over the application of generally accepted accounting principles within the financial reporting process.

      In order to maintain effective controls over the application of certain generally accepted accounting principles within the financial reporting process the Company must attract and retain a sufficient complement of personnel with a level of financial reporting expertise commensurate with the Company’s financial reporting requirements. Competition for qualified personnel with a level of financial reporting expertise commensurate with our financial reporting requirements is particularly intense in our marketplace and in our location. We have experienced, and may continue to experience, difficulty in hiring candidates and retaining employees with appropriate qualifications.

If our estimates or judgments relating to our critical accounting policies are based on assumptions that change or prove to be incorrect, our operating results could fall below expectations of securities analysts and investors, resulting in a decline in our stock price.

      Our discussion and analysis of financial condition and results of operations in this report is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. On an ongoing basis, we evaluate significant estimates used in preparing our financial statements, including those related to: sales returns and allowances; bad debt; inventory reserves; bonus and commission accruals, warranty reserves; restructuring reserves; intangible assets; and deferred taxes.

      We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, as provided in our discussion and analysis of financial condition and results of operations in this annual report, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Examples of such estimates include, but are not limited to, those associated with valuation allowances and accrued liabilities, specifically sales returns and other allowances, allowances for doubtful accounts and warranty reserves. SFAS No. 142 requires that goodwill and other indefinite lived intangibles no longer be amortized to earnings,

20

but instead be reviewed for impairment on an annual basis or on an interim basis if circumstances change or if events occur that would reduce the fair value of a reporting unit below its carrying value. We did not incur a goodwill impairment charge in 2005, 2004 or 2003. Actual results may differ from these and other estimates if our assumptions change or if actual circumstances differ from those in our assumptions, which could cause our operating results to fall below the expectations of securities analysts and investors, resulting in a decline in our stock price.

Changes to our senior management may have an adverse effect on our ability to execute our business strategy.

      Our future success will depend largely on the efforts and abilities of our senior management to execute our business plan. Changes in our senior management and any future departures of key employees may be disruptive to our business and may adversely affect our operations.

We must be able to hire and retain sufficient qualified employees or our business will be adversely affected.

      Our success depends in part on our ability to hire and retain key engineering, operations, finance, information systems, customer support and sales and marketing personnel. Our employees may leave us at any time. The loss of services of any of our key personnel, the inability to retain and attract qualified personnel in the future, or delays in hiring required personnel, particularly engineering and sales personnel, could delay the development and introduction of, and negatively impact our ability to sell, our products, software and services. We cannot assure you that we will be able to hire and retain a sufficient number of qualified personnel to meet our business needs.

We may be unable to adequately protect our intellectual property proprietary rights, which may limit our ability to compete effectively.

      We currently rely on a combination of patent, trademark, copyright, and trade secret laws, confidentiality provisions and other contractual provisions to protect our intellectual property. Our intellectual property program consists of an on-going patent disclosure and application process, the purchase of intellectual property assets from others and the licensing of intellectual property from others. We plan to continue our aggressive plan to build our intellectual property portfolio. Despite our efforts to protect our intellectual property, unauthorized parties may misappropriate or infringe our intellectual property. We plan to aggressively pursue any such misappropriation or infringement of our intellectual property. Our patent applications may not result in the issuance of any patents. Even if we obtain the patents we are seeking, that will not guarantee that our patent rights will be valuable, create a competitive barrier, or will be free from infringement. Furthermore, if any patent is issued, it might be invalidated or circumvented or otherwise fail to provide us any meaningful protection. We face additional risk when conducting business in countries that have poorly developed or inadequately enforced intellectual property laws. In any event, competitors may independently develop similar or superior technologies or duplicate the technologies we have developed, which could substantially limit the value of our intellectual property.

Potential intellectual property claims and litigation could subject us to significant liability for damages and invalidation of our proprietary rights.

      Litigation over intellectual property rights is not uncommon in our industry. We may face infringement claims from third parties in the future, or we may have to resort to litigation to protect our intellectual property rights. We expect that infringement or misappropriation claims will be more frequent as the number of products, feature sets in software and services and the number of competitors grows in the market segments in which we do business. Any litigation, regardless of its success, would probably be costly and require significant

21

time and attention of our key management and technical personnel. An adverse result in litigation could also force us to:

•  stop or delay selling, incorporating or using products that incorporate the challenged intellectual property;

•  pay damages;

•  enter into licensing or royalty agreements, which may be unavailable on acceptable terms; or

•  redesign products or services that incorporate infringing technology.

      If any of the above occurs, our revenue could decline and our business could suffer.

We have been named as defendant in litigation matters that could subject us to liability for significant damages.

      We are a defendant in on-going litigation matters. No estimate can be made of the possible loss or possible range of loss, if any, associated with the resolution of these litigation matters. Failure to prevail in these matters could have a material adverse effect on our consolidated financial position, results of operations, and cash flows in the future.

      In addition, the results of litigation are uncertain and the litigation process may utilize a significant portion of our cash resources and divert management’s attention from the day-to-day operations, all of which could harm our business.

We may have to defend lawsuits or pay damages in connection with any alleged or actual failure of our products and services.

      Our products and services provide and monitor Internet security. If a third party were able to circumvent our security measures, such a person or entity could misappropriate the confidential information or other property or interrupt the operations of end- users using our products, software and services. If that happens, affected end- users or others may file actions against us alleging product liability, tort or breach of warranty claims. Although we attempt to reduce the risk of losses from claims through contractual warranty disclaimers and liability limitations, these provisions may not be enforceable. Some courts, for example, have found contractual limitations of liability in standard computer and software contracts to be unenforceable in some circumstances. Defending a lawsuit, regardless of its merit, could be costly and could divert management attention. Although we currently maintain business liability insurance, this coverage may be inadequate or may be unavailable in the future on acceptable terms, if at all.

A security breach of our internal systems or those of our customers could harm our business.

      Because we provide Internet security, we may become a greater target for attacks by computer hackers. We will not succeed unless the marketplace is confident that we provide effective Internet security protection. Networks protected by our products, software and services may be vulnerable to electronic break-ins. Because the techniques used by computer hackers to access or sabotage networks change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques. Although we have not experienced significant damages from acts of sabotage or unauthorized access by a third party of our internal network to date, if an actual or perceived breach of Internet security occurs in our internal systems or those of our end-user customers, regardless of whether we cause the breach, it could adversely affect the market perception of our products, software and services. This could cause us to lose current and potential customers, resellers, distributors or other business partners. If any of the above occurs, our revenue could decline and our business could suffer.

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If our products do not interoperate with our end customers’ networks, installations could be delayed or cancelled, which could significantly reduce our revenue.

      Our products and software are designed to interface with existing networks of our end-users, each of which have different specifications and utilize multiple protocol standards. Many of the networks of our end- user’s contain multiple generations of products that have been added over time as these networks have grown and evolved. Our products and software must interoperate with the products within these networks as well as with future products that might be added to these networks in order to meet the requirements of our end-users. If we find errors in the existing software used in the networks of our end-users, we may elect to modify our software to fix or overcome these errors so that our products will interoperate and scale with their existing software and hardware. If our products and software do not interoperate properly, installations could be delayed or orders for our products could be cancelled, which could significantly reduce our revenue.

Product errors or defects could result in loss of revenue, delayed market acceptance and claims against us.

      We offer a one and two year warranty periods on our products. During the warranty period end users may receive a repaired or replacement product for any defective unit subject to completion of certain procedural requirements. Our products may contain undetected errors or defects. If there is a product failure, we may have to replace all affected products without being able to record revenue for the replacement units, or we may have to refund the purchase price for such units if the defect cannot be resolved. Despite extensive testing, some errors are discovered only after a product has been installed and used by customers. Any errors discovered after commercial release could result in loss of revenue and claims against us. Such product defects can negatively impact our products’ reputation and result in reduced sales.

Industry consolidation may lead to increased competition and may harm our operating results.

      There has been a trend toward industry consolidation in our market. We expect this trend toward industry consolidation to continue as companies attempt to strengthen or hold their market positions in an evolving industry and as companies are acquired or are unable to continue operations. We believe that industry consolidation may result in stronger competitors that are better able to compete with us. This could lead to more variability in operating results and could have a material adverse effect on our business, operating results, and financial condition.

If we are unable to meet our future capital requirements, our business will be harmed.

      We expect our cash on hand, cash equivalents to meet our working capital and capital expenditure needs for at least the next twelve months. However, at any time, we may decide to raise additional capital to take advantage of strategic opportunities available or attractive financing terms. If we issue equity securities, shareholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of common stock. If we cannot raise funds, if needed, on acceptable terms, we may not be able to develop or enhance our products, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, which could have a material adverse effect on our business, operating results, and financial condition.

Governmental regulations of imports or exports affecting Internet security could affect our revenue.

      Any additional governmental regulation of imports or exports or failure to obtain required export approval of our encryption technologies could adversely affect our international and domestic sales. The United States and various foreign governments have imposed controls, export license requirements and restrictions on the import or export of some technologies, especially encryption technology. In addition, from time to time, governmental agencies have proposed additional regulation of encryption technology, such as requiring the escrow and governmental recovery of private encryption keys. In response to terrorist activity, governments could enact additional regulation or restriction on the use, import or export of encryption technology. This additional regulation of encryption technology could delay or prevent the acceptance and use of encryption

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products and public networks for secure communications resulting in decreased demand for our products and services. In addition, some foreign competitors are subject to less stringent controls on exporting their encryption technologies. As a result, they may be able to compete more effectively than we can in the United States and the international Internet security market.

Our stock price may be volatile.

      The market price of our common stock has been highly volatile and has fluctuated significantly in the past. We believe that it may continue to fluctuate significantly in the future in response to the following factors, some of which are beyond our control:

•  general economic conditions and the effect that such conditions have upon customers’ purchasing decisions;

•  variations in quarterly operating results;

•  changes in financial estimates by securities analysts;

•  changes in market valuations of technology and Internet infrastructure companies;

•  announcements by us of significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;

•  the accretive or dilutive effects of acquisitions on operating results;

•  loss of a major client or failure to complete significant license transactions;

•  additions or departures of key personnel;

•  our ability to remediate material weaknesses and/or significant deficiencies, if any, in internal controls over financial reporting in an effective and timely manner;

•  receipt of an adverse or qualified opinion from our independent auditors regarding our internal controls over financial reporting;

•  sales of common stock in the future; and

•  fluctuations in stock market price and volume, which are particularly common among highly volatile securities of Internet-related companies.

The long sales and implementation cycles for our products may cause revenue and operating results to vary significantly.

      The decision of an end-user to purchase our products, software and services often involves a significant commitment of resources and a lengthy evaluation and product qualification process. Throughout the sales cycle, we often spend considerable time educating our channel partners and providing information for prospective end-users regarding the use and benefits of our products. Budget constraints and the need for multiple approvals within enterprises, carriers and government entities may delay purchase decisions. Failure to obtain the required approval for a particular project or purchase decision may delay the purchase of our products from our channel partners. As a result, the sales cycle for our security solutions could be longer than 90 days.

      Even after making the decision to purchase our products, software and services, end-users may not deploy these solutions broadly within their networks. The timing of implementation can vary widely and depends on the skill set of the end-user, the size of the network deployment, the complexity of the network environment and the degree of specialized hardware and software configuration necessary to deploy our products. End-users with large networks usually expand their networks in large increments on a periodic basis. Large deployments and purchases of our security solutions also require a significant outlay of capital by the end-user. If the deployment of our products in these complex network environments is slower than expected, sales through our

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distributors to our resellers would slow, our revenue could be below our expectations and our operating results could be adversely affected.

The inability to obtain any third-party license required developing new products and product enhancements could require us to obtain substitute technology of lower quality or performance standards or at greater cost, which could seriously harm our business, financial condition and results of operations.

      We license technology from third parties to develop new products or software or enhancements to existing products or software. Third-party licenses may not be available to us on commercially reasonable terms or at all. The inability to obtain third-party licenses required developing new products or software or enhancements to existing products or software could require us to obtain substitute technology of lower quality or performance standards or at greater cost, any of which could seriously harm our business, financial condition and results of operations.

Seasonality and concentration of revenue at the end of the quarter could cause our revenue to fall below the expectations of securities analysts and investors, resulting in a decline in our stock price.

      The rate of our domestic and international sales has been and may continue to be lower in the summer months or be adversely affected by other seasonal factors, both domestically and internationally. During these periods, businesses often defer purchasing decisions. As a result of customer buying patterns and the efforts of our sales force to meet or exceed quarterly and year-end quotas, we have historically received a substantial portion of a quarter’s sales orders and earned a substantial portion of a quarter’s revenue during its last month of each quarter. If expected revenue at the end of any quarter is delayed, our revenue for that quarter could fall below the expectations of securities analysts and investors, resulting in a decline in our stock price.

The requirement to record compensation expense for the value of stock options or other stock-based awards that we issue to our employees will harm our earnings.

      We believe that stock options are a key element in our ability to attract and retain employees in the markets in which we operate. In December 2004, the Financial Accounting Standards Board issued FASB Statement No. 123 (revised 2004), Share-based Payment, which requires public companies to recognize, as an expense, the fair value of stock option and other stock-based compensation to employees. This requirement becomes effective in the annual reporting period which commences January 1, 2006. Prior to this reporting period, we used the intrinsic value method to measure compensation expense for stock-based awards to our employees. Under this standard, we did not consider stock option grants issued under our employee stock option plans to be compensation when the exercise price of stock option is equal to or greater than the fair market value on the date of grant. For 2006 and thereafter, we will be required to record a compensation charge as stock options or other stock-based compensation awards are issued or as they vest, including the compensation related to the unvested portion of options that were granted prior to 2006. This compensation charge will be based on a calculated value of the option or other stock-based award using the modified prospective transition method and the Black-Scholes model. We believe that the effect of this incremental stock-based compensation expense will have a material adverse effect on our reported results.

Our business is especially subject to the risks of earthquakes, floods and other natural catastrophic events, and to interruption by manmade problems such as computer viruses or terrorism.

      Our corporate headquarters, including certain of our research and development operations and some of our contract manufacturer’s facilities, are located in the Silicon Valley area of Northern California, a region known for seismic activity. Additionally, certain of our facilities, which include one of our contracted manufacturing facilities, are located near rivers that have experienced flooding in the past. A significant natural disaster, such as an earthquake or a flood, could have a material adverse impact on our business, operating results, and financial condition. In addition, despite our implementation of network security measures, our servers are vulnerable to computer viruses, break-ins, and similar disruptions from unauthorized tampering with our computer systems. Any such event could have a material adverse effect on our business, operating results, and financial condition. In addition, the effects of war or acts of terrorism could have a

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material adverse effect on our business, operating results, and financial condition. The continued threat of terrorism and heightened security and military action in response to this threat, or any future acts of terrorism, may cause further disruptions to these economies and create further uncertainties. To the extent that such disruptions or uncertainties result in delays, curtailment or cancellations of customer orders, or the manufacture or shipment of our products, our revenue, gross profits and operating profits may decline and we may not achieve our financial goals and achieve or maintain profitability.

We face risks associated with changes in telecommunications regulation and tariffs.

      Changes in telecommunications requirements in the United States or other countries could affect the sales of our products. We believe it is possible that there may be changes in U.S. telecommunications regulations in the future that could slow the expansion of the service providers’ network infrastructures and materially adversely affect our business, operating results, and financial condition. Future changes in tariffs by regulatory agencies or application of tariff requirements to currently untariffed services could affect the sales of our products for certain classes of customers. Additionally, in the United States, our products must comply with various Federal Communications Commission requirements and regulations. In countries outside of the United States, our products must meet various requirements of local telecommunications authorities. Changes in tariffs or failure by us to obtain timely approval of products could have a material adverse effect on our business, operating results, and financial condition.

Due to the global nature of our business, economic or social conditions or changes in a particular country or region could adversely affect our sales or increase our costs and expenses, which would have a material adverse impact on our financial condition.

      We conduct significant sales and customer support operations in countries outside of the United States. Accordingly, our future results could be materially adversely affected by a variety of uncontrollable and changing factors including, among others, political or social unrest or economic instability in a specific country or region; macro economic conditions adversely affecting geographies where we do business; trade protection measures; environmental directives and other regulatory requirements which may affect our ability to import or export our products from various countries; government spending patterns affected by political considerations; and difficulties in staffing and managing international operations. Any or all of these factors could have a material adverse impact on our revenue, costs, expenses and financial condition.

ITEM 1B. Unresolved Staff Comments

      None.

ITEM 2. Properties

      Our corporate headquarters and executive offices are located in approximately 86,000 square feet of office space in Sunnyvale, California under a lease that expires in September 2009.

      In November 2005, in conjunction with our acquisition of Lasso Logic, Inc., we assumed the lease for 6,743 square feet of office space in San Francisco, California for a term that ends on September 30, 2006.

      In February 2006, in conjunction with our acquisition of MailFrontier, Inc., we assumed the lease for approximately 19,000 square feet of office space in Palo Alto, California for a term that ends on November 10, 2006. We do not expect to renew this lease beyond its current expiration.

      Additional sales and support offices are leased in the United Kingdom, France, Norway, Switzerland, the Netherlands, Australia, Brazil, Mexico, Germany, Japan, Sweden, Singapore, Hong Kong and China. We believe that our existing facilities are suitable and adequate for our current needs.

ITEM 3. Legal Proceedings

      On December 5, 2001, a securities class action complaint was filed in the U.S. District Court for the Southern District of New York against the Company, three of its officers and directors, and certain of the

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underwriters in the Company’s initial public offering in November 1999 and its follow-on offering in March 2000. Similar complaints were filed in the same court against numerous public companies that conducted initial public offerings (“IPOs”) of their common stock since the mid-1990s. All of these lawsuits were consolidated for pretrial purposes before Judge Shira Scheindlin. On April 19, 2002, plaintiffs filed an amended complaint. The amended complaint alleges claims under the Securities Act of 1933 and the Securities Exchange Act of 1934, and seeks damages or rescission for misrepresentations or omissions in the prospectuses relating to, among other things, the alleged receipt of excessive and undisclosed commissions by the underwriters in connection with the allocation of shares of common stock in the Company’s public offerings. On July 15, 2002, the issuers filed an omnibus motion to dismiss for failure to comply with applicable pleading standards. On October 8, 2002, the Court entered an Order of Dismissal as to all of the individual defendants in the SonicWALL IPO litigation, without prejudice. On February 19, 2003, the Court denied the motion to dismiss the Company’s claims. A tentative agreement has been reached with plaintiff’s counsel and the insurers for the settlement and release of claims against the issuer defendants, including SonicWALL, in exchange for a guaranteed recovery to be paid by the issuer defendants’ insurance carriers and an assignment of certain claims. Papers formalizing the settlement among the plaintiffs, issuer defendants, including SonicWALL, and insurers were presented to the Court on September 14, 2004. The settlement is subject to a number of conditions, including approval of the proposed settling parties and the Court. On July 14, 2004, underwriter defendants filed with the Court a memorandum in opposition to plaintiff’s motion for preliminary approval of the settlement with defendant issuers and individuals. Plaintiffs and issuers subsequently filed papers with the Court in further support of the settlement and addressing issues raised in the underwriter’s opposition. On February 15, 2005 the Court granted preliminary approval of the settlement, subject to the parties fulfilling certain conditions. To address the concerns raised by the Court, the parties submitted revised settlement documents that contained a more limited “bar order” that would not preclude claims by the underwriters for indemnification for an issuer pursuant to the IPO underwriting agreement. On August 31, 2005, the Court entered an order confirming its preliminary approval of the settlement. The Court has scheduled a hearing on the fairness of the settlement to the shareholder class for April 24, 2006. If the settlement does not occur, and litigation against the Company continues, the Company believes it has a meritorious defense and intends to defend the case vigorously. No estimate can be made of the possible loss or possible range of loss, if any, associated with the resolution of this contingency. As a result, no loss has been accrued in the Company’s financial statements as of December 31, 2005.

      In September 2003, Data Centered LLC filed a complaint against the Company in California Superior Court, Santa Clara County seeking compensatory and punitive damages, Data Centered LLC v. SonicWall, Inc., No. 103-CV-000060. The Company entered into a transaction with Data Centered for a technology license for, and the sale of load-balancing products for $522,500. The Company had acquired the load-balancing technology and products during the Company’s acquisition of Phobos Corporation. Former Phobos personnel operate Data Centered. Data Centered alleged that the load-balancing products purchased by Data Centered were defective and did not comply with a purported warranty on the products. The Company answered with a general denial of these allegations. The Company also filed a cross-complaint alleging, among other things, that Data Centered’s claims were based on a fraudulently altered document that included a warranty clause that was not part of the parties’ contract; the actual contract between the parties contained a warranty disclaimer. On March 25, 2005, the parties reached an agreement in principle requiring a formal settlement agreement under which the Company agreed to pay to DataCentered the sum of $103,500 and the parties agree to a full and complete release of claims and to dismiss all complaints against the other with prejudice. A formal settlement agreement was executed and on April 19, 2005, a Notice of Settlement was filed with the California Superior Court, Santa Clara County. The settlement amount of $103,500 was paid during the second quarter ended June 30, 2005. As a result, no loss has been accrued in the Company’s financial statements as of December 31, 2005.

      On March 23, 2005, Watchguard Technologies, Inc. (“Watchguard”) filed a complaint captioned Watchguard Technologies Inc., v. Michael N. Valentine and SonicWALL, Inc., No. 3-05CV0572-K, in the United States District Court for the Northern District of Texas. The Complaint seeks injunctive relief, compensatory and punitive damages in an amount in excess of the jurisdictional minimum, and cost of suit against its former employee, Michael N. Valentine, and the Company, his new employer, for purported

27

misappropriation of Watchguard trade secrets and unfair competition. On April 28, 2005, the Company answered with a general denial of the allegations contained in the complaint. On November 9, 2005, Watchguard filed its Motion for Preliminary Injunction. On December 20, 2005, the Company filed its Response to Plaintiff’s Motion for Preliminary Injunction. This motion is currently before the Court. There is no schedule as to when the Court may rule on this Motion. Concurrently, the parties are proceeding with discovery in accordance with the scheduling order issued by the Court. The Company believes that it has meritorious defenses and intends to defend the case vigorously. No estimate can be made of the possible loss or possible range of loss, if any, associated with this resolution of this contingency. As a result, no loss has been accrued in the Company’s financial statements as of December 31, 2005.

      Additionally, the Company is party to routine litigation incident to its business. The Company believes that none of these legal proceedings will have a material adverse effect on the Company’s consolidated financial statements taken as a whole or its results of operations, financial position and cash flows.

ITEM 4. Submission of Matters to a Vote Of Security Holders

      None.

PART II

ITEM 5. Market For Registrant’s Common Equity And Related Stockholder Matters

      Our common stock commenced trading on the NASDAQ National Market on November 11, 1999 and is traded under the symbol “SNWL”. As of December 31, 2005, there were approximately 119 holders of record of the common stock. The high and low sale prices for the common stock as reported on the NASDAQ National Market were:

		High		Low
Fiscal 2004
	First Quarter	$	10.05	$	7.71
	Second Quarter	$	9.59	$	6.71
	Third Quarter	$	8.35	$	5.26
	Fourth Quarter	$	7.25	$	5.00
Fiscal 2005
	First Quarter	$	6.50	$	5.00
	Second Quarter	$	6.27	$	4.97
	Third Quarter	$	6.49	$	5.33
	Fourth Quarter	$	8.02	$	5.57

      We have never paid a cash dividend on our capital stock. With the exception of the stock repurchase program, we currently anticipate that we will retain all available funds, for use in our business and we do not anticipate paying any cash dividends.

      In September 2003, we issued 50,000 shares of our common stock, which represented the payment of additional consideration for our acquisition of certain technologies and the expansion of our sales and marketing infrastructure in Europe, related to an acquisition that originally occurred in 2001. The issuance was not underwritten. The securities were issued in reliance upon the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended, and/or Regulation S, as promulgated by the Securities Act of 1933, as amended.

ITEM 5c. Issuer Purchases of Equity Securities (in thousands, except per-share amounts)

      In November 2004, the Company’s Board of Directors authorized a stock repurchase program to reacquire up to $50 million of common stock. The term of the stock repurchase plan was set at twelve

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(12) months from the date of authorization. In February 2005, the Company’s Board of Directors increased the amount authorized for repurchase from $50 million to $75 million, extended the term of the program from twelve (12) to twenty-four (24) months following the date of original authorization and increased certain predetermined pricing formulas. In April 2005 the Company’s Board of Directors authorized a modification to the stock repurchase program to delete certain elements that provided for systematic repurchases.

	Total				Total Number of Shares		Value of Shares That
	Number of		Average		Purchased as Part of		May Yet be
	Shares		Price Paid		Publicly Announced		Purchased Under the
Period	Purchased		per Share		Plans or Programs		Plans or Programs
Shares purchased prior to 6/30/05 under the current repurchase program		8,181	$	6.06		8,181	$	25,426
July 1, 2005 to December 31, 2005		None		None		None		None
Total		8,181				8,181	$	25,426

      During the fourth quarter of fiscal 2004, the Company repurchased and retired 3.2 million shares of SonicWALL common stock at an average price of $6.08 per share for an aggregate purchase price of $19.4 million. During fiscal 2005, the Company repurchased and retired 5.0 million shares of our common stock at an average price of $6.05 per share for an aggregate purchase price of $30.2 million. As of December 31, 2005, the Company had repurchased and retired 8.2 million shares of our common stock at an average price of $6.06 per share for an aggregate purchase price of $49.6 million since inception of the stock repurchase program. As of December 31, 2005, the remaining authorized amount for stock repurchases under this program was $25.4 million.

      In February 2006, The Company’s Board of Directors approved an increase in the amount authorized for repurchase under the plan from $75 million to $100 million and extended the term of the program from twenty-four (24) to thirty-six (36) months following the date of original authorization.

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ITEM 6. Selected Consolidated Financial Data

      The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and related notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this Form 10-K.

			Year Ended December 31,
			2005			2004			2003			2002			2001
			(In thousands, except per share data)
Statements of Operations Data:
Revenue:
	Product		$	75,525		$	82,994		$	65,931		$	78,184		$	86,777
	License and service			59,799			42,655			28,470			25,035			25,210
		Total revenue		135,324			125,649			94,401			103,219			111,987
Cost of revenue:
	Product			27,699			30,118			27,906			25,303			25,244
	License and service			8,031			7,002			5,617			4,659			1,431
	Amortization of purchased technology			4,552			4,543			4,543			4,543			4,399
		Total cost of revenue (excluding stock-based compensation)		40,282			41,663			38,066			34,505			31,074
Gross profit				95,042			83,986			56,335			68,714			80,913
Operating expenses:
	Research and development (excluding stock-based compensation)			22,603			23,337			19,864			18,900			21,327
	Sales and marketing (excluding stock-based compensation)			53,367			47,353			40,139			42,937			31,988
	General and administrative (excluding stock-based compensation)			15,535			14,365			11,893			11,200			9,571
	Amortization of goodwill and purchased intangible assets(1)			2,893			3,089			5,333			5,744			38,839
	Impairment of goodwill			—			—			—			87,640			—
	Restructuring charges			—			(171	)		1,833			3,969			—
	Stock-based compensation			201			75			700			1,400			3,009
		Total operating expenses		94,599			88,048			79,762			171,790			104,734
Income (loss) from operations				443			(4,062	)		(23,427	)		(103,076	)		(23,821	)
Interest income and other expense, net				6,867			4,050			4,169			6,044			9,258
Income (loss) before income taxes				7,310			(12	)		(19,258	)		(97,032	)		(14,563	)
Benefit from (provision for) income taxes				(1,034	)		(301	)		1,590			3,119			(6,351	)
Net income (loss)			$	6,276		$	(313	)	$	(17,668	)	$	(93,913	)	$	(20,914	)
Basic net income (loss) per share			$	0.10		$	(0.00	)	$	(0.26	)	$	(1.40	)	$	(0.32	)
Diluted net income (loss) per share			$	0.09		$	(0.00	)	$	(0.26	)	$	(1.40	)	$	(0.32	)
Shares used in computing basic net income (loss) per share				64,684			70,850			67,895			67,124			64,467
Shares used in computing diluted net income (loss) per share				66,797			70,850			67,895			67,124			64,467

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	As of December 31,
	2005		2004		2003		2002		2001
	(In thousands)
Consolidated Balance Sheet Data:
Cash and cash equivalents	$	42,593	$	23,446	$	30,467	$	23,030	$	60,908
Short-term investments		197,849		229,226		213,010		209,854		166,271
Total assets		387,683		386,845		381,721		405,098		516,351
Total shareholders’ equity		320,170		337,976		344,269		357,183		451,153
Long-term liabilities		—		—		—		12,272		17,625

(1)  In accordance with SFAS No. 142, goodwill and intangibles related to workforce are not being amortized effective January 1, 2002.

ITEM 7. Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

      This Form 10-K contains forward-looking statements which relate to future events or our future financial performance. In many cases you can identify forward-looking statements by terminology such as “may”, “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “intend” or “continue,” or the negative of such terms and other comparable terminology. In addition, forward-looking statements in this document include, but are not limited to, those regarding:growth of Internet usage and acceptance; increasing use of Broadband access technologies; increasing importance of network security; benefits of integrated solutions for network security, importance of productivity and mobility to our end users; factors fueling the growth of content filtering services; strength of international markets for our products; expected competition in the Internet security market and our ability to compete in markets in which we participate; ability to successfully introduce new products and services; pricing pressures on our solution based offerings; possible impact of government regulation on our operating results; possible impact of acquisition activity on our operating results; expectations regarding trends in operating expenses and operating cash flow; impact of stock based compensation expense on operating results; the strengths of the flexibility of our product architecture; benefits associated with our software and services revenue model; our ability to sustain success in targeted vertical markets; assessment of future effective tax rates and the continued need for a valuation allowance; expansion of market acceptance of our product offerings; our ability to grow international sales to match the rate of penetration of our products in domestic markets; our ability to implement operational efficiencies; our ability to leverage incremental revenue out of each product transaction; the impact of geopolitical and macro-economic conditions on demand for our offerings; our ability to achieve increased renewal rates for our service offerings; the ability of our contract manufacturers to meet our requirements; the belief that existing cash, cash equivalents and short-term investments will be sufficient to meet our cash requirements at least through the next twelve months; and the growth of market opportunity for our license and service business. These statements are only predictions, and they are subject to risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors, including, but not limited to, those set forth herein under the heading “Risk Factors”.. References to “we,” “our,” and “us” refer to SonicWALL, Inc. and its subsidiaries.

Overview

      SonicWALL provides security, productivity and mobility solutions for businesses of all sizes. Our access security products are typically deployed at the edges of small to medium sized local area networks. These networks are often aggregated into broader distributed deployments to support companies that do business in multiple physical locations, interconnect their networks with trading partners, or support a mobile or remote workforce. Our products are sold in over 50 countries worldwide.

      We generate revenue primarily from the sale of the four items: (1) product, (2) software licenses, (3) subscriptions for services such as content filtering, anti-virus protection and intrusion prevention, and (4) other services such as extended warranty and service contracts, training, consulting and engineering services.

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      We currently outsource our hardware manufacturing and assembly to contract manufacturers. Flash Electronics manufactures and assembles many of our products at facilities in both the U.S. and China. Our agreement with Flash Electronics, effective on June 4, 2004, provides for an initial term of one (1) year and automatic renewal terms of one (1) year each unless cancelled by either party upon 90 days prior written notice by either party. SerComm Corporation of Taiwan manufactures and assembles certain of our products at facilities located in Taiwan. Our agreement with SerComm, effective on January 20, 2005, specifies an initial term of one (1) year with automatic yearly renewal terms unless terminated by either party upon 90 days prior written notice. Outsourcing our manufacturing and assembly enables us to reduce fixed overhead and personnel costs and to provide flexibility in meeting market demand.

      We design and develop the key components for the majority of our products. In addition, we generally determine the components that are incorporated in our products and select the appropriate suppliers of these components. Product testing and burn-in are performed by our contract manufacturer using tests that we typically specify.

      We sell our products through distributors and value-added resellers, who in turn sell our products to end-users. Some of our resellers are carriers or service providers who provide solutions to the end-user customers as managed services.

      We seek to provide our channel and customers with differentiated solutions that are innovative, easy to use, reliable, and provide good value. To support this commitment, we dedicate significant resources to developing new products and marketing our products to our channels and end-user customers.

Key Success Factors of our Business

      We believe that there are several key success factors of our business, and that we create value in our business by focusing on our execution in these areas.

Channel

      Our distributors and resellers provide a valuable service in assisting end-users in the design, implementation and service of our security, productivity and mobility applications. We support our distribution and channel partners with sales, marketing and technical support to help them create and fulfill demand for our offerings. With this business model, we reduce the potential for conflict with our channel. We are also focused on helping our channel partners succeed with our products by concentrating on cost efficiencies in the distribution channel, comprehensive reseller training and certification, and support for our channel’s sales activities.

Product and Service Platform

      Our products serve as a platform for revenue generation for both us and our channel. Each appliance sale can result in additional revenue through the simultaneous or subsequent sale of add-on software licenses, such as our Global Management System, or through the sale of additional value-added services, such as Content Filtering, client Anti-Virus and integrated Gateway Anti-Virus, Anti-Spyware and Intrusion Prevention Services. We plan to introduce more service options for our platforms, which will allow us to generate additional revenue from both our installed base of platforms as well as from those services coupled to incremental product sales.

Distributed Architecture

      Our security solutions are based on a distributed architecture, which we believe allows our offerings to be deployed and managed at the most efficient location in the network. Specifically, we can provide protection at the gateway and enforced protection at the client level, and we can monitor and report on network activity. Thus, we are providing our customers and their service providers with mechanisms to enforce the networking and security policies they have defined for their business. We also use the flexibility of this architecture to allow us to enable new functionality in already-deployed platforms through the provisioning of an electronic

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key, which may be distributed through the Internet. This ability provides benefits to both us and our end-users, because there is no need to modify, physically adjust or replace devices, which might create a significant burden on the Company, channel partner or end-user where there are a large number of products installed or where the platforms are distributed over a broad area.

End User Acceptance

      We began offering integrated security appliances in 1997, and since that time we have shipped approximately 759,000 revenue units. When measured by units shipped, we are typically among the top three suppliers in the markets in which we compete. Our experience in serving a broad market and installed base of customers provides us with opportunities to become a leader in the areas of ease-of-use and reduced total cost of ownership. Additionally, our demonstrated end-user acceptance provides our current and prospective channel partners with an increased level of comfort when deciding to offer our products to their customers.

Integrated Design

      Our platforms utilize a highly integrated design in order to improve ease-of-use, lower acquisition and operational costs for our customers, and enhance performance. Each of our products ships with multiple Ethernet network connections. Various models also integrate 802.11a/b/g wireless access points, V.90 analog modems, and ISDN terminal adapters to support different connection alternatives. Every appliance also ships with pre-loaded firmware to provide for rapid set up and easy installation. Each of these tasks can be managed through a simple web-browser session.

Our Opportunities, Challenges and Risks

International Growth

      Our percentage of sales from international territories does not represent the same degree of penetration of those markets as we have achieved domestically. We believe that a significant opportunity exists to grow our revenue by increasing the international penetration rate to match the current domestic penetration rate.

      If we fail to achieve our goal of greater international sales, we may be at a disadvantage to competitors who are able to amortize their product investments over a larger available market.

License and Services Revenue

      We believe that the software and services component of our revenue has several characteristics that are positive for our business as a whole: the license and services revenue is associated with a higher gross profit than our product revenue; the services component of the revenue is recognized ratably over the services period, and thus provides in aggregate a more predictable revenue stream than product revenue, which is generally recognized at the time of the sale; and to the extent that we are able to achieve good renewal rates, we have the opportunity to lower our selling and marketing expenses attributable to that segment. If we are successful in licensing our software and selling our services to both our installed base and in conjunction with our new product sales, we will likely be able to generate incremental revenue out of each product transaction. However, should we not achieve reasonable rates of selling associated services to our installed base or as part of new product sales, or realize lower service renewal rates, we risk having our revenue concentrated in more unpredictable product and license sales.

Macro-economic factors affecting IT spending

      We believe that our products and services are subject to the macro-economic factors that affect much of the IT market. Growing IT budgets and an increase of funding for projects to provide security, mobility and productivity could drive product upgrade cycles and/or create demand for new applications of our products. Contractions in IT spending can affect our revenue by causing projects incorporating our products and services to be delayed and/or canceled.

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Vertical markets

      We have achieved significant sales in certain vertical markets. We believe that we can increase our sales in these markets through dedicated marketing and sales efforts focused on the unique requirements of these vertical markets. To the extent that we are able to do so, we expect to see revenue growth and increased sales and marketing efficiency. Should our efforts in these areas fall short of our goals, because of the unsuitability of our products, increased competition, or for other reasons, we would expect to see a poor return on our marketing and sales investments in these areas.

Critical Accounting Policies and Critical Accounting Estimates

      The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. On an ongoing basis, we evaluate significant estimates used in preparing our financial statements, including those related to: sales returns and allowances, bad debt allowances, provisions for excess and obsolete inventory, warranty reserves, restructuring reserves, intangible assets, and deferred income taxes. Actual results could differ from these estimates. The following critical accounting policies are impacted significantly by judgments, assumptions, and estimates used in the preparation of the Consolidated Financial Statements.

Revenue recognition

      The Company derives its revenue primarily from the sale of the four items: (1) product, (2) software licenses, (3) subscriptions for services such as content filtering, anti-virus protection and intrusion prevention, and (4) other services such as extended warranty and service contracts, training, consulting and engineering services. As described below, significant management judgments and estimates must be made and used in connection with the revenue recognized in any accounting period. The Company may experience material differences in the amount and timing of its revenue for any period if the management makes different judgments or utilize different estimates.

      The Company recognizes product and service revenues in accordance with SEC Staff Accounting Bulletin No. 101 (“SAB No. 101”), “Revenue Recognition in Financial Statements”, as amended by SAB No. 101A, SAB No. 101B, SAB 104 and EITF 00-21.

      The Company applies provisions of Statement of Position 97-2, “Software Revenue Recognition” (“SOP No. 97-2”), as amended by Statement of Position 98-9 (“SOP No. 98-9”), “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions”, to all transactions involving the sale of software products and hardware transactions where the software is not incidental. For hardware transactions where software is incidental, the Company does not apply separate accounting guidance to the hardware and software elements. The Company applies the provisions of Emerging Issues Task Force 03-05 (“EITF 03-05”), “Applicability of AICPA Statement of Position 97-2, Software Revenue Recognition, to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software”, to determine whether the provisions of SOP 97-2 apply to transactions involving the sale of products that include a software component.

      The Company recognizes revenue for products when persuasive evidence of an arrangement exists, the product has been delivered, title and risk of loss have been transferred to the customer, the fee is fixed or determinable and collection of the resulting receivable is reasonably assured. While the Company’s sales agreements contain standard terms and conditions, there are agreements that contain non-standard terms and conditions. In these cases, interpretation of non-standard provisions is required to determine the appropriate accounting for the transaction.

      Retroactive price protection rights tied to certain specific circumstances are contractually offered to the Company’s channel partners. The Company evaluates these rights carefully based on stock on hand in the channels that has been purchased within 60 days of the price change with the exception of Ingram Micro and Tech Data. Revenue from these two distributors is not recognized until they sell the product to their

34

customers. As a consequence, any requirement to provide price protection credits to these two distributors does not adversely impact previously recognized revenue. In general, retroactive price adjustments are infrequent in nature. At December 31, 2005, 2004, and 2003, the Company had a reserve for price protection in the amounts of $244,000, $33,000, $17,000, respectively.

      Delivery to domestic channel partners and international channel partners is generally deemed to occur when we deliver the product to a common carrier. However, certain distributor agreements provide for rights of return for stock rotation. These stock rotation rights are generally limited to 15% to 25% of the distributor’s prior 3 to 6 months purchases or other measurable restrictions, and we estimate reserves for these return rights as discussed below. Our two largest distributors, Ingram Micro and Tech Data, have rights of return under certain circumstances that are not limited, therefore, we do not deem delivery to have occurred for any sales to Ingram Micro and Tech Data until they sell the product to their customers, at which time their right of return expires.

      Evidence of an arrangement is manifested by a master distribution or OEM agreement, an individual binding purchase order, or a signed license agreement. In most cases, sales through our distributors and OEM partners are governed by a master agreement against which individual binding purchase orders are placed on a transaction-by-transaction basis.

      At the time of the transaction, the Company assesses whether the fee associated with the transaction is fixed or determinable and whether or not collection is reasonably assured. The Company assesses whether the fee is fixed or determinable based upon of the terms of the binding purchase order, including the payment terms associated with the transaction. If a significant portion of a fee is due beyond the Company’s normal payment terms, which are generally 30 to 90 days from invoice date, the Company accounts for the fee as not being fixed or determinable. In these cases, the Company recognizes revenue as the fees become due.

      The Company assesses probability of collection based on a number of factors, including past transaction history with, and credit-worthiness of, the distributor or reseller. The Company does not request collateral from our distributors or resellers. If the Company determines that collection of a fee is not reasonably assured, it defers the fee and recognizes revenue at the time collection becomes reasonably assured, which is generally upon receipt of cash.

      For arrangements with multiple obligations (for example, the sale of an appliance which includes a year of free maintenance or a subscription based product), the Company allocates revenue to each component of the arrangement based on the objective evidence of fair value of the undelivered elements, which is generally the average selling price of each element when sold separately. This allocation process means that the Company defers revenue from the arrangement equal to the fair value of the undelivered elements and recognizes such amounts as revenue when the elements are delivered.

      The Company’s arrangements do not generally include acceptance clauses. However, if an arrangement includes an acceptance provision, recognition of revenue occurs upon the earlier of receipt of a written customer acceptance or expiration of the acceptance period.

      The Company recognizes revenue for subscriptions and services, such as content filtering, anti-virus protection and intrusion prevention, and extended warranty and service contracts, ratably over the contract term. The Company’s training; consulting and engineering services are generally billed and recognized as revenue as these services are performed.

Sales returns and other allowances, allowance for doubtful accounts and warranty reserve

      The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amount of assets and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Specifically, we must make estimates of potential future product returns and price changes related to current period product revenue. We analyze historical returns, current economic trends, and changes in customer demand and acceptance of our products when evaluating the adequacy of the sales returns and other allowances. Significant management judgments

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and estimates must be made and used in connection with establishing the sales returns and other allowances in any accounting period. We may experience material differences in the amount and timing of our revenue for any period if management makes different judgments or utilizes different estimates.

      In addition, we must make estimates based upon a combination of factors to ensure that our accounts receivable balances are not overstated due to uncollectibility. We specifically analyze accounts receivable and historical bad debts, the length of time receivables are past due, macroeconomic conditions, deterioration in customer’s operating results or financial position, customer concentrations, and customer credit-worthiness, when evaluating the adequacy of the allowance for doubtful accounts.

      Our appliance products are generally covered by a warranty for a one to two year period. We accrue a warranty reserve for estimated costs to provide warranty services, including the cost of technical support, product repairs, and product replacement for units that cannot be repaired. Our estimate of costs to fulfill our warranty obligations is based on historical experience and expectation of future conditions. To the extent we experience increased warranty claim activity or increased costs associated with servicing those claims, our warranty accrual will increase, resulting in decreased gross profit.

Valuation of inventory

      We continually assess the valuation of our inventory and periodically write-down the value for estimated excess and obsolete inventory based upon assumptions about future demand and market conditions. Such estimates are difficult to make since they are based, in part, on estimates of current and future economic conditions. Reviews for excess inventory are done on a quarterly basis and required reserve levels are calculated with reference to our projected ultimate usage of that inventory. In order to determine the ultimate usage, we take into account forecasted demand, rapid technological changes, product life cycles, projected obsolescence, current inventory levels, and purchase commitments. The excess balance determined by this analysis becomes the basis for our excess inventory charge. If actual demand is lower than our forecasted demand, and we fail to reduce manufacturing output accordingly, we could be required to record additional inventory write-downs, which would have a negative effect on our gross profit and earnings.

Accounting for income taxes

      As part of the process of preparing our consolidated financial statements we are required to estimate our taxes in each of the jurisdictions in which we operate. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the statement of operations.

      Management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We have established a full valuation allowance against our deferred tax assets at December 31, 2005 based upon our determination that it is more likely than not that all of the deferred tax asset may not be realized in the foreseeable future due to historical operating losses. The net operating losses and research and development tax carryovers that make the vast majority of the deferred tax asset will expire at various dates through the year 2024. Going forward, we will assess the continued need for the valuation allowance. After we have demonstrated profitability for a period of time and begin utilizing a significant portion of the deferred tax assets, we may reverse the valuation allowance, likely resulting in a significant benefit to the statement of operations in some future period. At this time, we cannot reasonably estimate when this reversal might occur, if at all.

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Valuation of long-lived and intangible assets and goodwill

      Purchased intangibles consist of purchased technology, customer installed base/relationships, customer backlog and other intangibles. Intangible assets are amortized on a straight-line basis over their estimated useful lives which range from 3 months to six years. Amortization of intangible assets was $7.4 million, $7.6 million and $9.9 million in fiscal 2005, 2004 and 2003, respectively. The Company periodically evaluates its intangible assets for indications of impairment. If this evaluation indicates that the value of the intangible asset may be impaired, the Company makes an assessment of the recoverability of the net carrying value of the asset over its remaining useful life. If this assessment indicates that the intangible asset is not recoverable, based on the estimated undiscounted future cash flows of the technology over the remaining amortization period, the Company reduces the net carrying value of the related intangible asset to fair value and may adjust the remaining amortization period.

      Goodwill represents the excess of the aggregate purchase price over the fair market value of the net tangible and intangible assets acquired by the Company. Goodwill is tested for impairment in the fourth quarter of each fiscal year or more often if an event or circumstances indicate that an impairment loss has been incurred. An impairment charge is recognized if a reporting unit’s goodwill carrying amount exceeds its implied fair value. Goodwill impairment is determined using a two-step approach in accordance with SFAS 142 using one or more of the following fair value measures including: present value techniques of estimated future cash flows; or valuation techniques based on multiples of earnings or revenue, or a similar performance measure. Any such impairment charge could be significant and could have a material adverse effect on the Company’s reported financial statements. Based on the impairment tests performed, there was no impairment of goodwill in 2005, 2004, or 2003. The goodwill recorded as a result of the business combinations in the years presented is not deductible for tax purposes.

      The Company continually monitors events and changes in circumstances that could indicate carrying amounts of long-lived assets, including intangible assets, may not be recoverable. When such events or changes in circumstances occur, the Company assesses the recoverability of long-lived assets by determining whether the carrying value of such assets will be recovered through undiscounted expected future cash flows. If the total of the future cash flows is less than the carrying amount of those assets, the Company records an impairment charge based on the excess of the carrying amount over the fair value of the assets.

Significant Transactions

Acquisitions

      On November 28, 2005, the Company purchased Lasso Logic, Inc. (Lasso) for approximately $15.8 million in purchase consideration, consisting of cash, assumed stock options in the amount of $109,000 and $194,000 in direct transactions costs incurred in connection with the acquisition. Lasso provides continuous data protection for backup and recovery solutions for the small and medium business market. The Company believes that Lasso’s data backup solutions will provide a strong entry point to the growing data protection segment. In accordance with SFAS 141, Business Combinations, this transaction was accounted for as a purchase business combination.

      The former shareholders of Lasso made certain representations and warranties to the Company and agreed to indemnify the Company against damages which might arise from a breach of those undertakings. As security for the indemnification obligation’s SonicWALL retained approximately $1.8 million of the cash consideration, which is scheduled to be released to the former Lasso shareholders on the 12 month anniversary of the acquisition date. In addition, in connection with the acquisition, the Company has agreed to pay $1.7 million over the next 17 to 20 months to certain former shareholders of Lasso contingent upon continued employment with the Company. Amounts paid under these arrangements are recorded as compensation expense when earned.

      The Company allocated the purchase price based upon the fair value of the assets acquired and liabilities assumed. The excess of the purchase price over the fair value of the assets acquired and liabilities assumed has been allocated to the identified intangible assets in accordance with the requirements of SFAS 141 and

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SFAS 142, Goodwill and Other Intangible Assets. The following is the allocation of the purchase consideration (in thousands):

Net tangible assets	$	1,351
Intangible assets	$	14,421
Total purchase consideration	$	15,772

      The acquired intangible assets of $14.4 million consists of the following: (1) $3.7 million that was assigned to purchased technology and will be amortized over its estimated useful life of five years; (2) $0.1 million that was assigned to customer relationships and customer backlog which will be amortized over a period of 3 months to one year; and (3) $10.6 million that was assigned to goodwill.

      Under the terms of the definitive agreement, the purchase consideration consisted of cash and stock options assumed. The total calculated purchase consideration includes deferred stock-based compensation representing unearned stock-based compensation, equal to the fair value of assumed options, less the intrinsic value of such unvested options. Deferred stock-based compensation is amortized ratably as stock-based compensation expense over the remaining vesting period of the underlying options. The unamortized balance for deferred stock-based compensation is reflected as a reduction to additional paid-in capital in the Consolidated Statements of Shareholders’ Equity.

