10-K 1 d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K

 

 

(MARK ONE)

 

  x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED APRIL 30, 2011

OR

 

  ¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM                     TO                    

COMMISSION FILE NUMBER 000-28139

 

 

BLUE COAT SYSTEMS, INC.

(Exact Name of Registrant as Specified In Its Charter)

 

 

 

DELAWARE   91-1715963

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

420 NORTH MARY AVENUE

SUNNYVALE, CALIFORNIA 94085

(Address of Principal Executive Offices and Zip Code)

Registrant’s Telephone Number, Including Area Code: (408) 220-2200

 

 

Securities Registered Pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Stock, $.0001 Par Value   The NASDAQ Stock Market LLC

Securities Registered Pursuant to Section 12(g) of the Act:

None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YES  ¨    NO  x

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  ¨    NO  x

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  x    NO  ¨

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.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  x     Accelerated filer   ¨    Non-accelerated filer  ¨     Smaller reporting company   ¨ 
    (Do not check if a smaller

reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    YES  ¨    NO  x

The aggregate market value of the common stock held by non-affiliates of the registrant was $1,135,520,580 as of October 29, 2010, which is the last business day of the registrant’s most recently completed second fiscal quarter, based upon the closing sale price on the NASDAQ Global Select Market reported for such date. Shares of Common Stock held by each officer and director and by each person who may be deemed to be an affiliate have been excluded. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

There were 43,406,671 of the registrant’s Common Stock issued and outstanding as of June 2, 2011.

Documents Incorporated by Reference:

Part III—Portions of the registrant’s definitive proxy statement to be issued in conjunction with registrant’s 2011 annual stockholders’ meeting.

 

 

 


Table of Contents

BLUE COAT SYSTEMS, INC.

ANNUAL REPORT ON FORM 10-K

FOR THE FISCAL YEAR ENDED APRIL 30, 2011

TABLE OF CONTENTS

 

          Page  

PART I

     4   

Item 1.

  

Business

     4   

Item 1A.

  

Risk Factors

     15   

Item 1B.

  

Unresolved Staff Comments

     28   

Item 2.

  

Properties

     28   

Item 3.

  

Legal Proceedings

     28   

PART II

     29   

Item 5.

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     29   

Item 6.

  

Selected Financial Data

     31   

Item 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     32   

Item 7A.

  

Quantitative and Qualitative Disclosures about Market Risk

     52   

Item 8.

  

Financial Statements and Supplementary Data

     54   

Item 9.

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     95   

Item 9A.

  

Controls and Procedures

     95   

Item 9B.

  

Other Information

     96   

PART III

     98   

Item 10.

  

Directors, Executive Officers and Corporate Governance

     98   

Item 11.

  

Executive Compensation

     98   

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     98   

Item 13.

  

Certain Relationships and Related Transactions, and Director Independence

     98   

Item 14.

  

Principal Accounting Fees and Services

     98   

PART IV

     99   

Item 15.

  

Exhibits and Financial Statement Schedules

     99   
  

SIGNATURES

     100   
  

EXHIBITS

     101   
  

SCHEDULE II

     107   


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FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K, and other materials accompanying this Annual Report on Form 10-K contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements relate to our future plans, objectives, expectations, intentions and financial performance and the assumptions that underlie these statements. These forward-looking statements include, but are not limited to, statements concerning the following: plans to develop and offer new products and services and enter new markets; expectations with respect to future market growth opportunities; changes in and expectations with respect to revenues, gross margins and income tax provisions; future operating expense levels and operating margins; the impact of quarterly fluctuations of revenue and operating results; the success of our business strategy and changes in our business model and operations; the impact of macroeconomic conditions on our business; the adequacy of our capital resources to fund operations and growth; investments or potential investments in acquired businesses and technologies, as well as internally developed technologies; the effectiveness of our sales force, distribution channel, and marketing activities; the impact of recent changes in accounting standards and assumptions underlying any of the foregoing. In some cases, forward-looking statements are identified by the use of terminology such as “anticipate,” “expect,” “intend,” “plan,” “predict,” “believe,” “estimate,” “may,” “will,” “should,” “would,” “could,” “potential,” “continue,” “ongoing,” or negatives or derivatives of the foregoing, or other comparable terminology.

The forward-looking statements in this Annual Report on Form 10-K involve known and unknown risks, uncertainties and other factors that may cause industry and market trends, or our actual results, level of activity, performance or achievements, to be materially different from any future trends, results, level of activity, performance or achievements expressed or implied by these statements. For a detailed discussion of these risks, uncertainties and other factors, see the “Risk Factors” section in Item 1A of this Annual Report on Form 10-K. We undertake no obligation to revise or update forward-looking statements to reflect new information or events or circumstances occurring after the date of this Annual Report on Form 10-K.

 

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PART I

Item 1. Business

General

We design, develop and sell a family of proxy and other appliances, and related software and services that secure, accelerate and optimize the delivery of business applications, Web content and other information to distributed users over a Wide Area Network (“WAN”), or across an enterprise’s gateway to the public Internet (also known as the Web). Our products provide our end user customers with information about the applications and Web traffic running on their networks, including the ability to discover, classify, manage and control communications between users and applications across internal networks, the WAN and the Internet. Our products are also designed to accelerate and optimize the performance of our end users’ business applications and content, whether used internally or hosted by external providers. In addition to accelerating and optimizing the performance and delivery of applications, our products enable our end user customers to secure their Internet gateways and remote computer systems by providing protection from malicious code, or malware, and objectionable content.

Our products are based upon three core functionalities:

 

   

Security: Security of the delivery of business applications and content and protection from malware, spyware or other malicious threats, together with centrally managed policy enforcement that enables an enterprise to set, enforce and measure compliance with its corporate IT policies. When combined with visibility, policy controls offer enterprises multiple layers of network security from malicious threats and content.

 

   

Acceleration: Acceleration and optimization of the delivery of internal, external, real-time and customized applications and content across the networks of distributed enterprises. Optimizing the delivery of business-critical applications to provide faster response times enables an enterprise to more efficiently utilize existing bandwidth and to increase its users’ productivity.

 

   

Visibility: Visibility of applications, content and users on the network to enable distributed enterprises to discover, classify, prioritize and monitor applications, content and users according to their corporate IT policies. With centralized visibility into its application traffic, an enterprise can more efficiently monitor end user application response times and align its network investments with changing business requirements.

Traditionally, our principal product offerings have been hardware appliances that contain preloaded software. However, during the past two years, we have been expanding our offerings to deliver our core functionality in new ways, and in fiscal year 2011, we commercially released an offering that delivers our security functionality on a subscription basis over the Internet, adopting a model commonly known as “cloud computing.”

Our primary end user customers are large and medium distributed enterprises, including finance, healthcare, and other business enterprises, along with U.S. Federal, state and local, and foreign government agencies. Distributed enterprises deploy our products in their data centers and branch offices, at Internet gateways and on mobile devices worldwide.

Our Business Strategy

We offer products and services designed to optimize and secure the flow of information to network users across the distributed enterprise. Our products and services solve three key business challenges facing our customers today:

 

   

The need to contain costs, to maximize the return on their existing network investments, and to make more informed decisions and investments with respect to scaling their networks to meet business requirements;

 

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The slow, unpredictable access to applications and content, and resulting detrimental impact on user productivity, caused by increased reliance on the WAN and the Internet; and

 

   

Proliferation of security risks, including malware threats, and increasing regulatory compliance requirements, which primarily result from the widespread use of the Internet.

Our current business strategy is to expand our market opportunities by offering the core functionality of our products through new delivery models and to new markets and customers, and to increase sales of our products and services to our existing customer base. This includes cross-selling and continuing to improve and enhance our existing product portfolio, including providing enhanced functionality through technology partnerships with third parties.