      On November 28, 2005, the Company acquired certain assets from enKoo for approximately $2.4 million in consideration, consisting of cash and transaction costs. The Company acquired the enKoo assets for its secure remote access technology and plans to integrate the key features of enKoo’s technology into its SSL-VPN products. The assets acquired from enKoo included certain intangible assets. In addition, certain employees of enKoo became employees of the Company. Of the total purchase price of $2.4 million, $1.1 million was allocated to purchased technology and will be amortized over its estimated useful life of five years, and less than $50,000 was allocated to customer relationship and will be amortized over three months. The remaining $1.3 million was allocated to goodwill.

      The Consolidated Financial Statements include the operating results of each business from the date of acquisition. Pro forma results of operations have not been presented because these were not significant acquisitions as defined under the SEC’s S-X rule 3-05.

      Commercialization of the technologies acquired as a result of these transactions carries a significant risk due to the remaining efforts to achieve technical viability, rapidly changing customer markets, uncertain standards for new products, and significant competitive threats. The nature of the efforts to develop these technologies into commercially viable products consists primarily of planning, designing, experimenting, and testing activities necessary to determine that the technologies can meet market expectations, including functionality and technical requirements. Failure to bring these products to market in a timely manner could result in a loss of market share or a lost opportunity to capitalize on emerging markets and could have a material adverse impact on our business and operating results

      On February 8, 2006, the Company announced a definitive agreement to acquire privately held MailFrontier, Inc. The aggregate announced purchase price for this acquisition was approximately $30.7 million in cash. This acquisition closed on February 22, 2006. The company expects to file an 8-K/ A with audited financial statements of MailFrontier, Inc. including pro-forma results of operations on or before May 4th, 2006.

Restructuring

      During 2002 and 2003, we implemented two restructuring plans — one initiated in the second quarter of 2002 and the second initiated in the second quarter of 2003. The information contained in Note 6 to the Consolidated Financial Statements is hereby incorporated by reference into this Part II, Item 7.

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Results of Operations

      The following table sets forth financial data for the years indicated as a percentage of total revenue:

			Year Ended December 31,
			2005			2004			2003
Revenue:
	Product			55.8	%		66.1	%		69.8	%
	License and service			44.2			33.9			30.2
		Total revenue		100.0			100.0			100.0
Cost of revenue:
	Product			20.5			23.9			29.6
	License and service			5.9			5.6			5.9
	Amortization of purchase technology			3.4			3.6			4.8
		Total cost of revenue (excluding Stock-based compensation)		29.8			33.1			40.3
Gross profit				70.2			66.9			59.7
Operating expenses:
	Research and development (excluding Stock-based compensation)			16.8			18.5			21.0
	Sales and marketing (excluding Stock-based compensation)			39.4			37.7			42.5
	General and administrative (excluding Stock-based compensation)			11.5			11.4			12.6
	Amortization of purchased intangible assets			2.1			2.5			5.7
	Restructuring charges			—			(0.1	)		1.9
	Stock-based compensation			0.1			0.1			0.7
		Total operating expenses		69.9			70.1			84.4
Income (loss) from operations				0.3			(3.2	)		(24.7	)
Interest income and other expense, net				5.1			3.2			4.4
Income (loss) before income taxes				5.4			(0.0	)		(20.3	)
Benefit from (provision for) income taxes				(0.8	)		(0.2	)		1.7
Net Income (loss)				4.6	%		(0.2	)%		(18.6	)%

Revenue (in thousands, except for Percentage points)

			Year Ended December 31,									Dollar Change					Percent Change
			2005			2004			2003			2005 vs. 2004			2004 vs. 2003		2005 vs. 2004			2004 vs. 2003
Product			$	75,525		$	82,994		$	65,931		$	(7,470	)	$	17,063		-9	%		26	%
	% of total revenue			56	%		66	%		70	%
License and service				59,799			42,655			28,470			17,146			14,185		40	%		50	%
	% of total revenue			44	%		34	%		30	%
		Total revenue	$	135,324		$	125,649		$	94,401		$	9,676		$	31,248		8	%		33	%

Product revenue

      The decrease in product revenue in 2005 as compared to 2004 was primarily due to the mix of sales in all regions shifting to lower price point products, and a decline in the average sales price per unit of TZ and Pro product families. These effects were partially offset by an increase in the number of TZ units sold and bundled product offerings, SonicPoint G wireless access points, and the CSM 2100. The reduction in the TZ family average sales price per unit was in large part due to the extension of the low-end of our product line with the

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TZ150, which has achieved significant sales volume, but carries a relatively low average sales price per unit. During 2005, 2004 and 2003, we shipped approximately 159,000, 150,000 and 120,000 total units, respectively.

      During 2005, we continued to introduce new products including the SSL-VPN 2000, a product that provides organizations of all sizes with a secure clientless remote network and application access solution, and the PRO 4100, a 10-port, gigabit-class security solution. We also extended our suite of secure wireless solutions with the SonicPoint G wireless access point and also launched the CSM 2100, the latest version of our UTM-enabled content security management solution.

      The increase in product revenue in 2004 compared to 2003 was across all geographies, and across both our TZ Series and PRO Series products. The increase in 2004 as compared to 2003 was mainly due to an increase in the volume of units shipped.

      During 2004, product revenue growth was fueled by the introduction and market acceptance of our new generation products, including the continued expansion of our TZ 170 access security appliance which we believe provides a compelling blend of ease-of-use for basic networks and flexibility for more complex networks. In the fourth quarter of 2004, we introduced the TZ 150 as part of our TZ Series product offering which we believe provides a feature rich total security platform combining ease-of-use with the flexibility to meet the changing needs of small and medium-sized networks. In addition, we augmented our PRO Series product family with new product introductions in 2004. During the first quarter of 2004 we introduced the PRO 2040 comprehensive network security, mobility and productivity solution. During the second quarter of 2004 we introduced the PRO 5060, a gigabit-class appliance that extended the upward range of our PRO Series product offering.

License and Service Revenue

      License and service revenue is derived primarily from licensing of software products, such as our Global Management System and node upgrades and sales of subscription services such as Content Filtering, client Anti-Virus and integrated Gateway Anti-Virus, Anti-Spyware and Intrusion Prevention . In addition, we generate license and service revenue from the sale of extended service contracts and professional services related to training, consulting and engineering services. We have experienced significant growth in license and services revenue and expect the market opportunity for our license and subscription service offerings, in particular, to grow as customer awareness around the dynamic requirements of unified network threat prevention management becomes more pervasive. In addition, there is an opportunity to sell new subscription service offerings as well as renewals of existing contracts to our installed base of customers. During 2005, revenue from our subscription service offerings, including Content Filtering, client Anti-Virus and integrated Gateway Anti-Virus, Anti-Spyware and Intrusion Prevention, increased to $24.6 million from approximately $13.8 million in 2004. During 2004, revenue from our subscription service offerings, including Content Filtering, client Anti-Virus and integrated Gateway Anti-Virus and Intrusion Prevention, increased to $13.8 million from approximately $10.0 million in 2003. During 2005, revenue from extended service contracts increased to approximately $22.6 million from approximately $17.7 million in 2004. During 2004, revenue from extended service contracts increased to approximately $17.7 million from approximately $9.6 million in 2003. The increase in subscription services and other service contracts was primarily due to the increase in our installed base; increased marketing efforts; higher sales of software applications; and higher sales of subscription services sold in conjunction with our products.

Channel data

      SonicWALL products are sold primarily through distributors who then sell our products to VAR’s and then to end-users. Distribution channels accounted for approximately 97%, 98% and 96% of total revenue in 2005, 2004 and 2003, respectively. Two U.S. distributors, Ingram Micro and Tech Data, together accounted for approximately 39%, 38% and 43% of our revenue during 2005, 2004 and 2003, respectively. The decrease from 2003 to 2004 as a percentage of total revenue is primarily due to higher demand generated by other distributors in the Americas.

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      In addition to our distribution channels, we have also historically sold our products to Original Equipment Manufacturer (“OEM”) partners. We began a process to de-emphasize OEM sales in 2004 and completed the phase down of sales to OEMs after March 31, 2005. As a consequence, OEM revenue decreased to $216,000 during 2005 from $2.2 million during 2004 and $4.0 million during 2003.

Geographic revenue data (in thousands, except for Percentage Points)

		Year Ended December 31,									Dollar Change				Percent Change
		2005			2004			2003			2005 vs. 2004		2004 vs. 2003		2005 vs. 2004			2004 vs. 2003
Americas		$	94,956		$	87,450		$	66,548		$	7,506	$	20,902		9	%		31	%
	Percentage of total revenues		70	%		70	%		70	%
EMEA			23,725			23,275			18,522		$	450	$	4,753		2	%		26	%
	Percentage of total revenues		18	%		18	%		20	%
APAC			16,643			14,924			9,331		$	1,719	$	5,593		12	%		60	%
	Percentage of total revenues		12	%		12	%		10	%
	Total revenues	$	135,324		$	125,649		$	94,401		$	9,675	$	31,248		8	%		33	%

      The increase in revenue in 2005 compared to 2004 in the Americas was primarily due to significantly increased sales of our subscription and service products, offset by a moderate decrease in product revenue. The decrease in product revenue was primarily caused by a decline in the average sales price per unit of TZ and PRO product families, partially offset by an increase in the number of TZ units sold. Revenue in the Americas included non-U.S. net sales of $4.4 million, $3.7 million and $1.6 million for 2005, 2004 and 2003, respectively. The flat revenue in 2005 compared to 2004 in EMEA was primarily due to higher sales of subscriptions and services, and lower product unit sales in certain European countries caused by a decline in the average sales price per unit and a decrease of inventory in the sales channels. We believe the increase in revenue in 2005 compared to 2004 in APAC was primarily due to our efforts in strengthening relationships with our channel partners combined with increased marketing activities in the region. In addition, the hiring of new sales management and dedicated senior sales personnel, has contributed to our growth in the APAC region.

      The increase in revenues in 2004 compared to 2003 in the Americas was primarily due to market acceptance of our new products combined with modest improvements in the economy which resulted in increased IT spending over previous levels. The increase in revenues in 2004 compared to 2003 in EMEA was primarily due to the introduction and market acceptance of our new generation products, increased investment in sales and marketing personnel in the region, continued efforts to realign our distribution model and continued focus on recruiting large distributors that have the infrastructure necessary to sell a broader range of products in expanded territories. The increase in revenues in 2004 compared to 2003 in APAC was primarily due to the introduction and market acceptance of our new generation products, our efforts in strengthening relationships with our channel partners combined with increased marketing activities in the regions. In addition, the hiring of new sales management and dedicated senior sales personnel, contributed to our growth in the APAC region in 2004.

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Cost of Revenue and Gross Profit

      The following table shows the cost of revenue for product and the cost of revenue for license and service:

		Year Ended December 31,						Percent Variance
		2005		2004		2003		2005 vs. 2004			2004 vs. 2003
		(In thousands)
Product		$	27,699	$	30,118	$	27,906		(8	)%		8	%
License and service			8,031		7,002		5,617		15	%		25	%
Amortization of purchased technology			4,552		4,543		4,543		0	%		0	%
	Total cost of revenue	$	40,282	$	41,663	$	38,066		(3	)%		9	%

      Note — Effect of amortization of purchased technology and stock-based compensation has been excluded from product and license and service gross profit discussions below.

      The following table shows the gross profit for product and the gross profit for license and service:

		Gross Profit Amount									Gross Profit Year
		Year Ended December 31,									Ended December 31,
		2005			2004			2003			2005			2004			2003
		(In thousands)
Product		$	47,826		$	52,876		$	38,025			63	%		63	%		58	%
License and service			51,768			35,653			22,853			87	%		86	%		80	%
Amortization of purchased technology			(4,552	)		(4,543	)		(4,543	)
	Total gross profit	$	95,042		$	83,986		$	56,335			70	%		67	%		60	%

Cost of Product Revenue and Gross Profit

      Cost of product revenue includes all costs associated with the production of our products, including cost of materials, manufacturing and assembly costs paid to contract manufacturers, amortization of purchased technology related to our acquisitions, and related overhead costs associated with our manufacturing operations personnel. Additionally, warranty costs and inventory provisions or write-downs are included in cost of product revenue. Cost of product revenue decreased by 13% on a per unit basis despite the increase in shipments of 6%. The decrease in cost on a per unit basis is primarily the result of lower production cost associated with the expansion of our product offerings to include lower cost products, certain favorable reserve adjustments and a slight decrease in product cost across all product offerings due to lower component cost. We shipped approximately 159,000 units in 2005, compared to approximately 150,000 units in 2004.

      Gross profit from product sales decreased in 2005 compared to 2004 due to lower average sales prices on higher unit volume offset by a decrease in production cost per unit. We expected product gross profits to erode to the extent that we experience downward pressure on product pricing or upward pressure on production costs. A change in the mix of product sold could also change gross profits.

      Gross profit from product sales increased in 2004 compared 2003. The increase in product gross profit was primarily the result of increased sales of our new product offerings, such as the TZ 170 access security appliance and the PRO Series product family, which generate higher gross profits. Gross profit in 2003 was impacted by the write downs of inventory related to obsolete products; the proceeds from the subsequent sale of these obsolete products were less than $50,000. We expected gross profits to continue to be challenged by continued price competition. We also anticipated that these effects would to be moderated, however, by continued operational efficiencies, management of our cost structure and increased functionality of our offerings at attractive price points.

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Cost of License and Service Revenue and Gross Profit

      Cost of license and service revenue includes all costs associated with the production and delivery of our license and service offerings, including cost of packaging materials and related costs paid to contract manufacturers, technical support costs related to our service contracts, royalty costs related to certain subscription products, and personnel costs related to the delivery of training, consulting, and professional services. Cost of license and service revenue increased by 15% in 2005 as compared to 2004 and by 25% in 2004 d to 2003, as set forth in the table above. These increases were primarily caused by technical support costs to support our increased service contract offerings combined with the increased installed base. To deliver services under these contracts, we outsourced a significant portion of our technical support function to third party service providers.

      License and services gross profit percentages increased by 4% in 2005 compared to 2004 and by 3% in 2004 compared to 2003. The increases in license and service gross profit related primarily to fixed costs remaining relatively constant with the prior year along with the increase in license and service revenue.

Amortization of purchased technology

		Year Ended December 31,
		2005			2004			2003
		(In thousands)
Expenses		$	4,552		$	4,543		$	4,543
	Percentage of total revenue		3	%		4	%		5	%
	Period over period variance in Dollars		9			0
	Period over period variance in Percent		0	%		0	%

      Amortization of purchased technology represents the amortization of existing technology acquired in our business combinations accounted for as a purchase. Purchased technology is being amortized on a straight line basis over the estimated useful lives of three to six years. Amortization for the years ended December 31, 2005 and 2004 primarily consisted of $4.4 million and $173,000, relating to the amortization of purchased intangibles associated with the acquisitions of Phobos in 2000 and RedCreek in 2001, respectively. In December 2005, an additional $80,000 amortization expense related to the acquisitions of Lasso and enKoo was recorded.

      Amortization for both years ended December 31, 2004 and 2003 primarily consisted of $4.4 million and $173,000 relating to the amortization of purchased intangibles associated with the acquisitions of Phobos and RedCreek, respectively.

      Future amortization to be included in cost of revenue based on the current balance of purchased technology absent any additional investment is as follows (in thousands):

		Amortization
Fiscal Year		Amount
2006		$	4,821
2007			960
2008			960
2009			960
2010			880
	Total	$	8,581

      Our gross profit has been and will continue to be affected by a variety of factors, including competition; the mix and average selling prices of our offerings; new product introductions and enhancements; fluctuations in manufacturing volumes and the cost of components and manufacturing labor. We must manage each of these factors effectively for our gross profits to remain at current levels.

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Operating Expenses

Research and development

		Year Ended December 31,
		2005			2004			2003
		(In thousands)
Expenses		$	22,603		$	23,337		$	19,864
	Percentage of total revenue		17	%		19	%		21	%
	Period over period variance in Dollars		(734	)		3,473
	Period over period variance in Percent		(3	)%		17	%

      Research and development expenses primarily consist of personnel costs, contract consultants, outside testing services and equipment and supplies associated with enhancing existing products and developing new products. During 2005, the decrease in absolute dollars compared to 2004 was primarily as a result of a decrease in bonuses and other employee benefit expenses of approximately $590,000 and the reduction of expenses allocated for rent, depreciation, insurance and information technology administration of approximately $750,000 partially offset by an increase in contract labor of approximately $360,000 and the Company’s contribution to the defined contribution retirement plan of approximately $200,000.

      During 2004, the increase in absolute dollars was primarily as a result of increased personnel costs whereby salaries and related benefits increased by approximately $2.15 million. In addition, we created a compensation plan which is connected to the achievement of certain corporate goals whereby compensation costs increased by approximately $930,000. In particular, these increases were related to the development of new products and subscription services.

      We believe that our future performance will depend in large part on our ability to maintain and enhance our current product line, develop new products that achieve market acceptance, maintain technological competitiveness, and meet an expanding range of customer requirements. We plan to continuously invest in current and future product development and enhancement efforts, and incur expense associated with these initiatives, such as prototyping expense and non-recurring engineering charges associated with the development of new products and technologies. We intend to continuously broaden our existing product and service offerings and introduce new products and services.

Sales and marketing

		Year Ended December 31,
		2005			2004			2003
		(In thousands)
Expenses		$	53,367		$	47,353		$	40,139
	Percentage of total revenue		39	%		38	%		43	%
	Period over period variance in Dollars		6,014			7,214
	Period over period variance in Percent		13	%		18	%

      Sales and marketing expenses primarily consist of personnel costs, including commissions, costs associated with the development of our business and corporate identification, costs related to customer support, travel, tradeshows, promotional and advertising costs, and related facilities costs. During 2005, the increase in sales and marketing expenses compared to 2004 is primarily due to (1) higher personnel costs including salaries, commissions, related employee benefits and employee relocation costs of approximately $2.3 million due to increased headcount and acquisitions during 2005; (2) higher contract labor costs of approximately $3.1 million in technical support, sales management, general marketing, inside sales, training and EMEA marketing departments; and (3) an increase of approximately $1.1 million related to channel marketing programs, media advertising, sales conferences, and European sales and marketing activities. These increases were partially offset by a decrease in allocated facility cost and depreciation expense of approximately $600,000.

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      The increase in sales and marketing expenses in 2004 compared to 2003 was due to our expansion of international markets including increases in headcount, primarily in the areas of senior sales and marketing personnel, whereby salaries and related benefits increased by approximately $2.94 million. Our sales support activities and co-op advertising costs, and commission expense increased by approximately $1.03 million and $1.01 million, respectively, due to an increase in revenues. In 2005 and 2004, our travel related expenses increased by approximately $1.08 million and $920,000, respectively, to support our expansion into international markets. The decrease in the sales and marketing expense as a percentage of revenue in 2004 as compared to 2003 was due to the increase in revenues and realignment of resources.

      We expect to direct our sales and marketing expenses toward the expansion of domestic and international markets, introduction of new products and establishment and expansion of new distribution channels.

General and administrative

		Year Ended December 31,
		2005			2004			2003
		(In thousands)
Expenses		$	15,535		$	14,365		$	11,893
	Percentage of total revenue		12	%		11	%		13	%
	Period over period variance in Dollars		1,170			2,472
	Period over period variance in Percent		8	%		21	%

      General and administrative expenses consist primarily of personnel costs, directors and officers’ insurance, corporate governance costs, travel expense, and related facilities costs. The increase in 2005 compared to 2004 was primarily related to an increase in professional fees and expenses of approximately $1.5 million that were associated primarily with litigation related expenses and expenses associated with the pursuit of various corporate opportunities and an increase in contract labor expenses of approximately $190,000. These increases were partially offset by a decrease in insurance related expense of approximately $420,000, a decrease in the 2004 allowance for doubtful accounts of approximately $125,000 and a decrease in various bank and credit card processing related fees of approximately $125,000.

      In 2004, the increase in absolute dollars compared to 2003 was primarily due to an approximately $1.29 million increase in costs related to corporate governance. In addition, we created a compensation plan which is connected to the achievement of certain corporate goals whereby compensation costs increased by approximately $768,000.

      We believe that general and administrative expenses will increase in absolute dollars and remain relatively stable as a percentage of total revenue as we incur costs related to corporate governance matters and the pursuit of various corporate opportunities.

Amortization of purchased intangible assets included in operating expense.

		Year Ended December 31,
		2005			2004			2003
		(In thousands)
Expenses		$	2,893		$	3,089		$	5,333
	Percentage of total revenue		2	%		2	%		6	%
	Period over period variance in Dollars		(196	)		(2,244	)
	Period over period variance in Percent		(6	)%		(42	)%

      Amortization of purchased intangibles represents the amortization of assets arising from contractual or other legal rights acquired in business combinations accounted for as a purchase except for amortization of existing technology which is included in cost of revenue. Purchased intangible assets are being amortized over their estimated useful lives of three to six years.

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      The reduction in amortization expense included in operating expense in 2005 compared to 2004 resulted from the complete amortization of certain intangibles from various acquisitions. Amortization for 2005 primarily consisted of $698,000 relating to the amortization of purchased intangibles associated with the acquisition of Phobos. There was an additional $8,000 amortization expense related to the intangible assets acquired from Lasso in December 2005.

      The primary reason for the reduction in amortization expense in 2004 compared to 2003 was that certain intangibles from the Phobos and Ignyte acquisitions reached the end of their useful life. Amortization for the year ended December 31, 2004 primarily consisted of $2.8 million, $23,000, and $26,000 relating to the amortization of purchased intangibles associated with the acquisitions of Phobos, RedCreek, and Ignyte, respectively. Amortization for the year ended December 31, 2003 primarily consisted of $4.8 million, $23,000, and $153,000 associated with the acquisitions of Phobos, RedCreek, and Ignyte, respectively.

      Future amortization to be included in operating expense based on current balance of purchased intangibles absent any additional investment is as follows (in thousands):

Fiscal Year
2006		$	2,512
	Total	$	2,512

     Restructuring charges.

		Year Ended December 31,
		2005			2004			2003
		(In thousands)
Expenses		$	—		$	(171	)	$	1,833
	Percentage of total revenue		0	%		0	%		2	%
	Period over period variance in Dollars		171			(2,004	)
	Period over period variance in Percent		(100	)%		(109	)%

      As discussed in the Notes to our Condensed Consolidated Financial Statements, we have implemented two restructuring plans — one initiated in the second quarter of 2002 and the second initiated in the second quarter of 2003. Our restructuring plans were designed to realign and reduce our cost structure and integrate certain company functions. The execution of the 2003 restructuring plan was significantly completed as of the second quarter of 2003. We recognized a restructuring charge related to the 2003 plan of approximately $1.5 million during the fiscal year ended December 31, 2003. During 2004, we recorded additional restructuring charges related to the 2003 restructuring plan consisting of $5,000 related to properties vacated in connection with facilities consolidation, offset by $42,000 reversal for severance accrual for employees who have remained with us. The restructuring plan resulted in the elimination of 43 positions worldwide. The overall result of the reduction in workforce was less than the total positions eliminated, as we made investments in personnel in research and development and in our sales and marketing organization. In addition, as a result of the restructuring plan, we vacated four facilities. During 2005, we did not record any additional restructuring charges related to these plans.

      The execution of the 2002 restructuring plan was completed as of the second quarter of 2002; however, during the year ended December 31, 2003 we recorded additional restructuring charges totaling $354,000, consisting of $379,000 related to properties vacated in connection with facilities consolidation, offset by $25,000 reversal for severance accrual for an employee who has remained with us. During 2004, we recorded additional restructuring charges related to the 2002 plan consisting of $21,000 related to properties vacated in connection with facilities consolidation, offset by $155,000 reversal for a favorable lease modification related to properties vacated in connection with facilities consolidation.

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Stock-based compensation.

		Year Ended December 31,
		2005			2004			2003
		(In thousands)
Expenses		$	201		$	75		$	700
	Percentage of total revenue		0.1	%		0	%		1	%
	Period over period variance in Dollars		126			(625	)
	Period over period variance in Percent		168	%		(89	)%

      In December 2004, the Financial Accounting Standard Board (FASB) issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123R), which will be effective in the first quarter of 2006. SFAS 123R will result in the recognition of substantial compensation expense relating to our employee stock options and employee stock purchase plans (ESPP). The Company currently uses the intrinsic value method to measure compensation expense for a majority of its stock-based awards to its employees and accounted for subsequently modified stock-based awards under the variable accounting method. Under the intrinsic value method, no compensation expense is recorded related to stock option grants issued under stock option plans when the exercise price of the stock option is equal to or greater than the fair market value on the date of grant. In addition, discounts provided under ESPP do not currently require the recording of a corresponding compensation expense. Under SFAS 123R, the Company is required to adopt a fair value based method to measure and record the compensation expense related to employee stock awards, which will lead to substantial additional compensation expense and will have a material adverse effect on the Company’s financial results of operations.

      Note 1 to our Consolidated Financial Statements provides our pro forma net income and earnings per share as if we had used a fair value based method under SFAS 123 to determine the compensation expense for employee stock awards during 2005, 2004 and 2003.

      Stock-based compensation expense in 2005 is comprised of two elements; (1) $176,000 related to a stock option grant, which was modified in fiscal year 2003 and is subject to variable accounting treatment, resulting in expense or contra-expense recognition each period, using the cumulative expense method and (2) $37,000 related the amortization of deferred stock-based compensation for options assumed in the November 2005 acquisition of Lasso.

      The 2004 amortization of stock-based compensation expense relates to the modification of a stock option grant in fiscal 2004 which became subject to variable accounting treatment, resulting in expense or contra-expense recognition each period, using the cumulative expense method. The fiscal year 2003 amortization of stock-based compensation amount includes $42,000, $12,000 and $68,000 relating to deferred stock-based compensation associated with employee stock options issued in connection with the Phobos, Ignyte and RedCreek acquisitions, respectively. In addition we recorded $479,000 in stock-based compensation expense related to the 2003 acceleration of stock options for two employees. The decrease in expense from 2003 to 2004 was primarily caused by a number of the grants becoming fully vested.

Interest income and other expense, net.

      Interest income and other expense (net) were $6.9 million, $4.1 million and $4.2 million in the years ended December 31, 2005, 2004 and 2003, respectively and primarily consists of interest income on our cash, cash equivalents and short-term investments. The fluctuations in the short-term interest rates directly influence the interest income we recognize. For the year ended December 31, 2005, the increase was primarily due to higher effective interest rates earned in our investment portfolio. For the year ended December 31, 2004, the decrease was primarily due to lower interest rates offset by the increase in our cash, cash equivalents and short-term investments.

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Benefit from (provision for) income taxes.

		Year Ended December 31,
		2005			2004			2003
		(In thousands)
Benefit (provision)		$	(1,034	)	$	(301	)	$	1,590
	Percentage of total revenue		(0.8	)%		0	%		2	%
	Period over period variance in Dollars		(733	)		(1,891	)
	Period over period variance in Percent		(244	)%		(119	)%

      In all periods, the provision or benefit for income taxes is based on an estimated effective rate for each of the respective calendar years. Our effective tax rate differs from the statutory federal and state tax rates for the fiscal year ended December 31, 2005 due primarily to the effect of amortization of stock-based compensation, goodwill and intangible assets, which are permanent, non-deductible book/tax differences and the utilization of $885,000 of the deferred tax assets derived from previously acquired companies. The cumulative effect of these factors resulted in a reduction in goodwill. At December 31, 2005, we continue to have a full valuation allowance against our deferred tax assets based upon our determination that it is more likely than not that all deferred tax assets may not be realized in the foreseeable future given historical operating losses. The net operating loss and research and development tax credit carryovers that comprise the vast majority of the deferred tax assets will expire at various dates through the year 2024.

      Our effective tax rate differs from the statutory federal and state tax rates for the fiscal years ended December 31, 2004 and 2003 due primarily to the effect of amortization of stock-based compensation, goodwill and intangible assets, which are permanent, non-deductible book/tax differences. In addition, in 2003, we determined that it is more likely than not that all deferred tax assets may not be realized in the foreseeable future due to historical operating losses and therefore set up a full valuation allowance against our deferred tax assets, the impact of the change in the valuation allowance contributed also to the 2003 difference to the statutory rates. The net operating loss and research and development tax credit carryovers that comprise the vast majority of the deferred tax assets will expire at various dates through the year 2024.

      Going forward, we will assess the continued need for the valuation allowance. After we have demonstrated profitability for a period of time and begin utilizing a significant portion of the deferred tax assets, we may reverse the valuation allowance, likely resulting in a significant benefit to the statement of operations in some future period. At this time, we cannot reasonably estimate when this reversal might occur, if at all. In addition, we expect a significant increase in our effective tax rate well above the statutory federal and state tax rates primarily caused by following factors: (1). at December 31, 2005, we have completely utilized the regular net operating losses that were generated by SonicWALL, the remaining net operating losses consist of stock-option and acquired net operating losses in tax-free transactions and (2) we further expect that the stock-based compensation expense will create permanent and/ or temporary differences.

48

Quarterly Results of Operations

      The following tables set forth our unaudited quarterly results of operations, in dollars and as a percentage of total revenue, for the eight quarters ended December 31, 2005. You should read the following tables in conjunction with the financial statements and related notes contained elsewhere in this Form 10-K. We have prepared this unaudited information on the same basis as our audited financial statements. These tables include all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the quarters presented. You should not draw any conclusions about our future results from the results of operations for any quarter.

			Year Ended December 31, 2005												Year Ended December 31, 2004
			Q4			Q3			Q2			Q1			Q4			Q3			Q2			Q1
			(In thousands, except per share data)												(In thousands, except per share data)
Revenue:
	Product		$	19,649		$	18,236		$	19,032		$	18,608		$	19,524		$	18,143		$	22,609		$	22,718
	License and service			16,766			15,782			14,054			13,197			12,491			11,242			9,805			9,117
		Total revenue		36,415			34,018			33,086			31,805			32,015			29,385			32,414			31,835
Cost of revenue:
	Product			7,379			6,994			6,879			6,447			7,135			6,845			7,999			8,139
	License and service			2,165			1,956			1,932			1,978			2,101			1,781			1,605			1,515
	Amortization of purchased technology			1,142			1,138			1,136			1,136			1,136			1,135			1,136			1,136
		Total cost of revenue (excluding stock-based compensation)		10,686			10,088			9,947			9,561			10,372			9,761			10,740			10,790
Gross profit				25,729			23,930			23,139			22,244			21,643			19,624			21,674			21,045
Operating expenses:
	Research and development (excluding stock-based compensation)			6,100			5,410			5,637			5,456			5,614			5,556			6,187			5,980
	Sales and marketing (excluding stock-based compensation)			14,911			13,339			12,946			12,171			11,597			11,797			12,557			11,402
	General and administrative (excluding stock-based compensation)			4,574			3,414			3,997			3,550			3,846			3,204			3,525			3,790
	Amortization of purchased intangible assets			786			701			703			703			704			786			787			812
	Restructuring charges															(156	)		(143	)		115			13
	Stock-based compensation			182			84			10			(75	)		(30	)		(75	)		33			147
		Total operating expenses		26,553			22,948			23,293			21,805			21,575			21,125			23,204			22,144
Income (loss) from operations				(824	)		982			(154	)		439			68			(1,501	)		(1,530	)		(1,099	)
Interest income and other expense, net				2,199			1,748			1,564			1,356			1,325			1,105			785			835
Income (loss) before income taxes				1,375			2,730			1,410			1,795			1,393			(396	)		(745	)		(264	)
Benefit from (provision for) income taxes				(580	)		(162	)		(171	)		(121	)		72			(209	)		(79	)		(85	)
Net income (loss)			$	795		$	2,568		$	1,239		$	1,674		$	1,465		$	(605	)	$	(824	)	$	(349	)
Net income (loss) per share:
		Basic	$	0.01		$	0.04		$	0.02		$	0.03		$	0.02		$	(0.01	)	$	(0.01	)	$	(0.01	)
		Diluted	$	0.01		$	0.04		$	0.02		$	0.02		$	0.02		$	(0.01	)	$	(0.01	)	$	(0.01	)
Shares used in computing net income (loss) per share:
		Basic		64,733			64,308			63,995			65,713			70,837			71,344			71,134			70,051
		Diluted		67,503			66,183			65,595			67,998			73,126			71,344			71,134			70,051

49

Liquidity and Capital Resources

      SonicWALL ended December 31, 2005 with $240.4 million in cash, cash equivalents and short-term investments, consisting principally of commercial paper, corporate bonds, U.S. government securities and money market funds, a decrease of $12.2 million as compared to fiscal 2004 year end. Our primary source of cash is receipts from product, license and service revenue. The primary uses of cash are payroll (salaries and related benefits), general operating expenses (marketing, travel, office rent), the repurchase of shares of common stock under our share repurchase program, and payments for the production of our products. We also use cash to finance our inorganic growth initiatives.

Operating Activities

      Cash provided by operating activities was $32.5 million for fiscal 2005; a $15 million increase from 2004. During 2005, net cash provided by operating activities was generated primarily from net income of $6.3 million, adjusted by non-cash items such as depreciation and amortization and adjustment of goodwill of approximately $10.8 million and changes in our operating assets and liabilities of $15.5 million. Our primary source of operating cash flows is our net income plus depreciation and amortization and the increase in deferred revenue.

      Our days sales outstanding (DSO) in accounts receivable was 32 days at December 31, 2005 compared to 49 days at December 31, 2004 and 30 days at December 31, 2003. The decrease in DSO at December 31, 2005 as compared to December 31, 2004 was primarily due to the increased collection effort, the timing of collections and the non-linearity of shipments combined with increase in revenues. The increase in DSO at December 31, 2004 as compared to December 31, 2003 was primarily due to the timing of collections and the non-linearity of shipments combined with increase in revenues. Collection of accounts receivable and related DSO will fluctuate in future periods due to the timing and amount of our future billings, the payment terms that we extend to our customers and the effectiveness of our collection efforts. Deferred revenue increased primarily due to increased sales of subscription services as well as an increase related to shipments to distributors where revenue is recognized on a sell through basis. Prepaid expenses and other current assets increased mainly due to the increase in restricted cash in escrow in connection with the acquisition and the increase in the trust assets of the deferred compensation plan as fully described in Note 12 of the Notes to the Consolidated Financial Statements.

      Cash provided by operating activities was $17.5 million for fiscal 2004 primarily as a result of net loss adjusted by non-cash items, increases in deferred revenue and accrued payroll and related benefits offset by an increase in accounts receivables and a decrease in accounts payable. Deferred revenues increased due to increased sales of subscription and other services as well as increases related to shipments to distributors where revenue is recognized on a sell-through method. Accounts receivable increased due to non-linearity of shipments combined with increase in revenues. Accounts payable decreased due to the timing of payments to our vendors. Accrued payroll and related benefits increased primarily due to increased accruals resulting from the achievement of certain operating objectives in fiscal 2004, as part of our annual incentive compensation plan.

      Cash provided by operating activities was $9.2 million for fiscal 2003 primarily as a result of net loss adjusted for non-cash items, and decreases in accounts receivable and inventory and an increase in deferred revenue. Accounts receivables decreased due to improved cash collections and linearity of shipments. Inventory decreased due to increased revenue during the fourth quarter of 2003 as compared to the same period in 2002. Deferred revenue increased primarily due to increased sale of our maintenance services.

      In addition, our operating cash flows may be impacted in the future as a result of a number of factors, including fluctuations in our operating results, accounts receivable collections, inventory management, expensing stock options, and the timing and amount of tax and the timing of payments to our vendors for accounts payable. For additional discussion, see the section entitled “Risk Factors” in this Form 10-K.

50

Investing Activities

      Net cash provided by investing activities was $10.5 million in 2005, primarily as a result of the net sale of $30.8 million of short-term investments offset by (i) $18.8 million used for the acquisitions of Lasso and enKoo; and (ii) $1.4 million used for purchases of property and equipment. Net cash used in investing activities was $19.1 million in 2004, primarily as a result of the net purchase of $17.0 million of short-term investments and $2.1 million used for purchases of property and equipment. Net cash used in investing activities was $6.0 million in 2003, primarily as a result of the net purchase of $3.5 million of short-term investments and $2.5 million used for purchases of property and equipment.

Financing Activities

      Net cash used in financing activities was $23.9 million in 2005. In 2005, cash of $6.3 million was provided by common stock issuances as a result of stock option and employee stock purchase plan share exercises, offset by $30.2 million used under the Company’s stock repurchase program. In 2004, cash of $13.9 million was provided by common stock issuances as a result of stock option exercises, offset by $19.4 million used as part of the Company’s stock repurchase program. In 2003, net cash provided by financing activities was $4.2 million, primarily from common stock issuances as a result of stock option exercises.

Liquidity and Capital Resource Requirements

      We believe our existing cash, cash equivalents and short-term investments will be sufficient to meet our cash requirements at least through the next twelve months. However, we may be required, or could elect, to seek additional funding prior to that time. Our future capital requirements will depend on many factors, including our rate of revenue growth, the timing and extent of spending to support product development efforts and expansion of sales and marketing, the timing of introductions of new products and enhancements to existing products, market acceptance of our products, and pursuit of corporate opportunities. We cannot assure you that additional equity or debt financing will be available on acceptable terms or at all. Our sources of liquidity beyond twelve months, in management’s opinion, will be our then current cash balances, funds from operations and whatever long-term credit facilities we can arrange. We have no other agreements or arrangements with third parties to provide us with sources of liquidity and capital resources beyond twelve months. We believe that future liquidity and capital resources will not be materially affected in the event we are not able to prevail in litigation for which we have been named a defendant as described in Note 10 to the consolidated financial statements.

Off-Balance Sheet Arrangements and Contractual Obligations

      We do not have any debt, long-term obligations or long-term capital commitments. The following summarizes our principal contractual commitments as of December 31, 2005 (in thousands):

			Payments due by period
			Less than		1 to 3		3 to 5
Contractual Obligations	Total		one Year		Years		Years
Operating lease obligations	$	1,113	$	33	$	1,080	$	—
Non-cancelable purchase obligations	$	8,573	$	8,573	$	—	$	—

      The Company outsources its manufacturing operations primarily to one third party contract manufacturer, and at December 31, 2005 it had purchase obligations to this vendor totaling $14 million. Of this amount, $7.5 million cannot be cancelled. The Company is contingently liable for any inventory owned by the contract manufacturer that becomes excess and obsolete. As of December 31, 2005, $65,000 had been accrued for excess and obsolete inventory held by our primary contract manufacturer. In addition, as of December 31, 2005, in the normal course of business the Company had $1.1 million in non-cancelable purchase commitments.

51

Stock Repurchase Program

      In November 2004, our Board of Directors authorized a stock repurchase program. As of December 31, 2005, our Board of Directors has authorized the repurchase of up to $75 million of common stock under this program. During fiscal 2005, we repurchased and retired 5.0 million shares of our common stock at an average price of $6.05 per share for an aggregate purchase price of $30.2 million. As of December 31, 2005, we had repurchased and retired 8.2 million shares of our common stock at an average price of $6.06 per share for an aggregate purchase price of $49.6 million since the inception of the stock repurchase program, and the remaining authorized amount for stock repurchases under this program was $25.4 million with a termination date of November 2006. In February 2006, the Company’s Board of Directors approved an increase of $25 million in the amount authorized for repurchase under the Company’s stock repurchase program over the previously authorized $75 million and extended the expiration of the current program by an additional 12 months.

Recent Accounting Pronouncements

      The information contained in Note 1 to the Consolidated Financial Statements under the heading recent accounting pronouncements is hereby incorporated by reference into this Part II, Item 7.

ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk

Interest rate risk

      Our exposure to market risk for changes in interest rates relates primarily to our cash, cash equivalents and short-term investments. In accordance with Statement of Financial Accounting Standards No. 115 (“SFAS No. 115”), “Accounting for Certain Investments in Debt and Equity Securities,” we classified our short-term investments as available-for-sale. Consequently, investments are recorded on the balance sheet at the fair value with unrealized gains and losses reported as a separate component of accumulated other comprehensive income (loss), net of tax. As of December 31, 2005, our cash, cash equivalents and short-term investments included money-markets securities, corporate bonds, municipal bonds and commercial paper which are subject to no interest rate risk when held to maturity, but may increase or decrease in value if interest rates change prior to maturity.

      As stated in our investment policy, we are averse to principal loss and further the goal of preservation of our invested funds by limiting default and market risk. We mitigate default risk by investing in only investment-grade instruments. We do not use derivative financial instruments in our investment portfolio.

      The majority of our short-term investments maturing in more than one year are readily tradable in 7 to 28 days. Due to this and the short duration of the balance of our investment portfolio, we believe an immediate 10% change in interest rates would be immaterial to our financial condition or results of operations.

      The following table presents the amounts of our short-term investments that are subject to market risk by range of expected maturity and weighted average interest rates as of December 31, 2005:

	Maturing In
	Less than			More than
	one Year			one Year			Total
	(In thousands, except percentage data)
Short-term investments	$	35,339		$	162,510		$	197,849
Weighted average interest rate		3.32	%		3.98	%

52

Foreign currency risk

      We consider our exposure to foreign currency exchange rate fluctuations to be minimal. We invoice substantially all of our foreign customers from the United States in U.S. dollars and substantially all revenue is collected in U.S. dollars. For the year ended December 31, 2005, we earned approximately 32% of our revenue from international markets, which in the future may be denominated in various currencies. Because our sales are denominated in U.S. dollars, the weakness of a foreign country’s currency against the dollar could increase the price of our products in such country and reduce our product unit sales by making our products more expensive in the local currency. A weakened dollar could increase the cost of local operating expenses and procurement of raw materials to the extent we must purchase components in foreign currencies. Additionally, we have exposures to emerging market currencies, which can have extreme currency volatility. As a result, our operating results may become subject to significant fluctuations based upon changes in the exchange rates of some currencies in relation to the U.S. dollar and diverging economic conditions in foreign markets. Although we will continue to monitor our exposure to currency fluctuations, we cannot assure you that exchange rate fluctuations will not affect adversely our financial results in the future. In addition, we have minimal cash balances denominated in foreign currencies. We do not enter into forward exchange contracts to hedge exposures denominated in foreign currencies and do not use derivative financial instruments for trading or speculative purposes.

53

ITEM 8. Financial Statements And Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

AND FINANCIAL STATEMENT SCHEDULE

	Page
Reports of Independent Registered Public Accounting Firm		55
Consolidated Balance Sheets		58
Consolidated Statements of Operations		59
Consolidated Statements of Shareholders’ Equity		60
Consolidated Statements of Cash Flows		61
Notes to Consolidated Financial Statements		62
Financial Statement Schedule — Valuation and Qualifying Accounts		95

54

REPORT OF ARMANINO MCKENNA LLP, INDEPENDENT REGISTERED

PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders, SonicWALL, Inc.

      We have audited the accompanying consolidated balance sheet of SonicWALL, Inc. as of December 31, 2005, and the related consolidated statements of operations, shareholders’ equity, and cash flows for the year then ended. Our audit also included the financial statement schedule listed in the Index at Part IV, Item 15. These financial statements and schedule are the responsibility of the company’s management. Our responsibility is to express an opinion on these financial statements and schedule 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 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 audit provides a reasonable basis for our opinion.

      In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of SonicWALL, Inc. at December 31, 2005, and the consolidated results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

      We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of SonicWALL, Inc.’s internal control over financial reporting as of December 31, 2005, 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 14, 2006 expressed an unqualified opinion on management’s assessment of internal control over financial reporting and an unqualified opinion on the effectiveness of internal control over financial reporting.

/s/ ARMANINO MCKENNA LLP

San Ramon, California

March 14, 2006

55

REPORT OF ARMANINO MCKENNA LLP, INDEPENDENT REGISTERED

PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders, SonicWALL, Inc.

      We have audited management’s assessment, included in the accompanying Management Report on Internal Control Over Financial Reporting, appearing under Item 9A, that SonicWALL, Inc. maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). SonicWALL, Inc.’s management 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.

      In our opinion, management’s assessment that SonicWALL, Inc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, SonicWALL, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria.

      We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the 2005 consolidated financial statements of SonicWALL, Inc. and our report dated March 14, 2006 expressed an unqualified opinion thereon.

/s/ ARMANINO MCKENNA LLP

San Ramon, California

March 14, 2006

56

REPORT OF INDEPENDENT REGISTERED

PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of SonicWALL, Inc.:

      In our opinion, the consolidated balance sheet as of December 31, 2004 and the related consolidated statements of operations, shareholders’ equity and cash flows for each of two years in the period ended December 31, 2004 listed in the accompanying index present fairly, in all material respects, the financial position of SonicWALL Inc. and its subsidiaries at December 31, 2004, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule for each of the two years in the period ended December 31, 2004 listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

/s/ PricewaterhouseCoopers LLP

San Jose, California

March 16, 2005, except for the restatement described in Note 13 to the consolidated financial statements included in the Annual Report on Form 10-K/ A for the year ended December 31, 2004 (not presented herein), as to which the date is May 16, 2005

57

SONICWALL, INC.

CONSOLIDATED BALANCE SHEETS

				December 31,
				2005			2004
				(In thousands, except share
				data)
ASSETS
Current Assets:
	Cash and cash equivalents			$	42,593		$	23,446
	Short-term investments				197,849			229,226
	Accounts receivable, net of allowance for doubtful accounts of $123 and $188 in 2005 and 2004, respectively				13,113			14,204
	Inventories				3,707			2,191
	Prepaid expenses and other current assets				7,331			2,069
		Total current assets			264,593			271,136
Property and equipment, net					2,595			3,395
Goodwill					109,005			97,953
Purchased intangibles and other assets, net					11,490			14,361
		Total assets		$	387,683		$	386,845
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
	Accounts payable			$	7,445		$	5,737
	Accrued restructuring				—			398
	Accrued payroll and related benefits				9,054			7,342
	Other accrued liabilities				6,277			4,719
	Deferred revenue				44,642			30,173
	Income taxes payable				95			500
		Total current liabilities			67,513			48,869
Commitments and contingencies (Note 10)
Shareholders’ Equity:
	Common stock, no par value; 200,000,000 shares authorized; 65,026,138 and 68,623,042 shares issued and outstanding				440,453			463,733
	Deferred stock-based compensation				(281	)		—
	Accumulated other comprehensive loss, net				(1,367	)		(846	)
	Accumulated deficit				(118,635	)		(124,911	)
		Total shareholders’ equity			320,170			337,976
			Total liabilities and shareholders’ equity	$	387,683		$	386,845

The accompanying notes are an integral part of these consolidated financial statements.

58

SONICWALL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

			Year Ended December 31,
			2005			2004			2003
			(In thousands, except per share data)
Revenue:
	Product		$	75,525		$	82,994		$	65,931
	License and service			59,799			42,655			28,470
		Total revenue		135,324			125,649			94,401
Cost of revenue:
	Product, excluding amortization of stock-based compensation of $0, $0 and $7 in 2005, 2004 and 2003, respectively			27,699			30,118			27,906
	License and service			8,031			7,002			5,617
	Amortization of purchased technology			4,552			4,543			4,543
		Total cost of revenue		40,282			41,663			38,066
Gross profit				95,042			83,986			56,335
Operating expenses:
	Research and development, excluding amortization of stock-based compensation of $165, $75, and $70 in 2005, 2004 and 2003, respectively			22,603			23,337			19,864
	Sales and marketing, excluding amortization of stock-based compensation of $36, $0, and $398 in 2005, 2004 and 2003, respectively			53,367			47,353			40,139
	General and administrative, excluding amortization of stock-based compensation of $0, $0, and $225 in 2005, 2004 and 2003, respectively			15,535			14,365			11,893
	Amortization of purchased intangible assets			2,893			3,089			5,333
	Restructuring charges (reversals)			—			(171	)		1,833
	Stock-based compensation			201			75			700
		Total operating expenses		94,599			88,048			79,762
Income (loss) from operations				443			(4,062	)		(23,427	)
Interest income and other expense, net				6,867			4,050			4,169
Income (loss) before income taxes				7,310			(12	)		(19,258	)
Benefit from (provision for) income taxes				(1,034	)		(301	)		1,590
Net income (loss)			$	6,276		$	(313	)	$	(17,668	)
Net income (loss) per share:
	Basic		$	0.10		$	(0.00	)	$	(0.26	)
	Diluted		$	0.09		$	(0.00	)	$	(0.26	)
Shares used in computing net income (loss) per share:
	Basic			64,684			70,850			67,895
	Diluted			66,797			70,850			67,895

The accompanying notes are an integral part of these consolidated financial statements.

59

SONICWALL, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

												Accumulated
			Common Stock						Deferred			Other						Total
									Stock-Based			Comprehensive			Accumulated			Shareholders’
			Shares			Amount			Compensation			Income (Loss)			Deficit			Equity
			(In thousands, except for share data)
Balance at December 31, 2002				67,417,143		$	464,210		$	(364	)	$	267		$	(106,930	)	$	357,183
Issuance of common stock upon exercise of stock options				743,466			2,947			—			—			—			2,947
Issuance of common stock in connection with acquisition				50,000			243			—			—			—			243
Issuance of common stock in connection with the Employee Stock Purchase Plan (ESPP)				402,403			1,242			—			—			—			1,242
Stock-based compensation, net of cancellations				—			263			364			—			—			627
Comprehensive loss:
	Change in unrealized loss on investment securities			—			—			—			(305	)		—			(305	)
	Net loss			—			—			—			—			(17,668	)		(17,668	)
		Total comprehensive loss		—			—			—			—			—			(17,973	)
Balance at December 31, 2003				68,613,012			468,905			—			(38	)		(124,598	)		344,269
Issuance of common stock upon exercise of stock options				2,805,521			12,208			—			—			—			12,208
Issuance of common stock in connection with the Employee Stock Purchase Plan (ESPP)				387,509			1,717			—			—			—			1,717
Stock-based compensation				—			75			—			—			—			75
Repurchase of common stock				(3,183,000	)		(19,356	)		—			—			—			(19,356	)
Income tax benefit from stock option exercises				—			184			—			—			—			184
Comprehensive loss:
	Change in unrealized loss on investment securities			—			—			—			(808	)		—			(808	)
	Net loss			—			—			—			—			(313	)		(313	)
		Total comprehensive loss		—			—			—			—			—			(1,121	)
Balance at December 31, 2004				68,623,042		$	463,733		$	—		$	(846	)	$	(124,911	)	$	337,976
Issuance of common stock upon exercise of stock options				1,072,878			4,702			—			—			—			4,702
Issuance of common stock in connection with the Employee Stock Purchase Plan (ESPP)				328,018			1,623			—			—			—			1,623
Stock options assumed in connection with acquisition							426			(316	)								110
Stock-based compensation				—			166			35			—			—			201
Repurchase of common stock				(4,997,800	)		(30,218	)		—			—			—			(30,218	)
Income tax benefit from stock option exercises				—			21			—			—			—			21
Comprehensive income (loss):
	Change in unrealized loss on investment securities			—			—			—			(521	)		—			(521	)
	Net income			—			—			—			—			6,276			6,276
		Total comprehensive income		—			—			—			—			—			5,755
Balance at December 31, 2005				65,026,138		$	440,453		$	(281	)	$	(1,367	)	$	(118,635	)	$	320,170

The accompanying notes are an integral part of these consolidated financial statements.

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SONICWALL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

					Year Ended December 31,
					2005			2004			2003
					(In thousands)
Cash flows from operating activities:
	Net income (loss)				$	6,276		$	(313	)	$	(17,668	)
	Adjustments to reconcile net income (loss) to net cash provided by operating activities:
		Depreciation and amortization				9,847			11,216			13,508
		Adjustment of goodwill				885			—			—
		Income tax benefit from exercise of employee stock options				22			184			—
		Reduction in allowance for doubtful accounts and others				(110	)		(104	)		(575	)
		Deferred income taxes				—			—			(1,960	)
		Non-cash restructuring charges (reversals)				—			(171	)		98
		Amortization of stock-based compensation				201			75			700
		Changes in operating assets and liabilities, net of effects of businesses acquired:
			Accounts receivable			1,158			(4,936	)		4,685
			Inventories			(1,342	)		(236	)		3,810
			Prepaid expenses and other current assets			(3,099	)		520			827
			Other assets			315			(284	)		10
			Accounts payable			1,592			(1,639	)		574
			Accrued payroll and related benefits			1,537			2,354			208
			Accrued restructuring			(398	)		(682	)		(191	)
			Other accrued liabilities			1,554			889			(960	)
			Deferred revenue			14,469			10,993			5,786
			Income taxes payable			(405	)		(327	)		363
				Net cash provided by operating activities		32,502			17,539			9,215
Cash flows from investing activities:
	Purchases of property and equipment					(1,440	)		(2,105	)		(2,458	)
	Cash paid for acquisitions, net of cash acquired					(16,637	)		—			—
	Increase in restricted cash in escrow					(2,163	)		—			—
	Sales/ maturities of short-term investments					236,898			320,832			192,468
	Purchases of short-term investments					(206,119	)		(337,856	)		(195,977	)
				Net cash provided by (used in) investing activities		10,539			(19,129	)		(5,967	)
Cash flows from financing activities:
	Proceeds from exercise of stock options and warrants and issuance of common stock in connection with ESPP					6,324			13,925			4,189
	Repurchase of common stock					(30,218	)		(19,356	)		—
				Net cash provided by (used in) financing activities		(23,894	)		(5,431	)		4,189
Net increase (decrease) in cash and cash equivalents						19,147			(7,021	)		7,437
Cash and cash equivalents at beginning of year						23,446			30,467			23,030
Cash and cash equivalents at end of year					$	42,593		$	23,446		$	30,467
Supplemental disclosure of cash flow information:
	Cash paid for income taxes				$	498		$	445		$	270
Supplemental disclosure of non-cash investing and financing activities:
	Reversal of unearned deferred stock-based compensation for terminated employees				$	—		$	—		$	(216	)
	Issuance of common stock and assumption of stock options and warrants in connection with acquired businesses				$	110		$	—		$	243
	Unrealized loss on short-term investments, net				$	(521	)	$	(808	)	$	(305	)

The accompanying notes are an integral part of these consolidated financial statements.

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SONICWALL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 — The Company and Summary of Significant Accounting Policies:

      SonicWALL, Inc. (the “Company”) was incorporated in California in February 1991. SonicWALL, Inc. designs, develops, manufactures and sells Internet security infrastructure products designed to provide secure Internet access to broadband customers, enable secure Internet-based connectivity for distributed organizations and process secure transactions for enterprises and service providers. The following is a summary of the Company’s significant accounting policies:

Consolidation

      The consolidated financial statements include those of the Company and its wholly-owned subsidiaries Phobos Corporation, a Utah corporation, Lasso Logic, Inc, a California corporation, SonicWALL Switzerland, SonicWALL Norway and SonicWALL B.V., a subsidiary in The Netherlands. All intercompany accounts and transactions have been eliminated in consolidation.

Use of estimates

      The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ materially from those estimates.

Foreign Currencies

      The functional currency for all of the Company’s foreign subsidiaries is the US dollar. The Company remeasures assets and liabilities at the period end or historical exchange rate, as appropriate. Revenues and expenses are measured at the average exchange rate during the period. Currency remeasurement losses for the years ended December 31, 2005, 2004, and 2003 amounted to ($249,000), ($209,000), and ($195,000), respectively, and are included in interest income and other expense, net.

Cash and cash equivalents and short-term investments

      The Company considers all highly liquid investments purchased with an original maturity or remaining maturity at the date of purchase of three months or less to be cash equivalents, and investments maturing in three to twelve months to be short-term investments. Cash equivalents and short-term investments consist of money market funds, corporate bonds, U.S. government securities and commercial paper. Management has the ability and intent, if necessary, to liquidate any of these investments in order to meet our liquidity needs within the normal operating cycle. Accordingly, all marketable securities are classified as current assets. The Company classifies its short-term investments into categories in accordance with the provisions of Statement of Financial Accounting Standards No. 115 (“SFAS No. 115”), “Accounting for Certain Investments in Debt and Equity Securities.” Currently, the Company classifies its short-term investments as available-for-sale, which is reported at fair market value with the related unrealized gains and losses, net of taxes, included in shareholders’ equity. Realized gains and losses, declines in value of securities judged to be other than temporary, and interest and dividends on all securities are included in interest income and other expense, net. The fair value of the Company’s investments is based on quoted market prices. Realized gains and losses are computed using the specific identification method.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Fair value

      The carrying value of the Company’s financial instruments, including cash and cash equivalents, short-term investments, accounts receivable and accounts payable approximate their fair values due to their relatively short maturities. The Company does not hold or issue financial instruments for trading purposes.

Concentration of credit risk, foreign operations and significant customers

      Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents, short-term investments and accounts receivable. The Company places its temporary cash and short-term investments in corporate bonds, municipal bonds, commercial paper, and money market accounts with high credit quality financial institutions. Cash balances held with banks may periodically exceed the amount of insurance provided on such balances. The Company’s accounts receivable are derived from revenue earned from customers located in the U.S. and certain foreign countries and regions, including Europe, Canada, Japan and Australia. Sales to foreign customers for the years ended December 31, 2005, 2004 and 2003, all of which were denominated in U.S. dollars, accounted for 34%, 30%, and 30% of total revenue, respectively. The Company performs ongoing credit evaluations of its customers’ financial condition and requires no collateral from its customers. Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable. We determine the allowance based on historical write-off experience and probability of collection. We review our allowance for doubtful accounts monthly. Past due balances over 90 days and over a specified amount are reviewed individually to determine the probability of collection. All other balances are reviewed on a pooled basis by type of receivable. Account balances are charged off against the allowance when we feel it is probable the receivable will not be recovered. We do not have any off-balance-sheet credit exposure related to our customers.

      Sales through our two largest distributors, Ingram Micro and Tech Data represented the following percentages of total revenue:

	2005		2004		2003
Ingram Micro		18%		17%		23%
Tech Data		21%		21%		20%

      In addition, Ingram Micro and Tech Data represented the following percentages of our accounts receivable balance:

	December 31,
	2005		2004
Ingram Micro		15%		6%
Tech Data		11%		26%

      While a reduction in sales by either of these distributors would be largely offset by an increase in sales by the other or by the addition of other distributors, we would likely incur a temporary decline in sales.

      The Company outsources its manufacturing primarily to one third party contract manufacturer and some of the key components in the Company’s products come from single or limited sources of supply. The inability of any supplier or manufacturer to fulfill supply requirements of the Company could temporarily have negative impact on future operating results.

Inventories

      Inventories are stated at the lower of standard cost (which approximates cost determined on a first-in, first-out basis) or market. The Company writes-down the value of inventories for estimated excess and

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

obsolete inventories based upon assumptions about future demand and market conditions. Inventories consist primarily of finished goods. Inventory reserves, once established, are only reversed upon sale or disposition of related inventory.

Property and equipment

      Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets, which range from three to five years. Leasehold improvements are amortized over the lesser of the related lease term or the estimated useful life of the improvement, which ranges from two to five years. Depreciation expense for the years ended December 31, 2005, 2004 and 2003 was $2.4 million, $3.6 million, and $3.6 million, respectively.

Purchased intangibles

      Purchased intangibles consist of purchased technology, customer installed base/relationships, customer backlog and other intangibles. Intangible assets are amortized on a straight-line basis over their estimated useful lives which range from 3 months to six years. Amortization of intangible assets was $7.4 million, $7.6 million and $9.9 million in fiscal 2005, 2004 and 2003, respectively. The Company periodically evaluates its intangible assets for indications of impairment. If this evaluation indicates that the value of the intangible asset may be impaired, the Company makes an assessment of the recoverability of the net carrying value of the asset over its remaining useful life. If this assessment indicates that the intangible asset is not recoverable, based on the estimated undiscounted future cash flows of the technology over the remaining amortization period, the Company reduces the net carrying value of the related intangible asset to fair value and may adjust the remaining amortization period.

Goodwill and Impairment of goodwill

      Goodwill represents the excess of the aggregate purchase price over the fair market value of the net tangible and intangible assets acquired by the Company. Goodwill is tested for impairment in the fourth quarter of each fiscal year or more often if an event or circumstances indicate that an impairment loss has been incurred. An impairment charge is recognized if a reporting unit’s goodwill carrying amount exceeds its implied fair value. Goodwill impairment is determined using a two-step approach in accordance with SFAS 142 using one or more of the following fair value measures including: present value techniques of estimated future cash flows; or valuation techniques based on multiples of earnings or revenue, or a similar performance measure. Any such impairment charge could be significant and could have a material adverse effect on the Company’s reported financial statements. Based on the impairment tests performed, there was no impairment of goodwill in 2005, 2004, or 2003. The goodwill recorded as a result of the business combinations in the years presented is not deductible for tax purposes.

Impairment of other long-lived assets

      The Company continually monitors events and changes in circumstances that could indicate carrying amounts of long-lived assets, including intangible assets, may not be recoverable. When such events or changes in circumstances occur, the Company assesses the recoverability of long-lived assets by determining whether the carrying value of such assets will be recovered through undiscounted expected future cash flows. If the total of the future cash flows is less than the carrying amount of those assets, the Company records an impairment charge based on the excess of the carrying amount over the fair value of the assets.

Interest income and other expense, net

      Interest income and other expense, net consist primarily of interest income in the amount of $7.1 million, $4.2 million and $4.2 million for the years ended December 31, 2005, 2004 and 2003, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Stock-based compensation

      The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees, and complies with the disclosure provisions of SFAS 123, Accounting for Stock-Based Compensation. Under APB 25, compensation cost is determined based on the difference, if any, on the grant date between the fair value of the Company’s stock and the amount an employee must pay to acquire the stock. Compensation expense is recognized over the vesting period.

Pro forma stock-based compensation

      The Company has adopted the disclosure-only provisions of SFAS 123 and SFAS 148. Accordingly, no compensation cost has been recognized for employee awards granted under the Company’s stock option plan and the fair value of purchase rights issued under the ESPP in the accompanying statements of operations. Had compensation cost for the Company’s stock option plan and ESPP been determined based on the fair market value at the grant dates for stock options and purchase rights granted consistent with the provisions of SFAS 123, the Company’s net income (loss) would have been changed to the pro forma amounts indicated below:

		Year Ended December 31,
		2005			2004			2003
		(In thousands, except for per share
		amounts)
Net income (loss):
	As reported	$	6,276		$	(313	)	$	(17,668	)
	Expensed stock compensation under the intrinsic value method, net of related tax effect		201			75			700
	Stock-based compensation expense that would have been included in the determination of net income (loss) had the fair value method been applied, net of related tax effect		(14,431	)		(17,520	)		(24,388	)
	Pro forma net loss	$	(7,954	)	$	(17,758	)	$	(41,356	)
Net income (loss) per share — basic and diluted:
	Basic — as reported	$	0.10		$	(0.00	)	$	(0.26	)
	Diluted — as reported	$	0.09		$	(0.00	)	$	(0.26	)
	Basic — pro forma	$	(0.12	)	$	(0.25	)	$	(0.61	)
	Diluted — pro forma	$	(0.12	)	$	(0.25	)	$	(0.61	)

      The pro forma amounts reflect compensation expense related to stock option grants and look back features associated with the ESPP purchase rights from 1999 through 2005. The weighted average fair value of the options granted in 2005, 2004 and 2003 was $2.92, $3.95 and $3.57, respectively. The weighted average fair value of purchase rights issued under the 1999 ESPP in 2005, 2004 and 2003 was $1.90, $2.38 and $1.26 per share, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:

	2005		2004		2003
Expected volatility		48% to 71%		89%		90%
Risk-free interest rate		3.46% to 4.43%		2.52% to 3.55%		2.16% to 2.87%
Expected life		3.1 to 4  years		4 years		4 years
Dividend yield		0%		0%		0%

      The fair value of purchase rights issued under the Employee Stock Purchase Plan was estimated using the following assumptions:

	2005		2004		2003
Expected volatility		60%		60%		63%
Risk-free interest rate		1.00% to 2.77%		1.00% to 1.73%		1.01% to 1.33%
Expected life		0.5 year		0.5 year		1 year
Dividend yield		0%		0%		0%

      Options granted to consultants and other non-employees are accounted for in accordance with Emerging Issues Task Force Consensus No. 96-18, Accounting for Equity Investments That Are Issued to Other Than Employees for Acquiring, or In Conjunction with Selling, Goods or Services, and valued at fair value using the Black-Scholes method at the measurement date, generally when the services are completed.

Revenue recognition

      The Company derives its revenue primarily from the sale of four items: (1) products, (2) software licenses, (3) subscriptions for services such as content filtering, anti-virus protection and intrusion prevention, and (4) other services such as extended warranty and service contracts, training, consulting and engineering services. As described below, significant management judgments and estimates must be made and used in connection with the revenue recognized in any accounting period. The Company may experience material differences in the amount and timing of its revenue for any period if the management makes different judgments or utilize different estimates.

      The Company recognizes product and service revenues in accordance with SEC Staff Accounting Bulletin No. 101 (“SAB No. 101”), “Revenue Recognition in Financial Statements”, as amended by SAB No. 101A, SAB No. 101B, SAB 104 and EITF 00-21.

      The Company applies provisions of Statement of Position 97-2, “Software Revenue Recognition” (“SOP No. 97-2”), as amended by Statement of Position 98-9 (“SOP No. 98-9”), “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions”, to all transactions involving the sale of software products and hardware transactions where the software is not incidental. For hardware transactions where software is incidental, the Company does not apply separate accounting guidance to the hardware and software elements. The Company applies the provisions of Emerging Issues Task Force 03-05 (“EITF 03-05”), “Applicability of AICPA Statement of Position 97-2, Software Revenue Recognition, to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software”, to determine whether the provisions of SOP 97-2 apply to transactions involving the sale of products that include a software component.

      The Company recognizes revenue for products when persuasive evidence of an arrangement exists, the product has been delivered, title and risk of loss have been transferred to the customer, the fee is fixed or determinable and collection of the resulting receivable is reasonably assured. While the Company’s sales agreements contain standard terms and conditions, there are agreements that contain non-standard terms and

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

conditions. In these cases, interpretation of non-standard provisions is required to determine the appropriate accounting for the transaction.

      Retroactive price protection rights tied to certain specific circumstances are contractually offered to the Company’s channel partners. The Company evaluates these rights carefully based on stock on hand in the channels that has been purchased within 60 days of the price change with the exception of Ingram Micro and Tech Data. Revenue from these two distributors is not recognized until they sell the product to their customers. As a consequence, there is no adverse impact on recognized revenue. In general, retroactive price adjustments are infrequent in nature. At December 31, 2005, 2004, and 2003, the Company had a reserve for price protection on sales to the Company’s channel partners in the amounts of $244,000, $33,000, $17,000, respectively.

      Delivery to other domestic channel partners and to international channel partners is generally deemed to occur when we deliver the product to a common carrier. However, certain distributor agreements provide for rights of return for stock rotation. These stock rotation rights are generally limited to 15% to 25% of the distributor’s prior 3 to 6 months purchases or other measurable restrictions, and we estimate reserves for these return rights as discussed below. Our two largest distributors, Ingram Micro and Tech Data, have rights of return under certain circumstances that are not limited, therefore, we do not deem delivery to have occurred for any sales to Ingram Micro and Tech Data until they sell the product to their customers, at which time their right of return expires.

      Evidence of an arrangement is manifested by a master distribution or OEM agreement, an individual binding purchase order, or a signed license agreement. In most cases, sales through our distributors and OEM partners are governed by a master agreement against which individual binding purchase orders are placed on a transaction-by-transaction basis.

      At the time of the transaction, the Company assesses whether the fee associated with the transaction is fixed or determinable and whether or not collection is reasonably assured. The Company assesses whether the fee is fixed or determinable based upon the terms of the binding purchase order, including the payment terms associated with the transaction. If a significant portion of a fee is due beyond the Company’s normal payment terms, which are generally 30 to 90 days from invoice date, the Company accounts for the fee as not being fixed or determinable. In these cases, the Company recognizes revenue as the fees become due.

      The Company assesses probability of collection based on a number of factors, including past transaction history with and the credit-worthiness of the customer. The Company does not request collateral from our customers. If the Company determines that collection of a fee is not reasonably assured, it defers the fee and recognizes revenue at the time collection becomes reasonably assured, which is generally upon receipt of cash.

      For arrangements with multiple obligations (for example, the sale of an appliance which includes a year of free maintenance or a subscription based product), the Company allocates revenue to each component of the arrangement based on the objective evidence of fair value of the undelivered elements, which is generally the average selling price of each element when sold separately. This allocation process means that the Company defers revenue from the arrangement equal to the fair value of the undelivered elements and recognizes such amounts as revenue when the elements are delivered.

      The Company’s arrangements do not generally include acceptance clauses. However, if an arrangement includes an acceptance provision, recognition of revenue occurs upon the earlier of receipt of a written customer acceptance or expiration of the acceptance period.

      The Company recognizes revenue for subscriptions and services such as content filtering, anti-virus protection and intrusion prevention, and extended warranty and service contracts, ratably over the contract term. The Company’s training; consulting and engineering services are generally billed and recognized as revenue as these services are performed.

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SONICWALL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Sales returns and other allowances, allowance for doubtful accounts and warranty reserve.

      The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amount of assets and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Specifically, we must make estimates of potential future product returns and price changes related to current period product revenue. We analyze historical returns, current economic trends, and changes in customer demand and acceptance of our products when evaluating the adequacy of the sales returns and other allowances. Significant management judgments and estimates must be made and used in connection with establishing the sales returns and other allowances in any accounting period. We may experience material differences in the amount and timing of our revenue for any period if management makes different judgments or utilizes different estimates.

      In addition, we must make estimates based upon a combination of factors to ensure that our accounts receivable balances are not overstated due to an inability to collect. We specifically analyze accounts receivable and historical bad debts, the length of time receivables are past due, macroeconomic conditions, deterioration in customer’s operating results or financial position, customer concentrations, and customer credit-worthiness, when evaluating the adequacy of the allowance for doubtful accounts.

      Our appliance products are generally covered by a warranty for a one to two year period. We accrue a warranty reserve for estimated costs to provide warranty services, including the cost of technical support, product repairs, and product replacement for units that cannot be repaired. Our estimate of costs to fulfill our warranty obligations is based on historical experience and expectation of future conditions. To the extent we experience increased warranty claim activity or increased costs associated with servicing those claims, our warranty accrual will increase, resulting in decreased gross profit.

Shipping and Handling Costs

      The Company records costs related to shipping and handling of products in cost of sales for all periods presented.

Income taxes

      The Company accounts for income taxes under the liability method, which requires, among other things, that deferred income taxes be provided for temporary differences between the tax bases of the Company’s assets and liabilities and their financial statement reported amounts. In addition, deferred tax assets are recorded for the future benefit of utilizing net operating losses, research and development credit carry forwards and temporary differences. A valuation allowance is provided to reduce deferred tax assets to an amount for which realization is more likely than not.

Research and development and capitalized software development costs

      Software development costs incurred prior to the establishment of technological feasibility are charged to research and development expense as incurred. Technological feasibility is established upon completion of a working model, which is typically demonstrated by initial beta shipment. Software development costs incurred subsequent to the time a product’s technological feasibility has been established, through the time the product is available for general release to customers, are capitalized if material. To date, software development costs incurred subsequent to the establishment of technological feasibility have been immaterial and accordingly have not been capitalized.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Advertising Costs

      The Company expenses advertising costs as incurred. Advertising expense totaled $5.1 million, $4.8 million and $4.0 million for the years ended December 31, 2005, 2004 and 2003, respectively.

      The Company has agreements with certain of its distributors to provide marketing development funds. These agreements allow the distributors to be reimbursed by the Company for approved promotional activities, including advertising. The amounts available are related to a percentage of the distributors’ eligible purchases from the Company. The Company accrues for marketing development funds as the related revenue is recognized and records the cost as an offset to revenue or as sales and marketing expense in accordance with Emerging Issues Task Force No. 01-09, Accounting for Consideration Given by a Vendor to a Customer. In the years ended December 31, 2005, 2004, and 2003, the Company recorded provisions for marketing development fund costs of $3.9 million, $5.4 million, and $3.6 million, respectively. As of December 31, 2005 and December 31, 2004, the accompanying balance sheets include a liability for marketing development funds of $328,000, and $715,000, respectively.

Computation of net income (loss) per share

      Basic net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common shares outstanding during the period. Weighted average shares exclude shares subject to repurchase (“restricted shares”). Diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common and potential dilutive securities outstanding during the period. Potential dilutive securities are composed of unvested restricted shares, stock purchase warrants and incremental common shares issuable upon the exercise of stock options.

      The following table sets forth the computation of basic and diluted net income (loss) per share for the periods indicated (in thousands, except per share amounts):

			Year Ended December 31,
			2005		2004			2003
Numerator:
	Net income (loss)		$	6,276	$	(313	)	$	(17,668	)
Denominator:
	Weighted average shares used to compute basic EPS			64,684		70,850			67,895
	Effect of dilutive securities:
	Dilutive common stock equivalents			2,113		—			—
	Weighted average shares used to compute diluted EPS			66,797		70,850			67,895
Net income (loss) per share:
		Basic	$	0.10	$	(0.00	)	$	(0.26	)
		Diluted	$	0.09	$	(0.00	)	$	(0.26	)

      Because the Company reported a net loss during 2004 and 2003, the impact of stock options and warrants was excluded from the computation of dilutive earnings per share for these periods, as their effect would be anti-dilutive. For the years ended December 31, 2005, December 31, 2004, and December 31, 2003, 6,045,133, 5,311,564, and 3,689,077 stock options and warrants with a weighted average exercise price of $8.62, $8.60 and $11.05, respectively, were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares for the period and therefore, the effect would be anti-dilutive.

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SONICWALL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Recent accounting pronouncements

      In November 2005, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) Nos. FAS 115-1 and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. This FSP addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. This FSP also includes accounting considerations subsequent to the recognition of other-than-temporary impairments. The adoption of this FSP is not expected to have a material effect on the Company’s consolidated financial position, results of operations or cash flows. The guidance in this FSP will be applied to reporting periods beginning after December 15, 2005.

      In June 2005, the FASB issued Statement of Financial Accounting Standards No. 154, Accounting Changes and Error Corrections (SFAS 154), which changes the requirements for the accounting for and reporting of a change in accounting principle. Previously, most voluntary changes in accounting principles required recognition via a cumulative effect adjustment within net income of the period of the change. SFAS 154 requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005; however, SFAS 154 does not change the transition provisions of any existing accounting pronouncements.

      In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123R), which, the Company will be required to adopt beginning in its first quarter of fiscal 2006. The pro forma disclosures previously permitted under SFAS No. 123 no longer will be an alternative to financial statement recognition. SFAS 123R will result in the recognition of substantial compensation expense relating to the Company’s employee stock options and employee stock purchase plans. As noted in Note 1, currently the Company does not recognize any compensation expense related to stock option grants the Company issues to employees under its stock option plans or related to the discounts the Company provides under its employee stock purchase plans. Under the new rules, the Company will be required to adopt a fair-value-based method for measuring the compensation expense related to employee stock awards. SFAS 123R eliminates the ability to account for share-based compensation transactions using the intrinsic value method under APB 25 and generally requires that such transactions be accounted for using a fair-value-based method. In January 2005, the SEC issued SAB No. 107, which provides supplemental implementation guidance for SFAS 123R. SFAS 123R will be effective for the Company beginning in the first quarter of fiscal 2006. The Company plans to use the modified prospective transition method and the Black-Scholes-Merton model to adopt this new standard and expects the adoption will have a material impact on the consolidated results of operations. The Company anticipates that upon adoption of SFAS 123R, it will recognize share-based compensation cost on a straight-line basis over the requisite service period of the award. For the historical impact of share-based compensation expense, see the pro forma stock-based compensation information presented in the footnote above, however, uncertainties, including the Company’s future share-based compensation strategy, stock price volatility, estimated forfeitures and employee stock option exercise behavior make it difficult to determine whether the historic share-based compensation expense will be similar in future.

      In December 2004, the FASB issued Statement of Financial Accounting Standards No. 153, Exchanges of Nonmonetary Assets (SFAS 153), an amendment of Accounting Principles Board Opinion No. 29. SFAS 153 addresses the measurement of exchanges of nonmonetary assets and redefines the scope of transactions that should be measured based on the fair value of the assets exchanged. SFAS 153 is effective for the Company for nonmonetary asset exchanges beginning in the first quarter of fiscal 2006. The adoption of SFAS 153 is not expected to have a material effect on the Company’s consolidated financial position, results of operations or cash flows.

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Note 2 — Balance Sheet Components:

		December 31,
		2005			2004
		(In thousands)
Property and equipment, net:
	Equipment	$	9,610		$	8,756
	Office equipment and furniture		1,913			1,896
	Leasehold improvements		1,432			1,391
	Software		6,887			6,538
			19,842			18,581
	Less: accumulated depreciation		(17,247	)		(15,186	)
		$	2,595		$	3,395
Purchased intangibles and other assets, net:
	Purchased intangible assets	$	57,400		$	52,529
	Other assets		397			695
			57,797			53,224
	Less: accumulated amortization		(46,307	)		(38,863	)
		$	11,490		$	14,361

Note 3 — Goodwill and Purchased Intangibles:

      The following table presents the changes in goodwill (in thousands):

	December 31,
	2005			2004
Balance as of beginning of the year	$	97,953		$	97,953
Acquisitions::
enKoo		1,286			—
Lasso		10,651			—
Tax adjustment related to Phobos acquisition in 2000 (see Note 8)		(885	)		—
Balance as of end of the year	$	109,005		$	97,953

      Intangible assets for the year ended December 31, 2005 and 2004 consist of the following (in thousands):

			December 31, 2005							December 31, 2004
	Weighted Average		Gross							Gross
	Amortization		Carrying		Accumulated					Carrying		Accumulated
	Period		Amount		Amortization			Net		Amount		Amortization			Net
Purchased technology		70 months	$	31,771	$	(23,190	)	$	8,581	$	26,970	$	(18,567	)	$	8,403
Non-compete agreements		36 months		7,019		(7,019	)		—		7,019		(7,019	)		—
Customer base		69 months		18,140		(15,694	)		2,446		18,140		(12,904	)		5,236
Other		17 months		470		(404	)		66		400		(373	)		27
Total intangibles			$	57,400	$	(46,307	)	$	11,093	$	52,529	$	(38,863	)	$	13,666

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      All of the Company’s intangible assets excluding goodwill are subject to amortization. Estimated future amortization expense to be included in cost of revenue is as follows (in thousands):

Fiscal Year
2006		$	4,821
2007			960
2008			960
2009			960
2010			880
	Total	$	8,581

      Estimated future amortization expense to be included in operating expense is as follows (in thousands):

Fiscal Year
2006		$2,512
	Total	$2,512

Note 4 — Acquisitions:

      On November 28, 2005, the Company purchased Lasso Logic, Inc. (Lasso) for approximately $15.8 million in purchase consideration, consisting of cash, assumed stock options in the amount of $109,000 and $194,000 in direct transactions costs incurred in connection with the acquisition. Lasso provides continuous data protection for backup and recovery solutions for the small and medium business market. The Company believes that Lasso’s data backup solutions will provide a strong entry point to the growing data protection segment. In accordance with SFAS 141, Business Combinations, this transaction was accounted for as a purchase business combination.

      The former shareholders of Lasso made certain representations and warranties to the Company and agreed to indemnify the Company against damages which might arise from a breach of those undertakings. As security for the indemnification obligation’s SonicWALL retained approximately $1.8 million of the cash consideration, which is scheduled to be released to the former Lasso shareholders on the 12 month anniversary of the acquisition date. In addition, in connection with the acquisition, the Company has agreed to pay $1.7 million over the next 17 to 20 months to certain former shareholders of Lasso contingent upon continued employment with the Company. Amounts paid under these arrangements are recorded as compensation expense when earned.

      The Company allocated the purchase price based upon the fair value of the assets acquired and liabilities assumed. The excess of the purchase price over the fair value of the assets acquired and liabilities assumed has been allocated to the identified intangible assets in accordance with the requirements of SFAS 141 and SFAS 142, Goodwill and Other Intangible Assets. The following is the allocation of the purchase consideration (in thousands):

Net tangible assets	$	1,351
Intangible assets	$	14,421
Total purchase consideration	$	15,772

      The acquired intangible assets of $14.4 million consists of the following: (1) $3.7 million that was assigned to purchased technology and will be amortized over its estimated useful life of five years;

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(2) $0.1 million was assigned to customer relationships and customer backlog which will be amortized over a period of 3 months to one year; and (3) $10.6 million that was assigned to goodwill.

      Under the terms of the definitive agreement, the purchase consideration consisted of cash and stock options assumed. Part of the purchase consideration is allocated to deferred stock-based compensation as unearned stock-based compensation cost. The unearned stock-based compensation cost represents the fair value of assumed options to purchase SonicWall common stock issued, less the intrinsic value of the Lasso’s unvested options applicable to the remaining vesting period. Deferred stock-based compensation cost is amortized as stock-based compensation related to acquisitions over the remaining respective vesting periods. The unamortized balance for deferred stock-based compensation is reflected as a reduction to additional paid-in capital in the Consolidated Statements of Shareholders’ Equity.

      On November 28, 2005, the Company acquired certain assets from enKoo, Inc. (enKoo) for approximately $2.4 million in consideration, consisting of cash and transaction costs. The Company acquired the enKoo assets for its secure remote access technology and plans to integrate the key features of enKoo’s technology into its SSL-VPN products. The assets acquired from enKoo included certain intangible assets. In addition, certain employees of enKoo became employees of the Company. Of the total purchase price of $2.4 million, $1.1 million was allocated to purchased technology and will be amortized over its estimated useful life of five years, and less than $50,000 was allocated to customer relationship and will be amortized over three months. The remaining $1.3 million was allocated to goodwill.

      The Consolidated Financial Statements include the operating results of each business from the date of acquisition. Pro forma results of operations have not been presented because these were not significant acquisitions as defined under the SEC’s S-X rule 3-05.

Note 5 — Financial Instruments:

      Our investment portfolio consists of both corporate and government securities. All marketable securities are classified as available-for-sale and are summarized as follows (in thousands):

		Year Ended December 31, 2005
						Gross		Gross
						Unrealized		Unrealized
		Fair Value		Book Value		Gains		(Losses)
Marketable securities
Corporate debt securities		$	164,517	$	165,416		80	$	(979	)
U.S. government securities			32,401		32,845		—		(444	)
Municipal bonds and notes			931		955		—		(24	)
	Total marketable securities	$	197,849	$	199,216		80	$	(1,447	)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

		Year Ended December 31, 2004(1)
						Gross		Gross
						Unrealized		Unrealized
		Fair Value		Book Value		Gains		(Losses)
Marketable securities
Corporate debt securities		$	64,149	$	64,511		—	$	(362	)
U.S. government securities			51,546		51,938		—		(392	)
Municipal bonds and notes			113,531		113,545		—		(14	)
	Total marketable securities	$	229,226	$	229,994		—	$	(768	)

(1)  Of the total gross unrealized losses, approximately $27,000 of gross unrealized losses relates to corporate and municipal bonds with a fair value of $4.3 million that have been in a loss position for 12 months or more.

      The gross unrealized losses related to fixed income securities were primarily due to changes in interest rates and bond yields. The longer the duration of these securities, the more susceptible they are to changes in the market interest rates and bond yields. As yields increase, those securities purchased with a lower yield-at-cost show a mark-to-market unrealized loss. The Company’s management has determined that the gross unrealized losses on its investment securities at December 31, 2005 are temporary in nature. The Company reviews its investments to identify and evaluate investments that have indications of possible impairment. Factors considered in determining whether a loss is temporary include the length of time and extent to which fair value has been less than the cost basis, the financial condition and near-term prospects of the investee, 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. Substantially all of the Company’s fixed income securities are rated investment grade or better.

      The following tables provide the breakdown of the investments with unrealized losses at December 31, 2005 (in thousands):

		Unrealized Losses Less					Unrealized Losses 12
		Than 12 Months					Months or Greater					Total
				Gross					Gross					Gross
				Unrealized					Unrealized					Unrealized
		Fair Value		(Losses)			Fair Value		(Losses)			Fair Value		(Losses)
December 31, 2005
Marketable securities
Corporate debt securities		$	25,181	$	(189	)	$	51,301	$	(790	)	$	76,482	$	(979	)
U.S. government securities			10,703		(332	)		21,698		(112	)		32,401		(444	)
Municipal bonds and notes			—		—			931		(24	)		931		(24	)
	Total marketable securities	$	35,884	$	(521	)	$	73,930	$	(926	)	$	109,814	$	(1,447	)

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The estimated fair value of short-term investments classified by date of maturity as December 31, 2005 is as follows (in thousands):

	2005
Maturity
Due within one year	$	35,339
Due between one and five years		58,826
Due between five and ten years		12,885
Due after 10 years(1)		90,799
Total short-term investments	$	197,849

(1)  Represents auction rate securities of $70 million that have re-auction periods of 90 days or less but whose underlying agreements have original maturities of more than 90 days and asset backed securities of $21 million.

Note 6 — Restructuring Charges:

      During 2002 and 2003, the Company implemented two restructuring plans — one initiated in the second quarter of 2002 and the second initiated in the second quarter of 2003.

      In January 2003, the Company adopted the provisions of Statement of Financial Accounting Standards No. 146 (“SFAS No. 146”), “Accounting for Costs Associated with Exit or Disposal Activities”. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred and states that an entity’s commitment to an exit plan, by itself, does not create a present obligation that meets the definition of a liability. Accordingly, for exit or disposal activities initiated after December 31, 2002 the Company will record restructuring charges as the provisions of SFAS No. 146 are met.

2002 Restructuring Plan

      During the second quarter of 2002, the Company’s management approved and initiated a restructuring plan designed to reduce its cost structure and integrate certain Company functions.

      During 2003, the Company recorded additional restructuring charges related to the 2002 restructuring plan totaling $354,000, consisting of $379,000 related to properties vacated in connection with facilities consolidation, offset by $25,000 reversal for severance accrual for an employee who has remained with the Company. The additional facilities charges resulted from revisions of the Company’s estimates of future sublease income due to deterioration of the commercial real estate market. The estimated facility costs, which continued through December 2005, were based on the Company’s contractual obligations, net of estimated sublease income, based on then current comparable rates for leases in their respective markets. During 2004, the Company recorded additional restructuring charges related to the 2002 plan consisting of $21,000 related to properties vacated in connection with facilities consolidation, offset by $155,000 reversal for a favorable lease modification related to properties vacated in connection with facilities consolidation. The restructuring plan resulted in the vacating of three facilities and in the elimination of 77 positions, all of which were eliminated as of December 31, 2002.

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      The following table sets forth an analysis of the components of the 2002 restructuring plan and the payments made against the reserve from the second quarter of fiscal 2002 to December 31, 2005 (in thousands):

		Employee
		Severance			Facility			Asset
		Benefits			Costs			Impairments		Total
Reserve balance at December 31, 2002		$	25		$	1,417		$	—	$	1,442
Cash paid			—			(818	)		—		(818	)
Adjustments			(25	)		379			—		354
	Reserve balance at December 31, 2003		—			978			—		978
Cash paid			—			(529	)		—		(529	)
Adjustments			—			(134	)		—		(134	)
	Reserve balance at December 31, 2004	$	—		$	315		$	—	$	315
Cash paid			—			(315	)		—		(315	)
Adjustments			—			—			—		—
	Reserve balance at December 31, 2005	$	—		$	—		$	—	$	—

2003 Restructuring Plan

      During the second quarter of 2003, the Company’s management approved and initiated a restructuring plan designed to realign and further reduce its cost structure and integrate certain other Company functions. Accordingly, the Company recognized a restructuring charge related to the 2003 plan of approximately $1.5 million during the fiscal year ended December 31, 2003. The restructuring charge consisted of $1.1 million for workforce reduction costs across all geographic regions and functions; $242,000 for excess facilities consolidation costs related to lease commitments for space no longer needed to support ongoing operations; and $98,000 for abandonment of certain fixed assets consisting primarily of computer equipment and related software. During 2004, the Company recorded additional restructuring charges related to the 2003 restructuring plan consisting of $5,000 related to properties vacated in connection with facilities consolidation, offset by $42,000 reversal for severance accrual for employees who have remained with the Company.

      The restructuring plan resulted in the vacating of four facilities. The estimated facility costs were based on the Company’s discounted contractual obligations, net of assumed sublease income, based on current discounted comparable rates for leases in their respective markets. As the remaining lease term became shorter, it became more difficult to find a suitable tenant to sublease these facilities on a relatively short term basis. As a consequence, the actual loss could exceed this estimate. Future cash outlays were anticipated through June 2005, unless the Company negotiated to exit the leases at an earlier date. The restructuring plan resulted in the elimination of 43 positions worldwide. At the same time, the Company made investments in personnel in research and development and in the sales and marketing organization. As a consequence, the overall reduction in workforce was less than the number of positions eliminated as a result of the restructuring.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The following table sets forth an analysis of the components of the 2003 restructuring plan and the payments made for the plan from the second quarter of fiscal 2003 to December 31, 2005 (in thousands):

		Employee
		Severance			Facility			Asset
		Benefits			Costs			Impairments			Total
Restructuring charges incurred		$	1,139		$	242		$	98		$	1,479
	Cash paid		(1,048	)		(60	)		—			(1,108	)
	Non-cash charges		—			—			(98	)		(98	)
	Reserve balance at December 31, 2003		91			182			—			273
	Cash paid		(49	)		(104	)		—			(153	)
	Adjustments		(42	)		5			—			(37	)
	Reserve balance at December 31, 2004	$	—		$	83		$	—		$	83
	Cash paid		—			(83	)		—			(83	)
	Adjustments		—			—			—			—
	Reserve balance at December 31, 2005	$	—		$	—		$	—		$	—

Summary information for combined restructuring plans

      The following table sets forth an analysis of the components of both the 2002 and 2003 restructuring plan and the payments made for the plans from December 31, 2003 to December 31, 2005 (in thousands):

		Employee
		Severance			Facility			Asset
		Benefits			Costs			Impairments			Total
	Reserve balance at December 31, 2002	$	25		$	1,417		$	—		$	1,442
Restructuring charges incurred			1,139			242			98			1,479
Cash paid			(1,048	)		(878	)		—			(1,926	)
Adjustments			(25	)		379			—			354
Non-cash charges			—			—			(98	)		(98	)
	Reserve balance at December 31, 2003		91			1,160			—			1,251
Cash paid			(49	)		(633	)		—			(682	)
Adjustments			(42	)		(129	)		—			(171	)
	Reserve balance at December 31, 2004	$	—		$	398		$	—		$	398
Cash paid			—			(398	)		—			(398	)
Adjustments			—			—			—			—
	Reserve balance at December 31, 2005	$	—		$	—		$	—		$	—

Note 7 — Shareholders’ Equity:

Stock Option Exchange Program

      In January 2003, the Company offered a voluntary stock option exchange program to its employees. The plan allowed employees, at their election, to cancel all or any portion of their unexercised stock options with exercise prices equal to or greater than $10.00 per share effective February 7, 2003, provided that, should an employee participate, any options granted to that employee within the six-month period preceding February 7, 2003 would be automatically cancelled. In exchange, the employees were granted on August 11, 2003,

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provided they were still employed by the Company at that time, new options to purchase a number of shares equal to the number of shares underlying the cancelled options. Members of the SonicWALL Board of Directors, SonicWALL executive officers and certain other employees were not eligible to participate in the program.

      Details regarding options cancelled under the program are as follows:

	Shares						Weighted Average Exercise Price
Price	Vested		Unvested		Total		Vested		Unvested		Total
$10.75 - $19.00		774,739		944,008		1,718,747	$	14.79	$	14.98	$	14.89
$19.01 - $38.00		216,951		130,049		347,000		24.78		23.69		24.37
$38.01 - $52.06		88,073		46,927		135,000		49.67		50.56		49.98
		1,079,763		1,120,984		2,200,747	$	19.64	$	17.48	$	18.54

      To replace the cancelled options, options to purchase approximately 1.8 million shares of Common Stock were granted on August 11, 2003, at an exercise price of $4.93 per share as quoted on the NASDAQ National Market at the close of business at that day. The vesting of the replacement options remained unchanged. Under SFAS Interpretation No. 44 (FIN 44), “Accounting for Certain Transactions involving Stock Compensation”, stock options granted to participants of the option exchange program during the six month period prior to implementation of the option exchange program that were not cancelled as part of the program, and during the six month period following implementation of the option exchange program, are subject to variable plan accounting beginning in the fiscal quarter when the grant occurred. Options granted to employees participating in the program within the six month period prior to the start of the offer period were all cancelled as part of the exchange. In addition, the Company did not grant any stock options to the employees participating in the exchange program in the 6 months following the cancellation date. Accordingly, the replacement option to purchase 1.8 million shares of Common Stock that were granted outside the six month period following the implementation of the option exchange program are subject to fixed plan accounting.

1999 Employee Stock Purchase Plan

      In August 1999, the Company’s Board of Directors adopted and the shareholders approved the 1999 Employee Stock Purchase Plan (the “1999 ESPP”). The 1999 ESPP is designed to enable eligible employees to purchase shares of the Company’s common stock at a discount and was effective on the effective date of our initial public offering. Except for the first offering period, each offering period will be for one year and will consist of two six-month purchase periods. The first offering period commenced on the date of our initial public offering and ended July 31, 2001. All subsequent offering periods begin on August 1 and February 1. The purchase price for shares of common stock under the 1999 ESPP is 85% of the lesser of the fair market value of the Company’s common stock on the first day of the applicable offering period or the last day of each purchase period.

      The Company initially reserved 500,000 shares of common stock for issuance under the 1999 ESPP. In December 2000, 2002, and 2003, our Board recommended to the shareholders and the shareholders voted to increase the number of shares authorized for issuance under the 1999 ESPP by 200,000, 325,000, and 1,500,000 shares, respectively, bringing the total shares currently reserved for issuance under the 1999 ESPP to 2,525,000 shares. At December 31, 2005, 981,342 shares were available for issuance under the 1999 ESPP. The weighted average fair value of purchase rights issued under the 1999 ESPP in 2005, 2004 and 2003 was $4.94, $2.38 and $1.26 per share, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Stock Option Plans

      The Company’s Stock Option Plans (the “Plans”), as amended, authorize the Board of Directors to grant incentive stock options and nonstatutory stock options to employees, directors and consultants to purchase up to a total of 33,689,384 shares of the Company’s common stock. Under the Plans, incentive stock options are granted at an exercise price that is not to be less than 100% of the fair market value of the Company’s common stock on the date of grant, as determined by the Company’s Board of Directors. Nonqualified stock options are granted at a price that is not to be less than 85% of the fair market value of the common stock on the date of grant, as determined by the Board of Directors. Generally, options granted under the Plans are exercisable for a period of ten years after the date of grant, and vest over four years The following table summarizes option activity under the stock option plans:

				Options Outstanding
									Weighted
									Average
	Available for								Exercise
	Grant			Shares			Exercise Price		Price
Balance at December 31, 2002		4,562,676			10,268,375		$	0.04 - 52.06	$	10.59
Authorized		2,696,685			—			—		—
Granted		(10,103,497	)		10,103,497		$	3.38 -  8.02	$	5.41
Exercised		—			(743,466	)	$	0.04 -  6.45	$	3.96
Canceled		4,235,938			(5,071,454	)	$	1.42 - 52.06	$	13.79
Balance at December 31, 2003		1,391,802			14,556,952		$	0.06 - 45.56	$	6.22
Authorized		2,744,520			—			—		—
Granted		(3,793,070	)		3,793,070		$	5.30 -  9.85	$	6.09
Exercised		—			(2,805,521	)	$	0.06 -  7.73	$	4.35
Canceled		1,617,149			(1,989,789	)	$	2.87 - 19.97	$	9.79
Balance at December 31, 2004		1,960,401			13,554,712		$	0.06 - 45.56	$	6.05
Authorized		2,744,922			—			—		—
Options assumed related to acquisition					59,589		$	0.30 -  0.30	$	0.30
Granted		(5,925,524	)		5,925,524		$	5.10 -  7.71	$	6.77
Exercised		—			(1,072,878	)	$	0.06 -  7.73	$	4.38
Canceled		1,567,766			(1,643,509	)	$	1.42 - 31.94	$	6.98
Balance at December 31, 2005		347,565			16,823,438		$	0.30 - 45.56	$	6.33

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The following table summarizes information regarding stock options outstanding at December 31, 2005:

	Options Outstanding						Options Exercisable
					Weighted Average
					Remaining
	Weighted Average				Contractual Life				Weighted Average
Exercise Prices	Exercise Price		Shares		(Years)		Shares		Exercise Price
$ 0.30 - $ 0.30	$	0.30		59,589		9.10		11,765	$	0.30
$ 1.42 - $ 1.42	$	1.42		5,506		3.60		5,506	$	1.42
$ 2.87 - $ 4.28	$	3.45		3,287,713		7.10		2,285,776	$	3.45
$ 4.48 - $ 6.61	$	5.69		6,747,393		8.10		2,537,683	$	5.56
$ 6.75 - $ 9.85	$	7.58		6,391,483		9.00		1,512,136	$	7.69
$10.57 - $12.75	$	11.28		88,144		5.00		88,144	$	11.28
$15.88 - $19.97	$	17.76		123,610		5.30		123,610	$	17.76
$29.75 - $29.75	$	29.75		20,000		4.40		20,000	$	29.75
$45.56 - $45.57	$	45.56		100,000		4.50		100,000	$	45.56
$0.30 - $45.57	$	6.33		16,823,438		8.20		6,684,620	$	6.28

      At December 31, 2004 and 2003, 5,248,342 and 5,421,252 outstanding options were exercisable, respectively. The weighted average exercise price of exercisable options outstanding was $6.49 and $7.13 at December 31, 2004 and 2003, respectively.

      The Company has assumed certain option plans in connection with business combinations. Generally, the options granted under these plans have terms similar to the Company’s own options. The exercise prices of such options have been adjusted to reflect the relative exchange ratios.

      During 2003, the Company entered into an agreement with two employees to accelerate the vesting of certain stock options. As a result, the Company recorded stock-based compensation expense of $480,000 based on the change in the intrinsic value at the time of modification to the stock option.

Stock Repurchase Program

      In November 2004, the Company’s Board of Directors authorized a stock repurchase program to reacquire up to $50 million of common stock. The term of the stock repurchase plan was set at twelve (12) months from the date of authorization. In February 2005, the Company’s Board of Directors increased the amount authorized for repurchase from $50 million to $75 million, extended the term of the program from twelve (12) to twenty-four (24) months following the date of original authorization and increased certain predetermined pricing formulas. In April 2005, the Company’s Board of Directors authorized a modification to the stock repurchase program to delete certain elements that provided for systematic repurchases.