Our Product Strategy and Markets

We operate our business in a single segment and conduct business worldwide. Our net revenue is attributed to one of three geographic areas based on the location of the customer. Our business consists of two categories: products and services. Products represented 59.9%, 64.9% and 68.7% of our revenues for fiscal 2011, 2010, and 2009, respectively. Services represented 40.1%, 35.1% and 31.3% of our revenues for fiscal 2011, 2010 and 2009, respectively. See Note 14 of Notes to Consolidated Financial Statements for additional information related to our revenue categories and a summary of net revenue by geographic area.

We currently categorize our products and services into three basic service and product offerings: Web Security, WAN Optimization and Cloud Service. Our products and services principally are sold to both strategic and large enterprise customers (generally having 10,000 or more users) and mid-enterprise customers (generally having 1,500-10,000 users), although some of our products and services are also purchased by small and medium businesses with less than 1,500 users.

Web Security

Since 2002, we have designed, developed and sold proxy appliances used to control and secure communications for users of a corporate network accessing content on the Internet. These appliances are located at the customer’s Internet gateway, which is the point where the corporate network connects to the Internet.

One of the key strengths of our appliances is our advanced proxy technology. Our proxy appliance acts as a middleman between users and various applications or Internet content. Users communicate with the proxy appliance on one side of the transaction, and applications and Internet content communicate with the proxy appliance on the other side of the transaction. There are two separate connections, both controlled and managed by the proxy appliance. Consequently, no content can get past the appliance unless it is in accordance with an IT policy that is set by the customer’s IT administrator and that is automatically enforced by the appliance. This enables our proxy appliances to protect businesses from many of the security dangers, such as malware, phishing and viruses that can arise from using the Internet.

Our Web Security products are designed to perform the following functions to provide more secure communications with the Internet:

 

   

Prevent the installation of malware and other malicious code on individual user computers and reduce the network’s exposure to security vulnerabilities without compromising its performance;

 

   

Identify and block security threats arising from the use of the SSL, or Secure Sockets Layer, protocol. While the use of SSL improves security by encrypting confidential data communicated over the Web, it may also provide a means to disguise viruses, worms and other security threats and allow them to enter the network;

 

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Comply with regulatory and industry data protection requirements by monitoring network, webmail and Internet bound traffic, including SSL traffic, to prevent loss or transmission of data in violation of applicable law or policy;

 

   

Provide data security and policy enforcement for mobile workers and small branch offices through client-based software that can utilize our WebPulse™ dynamic web content rating service for unrated or newly published web content to enhance web content categorization;

 

   

Provide users the ability to proactively manage or block specific types of Web content from entering the corporate network in order to prevent potential security breaches and to block employees from viewing inappropriate content when using the company’s computer systems;

 

   

Automatically validate a user who requests access to secure corporate content. Our appliances interface with virtually all leading identity authentication systems including: NT LAN Manager, RADIUS, LDAP and Active Directory; and

 

   

Provide protection by automatically scanning and blocking malware, phishing, viruses and other potentially malicious network traffic using leading third party anti-malware products.

Our Web Security products are sold to strategic and large enterprise customers, and mid-enterprise customers.

Our principal products for Web Security are our Blue Coat ProxySG® Proxy Edition appliance, which provides proxy, policy and authentication functionality; Blue Coat ProxyAV™ appliance, which provides malware scanning; and Blue Coat WebFilter product, which is a content filtering database that operates on our ProxySG appliance and includes client-based software for remote workers.

WAN Optimization

Our WAN Optimization products are designed to help distributed enterprises optimize and secure the delivery of their business applications and are based upon our ProxySG technology that also serves as the foundation for our key Web Security products. They enable IT administrators to set and enforce corporate IT policies to protect information from theft and loss. In addition, they provide the ability to manage recreational traffic to ensure business-critical applications have adequate bandwidth during peak demand. Our WAN Optimization technology provides five key capabilities that are designed to optimize the delivery of business applications to users across the distributed enterprise, including:

 

   

Bandwidth management—the ability to assign a set level of bandwidth to specific users and applications and prioritize delivery of that traffic over the WAN;

 

   

Protocol optimization—a technique that enhances the efficiency of protocols by reducing the communication required between the user and the application;

 

   

Object caching—a technique where reusable content is stored on the appliance eliminating the need to repeatedly transfer the same information across the WAN;

 

   

Byte caching—a technique that assigns, stores and uses abbreviated expressions that represent repetitive WAN traffic, which conserves bandwidth and accelerates delivery of the application; and

 

   

Compression—a technique that uses an industry standard algorithm to package and unpackage information for efficient transmission across the WAN.