      During the fourth quarter of fiscal 2004, the Company repurchased and retired 3.2 million shares of SonicWALL common stock at an average price of $6.08 per share for an aggregate purchase price of $19.4 million. During fiscal year 2005, the Company repurchased and retired 5.0 million shares of SonicWALL common stock at an average price of $6.05 per share for an aggregate purchase price of $30.2 million. As of December 31, 2005, the remaining authorized amount for stock repurchases under this program was $25.4 million.

      In February 2006, the Company’s Board of Directors approved an increase in the amount authorized for repurchase under the plan from $75 million to $100 million and extended the term of the program from twenty-four (24) months to thirty-six (36) months following the date of original authorization.

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SONICWALL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 8 — Income Taxes:

      The (provision for) benefit from income taxes consists of the following (in thousands):

		Year Ended December 31,
		2005			2004			2003
Current tax (expense) benefit:
	Federal	$	193		$	39		$	3,724
	State		(74	)		(77	)		(1	)
	Foreign		(268	)		(263	)		(341	)
			(149	)		(301	)		3,382
Deferred tax (expense) benefit:
	Federal		(885	)		—			(1,792	)
	State		—			—			—
			(885	)		—			(1,792	)
		$	(1,034	)	$	(301	)	$	1,590

      As part of the process of preparing the Company’s consolidated financial statements, the Company is required to estimate its income taxes in each of the jurisdictions in which it operates. This process involves determining the Company’s income tax (expense) benefit together with calculating the deferred income tax (expense) benefit related to temporary differences resulting from differing treatment of items, such as deferred revenue or deductibility of certain intangible assets, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the consolidated balance sheet. The Company must then assess the likelihood that the deferred tax assets will be recovered through the generation of future taxable income.

      As of December 31, 2005, the Company has a full valuation allowance against its net deferred tax assets because the Company determined that it is more likely than not that all deferred tax assets will not be realized in the foreseeable future due to historical operating losses.

      Significant components of the deferred tax assets and liabilities are as follows (in thousands):

			December 31,
			2005			2004
Deferred tax assets:
	Net operating loss carryforwards		$	27,173		$	31,376
	Inventory reserves			419			462
	Deferred revenue			316			442
	Tax credits			6,404			6,182
	Other reserves and accruals			7,951			8,415
		Total deferred tax assets		42,263			46,877
	Valuation allowance			(38,197	)		(41,402	)
		Net deferred tax assets	$	4,066		$	5,475
Deferred tax liabilities:
	Intangible assets		$	(4,066	)	$	(5,475	)

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SONICWALL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      As of December 31, 2005, the Company has net operating loss carryforwards of approximately $71.5 million to offset future federal taxable income, which expire at various dates through the year 2024. This amount includes approximately $31.8 million of net operating loss carryforwards from the acquisition of Phobos. The federal net operating loss carryforward also includes approximately $38.2 million resulting from employee exercises of non-qualified stock options or disqualifying dispositions, the tax benefits of which, when realized, will be recorded as an addition to common stock rather than a reduction of the provision for income taxes.

      The deferred tax assets related to the acquired companies, approximately $8.4 million as of December 31, 2005, if and when realized, will be used to reduce the amount of goodwill and intangibles recorded at the date of acquisition. Valuation allowances have been recorded for this portion of these deferred tax assets as a result of the uncertainties regarding realization of the assets based upon the limitation on the use of the net operating losses in the future. In fiscal year 2005, the Company utilized $885,000 of the deferred tax assets related to the acquired companies resulting in a reduction in goodwill. The Company’s overall change in valuation allowance was $3.2 million, $10.3 million and $10.6 million for the years ended December 31, 2005, 2004 and 2003, respectively.

      The Company’s effective tax rate on income (loss) differs from the U.S. Federal statutory regular tax rate (benefit) as follows:

	Year Ended December 31,
	2005			2004			2003
Federal statutory rate (benefit)		35	%		(35	)%		(35	)%
State taxes, net of federal benefit		4			(4	)		(5	)
Deferred compensation charge		—			1,532			1
Tax credits		(2	)		(922	)		(4	)
Change in valuation allowance		(18	)		2,244			33
Other		(5	)		314			2
		14	%		2501	%		(8	)%

      Undistributed earnings of the Company’s foreign subsidiaries of approximately $2.5 million at December 31, 2005, are considered to be indefinitely reinvested and, accordingly, no provisions for federal and state income taxes have been provided thereon. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to various foreign countries.

      The Company’s income (loss) before income taxes was earned in the following jurisdictions (in thousands):

	Year Ended December 31,
	2005		2004			2003
Domestic	$	6,479	$	(822	)	$	(19,329	)
Foreign		831		810			71
Total	$	7,310	$	(12	)	$	(19,258	)

Note 9 — Segment Reporting:

      The Company adopted Statement of Financial Accounting Standard No. 131 (“SFAS 131”), Disclosures About Segments of an Enterprise and Related Information. SFAS 131 requires publicly held companies to report financial and other information about key revenue segments of the entity for which such information

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

is available and is utilized by the chief operating decision maker. The Company conducts its business within one business segment.

      Revenue by geographic region, as taken from the internal management system, is as follows (in thousands):

	Year Ended December 31,
	2005		2004		2003
United States	$	90,432	$	83,757	$	64,983
All other countries		44,892		41,892		29,418
Total	$	135,324	$	125,649	$	94,401

      Long-lived assets, which consist primarily of property and equipment, by geographic region based on the location of the asset are presented as follows (in thousands):

	Year Ended December 31,
	2005		2004		2003
United States	$	2,679	$	3,381	$	5,024
International		313		386		261
Total	$	2,992	$	3,767	$	5,285

      The following two customers accounted for 10% or more of the Company’s revenue:

	Year Ended
	December 31,
	2005		2004		2003
Ingram Micro		18%		17%		23%
Tech Data		21%		21%		20%

      Revenue derived from Ingram Micro and Tech Data are solely in the Americas. No other customer represented more than 10% of our sales in those years.

Note 10 — Commitments and Contingencies:

      The Company’s corporate headquarters and executive offices are located in approximately 86,000 square feet of office space in Sunnyvale, California under a lease that expires in September 2009. The lease provides for one five year renewal option. Additional sales and support offices are leased worldwide under leases that expire at various dates ranging from 2005 to 2008. Rent expense was approximately $1.1 million, $1.4 million and $2.0 million for the years ended December 31, 2005, 2004 and 2003, respectively. Future annual minimum lease payments under all noncancelable operating leases with an initial term in excess of one year as of December 31, 2005 were as follows (in thousands):

Year Ending December 31,
2006	$	33
2007		162
2008		530
2009		388
2010		0
	$	1,113

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SONICWALL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Purchase commitments

      The Company outsources its manufacturing function primarily to Flash Electronics, a third party contract manufacturer, and at December 31, 2005 it has purchase obligations to this vendor totaling $14 million. Of this amount, $7.5 million cannot be cancelled. The Company is contingently liable for any inventory owned by the contract manufacturer that becomes excess and obsolete. As of December 31, 2005, $69,000 had been accrued for excess and obsolete inventory held by our primary contract manufacturer. In addition, as of December 31, 2005 in the normal course of business the Company had $1.1 million in non-cancelable purchase commitments.

Product warranties

      The Company’s standard warranty period for hardware is one to two years and includes repair or replacement obligations for units with product defects. The Company’s software products carry a 90-day warranty and include technical assistance, insignificant bug fixes and feature updates. The Company estimates the accrual for future warranty costs based upon its historical cost experience and its current and anticipated product failure rates. If actual product failure rates or replacement costs differ from its estimates, revisions to the estimated warranty obligations would be required. However, the Company concluded that no adjustment to pre- existing warranty accruals were necessary for the years ended December 31, 2005, 2004 or 2003, respectively. A reconciliation of the changes to the Company’s warranty accrual for the years ended December 31, 2005, 2004, and 2003 is as follows:

	Year Ended December 31,
	2005			2004			2003
	(In thousands)
Beginning balance	$	1,071		$	1,290		$	1,168
Accruals for warranties issued		402			386			933
Settlements made during the period		(683	)		(605	)		(811	)
Ending balance	$	790		$	1,071		$	1,290

Guarantees and Indemnification Agreements

      The Company enters into standard indemnification agreements in its ordinary course of business. As part of its standard distribution agreements, the Company, indemnifies, holds harmless, and agrees to reimburse the indemnified parties for losses suffered or incurred by the indemnified party, in connection with any U.S. patent or any copyright or other intellectual property infringement claim by any third party with respect to the Company’s products, software or services. The indemnification agreements commence upon execution of the agreement and do not have specific terms. The maximum potential amount of future payments the Company could be required to make under these agreements is not limited. The Company has never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the Company believes the estimated fair value of these agreements is minimal.

      The Company’s articles of incorporation limit the liability of directors to the full extent permitted by California law. In addition, the Company’s bylaws provide that the Company will indemnify its directors and officers to the fullest extent permitted by California law, including circumstances in which indemnification is otherwise discretionary under California law. The Company has entered into indemnification agreements with its directors and officers that may require the Company: to indemnify its directors and officers against liabilities that may arise by reason of their status or service as directors or officers, other than liabilities arising from willful misconduct of a culpable nature; to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified; and to obtain directors’ and officers’ insurance if available

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

on reasonable terms, which the Company currently has in place. The Company has not incurred costs related to these indemnification agreements.

      On July 29, 2004, the Company amended and restated its employment agreement with Matthew Medeiros. Under the terms of the revised agreement, the Company may be required to pay severance benefits of 24 months salary, bonus and accelerate stock options in the event of termination of Mr. Medeiros’s employment under certain circumstances, including a change of control. In addition, the Company has entered into agreements with certain other executives where the Company may be required to pay severance benefits up to 12 months of salary, bonuses and accelerate stock options in the event of termination of employment under certain circumstances, including a change of control. In 2005, the Company paid severance benefits to certain of its former executives in the amount of $270,000.

Legal Proceedings

      On December 5, 2001, a securities class action complaint was filed in the U.S. District Court for the Southern District of New York against the Company, three of its officers and directors, and certain of the underwriters in the Company’s initial public offering in November 1999 and its follow-on offering in March 2000. Similar complaints were filed in the same court against numerous public companies that conducted initial public offerings (“IPOs”) of their common stock since the mid-1990s. All of these lawsuits were consolidated for pretrial purposes before Judge Shira Scheindlin. On April 19, 2002, plaintiffs filed an amended complaint. The amended complaint alleges claims under the Securities Act of 1933 and the Securities Exchange Act of 1934, and seeks damages or rescission for misrepresentations or omissions in the prospectuses relating to, among other things, the alleged receipt of excessive and undisclosed commissions by the underwriters in connection with the allocation of shares of common stock in the Company’s public offerings. On July 15, 2002, the issuers filed an omnibus motion to dismiss for failure to comply with applicable pleading standards. On October 8, 2002, the Court entered an Order of Dismissal as to all of the individual defendants in the SonicWALL IPO litigation, without prejudice. On February 19, 2003, the Court denied the motion to dismiss the Company’s claims. A tentative agreement has been reached with plaintiff’s counsel and the insurers for the settlement and release of claims against the issuer defendants, including SonicWALL, in exchange for a guaranteed recovery to be paid by the issuer defendants’ insurance carriers and an assignment of certain claims. Papers formalizing the settlement among the plaintiffs, issuer defendants, including SonicWALL, and insurers were presented to the Court on September 14, 2004. The settlement is subject to a number of conditions, including approval of the proposed settling parties and the Court. On July 14, 2004, underwriter defendants filed with the Court a memorandum in opposition to plaintiff’s motion for preliminary approval of the settlement with defendant issuers and individuals. Plaintiffs and issuers subsequently filed papers with the Court in further support of the settlement and addressing issues raised in the underwriter’s opposition. On February 15, 2005 the Court granted preliminary approval of the settlement, subject to the parties fulfilling certain conditions. To address the concerns raised by the Court, the parties submitted revised settlement documents that contained a more limited “bar order” that would not preclude claims by the underwriters for indemnification for an issuer pursuant to the IPO underwriting agreement. On August 31, 2005, the Court entered an order confirming its preliminary approval of the settlement. The Court has scheduled a hearing on the fairness of the settlement to the shareholder class for April 24, 2006. If the settlement does not occur, and litigation against the Company continues, the Company believes it has a meritorious defense and intends to defend the case vigorously. No estimate can be made of the possible loss or possible range of loss, if any, associated with the resolution of this contingency. As a result, no loss has been accrued in the Company’s financial statements as of December 31, 2005.

      In September 2003, Data Centered LLC filed a complaint against the Company in California Superior Court, Santa Clara County seeking compensatory and punitive damages, Data Centered LLC v. SonicWall, Inc., No. 103-CV-000060. The Company entered into a transaction with Data Centered for a technology license for, and the sale of load-balancing products for $522,500. The Company had acquired the load-

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

balancing technology and products during the Company’s acquisition of Phobos Corporation. Former Phobos personnel operate Data Centered. Data Centered alleged that the load-balancing products purchased by Data Centered were defective and did not comply with a purported warranty on the products. The Company answered with a general denial of these allegations. The Company also filed a cross-complaint alleging, among other things, that Data Centered’s claims were based on a fraudulently altered document that included a warranty clause that was not part of the parties’ contract; the actual contract between the parties contained a warranty disclaimer. On March 25, 2005, the parties reached an agreement in principle requiring a formal settlement agreement under which the Company agreed to pay to DataCentered the sum of $103,500 and the parties agree to a full and complete release of claims and to dismiss all complaints against the other with prejudice. A formal settlement agreement was executed and on April 19, 2005, a Notice of Settlement was filed with the California Superior Court, Santa Clara County. The settlement amount of $103,500 was paid during the second quarter ended June 30, 2005. As a result, no loss has been accrued in the Company’s financial statements as of December 31, 2005.

      On March 23, 2005, Watchguard Technologies, Inc. (“Watchguard”) filed a complaint captioned Watchguard Technologies Inc., v. Michael N. Valentine and SonicWALL, Inc., No. 3-05CV0572-K, in the United States District Court for the Northern District of Texas. The Complaint seeks injunctive relief, compensatory and punitive damages in an amount in excess of the jurisdictional minimum, and cost of suit against its former employee, Michael N. Valentine, and the Company, his new employer, for purported misappropriation of Watchguard trade secrets and unfair competition. On April 28, 2005, the Company answered with a general denial of the allegations contained in the complaint. On November 9, 2005, Watchguard filed its Motion for Preliminary Injunction. On December 20, 2005, the Company filed its Response to Plaintiff’s Motion for Preliminary Injunction. This motion is currently before the Court. There is no schedule as to when the Court may rule on this Motion. Concurrently, the parties are proceeding with discovery in accordance with the scheduling order issued by the Court. The Company believes that it has meritorious defenses and intends to defend the case vigorously. No estimate can be made of the possible loss or possible range of loss, if any, associated with this resolution of this contingency. As a result, no loss has been accrued in the Company’s financial statements as of December 31, 2005.

      Additionally, the Company is party to routine litigation incident to its business. The Company believes that none of these legal proceedings will have a material adverse effect on the Company’s consolidated financial statements taken as a whole or its results of operations, financial position and cash flows.

Note 11 — Comprehensive Income (Loss):

      Comprehensive income (loss) includes unrealized gains on investment securities that have been reflected as a component of shareholders’ equity and have not affected net income (loss). The amount of income tax expense or benefit allocated to unrealized gains on investment securities is equivalent to the effective tax rate in each of the respective periods. Comprehensive income (loss) is comprised, net of tax, as follows (in thousands):

	Year Ended December 31,
	2005			2004			2003
Net income (loss)	$	6,276		$	( 313	)	$	(17,668	)
Change in unrealized (losses) on investment securities, net of tax benefit (expense)		(521	)		(808	)		(305	)
Comprehensive income (loss)	$	5,755		$	(1,121	)	$	(17,973	)

      Accumulated other comprehensive income (loss), as presented on the accompanying condensed consolidated balance sheets, consists of the unrealized gains and losses on available-for-sale securities.

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SONICWALL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 12 — Employee Benefits:

Pension Plan

      The Company has a defined contribution retirement plan covering substantially all of its eligible United States employees. The Company’s contribution to this plan is discretionary. For the years ended December 31, 2004 and 2003, the Company did not make any contributions to the plan.

      Effective January 1, 2005, the Company modified the terms of the defined contribution retirement plan to provide a discretionary matching contribution amount which is currently 50% of the employee contribution up to a maximum of $2,000 annually for each participant. All such employer contributions vest immediately. As a result, the Company has expensed approximately $471,000 during 2005.

Deferred Compensation Plan

      In June 2004, SonicWALL adopted a deferred compensation plan (DCP) to provide specified benefits to, and help retain, a select group of management and highly compensated employees and directors (Participants) who contribute materially to the Company’s continued growth, development and future business success. Under the DCP, Participants may defer up to 80% of their salary and up to 100% of their annual bonus and commission. Each Participant’s deferral account is credited with an amount equal to the net investment return of one or more equity or bond funds selected by the Participant. Amounts in a Participant’s deferral account represent an unsecured claim against the Company’s assets and are paid, pursuant to the Participant’s election, in a lump-sum or in quarterly installments at a specified date during the officer’s employment or upon the Participant’s termination of employment with the Company. The Company pays for the insurance coverage provided under this plan, but does not make any contributions to this plan. At December 31, 2005, the trust assets and the corresponding deferred compensation liabilities were $1,804,000 and $1,821,000, respectively, and are included in other current assets and other current liabilities, respectively.

Note 13 — Pending Business Combination

      On February 8, 2006, the Company announced a definitive agreement to acquire privately held MailFrontier, Inc. The aggregate announced purchase price for this acquisition was approximately $31 million in cash. This acquisition closed on February 22, 2006.

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ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

      None

ITEM 9A. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

      The Company, with the participation of our Chief Executive Officer (CEO), Chief Financial Officer (CFO), and Chief Accounting Officer (CAO), has evaluated the effectiveness of the design and operation of its disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of December 31, 2005. Based on the evaluation, the CEO, CFO and CAO have concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2005 for the information required to be disclosed in the reports we file or submit under the Exchange Act to be recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms and such information is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure.

Remediation of Prior Year Material Weaknesses

      For the fiscal year ended December 31, 2004, management had previously concluded that the Company did not maintain effective internal control over the application of certain generally accepted accounting principles within the financial reporting process because the Company lacked a sufficient complement of personnel with a level of financial reporting expertise commensurate with the Company’s financial reporting requirements. This material weakness contributed to the following individual material weaknesses: (i) the Company improperly recognized revenue on certain transactions where delivery and transfer of title or the evidence of a final arrangement had not yet occurred; (ii) the Company did not properly account for certain lease transactions; and (iii) the Company failed to properly accrue its obligations for bonuses and commissions based on information known by management prior to the filing of the interim and annual financial statements during 2004. Control deficiencies associated with the failure to properly accrue its obligations for bonuses and commissions resulted in the restatement of the Company’s 2004 annual consolidated financial statements as described in Note 13 in this Form 10-K.

      Throughout 2005, management has taken the following actions to remediate the material weaknesses described above: (1) the implementation of a series of additional controls designed to provide greater assurance that revenue is recognized in accordance with generally accepted accounting principles; (2) increased scrutiny and review of non-routine transactions and accounting areas requiring higher levels of management judgment; and (3) added personnel with a level of financial expertise commensurate with the Company’s revenue recognition, general accounting and financial reporting requirements. During 2005, the Company successfully recruited a number of senior accounting professionals.

      With the implementation of the above measures and internal control testing procedures performed throughout 2005, the Company has improved its internal control over financial reporting. Management therefore concluded that the above referenced material weaknesses in internal control over financial reporting have been fully remediated as of December 31, 2005.

Changes in Internal Control over Financial Reporting

      During the fourth quarter ended December 31, 2005, there have not been any changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d — 15(f) under the Exchange Act) that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting, other than refinement and complete implementation of controls necessary to remediate the material weaknesses discussed above. As part of the Company’s ongoing process improvement and compliance efforts, the Company performed testing procedures on our internal controls deemed effective at December 31, 2004 and on our internal controls implemented during fiscal year 2005. The Company believes that its disclosure controls and procedures were operating effectively as of December 31, 2005.

88

Management Report on Internal Control over Financial Reporting

      Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). The management, under the supervision and with the participation of its CEO, CFO and CAO, assessed the effectiveness of our internal controls over financial reporting based on the criteria established in “Internal Control — Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Management’s assessment included evaluation of such elements as the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies and our overall control environment. This assessment is supported by testing and monitoring performed by our internal finance organization and our retained internal audit organization. Based upon the assessment performed, the management believes that, as of December 31, 2005, the Company’s internal control over financial reporting is effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles. We review with the Audit Committee of the Board of Directors on a regular basis our assessment of our internal controls over financial reporting including the evaluation of any changes in our internal control over financial reporting environment to determine if material changes have occurred.

      Armanino McKenna LLP, the independent registered public accounting firm that audited our financial statements included in this Annual Report on Form 10-K, has also audited our management’s assessment of the effectiveness of our internal control over financial reporting and independently assessed the effectiveness of internal control over financial reporting as of December 31, 2005. Armanino McKenna L.L.P. has issued an attestation report concurring with management’s assessment. This attestation report is included herein under Item 8.

PART III

ITEM 10. Directors and Executive Officers of the Registrant

      You will find information regarding our Directors, Code of Ethics and compliance with Section 16(a) of the Securities Exchange Act of 1934, in the sections entitled “Proposal 1 — Audit Committee, Audit Committee Financial Expert, Election of Directors,” “Code of Ethics” and “Section 16(a) Beneficial Ownership Reporting Compliance,” respectively, in the Proxy Statement which we will deliver to our shareholders in connection with our Annual Meeting of Shareholders to be held on June 9, 2006. We are incorporating the information contained in those sections of our Proxy Statement here by reference.

ITEM 11. Executive Compensation

      You will find this information in the section captioned “Executive Compensation and Other Matters,” which will appear in the Proxy Statement we will deliver to our shareholders in connection with our Annual Meeting of Shareholders to be held on June 9, 2006. We are incorporating the information contained in that section here by reference.

ITEM 12. Security Ownership of Certain Beneficial Owners and Management

      You will find this information in the section captioned “Security Ownership of Certain Beneficial Owners and Management” and “Executive Compensation and Other Matters,” which will appear in the Proxy Statement we will deliver to our shareholders in connection with our Annual Meeting of Shareholders to be held on June 9, 2006. We are incorporating the information contained in that section here by reference.

ITEM 13. Certain Relationships and Related Transactions

      You will find this information in the section captioned “Certain Relationships and Related Transactions,” which will appear in the Proxy Statement we will deliver to our shareholders in connection with our Annual

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Meeting of Shareholders to be held on June 9, 2006. We are incorporating the information contained in that section here by reference.

ITEM 14. Principal Accountant Fees and Services

      You will find this information in the section captioned “Principal Accountant Fees and Services,” which will appear in the Proxy Statement we will deliver to our shareholders in connection with our Annual Meeting of Shareholders to be held on June 9, 2006. We are incorporating the information contained in that section here by reference.

PART IV

ITEM 15. Exhibits and Financial Statement Schedules

      (a) The following documents are filed as part of this report:

      1. Financial Statements — See Index to Consolidated Financial Statements in Part II, Item 8.

      2. Financial Statement Schedules — Schedule II (Valuation and Qualifying Accounts) are included in this Annual Report on Form 10-K. All other financial statement schedules have been omitted because the information required is not applicable or is shown in the Consolidated Financial Statements or notes thereto.

      3. Exhibits —

Number			Description
	2	.1	Agreement and Plan of Merger and Reorganization, dated as of October 16, 2000, among Registrant, Pluto Acquisition Corp., Phobos Corporation, and GMS Capital Partners, L.P. (Incorporated by reference to Registrant’s Current Report on Form 8-K (File No. 000-27723) filed on November 27, 2000).
	2	.2	Amendment to Agreement and Plan of Merger dated as of November 6, 2000, by and among Registrant, Pluto Acquisition Corp., Phobos Corporation, and GMS Capital Partners, L.P. (Incorporated by reference to Registrant’s Current Report on Form 8-K (File No. 000-27723) filed on November 27, 2000).
	2	.3	Agreement and Plan of Merger and Reorganization, dated March 1, 2001, among Registrant, ITI Acquisition Corp., Ignyte Technology, Inc., and Jeff Stark. (Incorporated by reference to Registrant’s Registration Statement on Form S-3 (File No. 333-61168), filed on May 17, 2001).
	2	.4	Amendment No. 1 to the Agreement and Plan of Merger and Reorganization by and among Registrant, ITI Acquisition Corp., Ignyte Technology, Inc., and Jeff Stark, dated as of March 6, 2001. (Incorporated by reference to Registrant’s Registration Statement on Form S-3 (File No. 333-61168), filed on May 17, 2001).
	3	.1	Registrant’s Amended and Restated Articles of Incorporation (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
	3	.2*	Registrant’s Bylaws, as amended December 12, 2003.
	4	.1	Registrant’s specimen common stock certificate (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
	10	.1	Registrant’s 1994 Stock Option Plan, as amended to date (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
	10	.2	Form of Stock Option Agreement for Registrant’s 1994 Stock Option Plan (Incorporated by reference to the Registrant’s Filing on Schedule TO (File No. 005-58485), filed on January 9, 2003).

90

Number			Description
	10	.3	Registrant’s 1998 Stock Option Plan, as amended to date (Incorporated by reference to the Registrant’s 2000 Definitive Proxy Statement (File No. 000-27723), which was filed on November 7, 2001).
	10	.4	Form of Stock Option Agreement for Registrant’s 1998 Stock Option Plan (Incorporated by reference to the Registrant’s Filing on Schedule TO (File No. 005-58485), filed on January 9, 2003).
	10	.5	Registrant’s 1999 Employee Stock Purchase Plan (Incorporated by reference to the Registrant’s 2003 Definitive Proxy Statement (File No. 000-27723), which was filed on November 5, 2003).
	10	.6	Form of Stock Option Agreement under Phobos Corporation 1998 Stock Plan (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 (File No. 333-54976), filed on February 5, 2001).
	10	.7	Form of Stock Option Agreement under Phobos Corporation 1999 Stock Plan (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 (File No. 333-54976), filed on February 5, 2001).
	10	.8	RedCreek Communications, Inc. 2001 Stock Option Plan (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 (File No. 333-81492), filed on January 28, 2002).
	10	.9	Employment agreement dated June 21, 2003 between Registrant and Kathleen Fisher (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended June 30, 2003).
	10	.10	Registrant’s Form of Individual Compensation Arrangements (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 (File No. 333-81492), filed on January 28, 2002).
	10	.11	Form of Indemnification Agreement entered into by Registrant with each of its officers and directors (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended September 30, 2001, filed on November 14, 2001).
	10	.12	Loan and Security Agreement dated May 26, 1995 between Registrant and Comerica Bank (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
	10	.13++	Distribution Agreement dated February 9, 1999 between Registrant and Tech Data Product Management, Inc. (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
	10	.14++	Distribution Agreement dated July 5, 1998 between Registrant and Sumitomo Metal Systems Development Co., Ltd. (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
	10	.15++	Distribution Agreement dated November 11, 1992 between Registrant and Ingram Micro, Inc. (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
	10	.16	Agreement of Sublease dated as of October 26, 1998 between Registrant and AMP Incorporated (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
	10	.17	Purchase Agreement dated September 28, 1999 between Registrant and Flash Electronics Inc. (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
	10	.18	Lease dated September 27, 1999 between Registrant, as Tenant, and AMB Property, L.P., as Landlord (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
	10	.19	First Amendment to Lease dated May 2, 2001 between Registrant, as Tenant, and AMB Property, L.P., as Landlord (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the fiscal year ended December 31, 2001).

91

Number			Description
	10	.20	Second Amendment to Lease dated September 26, 2001 between Registrant, as Tenant, and AMB Property, L.P., as Landlord (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the fiscal year ended December 31, 2001).
	10	.21++	OEM Hardware (with Software) License and Purchase Agreement effective as of May 29, 2001 between Registrant and Cisco Systems, Inc. (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the fiscal year ended December 31, 2001).
	10	.22++	Amendment Number One to OEM Hardware (with Software) License and Purchase Agreement dated June 25, 2002 between Registrant and Cisco Systems, Inc. (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended June 30, 2002).
	10	.23	Employment agreement dated March 14, 2003 between Registrant and Matthew Medeiros (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the fiscal year ended December 21, 2002.
	10	.24	Employment agreement dated August 11, 2003 between Registrant and Michael Stewart (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended September 30, 2003).
	10	.25	Employment agreement dated October 29, 2003 between Registrant and Robert Knauff (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the fiscal year ended December 31, 2003).
	10	.26	Manufacturing and Purchase Agreement dated June 4, 2004 by and between Flash Electronics, Inc. and SonicWALL, Inc. (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended June 30, 2004).
	10	.27	Third Amendment to Lease executed on April 28, 2004 by and between AMB Property, L.P., as Landlord, and SonicWALL, Inc. as Tenant. (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended June 30, 2004).
	10	.28	Retention and Severance Agreement for Executive Officers dated April 20, 2004. (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended June 30, 2004).
	10	.29	SonicWALL, Inc. Stock Option Agreement dated July 29, 2004 (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended September 30, 2004).
	10	.30	SonicWALL, Inc. Stock Option Agreement dated July 29, 2004 (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended September 30, 2004).
	10	.31	SonicWALL, Inc. Matthew Medeiros Employment Agreement as amended and restated July 29, 2004 (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended September 30, 2004).
	10	.32	SonicWALL, Inc Stock Option Agreement for Outside Directors dated July 29, 2004 (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended September 30, 2004).
	10	.33	SonicWALL, Inc. Stock Option Agreement dated July 29, 2004 (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended September 30, 2004).
	10	.34	Issuer Repurchase Plan Agreement dated November 29, 2004 between SonicWALL, Inc. and RBC Dain Rauscher Inc. (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the year ended December 31, 2004).
	10	.35	Amended and Restated Issuer Repurchase Plan Agreement dated February 15, 2005 between SonicWALL, Inc. and RBC Dain Rauscher Inc. (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the year ended December 31, 2004).
	10	.36*	Agreement and Plan of Merger and Reorganization, dated November 18, 2005, by and among the Registrant, Spectrum Acquisition Corporation and Lasso Logic, Inc., et al.

92

Number			Description
	21		Subsidiaries (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the fiscal year ended December 31, 2001).
	23	.1*	Consent of Independent Registered Public Accounting Firm
	23	.2*	Consent of Independent Registered Public Accounting Firm
	31	.1*	Certification of Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-15(e) and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	31	.2*	Certification of Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-15(e) and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	32	.1*	Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

* Filed herewith.

++  Confidential treatment has been obtained or requested for portions of this exhibit. The omitted material has been separately filed with the Securities and Exchange Commission.

      (b) Exhibits

      See Item 15(a) (3) above.

      (c) Financial Statement Schedules

      See Item 15(a) (2) above.

93

SIGNATURES

      Pursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Sunnyvale, State of California. Date: March 15, 2006

SONICWALL, INC.

By:  /s/ Matthew Medeiros

Matthew Medeiros

Chief Executive Officer

      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 in the capacities and on the dates indicated.

Signature	Title	Date
/s/ Matthew Medeiros Matthew Medeiros	President, Chief Executive Officer and Director (Principal Executive Officer)	March 15, 2006
/s/ Robert Selvi Robert Selvi	Chief Financial Officer (Principal Financial Officer)	March 15, 2006
/s/ Robert Knauff Robert Knauff	Chief Accounting Officer (Principal Accounting Officer)	March 15, 2006
/s/ Charles Kissner Charles Kissner	Chairman of the Board of Directors	March 15, 2006
/s/ Charles Berger Charles Berger	Director	March 15, 2006
/s/ David W. Garrison David W. Garrison	Director	March 15, 2006
/s/ Keyur A. Patel Keyur A. Patel	Director	March 15, 2006
/s/ John C. Shoemaker John C. Shoemaker	Director	March 15, 2006
/s/ Edward F. Thompson Edward F. Thompson	Director	March 15, 2006
/s/ Cary Thompson Cary Thompson	Director	March 15, 2006

94

Schedule II

VALUATION AND QUALIFYING ACCOUNTS

		Balance at				Charged to			Deductions/			Balance
		Beginning				Cost and			Write-off of			at End
		of Year		Other		Expenses			Accounts			of Year
		(In thousands)
Year ended December 31, 2003
	Allowance for doubtful accounts	$	1,397		—	$	(575	)	$	(373	)	$	449
	Inventory reserves		3,222		—		2,627			(4,358	)		1,491
Year ended December 31, 2004
	Allowance for doubtful accounts		449		—		(104	)		(157	)		188
	Inventory reserves		1,491		—		712			(1,026	)		1,177
Year ended December 31, 2005
	Allowance for doubtful accounts		188		—		27			(92	)		123
	Inventory reserves		1,177		—		171			(283	)		1,065

95

EXHIBIT INDEX

Number			Description
	2	.1	Agreement and Plan of Merger and Reorganization, dated as of October 16, 2000, among Registrant, Pluto Acquisition Corp., Phobos Corporation, and GMS Capital Partners, L.P. (Incorporated by reference to Registrant’s Current Report on Form 8-K (File No. 000-27723) filed on November 27, 2000).
	2	.2	Amendment to Agreement and Plan of Merger dated as of November 6, 2000, by and among Registrant, Pluto Acquisition Corp., Phobos Corporation, and GMS Capital Partners, L.P. (Incorporated by reference to Registrant’s Current Report on Form 8-K (File No. 000-27723) filed on November 27, 2000).
	2	.3	Agreement and Plan of Merger and Reorganization, dated March 1, 2001, among Registrant, ITI Acquisition Corp., Ignyte Technology, Inc., and Jeff Stark. (Incorporated by reference to Registrant’s Registration Statement on Form S-3 (File No. 333-61168), filed on May 17, 2001).
	2	.4	Amendment No. 1 to the Agreement and Plan of Merger and Reorganization by and among Registrant, ITI Acquisition Corp., Ignyte Technology, Inc., and Jeff Stark, dated as of March 6, 2001. (Incorporated by reference to Registrant’s Registration Statement on Form S-3 (File No. 333-61168), filed on May 17, 2001).
	3	.1	Registrant’s Amended and Restated Articles of Incorporation (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
	3	.2*	Registrant’s Bylaws, as amended December 12, 2003.
	4	.1	Registrant’s specimen common stock certificate (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
	10	.1	Registrant’s 1994 Stock Option Plan, as amended to date (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
	10	.2	Form of Stock Option Agreement for Registrant’s 1994 Stock Option Plan (Incorporated by reference to the Registrant’s Filing on Schedule TO (File No. 005-58485), filed on January 9, 2003).
	10	.3	Registrant’s 1998 Stock Option Plan, as amended to date (Incorporated by reference to the Registrant’s 2000 Definitive Proxy Statement (File No. 000-27723), which was filed on November 7, 2001).
	10	.4	Form of Stock Option Agreement for Registrant’s 1998 Stock Option Plan (Incorporated by reference to the Registrant’s Filing on Schedule TO (File No. 005-58485), filed on January 9, 2003).
	10	.5	Registrant’s 1999 Employee Stock Purchase Plan (Incorporated by reference to the Registrant’s 2003 Definitive Proxy Statement (File No. 000-27723), which was filed on November 5, 2003).
	10	.6	Form of Stock Option Agreement under Phobos Corporation 1998 Stock Plan (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 (File No. 333-54976), filed on February 5, 2001).
	10	.7	Form of Stock Option Agreement under Phobos Corporation 1999 Stock Plan (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 (File No. 333-54976), filed on February 5, 2001).
	10	.8	RedCreek Communications, Inc. 2001 Stock Option Plan (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 (File No. 333-81492), filed on January 28, 2002).
	10	.9	Employment agreement dated June 21, 2003 between Registrant and Kathleen Fisher (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended June 30, 2003).
	10	.10	Registrant’s Form of Individual Compensation Arrangements (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 (File No. 333-81492), filed on January 28, 2002).

Number			Description
	10	.11	Form of Indemnification Agreement entered into by Registrant with each of its officers and directors (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended September 30, 2001, filed on November 14, 2001).
	10	.12	Loan and Security Agreement dated May 26, 1995 between Registrant and Comerica Bank (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
	10	.13++	Distribution Agreement dated February 9, 1999 between Registrant and Tech Data Product Management, Inc. (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
	10	.14++	Distribution Agreement dated July 5, 1998 between Registrant and Sumitomo Metal Systems Development Co., Ltd. (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
	10	.15++	Distribution Agreement dated November 11, 1992 between Registrant and Ingram Micro, Inc. (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
	10	.16	Agreement of Sublease dated as of October 26, 1998 between Registrant and AMP Incorporated (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
	10	.17	Purchase Agreement dated September 28, 1999 between Registrant and Flash Electronics Inc. (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
	10	.18	Lease dated September 27, 1999 between Registrant, as Tenant, and AMB Property, L.P., as Landlord (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
	10	.19	First Amendment to Lease dated May 2, 2001 between Registrant, as Tenant, and AMB Property, L.P., as Landlord (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the fiscal year ended December 31, 2001).
	10	.20	Second Amendment to Lease dated September 26, 2001 between Registrant, as Tenant, and AMB Property, L.P., as Landlord (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the fiscal year ended December 31, 2001).
	10	.21++	OEM Hardware (with Software) License and Purchase Agreement effective as of May 29, 2001 between Registrant and Cisco Systems, Inc. (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the fiscal year ended December 31, 2001).
	10	.22++	Amendment Number One to OEM Hardware (with Software) License and Purchase Agreement dated June 25, 2002 between Registrant and Cisco Systems, Inc. (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended June 30, 2002).
	10	.23	Employment agreement dated March 14, 2003 between Registrant and Matthew Medeiros (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the fiscal year ended December 21, 2002.
	10	.24	Employment agreement dated August 11, 2003 between Registrant and Michael Stewart (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended September 30, 2003).
	10	.25	Employment agreement dated October 29, 2003 between Registrant and Robert Knauff (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the fiscal year ended December 31, 2003).
	10	.26	Manufacturing and Purchase Agreement dated June 4, 2004 by and between Flash Electronics, Inc. and SonicWALL, Inc. (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended June 30, 2004).
	10	.27	Third Amendment to Lease executed on April 28, 2004 by and between AMB Property, L.P., as Landlord, and SonicWALL, Inc. as Tenant. (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended June 30, 2004).

Number			Description
	10	.28	Retention and Severance Agreement for Executive Officers dated April 20, 2004. (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended June 30, 2004).
	10	.29	SonicWALL, Inc. Stock Option Agreement dated July 29, 2004 (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended September 30, 2004).
	10	.30	SonicWALL, Inc. Stock Option Agreement dated July 29, 2004 (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended September 30, 2004).
	10	.31	SonicWALL, Inc. Matthew Medeiros Employment Agreement as amended and restated July 29, 2004 (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended September 30, 2004).
	10	.32	SonicWALL, Inc Stock Option Agreement for Outside Directors dated July 29, 2004 (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended September 30, 2004).
	10	.33	SonicWALL, Inc. Stock Option Agreement dated July 29, 2004 (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended September 30, 2004).
	10	.34	Issuer Repurchase Plan Agreement dated November 29, 2004 between SonicWALL, Inc. and RBC Dain Rauscher Inc. (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the year ended December 31, 2004).
	10	.35	Amended and Restated Issuer Repurchase Plan Agreement dated February 15, 2005 between SonicWALL, Inc. and RBC Dain Rauscher Inc. (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the year ended December 31, 2004).
	10	.36*	Agreement and Plan of Merger and Reorganization, dated November 18, 2005, by and among the Registrant, Spectrum Acquisition Corporation and Lasso Logic, Inc., et al.
	21		Subsidiaries (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the fiscal year ended December 31, 2001).
	23	.1*	Consent of Independent Registered Public Accounting Firm
	23	.2*	Consent of Independent Registered Public Accounting Firm
	31	.1*	Certification of Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-15(e) and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	31	.2*	Certification of Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-15(e) and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	32	.1*	Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

*  Filed herewith.

++  Confidential treatment has been obtained or requested for portions of this exhibit. The omitted material has been separately filed with the Securities and Exchange Commission.

EX-3.2

Exhibit 3.2

BYLAWS OF

SONICWALL, INC.

As Amended December 12, 2003

BYLAWS
OF
SONICWALL, INC.

TABLE OF CONTENTS

			Page
ARTICLE I OFFICES				1
	1.01	Principal Office		1
	1.02	Other Offices		1
ARTICLE II MEETINGS OF SHAREHOLDERS				1
	2.01	Place Of Meetings		1
	2.02	Annual Meetings Of Shareholders		1
	2.03	Special Meetings		2
	2.04	Notice Of Shareholders’ Meetings		2
	2.05	Manner Of Giving Notice; Affidavit Of Notice		2
	2.06	Quorum		3
	2.07	Adjourned Meeting And Notice Thereof		3
	2.08	Voting		4
	2.09	Waiver Of Notice Or Consent By Absent Shareholders		4
	2.10	Shareholder Action By Written Consent Without A Meeting		5
	2.11	Record Date For Shareholder Notice, Voting And Giving Consents		5
	2.12	Proxies		6
	2.13	Inspectors Of Election		6
	2.14	Advance Notice Of Shareholder Proposals And Director Nominations		7
ARTICLE III DIRECTORS				8
	3.01	Powers		8
	3.02	Number And Qualification Of Directors		9
	3.03	Election And Term Of Office Of Directors		9
	3.04	Vacancies		9
	3.05	Place Of Meetings And Telephonic Meetings		10
	3.06	Annual Meetings		10
	3.07	Other Regular Meetings		10
	3.08	Special Meetings		10
	3.09	Quorum		11
	3.10	Waiver of Notice		11
	3.11	Adjournment		11
	3.12	Notice of Adjournment		11
	3.13	Action Without Meeting		11
	3.14	Fees and Compensation of Directors		12

-i-

TABLE OF CONTENTS
(Continued)

			Page
ARTICLE IV COMMITTEES				12
	4.01	Committees of Directors		12
	4.02	Meetings and Action of Committees		13
	4.03	Compensation Committee		13
ARTICLE V OFFICERS				13
	5.01	Officers		13
	5.02	Election of Officers		14
	5.03	Subordinate Officers, Etc		14
	5.04	Removal and Resignation of Officers		14
	5.05	Vacancies in Offices		14
	5.06	Chairman of the Board		14
	5.07	President		14
	5.08	Vice Presidents		15
	5.09	Secretary		15
	5.10	Chief Financial Officer		15
ARTICLE VI INDEMNIFICATION OF DIRECTORS, OFFICERS, EMPLOYEES AND OTHER AGENTS				16
	6.01	Indemnification of Directors and Officers		16
	6.02	Indemnification of Others		16
	6.03	Advance of Expenses		16
	6.04	Other Contractual Rights		17
	6.05	Limitations		17
	6.06	Insurance		17
	6.07	Fiduciaries of Corporate Employee Benefit Plans		17
	6.08	Other Indemnification		18
ARTICLE VII RECORDS AND REPORTS				18
	7.01	Maintenance and Inspection of Share Register		18
	7.02	Maintenance and Inspection of Bylaws		18
	7.03	Maintenance and Inspection of Other Corporate Records		19
	7.04	Inspection by Directors		19
	7.05	Annual Report to Shareholders		19
	7.06	Financial Statements		20
	7.07	Annual Statement of General Information		20
ARTICLE VIII CORPORATE LOANS AND GUARANTEES				21
	8.01	Shareholder Approval		21
	8.02	Board Approval		21

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TABLE OF CONTENTS
(Continued)

			Page
ARTICLE IX GENERAL CORPORATE MATTERS				21
	9.01	Record Date for Purposes Other Than Notice and Voting		21
	9.02	Checks, Drafts, Evidences of Indebtedness		22
	9.03	Corporate Contracts and Instruments; How Executed		22
	9.04	Certificates for Shares		22
	9.05	Lost Certificates		22
	9.06	Representation of Shares of Other Corporations		23
	9.07	Construction and Definitions		23
ARTICLE X AMENDMENTS				23
	10.01	Amendment By Shareholders		23
	10.02	Amendment By Directors		23

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BYLAWS

OF

SONICWALL, INC.

ARTICLE I

OFFICES

     1.01   PRINCIPAL OFFICE

     The Board of Directors shall fix the location of the principal executive office of the corporation at any place within or outside the State of California. If the principal executive office is located outside this state, and the corporation has one or more business offices in this state, the Board of Directors shall likewise fix and designate a principal business office in the State of California.

     1.02   OTHER OFFICES

     The Board of Directors may at any time establish branch or subordinate offices at any place or places where the corporation is qualified to do business.

ARTICLE II

MEETINGS OF SHAREHOLDERS

     2.01   PLACE OF MEETINGS

     Meetings of shareholders shall be held at any place within or outside the State of California designated by the Board of Directors. In the absence of any such designation, shareholders’ meetings shall be held at the principal executive office of the corporation.

     2.02   ANNUAL MEETINGS OF SHAREHOLDERS

     The annual meeting of shareholders shall be held each year on a date and at a time designated by the Board of Directors. At each annual meeting directors shall be elected, and any other proper business may be transacted.

     2.03   SPECIAL MEETINGS

     A special meeting of the shareholders may be called at any time by the Board of Directors, or by the Chairman of the Board, or by the President, or by one or more shareholders holding shares in the aggregate entitled to cast not less than ten percent (10%) of the votes at any such meeting.

     If a special meeting is called by any person or persons other than the Board of Directors, the request shall be in writing, specifying the time of such meeting and the general nature of the business proposed to be transacted, and shall be delivered personally or sent by registered mail or by telegraphic or other facsimile transmission to the Chairman of the Board, the President, any Vice President or the Secretary of the corporation. The officer receiving such request forthwith shall cause notice to be given to the shareholders entitled to vote, in accordance with the provisions of Sections 2.04 and 2.05, that a meeting will be held at the time requested by the person or persons calling the meeting, not less than thirty-five (35) nor more than sixty (60) days after the receipt of the request. If the notice is not given within twenty (20) days after receipt of the request, the person or persons requesting the meeting may give the notice. Nothing contained in this paragraph of this Section 2.03 shall be construed as limiting, fixing or affecting the time when a meeting of shareholders called by action of the Board of Directors may be held.

     2.04   NOTICE OF SHAREHOLDERS’ MEETINGS.

     All notices of meetings of shareholders shall be sent or otherwise given in accordance with Section 2.05 not less than ten (10) nor more than sixty (60) days before the date of the meeting being noticed. The notice shall specify the place, date and hour of the meeting and (i) in the case of a special meeting, the general nature of the business to be transacted, or (ii) in the case of the annual meeting those matters which the Board of Directors, at the time of giving the notice, intends to present for action by the shareholders. The notice of any meeting at which directors are to be elected shall include the name of any nominee or nominees which, at the time of the notice, management intends to present for election.

     If action is proposed to be taken at any meeting for approval of (i) a contract or transaction in which a director has a direct or indirect financial interest, pursuant to Section 310 of the Corporations Code of California, (ii) an amendment of the Articles of Incorporation, pursuant to Section 902 of such Code, (iii) a reorganization of the corporation, pursuant to Section 1201 of such Code, (iv) a voluntary dissolution of the corporation, pursuant to Section 1900 of such Code, or (v) a distribution in dissolution other than in accordance with the rights of outstanding preferred shares pursuant to Section 2007 of such Code, the notice shall also state the general nature of such proposal.

     2.05   MANNER OF GIVING NOTICE; AFFIDAVIT OF NOTICE

     Notice of any meeting of shareholders shall be given either personally or by first-class mail or telegraphic or other written communication, charges prepaid, addressed to the shareholder at the address of such shareholder appearing on the books of the corporation or given by the shareholder to the corporation for the purpose of notice. If no such address appears on the corporation’s books or

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has been so given, notice shall be deemed to have been given if sent by first-class mail or telegraphic or other written communication to the corporation’s principal executive office, or if published at least once in a newspaper of general circulation in the county where such office is located. Notice shall be deemed to have been given at the time when delivered personally or deposited in the mail or sent by telegram or other means of written communication.

     If any notice addressed to a shareholder at the address of such shareholder appearing on the books of the corporation is returned to the corporation by the United States Postal Service marked to indicate that the United States Postal Service is unable to deliver the notice to the shareholder at such address, all future notices or reports shall be deemed to have been duly given without further mailing if the same shall be available to the shareholder upon written demand of the shareholder at the principal executive office of the corporation for a period of one (1) year from the date of the giving of such notice.

     An affidavit of the mailing or other means of giving any notice of any shareholders’ meeting shall be executed by the Secretary, Assistant Secretary or any transfer agent of the corporation giving such notice, and shall be filed and maintained in the minute book of the corporation.

     2.06   QUORUM

     The presence in person or by proxy of the holders of a majority of the shares entitled to vote at any meeting of shareholders shall constitute a quorum for the transaction of business. The shareholders present at a duly called or held meeting at which a quorum is present may continue to do business until adjournment, notwithstanding the withdrawal of enough shareholders to leave less than a quorum, if any action taken (other than adjournment) is approved by at least a majority of the shares required to constitute a quorum.

     2.07   ADJOURNED MEETING AND NOTICE THEREOF

     Any shareholders’ meeting, annual or special, whether or not a quorum is present, may be adjourned from time to time by the vote of the majority of the shares represented at such meeting, either in person or by proxy, but in the absence of a quorum, no other business may be transacted at such meeting, except as provided in Section 2.06.

     When any meeting of shareholders, either annual or special, is adjourned to another time or place, notice need not be given of the adjourned meeting if the time and place thereof are announced at a meeting at which the adjournment is taken, unless a new record date for the adjourned meeting is fixed, or unless the adjournment is for more than forty-five (45) days from the date set for the original meeting, in which case the Board of Directors shall set a new record date. Notice of any such adjourned meeting, if required, shall be given to each shareholder of record entitled to vote at the adjourned meeting in accordance with the provisions of Sections 2.04 and 2.05. At any adjourned meeting, the corporation may transact any business which might have been transacted at the original meeting.

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     2.08   VOTING

     The shareholders entitled to vote at any meeting of shareholders shall be determined in accordance with the provisions of Section 2.11, subject to the provisions of Sections 702 and 704, inclusive, of the Corporations Code of California (relating to voting shares held by a fiduciary, in the name of a corporation or in joint ownership). Such vote may be by voice vote or by ballot; provided, however, that all elections for directors must be by ballot upon demand by a shareholder at any election and before the voting begins. Any shareholder entitled to vote on any matter (other than the election of directors) may vote part of the shares in favor of the proposal and refrain from voting the remaining shares or vote them against the proposal, but, if the shareholder fails to specify the number of shares such shareholder is voting affirmatively, it will be conclusively presumed that the shareholder’s approving vote is with respect to all shares such shareholder is entitled to vote. If a quorum is present, the affirmative vote of the majority of the shares represented at the meeting and entitled to vote on any matter (other than the election of directors) shall be the act of the shareholders, unless the vote of a greater number or voting by classes is required by the California General Corporation Law or the Articles of Incorporation.

     At a shareholders’ meeting involving the election of directors, no shareholder shall be entitled to cumulate votes (i.e., cast for any one or more candidates a number of votes greater than the number of the shareholder’s shares) unless such candidate or candidates’ names have been placed in nomination prior to commencement of the voting and a shareholder has given notice prior to commencement of the voting of the shareholder’s intention to cumulate votes. If any shareholder has given such notice, then every shareholder entitled to vote may cumulate such shareholder’s votes for candidates in nomination and give one candidate a number of votes equal to the number of directors to be elected multiplied by the number of votes to which such shareholder’s shares are entitled, or distribute the shareholder’s votes on the same principle among any or all of the candidates, as the shareholder thinks fit. The candidates receiving the highest number of votes, up to the number of directors to be elected, shall be elected. On and after the date upon which this corporation becomes a “listed corporation” as defined in Section 301.5 of the Corporations Code of California, cumulative voting shall no longer be available to the shareholders and the immediately preceding paragraph shall no longer be applicable.

     2.09   WAIVER OF NOTICE OR CONSENT BY ABSENT SHAREHOLDERS

     The transactions of any meeting of shareholders, either annual or special, however called and noticed, and wherever held, shall be as valid as though had at a meeting duly held after regular call and notice, if a quorum be present either in person or by proxy, and if, either before or after the meeting, each person entitled to vote, not present in person or by proxy, signs a written waiver of notice or a consent to a holding of the meeting, or an approval of the minutes thereof. The waiver of notice or consent need not specify either the business to be transacted or the purpose of any annual or special meeting of shareholders, except that if action is taken or proposed to be taken for approval of any of those matters specified in the second paragraph of Section 2.04, the waiver of notice or consent shall state the general nature of such proposal. All such waivers, consents or approvals shall be filed with the corporate records or made a part of the minutes of the meeting.

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     Attendance of a person at a meeting shall also constitute a waiver of notice of such meeting, except when the person objects, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened, and except that attendance at the meeting is not a waiver of any right to object to the consideration of matters not included in the notice of the meeting if such objection is expressly made at the meeting.

     2.10    SHAREHOLDER ACTION BY WRITTEN CONSENT WITHOUT A MEETING

     Any action which may be taken at any annual or special meeting of shareholders may be taken without a meeting and without prior notice, if a consent in writing, setting forth the action so taken, is signed by the holders of outstanding shares having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted. In the case of election of directors, such consent shall be effective only if signed by the holders of all outstanding shares entitled to vote for the election of directors; provided, however, that a director may be elected at any time to fill a vacancy not filled by the directors by the written consent of the holders of a majority of the outstanding shares entitled to vote for the election of directors. All such consents shall be filed with the Secretary of the corporation and shall be maintained in the corporate records. Any shareholder giving a written consent, or the shareholder’s proxy holders, or a transferee of the shares or a personal representative of the shareholder or their respective proxy holder, may revoke the consent by a writing received by the Secretary of the corporation prior to the time that written consents of the number of shares required to authorize the proposed action have been filed with the Secretary.

     If the consents of all shareholders entitled to vote have not been solicited in writing, and if the unanimous written consent of all such shareholders shall not have been received, the secretary shall give prompt notice of the corporate action approved by the shareholders without a meeting. Such notice shall be given in the manner specified in Section 2.05. In the case of approval of (i) contracts or transactions in which a director has a direct or indirect financial interest, pursuant to Section 310 of the Corporations Code of California, (ii) indemnification of agents of the corporation, pursuant to Section 317 of such Code, (iii) a reorganization of the corporation, pursuant to Section 1201 of such Code, or (iv) a distribution in dissolution other than in accordance with the rights of outstanding preferred shares pursuant to Section 2007 of such Code, such notice shall be given at least ten (10) days before the consummation of any such action authorized by any such approval. On and after the date upon which this corporation becomes a “listed corporation” as defined in Section 301.5 of the Corporations Code of California, this Section 2.10 shall be deleted in its entirety.

     2.11    RECORD DATE FOR SHAREHOLDER NOTICE, VOTING AND GIVING CONSENTS

     For purposes of determining the shareholders entitled to notice of any meeting or to vote or entitled to give consent to corporate action without a meeting, the Board of Directors may fix, in advance, a record date, which shall not be more than sixty (60) days nor less than ten (10) days prior to the date of any such meeting nor more than sixty (60) days prior to such action without a meeting, and in such case only shareholders of record on the date so fixed are entitled to notice and to vote or

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to give consents, as the case may be, notwithstanding any transfer of any shares of the books of the corporation after the record date fixed as aforesaid, except as otherwise provided in the California General Corporation Law.

     If the Board of Directors does not so fix a record date:

          (a) The record date for determining shareholders entitled to notice of or to vote at a meeting of shareholders shall be at the close of business on the business day next preceding the day on which notice is given or, if notice is waived, at the close of business on the business day next preceding the day on which the meeting is held.

          (b) The record date for determining shareholders entitled to give consent to corporate action in writing without a meeting, (i) when no prior action by the Board has been taken, shall be the day on which the first written consent is given, or (ii) when prior action of the Board has been taken, shall be at the close of business on the day on which the Board adopts the resolution relating thereto, or the sixtieth (60th) day prior to the date of such other action, whichever is later.

     2.12   PROXIES

     Every person entitled to vote for directors or on any other matter shall have the right to do so either in person or by one or more agents authorized by a written proxy signed by the person and filed with the Secretary of the corporation. A proxy shall be deemed signed if the shareholder’s name is placed on the proxy (whether by manual signature, typewriting, telegraphic transmission or otherwise) by the shareholder or the shareholder’s attorney-in- fact. A validly executed proxy which does not state that it is irrevocable shall continue in full force and effect unless (i) revoked by the person executing it, prior to the vote pursuant thereto, by a writing delivered to the corporation stating that the proxy is revoked or by a subsequent proxy executed by, or attendance at the meeting and voting in person by, the person executing the proxy; or (ii) written notice of the death or incapacity of the maker of such proxy is received by the corporation before the vote pursuant thereto is counted; provided, however, that no such proxy shall be valid after the expiration of eleven (11) months from the date of such proxy, unless otherwise provided in the proxy. The revocability of a proxy that states on its face that it is irrevocable shall be governed by the provisions of Section 705(e) and (f) of the Corporations Code of California.

     2.13   INSPECTORS OF ELECTION

     Before any meeting of shareholders, the Board of Directors may appoint any persons other than nominees for office to act as inspectors of election at the meeting or its adjournment. If no inspectors of election are so appointed, the chairman of the meeting may, and on the request of any shareholder or a shareholder’s proxy shall, appoint inspectors of election at the meeting. The number of inspectors shall be either one (1) or three (3). If inspectors are appointed at a meeting on the request of one or more shareholders or proxies, the holders of a majority of shares or their proxies present at the meeting shall determine whether one (1) or three (3) inspectors are to be appointed. If any person appointed as inspector fails to appear or fails or refuses to act, the chairman

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of the meeting may, and upon the request of any shareholder or a shareholder’s proxy shall, appoint a person to fill such vacancy.

     The duties of these inspectors shall be as follows:

          (a) Determine the number of shares outstanding and the voting power of each, the shares represented at the meeting, the existence of a quorum, and the authenticity, validity and effect of proxies;

          (b) Receive votes, ballots or consents;

          (c) Hear and determine all challenges and questions in any way arising in connection with the right to vote;

          (d) Count and tabulate all votes or consents;

          (e) Determine when the polls shall close;

          (f) Determine the result; and

          (g) Do any other acts that may be proper to conduct the election or vote with fairness to all shareholders.

     2.14   ADVANCE NOTICE OF SHAREHOLDER PROPOSALS AND DIRECTOR NOMINATIONS

     Shareholders may nominate one or more persons for elections as directors at a meeting of shareholders or propose business to be brought before a meeting of shareholders, or both, only if such shareholder has given timely notice in proper written form of such shareholder’s intent to make such nomination or nominations or to propose such business. To be timely, a shareholder’s notice must be received by the Secretary of the Corporation not later than sixty (60) days prior to such meeting; provided, however, that in the event less than seventy (70) days’ notice or prior public disclosure of the date of the meeting is given or made to shareholders, notice by such shareholder to be timely must be so received not later than the close of business on the 10th day following the day on which such notice of the date of the meting was mailed or such public disclosure was made. To be in proper written form a shareholder’s notice to the Secretary shall set forth (i) the name and address of the shareholder who intends to make the nominations or propose the business and, as the case may be, of the person or persons to be nominated or of the business to be proposed, (ii) a representation that the shareholder is a holder of record of stock of the corporation that intends to vote such stock at such meeting and, if applicable, intends to appear in person or by proxy at the meeting to nominate the person or persons specified in the notice, (iii) if applicable, a description of all arrangements or understandings between the shareholder and each nominee or any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by the shareholder, (iv) such other information regarding each nominee or each matter of business to be proposed by such shareholder as would be required to be included in a proxy

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statement filed pursuant to Regulation 14A promulgated by the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934 had the nominee been nominated, or intended to be nominated, or the matter been proposed, or intended to be proposed, by the Board of Directors of the Corporation and (v) if applicable, the consent of each nominee as director of the corporation if so elected. The chairman of a meeting of shareholders may refuse to acknowledge the nomination of any person or the proposal of any business not made in compliance with the foregoing procedure.

ARTICLE III

DIRECTORS

     3.01    POWERS

     Subject to the provisions of the California General Corporation Law and any limitations in the Articles of Incorporation and these Bylaws relating to action required to be approved by the shareholders or by the outstanding shares, the business and affairs of the corporation shall be managed and all corporate powers shall be exercised by or under the direction of the Board of Directors.

     Without prejudice to such general powers, but subject to the same limitations, it is hereby expressly declared that the directors shall have the power and authority to:

          (a) Select and remove all officers, agents and employees of the corporation, prescribe such powers and duties for them as may not be inconsistent with law, the Articles of Incorporation or these Bylaws, fix their compensation and require from them security for faithful service.

          (b) Change the principal executive office or the principal business office in the State of California from one location to another; cause the corporation to be qualified to do business in any other state, territory, dependency or foreign country and conduct business within or outside the State of California; designate any place within or without the state for the holding of any shareholders’ meeting or meetings, including annual meetings; adopt, make and use a corporate seal, and prescribe the forms of certificates of stock, and alter the form of such seal and of such certificates from time to time as in their judgment they may deem best, provided that such forms shall at all times comply with the provisions of law.

          (c) Authorize the issuance of shares of stock of the corporation from time to time, upon such terms as may be lawful, in consideration of money paid, labor done or services actually rendered, debts or securities cancelled or tangible or intangible property actually received.

          (d) Borrow money and incur indebtedness for the purposes of the corporation, and cause to be executed and delivered therefor, in the corporate name, promissory notes, bonds, debentures, deeds of trust, mortgages, pledges, hypothecations or other evidences of debt and securities therefor.

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     3.02   NUMBER AND QUALIFICATION OF DIRECTORS

     The authorized number of directors of the corporation shall be not less than five (5) nor more than nine (9). The exact number of directors shall be set forth from time to time within the limits specified above, by a resolution setting forth such exact number duly adopted by the Board of Directors or approved by the shareholders (as set forth in Section 153 of the California Corporations Code). The minimum and maximum number of directors may be changed, or a definite number may be fixed without provision for an indefinite number, by an amendment to the Articles of Incorporation or by an amendment to this Bylaw duly adopted by vote or written consent of holders of a majority of the outstanding shares entitled to vote. No amendment may change the stated maximum number of authorized directors to a number greater than two (2) times the stated minimum number of authorized directors minus one (1).

     3.03   ELECTION AND TERM OF OFFICE OF DIRECTORS

     Directors shall be elected at each annual meeting of the shareholders to hold office until the next annual meeting. Each director, including a director elected to fill a vacancy, shall hold office until the expiration of the term for which elected and until a successor has been elected and qualified.

     3.04   VACANCIES

     Vacancies in the Board of Directors may be filled by approval of the Board or, if the number of directors then in office is less than a quorum, by (i) the unanimous written consent of the directors then in office, (ii) the affirmative vote of a majority of the directors then in office at a meeting held pursuant to notice or waivers of notice complying with Section 307 or (iii) a sole remaining director, except that a vacancy created by the removal of a director by the vote or written consent of the shareholders or by court order may be filled only by the vote of a majority of the shares entitled to vote represented at a duly held meeting at which a quorum is present, or by the written consent of holders of a majority of the outstanding shares entitled to vote. Each director so elected shall hold office until the next annual meeting of the shareholders and until a successor has been elected and qualified.

     A vacancy or vacancies in the Board of Directors shall be deemed to exist in the case of the death, resignation or removal of any director, or if the Board of Directors by resolution declares vacant the office of a director who has been declared of unsound mind by an order of court or convicted of a felony, or if the authorized number of directors be increased, or if the shareholders fail, at any meeting of shareholders at which any director or directors are elected, to elect the full authorized number of directors to be voted for at that meeting.

     The shareholders may elect a director or directors at any time to fill any vacancy or vacancies not filled by the directors, but any such election by written consent shall require the consent of a majority of the outstanding shares entitled to vote.

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     Any director may resign upon giving written notice to the Chairman of the Board, the President, the Secretary or the Board of Directors. A resignation shall be effective upon the giving of the notice, unless the notice specifies a later time for its effectiveness. If the resignation of a director is effective at a future time, the Board of Directors may elect a successor to take office when the resignation becomes effective.

     No reduction of the authorized number of directors shall have the effect of removing any director prior to the expiration of his term of office.

     3.05    PLACE OF MEETINGS AND TELEPHONIC MEETINGS

     Regular meetings of the Board of Directors may be held at any place within or without the State that has been designated from time to time by resolution of the Board. In the absence of such designation, regular meetings shall be held at the principal executive office of the corporation. Special meetings of the Board shall be held at any place within or without the State that has been designated in the notice of the meeting or, if not stated in the notice or if there is no notice, at the principal executive office of the corporation. Any meeting, regular or special, may be held by conference telephone or similar communication equipment, so long as all directors participating in such meeting can hear one another, and all such directors shall be deemed to be present in person at such meeting.

     3.06   ANNUAL MEETINGS

     Immediately following each annual meeting of shareholders, the Board of Directors shall hold a regular meeting for the purpose of organization, any desired election of officers and the transaction of other business. Notice of this meeting shall not be required.

     3.07   OTHER REGULAR MEETINGS

     Other regular meetings of the Board of Directors shall be held without call at such time as shall from time to time be fixed by the Board of Directors. Such regular meetings may be held without notice.

     3.08    SPECIAL MEETINGS

     Special meetings of the Board of Directors for any purpose or purposes may be called at any time by the Chairman of the Board or the President or any Vice President or Secretary or any two (2) directors.

     Notice of the time and place of special meetings shall be delivered personally or by telephone to each director or sent by first-class mail or telegram, charges prepaid, addressed to each director at his or her address as it is shown upon the records of the corporation. In case such notice is mailed, it shall be deposited in the United States mail at least four (4) days prior to the time of the holding of the meeting. In case such notice is delivered personally, or by telephone or telegram, it shall be delivered personally or by telephone or to the telegraph company at least forty-eight (48) hours prior

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to the time of the holding of the meeting. Any oral notice given personally or by telephone may be communicated to either the director or to a person at the office of the director who the person giving the notice has reason to believe will promptly communicate it to the director. The notice need not specify the purpose of the meeting or the place if the meeting is to be held at the principal executive office of the corporation.

     3.09   QUORUM

     A majority of the authorized number of directors shall constitute a quorum for the transaction of business, except to adjourn as hereinafter provided. Every act or decision done or made by a majority of the directors present at a meeting duly held at which a quorum is present shall be regarded as the act of the Board of Directors, subject to the provisions of Section 310 of the Corporations Code of California (approval of contracts or transactions in which a director has a direct or indirect material financial interest), Section 311 (appointment of committees), and Section 317(e) (indemnification of directors). A meeting at which a quorum is initially present may continue to transact business notwithstanding the withdrawal of directors, if any action taken is approved by at least a majority of the required quorum for such meeting.

     3.10   WAIVER OF NOTICE

     The transactions of any meeting of the Board of Directors, however called and noticed or wherever held, shall be as valid as though had at a meeting duly held after regular call and notice if a quorum be present and if, either before or after the meeting, each of the directors not present signs a written waiver of notice, a consent to holding the meeting or an approval of the minutes thereof. The waiver of notice or consent need not specify the purpose of the meeting. All such waivers, consents and approvals shall be filed with the corporate records or made a part of the minutes of the meeting. Notice of a meeting shall also be deemed given to any director who attends the meeting without protesting, prior thereto or at its commencement, the lack of notice to such director.

     3.11   ADJOURNMENT

     A majority of the directors present, whether or not constituting a quorum, may adjourn any meeting to another time and place.

     3.12   NOTICE OF ADJOURNMENT

     Notice of the time and place of holding an adjourned meeting need not be given, unless the meeting is adjourned for more than twenty-four (24) hours, in which case notice of such time and place shall be given prior to the time of the adjourned meeting, in the manner specified in Section 3.08, to the directors who were not present at the time of the adjournment.

     3.13   ACTION WITHOUT MEETING

     Any action required or permitted to be taken by the Board of Directors may be taken without a meeting, if all members of the Board shall individually or collectively consent in writing to such

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action. Such action by written consent shall have the same force and effect as a unanimous vote of the Board of Directors. Such written consent or consents shall be filed with the minutes of the proceedings of the Board.

     3.14    FEES AND COMPENSATION OF DIRECTORS

     Directors and members of committees may receive such compensation, if any, for their services, and such reimbursement of expenses, as may be fixed or determined by resolution of the Board of Directors. Nothing herein contained shall be construed to preclude any director from serving the corporation in any other capacity as an officer, agent, employee or otherwise, and receiving compensation for such services.

ARTICLE IV

COMMITTEES

     4.01 COMMITTEES OF DIRECTORS

     The Board of Directors may, by resolution adopted by a majority of the authorized number of directors, designate one (1) or more committees, each consisting of two (2) or more directors, to serve at the pleasure of the Board. The Board may designate one (1) or more directors as alternate members of any committee, who may replace any absent member at any meeting of the committee. Any such committee, to the extent provided in the resolution of the Board, shall have all the authority of the Board, except with respect to:

          (a) the approval of any action which, under the General Corporation Law of California, also requires shareholders’ approval or approval of the outstanding shares;

          (b) the filling of vacancies on the Board of Directors or in any committee;

          (c) the fixing of compensation of the directors for serving on the Board or on any committee;

          (d) the amendment or repeal of Bylaws or the adoption of new Bylaws;

          (e) the amendment or repeal of any resolution of the Board of Directors which by its express terms is not so amendable or repealable;

          (f) a distribution to the shareholders of the corporation, except at a rate or in a periodic amount or within a price range determined by the Board of Directors; or

          (g) the appointment of any other committees of the Board of Directors or members thereof.

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     4.02   MEETINGS AND ACTION OF COMMITTEES

     Meetings and actions of committees shall be governed by, and held and taken in accordance with, the provisions of Article III of these Bylaws, Section 3.05 (place of meetings), 3.07 (regular meetings), 3.08 (special meetings and notice), 3.09 (quorum), 3.10 (waiver of notice), 3.11 (adjournment), 3.12 (notice of adjournment) and 3.13 (action without meeting), with such changes in the context of those Bylaws as are necessary to substitute the committee and its members for the Board of Directors and its members, except that the time of regular meetings of committees may be determined by resolution of the Board of Directors as well as the committee, special meetings of committees may also be called by resolution of the Board of Directors and notice of special meetings of committees shall also be given to all alternate members, who shall have the right to attend all meetings of the committee. The Board of Directors may adopt rules for the government of any committee not inconsistent with the provisions of these Bylaws.

     4.03   COMPENSATION COMMITTEE

     The Compensation Committee (the “Committee”) shall be designated by the Board of Directors. The Committee shall have exclusive power to set and approve the salaries and other compensation including, but not limited to any equity (including stock or stock options), to be paid or granted to any officer, director or Significant Shareholder (as defined in that certain Series A Preferred Stock Purchase Agreement dated as of February 19, 1999) of the corporation and shall consist of three non-employee directors of the Board as follows: one (1) non-employee director elected by the Series A Preferred shareholders pursuant to that certain Voting Agreement dated as of February 19, 1999, one (1) independent non-employee director and one (1) additional non-employee director of the corporation. The Committee’s actions and meeting shall be governed by Section 4.02 of these Bylaws. On and after the date upon which this corporation becomes a “listed corporation” as defined in Section 301.5 of the Corporation Code of California, this paragraph shall no longer be applicable.

ARTICLE V

OFFICERS

     5.01    OFFICERS

     The officers of the corporation shall be a President, a Secretary and Chief Financial Officer. The corporation may also have, at the discretion of the Board of Directors, a Chairman of the Board, one or more Vice Presidents, one or more Assistant Secretaries, one or more Assistant Treasurers and such other officers as may be appointed in accordance with the provisions of Section 5.03. Any number of offices may be held by the same person.

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     5.02   ELECTION OF OFFICERS

     The officers of the corporation, except such officers as may be appointed in accordance with the provisions of Section 5.03, shall be chosen by the Board of Directors, and each shall serve at the pleasure of the Board, subject to the rights, if any, of an officer under any contract of employment.

     5.03   SUBORDINATE OFFICERS, ETC.

     The Board of Directors may appoint, and may empower the President to appoint, such other officers as the business of the corporation may require, each of whom shall hold office for such period, have such authority and perform such duties as are provided in the Bylaws or as the Board of Directors may from time to time determine.

     5.04   REMOVAL AND RESIGNATION OF OFFICERS

     Subject to the rights, if any, of an officer under any contract of employment, any officer may be removed, either with or without cause, by the Board of Directors, at any regular or special meeting thereof, or, except in case of an officer chosen by the Board of Directors, by any officer upon whom such power of removal may be conferred by the Board of Directors.

     Any officer may resign at any time by giving written notice to the corporation. Any such resignation shall take effect at the date of the receipt of such notice or at any later time specified therein; and, unless otherwise specified therein, the acceptance of such resignation shall not be necessary to make it effective. Any such resignation is without prejudice to the rights, if any, of the corporation under any contract to which the officer is a party.

     5.05   VACANCIES IN OFFICES

     A vacancy in any office because of death, resignation, removal, disqualification or any other cause shall be filled in the manner prescribed in these Bylaws for regular appointments to such office.

     5.06   CHAIRMAN OF THE BOARD

     The Chairman of the Board, if such an officer be elected, shall, if present, preside at all meetings of the Board of Directors and exercise and perform such other powers and duties as may be from time to time assigned to him by the Board of Directors or prescribed by the Bylaws. If there is no President, the Chairman of the Board shall, in addition, be the Chief Executive Officer of the corporation and shall have the powers and duties prescribed in Section 5.07.

     5.07   PRESIDENT

     Subject to such supervisory powers, if any, as may be given by the Board of Directors to the Chairman of the Board, if there be such an officer, the President shall be the Chief Executive Officer of the corporation and shall, subject to the control of the Board of Directors, have general

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supervision, direction and control of the business and the officers of the corporation. He shall preside at all meetings of the shareholders and, in the absence of the Chairman of the Board, or if there be none, at all meetings of the Board of Directors. He shall have the general powers and duties of management usually vested in the office of President of a corporation, and shall have such other powers and duties as may be prescribed by the Board of Directors or the Bylaws.

     5.08   VICE PRESIDENTS

     In the absence or disability of the President, the Vice Presidents, if any, in order of their rank as fixed by the Board of Directors or, if not ranked, a Vice President designated by the Board of Directors, shall perform all the duties of the President, and when so acting shall have all the powers of, and be subject to all the restrictions upon, the President. The Vice Presidents shall have such other powers and perform such other duties as from time to time may be prescribed for them, respectively, by the Board of Directors or the Bylaws, the President or the Chairman of the Board if there is no President.

     5.09   SECRETARY

     The Secretary shall keep, or cause to be kept, at the principal executive office or such other place as the Board of Directors may order, a book of minutes of all meetings and actions of directors, committees of directors and shareholders, with the time and place of holding, whether regular or special, and, if special, how authorized, the notice thereof given, the names of those present at directors’ and committee meetings, the number of shares present or represented at shareholders’ meetings, and the proceedings thereof.

     The Secretary shall keep, or cause to be kept, at the principal executive office or at the office of the corporation’s transfer agent or registrar, as determined by resolution of the Board of Directors, a share register, or a duplicate share register, showing the names of all shareholders and their addresses, the number and classes of shares held by each, the number and date of certificates issued for the same, and the number and date of cancellation of every certificate surrendered for cancellation.

     The Secretary shall give, or cause to be given, notice of all meetings of the shareholders and of the Board of Directors required by the Bylaws or by law to be given, and he shall keep the seal of the corporation, if one be adopted, in a safe custody, and shall have such other powers and perform such other duties as may be prescribed by the Board of Directors or by the Bylaws.

     5.10   CHIEF FINANCIAL OFFICER

     The Chief Financial Officer shall keep and maintain, or cause to be kept and maintained, adequate and correct books and records of accounts of the properties and business transactions of the corporation, including accounts of its assets, liabilities, receipts, disbursements, gains, losses, capital, retained earnings and shares. The books of account shall be open at all reasonable times to inspection by any director.

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     The Chief Financial Officer shall deposit all moneys and other valuables in the name and to the credit of the corporation with such depositaries as may be designated by the Board of Directors. He shall disburse the funds of the corporation as may be ordered by the Board of Directors, shall render to the President and directors, whenever they request it, an account of all of his transactions as Chief Financial Officer and of the financial condition of the corporation, and shall have other powers and perform such other duties as may be prescribed by the Board of Directors or the Bylaws.

ARTICLE VI

INDEMNIFICATION OF DIRECTORS, OFFICERS,
EMPLOYEES AND OTHER AGENTS

     6.01   INDEMNIFICATION OF DIRECTORS AND OFFICERS

     The corporation shall, to the maximum extent and in the manner permitted by the Corporations Code of California indemnify each of its directors and officers against expenses (as defined in Section 317(a) of the Code), judgments, fines, settlements, and other amounts actually and reasonably incurred in connection with any proceeding (as defined in Section 317(a) of the Code), arising by reason of the fact that such person is or was an agent of the corporation. For purposes of this Article VI, a “director” or “officer” of the corporation includes any person (i) who is or was a director or officer of the corporation, (ii) who is or was serving at the request of the corporation as a director or officer of another corporation, partnership, joint venture, trust or other enterprise, or (iii) who was a director or officer of a corporation which was a predecessor corporation of the corporation or of another enterprise at the request of such predecessor corporation.

     6.02   INDEMNIFICATION OF OTHERS

     The corporation shall have the power, to the extent and in the manner permitted by the Corporations Code of California, to indemnify each of its employees and agents (other than directors and officers) against expenses (as defined in Section 317(a) of the Code), judgments, fines, settlements, and other amounts actually and reasonably incurred in connection with any proceeding (as defined in Section 317(a) of the Code), arising by reason of the fact that such person is or was an agent of the corporation. For purposes of this Article VI, an “employee” or “agent” of the corporation (other than a director or officer) includes any person (i) who is or was an employee or agent of the corporation, (ii) who is or was serving at the request of the corporation as an employee or agent of another corporation, partnership, joint venture, trust or other enterprise, or (iii) who was an employee or agent of a corporation which was a predecessor corporation of the corporation or of another enterprise at the request of such predecessor corporation.

     6.03   ADVANCE OF EXPENSES

     Expenses incurred in defending any proceeding shall be advanced by the corporation prior to the final disposition of such proceeding upon receipt of an undertaking by or on behalf of the agent

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to repay such amount unless it shall be determined ultimately that the agent is entitled to be indemnified as authorized in this Article.

     6.04   OTHER CONTRACTUAL RIGHTS

     No provision made by the corporation to indemnify its or its subsidiary’s directors or officers for the defense of any proceeding, whether contained in a resolution of shareholders or directors, an agreement or otherwise, shall be valid unless consistent with this Article. Nothing contained in this Article shall affect any right to indemnification to which persons other than such directors and officers may be entitled by contract or otherwise.

     6.05   LIMITATIONS

     No indemnification or advance shall be made under this Section, except as provided in Section 6.01 or Section 6.02, in any circumstance where it appears:

          (a) That it would be inconsistent with a provision of the Articles, Bylaws, a resolution of the shareholders or an agreement in effect at the time of the accrual of the alleged cause of action asserted in the proceeding in which the expenses were incurred or other amounts were paid, which prohibits or otherwise limits indemnification; or

          (b) That it would be inconsistent with any condition expressly imposed by a court in approving a settlement.

     6.06    INSURANCE

     The corporation shall have the power to purchase and maintain insurance on behalf of any agent of the corporation against any liability asserted against or incurred by the agent in such capacity or arising out of the agent’s status as such, whether or not the corporation would have the power to indemnify the agent against such liability under the provisions of this Article.

     6.07   FIDUCIARIES OF CORPORATE EMPLOYEE BENEFIT PLANS

     This Article does not apply to any proceeding against any trustee, investment manager or other fiduciary of an employee benefit plan in such person’s capacity as such, even though such person may also be an agent as defined in Section 6.01 of the employer corporation. The corporation shall, and it hereby agrees to, indemnify each officer, director or employee of the corporation against expenses, judgments, fines, settlements and other amounts actually and reasonably incurred in connection with any action taken or omitted by such person in such person’s capacity as trustee, investment manager or other fiduciary of any employee benefit plan of the corporation unless, or to the extent that, the Board of Directors of the corporation shall reasonably determine that any such action so taken or omitted by such person constituted gross negligence or willful misconduct on the part of such person. Expenses reasonably incurred by any such person in defending any liability asserted against such person in any such capacity shall be advanced by the corporation but shall be repaid to the corporation by such person if, or to the extent that, the Board of

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Directors of the corporation shall reasonably determine that the action allegedly taken or omitted by such person upon which the asserted liability is based constituted gross negligence or willful misconduct on the part of such person.

     6.08    OTHER INDEMNIFICATION

     Nothing in this Article shall restrict the power of the corporation to indemnify its agents under any provision of the California General Corporation Law, as amended from time to time, or under any other provision of law from time to time applicable to the corporation, nor shall anything in this Article authorize the corporation to indemnify its agents in situations prohibited by the California General Corporation Law or other applicable law.

ARTICLE VII

RECORDS AND REPORTS

     7.01   MAINTENANCE AND INSPECTION OF SHARE REGISTER

     The corporation shall keep at its principal executive office, or at the office of its transfer agent or registrar, if either be appointed and as determined by resolution of the Board of Directors, a record of its shareholders, giving the names and addresses of all shareholders and the number and class of shares held by each shareholder.

     A shareholder or shareholders of the corporation holding at least five percent (5%) in the aggregate of the outstanding voting shares of the corporation may (i) inspect and copy the records of shareholders’ names and addresses and shareholdings during usual business hours upon five (5) days’ prior written demand upon the corporation, and/or (ii) obtain from the transfer agent of the corporation, upon written demand and upon the tender of such transfer agent’s usual charges for such list, a list of the shareholders’ names and addresses, who are entitled to vote for the election of directors, and their shareholdings, as of the most recent record date for which such list has been compiled or as of the date specified by the shareholder subsequent to the date of demand. Such list shall be made available to such shareholder or shareholders by the transfer agent on or before the later of five (5) days after the demand is received or the date specified therein as the date as of which the list is to be compiled. The record of shareholders shall also be open to inspection upon the written demand of any shareholder or holder of a voting trust certificate, at any time during usual business hours, for a purpose reasonably related to such holder’s interests as a shareholder or as the holder of a voting trust certificate. Any inspection and copying under this Section 1 may be made in person or by an agent or attorney of the shareholder or holder of a voting trust certificate making such demand.

     7.02   MAINTENANCE AND INSPECTION OF BYLAWS

     The corporation shall keep at its principal executive office, or if its principal executive office is not in the State of California, at its principal business office in this State, the original or a copy of the Bylaws as amended to date, which shall be open to inspection by the shareholders at all

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reasonable times during office hours. If the principal executive office of the corporation is outside this State and the corporation has no principal business office in this State, the Secretary shall, upon the written request of any shareholder, furnish to such shareholder a copy of the Bylaws as amended to date.

     7.03   MAINTENANCE AND INSPECTION OF OTHER CORPORATE RECORDS

     The accounting books and records and minutes of proceedings of the shareholders and the Board of Directors and any committee or committees of the Board of Directors shall be kept at such place or places designated by the Board of Directors, or, in the absence of such designation, at the principal executive office of the corporation. The minutes shall be kept in written form and the accounting books and records shall be kept either in written form or in any other form capable of being converted into written form. Such minutes and accounting books and records shall be open to inspection upon the written demand of any shareholder or holder of a voting trust certificate, at any reasonable time during usual business hours, for a purpose reasonably related to such holder’s interests as a shareholder or as the holder of a voting trust certificate. Such inspection may be made in person or by an agent or attorney, and shall include the right to copy and make extracts. The foregoing rights of inspection shall extend to the records of each subsidiary corporation of the corporation.

     7.04   INSPECTION BY DIRECTORS

     Every director shall have the absolute right at any reasonable time to inspect all books, records and documents of every kind and the physical properties of the corporation and each of its subsidiary corporations. Such inspection by a director may be made in person or by agent or attorney and the right of inspection includes the right to copy and make extracts.

     7.05   ANNUAL REPORT TO SHAREHOLDERS

     Unless otherwise expressly required by the General Corporation Law or by this Section 7.05, the annual report to shareholders referred to in Section 1501 of the General Corporation Law is hereby expressly waived and dispensed with; provided, that nothing herein set forth shall be construed to prohibit or restrict the right of the Board to issue such annual or other periodic reports to the shareholders of the corporation as they may from time to time consider appropriate.

     In the event that the corporation shall have one hundred (100) or more shareholders of record (determined as provided in Section 605 of the General Corporation Law) at the close of any fiscal year of the corporation, the Board shall cause a report to be sent to the shareholders not later than one hundred twenty (120) days after the close of said fiscal year, and each fiscal year thereafter ensuing. The report shall be sent at least fifteen (15) days (or thirty-five (35) days if sent by third-class mail as permitted by Section 2.04 before the annual meeting of shareholders to be held during the next fiscal year in the manner specified in Section 2.04 of these Bylaws for reports to shareholders of the corporation. The annual report shall contain a balance sheet as of the end of the fiscal year and an income statement and statement of changes in financial position for the fiscal year, accompanied by any report of independent accountants, or if there is no such report, the certificate of

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an authorized officer of the corporation that the statements were prepared without audit from the books and records of the corporation. The annual report shall also contain a brief description, as required by Section 1501(b) of the General Corporation Law, of (i) any transaction with interested officers, directors or shareholders during the previous fiscal year; and (ii) any indemnification or advance made during the fiscal year to any officer or director of the corporation.

     7.06   FINANCIAL STATEMENTS

     A copy of any annual financial statement and any income statement of the corporation for each quarterly period of each fiscal year, and any accompanying balance sheet of the corporation as of the end of each period, that has been prepared by the corporation shall be kept on file in the principal executive office of the corporation for twelve (12) months and each such statement shall be exhibited at all reasonable times to any shareholder demanding an examination of any such statement or a copy shall be mailed to any such shareholder.

     If a shareholder or shareholders holding at least five percent (5%) of the outstanding shares of any class of stock of the corporation make a written request to the corporation for an income statement of the corporation for the three-month, six-month or nine-month period of the current fiscal year ended more than thirty (30) days prior to the date of the request, and a balance sheet of the corporation as of the end of such period, the Chief Financial Officer shall cause such statement to be prepared, if not already prepared, and shall deliver personally or mail such statement or statements to the person making the request within thirty (30) days after the receipt of such request. If the corporation has not sent to the shareholders its annual report for the last fiscal year, this report shall likewise be delivered or mailed to such shareholder or shareholders within thirty (30) days after such request.

     The corporation also shall, upon the written request of any shareholder, mail to the shareholder a copy of the last annual, semi-annual or quarterly income statement which it has prepared and a balance sheet as of the end of such period.

     The quarterly income statements and balance sheets referred to in this Section shall be accompanied by the report thereon, if any, of any independent accountants engaged by the corporation or the certificate of an authorized officer of the corporation that financial statements were prepared without audit from the books and records of the corporation.

     7.07   ANNUAL STATEMENT OF GENERAL INFORMATION

     The corporation shall each year during the calendar month in which its Articles of Incorporation were originally filed with the California Secretary of State, or at any time during the immediately preceding five (5) calendar months, file with the California Secretary of State, a statement on the prescribed form and in compliance with Section 1502 of the General Corporation Law.

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ARTICLE VIII

CORPORATE LOANS AND GUARANTEES

     8.01   SHAREHOLDER APPROVAL

     The corporation shall not make any loan of money or property to, or guarantee the obligation of, any director or officer of the corporation or its parent or subsidiary, unless the transaction or an employee benefit plan authorizing such loans or guarantees, after disclosure of the right under such a plan to include officers or directors:

          (a) is approved by the shareholders, with the shares owned by the director or officer, or by the directors or officers then eligible to participate in such plan not being entitled to vote thereon; or

          (b) is approved by the unanimous vote of the shareholders.

     8.02   BOARD APPROVAL

     Notwithstanding Section 8.01, in the event the corporation has outstanding shares held of record by one hundred (100) or more persons on the date of approval by the Board, the Board alone by a vote sufficient without counting the vote of any interested director or directors may approve such a loan or guarantee to an officer, whether or not a director, or an employee benefit plan authorizing such a loan or guarantee to an officer, provided that the Board determines that such a loan or guarantee or plan may reasonably be expected to benefit the corporation.

ARTICLE IX

GENERAL CORPORATE MATTERS

     9.01   RECORD DATE FOR PURPOSES OTHER THAN NOTICE AND VOTING

     For purposes of determining the shareholders entitled to receive payment of any dividend or other distribution or allotment of any rights or entitled to exercise any rights in respect of any other lawful action (other than action by shareholders by written consent without a meeting), the Board of Directors may fix, in advance, a record date, which shall not be more than sixty (60) days prior to any such action, and in such case only shareholders of record on the date so fixed are entitled to receive the dividend, distribution or allotment of rights or to exercise the rights, as the case may be, notwithstanding any transfer of any shares on the books of the corporation after the record date fixed as aforesaid, except as otherwise provided in the California General Corporation Law.

     If the Board of Directors does not so fix a record date, the record date for determining shareholders for any such purpose shall be at the close of business on the day on which the Board

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adopts the resolution relating thereto, or the sixtieth (60th) day prior to the date of such action, whichever is later.

     9.02    CHECKS, DRAFTS, EVIDENCES OF INDEBTEDNESS

     All checks, drafts or other orders for payment of money, notes or other evidences of indebtedness, issued in the name of or payable to the corporation, shall be signed or endorsed by such person or persons and in such manner as, from time to time, shall be determined by resolution of the Board of Directors.

     9.03    CORPORATE CONTRACTS AND INSTRUMENTS; HOW EXECUTED

     The Board of Directors, except as otherwise provided in these Bylaws, may authorize any officer or officers, agent or agents, to enter into any contract or execute any instrument in the name of and on behalf of the corporation, and such authority may be general or confined to specific instances; and, unless so authorized or ratified by the Board of Directors or within the agency power of an officer, no officer, agent or employee shall have any power or authority to bind the corporation by any contract or engagement or to pledge its credit or to render it liable for any purpose or to any amount.

     9.04   CERTIFICATES FOR SHARES

     A certificate or certificates for shares of the capital stock of the corporation shall be issued to each shareholder when any such shares are fully paid, and the Board of Directors may authorize the issuance of certificates or shares as partly paid, provided that such certificates shall state the amount of the consideration to be paid therefor and the amount paid thereon. All certificates shall be signed in the name of the corporation by the Chairman of the Board or Vice Chairman of the Board or the President or Vice President and by the Chief Financial Officer or an Assistant Treasurer or the Secretary or any Assistant Secretary, certifying the number of shares and the class or series of shares owned by the shareholder. Any or all of the signatures on the certificates may be facsimile. In case any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the corporation with the same effect as if such person were an officer, transfer agent or registrar at the date of issue.

     9.05   LOST CERTIFICATES

     Except as hereinafter in this Section 9.05 provided, no new certificates for shares shall be issued in lieu of an old certificate unless the latter is surrendered to the corporation and cancelled at the same time. The Board of Directors may in case any share certificate or certificate for any other security is lost, stolen or destroyed, authorize the issuance of a new certificate in lieu thereof, upon such terms and conditions as the Board may require, including provisions for indemnification of the corporation secured by a bond or other adequate security sufficient to protect the corporation against any claim that may be made against it, including any expense or liability, on account of the alleged loss, theft or destruction of such certificate or the issuance of such new certificate.

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     9.06    REPRESENTATION OF SHARES OF OTHER CORPORATIONS

     The Chairman of the Board, the President, or any Vice President, or any other person authorized by resolution of the Board of Directors or by any of the foregoing designated officers, is authorized to vote on behalf of the corporation any and all shares of any other corporation or corporations, foreign or domestic, standing in the name of the corporation. The authority herein granted to said officers to vote or represent on behalf of the corporation any and all shares held by the corporation in any other corporation or corporations may be exercised by any such officer in person or by any person authorized to do so by proxy duly executed by said officer.

     9.07   CONSTRUCTION AND DEFINITIONS

     Unless the context requires otherwise, the general provisions, rules of construction and definitions in the California General Corporation Law shall govern the construction of the Bylaws. Without limiting the generality of the foregoing, the singular number includes the plural, the plural number includes the singular, and the term “person” includes both a corporation and a natural person.

ARTICLE X

AMENDMENTS

     10.01   AMENDMENT BY SHAREHOLDERS

     New Bylaws may be adopted or these Bylaws may be amended or repealed by the vote or written consent of holders of a majority of the outstanding shares entitled to vote; provided, however, that if the Articles of Incorporation of the corporation set forth the number of authorized directors of the corporation, the authorized number of directors may be changed only by an amendment of the Articles of Incorporation.

     10.02   AMENDMENT BY DIRECTORS

     Subject to the rights of the shareholders as provided in Section 10.01, Bylaws, other than a Bylaw or an amendment thereof changing the authorized number of directors, may be adopted, amended or repealed by the Board of Directors.

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EX-10.36

Exhibit 10.36

AGREEMENT AND PLAN OF MERGER AND REORGANIZATION

by and among

SONICWALL, INC.

SPECTRUM ACQUISITION CORPORATION

LASSO LOGIC, INC.

STEVEN GOODMAN

and

SAL SFERLAZZA

as Principal Stockholders

and

STEVEN GOODMAN

as Stockholder Representative

November 18, 2005

TABLE OF CONTENTS

			Page
ARTICLE 1 DEFINITIONS AND INTERPRETATIONS				2
	1.1	Certain Definitions		2
	1.2	Certain Interpretations		7
ARTICLE 2 THE MERGER				8
	2.1	The Merger		8
	2.2	Closing and Effective Time		8
	2.3	Legal Effect of the Merger		9
	2.4	Certificate of Incorporation and Bylaws		9
	2.5	Directors and Officers		9
	2.6	Capital Stock of Constituent Corporations		9
	2.7	Determination of Cash Balance		13
	2.8	Dissenting Shares		14
	2.9	Surrender of Certificates		15
	2.10	No Further Ownership Rights in Company Capital Stock		16
	2.11	Lost, Stolen or Destroyed Certificates		16
	2.12	Further Assurances		16
ARTICLE 3 REPRESENTATIONS AND WARRANTIES OF THE COMPANY AND THE PRINCIPAL SHAREHOLDERS				16
	3.1	Organization		17
	3.2	Authority		17
	3.3	Conflicts		18
	3.4	Consents		18
	3.5	Company Capital Structure		18
	3.6	Subsidiaries		19
	3.7	Company Financial Statements		20
	3.8	No Undisclosed Liabilities		20
	3.9	No Changes		20
	3.10	Taxes		20
	3.11	Employee Benefit Plans and Compensation		23
	3.12	Intellectual Property		26
	3.13	Restrictions on Business Activities		30
	3.14	Properties		30
	3.15	Material Contracts		31
	3.16	Insurance		33
	3.17	Litigation		33
	3.18	Governmental Authorization		33
	3.19	Compliance with Laws		34
	3.20	Environmental Compliance		34
	3.21	Interested Party Transactions		34
	3.22	Minute Books		35
	3.23	Brokers’ and Finders’ Fees		35
	3.24	Accounts Receivable		35

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TABLE OF CONTENTS
(Continued)

			Page
	3.25	Warranties; Indemnities		35
	3.26	Financial Projections/Operating Plan		35
	3.27	Banks and Brokerage Accounts		35
	3.28	Customers and Suppliers		36
	3.29	Representations Complete		36
ARTICLE 4 REPRESENTATIONS AND WARRANTIES OF PARENT AND MERGER SUB				36
	4.1	Organization, Standing and Power		36
	4.2	Authority		36
	4.3	Consents		37
	4.4	Broker’s and Finders’ Fees		37
ARTICLE 5 CONDUCT OF THE COMPANY PRIOR TO THE EFFECTIVE TIME				37
	5.1	Conduct of Business of the Company		37
	5.2	No Solicitation		40
ARTICLE 6 ADDITIONAL AGREEMENTS				41
	6.1	Stockholder Approval		41
	6.2	Commercially Reasonable Efforts; Governmental Approvals; Contract Consents		41
	6.3	Notification of Certain Matters		42
	6.4	Access to Information		42
	6.5	Confidentiality		43
	6.6	Public Disclosure		43
	6.7	Employment Arrangements		43
	6.8	Employee Plans		43
	6.9	Proprietary Information and Inventions Assignment Agreement		44
	6.10	Spreadsheet		44
	6.11	Expenses		44
ARTICLE 7 CONDITIONS TO THE MERGER				45
	7.1	Conditions to Obligations of Each Party		45
	7.2	Conditions to the Obligations of Parent and Merger Sub		45
	7.3	Conditions to Obligations of the Company and the Principal Stockholders		47
ARTICLE 8 SURVIVAL AND INDEMNIFICATION				48
	8.1	Survival of Representations, Warranties and Covenants		48
	8.2	Indemnification		48
	8.3	Limitations on Indemnification		48
	8.4	Notice of Claim		49
	8.5	Resolution of Notice of Claim		50
	8.6	Release of Closing Escrow Fund		52
	8.7	Third-Party Claims		52
	8.8	Stockholder Representative		52
	8.9	Contingent Payment Escrow Fund		54

-ii-

TABLE OF CONTENTS
(Continued)

			Page
	8.10	Notice of Release of Funds		54
ARTICLE 9 TERMINATION, AMENDMENT AND WAIVER				55
	9.1	Termination		55
	9.2	Effect of Termination		56
	9.3	Amendment		56
	9.4	Extension and Waiver		56
ARTICLE 10 GENERAL PROVISIONS				57
	10.1	Notices		57
	10.2	Counterparts		58
	10.3	Entire Agreement		58
	10.4	Third Party Beneficiaries		58
	10.5	Assignment		58
	10.6	Severability		58
	10.7	Other Remedies		59
	10.8	Governing Law		59
	10.9	Waiver of Jury Trial		59
	10.10	Specific Performance		59

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INDEX OF EXHIBITS

Exhibit	Description
Exhibit A	Form of Voting Agreement
Exhibit B	Form of Escrow Agreement
Exhibit C	Form of Contingent Payment Escrow Agreement
Exhibit D	Form of Legal Opinion of Montgomery Law Group, LLP

AGREEMENT AND PLAN OF MERGER AND REORGANIZATION

     THIS AGREEMENT AND PLAN OF MERGER AND REORGANIZATION (the “Agreement”) is made and entered into as of November 18, 2005 (the “Signing Date”), by and among SonicWALL, Inc., a California corporation (“Parent”), Spectrum Acquisition Corporation, a Delaware corporation and a wholly-owned subsidiary of Parent (“Merger Sub”), Lasso Logic, Inc., a Delaware corporation (the “Company”), Steve Goodman and Sal Sferlazza, principal stockholders of the Company (each, a “Principal Stockholder,” and collectively the “Principal Stockholders”), and Steven Goodman (the “Stockholder Representative”).