Our WAN Optimization products are also designed to improve the performance of real-time and encrypted applications, including streaming video, encrypted SSL applications and applications hosted by third parties and accessed over the Internet.

 

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Our WAN Optimization appliances are deployed in both centralized data centers and in branch offices. In addition, we make WAN Optimization functionality available as client-based software for users requiring optimized application performance while working outside of the corporate network or at offices where an appliance is not installed.

Our principal products that address the WAN Optimization market are our Blue Coat ProxySG MACH5 appliance, which is directed at strategic and large enterprise customers, and mid-enterprise customers; ProxySG Virtual Appliance, which is directed at strategic and large enterprise customers, and mid-enterprise customers; and CacheFlow® 5000 appliance, which is directed at the carrier infrastructure, or telecommunications service provider, market.

We now also include in this category our application performance monitoring products that identify and classify the applications on the network, provide visibility into network utilization and monitor application response times, utilization and performance. These products assist our strategic and large enterprise customers, and mid-enterprise end user customers in shaping their network traffic and provide Quality of Service provisioning to ensure that critical applications have priority. Our principal product that provides this functionality is our PacketShaper®appliance.

Cloud Service

During the fourth quarter of fiscal 2011, we commercially released the first module of our Blue Coat Cloud Service, and we currently have a number of end user trials underway. These end user trials include both strategic and large enterprise customers, and mid-enterprise customers, as well as small and medium businesses. Our Cloud Service is intended to extend and strengthen our position in the enterprise market, by more efficiently addressing the requirements of mobile users and smaller, distributed branch locations. As well, it is intended to build our market share in the small and medium business segment by providing a high quality enterprise grade Web security solution that requires no end user equipment or installation and that is sold by our channel partners.

Our Cloud Service is a subscription-based service that utilizes Blue Coat owned equipment located in geographically dispersed data centers to deliver our functionality through the Internet on demand. This is a scalable solution that substantially reduces the time and initial investment necessary for our subscribers to deploy our technology. The first module of our Cloud Service is our Web Security Module, which utilizes our security technology and our WebPulse service to deliver the Web gateway security to end users on a subscriber network. The benefits available to subscribers to the Web Security Module include:

 

   

Real-time Web Protection: The Web Security Module utilizes a combination of our WebPulse service and inline malware scanning technology to provide comprehensive protection from Web-based threats and to categorize new and unknown Web content in real time. Web content is examined by our WebPulse service, using advanced analysis techniques to identify suspicious and malicious Web sites. When malware is discovered through this analysis, it is appropriately categorized to protect future users who seek future access to that Web site.

 

   

Safe, Controlled Access to Social Networking: The Web Security Module uses a combination of granular social media application controls and flexible policies to allow subscribers to protect their network users from malware or other threats contained in social media and to prevent inappropriate use of social media, while permitting the use of features that are deemed important to the business. For example, a subscriber could permit its users to access the Facebook Web site, but could prevent them from uploading video or pictures. Similarly, a subscriber could permit its users to access and use Webmail, but could prevent them from sending attachments through Webmail.

 

   

Dynamic, Location-Aware Web Security: The Web Security Module has a built-in auto tracking feature that dynamically routes Web traffic to the closest Blue Coat data center based on the user’s

 

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current geographic location to minimize response time. The subscriber can apply global policies to provide consistent protection and enforcement for individual users of its network, even if located remotely.

 

   

Instant Visibility into Web Threats: The Web Security Module has a built-in reporting interface, so that subscribers’ IT administrators can track threats and can quickly identify computers on the network that are infected with malware, including where the malware is seeking to automatically forward information from the computer or network, so that the malware can be properly addressed.