WITNESSETH:

     WHEREAS, the Boards of Directors of each of Parent, Merger Sub and the Company believe it is in the best interests of their respective companies and the shareholders or stockholders, as applicable, of their respective companies that Parent acquire the Company through the statutory merger of Merger Sub with and into the Company (the “Merger”) and, in furtherance thereof, have approved this Agreement, the Merger and the other transactions contemplated hereby.

     WHEREAS, pursuant to the Merger, Merger Sub will merge with and into the Company whereupon the separate corporate existence of Merger Sub will cease and the Company will continue as a wholly-owned subsidiary of Parent, and all of the outstanding capital stock of the Company will be converted into the right to receive the consideration set forth herein.

     WHEREAS, concurrently with the execution and delivery of this Agreement, and as a material inducement to Parent and Merger Sub to enter into this Agreement, each of the Principal Stockholders, and certain other employees of the Company, are entering into a separate Employment Agreement (each, an “Employment Agreement” and collectively, the “Employment Agreements”) and a separate non-competition and non-solicitation agreement with a term of two (2) years from the Closing Date (as defined in Section 2.2)(each, a “Non-Compete Agreement” and collectively, the “Non-Compete Agreements”).

     WHEREAS, concurrently with the execution and delivery of this Agreement, holders of at least 51% of the Company Common Stock and the Company Preferred Stock, on an as converted basis, outstanding immediately prior to the Signing Date are entering into separate Voting Agreements in the form attached hereto as Exhibit A (each, a “Voting Agreement” and collectively, the “Voting Agreements”).

     WHEREAS, the Company and the Principal Stockholders, on the one hand, and Parent and Merger Sub, on the other hand, desire to make certain representations, warranties, covenants and other agreements in connection with the Merger.

     NOW, THEREFORE, in consideration of the foregoing premises, the mutual agreements and other covenants set forth herein, the mutual benefits to be gained by the

performance thereof, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged and accepted, the parties hereto hereby agree as follows:

ARTICLE 1

DEFINITIONS AND INTERPRETATIONS

     1.1 Certain Definitions. For all purposes of and under this Agreement, the capitalized terms set forth below shall have the respective meanings ascribed thereto below:

     “Affiliate” shall mean, as applied to any Person, (a) any other Person directly or indirectly controlling, controlled by or under common control with, that Person, (b) any other Person that owns or controls ten percent (10%) or more of any class of equity securities (including any equity securities issuable upon the exercise of any option or convertible security) of that Person or any of its affiliates, or (c) as to a corporation, each director and officer thereof, and as to a partnership, each general partner thereof, and as to a limited liability company, each managing member or similarly authorized Person thereof (including officers), and as to any other entity, each Person exercising similar authority to those of a director or officer of a corporation. For the purposes of this definition, “control” (including with correlative meanings, the terms “controlling”, “controlled by”, and “under common control with”) as applied to any Person shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of that Person, whether through ownership of voting securities or by contract or otherwise.

     “Ancillary Agreements” shall mean the Employment Agreements, the Voting Agreements, the Escrow Agreement, and the Contingent Payment Escrow Agreement.

     “Breakup Fee” shall mean Two Hundred Thousand United States Dollars $200,000.

     “Cash Amount” shall mean an amount equal to the sum of (x) Sixteen Million One Hundred Eighty-Three Thousand Five Hundred Ninety United States Dollars ($16,183,590), plus (y) the Cash Balance as set forth in the Signing Balance Sheet.

     “Cash Balance” shall mean, as of the Signing Balance Sheet Date, the Company’s cash and cash equivalents as determined in accordance with GAAP.

     “Closing Escrow Cash Amount” shall mean an amount of cash equal to One Million Eight Hundred Thousand United States Dollars ($1,800,000).

     “Closing Escrow Fund” shall mean the fund established pursuant to Section 2.6(g) into which the Closing Escrow Cash Amount is to be deposited.

     “Contingent Payment Escrow Fund” shall mean the fund established pursuant to Section 2.6(i) into which the Contingent Payment Escrow Amount is to be deposited.

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     “COBRA” shall mean the Consolidated Omnibus Budget Reconciliation Act of 1985, as amended and as codified in Section 4980B of the Code and Section 601 et. seq. of ERISA.

     “Code” shall mean the Internal Revenue Code of 1986, as amended.

     “Company Capital Stock” shall mean the Company Common Stock and any other shares of capital stock of the Company, taken together.

     “Company Common Stock” shall mean the common stock of the Company.

     “Company Employee” shall mean any current director, employee or consultant of the Company or any ERISA Affiliate.

     “Company Employee Plan” shall mean any plan, program, policy, practice, contract, agreement or other arrangement providing for compensation, severance, termination pay, deferred compensation, performance awards, stock or stock-related awards, fringe benefits or other employee benefits or remuneration of any kind, whether written, unwritten or otherwise, funded or unfunded, including without limitation, each “employee benefit plan,” within the meaning of Section 3(3) of ERISA which is or has been maintained, contributed to, or required to be contributed to, by the Company or any ERISA Affiliate for the benefit of any Company Employee, or with respect to which the Company or any ERISA Affiliate has or may have any liability or obligation.

     “Company Intellectual Property” shall mean any Intellectual Property and Intellectual Property Rights that are owned by or exclusively licensed to the Company.

     “Company International Employee Plan” shall mean any Company Employee Plan that has been adopted or maintained by the Company or any ERISA Affiliates, whether formally or informally, or with respect to which the Company or any ERISA Affiliate will or may have any liability, with respect to Company Employees who perform services outside the United States.

     “Company Material Adverse Effect” shall mean any change, event or effect that has had, or is reasonably likely to have, a material adverse effect on the business, assets (including intangible assets), liabilities, financial condition, results of operations, or capitalization of the Company, taken as a whole.

     “Company Options” shall mean options (including commitments to grant options or other rights) to purchase or otherwise acquire Company Capital Stock (whether or not vested) granted or otherwise issued under the Company Stock Option Plan or Company Unit Plan.

     “Company Preferred Stock” shall mean the Series A Preferred Stock of the Company.

     “Company Stock Option Plan” shall mean the Company’s 2005 Stock Plan.

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     “Company Unit Plan” shall mean the Company’s Employee Common Unit Option Plan.

     “Contract” shall mean any written or oral legally binding contract, agreement, instrument, commitment or undertaking (including leases, licenses, mortgages, notes, guarantees, sublicenses, subcontracts and purchase orders).

     “DOL” shall mean the United States Department of Labor or any successor thereto.

     “Employee” shall mean any Company Employee.

     “Employee Agreement” shall mean each management, employment, severance, consulting, relocation, repatriation, expatriation, visa, work permit or other agreement, contract or understanding between the Company or any ERISA Affiliate and any Employee.

     “Employment Agreement” shall have the meaning ascribed to the term in the Recitals above.

     “ERISA” shall mean the Employee Retirement Income Security Act of 1974, as amended, and the rules and regulations promulgated thereunder.

     “ERISA Affiliate” shall mean each Subsidiary of the Company and any other person or entity under common control with the Company or any of its Subsidiaries within the meaning of Section 414(b), (c), (m) or (o) of the Code and the regulations issued thereunder.

     “Escrow Agent” shall mean U.S. Bank National Association or another institution reasonably acceptable to Parent and the Stockholder Representative.

     “Equity Value” shall mean the Cash Amount, plus the amount of Option Exercise Proceeds, minus the Preferred Preference Amount, minus the out-of-pocket expenses payable at the Closing as contemplated by Section 6.11.

     “Exchange Act” shall mean the Securities Exchange Act of 1934, as amended.

     “FMLA” shall mean the Family Medical Leave Act of 1993, as amended.

     “Fully Diluted Company Capital Stock” shall mean the aggregate number of shares of Company Common Stock and Company Preferred Stock, including Company Options and any other rights, whether vested or unvested convertible into, exercisable for or exchangeable for shares of Company Common Stock, on an as-converted, as-exercised basis.

     “GAAP” shall mean United States generally accepted accounting principles.

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     “Governmental Authority” shall mean any court, administrative agency or commission or other federal, state, county, local or other foreign governmental authority, instrumentality, agency or commission.

     “HIPAA” shall mean the Health Insurance Portability and Accountability Act of 1996, as amended.

     “Intellectual Property” shall mean any or all of the following (i) works of authorship including computer programs, source code, and executable code, whether embodied in software, firmware or otherwise, architecture, documentation, designs, files, records, data and mask works, (ii) inventions (whether or not patentable), discoveries, improvements, and technology, (iii) proprietary and confidential information, trade secrets and know how, (iv) databases, data compilations and collections and technical data, (v) logos, trade names, trade dress, trademarks and service marks, (vi) domain names, web addresses and sites, (vii) tools, methods and processes, and (viii) any and all instantiations of the foregoing in any form and embodied in any media.

     “Intellectual Property Rights” shall mean worldwide common law and statutory rights associated with (i) patents and patent applications, (ii) copyrights, copyright registrations and copyright applications, “moral” rights and mask work rights, (iii) the protection of trade and industrial secrets and confidential information, (iv) other proprietary rights relating to intangible intellectual property, (v) domain name registrations, (vi) trademarks, trade names and service marks, and registrations and registration applications therefor (vii) analogous rights to those set forth above, and (viii) divisions, continuations, renewals, reissuances and extensions of the foregoing (as applicable).

     “IRS” shall mean the United States Internal Revenue Service or any successor thereto.

     “Knowledge” with respect to the Company shall mean the knowledge of each of the Principal Stockholders, as applicable.

     “Liability” or “Liabilities” shall mean any debt, liability or obligation, whether accrued or fixed, absolute or contingent, matured or unmatured, determined or determinable, known or unknown, including those arising under any law, action or governmental order and those arising under any Contract.

     “Lien” shall mean any lien, pledge, charge, claim, mortgage, security interest or other encumbrance of any kind whatsoever; provided, however, that as used herein “Liens” shall not include the following: (a) liens for taxes not yet delinquent or liens for taxes being contested in good faith and by appropriate proceedings for which adequate reserves have been established; (b) liens in respect of property or assets imposed by law that were incurred in the ordinary course of business, such as carriers’, warehousemen’s, materialmen’s and mechanics’ liens and other similar liens arising in the ordinary course of business that are not delinquent or remain payable without penalty or that are being contested in good faith and by appropriate proceedings; and (c) liens incurred or deposits

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made in the ordinary course of business in connection with workers’ compensation, unemployment insurance and other types of social security, and other liens to secure the performance of tenders, statutory obligations, contract bids, government contracts, performance and return of money bonds and other similar obligations, incurred in the ordinary course of business, whether pursuant to statutory requirements, common law or consensual arrangements.

     “Losses” shall mean all damages, costs, Liabilities, losses (including lost profits and diminution in value), fines, penalties, Taxes, deficiencies and expenses, including reasonable attorneys’ fees, other professionals’ and experts fees, costs of investigation and court costs.

     “Multiemployer Plan” shall mean any “Pension Plan” which is a “multiemployer plan,” as defined in Section 3(37) of ERISA.

     “Option Exercise Proceeds” shall mean an aggregate amount equal to the amount of any cash that is paid or deemed to have been paid to the Company upon the exercise of any Vested Company Options from and after the date of this Agreement through and including the Effective Time.

     “Pension Plan” shall mean each Company Employee Plan that is an “employee pension benefit plan,” within the meaning of Section 3(2) of ERISA.

     “Per-Share Common Amount” means the quotient obtained by dividing (x) the Equity Value by (y) the Fully Diluted Company Capital Stock.

     “Per-Share Preferred Amount” shall mean the liquidation preference of thirty-five cents ($0.35) in cash payable, pursuant to and in accordance with the Certificate of Incorporation of the Company, in respect of each share of Company Preferred Stock upon consummation of the Merger.

     “Person” shall mean any natural person, corporation, general partnership, limited partnership, limited liability company or partnership, proprietorship, other business organization, trust, union, association or Governmental Authority.

     “Preferred Preference Amount” shall mean thirty-five cents ($0.35) multiplied by the number of outstanding shares of Company Preferred Stock.

     “Principal Stockholders” shall mean Steve Goodman and Sal Sferlazza.

     “Registered Intellectual Property” shall mean Intellectual Property and Intellectual Property Rights that have been registered, filed, certified or otherwise perfected or recorded with any state, government or other public legal authority.

     “SEC” shall mean the United States Securities and Exchange Commission, or any successor thereto.

     “Securities Act” shall mean the Securities Act of 1933, as amended.

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     “Signing Balance Sheet” shall mean the Company’s balance sheet as of the Signing Balance Sheet Date delivered to Parent concurrently herewith, which has been reviewed and approved in advance of the date hereof by Parent.

     “Signing Balance Sheet Date” shall mean the date of this Agreement.

     “Signing Date” shall mean the date of this Agreement.

     “Stockholder” shall mean any holder of shares of Company Capital Stock immediately prior to the Effective Time.

     “Tax” or, collectively, “Taxes” shall mean (i) any and all U.S. federal, state, local and non-U.S. taxes, assessments and other governmental charges, duties, impositions and liabilities, including taxes based upon or measured by gross receipts, income, profits, sales, use and occupation, and value added, ad valorem, transfer, franchise, withholding, payroll, recapture, employment, excise and property taxes as well as public imposts, fees and social security charges (including but not limited to health, unemployment and pension insurance), together with all interest, penalties and additions imposed with respect to such amounts, (ii) any liability for the payment of any amounts of the type described in the foregoing clause (i) as a result of being a member of an affiliated, consolidated, combined or unitary group for any period (including any arrangement for group or consortium relief or similar arrangement), and (iii) any liability for the payment of any amounts of the type described in the clauses (i) or (ii) as a result of any express or implied obligation to indemnify any other Person or as a result of any obligation under any agreement or arrangement with any other Person with respect to such amounts and including any liability for taxes of a predecessor entity.

     “Total Outstanding Shares” shall mean the aggregate number of shares of Company Capital Stock issued and outstanding immediately prior to the Effective Time.

     “U.S. Person” has the meaning set forth in Regulation S of the Securities Act.

     “Unvested Common Stock” shall mean all outstanding shares of Common Stock that are subject to continuing Company repurchase obligations.

     “Vested Common Stock” shall mean all outstanding shares of Common Stock that are not subject to continuing Company repurchase obligations.

     “Vested Company Options” shall mean any Company Options that are vested as of the Effective Time, including any such Company Option the vesting of which accelerates at or prior to the Effective Time.

     1.2 Certain Interpretations.

          (a) When a reference is made in this Agreement to Exhibits, such reference shall be to an Exhibit to this Agreement unless otherwise indicated. When a reference is made in this Agreement to Sections, such reference shall be to a Section of

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this Agreement unless otherwise indicated. When a reference is made in this Agreement to Articles, such reference shall be to an Article of this Agreement unless otherwise indicated.

          (b) The words “include”, “includes” and “including” when used herein shall be deemed in each case to be followed by the words “without limitation.”

          (c) The headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement.

          (d) Reference to Parent shall be deemed to refer to Parent and its subsidiaries unless the context otherwise requires.

          (e) Reference to the subsidiaries of an entity shall be deemed to include all direct and indirect subsidiaries of such entity.

          (f) The parties hereto agree that they have been represented by legal counsel during the negotiation and execution of this Agreement and, therefore, waive the application of any law, regulation, holding or rule of construction providing that ambiguities in an agreement or other document shall be construed against the party drafting such agreement or document.

ARTICLE 2

THE MERGER

     2.1 The Merger. At the Effective Time and subject to and upon the terms and conditions of this Agreement and the applicable provisions of the General Corporation Law of the State of Delaware (“DGCL”), Merger Sub shall be merged with and into the Company, the separate corporate existence of Merger Sub shall cease, and the Company shall continue as the surviving corporation and as a wholly-owned subsidiary of Parent. The Company, as the surviving corporation after the Merger, is sometimes referred to herein as the “Surviving Corporation.”

     2.2 Closing and Effective Time. Unless this Agreement is earlier terminated pursuant to Section 9.1, within three (3) business days following the satisfaction or waiver of the conditions set forth in Article 7 (other than those conditions which, by their terms, are to be satisfied or waived at Closing, but subject to the fulfillment or waiver of those conditions), the parties hereto shall consummate the Merger and the other transactions contemplated hereby at a closing (the “Closing”) to occur at the offices of Wilson Sonsini Goodrich & Rosati, Professional Corporation, 650 Page Mill Road, Palo Alto, California 94304, unless another time or place is mutually agreed upon in writing by Parent and the Company. The date upon which the Closing shall actually occur shall be referred to herein as the “Closing Date.” On the Closing Date, the parties hereto shall cause the Merger to be consummated by filing a certificate of merger (the “Certificate of Merger”) in customary form and substance with the Secretary of State of the State of

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Delaware in accordance with the applicable provisions of the DGCL (the time of acceptance of such filing by the Secretary of State of the State of Delaware shall be referred to herein as the “Effective Time”).

     2.3 Legal Effect of the Merger. At the Effective Time, the effect of the Merger shall be as provided under the applicable provisions of the DGCL. Without limiting the generality of the foregoing, and subject thereto, at the Effective Time, all the property, rights, privileges, powers and franchises of the Company and Merger Sub shall vest in the Surviving Corporation, and all debts, liabilities and duties of the Company and Merger Sub shall become the debts, liabilities and duties of the Surviving Corporation.

     2.4 Certificate of Incorporation and Bylaws.

          (a) Certificate of Incorporation. At the Effective Time the Certificate of Incorporation of the Company shall be amended and restated in its entirety to read the same as the Certificate of Incorporation of Merger Sub as in effect immediately prior to the Effective Time (except that Article 1 thereof shall be amended and restated in its entirety to read as follows: “The name of the corporation is Lasso Logic, Inc.”), and such amended and restated Certificate of Incorporation shall be the Certificate of Incorporation of the Surviving Corporation until thereafter amended in accordance with the DGCL and such Certificate of Incorporation.

          (b) Bylaws. At the Effective Time the Bylaws of Merger Sub, as in effect immediately prior to the Effective Time, shall be the Bylaws of the Surviving Corporation until thereafter amended in accordance with the DGCL, the Certificate of Incorporation of the Surviving Corporation and such Bylaws.

     2.5 Directors and Officers. Parent shall have received a written resignation from each of the officers and directors of the Company, effective as of the Effective Time.

          (a) Directors. Unless otherwise determined by Parent prior to the Effective Time, the directors of Merger Sub immediately prior to the Effective Time shall be the directors of the Surviving Corporation as of the Effective Time, each to hold the office of a director of the Surviving Corporation in accordance with the provisions of the DGCL and the Certificate of Incorporation and Bylaws of the Surviving Corporation until their successors are duly elected and qualified.

          (b) Officers. Unless otherwise determined by Parent prior to the Effective Time, the officers of Merger Sub immediately prior to the Effective Time shall be the officers of the Surviving Corporation as of the Effective Time, each to hold office in accordance with the provisions of the Bylaws of the Surviving Corporation.

     2.6 Capital Stock of Constituent Corporations.

          (a) Merger Sub Capital Stock. Each share of Common Stock of Merger Sub issued and outstanding immediately prior to the Effective Time shall be converted into and exchanged for one validly issued, fully paid and nonassessable share

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of Common Stock of the Surviving Corporation. Each stock certificate of Merger Sub evidencing ownership of any such shares shall continue to evidence ownership of such shares of capital stock of the Surviving Corporation.

          (b) Company Capital Stock.

               (i) On the terms and subject to the conditions set forth in this Agreement, at the Effective Time, each share of Company Common Stock that is outstanding immediately prior to the Effective Time (other than Dissenting Shares (as defined in Section 2.8) and Unvested Common Stock) shall, by virtue of the Merger and without the need for any further action on the part of the holder thereof (except as expressly provided herein), be converted into and represent the right to receive (without interest) a cash payment equal to the Per-Share Common Amount.

               (ii) On the terms and subject to the conditions set forth in this Agreement, at the Effective Time, each share of Company Preferred Stock that is outstanding immediately prior to the Effective Time (other than Dissenting Shares (as defined in Section 2.8)) shall, by virtue of the Merger and without the need for any further action on the part of the holder thereof (except as expressly provided herein), be converted into and represent the right to receive (without interest) a cash payment equal to the Per-Share Preferred Amount plus the Per-Share Common Amount.

               (iii) Each share of Unvested Common Stock shall, by virtue of the Merger and without the need for any further action on the part of the holder thereof, be converted into and represent the right to receive a contingent cash payment pursuant to Section 2.6(i).

          (c) Company-Owned Company Capital Stock. Notwithstanding the terms of Section 2.6(b), each share of Company Capital Stock held by the Company immediately prior to the Effective Time shall be cancelled and extinguished without any conversion thereof or consideration paid therefor.

          (d) Company Options.

               (i) At the Effective Time, each outstanding Company Option under the Company Stock Option Plan or Company Unit Plan whether or not vested, shall by virtue of the Merger be assumed by Parent. Each Company Option so assumed by Parent under this Agreement will continue to have, and be subject to, the same terms and conditions of such options immediately prior to the Effective Time except that: (x) each Company Option will be solely exercisable (or will become exercisable in accordance with its terms) for that number of whole shares of Parent common stock equal to the product of the number of Company Common Stock that were issuable upon exercise of such Company Option immediately prior to the Effective Time multiplied by the Option Exchange Ratio (as defined below), rounded down to the nearest whole number of shares of Parent common stock and (y) the per share exercise price for the shares of Parent common stock issuable upon exercise of such assumed Company Option will be equal to the quotient determined by dividing the exercise price per share of

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Company Common Stock at which such Company Option was exercisable immediately prior to the Effective Time by the Option Exchange Ratio, rounded up to the nearest whole cent.

               (ii) Parent shall comply with the terms of all such Company Options and use its best efforts to ensure, to the extent required by, and subject to the provisions of, the Company Stock Option Plan and Company Unit Plan and permitted under the Code or other relevant laws and regulations that any Company Options that qualified for tax treatment under Section 422 of the Code prior to the Effective Time continue to so qualify, with the same rights, after the Effective Time. Parent shall take all corporate actions necessary to reserve for issuance a sufficient number of shares of Parent common stock for delivery upon exercise of all Company Options pursuant to the terms set forth in this Section 2.6(d). Prior to the Effective Time, the Company shall take all actions necessary to effect the transactions contemplated by this Section 2.6(d); provided, however, Company shall not be required to obtain consents from optionees with respect to the option assumption formula set forth herein.

               (iii) The “Per Share Residual Amount” shall be equal to the quotient obtained by dividing (x) the Cash Amount by (y) the aggregate number of shares of Company Capital Stock (including Company Options, Company Preferred Stock, and any other rights whether vested or unvested convertible into, exercisable for or exchangeable for, shares of Company Capital Stock on an as-converted, exercised or exchanged to Company Common Stock basis), rounded down to the nearest whole cent.

               (iv) The “Option Exchange Ratio” shall be equal to the quotient obtained by dividing (x) the Per Share Residual Amount, by (y) the average closing sale price of one share of Parent common stock as reported on the Nasdaq National Market for the five (5) consecutive trading days preceding the Closing Date (as adjusted as appropriate to reflect any stock splits, stock dividends, combinations, reorganizations, reclassifications or similar events), rounded down to the nearest whole cent.

               (v) As soon as practicable after the Closing Date, Parent shall file with the SEC a registration statement on Form S-8 (or any successor or other appropriate form), or another appropriate form with respect to the shares of Parent common stock subject to such assumed Company Options and shall use its reasonable efforts to maintain the effectiveness of such registration statement (and maintain the current status of the prospectus or prospectuses contained therein) for so long as such assumed Company Options remain outstanding.

          (e) Withholding Taxes. Parent or the Exchange Agent shall be entitled to deduct and withhold from the consideration otherwise payable in connection with the transactions contemplated by this Agreement such amounts as Parent or the Exchange Agent is required to deduct and withhold under the Code or any provision of state, local or foreign tax law. To the extent that amounts are so withheld by Parent or the Exchange Agent, such withheld amounts shall be treated for all purposes of this Agreement as having been paid to the former holder of shares of Company Capital Stock

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in respect of which such deduction and withholding was made by Parent or the Exchange Agent.

          (f) U.S. Federal Income Tax Consequences. The parties acknowledge and agree that the Merger will be treated as a taxable purchase of the outstanding capital stock of the Company by Parent for U.S. federal income tax purposes.

          (g) Closing Escrow Cash Amount. Effective as of Closing, Parent, the Stockholder Representative and the Escrow Agent are entering into the Escrow Agreement substantially in the form attached hereto as Exhibit B (the “Escrow Agreement”). Notwithstanding anything to the contrary set forth in this Agreement, at the Effective Time, Parent shall withhold from the cash otherwise payable to each holder of Company Capital Stock (other than Dissenting Shares) immediately prior to the Effective Time cash in an amount equal to such holder’s Pro Rata Share of the Closing Escrow Cash Amount. For purposes of the foregoing, each such holder’s “Pro Rata Share” shall be a fraction whose numerator is that portion of the aggregate consideration to be paid pursuant to this Agreement to such holder and the denominator is the aggregate consideration to be paid pursuant to this Agreement to all holders of Company Capital Stock. Upon the Closing Date, Parent shall cause the cash to be deposited with the Escrow Agent and the Escrow Agent shall hold such cash in the Closing Escrow Fund as security for the indemnification obligations under Article 9.

          (h) Closing Escrow Distributions. Each distribution of cash made from the Closing Escrow Fund shall be made to the Stockholders in proportion to their respective Escrow Fractions, as determined at the time of such distribution; provided, however, with respect to each Key Employee Stockholder (as defined below), any distributable amount attributable to Unvested Common Stock shall be: (i) paid into the Contingent Payment Escrow Fund if any amounts then remain in such account on behalf of such Key Employee Stockholder, (ii) to the Company if any amount held on behalf of such Key Employee Stockholder had been previously released to the Company, and (iii) in all other cases, paid to the Key Employee Stockholder. For purposes of this Agreement, the “Escrow Fraction” of a Stockholder at the time of any distribution of cash from the Closing Escrow Fund means a fraction (i) having a numerator equal to the aggregate amount withheld by Parent pursuant to Section 2.6(g) from cash otherwise payable to such Stockholder pursuant to Section 2.6(b), and (ii) having a denominator equal to the aggregate amount withheld by Parent pursuant to Section 2.6(g) from cash otherwise payable to all such Stockholders pursuant to Section 2.6(b).

          (i) Contingent Payment Escrow Fund. Effective as of Closing, Parent, the Stockholder Representative and the Escrow Agent are entering into the Contingent Payment Escrow Agreement substantially in the form attached hereto as Exhibit C (the “Contingent Payment Escrow Agreement”) to establish the Contingent Payment Escrow Fund (the “Contingent Payment Escrow Fund”). Notwithstanding anything to the contrary set forth in this Agreement, at the Effective Time, Parent shall withhold from the cash otherwise payable to each holder of Unvested Common Stock (other than Dissenting Shares) immediately prior to the Effective Time cash in an amount equal to the Per-Share

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Common Amount multiplied by each share of Unvested Common Stock (excluding any Dissenting Shares) held by such holder (the “Contingent Payment Escrow Amount”).

          (j) Interest and Withholding. All interest earned on the Closing Escrow Fund and the Contingent Payment Escrow Fund shall be included by Parent as taxable income or loss of Parent and the Escrow Agreement shall provide for the Escrow Agent to make quarterly distributions to the Parent equal to forty percent (40%) of the taxable income recognized in such quarter to satisfy any Tax obligations that arise as a result of such interest being attributed to Parent. Any income and gains of the Closing Escrow Fund shall be available to Parent as part of the Closing Escrow Fund, but if not paid to Parent in connection with the indemnification obligations owed to any Parent Indemnified Party, or paid to Parent to cover Taxes, shall ultimately be distributable to the Stockholders in accordance with this Agreement and the Escrow Agreement. Each Stockholder’s pro rata portion of any income and gains of the Contingent Payment Escrow Fund shall be distributable to such Stockholder in accordance with this Section 2.6(j) and the Contingent Payment Escrow Agreement, unless forfeited to Company pursuant to the terms of this Agreement and such Contingent Payment Escrow Agreement.

     2.7 Determination of Cash Balance.

          (a) The Company has delivered to Parent a copy of the Signing Balance Sheet. Within three (3) business days of the Closing Date, Parent may at its option provide the Stockholder Representative with a notice (the “Signing Balance Sheet Dispute Notice”) containing detailed written explanations of any disputed items in the Signing Balance Sheet and Parent’s calculation of Cash Balance. If Parent does not provide the Stockholder Representative with a Signing Balance Sheet Dispute Notice on or prior to such date, Parent shall be deemed to have accepted the Signing Balance Sheet (and the calculation of Cash Balance set forth therein) as correct, final and binding for all purposes under this Agreement. If Parent delivers a Signing Balance Sheet Dispute Notice on a timely basis, Parent and the Stockholders’ Representative will attempt to resolve in good faith any disputed items during the 15-day period subsequent to the Stockholder Representative’s receipt of the Signing Balance Sheet Dispute Notice.

          (b) If, after such 15-day period, the Stockholder Representative and Parent cannot resolve such dispute, the unresolved disputed items will be referred a nationally-recognized firm of certified public accountants as Parent and Stockholder Representative may designate (the “Firm”). Such referral shall be in the form of written statements of position by the Stockholder Representative and Parent to the Firm, with each party having the opportunity to respond to such written statements and any requests for statements or information that may be made by the Firm. The Firm shall as promptly as practicable (and in any event within 30 days) make a final determination of Cash Balance which shall be final and binding on the parties (the “Final Cash Balance”). Each of Parent and the Stockholder Representative shall provide the Firm with all information and documentation that the Firm reasonably requests in connection with its review of the disputed items. The fees and expenses incurred by the Firm in connection with its review of the disputed items shall be borne (i) by Parent, in the event that the Final Cash Balance

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is greater than Cash Balance as determined by the Company in the Signing Balance Sheet by an amount equal to or greater than five percent (5%) of Cash Balance as determined by the Company in the Signing Balance Sheet, (ii) from the cash in the Closing Escrow Fund, in the event that the Final Cash Balance is less than the Cash Balance as determined by Company in the Signing Balance Sheet by an amount equal to or greater than five percent (5%) of Cash Balance as determined by Company in the Signing Balance Sheet, or (iii) in all other circumstances, fifty percent (50%) by Parent and fifty percent (50%) from the cash in the Closing Escrow Fund.

          (c) If the amount of Cash Balance is finally agreed upon by Parent and the Stockholder Representative or otherwise finally determined as provided in clause “(a)” or clause “(b)” above following the Closing, and the amount of Cash Balance as so finally agreed upon or determined exceeds the amount of Cash Balance as set forth in the Signing Balance Sheet, Parent shall make additional payments to the Stockholders in the amount of such excess. If the amount of Cash Balance is finally agreed upon by Parent and the Stockholder Representative or otherwise finally determined as provided in clause “(a)” or clause “(b)” above following the Closing, and the amount of Cash Balance as so finally agreed upon or determined is less than the amount of Cash Balance as set forth in the Signing Balance Sheet, the Stockholder Representative and Parent shall jointly instruct the Escrow Agent to release to Parent cash from the Closing Escrow Fund in an amount equal to the amount of such deficit.

     2.8 Dissenting Shares.

          (a) Notwithstanding any other provisions of this Agreement to the contrary, any shares of Company Capital Stock held by a Stockholder who has demanded and perfected appraisal rights for such shares in accordance with the DGCL and who, as of the Effective Time, has not effectively withdrawn or lost such appraisal rights (“Dissenting Shares”), shall not be converted into or represent a right to receive the consideration for Company Capital Stock set forth in Section 2.6, but the holder thereof shall only be entitled to such rights as are provided by the DGCL.

          (b) Notwithstanding the provisions of Section 2.8(a), if any holder of Dissenting Shares shall effectively withdraw or lose (through failure to perfect or otherwise) such holder’s appraisal rights under the DGCL, then, as of the later of the Effective Time or the occurrence of such event, such holder’s shares shall automatically be converted into and represent only the right to receive the consideration for Company Capital Stock set forth in Section 2.6, without interest thereon, upon surrender of the Certificate or Certificates representing such shares, subject to the contributions to the Closing Escrow Fund or the Contingent Payment Escrow Fund to be made from such consideration as provided in Sections 2.6(g) or 2.6(i), respectively.

          (c) The Company shall give Parent (i) prompt notice of any written demand for appraisal rights received by the Company pursuant to the applicable provisions of the DGCL, and (ii) the opportunity to participate in all negotiations and proceedings with respect to such demands. The Company shall not, except with the prior written consent of Parent, voluntarily make any payment with respect to any such

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demands or offer to settle or settle any such demands. Notwithstanding the foregoing, to the extent that Parent or the Company (i) makes any payment or payments in respect of any Dissenting Shares in excess of the consideration that otherwise would have been payable in respect of such shares in accordance with this Agreement or (ii) incurs any other reasonable costs or expenses in respect of any Dissenting Shares (excluding payments for such shares) (together “Dissenting Share Payments”), Parent shall be entitled to indemnification as set forth in Article 9 in respect of such Dissenting Share Payments; provided, however, that to the extent Parent makes any payment in respect of any Dissenting Shares and the sum of (x) the amount of such payment plus (y) the amount of any other reasonable costs or expenses incurred by Parent in respect of any Dissenting Shares (excluding payments for such shares), is less than the consideration that otherwise would have been payable in respect of such Dissenting Shares in accordance with this Agreement, then Parent shall distribute to the Stockholders, on the same basis as the Cash Amount has been distributed to them, additional cash in an amount equal to the amount of such difference.

     2.9 Surrender of Certificates.

          (a) Exchange Agent. The secretary of Parent shall serve as the exchange agent (the “Exchange Agent”) for the Merger.

          (b) Parent to Provide Cash. At the Effective Time, (i) Parent shall make available to the Exchange Agent for exchange in accordance with this Article 2 the cash payable pursuant to Sections 2.6(b), in exchange for outstanding shares of Company Capital Stock (other than the Closing Escrow Cash Amount and the Contingent Payment Escrow Amount) and (ii) Parent shall deposit into the Closing Escrow Fund and the Contingent Payment Escrow Fund the Closing Escrow Cash Amount and Contingent Payment Escrow Amount, respectively.

          (c) Exchange Procedures. On or promptly after the Closing Date and in any event within five (5) business days after the Closing Date, Parent shall mail or cause to be mailed to each holder of record of shares of Company Capital Stock (the certificates evidencing such shares being referred to herein as a “Certificate” and, collectively, as “Certificates”), at the address set forth opposite each such holder’s name on the Spreadsheet (as defined in Section 6.10), a letter of transmittal in customary form and substance (which shall specify that delivery shall be effected, and risk of loss and title shall pass, only upon delivery of the Certificates to the Exchange Agent and shall be in such form and have such other provisions as Parent and the Stockholder Representative may reasonably specify and contain an acknowledgment that the rights of a holder of Company Capital Stock to receive consideration in the Merger are subject to the indemnification provisions set forth in Article 8 and elsewhere in this Agreement) and instructions for use in effecting the surrender of Certificates in exchange for shares of Parent Common Stock and cash pursuant to Section 2.6. Upon surrender of a Certificate for cancellation, subject to Section 2.11, to the Exchange Agent, or such other agent or agents as may be appointed by Parent, together with such letter of transmittal, duly completed and validly executed in accordance with the instructions thereto, the holder of such Certificate shall be entitled to receive from the Exchange Agent in exchange

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therefor, a cash payment equal to the cash to which such holder is entitled pursuant to Section 2.6(b), less the amount of cash to be deposited into the Closing Escrow Fund on such holder’s behalf pursuant to Section 2.6(g) or the Contingent Payment Escrow Fund pursuant to Section 2.6(i), and the Certificate so surrendered shall forthwith be canceled. Until so surrendered, each Certificate outstanding after the Effective Time will be deemed for all corporate purposes to evidence only the right to receive the consideration set forth in Section 2.6.

          (d) No Liability. Notwithstanding anything to the contrary in this Section 2.9, none of the Exchange Agent, Parent, the Surviving Corporation or any other party hereto shall be liable to a holder of shares of Company Capital Stock for any amount properly paid to a public official pursuant to any applicable abandoned property, escheat or similar law.

     2.10 No Further Ownership Rights in Company Capital Stock. The shares of Parent Common Stock and cash paid in respect of the surrender for exchange of shares of Company Capital Stock in accordance with the terms hereof shall be deemed to be full satisfaction of all rights pertaining to such shares of Company Capital Stock, and there shall be no further registration of transfers on the records of the Surviving Corporation of shares of Company Capital Stock that were outstanding immediately prior to the Effective Time. If, after the Effective Time, Certificates are presented to the Surviving Corporation for any reason, they shall be canceled and exchanged as provided in this Article 2.

     2.11 Lost, Stolen or Destroyed Certificates. In the event any Certificates evidencing shares of Company Capital Stock shall have been lost, stolen or destroyed, the Exchange Agent shall issue in exchange for such lost, stolen or destroyed Certificates, upon the making of an affidavit of that fact by the holder thereof, such amount, if any, as may be required pursuant to Section 2.6; provided, however, that Parent may, in its discretion and as a condition precedent to the issuance thereof, require the holder of such lost, stolen or destroyed Certificates to either (i) deliver a bond in such amount as it may reasonably direct, or (ii) provide an indemnification agreement in a form and substance acceptable to Parent, against any claim that may be made against Parent or the Exchange Agent with respect to the Certificates alleged to have been so lost, stolen or destroyed.

     2.12 Further Assurances. If at any time after the Effective Time, any further action is necessary or desirable to carry out the purposes of this Agreement and to vest the Surviving Corporation with full right, title and possession to all assets, property, rights, privileges, powers and franchises of the Company and Merger Sub, and the officers and directors of Parent and the Surviving Corporation shall be fully authorized in the name of their respective corporations or otherwise to take, and will take, all such lawful and necessary action.

ARTICLE 3

REPRESENTATIONS AND WARRANTIES

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OF THE COMPANY AND THE PRINCIPAL SHAREHOLDERS

     The Company and each Principal Stockholder hereby represents and warrants to Parent and Merger Sub, subject to such exceptions as are disclosed in the disclosure schedule (referencing the appropriate section and paragraph numbers or that are disclosed with respect to other sections or paragraphs but it is readily apparent from such disclosure that such information is applicable to the original section or paragraph) supplied as of the date hereof by the Company to Parent (the “Disclosure Schedule”), as follows:

     3.1 Organization. The Company is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware. The Company has the corporate power to own its properties and to carry on its business as currently conducted. The Company is duly qualified or licensed to do business and is in good standing as a foreign corporation in each jurisdiction in which such qualification or license is required. The Company has delivered a true and correct copy of its Certificate of Incorporation and Bylaws, each as amended to date and in full force and effect on the date hereof, to Parent. Section 3.1 of the Disclosure Schedule contains a complete and accurate list of the directors and officers of the Company as of the date hereof. The operations now being conducted by the Company are not now and have never been conducted by the Company under any other name. Section 3.1 of the Disclosure Schedule also contains a complete and accurate list of every state or foreign jurisdiction in which the Company has employees or facilities.

     3.2 Authority. The Company has all requisite corporate power and authority to enter into this Agreement and any Ancillary Agreements to which it is a party and to consummate the transactions contemplated hereby and thereby. The execution and delivery of this Agreement and any Ancillary Agreements to which the Company is a party and the consummation of the transactions contemplated hereby and thereby have been duly authorized by all necessary corporate action on the part of the Company and no further action is required on the part of the Company to authorize the Agreement and any Ancillary Agreements to which it is a party and the transactions contemplated hereby and thereby. The approval of the principal terms of the Merger by (i) holders of a majority of the Company Common Stock and the Company Preferred Stock (voting together as a single class on an as-converted to common basis), and (ii) holders of a majority of the Company Preferred Stock (voting together as a single class on an as-converted to common basis) (together (i) and (ii), the “Requisite Stockholder Approval”) are the only approvals of the Stockholders that are necessary to consummate the Merger and the other transactions contemplated hereby under the DGCL, the Certificate of Incorporation and Bylaws of the Company and any Contract to which the Company is a party or otherwise bound. The Board of Directors of the Company has unanimously approved this Agreement, the Merger and the other transactions contemplated hereby. This Agreement and each of the Ancillary Agreements to which the Company is a party has been duly executed and delivered by the Company and assuming the due authorization, execution and delivery by the other parties hereto and thereto, constitute the valid and binding obligations of the Company, enforceable against the Company in accordance with their respective terms, except as enforcement thereof may be limited by (i) bankruptcy,

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insolvency, reorganization, moratorium and similar laws, both state and federal, affecting the enforcement of creditors’ rights or remedies in general as from time to time in effect or (ii) the exercise by courts of equity powers.

     3.3 Conflicts. The execution and delivery by the Company of this Agreement and any Ancillary Agreement to which the Company is a party, and the consummation of the transactions contemplated hereby and thereby, will not (x) conflict with or result in any violation of or default under (with or without notice or lapse of time, or both) or give rise to a right of termination, cancellation, modification or acceleration of any obligation or loss of any benefit under (any such event, a “Conflict”) (i) any provision of the Certificate of Incorporation and Bylaws of the Company, (ii) any Contract to which the Company is a party or any of its properties or assets is subject, or (iii) any judgment, order, decree, statute, law, ordinance, rule or regulation applicable to the Company or any of its properties or assets or (y) result in the imposition or creation of any Lien upon or with respect to any of the assets owned or used by the Company, except in the case of clauses (x)(ii), (x)(iii) and (y) where such Conflict or Lien does not constitute a Company Material Adverse Effect.

     3.4 Consents. No consent, waiver, approval, order or authorization of, or registration, declaration or filing with any Governmental Authority or any third party, including a party to any Contract with the Company (so as not to trigger any Conflict), is required by or with respect to the Company in connection with the execution and delivery of this Agreement and any Ancillary Agreement to which the Company is a party or the consummation of the transactions contemplated hereby and thereby, except for (i) such consents, waivers, approvals, orders, authorizations, registrations, declarations and filings as may be required under applicable securities laws, (ii) the Requisite Stockholder Approval, (iii) such consents, waivers, approvals, orders, authorizations, registrations, declarations and filings that, if not obtained or made, would not constitute a Company Material Adverse Effect, and (iv) the filing of the Certificate of Merger with the Secretary of State of the State of Delaware. Section 3.4 of the Disclosure Schedule sets forth a complete and accurate list of all consents, waivers and approvals of parties to any Contract as are required thereunder in connection with the Merger, or for any such Contracts to remain in full force and effect without limitation, modification or alteration after the Effective Time so as to preserve all rights of, and benefits to, the Surviving Corporation under such Contracts from and after the Effective Time.

     3.5 Company Capital Structure.

          (a) The authorized capital stock of the Company consists of 21,000,000 shares of Common Stock and 10,211,401 shares of Preferred Stock. As of the date hereof, the capitalization of the Company is as set forth in Section 3.5(a) of the Disclosure Schedule. The total number of shares of each class and series of Company Capital Stock outstanding as of the date hereof, the total number of shares underlying each security convertible into, or exercisable or exchangeable for, shares of Company Capital Stock outstanding as of the date hereof and the total number of shares underlying all Company Options outstanding as of the date hereof is as set forth in Section 3.5(a) of the Disclosure Schedule. As of the date hereof, each one (1) outstanding share of

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Company Preferred Stock is convertible into one (1) share of Company Common Stock. The Company Capital Stock is held by the Persons with the domicile addresses and in the amounts set forth in Section 3.5(a) of the Disclosure Schedule. All outstanding shares of Company Capital Stock are duly authorized, validly issued, fully paid and non-assessable and not subject to preemptive rights created by statute, the Certificate of Incorporation or Bylaws of the Company, or any agreement to which the Company is a party or by which it is bound. All outstanding shares of Company Capital Stock and Company Options have been issued or repurchased (in the case of shares that were outstanding and repurchased by the Company or any Stockholder of the Company) in compliance with all applicable federal, state, foreign, or local statues, laws, rules, or regulations, including federal and state securities laws. The Company has not, and will not have, suffered or incurred any Liability relating to or arising out of the issuance or repurchase of any Company Capital Stock or Company Options, or out of any agreements or arrangements relating thereto. There are no declared or accrued but unpaid dividends with respect to any shares of Company Capital Stock. The Company has no other capital stock authorized, issued or outstanding. No vesting provisions, repurchase options, risks of forfeiture or other conditions under any applicable stock restriction agreement or other agreement with the Company that are applicable to any shares of Company Capital Stock, Company Options or to any other rights to purchase Company Capital Stock, will accelerate as a result of the Merger or as a result of any other events (whether or not associated with the Merger). No shares of Company Capital Stock are unvested or subject to a repurchase option, risk of forfeiture or other condition under any applicable stock restriction agreement or other agreement with the Company.

          (b) Except for the Company Stock Option Plan and the Company Unit Plan, the Company has never adopted or maintained any stock option plan or other plan providing for equity compensation of any Person. Section 3.5(b) of the Disclosure Schedule sets forth for each outstanding Company Option, the name of the holder of such option or warrant, the number of shares of Company Capital Stock issuable upon the exercise of such option or warrant and the exercise price of such option or warrant. Except for the Company Options, there are no options, warrants, calls, rights, commitments or agreements of any character, written or oral, to which the Company is a party or by which it is bound obligating the Company to issue, deliver, sell, repurchase or redeem, or cause to be issued, delivered, sold, repurchased or redeemed, any shares of the capital stock of the Company or obligating the Company to grant, extend, accelerate the vesting of, change the price of, otherwise amend or enter into any such option, warrant, call, right, commitment or agreement. There are no outstanding or authorized stock appreciation, phantom stock, profit participation, or other similar rights with respect to the Company. Except as contemplated hereby, there are no voting trusts, proxies, or other agreements or understandings with respect to the voting stock of the Company. As a result of the Merger, Parent will be the sole record and beneficial holder of all issued and outstanding Company Capital Stock and all rights to acquire or receive any shares of Company Capital Stock, whether or not such shares of Company Capital Stock are outstanding.

     3.6 Subsidiaries. The Company does not have, and has never had, any subsidiaries or any “affiliated” companies (within the meaning of Rule 145 promulgated

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under the Securities Act) and does not otherwise own, and has never otherwise owned, any shares of capital stock or any interest in, or control, directly or indirectly, any other corporation, partnership, association, joint venture or other business entity.

     3.7 Company Financial Statements. Section 3.7 of the Disclosure Schedule sets forth the Company’s unaudited balance sheet as of September 30, 2005, and the related unaudited statement of income, cash flow and shareholders’ equity for the nine-month period then ended, and the unaudited balance sheets as of December 31, 2004 and the related unaudited statements of income, cash flow and shareholders’ equity for the twelve-month period then ended (the “Company Financial Statements”). The Company Financial Statements have been prepared in accordance with GAAP applied on a consistent basis throughout the periods indicated and consistent with each other (except that the unaudited Company Financial Statements do not contain footnotes and other presentation items that may be required by GAAP). The Company Financial Statements present fairly in all material respects the Company’s financial condition and operating results as of the dates and during the periods indicated therein. The Company’s unaudited balance sheet as of September 30, 2005, is referred to hereinafter as the “Current Balance Sheet” and the date thereof is referred to herein as the “Current Balance Sheet Date.” The Company maintains and shall continue to maintain an adequate system of internal controls established and administered in accordance with GAAP.

     3.8 No Undisclosed Liabilities. The Company has no Liability that would be required to be reflected in financial statements prepared in accordance with GAAP except Liabilities (i) reflected in the Current Balance Sheet, or (ii) incurred in the ordinary course of business consistent with past practices since the Current Balance Sheet Date and through the Signing Date, which do not exceed $50,000 in the aggregate.

     3.9 No Changes. From the Current Balance Sheet Date through the date hereof, except with respect to the transactions contemplated hereby, (a) the business of the Company has been conducted in the ordinary course and consistent with past practices, (b) there has not been any employment dispute, including any claims or matters raised by any individuals or any workers’ representative organization or union regarding labor trouble or claim of wrongful discharge or other unlawful employment or labor practice or action with respect to the Company, (c) there has not been any destruction of, damage to, or loss of any material assets or business of the Company, or any Significant Customer or Significant Supplier (whether or not covered by insurance) and (d) the Company has not taken any of the actions described in paragraphs (i) through (xxi) of Section 5.1(b) hereof.

     3.10 Taxes.

          (a) The Company has (i) prepared and timely filed all U.S. federal, state, local and non-U.S. returns, estimates, information statements and reports (“Returns”) relating to any and all Taxes concerning or attributable to the Company or its operations and such Returns are true and correct in all material respects and have been completed in accordance with applicable law in all material respects and (ii) timely paid all Taxes it is required to pay.

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          (b) The Company has timely paid or withheld with respect to Company Employees and other third parties all U.S. federal, state and non-U.S. income taxes and social security charges and similar fees, Federal Insurance Contribution Act, Federal Unemployment Tax Act and other Taxes required to be withheld, and has timely paid such Taxes withheld over to the appropriate authorities.

          (c) The Company has not been delinquent in the payment of any Tax, nor is there any Tax deficiency outstanding, assessed or proposed against the Company, nor has the Company executed any waiver of any statute of limitations on or extending the period for the assessment or collection of any Tax.

          (d) No audit or other examination of any Return of the Company is presently in progress, nor has the Company been notified of any request for such an audit or other examination.

          (e) The Company has no liabilities for unpaid Taxes which have not been accrued or reserved on the Current Balance Sheet, whether asserted or unasserted, contingent or otherwise, and the Company has not incurred any liability for Taxes since the date of the Current Balance Sheet other than in the ordinary course of business.

          (f) The Company has made available to Parent or its legal counsel copies of all Tax Returns for the Company filed for all periods since its inception.

          (g) There are (and immediately following the Effective Time there will be) no Liens on the assets of the Company relating to or attributable to Taxes other than Liens for Taxes not yet due and payable.

          (h) The Company has no Knowledge of any basis for the assertion of any claim relating or attributable to Taxes that, if adversely determined, would result in any Lien on the assets of the Company.

          (i) None of the Company’s assets are treated as “tax-exempt use property,” within the meaning of Section 168(h) of the Code.

          (j) The Company has (i) never been a member of an affiliated group (within the meaning of Code §1504(a)) filing a consolidated federal income Tax Return (other than a group the common parent of which was Company), (ii) never been a party to any Tax sharing, indemnification or allocation agreement, (iii) no liability for the Taxes of any Person (other than Company) under Treasury Regulation § 1.1502-6 (or any similar provision of state, local or foreign law, including any arrangement for group or consortium relief or similar arrangement), as a transferee or successor, by contract or agreement, or otherwise and (iv) never been a party to any joint venture, partnership or other arrangement that could be treated as a partnership for Tax purposes.

          (k) The Company has not been, at any time, a “United States Real Property Holding Corporation” within the meaning of Section 897(c)(2) of the Code.

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          (l) No adjustment relating to any Return filed by the Company has been proposed formally or, to the Knowledge of the Company, informally by any tax authority to the Company or any representative thereof.

          (m) The Company has not constituted either a “distributing corporation” or a “controlled corporation” in a distribution of stock intended to qualify for tax-free treatment under Section 355 of the Code.

          (n) No claim has ever been made by a taxing authority in a jurisdiction where the Company does not file Returns that it is or may be subject to taxation by that jurisdiction.

          (o) The Company does not have and has not had a permanent establishment in any foreign country, as defined in any applicable Tax treaty or convention between the United States and such foreign country.

          (p) None of the outstanding indebtedness of the Company constitutes indebtedness with respect to which any interest deductions may be disallowed under Sections 163(i), 163(l) or 279 of the Code or under any other provision of applicable law.

          (q) The Company has not engaged in a reportable transaction within the meaning of Treasury Regulations §1.6011-(4)(b), including a transaction that is the same as or substantially similar to one of the types of transactions that the Internal Revenue Service has determined to be a tax avoidance transaction and identified by notice, regulation, or other form of published guidance as a listed transaction, as set forth in Treasury Regulations §1.6011-4(b)(2).

          (r) The Company will not be required to include any income or gain or exclude any deduction or loss from taxable income as a result of any (i) change in method of accounting under Section 481(c) of the Code, (ii) closing agreement under Section 7121 of the Code, (iii) deferred intercompany gain or excess loss account under Treasury Regulations under Section 1502 of the Code (or in the case of each of clauses (i), (ii), and (iii), under any similar provision of applicable law), (iv) installment sale or open transaction disposition or (v) prepaid amount.

          (s) The Disclosure Schedule sets forth the following information with respect to the Company: (a) the basis of the Company in its assets; (b) the amount of any net operating loss, net capital loss, unused investment, foreign, or other Tax credit and the amount of any limitation upon any of the foregoing; and (c) the amount of any deferred gain or loss allocable to the Company arising out of any deferred intercompany transaction as defined in Treasury Regulation §1.1502-13 or any similar provision of applicable law.

          (t) No Stockholder holds shares of Company Capital Stock that are non-transferable and subject to a substantial risk of forfeiture within the meaning of Section 83 of the Code with respect to which, to the Knowledge of the Company, a valid election under Section 83(b) of the Code has not been made, and no payment to any Stockholder of any portion of the consideration payable pursuant to this Agreement will

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result in compensation or other income to such Stockholder with respect to which Parent, the Company or any subsidiary of Parent or the Company would be required to deduct or withhold any Taxes.

     3.11 Employee Benefit Plans and Compensation.

          (a) Section 3.11(a) of the Disclosure Schedule contains a complete and accurate list of each Company Employee Plan and each Employee Agreement. Neither the Company nor any ERISA Affiliate has made any plan or commitment to establish any new Company Employee Plan or Employee Agreement, to modify any Company Employee Plan or Employee Agreement (except to the extent required by law or to conform any such Company Employee Plan or Employee Agreement to the requirements of any applicable law, in each case as previously disclosed to Parent in writing, or as required by this Agreement), or to adopt or enter into any Company Employee Plan or Employee Agreement. Section 3.11(a) of the Disclosure Schedule sets forth a table setting forth the name, compensation and annual bonus of each Company Employee.

          (b) The Company has provided to Parent (i) correct and complete copies of all documents embodying each Company Employee Plan and each Employee Agreement including, without limitation, all amendments thereto and all related trust documents administrative service agreements, group annuity contracts, group insurance contracts, and policies pertaining to fiduciary liability insurance covering the fiduciaries for each Company Employee Plan, (ii) the three (3) most recent annual reports (Form Series 5500 and all schedules and financial statements attached thereto), if any, required under ERISA or the Code in connection with each Company Employee Plan, (iii) if the Company Employee Plan is funded, the most recent annual and periodic accounting of Company Employee Plan assets, (iv) the most recent summary plan description together with the summary(ies) of material modifications thereto, if any, required under ERISA with respect to each Company Employee Plan, (v) all communications material to any Company Employee or Company Employees relating to any Company Employee Plan and any proposed Company Employee Plans, in each case, relating to any amendments, terminations, establishments, increases or decreases in benefits, acceleration of payments or vesting schedules or other events which would result in any material liability to the Company, (vi) all correspondence to or from any governmental agency relating to any Company Employee Plan, (vii) all standard COBRA forms and related notices, (viii) the most recent annual actual valuations, if any, prepared for each Company Employee Plan, (ix) all discrimination tests for each Company Employee Plan for the three (3) most recent plan years (if applicable), and (x) all IRS determination, opinion, notification and advisory letters with respect to each Company Employee Plan, if any.

          (c) The Company and its ERISA Affiliates have performed all obligations required to be performed by them under each Company Employee Plan, and each Company Employee Plan has been established and maintained in all respects in accordance with its terms and in material compliance with all applicable laws, statutes, orders, rules and regulations, including but not limited to ERISA or the Code. Any Company Employee Plan intended to be qualified under Section 401(a) of the Code and each trust intended to qualify under Section 501(a) of the Code has obtained a favorable

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determination, notification, advisory and/or opinion letter, as applicable, as to its qualified status from the IRS. For each Company Employee Plan that is intended to be qualified under Section 401(a) of the Code there has been no event, condition or circumstance that has adversely affected or is likely to adversely affect such qualified status. No “prohibited transaction,” within the meaning of Section 4975 of the Code or Sections 406 and 407 of ERISA, and not otherwise exempt under Section 408 of ERISA (and the regulations issued thereunder), has occurred with respect to any Company Employee Plan. There are no actions, suits or claims pending, or, to the Knowledge of the Company, threatened or reasonably anticipated (other than routine claims for benefits) against any Company Employee Plan or against the assets of any Company Employee Plan. Each Company Employee Plan can be amended, terminated or otherwise discontinued after the Effective Time in accordance with its terms, without liability to Parent, Company or any of its ERISA Affiliates (other than ordinary administration expenses). There are no audits, inquiries or proceedings pending or, to the Knowledge of the Company or any ERISA Affiliates, threatened by the IRS or DOL, or any other Governmental Authority with respect to any Company Employee Plan. Neither the Company nor any Affiliate is subject to any penalty or tax with respect to any Company Employee Plan under Section 502(i) of ERISA or Sections 4975 through 4980 of the Code. The Company and each ERISA Affiliate have timely made all contributions and other payments required by and due under the terms of each Company Employee Plan.

          (d) Neither the Company nor any ERISA Affiliate has ever maintained, established, sponsored, participated in, or contributed to, any (i) Pension Plan which is subject to Title IV of ERISA or Section 412 of the Code, (ii) Multiemployer Plan, (iii) plan described in Section 413 of the Code, or (iv) a “funded welfare plan” within the meaning of Section 419 of the Code. No Company Employee Plan provides health benefits that are not fully insured through an insurance contract.

          (e) No Company Employee Plan or Employee Arrangement provides, or reflects or represents any liability to provide, retiree life insurance, retiree health or other retiree employee welfare benefits to any Person for any reason, except as may be required by COBRA or other applicable statute, and the Company has never represented, promised or contracted (whether in oral or written form) to any Company Employee (either individually or to Company Employees as a group) or any other Person that such Company Employee(s) or other Person would be provided with retiree life insurance, retiree health or other retiree employee welfare benefits, except to the extent required by statute.

          (f) The Company and each Affiliate has, prior to the Effective Time, complied in all materials respects with the health care continuation requirements of COBRA, FMLA, HIPAA, the Women’s Health and Cancer Rights Act of 1998, the Newborns’ and Mothers’ Health Protection Act of 1996, and any similar provisions of state law applicable to Company Employees.

          (g) The execution of this Agreement and the consummation of the transactions contemplated hereby will not (either alone or upon the occurrence of any additional or subsequent events) constitute an event under any Company Employee Plan,

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Employee Agreement, trust or loan that will or may result in any payment (whether of severance pay or otherwise), acceleration, forgiveness of indebtedness, vesting, distribution, increase in benefits or obligation to fund benefits with respect to any Company Employee.

          (h) No payment or benefit which has been, will or may be made by the Company or its Affiliates with respect to any Company Employee or any other “disqualified individual” (as defined in Section 280G of the Code and the regulations thereunder) will be characterized as a “parachute payment,” within the meaning of Section 280G(b)(2) of the Code. No amounts are or will be included in income for any current or former employee by operation of Code Section 409A.

          (i) The Company: (i) is in compliance in all material respects with all applicable foreign, federal, state and local laws, rules and regulations respecting employment, employment practices, terms and conditions of employment and wages and hours, in each case, with respect to Company Employees; (ii) has withheld and reported all amounts required by law or by agreement to be withheld and reported with respect to wages, salaries and other payments to Employees; (iii) is not liable for any arrears of wages or any taxes or any penalty for failure to comply with any of the foregoing; and (iv) is not liable for any payment to any trust or other fund governed by or maintained by or on behalf of any governmental authority, with respect to unemployment compensation benefits, social security or other benefits or obligations for Company Employees (other than routine payments to be made in the normal course of business and consistent with past practice). There are no pending, reasonably anticipated, or to the Knowledge of the Company, threatened claims or actions against the Company under any worker’s compensation policy or long-term disability policy. Neither the Company nor any Affiliate has direct or indirect liability with respect to any misclassification of any Person as an independent contractor rather than as an employee, or with respect to any employee leased from another employer. The services provided by each of the Company’s and its Affiliates’ Company Employees is terminable at the will of the Company and its Affiliates and any such termination would result in no liability to the Company or any Affiliate.

          (j) No work stoppage or labor strike against the Company or any Affiliate is pending, reasonably anticipated or, to the Knowledge of the Company, threatened. The Company does not know of any activities or proceedings of any labor union to organize any Company Employees. There are no actions, suits, claims, labor disputes or grievances pending, or, to the Knowledge of the Company, threatened or reasonably anticipated relating to any labor, safety or discrimination matters involving any Company Employee, including, without limitation, charges of unfair labor practices or discrimination complaints. The Company has not engaged in any unfair labor practices within the meaning of the National Labor Relations Act. The Company is not presently, nor has it been in the past, a party to, or bound by, any collective bargaining agreement or union contract with respect to Company Employees and no collective bargaining agreement is being negotiated with respect to Company Employees. Neither the Company nor any of its Subsidiaries have incurred any material liability or material

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obligation under the Work Adjustment and Retraining Notification Act or any similar state or local law which remains unsatisfied.

          (k) Neither the Company nor any Affiliate currently or has ever had the obligation to maintain, establish, sponsor, participate in, be bound by or contribute to any Company International Employee Plan.

     3.12 Intellectual Property.

          (a) Section 3.12(a) of the Disclosure Schedule contains a complete and accurate list of (i) all Registered Intellectual Property owned by, or filed in the name of, the Company (the “Company Registered Intellectual Property”), and (ii) any proceedings or actions before any court, tribunal (including the United States Patent and Trademark Office (the “PTO”) or equivalent authority anywhere in the world) related to any of the Company Registered Intellectual Property, including all actions required to be taken by the Company within one hundred twenty (120) days following the Closing Date.

          (b) Each item of Company Intellectual Property owned by the Company including all Company Registered Intellectual Property listed in Section 3.12(a) of the Disclosure Schedule, and to the Company’s Knowledge, each item of Company Intellectual Property exclusively licensed to the Company, is free and clear of any Liens, other than licenses pursuant to which the Company grants non-exclusive rights to any third party with respect to the Company’s products in the ordinary course of business. The Company is the sole owner or exclusive licensee of all Company Intellectual Property.

          (c) To the extent that any Intellectual Property has been developed or created on behalf of the Company independently or jointly by any person other than the Company, the Company has a written agreement with such person with respect thereto, and the Company thereby has obtained ownership of, and is the exclusive owner of, all such Intellectual Property therein and associated Intellectual Property Rights by operation of law or by valid assignment, and has required the waiver of all non-assignable rights, including but not limited to, all author or moral rights.

          (d) The Company has not transferred ownership of, or granted any exclusive license of or exclusive right to use, or authorized the retention of any exclusive rights to use or joint ownership of, any Company Intellectual Property, to any other Person.

          (e) Other than “shrink-wrap” and similar widely available binary code and commercial end-user licenses with license fees under $5,000 (“Commercially-Available Licenses”), but not including Open Source Materials (as defined in Section 3.12(q)), the Company Intellectual Property constitutes all the Intellectual Property and Intellectual Property Rights used in or necessary for the conduct of the business of the Company as it currently is conducted, including, without limitation, the design, development, manufacture, use, import and sale of products, technology and services (including products, technology or services currently under development).

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          (f) Other than (i) Commercially-Available Licenses, but not including Open Source Materials, and (ii) other non-exclusive licenses and related agreements with respect thereto of the Company’s products to end-users pursuant to written agreements that have been entered into in the ordinary course of business, Section 3.12(f) of the Disclosure Schedule contains a complete and accurate list of all Contracts to which the Company is a party and pursuant to which the Company (A) grants any rights to any third party under or with respect to any Company Intellectual Property; or (B) is granted any rights under the Intellectual Property Right of any third party. No third party who has licensed Intellectual Property or Intellectual Property Rights to the Company has ownership rights or license rights to improvements made by the Company to such Intellectual Property that are made within the scope of the license.

          (g) Other than (i) Commercially-Available Licenses, but not including Open Source Materials, and (ii) other non-exclusive licenses and related agreements with respect thereto of the Company’s products to end-users pursuant to written agreements that have been entered into in the ordinary course of business, Section 3.12(g) of the Disclosure Schedule contains a complete and accurate list of all Contracts between the Company and any other Person wherein or whereby the Company has agreed to, or assumed, any obligation or duty to defend, indemnify, reimburse, hold harmless, or guaranty such other Person with respect to the actual or alleged infringement or misappropriation by the Company or such other Person of the Intellectual Property Rights of any Person other than the Company.

          (h) The operation of the business of the Company as it currently is conducted, including but not limited to the design, development, use, import, manufacture and sale of the products, technology or services (including products, technology or services currently under development) of the Company, does not infringe or misappropriate the Intellectual Property Rights of any Person, or constitute unfair competition or trade practices under the laws of any jurisdiction in which the Company conducts business or in which the Company sells or offers for sale, directly or indirectly, products or services. The Company has not received any notice from any Person claiming that such operation or any act, product, technology or service (including products, technology or services currently under development) of the Company infringes or misappropriates the Intellectual Property Rights of any Person or constitutes unfair competition or trade practices under the laws of any jurisdiction in which the Company conducts business or in which the Company sells or offers for sale, directly or through licensees or distributors, products or services, nor does Company have any Knowledge of any basis therefor.

          (i) Each item of Company Registered Intellectual Property is valid and subsisting (other than pending applications for Company Registered Intellectual Property), and all necessary registration, maintenance and renewal fees in connection with such Company Registered Intellectual Property have been paid and all necessary documents and certificates in connection with such Company Registered Intellectual Property have been filed with the relevant patent, copyright, trademark or other authorities in the United States or foreign jurisdictions, as the case may be, for the purposes of maintaining such Company Registered Intellectual Property. Other than as

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set forth in Section 3.12(a) of the Disclosure Schedule, there are no actions that must be taken by the Company within one-hundred twenty (120) days of the Closing Date, including the payment of any registration, maintenance or renewal fees or the filing of any documents, applications or certificates for the purposes of maintaining, perfecting or preserving or renewing any Company Registered Intellectual Property. In each case in which the Company has acquired ownership of any Intellectual Property Rights from any Person, the Company has obtained a valid and enforceable assignment sufficient to irrevocably transfer all rights in such Intellectual Property and the associated Intellectual Property Rights (including the right to seek past and future damages with respect thereto) to the Company and, to the maximum extent provided for by, and in accordance with, applicable laws and regulations, the Company has recorded each such assignment with the relevant governmental authorities, including the PTO, the U.S. Copyright Office, or their respective equivalents in any relevant foreign jurisdiction, as the case may be.

          (j) There are no Contracts between the Company and any other Person with respect to Company Intellectual Property or other Intellectual Property used in or necessary to the conduct of the business as it is currently conducted under which there is any dispute regarding the scope of such Contract, or performance under such Contract including with respect to any payments to be made or received by the Company thereunder.

          (k) Neither the execution of this Agreement by the Company nor the transactions contemplated by this Agreement, including the assignment to Parent by operation of law or otherwise of any Contracts to which the Company is a party, will result in (i) Parent, Merger Sub, the Company or the Surviving Corporation granting to any third party any right to or with respect to any Intellectual Property owned by, or licensed to, any of them under any Contract to which the Company is a party or by which it is bound, (ii) Parent, Merger Sub, the Company or the Surviving Corporation being bound by, or subject to, any non-compete or other material restriction on the operation or scope of their respective businesses under any Contract to which the Company is a party or by which it is bound, or (iii) Parent, Merger Sub, the Company or the Surviving Corporation being obligated to pay any royalties or other material amounts to any third party under any Contract to which the Company is a party or by which it is bound in excess of those payable by any of them, respectively, in the absence of this Agreement or the transactions contemplated hereby.

          (l) To the Knowledge of the Company, no Person or entity is infringing or misappropriating any Company Intellectual Property.

          (m) The Company has taken all reasonable steps that are required or necessary to protect the Company’s rights in confidential information and trade secrets of the Company or provided by any other Person or entity to the Company. Without limiting the foregoing, the Company has, and enforces, a policy requiring each employee, consultant, and contractor to execute proprietary information, confidentiality and assignment agreements substantially in the Company’s standard forms, and all current and former employees, consultants and contractors of the Company have executed such

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an agreement in substantially the Company’s standard form, a copy of which had been delivered to Parent.

          (n) As of the date of this Agreement, and to the Knowledge of the Company, no Company Intellectual Property is subject to any proceeding or outstanding decree, order, judgment or settlement agreement or stipulation that restricts in any manner the use, transfer or licensing thereof by the Company or may affect the validity, use or enforceability of such Company Intellectual Property.

          (o) To the Knowledge of the Company, no (i) product, technology, service or publication of the Company, (ii) material published or distributed by the Company, or (iii) conduct or statement of the Company constitutes obscene material, a defamatory statement or material, false advertising or otherwise violates any law or regulation of any jurisdiction in which the Company conducts business or in which the Company sells or offers for sale, directly or through licensees or distributors, products and services.

          (p) No government funding, facilities or resources of a university, college, other educational institution or research center or funding from third parties was used in the development of the Company Intellectual Property, and no Governmental Authority, university, college, other educational institution or research center has any claim or right in or to the Company Intellectual Property. No current or former employee, consultant or independent contractor of the Company who was involved in, or who contributed to, the creation or development of any Company Intellectual Property, has performed services for the government, a university, college or other educational institution, or a research center, during a period of time during which such employee, consultant or independent contractor was also performing services for the Company.

          (q) Section 3.12(q) of the Disclosure Schedule contains a complete and accurate list of all Intellectual Property of the Company, of a third party or in the public domain that constitutes open source, public source or freeware Intellectual Property, or any modification or derivative thereof, including any version of any software licensed pursuant to any GNU general public license or limited general public license (“Open Source Materials”) that was used in, incorporated into, integrated or bundled with any Intellectual Property that is, or was, used by the Company in its business, or incorporated in or used in the development or compilation of any products or technology of the Company, and describes the manner in which such Open Source Materials were used (such description shall include whether (and, if so, how) the Open Source Materials were modified and/or distributed by the Company or its Subsidiary).

          (r) The Company has not (i) incorporated Open Source Materials into, or combined Open Source Materials with, any Company products or technology, (ii) distributed Open Source Materials in conjunction with any Company Intellectual Property or Company products or technology, or (iii) used Open Source Materials in such a way that, with respect to (i) or (ii) creates, or purports to create, obligations for the Company with respect to any Company Intellectual Property or grants, or purports to grant, to any third party, any rights or immunities under any Company products or

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technology (including, but not limited to, using any Open Source Materials that require, as a condition of use, modification and/or distribution of such Open Source Materials that other software incorporated into, derived from or distributed with such Open Source Materials be (A) disclosed or distributed in source code form, (B) be licensed for the purpose of making derivative works, or (C) be redistributable at no charge).

          (s) The Company has secured all export licenses necessary or appropriate for the distribution of the Company’s products, services and technology outside of the United States in any jurisdiction in which the Company conducts business or in which the Company sells or offers for sale, directly or through licensees or distributors, products and services, and all such licenses are in full force and effect.

          (t) The Company’s products do not contain any virus, Trojan horse, worm or other software routines or hardware components designed to permit unauthorized access, to disable, erase or otherwise harm software, hardware or data.

     3.13 Restrictions on Business Activities. Section 3.13 of the Disclosure Schedule sets forth a complete and accurate list of each Contract (non-competition or otherwise), judgment, injunction, order or decree to which the Company is a party or otherwise binding upon the Company which has or may reasonably be expected to have the effect of prohibiting or impairing any business practice of the Company (including any restrictions on selling, licensing, manufacturing or otherwise distributing any of its technology or products or from providing services to customers or potential customers or any class of customers, in any geographic area, during any period of time, or in any segment of the market, any acquisition of property (tangible or intangible) by the Company, the conduct of business by the Company, or otherwise limiting the freedom of the Company to engage in any line of business or to compete with any Person.)

     3.14 Properties.

     (a) The Company does not own any real property, nor has the Company ever owned any real property. Section 3.14(a) of the Disclosure Schedule sets forth a complete and accurate list of all real property currently leased by the Company or otherwise used or occupied by the Company for the operation of the Company’s business (the “Leased Real Property”), the name of the lessor, the name and date of each lease agreement related thereto and each amendment thereto. The Company has provided Parent true, correct and complete copies of all leases, lease guaranties, subleases, agreements for the leasing, use or occupancy of, or otherwise granting a right in or relating to the Leased Real Property, including all amendments, terminations and modifications thereof, and there are no other lease agreements for real property affecting the real property or to which Company is bound. All such lease Contracts are valid and enforceable and not in default, no rentals are past due, and no circumstance exists, which, with notice, the passage of time or both, could constitute a default under any such lease agreement. The Company has received no notice of a default, alleged failure to perform, or any offset or counterclaim with respect to any such lease agreement, which has not been fully remedied and withdrawn. The consummation of the Merger and the other transactions contemplated hereby will not affect the enforceability against any Person of

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any such lease agreement or the rights of the Company or the Surviving Corporation to the continued use and possession of the real property for the conduct of business as presently conducted. The Leased Real Property is in good operating condition and repair and is maintained in a manner consistent with standards generally followed with respect to similar properties, and to the Knowledge of the Company is structurally sufficient and otherwise suitable for the conduct of the business as presently conducted and free from structural, physical and mechanical defects.

          (b) The Company has good and valid title to, or, in the case of leased properties and assets, valid leasehold interests in, all of its tangible properties and assets, real, Personal and mixed, used or held for use in its business, free and clear of any Liens, except Liens for Taxes not yet due and payable and such imperfections of title and encumbrances, if any, which do not detract from the value or interfere with the present use of the property subject thereto or affected thereby. The foregoing assets and the Company Intellectual Property constitute all of the assets used in, and necessary for, the business of the Company as currently conducted or currently contemplated to be conducted.

          (c) All material items of equipment owned or leased by the Company is adequate for the conduct of the business of the Company as currently conducted and as currently contemplated to be conducted and in good operating condition, regularly and properly maintained, subject to normal wear and tear.

          (d) The Company has sole and exclusive ownership, free and clear of any Liens, of all customer lists, customer contact information, customer correspondence and customer licensing and purchasing histories relating to its current and former customers not reserved by such customer. No Person other than the Company possesses any claims or rights with respect to use of such customer information.

     3.15 Material Contracts.

          (a) Section 3.15 of the Disclosure Schedule sets forth a complete and accurate list of the following Contracts in effect as of the date hereof (together with the Contracts set forth in Section 3.12(f) and (g) (Intellectual Property), Section 3.13 (Restrictions on Business Activities) or Section 3.14(a) (Leases), of the Disclosure Schedule, each a “Material Contract” and, collectively, the “Material Contracts”):

               (i) any employment or consulting Contract with an employee or individual consultant or salesperson, or consulting or sales Contract with a firm or other organization;

               (ii) any Contract or plan, including, without limitation, any stock option plan, stock appreciation rights plan or stock purchase plan, any of the benefits of which will be increased, or the vesting of benefits of which will be accelerated, by the occurrence of any of the transactions contemplated by this Agreement or the value of any of the benefits of which will be calculated on the basis of any of the transactions contemplated by this Agreement;

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               (iii) any Contract relating to the lease of personal property involving future payments in excess of $25,000 individually or $50,000 in the aggregate;

               (iv) any Contract relating to capital expenditures and involving future payments in excess of $25,000 individually or $50,000 in the aggregate;

               (v) any Contract relating to the disposition or acquisition of assets or any interest in any business enterprise outside the ordinary course of the Company’s business;

               (vi) any mortgages, indentures, guarantees, loans or credit agreements, security agreements or other Contracts relating to the borrowing of money or extension of credit (other than trade payables in the ordinary course of business consistent with past practices);

               (vii) any Contract for the purchase by the Company of goods or services involving in excess of $25,000 individually or $50,000 in the aggregate;

               (viii) any Contract for the purchase by customers of goods or services involving in excess of $25,000 individually or $50,000 in the aggregate;

               (ix) any dealer, distribution, joint marketing, strategic alliance or development Contract;

               (x) any standstill or similar Contract;

               (xi) any non-employee sales representative, original equipment manufacturer, manufacturing, value added, remarketer, reseller, or independent software vendor, or other Contract for use or distribution of the Company’s products, technology or services;

               (xii) any Contract (a) of a nature required to be disclosed on Section 3.21 of the Disclosure Schedule, or (b) granting a power of attorney, agency or similar authority to another person or entity;

               (xiii) any other Contract that (a) involves future payments in excess of $25,000 individually or $50,000 in the aggregate or more and is not cancelable without penalty within thirty (30) days, (b) has an unexpired term as of the Current Balance Sheet Date in excess of twelve months and is not otherwise listed on Section 3.15 of the Disclosure Schedule, or (c) is otherwise material to the business of the Company and not otherwise listed on Section 3.15 of the Disclosure Schedule; or

               (xiv) except as set forth on Schedule 3.15(a)(xiv), any Contract in which the Company has agreed to no limitation on the Company’s liability thereunder.

          (b) The Company is in compliance with and has not breached, violated or defaulted under, or received notice that it has breached, violated or defaulted under, any of the terms or conditions of any Material Contract, nor does the Company have any

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Knowledge of any event that would constitute such a breach, violation or default with the lapse of time, giving of notice or both. Each Material Contract is in full force and effect, enforceable in accordance with its terms, and the Company is not in default thereunder, nor, to the Knowledge of the Company, is any party obligated to the Company pursuant to any such Material Contract in default thereunder. Following the Effective Time, the Surviving Corporation will be permitted to exercise all of its rights under the Material Contracts without the payment of any additional amounts or consideration other than ongoing fees, royalties or payments which the Company would otherwise be required to pay pursuant to the terms of such Material Contracts had the transactions contemplated by this Agreement not occurred.

     3.16 Insurance. Section 3.16 of the Disclosure Schedule contains a complete and accurate list of all insurance policies and bonds covering the assets, business, equipment, properties, operations, employees, officers and directors of the Company or any of its Affiliates (the “Insurance Policies”). There is no claim by the Company or any of its Affiliates pending under any of such policies or bonds as to which coverage has been questioned, denied or disputed or that the Company or any of its Affiliates has a reason to believe will be denied or disputed by the underwriters of such policies or bonds. In addition, there is no pending claim of which its total value (inclusive of defense expenses) will exceed the policy limits. All premiums due and payable under all such policies and bonds have been paid, (or if installment payments are due, will be paid if incurred prior to the Closing Date) and the Company and its Affiliates are otherwise in material compliance with the terms of such policies and bonds (or other policies and bonds providing substantially similar insurance coverage). The Company has no Knowledge or reasonable belief of threatened termination of, or premium increase with respect to, any of such policies.

     3.17 Litigation. There is no action, suit, claim or proceeding of any nature pending or, to the Knowledge of the Company, threatened against the Company, its properties (tangible or intangible) or any of its officers or directors (in their capacity as such), nor to the Knowledge of the Company is there any reasonable basis therefor. There is no investigation or other proceeding pending or, to the Knowledge of the Company, threatened against the Company, any of its properties (tangible or intangible) or any of its officers or directors (in their capacity as such) by or before any Governmental Authority, nor to the Knowledge of the Company is there any reasonable basis therefor. No Governmental Authority has at any time challenged or questioned the legal right of the Company to conduct its operations as presently or previously conducted or as presently contemplated to be conducted.

     3.18 Governmental Authorization. Each consent, license, permit, grant or other authorization (i) pursuant to which the Company currently operates or holds any interest in any of its properties, or (ii) which is required for the operation of the Company’s business as currently conducted or currently contemplated to be conducted or the holding of any such interest (collectively, “Company Authorizations”) has been issued or granted to the Company. The Company Authorizations are in full force and effect and constitute all Company Authorizations required to permit the Company to operate or conduct its business or hold any interest in its properties or assets.

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     3.19 Compliance with Laws. The Company has complied with, is not in violation of, and has not received any notices of violation with respect to, any foreign, federal, state or local statute, law or regulation applicable to the Company, its business or its assets (whether tangible or intangible).

     3.20 Environmental Compliance.

          (a) The Company has not (i) operated any underground storage tanks at any property that the Company has at any time owned, operated, occupied or leased, or (ii) released any amount of any substance that has been designated by any Governmental Authority or by applicable federal, state or local law to be radioactive, toxic, hazardous or otherwise a danger to health or the environment, including, without limitation, PCBs, asbestos, petroleum, and urea-formaldehyde and all substances listed as hazardous substances pursuant to the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended, or defined as a hazardous waste pursuant to the United States Resource Conservation and Recovery Act of 1976, as amended, and the regulations promulgated pursuant to said laws (a “Hazardous Material”), but excluding office and janitorial supplies properly and safely maintained. No Hazardous Materials are present in, on or under any property (including the land and the improvements, ground water and surface water thereof) that the Company has at any time owned, operated, occupied or leased.

          (b) The Company has not transported, stored, used, manufactured, disposed of, released or exposed its employees or others to Hazardous Materials in violation of any law or in a manner that would result in liability to the Company, nor has the Company disposed of, transported, sold, or manufactured any product containing a Hazardous Material (any or all of the foregoing being collectively referred to herein as “Hazardous Materials Activities”) in violation of any rule, regulation, treaty or statute promulgated by any Governmental Authority to prohibit, regulate or control Hazardous Materials or any Hazardous Material Activity.

          (c) No action, proceeding, revocation proceeding, amendment procedure, writ, injunction or claim is pending, or to the Knowledge of the Company, threatened, concerning any Environmental Permit, Hazardous Material or any Hazardous Materials Activity of the Company. The Company has no Knowledge of any fact or circumstance that could involve the Company in any environmental litigation or impose upon the Company any environmental liability.

     3.21 Interested Party Transactions. To the Knowledge of the Company, no officer, director, consultant or shareholder of the Company (nor any ancestor, sibling, descendant or spouse of any of such Persons, or any trust, partnership or corporation in which any of such Persons has or has had an interest), has or has had, directly or indirectly, (i) an interest in any entity which furnished or sold, or furnishes or sells, services, products or technology that the Company furnishes or sells, or proposes to furnish or sell, (ii) any interest in any entity that purchases from or sells or furnishes to the Company, any goods or services, or (iii) a beneficial interest in any Contract to which the Company is a party; provided, however, that ownership of no more than one percent

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(1%) of the outstanding capital stock of a corporation shall not be deemed to be an “interest in any entity” for purposes of this Section 3.21. There are no Contracts with regard to contribution or indemnification between or among any of the Stockholders.

     3.22 Minute Books. The minutes of the Company made available to counsel for Parent are the only minutes of the Company and contain accurate summaries of all meetings or actions by written consent of the Board of Directors (or committees thereof) of the Company and contain all shareholder actions by written consent since the time of incorporation of the Company.

     3.23 Brokers’ and Finders’ Fees. The Company has not incurred, nor will it incur, directly or indirectly, any liability for brokerage or finders’ fees or agents’ commissions or any similar charges in connection with the Agreement or any transaction contemplated hereby.

     3.24 Accounts Receivable. All of the Company’s accounts receivable arose in the ordinary course of business, are carried at values determined in accordance with GAAP consistently applied, and are collectible except to the extent of reserves therefor set forth in the Current Balance Sheet or, for receivables arising subsequent to the Current Balance Sheet Date, as reflected on the books and records of the Company (which are prepared in accordance with GAAP). No Person has any Lien on any of the Company’s accounts receivable and no request or agreement for deduction or discount has been made with respect to any of the Company’s accounts receivable.

     3.25 Warranties; Indemnities. Except for the warranties and indemnities contained in those Contracts set forth in Section 3.12(g) of the Disclosure Schedule and warranties implied by law, the Company has not given any warranties or indemnities relating to products or technology sold or services rendered by the Company.

     3.26 Financial Projections/Operating Plan. The Company has made available to Parent certain financial projections with respect to the Company’s business which projections were prepared for internal use only. Such projections were prepared in good faith and are based on assumptions believed by the Company to be reasonable as of the date of this Agreement; provided, however, that the failure to achieve any aspect of such projections prepared in good faith shall not be deemed to constitute a breach of any representation or warranty of the Company.

     3.27 Banks and Brokerage Accounts. Section 3.27 of the Disclosure Schedule sets forth (a) a complete and accurate list of the names and locations of all banks, trust companies, securities brokers and other financial institutions at which the Company has an account or a safe deposit box or maintains a banking, custodial, trading or other similar relationship, and (b) a complete and accurate list and description of each such account, box and relationship, indicating in each case the account number and the names of the respective officers, employees, agents or other similar representatives of the Company having signatory power with respect thereto.

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     3.28 Customers and Suppliers. Since June 30, 2005, none of the ten (10) largest customers of the Company on the basis of orders booked during the three months prior to the Signing Date (the “Significant Customers”) or the thirty (30) largest suppliers of the Company on the basis of cost of goods or services purchased by the Company during the last twelve (12) calendar months prior to the Signing Date (the “Significant Suppliers”) has cancelled or materially reduced or, to the Knowledge of the Company, threatened to cancel or materially reduce its business with the Company. To the Knowledge of the Company, no such Significant Customer or Significant Supplier is threatened with bankruptcy or insolvency.

     3.29 Representations Complete. None of the representations or warranties made by the Company herein or in any Ancillary Agreement or schedule or exhibit hereto, including the Disclosure Schedule, or in any certificate or other document furnished by the Company pursuant to this Agreement or in connection with the transactions contemplated hereby, contains any untrue statement of a material fact or omits to state any material fact necessary in order to make the statements contained herein or therein, in the light of the circumstances under which made, not misleading.

ARTICLE 4

REPRESENTATIONS AND WARRANTIES
OF PARENT AND MERGER SUB

     Each of Parent and Merger Sub hereby represents and warrants to the Company and the Principal Stockholders, subject to such exceptions as are specifically disclosed in the disclosure schedule (referencing the appropriate section and paragraph numbers) supplied as of the date hereof by Parent to Company (the “Parent Disclosure Schedule”), as follows as of the date hereof and as of the Effective Time:

     4.1 Organization, Standing and Power. Parent is a corporation duly organized, validly existing and in good standing under the laws of the State of California, and Merger Sub is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware. Each of Parent and Merger Sub has the corporate power to own its properties and to carry on its business as now being conducted and is duly qualified or licensed to do business and is in good standing in each jurisdiction in which the failure to be so qualified or licensed would have a Parent Material Adverse Effect.

     4.2 Authority. Each of Parent and Merger Sub has all requisite corporate power and authority to enter into this Agreement and any Ancillary Agreements to which it is a party and to consummate the transactions contemplated hereby and thereby. The execution and delivery of this Agreement and any Ancillary Agreements to which it is a party and the consummation of the transactions

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contemplated hereby and thereby have been duly authorized by all necessary corporate action on the part of Parent and Merger Sub and no further action is required on the part of Parent or Merger Sub to authorize the Agreements or the Ancillary Agreements to which it is a party and the transactions contemplated hereby and thereby. This Agreement and any Ancillary Agreements to which Parent and Merger Sub are parties have been duly executed and delivered by Parent and Merger Sub and constitute the valid and binding obligations of Parent and Merger Sub, enforceable against each of Parent and Merger Sub in accordance with their respective terms, except as enforcement thereof may be limited by (i) bankruptcy, insolvency, reorganization, moratorium and similar laws, both state and federal, affecting the enforcement of creditors’ rights or remedies in general as from time to time in effect or (ii) the exercise by courts of equity powers.

     4.3 Consents. No consent, waiver, approval, order or authorization of, or registration, declaration or filing with, any Governmental Authority, or any third party, including a party to any Contract with Parent (so as not to trigger any Conflict) is required by or with respect to Parent or Merger Sub in connection with the execution and delivery of this Agreement and any Ancillary Agreements to which Parent or Merger Sub is a party or the consummation of the transactions contemplated hereby and thereby, except for (i) such consents, waivers, approvals, orders, authorizations, registrations, declarations and filings as may be required under applicable securities laws, (ii) such consents, waivers, approvals, orders, authorizations, registrations, declarations and filings that, if not obtained or made, would not have a Parent Material Adverse Effect, and (iii) the filing of the Certificate of Merger with the Secretary of State of the State of Delaware.

     4.4 Broker’s and Finders’ Fees. Neither Parent nor Merger Sub has incurred, nor will it incur, directly or indirectly, any liability for brokerage or finders’ fees or agents’ commissions or any similar charges in connection with this Agreement or any transaction contemplated hereby.

ARTICLE 5

CONDUCT OF THE COMPANY
PRIOR TO THE EFFECTIVE TIME

     5.1 Conduct of Business of the Company.

          (a) Except as set forth on Schedule 5.1(a) or except to the extent that Parent shall otherwise consent in writing (which consent shall not be unreasonably withheld or delayed), until the earlier of the Effective Time or the termination of this Agreement pursuant to Section 9.1, the Company shall conduct its business and operations (including working capital and cash management practices and the collection of accounts receivable) in the usual, regular and ordinary course in substantially the same manner as heretofore conducted, pay the debts and Taxes of the Company when due (subject to Section 5.1(b)(xiii)), pay or perform its other obligations when due, and, to the extent consistent with such business, preserve intact the Company’s present business organizations, use reasonable efforts to keep available the services of the Company’s present officers, key employees and consultants and preserve the Company’s relationships with customers, suppliers, distributors, licensors, licensees, and others

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having business dealings with it, all with the goal of preserving unimpaired the Company’s goodwill and ongoing businesses at the Effective Time.

          (b) Except (x) as set forth on Schedule 5.1(b), (y) to the extent that Parent shall otherwise consent in writing (which consent shall not be unreasonably withheld or delayed), or (z) as contemplated hereunder or under the Ancillary Agreements, until the earlier of the Effective Time or the termination of this Agreement pursuant to Section 9.1, the Company shall not:

               (i) cause or permit any amendments to its Certificate of Incorporation, Bylaws or other organizational documents of the Company;

               (ii) declare, set aside, or pay any dividends on or make any other distributions (whether in cash, stock or property) in respect of any Company Capital Stock, or split, combine or reclassify any Company Capital Stock or issue or authorize the issuance of any other securities in respect of, in lieu of or in substitution for shares of Company Capital Stock, or repurchase, redeem or otherwise acquire, directly or indirectly, any shares of Company Capital Stock (or options, warrants or other rights exercisable therefor);

               (iii) issue, grant, deliver or sell or authorize or propose the issuance, grant, delivery or sale of, or purchase or propose the purchase of, any shares of capital stock of the Company or any securities convertible into, or subscriptions, rights, warrants or options to acquire, or other agreements or commitments of any character obligating it to issue or purchase any such shares or other convertible securities except for issuances of Company Capital Stock pursuant to the exercise of outstanding Company Options;

               (iv) grant any severance or termination pay (whether in cash, equity or otherwise) to any officer or employee except pursuant to Contracts outstanding, or policies existing, on the date hereof and set forth on Schedule 5.1(b)(iv), or adopt any new severance plan, or amend or modify or alter in any respect any such severance plan, agreement or arrangement existing on the date hereof, or grant any equity-based compensation;

               (v) adopt or amend any Company Employee Plan, enter into any employment contract, pay or agree to pay any special bonus or special remuneration to any director or Employee, or increase the salaries, wage rates, or other compensation of its Employees except payments made pursuant to standard written agreements outstanding on the date hereof and disclosed on Schedule 5.1(b)(v) or except to the extent required by law;

               (vi) except as set forth on Schedule 5.1(b)(vi), hire or terminate (other than for cause) any Employees, or knowingly encourage any Employees to resign from the Company or any Affiliate;

               (vii) waive any stock repurchase rights, accelerate, amend or change the period of exercisability of options or restricted stock, or reprice options granted under any employee, consultant, director or other stock plans or authorize cash payments in exchange for any options

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granted under any of such plans, except for the acceleration of vesting of Company Options held by the Persons listed on Schedule 5.1(b)(vii) pursuant to agreements with the Company in effect as of the Signing Date;

               (viii) incur any indebtedness (other than trade payables in the ordinary course of business consistent with past practices) or guarantee any indebtedness or issue or sell any debt securities or guarantee any debt securities of others;

               (ix) pay, discharge or satisfy, in an amount in excess of $25,000 in any one case, or $50,000 in the aggregate, any Liability, other than the payment, discharge or satisfaction of Liabilities reflected or reserved against in the Current Balance Sheet;

               (x) make any expenditures (including any capital expenditures) or enter into any commitment or transaction exceeding $25,000 individually or $50,000 in the aggregate;

               (xi) sell, lease, license or otherwise dispose of any of its properties or assets (whether tangible or intangible), including without limitation the sale of any accounts receivable of the Company, except the sale of Company’s products in the ordinary course of business consistent with past practices;

               (xii) revalue any of its assets (whether tangible or intangible), including writing down the value of inventory or writing off notes or accounts receivable other than in the ordinary course of business and consistent with GAAP;

               (xiii) make or change any election in respect of Taxes, adopt or change any accounting method or practices (other than as required by GAAP), settle any claim or assessment in respect of Taxes, consent to any extension or waiver of the limitation period applicable to any claim or assessment in respect of Taxes, or file any material Tax Return or any amended Tax Return, unless such Tax Return has been provided to Parent for its review and consent a reasonable period of time prior to the due date for filing;

               (xiv) waive or release any right or claim of the Company;

               (xv) commence, threaten or settle any litigation;

               (xvi) (A) sell, license or transfer to any Person any rights to any Company Intellectual Property or enter into any agreement with respect to any Company Intellectual Property with any Person or entity, (B) buy or license any Intellectual Property or enter into any agreement with respect to the Intellectual Property of any Person or entity, (C) enter into any agreement with respect to the development of any Intellectual Property with a third party, or (D) change pricing or royalties charged by the Company to its customers or licensees, or the pricing or royalties set or charged by Persons who have licensed Intellectual Property to the Company;

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               (xvii) acquire or agree to acquire by merging or consolidating with, or by purchasing any assets or equity securities of, or by any other manner, any business or any corporation, partnership, association or other business organization or division thereof, or otherwise acquire or agree to acquire any assets which are material, individually or in the aggregate, to the Company’s business;

               (xviii) enter into, renew, fail to renew, renegotiate, amend or otherwise modify, or materially breach the terms of any Material Contract;

               (xix) terminate, amend or fail to renew any Insurance Policy;

               (xx) terminate or fail to review or preserve any Company Authorization; or

               (xxi) take, or agree in writing or otherwise to take, any of the actions described in Section 5.1(b)(i) through Section 5.1(b)(xx) hereof, or any other action that would prevent the Company or any of the Principal Stockholders from performing, or cause the Company or any of the Principal Stockholders not to perform, their respective covenants hereunder.

     5.2 No Solicitation. Until the earlier of the Effective Time or the termination of this Agreement pursuant to Section 9.1, neither the Company nor the Principal Stockholders shall (nor shall the Company or Principal Stockholders permit, as applicable, any of their respective officers, directors, employees, shareholders, agents, representatives or affiliates to), directly or indirectly, take any of the following actions with any party other than Parent and its designees: (a) solicit, knowingly encourage, initiate or participate in any inquiry, negotiations or discussions with respect to any offer or proposal to purchase or otherwise acquire all or any part of the Company’s business, properties or technologies, or all or any amount of the Company Capital Stock (whether or not outstanding), whether by merger, purchase of assets, tender offer, license or otherwise, (b) disclose any information not customarily disclosed to any Person concerning the Company’s business, properties or technologies, or afford to any Person access to its properties, technologies, books or record not customarily afforded such access, (c) assist or cooperate with any Person to make any proposal to purchase or otherwise acquire all or any part of the Company’s business, properties or technologies or all or any amount of the Company Capital Stock other than sales to customers in the ordinary course, or (d) enter into any Contract with any Person providing for any of the foregoing. In the event that the Company, any Principal Stockholder, or any of the Company’s affiliates shall receive any offer, proposal, or request, directly or indirectly, of the type referenced in clauses (a), (c), or (d) above, or any request for disclosure or access as referenced in clause (b) above, the Company or such Principal Stockholder, as applicable, shall immediately (x) suspend any discussions with such offeror or party with regard to such offers, proposals, or requests and (y) notify Parent thereof, including information as to the identity of the offeror or the party making any such offer or proposal and the specific terms of such offer or proposal, as the case may be, and such other information related thereto as Parent may reasonably request. The parties hereto agree that it would be impossible to measure in money the damages to Parent that would

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occur in the event that the provisions of this Section 5.2 were not performed in accordance with their specific terms or were otherwise breached. It is accordingly agreed by the parties hereto that Parent shall be entitled to seek an immediate injunction or injunctions, without the necessity of proving the inadequacy of money damages as a remedy and without the necessity of posting any bond or other security, to prevent breaches of the provisions of this Section 5.2 and to enforce specifically the terms and provisions hereof in any court of the United States or any state having jurisdiction, this being in addition to any other remedy to which Parent may be entitled at law or in equity.

ARTICLE 6

ADDITIONAL AGREEMENTS

     6.1 Stockholder Approval.

          (a) As soon as practicable following the execution of this Agreement, Company will take all action necessary in accordance with the DGCL and its Certificate of Incorporation and Bylaws to (i) convene a special meeting of the Stockholders to be held as promptly as practicable for the purpose of obtaining, or (ii) obtain, by written consent, the Requisite Stockholder Approval.

          (b) Notice of Stockholder Consent. As promptly as practicable following the receipt of the Requisite Stockholder Approval, the Company shall give written notice of this Agreement, the proposed Merger and the Requisite Stockholder Approval to all Stockholders pursuant to the requirements of the DGCL.

          (c) The materials submitted to the Stockholders by the Company in respect of this Agreement, the proposed Merger and the Requisite Stockholder Approval shall comply in all respects with the applicable provisions of the DGCL and shall have been subject to prior review and comment by Parent and shall include information regarding the Company, the Requisite Stockholder Approval, the terms of the Merger and this Agreement and such other documents as may be reasonably required by Parent. Each of Parent and Merger Sub, on the one hand, and the Company, on the other, shall provide to the other such information about itself as the other shall reasonably request in connection with any Stockholder notice or communications required under this Section 6.1 and the DGCL.