During fiscal 2012, we intend to continue to invest in adding additional data centers and equipment to support our Cloud Service and to continue to enhance the functionality of the Web Security Module. As the Cloud Service is offered on a subscription basis, revenue from the service is recognized ratably, which could impact our profitability.

Product Offerings

As of April 30, 2011, our principal product offerings, in addition to our Cloud Service, are the following:

ProxySG Appliance

Our Blue Coat ProxySG® family of proxy appliances serves as the foundation for both our Web Security products (ProxySG Proxy Edition) and our WAN Optimization offerings (ProxySG MACH5 Edition). The appliance, when appropriately configured, may be placed at the Internet gateway, to provide security with respect to Web-based communications, or may be placed at connection points for entry to or exit from a WAN (or “WAN links”) to enhance and accelerate the performance of business applications and Web-based content, including video, rich media and Web 2.0 content, over that WAN. Our ProxySG appliances run our proprietary SGOS™ operating system, which is specifically designed to support the security, acceleration and policy control features of those appliances.

Our Blue Coat ProxyClient software supplements our ProxySG appliance and is designed to be used on desktop or laptop computers at remote sites that do not have a ProxySG appliance installed and on computers used by mobile employees. It can be administered with the ProxySG management console. The software provides both WAN optimization and security features. It accelerates the delivery of business applications accessed by a remote or mobile computer through use of the caching, compression and protocol optimization technologies employed in our ProxySG appliance, which provides the user with performance that is similar to that provided by a ProxySG appliance to users of large WAN installations. The ProxyClient software also provides remote or mobile computer users with real-time protection against Web threats, such as malware, and supports the Internet acceptable use policies of the enterprise even when the computer is not connected to corporate network.

ProxySG Virtual Appliance

Our Blue Coat ProxySG Virtual Appliance is software that provides our WAN Optimization functionality and operates on a virtual environment running on an industry standard server.

CacheFlow 5000 Appliance

Our CacheFlow 5000 appliance is directed at large telecommunications service providers and is intended to address the problems confronted by these organizations as a consequence of the tremendous growth in Web and media rich content delivered by these carriers. We initially are targeting sales to carriers in geographies where bandwidth is relatively scarce and expensive, since our first appliance principally focuses on the reduction of bandwidth consumption. We currently plan to continue to develop this product and to provide broader functionality to make it attractive to carriers globally.

 

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Blue Coat ProxyAV Appliance

Our Blue Coat ProxyAV appliances are designed for use with ProxySG appliances to provide inline threat protection and malware scanning of Web content at the Internet gateway. They also work in conjunction with Blue Coat WebPulse and WebFilter to provide additional defense against the entry of viruses, Trojans, worms, and other forms of malicious content into the end user’s network. In addition to operating with Blue Coat proprietary databases, ProxyAV supports various leading malware engines.

Blue Coat WebFilter Software

Our Blue Coat WebFilter software is a content filtering database that operates on our ProxySG appliance and includes client-based software for remote workers. Our WebFilter software is updated on a real-time basis through our remotely hosted WebPulse service, which provides real-time, multi-lingual rating of Web content and threats. It helps enterprises and service providers protect their users and networks from Internet threats and inappropriate content and traffic, such as adult content, spyware, phishing attacks, peer-to-peer (P2P) traffic, instant messaging (IM), viral content and streaming traffic. Our WebFilter software provides a comprehensive database that is organized into relevant and useful categories. In addition to our proprietary WebFilter software, our Proxy SG appliances also support the use of various third party content filtering databases.

PacketShaper Appliance

Our PacketShaper family of appliances enables an IT administrator to monitor the applications running on the enterprise’s network to obtain better information on its LAN/WAN/Internet traffic and to identify and diagnose performance problems and unauthorized applications operating on the network. PacketShaper appliances identify, measure and control a variety of traffic types, including mission-critical applications, social networking, recreational, Web-based applications and real-time applications such as voice over IP traffic and video conferencing. The administrator can use this information to track, troubleshoot and manage the network traffic to meet service level agreements and Quality of Service standards.

Services and Support

We provide a comprehensive range of service and support options to our end user customers and our channel partners, which are delivered either directly by our service and support organization or by one of our service and support partners that has been trained, qualified and authorized under one of our service delivery programs. Our service and support options include hardware and software support. We provide a warranty with our appliances and also make available proactive technical support (through the assignment of an identified technical account manager), professional services, and training services.

Our global service delivery partner programs include the following programs:

 

   

Our BlueTouch Support Partner Program, which provides training to and also qualifies and authorizes partners to deliver to end user customers front-line technical support of our products and Cloud Service, with back-line support to the partners provided by Blue Coat’s global 24x7 support centers and logistics team;

 

   

Our BlueTouch Professional Services Partner Program, which provides training to and also qualifies and authorizes partners to provide professional services relating to our products to our end user customers; and

 

   

Our Authorized Training Center Program, which provides training to and also qualifies and authorizes partners to deliver classroom and virtual classroom product training courses relating to our products to our end user customers.

 

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Sales

Our worldwide sales strategy employs a multiple tier channel distribution model to provide complementary personnel, tactics, approaches and capabilities to address existing and prospective customers based upon their size, the type of business in which they are engaged, their location and their purchasing practices. Our current sales model provides sales resources focused on the level of sales opportunity and allocates our sales support personnel, such as sales engineers, based on their skill sets, rather than assigning them to a single sales team. During the first quarter of fiscal 2011, we established a separate sales team focused on the telecommunications carrier market and managed service provider market and in the second half of fiscal 2011, we established a specialized sales team focused on sales of our WAN optimization products.

Our sales organization is comprised of sales representatives or account managers and systems engineers; an inside sales team; and a channel sales organization. Our sales representatives or account managers work both with our channel partners and directly with end user customers to assess end user customer requirements and to assist in the completion of sales transactions. The primary role of our sales engineers is to provide the technical expertise necessary to complete sales transactions. Our inside sales team evaluates end user customer leads, makes initial contact with end user customers and provides general support to the sales team. The role of our channel sales organization is to enable and grow the revenue contribution of our channel partners, which include value-added resellers, global system integrators, managed service providers and distributors (collectively, our “channel partners”). Our channel sales organization provides sales and technical education, co-marketing programs, and demonstration equipment and support programs, either directly or through our value-added channel partners. It is responsible for the identification, development and support of local and regional value-added resellers, global systems integrators and service providers. During fiscal 2011, approximately 99% of our sales were made through our channel partners. Certain of our global distributors, including their various affiliates, account for more than 10% of our net revenue. In fiscal 2011, ComputerLinks, Westcon Group, Inc. and Arrow Enterprise Computing Solutions Inc. accounted for 25.5% 16.2% and 13.7%, of our total net revenue, respectively.

Our end user customers are categorized as strategic and large enterprise, mid-enterprise or small and medium business, based upon market segmentation. Each category is supported by the appropriate level of our direct sales organization, including account and territory managers focused on that category and system engineers that support these sales efforts together with our distributors and other channel partners.

Marketing

Our marketing investments are focused on increasing the awareness of the Blue Coat brand and its products and services among both traditional IT decision makers (network and security managers and administrators) and strategic IT decision makers (CIOs and their direct staff); educating the market about the business and technology challenges that drive the need for our products and services; and creating demand for our products, services and capabilities. We develop marketing programs to support the sale and distribution of our products and services, and to inform existing and prospective customers within our target market segments about the capabilities and benefits of our products.

Our strategic marketing investments include brand advertising intended to increase awareness of Blue Coat among strategic IT decision makers and targeted demand generation activities to stimulate demand for our products and services. Our worldwide marketing efforts include participation in industry trade shows, informational seminars and webinars, preparation and commissioning of competitive analyses, sales training, maintenance of our Web site, advertising, public relations, industry analyst relations, preparation of collateral and documentation regarding our products and services, and various other demand generation and direct marketing activities. In addition, we provide similar types of marketing support for our major channel partners and technology integration partners worldwide.

 

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Research and Development

We believe that innovation and strong internal product development capabilities are essential to our continued success and growth. We continue to add new features, strengthen existing features of our products and invest in exploring new and adjacent markets and products that build on our core competence. In fiscal 2011, we invested in developing our cloud-based service, although we anticipate that this subscription-based service will not generate material revenue in the next few years.