     6.2 Commercially Reasonable Efforts; Governmental Approvals; Contract Consents. Subject to the terms and conditions set forth in this Agreement, each of the parties hereto shall use commercially reasonable efforts to take promptly, or cause to be taken promptly, all actions, and to do promptly, or cause to be done promptly, all things necessary, proper or advisable under applicable laws and regulations to satisfy the conditions set forth in Article 7 and to remove any injunctions or other impediments or delays, legal or otherwise, in order to consummate and make effective the transactions contemplated by this Agreement for the purpose of securing to the parties hereto the benefits contemplated by this Agreement.

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          (a) Each of the Company and Parent shall promptly execute and file, or join in the execution and filing of, any application, notification or other document that may be necessary in order to obtain the authorization, approval or consent of any Governmental Authority, whether federal, state, local or foreign, which may be reasonably required, or which Parent may reasonably request, in connection with the consummation of the Merger and the other transactions contemplated hereby. Each of the Company and Parent shall use commercially reasonable efforts to obtain all such authorizations, approvals and consents. Each of the Company and Parent shall promptly inform the other of any material communication between the Company or Parent (as applicable) and any Governmental Authority regarding the Merger or any other transactions contemplated hereby. If the Company or Parent or any affiliate thereof shall receive any formal or informal request for supplemental information or documentary material from any Governmental Authority with respect to the Merger or any other transactions contemplated hereby, then the Company or Parent (as applicable) shall make, or cause to be made, as soon as reasonably practicable, a response in compliance with such request. Each of the Company and Parent shall direct, in its sole discretion, the making of such response, but shall consider in good faith the views of the other.

          (b) The Company shall use commercially reasonable efforts to obtain all necessary consents, waivers and approvals of any parties to any Contract as are required thereunder in connection with the Merger or for any such Contracts to remain in full force and effect so as to preserve all rights of, and benefits to, the Surviving Corporation under such Contract from and after the Effective Time.

     6.3 Notification of Certain Matters. The Company shall give prompt notice to Parent of: (i) the occurrence or non-occurrence of any event, the occurrence or non-occurrence of which has caused or is likely to cause any representation or warranty of the Company or any Principal Stockholder, respectively and as the case may be, set forth in this Agreement to be untrue or inaccurate at or at any time prior to the Effective Time, and (ii) any failure of the Company or any Principal Stockholder, as the case may be, to comply with or satisfy any covenant, condition or agreement to be complied with or satisfied by it hereunder; provided, however, that no such notice shall be required in the event such occurrence or non-occurrence or failure has not resulted in, and is reasonably likely not to result in, Losses to the Company in excess of $25,000. No information or knowledge obtained pursuant to this Section 6.3 shall affect or be deemed to modify any representation or warranty contained herein, the right to indemnification under Article 8 or the conditions to the obligations of the parties to consummate the Merger in accordance with the terms and provisions hereof.

     6.4 Access to Information. The Company shall afford Parent and its accountants, counsel and other representatives, reasonable access during the period commencing on the Signing Date and continuing through the earlier of the Effective Time or the termination of this Agreement, to (i) the Company’s properties, books, contracts, commitments and records, (ii) other information concerning the business, properties and Personnel (subject to restrictions imposed by applicable law) of the Company as Parent may reasonably request, and (iii) employees, officers, directors, customers, suppliers and creditors of the Company as may be reasonably necessary or

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appropriate for the purpose of enabling Parent to familiarize itself with the business of the Company. The Company shall afford Parent and its accountants, counsel and other representatives copies of internal financial statements (including Tax Returns and supporting documentation) and any other documentation reasonably requested by Parent, promptly upon request. No information or knowledge obtained in any investigation pursuant to this Section 6.4 shall affect or be deemed to modify any representation or warranty contained herein, the right to indemnification under Article 8 or the conditions to the obligations of the parties to consummate the Merger in accordance with the terms and provisions hereof.

     6.5 Confidentiality. Each of the parties hereto hereby agrees that the information obtained in any investigation pursuant to Section 6.4 hereof, or in connection with the negotiation and execution of this Agreement or the effectuation of the Merger and the other transactions contemplated hereby, shall be governed by the terms of the Confidential Disclosure Agreement (the “Confidential Disclosure Agreement”) between the Company and Parent.

     6.6 Public Disclosure. No party shall issue or make any statement or other communication or disclosure to any third party (other than their respective agents or employees of the Company) regarding this Agreement, the Merger or the other transactions contemplated hereby, including, if applicable, the termination of this Agreement and the reasons therefor, without the written consent of the other party hereto, subject to Parent’s obligation to comply with applicable laws and the rules and regulations of the Nasdaq Stock Market and the Company’s obligation to comply with applicable laws.

     6.7 Employment Arrangements. Parent may offer certain persons who are employees of the Company immediately prior to the Closing Date “at-will” employment by Parent or the Surviving Corporation, to be effective as of the Closing Date, upon proof of citizenship or appropriate employment authorization from the U.S. Immigration and Naturalization Service or the United States Department of State evidencing a right to work in the United States. Such “at-will” employment arrangements will (i) be set forth in offer letters based on Parent’s standard form (each, an “Offer Letter”), (ii) be subject to and in compliance with Parent’s applicable human resources policies and procedures, (iii) have terms, including the position and salary of such employee, which will be determined by Parent, and (iv) supersede any prior employment agreements and other arrangements with such employee in effect prior to the Closing Date. Each employee of the Company who remains an employee of Parent or the Surviving Corporation after the Closing Date shall be referred to hereafter as a “Continuing Employee.” Continuing Employees shall be eligible to receive benefits, including, if applicable, eligibility for participation in stock option plans, bonus plans and 401(k) plans, consistent with Parent’s applicable human resources policies and subject to Section 6.9.

     6.8 Employee Plans. The Company and its Affiliates, as applicable, shall each terminate, effective as of the day immediately preceding the Closing Date, unless Parent provides notice to the Company prior to such time that such termination is not necessary: (i) any and all group severance, separation or salary continuation plans, programs, or

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arrangements, and (ii) any and all 401(k) plans. Parent shall receive from the Company evidence that the Company’s and each of its Affiliate’s, as applicable, plan(s) and/or program(s) have been terminated pursuant to resolutions of each such entity’s Board of Directors (the form and substance of such resolutions shall be subject to review and approval of Parent), effective no later than the day immediately preceding the Closing Date. The Company also shall take such other actions in furtherance of terminating such plans, policies and arrangements as Parent may reasonably require. With respect to each benefit plan, program, practice, policy or arrangement maintained by Parent or a subsidiary of Parent in which employees of the Company subsequently participate (the “Parent Plans”), for purposes of determining eligibility and vesting (but not for accrual of pension benefits), service with the Company (or predecessor employers to the extent the Company provides past service credit under applicable Company Employee Plans) shall be treated as service with Parent; provided, that such service shall not be recognized to the extent that such recognition would result in a duplication of benefits or to the extent that such service was not recognized under the applicable Company Employee Plan. In the event that distribution or rollover of assets from the trust of a 401(k) plan which is terminated is reasonably anticipated to trigger liquidation charges, surrender charges, or other fees to be imposed upon the account of any participant or beneficiary of such terminated plan or upon the Company or the plan sponsor, then the Company shall take such actions as are necessary to reasonably estimate the amount of such charges and/or fees and provide such estimate to Parent in the Signing Balance Sheet.

     6.9 Proprietary Information and Inventions Assignment Agreement. The Company will use its commercially reasonable efforts to cause each employee and contractor of the Company not already a party to a proprietary information and inventions assignment agreement with the Company to enter into and execute such agreement in a form reasonably satisfactory to Parent.

     6.10 Spreadsheet. At the Closing, the Company shall deliver to Parent a spreadsheet (the “Spreadsheet”), which spreadsheet shall be certified as complete and correct by the Chief Executive Officer of the Company as of the Closing and which shall separately list, as of the Closing, (a) all record holders of Company Capital Stock and their respective addresses, the number of shares of Company Capital Stock held of record by each such holder, and the amount of cash to be deposited into the Closing Escrow Fund and Contingent Payment Escrow Fund, as applicable, on behalf of such holder and (b) all holders of outstanding options to purchase shares of Company Common Stock with their respective addresses and, for each such option, the number of shares of Company Common Stock for which such option is exercisable, the strike price, whether the option is intended to be an Incentive Stock Option (as defined in Section 422 of the Code), the grant date and the vesting schedule, including a description of any acceleration or early-exercise provisions.

     6.11 Expenses. Whether or not the Merger is consummated, all fees and expenses incurred in connection with the Merger including, without limitation, all legal, accounting, financial advisory, consulting and all other fees and expenses of third parties incurred by a party in connection with the negotiation and effectuation of the terms and conditions of this Agreement and the transactions contemplated hereby, shall be the

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obligation of the respective party incurring such fees and expenses; provided, however, that in the event the Merger is consummated, the Stockholders shall pay all out-of-pocket expenses incurred by the Company in connection with the contemplated transaction, including, without limitation all attorney and accountant fees (with such payment being made at the Closing by way of a reduction to the Equity Value).

ARTICLE 7

CONDITIONS TO THE MERGER

     7.1 Conditions to Obligations of Each Party. The respective obligations of the Company and the Principal Stockholders and of Parent and Merger Sub to effect the Merger shall be subject to the satisfaction, at or prior to the Effective Time, of the following conditions:

          (a) No Orders. No Governmental Authority shall have enacted, issued, promulgated, enforced or entered any statute, rule, regulation, executive order, decree, injunction or other order (whether temporary, preliminary or permanent) which is in effect and which has the effect of making the Merger illegal or otherwise prohibiting the consummation of the Merger or any other transaction contemplated hereby.

          (b) No Injunctions. No temporary restraining order, preliminary or permanent injunction or other order issued by any court of competent jurisdiction or other similar legal restraint shall be in effect that has the effect of prohibiting the consummation of the Merger or any other transaction contemplated hereby.

          (c) Governmental Approvals. Parent and the Company shall have obtained all consents and approvals from any Governmental Authority that are necessary to consummate the Merger and the other transactions contemplated hereby.

          (d) Requisite Stockholder Approval. The Company shall have obtained the Requisite Stockholder Approval and such Requisite Stockholder Approval shall not have been rescinded, revoked or otherwise repudiated.

          (e) Legal Proceedings. No Governmental Authority shall have commenced, or notified either Parent or the Company or any of their respective representatives that such Governmental Authority intends to commence, proceedings to restrain, prohibit, condition, rescind or take any substantially similar action with respect to any of the transactions contemplated by this Agreement or any of the Ancillary Agreements, unless such Governmental Authority shall have withdrawn such notice and abandoned all such proceedings.

     7.2 Conditions to the Obligations of Parent and Merger Sub. The obligations of Parent and Merger Sub to consummate the Merger and the other transactions contemplated hereby shall be subject to the satisfaction at or prior to the Effective Time of each of the following conditions, any of which may be waived, in writing, exclusively by Parent and Merger Sub:

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          (a) Covenants. The Company and the Principal Stockholders shall have performed and complied in all material respects with all material covenants and obligations under this Agreement required to be performed and complied with by such parties as of the Closing.

          (b) No Company Material Adverse Change. Since the Signing Date, there shall not have occurred any event or condition of any kind or character that has had, or is reasonably likely to have, a Company Material Adverse Change. For purposes of this Section 7.2(b), “Company Material Adverse Change” shall mean a material adverse change in the business, capitalization, assets (including intangible assets), liabilities, financial condition or results of operations of Company, taken as a whole; provided, however, that none of the following (individually or in combination) shall be deemed to constitute, or shall be taken into account in determining whether there has been, a Company Material Adverse Change: (a) any adverse effect to the extent resulting from general business or economic conditions; (b) any adverse effect to the extent resulting from conditions generally affecting any industry or industry sector in which the Company operates or competes; (c) any adverse effect to the extent resulting from the announcement, execution or delivery of this Agreement or the pendency or consummation of the Merger; (d) any adverse effect to the extent resulting from any change in accounting requirements or principles or any change in applicable laws, rules or regulations or the interpretation thereof; or (e) any adverse effect to the extent resulting from (i) any action taken by the Company at Parent’s direction, (ii) the failure to take any action referred to in Section 5.1 that was not taken by the Company because Parent unreasonably withheld or delayed its consent, or (iii) the payment of any amounts due to, or the provision of any other benefits to, any Persons or entities pursuant to the Company’s obligations under Contracts in existence as of the date of this Agreement and disclosed in the Disclosure Schedule.

          (c) Representations and Warranties. The representations and warranties of the Company and the Principal Stockholders shall be true and correct as of the Closing in all material respects (without regard to any materiality qualifications contained therein).

          (d) Certificate of the Company. Parent shall have received a certificate of the Company, executed by the Chief Executive Officer of the Company, certifying as to the matters set forth in Section 7.2(a), (b) and (c) hereof, which certificate will include a reaffirmation of the representations and warranties of the Company set forth in this Agreement and the Ancillary Agreements as of the Effective Time.

          (e) Certificate of the Principal Stockholders. Parent shall have received a certificate of each of the Principal Stockholders, executed by the Chief Executive Officer of the Company, certifying as to the matters set forth in Section 7.2(a) and Section 7.2(b) hereof.

          (f) Good Standing Certificates. Parent shall have received good standing certificates with respect to the Company issued by the Secretaries of State of the States of California and Delaware and a tax good standing certificate with respect to the

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Company issued by the California Franchise Tax Board, each dated within two days prior to the Closing.

          (g) Legal Opinion. Parent shall have received a legal opinion from Montgomery Law Group, LLP, legal counsel to the Company, as to the matters set forth in Exhibit D.

          (h) Ancillary Agreements. Each Ancillary Agreement shall be in full force and effect and none of the parties thereto (other than Parent or Merger Sub and, in the case of the Escrow Agreement and Contingent Payment Escrow Agreement, the Escrow Agent) shall have taken any action to rescind, revoke or otherwise repudiate such party’s Ancillary Agreement(s).

          (i) FIRPTA Certificate. Parent shall have received a certificate, in a form reasonably acceptable to Parent, for purposes of satisfying Parent’s obligations under Treasury Regulation Section 1.1445-2(c)(3), validly executed by the Chief Executive Officer of the Company.

          (j) Company Stockholder Approval. The Company shall have obtained the Requisite Stockholder Approval and such Requisite Stockholder Approval shall not have been rescinded, revoked or otherwise repudiated.

          (k) Employment Matters. Effective as of the Closing Date, each of the Employees of the Company listed on Schedule 7.2(k) of the Disclosure Schedule (the “Identified Individuals”) shall have accepted and not rescinded Parent’s offer of employment and shall have executed and delivered to Parent the Employment Agreement and Non-Compete Agreement, which Agreement shall be in full force and effect from the Closing Date.

     7.3 Conditions to Obligations of the Company and the Principal Stockholders. In addition to the conditions set forth in Section 8.1, the obligations of the Company and each of the Principal Stockholders to consummate the Merger and the other transactions contemplated hereby shall be subject to the satisfaction at or prior to the Effective Time of the following condition, which may be waived, in writing, exclusively by the Company and the Principal Stockholders:

          (a) Covenants. Each of Parent and Merger Sub shall have performed and complied in all material respects with all material covenants and obligations under this Agreement required to be performed and complied with by it as of the Closing.

          (b) Representations and Warranties. The representations and warranties of the Company and the Principal Stockholders shall be true and correct as of the Closing in all material respects (without regard to any materiality qualifications contained therein).

          (c) Certificate of Parent. The Company shall have received a certificate of Parent, executed by a duly authorized officer of Parent, certifying as to the matters set forth in Sections 7.3(a) and (b) hereof.

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ARTICLE 8

SURVIVAL AND INDEMNIFICATION

     8.1 Survival of Representations, Warranties and Covenants. The representations, warranties, covenants and obligations of the Company and the Principal Stockholders and of Parent and Merger Sub set forth in this Agreement, any certificate or other instrument delivered pursuant hereto, or any Ancillary Agreement, shall survive for a period of twelve (12) months following the Closing Date (the “Termination Date”); provided, however, that any such covenants and obligations of Parent or Merger Sub that pursuant to their terms continue beyond the Termination Date shall survive the Closing in accordance with their terms. If a Notice of Claim has been delivered in compliance with this Article 8 prior to the Termination Date, then such representations, warranties, covenants and obligations, as the case may be, shall survive as to such claim until the claim has been finally resolved.

     8.2 Indemnification.

          (a) Parent and its Affiliates, including the Surviving Corporation, and their respective officers, directors, employees, agents, successors and assigns (each, a “Parent Indemnified Party” and collectively, the “Parent Indemnified Parties”), shall, subject to Section 8.3, be held harmless against all Losses incurred or sustained by the Parent Indemnified Parties, or any of them, directly or indirectly, as a result of, arising out of or relating to (i) any breach of a representation or warranty of the Company or the Principal Stockholders set forth in this Agreement or in any certificate or instrument delivered in connection herewith (including, without limitation, the Signing Balance Sheet and the Spreadsheet) or in any Ancillary Agreement, (ii) any failure by the Company or the Principal Stockholders to perform or comply with any covenant applicable to it contained in this Agreement or in any Ancillary Agreement, (iii) any fraud or (iv) any amount payable (and not paid) from the Closing Escrow Fund as described in Section 2.8(c) (Dissenting Shares) or Section 2.7(c) (Cash Balance). There shall not exist any right of contribution from the Surviving Corporation or Parent with respect to any Loss for which indemnity may be claimed hereunder.

          (b) Each Stockholder and each Stockholder’s Affiliates, officers, directors, employees, agents, successors and assigns, as applicable (each, a “Company Indemnified Party” and collectively, the “Company Indemnified Parties”), shall, subject to Section 8.3, be held harmless by Parent against all Losses incurred or sustained by the Company Indemnified Parties, or any of them, directly or indirectly, as a result of or arising out of (i) any breach of a representation or warranty of the Parent or Merger Sub set forth in this Agreement or in any certificate or instrument delivered in connection herewith or in any Ancillary Agreement or (ii) any failure by Parent or Merger Sub to perform or comply with any covenant applicable to it contained in this Agreement or in any Ancillary Agreement.

     8.3 Limitations on Indemnification

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          (a) Notwithstanding Section 8.2, no Parent Indemnified Party or Company Indemnified Party may recover pursuant to the indemnity set forth in Section 8.2 unless and until Losses in excess of $50,000 in the aggregate (the “Deductible Amount”) has or have been incurred, after which case such Person shall be entitled to recover pursuant to the indemnity set forth in Section 8.2 only with respect to any such Losses in excess of the Deductible Amount; provided, however, that the limitations set forth in this Section 8.3(a) shall not apply to (i) any claim against the Closing Escrow Fund based on fraud or (ii) any claim described in Section 2.7(c).

          (b) Claims for indemnification against the Closing Escrow Fund shall be the sole and exclusive remedy for the Parent Indemnified Parties with respect to claims resulting from or relating to any of the matters set forth in Section 8.2(a)(i), (ii), or (iv).

          (c) Nothing in this Agreement shall limit the liability of any Person in respect of any fraud committed by such Person; provided, however, that no Person shall be liable for any fraud committed by any other Person, except, in the case of a claim for indemnification brought pursuant to Section 8.2(a)(iii) above, to the extent of such Person’s beneficial interest in the Closing Escrow Fund.

          (d) The maximum aggregate amount that all Company Indemnified Parties shall be eligible to recover pursuant to the indemnity set forth in Section 8.2(b) shall be equal to the amount initially deposited by Parent into the Closing Escrow Fund (subject to any adjustment made pursuant to Section 2.7(c)).

     8.4 Notice of Claim.

          (a) As used herein, the term “Claim” shall mean a claim for indemnification under this Article 8, “Indemnified Party” shall mean any Parent Indemnified Party or Company Indemnified Party making a claim for indemnification pursuant to Sections 8.2(a) or 8.2(b) respectively, and “Indemnifying Party” shall mean the Closing Escrow Fund, in the case of a claim brought pursuant to Sections 8.2(a), or Parent, in the case of a claim brought pursuant to Section 8.2(b). Subject to the terms of this Agreement, the Indemnified Party shall give written notice of a Claim (a “Notice of Claim”) to the Indemnifying Party (with a copy to the Escrow Agent and the Stockholder Representative) promptly after such Indemnified Party becomes aware of the existence of any potential claim by such Indemnified Party for indemnification from the Indemnifying Party under this Article 8; provided, however, no Notice of Claim shall be required in connection with any dispute relating to the determination of Cash Balance, which disputes shall be governed by the procedures set forth in Section 2.7.

          (b) Each Notice of Claim by an Indemnified Party given pursuant to Section 8.4(a) shall contain the following information: (i) that such Indemnified Party has directly or indirectly incurred, paid or properly accrued, or sustained or, in good faith, believes it is reasonably likely that it shall have to directly or indirectly incur or sustain, Losses in an aggregate stated amount arising from such Claim (which amount may be the amount of damages claimed by a third party in an action brought against such

49

Indemnified Party based on alleged facts, which if true, would give rise to liability for Losses indemnifiable to such Indemnified Party under this Article 8); and (ii) a brief description, in reasonable detail (to the extent reasonably available to such Indemnified Party), of the facts, circumstances or events giving rise to the alleged Losses based on such Indemnified Party’s good faith belief thereof, including the identity and address of any third-party claimant (to the extent reasonably available to such Indemnified Party) and copies of any formal demand or complaint, the amount of Losses, the date each such item was incurred, paid or properly accrued, or sustained, or the basis for such anticipated liability, and the specific nature of the breach to which such item is related.

          (c) An Indemnified Party may submit a Notice of Claim at any time during the period commencing with the Effective Time and ending on the Termination Date, but shall not be permitted to bring a Notice of Claim at any time after the Termination Date (and any delivery or attempted delivery of a Notice of Claim after such time shall be void and of no force or effect). Notwithstanding anything contained herein to the contrary, any Claims for Losses specified in any Notice of Claim delivered to an Indemnifying Party prior to expiration of the Termination Date shall remain outstanding until such Claims for Losses have been resolved or satisfied, notwithstanding the passage of the Termination Date. Until the Termination Date, no delay on the part of an Indemnified Party in giving the Indemnifying Party a Notice of Claim shall relieve the Indemnifying Party from any of its obligations under this Article 8 unless (and then only to the extent that) the Indemnifying Party is materially prejudiced thereby.

     8.5 Resolution of Notice of Claim. Each Notice of Claim given by an Indemnified Party shall be resolved as follows:

          (a) If, within twenty (20) days after a Notice of Claim is received by the Indemnifying Party, the Indemnifying Party (or, in the case of the Closing Escrow Fund, the Stockholder Representative) does not contest such Notice of Claim in writing to the Indemnified Party delivering such Notice of Claim, the Indemnifying Party shall be conclusively deemed to have consented to the recovery by the Indemnified Party of the full amount of Losses specified in the Notice of Claim in accordance with this Article 8. Such recovery shall be limited, in the case of claims brought pursuant to Section 8.2(a), to the forfeiture of that portion of the Closing Escrow Fund having an aggregate value equal to such Losses. In the case of claims brought pursuant to Section8.2(b), such recovery shall be by payment of additional cash equal to the value of such Losses to the Stockholders in proportion to their respective Pro Rata Share of the remaining portion of the Closing Escrow Fund. Notwithstanding anything in this Section 8.5(a) to the contrary, where the basis for a claim against an Indemnifying Party is that an Indemnified Party has become aware of the existence of a potential claim and reasonably anticipates that it will incur or sustain Losses, no payment or distribution will be made to such Indemnified Party for such Losses unless and until such Losses are actually incurred, or properly accrued or sustained.

          (b) If the Indemnifying Party (or, in the case of the Closing Escrow Fund, the Stockholder Representative) gives the Indemnified Party delivering a Notice of Claim written notice contesting all or any portion of such Notice of Claim (a “Contested

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Claim”) (with a copy to the Escrow Agent) within the twenty (20) day period specified in Section 8.5(a), then such Contested Claim shall be resolved by either (i) a written settlement agreement executed by Parent and the Stockholder Representative (a copy of which shall be furnished to the Escrow Agent, if applicable) or (ii) in the absence of such a written settlement agreement within forty-five (45) days following receipt by the Indemnified Party of the written notice from the Indemnifying Party (or, in the case of the Closing Escrow Fund, the Stockholder Representative), by arbitration between Parent and the Stockholder Representative in accordance with the terms and provisions of Section 8.5(c). In the event that an Indemnified Party shall prevail in any such arbitration, the Indemnified Party shall be entitled to recover, in addition to any other rights they may have, the amount of Losses awarded in such arbitration. The prevailing party’s recovery shall be limited, in the case of claims brought pursuant to Section 8.2(a), to the forfeiture of that portion of the Closing Escrow Fund having an aggregate value equal to such awarded Losses. In the case of claims brought pursuant to Section 8.2(b), such recovery shall be by payment of additional cash equal to the value of such awarded Losses to the Stockholders in proportion to their respective Pro Rata Share of the remaining portion of the Closing Escrow Fund.

          (c) Arbitration.

               (i) Contested Claims under Section 8.5(c)(ii) and disputes pursuant to Section 8.10 shall be submitted for arbitration, unless the amount of the Losses is at issue in pending litigation with a third party, in which event arbitration shall not be commenced until such amount is ascertained or both parties agree to arbitration; and in either such event the matter shall be settled by arbitration conducted by one arbitrator mutually agreeable to Parent and the Stockholder Representative. In the event that within thirty (30) days after submission of any dispute to arbitration, Parent and the Stockholder Representative (or, in the case of a dispute under Section 8.10, the Key Employee Stockholder) cannot mutually agree on one arbitrator, the matter shall be settled by arbitration conducted by three arbitrators consisting of one arbitrator selected by Parent, one arbitrator selected by the Stockholder Representative (or Key Employee Stockholder), and one arbitrator selected by the two arbitrators so selected by Parent and the Stockholder Representative (or Key Employee Stockholder). The arbitrator or arbitrators, as the case may be, shall set a limited time period and establish procedures designed to reduce the cost and time for discovery while allowing the parties an opportunity, adequate in the sole judgment of the arbitrator or majority of the three arbitrators, as the case may be, to discover relevant information from the opposing parties about the subject matter of the dispute. The arbitrator or a majority of the three arbitrators, as the case may be, shall rule upon motions to compel or limit discovery and shall have the authority to impose sanctions, including attorneys’ fees and costs, to the same extent as a competent court of law or equity, should the arbitrators or a majority of the three arbitrators, as the case may be, determine that discovery was sought without substantial justification or that discovery was refused or objected to without substantial justification. The decision of the arbitrator or a majority of the three arbitrators, as the case may be, as to the validity and amount of any Contested Claim or the characterization of any termination of a Key Employee Stockholder shall be binding and conclusive upon the parties to this Agreement. Such decision shall be written and shall be supported by

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written findings of fact and conclusions, which shall set forth the award, judgment, decree or order awarded by the arbitrator(s).

               (ii) Judgment upon any award rendered by the arbitrator(s) may be entered in any court having jurisdiction. Any such arbitration shall be held in the County of Santa Clara, under the rules then in effect of the American Arbitration Association. The arbitrator(s) shall determine how all expenses relating to the arbitration shall be paid, including without limitation, the respective expenses of each party, the fees of each arbitrator and the administrative fee of the American Arbitration Association.

     8.6 Release of Closing Escrow Fund. Subject to the provisions of Section 8.1, the Closing Escrow Fund then held by the Escrow Agent shall be released by the Escrow Agent to the Stockholders at 5:00 p.m., local time at Parent’s headquarters, on the Termination Date; provided, however, that the escrow period shall not terminate with respect to any amount which, in the reasonable judgment of Parent, is necessary to satisfy any unsatisfied claims specified in any Notice of Claim theretofore delivered to the Escrow Agent and, in the case of claims made pursuant to Section 8.2(a), the Stockholder Representative, prior to the Termination Date with respect to facts and circumstances existing prior to the Termination Date and unresolved prior to the Termination Date (“Unresolved Claims”). On the Termination Date, the Escrow Agent shall deliver the entire remaining portion of the Closing Escrow Fund (other than amounts set forth in any such pending Notices of Claim to satisfy any Unresolved Claims), as described above, in the following manner: (i) first, to the Stockholder Representative for any Stockholder Representative Expenses (as defined in Section 8.8(b)), and (ii) then to the Stockholders in proportion to their respective Pro Rata Portions of the remaining portion of the Closing Escrow Fund. Thereafter, as soon as any such Unresolved Claims have been resolved, the Escrow Agent shall deliver the remaining portion of the Closing Escrow Fund, if any, no longer required to satisfy such previously Unresolved Claims in the manner set forth in the preceding sentence.

     8.7 Third-Party Claims. In the event Parent becomes aware of a third party claim (a “Third Party Claim”) which Parent reasonably believes may result in a demand for indemnification pursuant to this Article 8, Parent shall notify the Stockholder Representative of such claim, and the Stockholder Representative shall be entitled on behalf of the Indemnifying Parties, at its expense, to participate in, but not to determine or conduct, the defense of such Third Party Claim. Parent shall have the right in its sole discretion to conduct the defense of, and to settle, any such Third Party Claim; provided, however, that except with the prior written consent of such settlement by the Stockholder Representative (which consent shall not be unreasonably withheld or delayed), no settlement of any such Third Party Claim with third party claimants shall be determinative of the amount of Losses relating to such matter. In the event that the Stockholder Representative has consented to any such settlement, the Indemnifying Parties shall have no power or authority to object under any provision of this Article 8 to the amount of any Third Party Claim by Parent against the Closing Escrow Fund with respect to such settlement.

     8.8 Stockholder Representative.

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          (a) The approval by the Stockholders of the principal terms of the Merger shall automatically and without any further action on the part of any Stockholder constitute the appointment of the Stockholder Representative as the agent and attorney-in-fact for each of the Stockholders, to give and receive notices and communications, to authorize payment to any Indemnified Party from the Closing Escrow Fund in satisfaction of claims by any Indemnified Party, to object to such payments, to bring any claim for indemnification on behalf of any Company Indemnified Party, to agree to, negotiate, enter into settlements and compromises of, and demand arbitration and comply with orders of courts and awards of arbitrators with respect to such claims, to assert, negotiate, enter into settlements and compromises of, and demand arbitration and comply with orders of courts and awards of arbitrators with respect to, any other claim by any Indemnified Party against any Stockholder or by any such Stockholder against any Indemnified Party or any dispute between any Indemnified Party and any such Stockholder, in each case relating to this Agreement or the transactions contemplated hereby, and to take all other actions that are either (i) necessary or appropriate in the judgment of the Stockholder Representative for the accomplishment of the foregoing or (ii) specifically mandated by the terms of this Agreement. Such agency may be changed by the Stockholders from time to time upon not less than thirty (30) days’ prior written notice to Parent; provided, however, that the Stockholder Representative may not be removed unless holders of a majority in interest of the Closing Escrow Fund agree to such removal and to the identity of the substituted agent. A vacancy in the position of Stockholder Representative may be filled by the holders of a majority in interest of the Closing Escrow Fund. No bond shall be required of the Stockholder Representative, and the Stockholder Representative shall not receive any compensation for its services. Notices or communications to or from the Stockholder Representative shall constitute notice to or from the Stockholders

          (b) The Stockholder Representative shall not be liable for any act done or omitted hereunder as Stockholder Representative while acting in good faith and in the exercise of reasonable judgment. The Stockholders on whose behalf the Closing Escrow Fund was constituted shall indemnify the Stockholder Representative and hold the Stockholder Representative harmless against any loss, liability or expense incurred without gross negligence or bad faith on the part of the Stockholder Representative and arising out of or in connection with the acceptance or administration of the Stockholder Representative’s duties hereunder, including the reasonable fees and expenses of any legal counsel retained by the Stockholder Representative (“Stockholder Representative Expenses”). Promptly after the Termination Date, and subject to Section 8.6, any cash or other property that remains available in the Closing Escrow Fund shall constitute security for the indemnification obligations set forth in the immediately preceding sentence and shall be released to the Stockholder Representative upon delivery by the Stockholder Representative to Parent and the Escrow Agent prior to the Termination Date of a certificate signed by the Stockholder Representative (i) stating that the Stockholder Representative is entitled to such indemnity payment, (ii) specifying in reasonable detail the basis of such claim, and (iii) accompanied by any additional documentation evidencing the validity of the Stockholder Representative Expenses reasonably requested by the Escrow Agent, Parent or any holder of Company Capital Stock. A decision, act, consent or instruction of the Stockholder Representative shall constitute a decision of the

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Stockholders and shall be final, binding and conclusive upon the Stockholders, and the Escrow Agent and Parent may rely upon any such decision, act, consent or instruction of the Stockholder Representative as being the decision, act, consent or instruction of the Stockholders. The Escrow Agent and Parent are hereby relieved from any liability to any Person for any acts done by them in accordance with such decision, act, consent or instruction of the Stockholder Representative.

     8.9 Contingent Payment Escrow Fund. Each Stockholder that is a holder of shares of Unvested Common Stock (a “Key Employee Stockholder”) shall become a party to the Contingent Payment Escrow Agreement. Pursuant to such Contingent Payment Escrow Agreement, such Key Employee Stockholder shall be entitled, in consideration of cancellation of all shares of Unvested Common Stock, to contingent payments in an amount and upon such dates as specified in such agreement (the “Payment Schedule”). In the event such Key Employee Stockholder ceases to be an employee or consultant (a “Service Provider”) to the Parent for any reason other than as a result of a termination for Cause (as such term is defined in such Stockholder’s Employment Agreement, each dated as of the Effective Date) (a “Termination for Convenience”), the Escrow Agent shall deliver to such Stockholder that portion of the Contingent Payment Escrow Fund equal to any and all amounts that remain payable to such Stockholder pursuant to the Payment Schedule. In the event the Company terminates such Key Employee Stockholder’s status as a Service Provider for Cause or the Key Employee Stockholder resigns as a Service Provider other than for Good Reason (as such term is defined in such Key Employee Stockholder’s Employment Agreement), the Escrow Agent shall deliver to Parent that portion of the Contingent Payment Escrow Fund equal to any and all amounts that remain payable to such Key Employee Stockholder pursuant to the Payment Schedule (a “Termination Other than for Convenience”).

     8.10 Notice of Release of Funds.

          (a) Within ten (10) business days of any Stockholder that is a party to the Contingent Payment Escrow Agreement ceasing to be a Service Provider, the Parent shall deliver to the Escrow Agent, with a copy to the Key Employee Stockholder, a notice requesting the release of all funds from the Contingent Payment Escrow Fund that are being held on behalf of such Key Employee Stockholder (“Contingent Payment Release Notice”). Such Contingent Payment Release Notice shall specify whether the termination of services is a Termination for Convenience or a Termination Other than for Convenience.

          (b) If, within twenty (20) days after a Contingent Payment Release Notice is received by the Key Employee Stockholder, such Key Employee Stockholder does not contest such notice in writing to the Parent, with a copy to the Escrow Agent, the Key Employee Stockholder shall be conclusively deemed to have consented to characterization of the separation as a Termination for Convenience or a Termination Other than for Convenience, as applicable. If, within such twenty (20) day period the Key Employee Stockholder does timely contest the characterization of such termination

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of services, then the characterization of the termination of service as either a Termination for Convenience or a Termination Other than for Convenience shall be resolved by either (i) a written settlement agreement executed by Parent and the applicable Key Employee Stockholder (a copy of which shall be furnished to the Escrow Agent, if applicable) or (ii) in the absence of such a written settlement agreement within forty-five (45) days following receipt by the Key Employee Stockholder of the written notice from the Parent, by arbitration between Parent and the Key Employee Stockholder in accordance with the terms and provisions of Section 8.5(c).

ARTICLE 9

TERMINATION, AMENDMENT AND WAIVER

     9.1 Termination. Except as provided in Section 9.2, this Agreement may be terminated and the Merger abandoned at any time prior to the Closing:

          (a) by mutual agreement of Parent and the Company;

          (b) by Parent or the Company, if the Closing Date shall not have occurred by December 9, 2005; provided, however, that the right to terminate this Agreement under this Section 9.1(b) shall not be available to any party whose action or failure to act has been a principal cause of, or resulted in, the failure of the Merger to occur on or before such date and such action or failure to act constitutes a breach of this Agreement;

          (c) by Parent or the Company, if the Requisite Stockholder Approval has not been obtained by written consent of the Company Stockholders or at a meeting of the Company’s Stockholders duly called and held in accordance with the Company’s Certificate of Incorporation, or any postponement or adjournment thereof; provided, however, that the right to terminate this Agreement under this Section 9.1(c) shall not be available to any party whose action or failure to act has been a principal cause of, or resulted in, the failure to obtain the Requisite Stockholder Approval at a meeting of the Company’s Stockholders and such action or failure to act constitutes a breach of this Agreement;

          (d) by Parent or the Company, if (i) a court of competent jurisdiction or other Governmental Authority shall have issued a nonappealable final order, decree or ruling or taken any other action, in each case having the effect of permanently restraining, enjoining or otherwise prohibiting the Merger or any other material transaction contemplated by this Agreement, or (ii) any statute, rule, regulation or order is enacted, promulgated or issued by any Governmental Authority that would make consummation of the Merger illegal;

          (e) by Parent, if (i) it is not in material breach of its obligations under this Agreement and (ii) there has been a breach of any representation, warranty, covenant or agreement of the Company or the Principal Stockholders contained in this Agreement

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such that the conditions set forth in Section 7.2(a) or Section 7.2(b) would not be satisfied at the time of such breach and such breach has not been cured within ten (10) business days after written notice thereof to the Company or the applicable Principal Stockholder; provided, however, that no cure period shall be required for a breach which by its nature cannot be cured;

          (f) by Parent, if the Board of Directors of the Company shall withhold, withdraw, change or otherwise modify in a manner adverse to Parent its unanimous recommendation that the Stockholders adopt this Agreement and approve the Merger;

          (g) by Parent, if Parent’s review of the Signing Balance Sheet, to be completed no more than three business days after the Signing Date, reveals that Company’s financial position is materially weaker than previously disclosed; or

          (h) by the Company, if (i) none of the Company or the Principal Stockholders is in material breach of its obligations under this Agreement and (ii) there has been a breach of any representation, warranty, covenant or agreement contained in this Agreement such that the conditions set forth in Section 7.3(a) or Section 7.3(b) would not be satisfied and such breach has not been cured within ten (10) business days after written notice thereof to Parent; provided, however, that no cure period shall be required for a breach which by its nature cannot be cured.

          (i) by Parent, upon payment of the Breakup Fee.

     9.2 Effect of Termination. In the event of termination of this Agreement pursuant to Section 9.1, this Agreement shall forthwith become void and there shall be no liability or obligation on the part of Parent, Merger Sub, the Company or the Principal Stockholders, or their respective officers, directors or shareholders, if applicable; provided, however, that (i) each party hereto shall remain liable for any breaches of this Agreement prior to its termination; (ii) the provisions of Section 6.5 (Confidentiality), Section 6.6 (Public Disclosure) and Section 6.11 (Expenses), Article 10 (General Provisions) and this Section 9.2 shall remain in full force and effect and survive any termination of this Agreement pursuant to the terms of this Article 9; and (iii) in the event of a termination of this Agreement by Parent or Company (for purposes of this clause, the “Terminating Party”) pursuant to either Section 9.1(e) or 9.1(h), respectively, the other party shall within ten (10) days following the date of such termination reimburse the Terminating Party for the Terminating Party’s reasonable expenses (including reasonable attorneys’ and accountants’ fees and expenses) incurred in connection with the transactions contemplated herein.

     9.3 Amendment. The parties hereto may amend this Agreement at any time solely by executing an instrument in writing signed on behalf of the party against whom enforcement is sought.

     9.4 Extension and Waiver. At any time prior to the Closing, Parent, the Company and the Principal Stockholders may, to the extent legally permitted, (i) extend

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the time for the performance of any of the obligations of the other party hereto, (ii) waive any inaccuracies in the representations and warranties made to such party contained herein or in any document delivered pursuant hereto, and (iii) waive compliance with any of the agreements or conditions for the benefit of such party contained herein. Any agreement on the part of a party hereto to any such extension or waiver shall be valid only if set forth in an instrument in writing signed on behalf of such party.

ARTICLE 10

GENERAL PROVISIONS

     10.1 Notices. All notices and other communications hereunder shall be in writing and shall be deemed given if delivered personally or by commercial messenger or courier service, or mailed by registered or certified mail (return receipt requested) or sent via facsimile (with acknowledgment of complete transmission) to the parties at the following addresses (or at such other address for a party as shall be specified by like notice); provided, however, that notices sent by mail will not be deemed given until received:

(a) if to Parent, Merger Sub or Surviving Corporation to:

     SonicWALL, Inc.
     1143 Borregas Avenue
     Sunnyvale, CA 94089-1306
     Attention: Legal Department
     Telephone No.: (408) 745-9600
     Facsimile No.: (408) 745-9300

with a copy to:

     Wilson Sonsini Goodrich & Rosati
     Professional Corporation
     650 Page Mill Road
     Palo Alto, CA 94304
     Attention: Page Mailliard, Esq.
     Telephone No.: (650) 320-4644
     Facsimile No.: (650) 493-6811

(b) if to the Company, to:

     Lasso Logic, Inc.
     118 Second Street, 4th Floor
     San Francisco, CA 94105
     Attention: Legal Department
     Telephone No.: (415) 357-9688
     Facsimile No.: (415) 358-8679

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with a copy to:

     Montgomery Law Group, LLP
     525 Middlefield Road, Suite 250
     Menlo Park, CA 94025
     Attention: John Montgomery, Esq.
     Telephone No.: (650) 331-7002
     Facsimile No.: (650) 331-7001

(c) If to the Stockholder Representative, to:

     Steven Goodman
     2670 Chestnut Street
     San Francisco, CA 94123

          (d) If to a Principal Stockholder, to the address set forth opposite his, her or its name in the Spreadsheet delivered to Parent at the Closing Date or to any new address delivered by such Principal Stockholder to Parent.

     10.2 Counterparts. This Agreement may be executed in one or more counterparts, all of which shall be considered one and the same agreement and shall become effective when one or more counterparts have been signed by each of the parties and delivered to the other party, it being understood that all parties need not sign the same counterpart.

     10.3 Entire Agreement. This Agreement, the Exhibits hereto, the Disclosure Schedule, the Confidential Disclosure Agreement, and the documents and instruments and other agreements among the parties hereto referenced herein constitute the entire agreement among the parties with respect to the subject matter hereof and supersede all prior agreements and understandings both written and oral, among the parties with respect to the subject matter hereof.

     10.4 Third Party Beneficiaries. No provisions of this Agreement are intended, nor shall be interpreted, to provide or create any third party beneficiary rights or any other rights of any kind in any client, customer, employee, affiliate, shareholder, partner or any party hereto or any other Person unless specifically provided otherwise herein and, except as so provided, all provisions hereof shall be personal solely between the parties to this Agreement except that Article 2 is intended to benefit the Stockholders and Sections 8.1 and 8.2 are intended to benefit the Stockholders and the other Persons described therein.

     10.5 Assignment. This Agreement shall not be assigned by operation of law or otherwise, except that Parent may assign its rights and delegate its obligations hereunder to an Affiliate controlled by Parent as long as Parent remains ultimately liable for all of Parent’s obligations hereunder.

     10.6 Severability. In the event that any provision of this Agreement or the application thereof, becomes or is declared by a court of competent jurisdiction to be

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illegal, void or unenforceable, the remainder of this Agreement will continue in full force and effect and the application of such provision to other Persons or circumstances will be interpreted so as reasonably to effect the intent of the parties hereto.

     10.7 Other Remedies. Any and all remedies herein expressly conferred upon a party will be deemed cumulative with and not exclusive of any other remedy conferred hereby, or by law or equity upon such party, and the exercise by a party of any one remedy will not preclude the exercise of any other remedy.

     10.8 Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of California, regardless of the laws that might otherwise govern under applicable principles of conflicts of laws thereof. Each of the parties hereto irrevocably consents to the jurisdiction and venue of any court within Santa Clara County, State of California, in connection with any matter based upon or arising out of this Agreement or the matters contemplated herein, agrees that process may be served upon them in any manner authorized by the laws of the State of California for such Persons and waives and covenants not to assert or plead any objection which they might otherwise have to such jurisdiction, venue and such process.

     10.9 Waiver of Jury Trial. EACH OF THE PARTIES HERETO HEREBY IRREVOCABLY WAIVES ALL RIGHT TO TRIAL BY JURY AND ANY ACTION, PROCEEDING OR COUNTERCLAIM (WHETHER BASED ON CONTRACT, TORT, OR OTHERWISE) ARISING OUT OF OR RELATING TO THIS AGREEMENT OR THE ACTIONS OF ANY PARTY HERETO IN NEGOTIATION, ADMINISTRATION, PERFORMANCE OR ENFORCEMENT HEREOF.

     10.10 Specific Performance. The parties hereto agree that irreparable damage would occur if any provision of this Agreement were not performed in accordance with the terms hereof and that the parties shall be entitled to seek an injunction or injunctions to prevent breaches of this Agreement, in addition to any other remedy to which they are entitled at law or in equity.

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59

CONFIDENTIAL

     IN WITNESS WHEREOF, Parent, Merger Sub, the Company, each Principal Stockholder and the Stockholder Representative have caused this Agreement to be executed as of the date first above written.

SONICWALL, INC.

By:

Name: Matthew Medeiros

Title: President and CEO

SPECTRUM ACQUISITION CORPORATION

By:

Name: Matthew Medeiros

Title: President and CEO

SIGNATURE PAGE TO
AGREEMENT AND PLAN OF MERGER AND REORGANIZATION

     IN WITNESS WHEREOF, Parent, Merger Sub, the Company, each Principal Stockholder and the Stockholder Representative have caused this Agreement to be executed as of the date first above written.

LASSO LOGIC, INC.

By:

Name: Steven Goodman

Title: Chief Executive Officer

SIGNATURE PAGE TO
AGREEMENT AND PLAN OF MERGER AND REORGANIZATION

     IN WITNESS WHEREOF, Parent, Merger Sub, the Company, each Principal Stockholder and the Stockholder Representative have caused this Agreement to be executed as of the date first above written.

STOCKHOLDER REPRESENTATIVE

Steven Goodman

SIGNATURE PAGE TO
AGREEMENT AND PLAN OF MERGER AND REORGANIZATION

     IN WITNESS WHEREOF, Parent, Merger Sub, the Company, each Principal Stockholder and the Stockholder Representative have caused this Agreement to be executed as of the date first above written.

PRINCIPAL STOCKHOLDERS:

Steven Goodman

Sal Sferlazza

SIGNATURE PAGE TO
AGREEMENT AND PLAN OF MERGER AND REORGANIZATION

EX-23.1

Exhibit 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

     We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (No. 333-72730) and Form S-8 (No. 333-131016, No. 333-130381, No. 333-125074, No. 333-117007, No. 333-103663, No. 333-61248, No. 333-54976, No. 333-52634, No. 333-47020, No. 333-92619 and No. 333-81492) of SonicWALL, Inc. of our reports dated March 14, 2006, relating to the financial statements, financial statement schedule, management’s assessment of the effectiveness of internal control over financial reporting and the effectiveness of internal control over financial reporting, which appear in this Form 10-K.

/s/ ARMANINO MCKENNA, LLP

San Ramon, California
March 14, 2006

EX-23.2

Exhibit 23.2

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (No. 333-72730) and Form S-8 (No. 333-131016, 333-130381, 333-117007, No. 333-103663, No. 333-61248, No. 333-54976, No. 333-52634, No. 333-47020, No. 333-92619 and No. 333-81492) of SonicWALL, Inc. of our report dated March 16, 2005, except for the restatement described in Note 13 to the consolidated financial statements in the Annual Report on Form 10-K/A for the year ended December 31, 2004 (not presented herein), as to which the date is May 16, 2005, relating to the financial statements and financial statement schedule, which appears in this Form 10-K.

/s/ PricewaterhouseCoopers LLP

San Jose, California
March 13, 2006

EX-31.1

Exhibit 31.1

CERTIFICATIONS

I, Matthew Medeiros, certify that:

1.	I have reviewed this annual report on Form 10-K of SonicWALL, 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(s) 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)) 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(s) 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 the registrant’s board of directors (or persons performing the equivalent functions):

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.

Date: March 15, 2006	/s/ Matthew Medeiros
	Matthew Medeiros
	President and Chief Executive Officer

EX-31.2

Exhibit 31.2

I, Robert Selvi, certify that:

1.	I have reviewed this annual report on Form 10-K of SonicWALL, 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(s) 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)) 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(s) 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 the registrant’s board of directors (or persons performing the equivalent functions):

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.

Date: March 15, 2006	/s/ Robert Selvi
	Robert Selvi
	Chief Financial Officer

EX-32.1

EXHIBIT 32.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

     I, Matthew Medeiros, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Annual Report of SonicWALL, Inc. on Form 10-K for the fiscal year ended December 31, 2005 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Annual Report on Form 10-K fairly presents in all material respects the financial condition and results of operations of SonicWALL, Inc.

Date: March 15, 2006	By:	/s/ Matthew Medeiros
	Name:	Matthew Medeiros
	Title:	Chief Executive Officer

     I, Robert Selvi, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Annual Report of SonicWALL, Inc. on Form 10-K for the fiscal year ended December 31, 2005 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Annual Report on Form 10-K fairly presents in all material respects the financial condition and results of operations of SonicWALL, Inc.

Date: March 15, 2006	By:	/s/ Robert Selvi
	Name:	Robert Selvi
	Title:	Chief Financial Officer