Our research and development team consists of engineers with extensive technical backgrounds in relevant disciplines. We believe that the experience and capabilities of our research and development professionals is one of our significant competitive advantages. We also work closely with our customers to understand their business needs and to focus our development of new products and product enhancements to better meet customer needs.

While we anticipate that most enhancements to our existing and future products will be accomplished by internal development, we currently license certain technologies from third parties and will continue to evaluate externally developed products and technology for integration with our products or as supplemental offerings. As well, we have acquired third party businesses, technologies and products to expand our capabilities and market, and may continue to do so in the future.

Research and development expense was $82.2 million, $84.9 million and $76.7 million for fiscal years 2011, 2010, and 2009, respectively, including stock-based compensation expense attributable to our research and development organization of $7.1 million, $6.5 million and $5.3 million, respectively.

Manufacturing

We currently outsource the manufacturing of our appliances and principally use industry standard parts and components that are available from multiple vendors. This approach allows us to reduce our investment in manufacturing equipment, facilities and raw material inventory, and to take advantage of the expertise of our vendors. We have limited sources of supply for certain key components of our products, which exposes us to the risk of component shortages or unavailability. We have contracted with SMTC Corporation to manufacture certain of our current product offerings. We have contracted with MiTAC International Corporation, Dell Inc., Inventec Corporation and Lanner Electronics, Inc. to design and manufacture certain of our current product offerings. We also have contracted with Menlo Worldwide Logistics and MiTAC International to load our software on our appliances, test our products prior to final delivery and provide fulfillment servicing for our products. Each of these agreements is non-exclusive.

Our internal manufacturing operations consist primarily of project management, prototype development, materials and production planning, quality and reliability assurance, test, new product introduction engineering and procurement services, as required in support of our relationships with our outsourced manufacturing partners.

Backlog

Our backlog is comprised of amounts for product orders that we have accepted, but not shipped, and related service orders. Our backlog was approximately $2.2 million at April 30, 2011 compared with $17.0 million at April 30, 2010. Although we believe that the backlog orders are firm, purchase orders may be cancelled by the customer prior to shipment without significant penalty. We believe that our backlog at any given date is not a reliable indicator of future revenues.

Competition

We are a market and technology leader in the Web Security market, although we may face increased competition in this market given recent consolidations. Our principal competitors in this market are Intel

 

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Corporation through its acquisition of McAfee, Inc., Websense, Inc. and Cisco Systems, Inc. In addition, we expect additional competition from other established and emerging companies as the Web Security market continues to develop and expand and as consolidation occurs.

Our principal competitors in the WAN Optimization market are Riverbed Technology, Inc. and Cisco Systems, Inc. In addition, we expect additional competition from other established and emerging companies as the WAN Optimization market continues to develop and expand and as consolidation occurs.

Our principal competitors in the Cloud Service market are Zscaler, Inc. and Cisco Systems, Inc., through its acquisition of ScanSafe. In addition, we expect additional competition from other established and emerging companies as the market for security-as-a-service continues to develop and expand and as consolidation occurs.

The primary factors considered by our customers in selecting an appropriate solution include product characteristics such as reliability, feature sets, scalability and ease of use, as well as factors such as price and the availability and quality of customer support.

Environment

We are subject to regulations that have been adopted with respect to environmental matters, such as the Waste Electrical and Electronic Equipment (WEEE), Restriction of the Use of Certain Hazardous Substances in Electrical and Electronic Equipment (RoHS) and the regulations concerning the Registration, Evaluation, Authorisation and Restriction of Chemicals (REACH) adopted by the European Union. As well, we are engaging in efforts to design and develop our products in a manner that will improve their energy efficiency and will enhance the ability to recycle them.

We have implemented a new program to encourage end user customers who have replaced outdated Blue Coat appliances with current models to return the outdated appliances to us, at no charge, for component reuse in connection with the provision of support or for recycling. The goal of the program is to reduce Blue Coat product waste destined for landfills, as well as to generate cost savings. Savings from this program exceeded the cost of administration of the service in fiscal 2011.

Through our company-wide BluePlanet™ program, we are taking steps to educate our employees about environmental matters and to encourage them to act in an environmentally responsible manner. We are engaged in projects to conserve energy and water and to reduce our waste to landfills in our principal corporate offices. To date, our compliance with federal, state, local, and foreign laws enacted for the protection of the environment has not materially affected our capital expenditures, earnings or competitive position. We continue to actively monitor developments of new and changing environmental regulations around the globe.

Intellectual Property and Other Proprietary Rights

Our success is heavily dependent on our ability to create proprietary technology and to protect and enforce our intellectual property rights in that technology, as well as our ability to defend against adverse claims of third parties with respect to our technology and intellectual property. To protect our proprietary technology, we rely primarily on a combination of contractual provisions and confidentiality procedures to protect trade secrets, copyright and trademark laws, and patents. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or obtain and use information that we regard as proprietary. Policing unauthorized use of our products is difficult. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States. Our means of protecting our proprietary rights may not be adequate and unauthorized third parties, including our competitors, may independently develop similar or superior technology, duplicate or reverse-engineer aspects of our products, or design around our patented technology or other intellectual property.

As of April 30, 2011, we had 128 issued U.S. patents, 63 pending U.S. patent applications (provisional and non-provisional) and 4 foreign issued patents. There can be no assurance that any of our pending patent

 

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applications will issue or that the patent examination process will not result in our narrowing the claims applied for. Furthermore, there can be no assurance that we will be able to detect any infringement of patents or, if infringement is detected, that our patents will be enforceable or that any damages awarded to us will be sufficient to adequately compensate us.

There can be no assurance or guarantee that any products, services or technologies that we are presently developing, or will develop in the future, will result in intellectual property that is protectable under law, whether in the United States or a foreign jurisdiction, that such intellectual property will produce competitive advantage for us, or that the intellectual property of competitors will not restrict our freedom to operate or put us at a competitive disadvantage. From time to time we may and do receive notices from third parties alleging infringement of patents or other intellectual property rights or offering licenses under such intellectual property rights. While it is our policy to respect the legitimate intellectual property rights of others, we may defend against such claims or seek to negotiate licenses on commercially reasonable terms or otherwise settle such claims, where appropriate. There has been a substantial amount of litigation over intellectual property rights in our industry, including from third parties that are not competitors, and we expect this to continue. Hence, third parties may claim that we, or our customers (including end users) or our current or future products, infringe their intellectual property rights, and any such claims, whether with or without merit, could be time-consuming, result in costly litigation, result in the assessment of damages, result in management distraction, cause product shipment delays or require us to enter into royalty or licensing agreements. Royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all, which could seriously harm our business.

Employees

As of April 30, 2011, we had a total of 1,333 full-time equivalent employees, comprised of 491 in sales and marketing, 366 in research and development, 242 in customer support, 186 in general and administrative and 48 in manufacturing. Of these employees, 867 were located in North America and 466 were located in various other international locations. Certain of our international employees are subject to collective bargaining agreements, which typically are applicable to all employees of a designated industry located in the employing jurisdiction. We have not experienced any work stoppages and consider our relations with our employees to be good.

Seasonality

We experience some seasonal trends in the sale of our products and services. Product revenues in our third and fourth fiscal quarters are typically stronger due to the calendar year-end and subsequent start to the budget cycle for most of our customers. Our fourth fiscal quarter also tends to experience higher product revenues due to our annual compensation plans, which incentivize sales activity during the fourth quarter as a result of compensation accelerators. In addition, sales to U.S. Federal government agencies tend to be higher during our second fiscal quarter than other quarters. General economic conditions also have an impact on our business and financial results. The markets in which we sell our products and services have, in the past, experienced weak economic conditions from time to time that have negatively affected our revenues.

Corporate Background

We were incorporated in Delaware, as Web Appliance Inc, on March 13, 1996. We changed our name to CacheFlow, Inc. on March 25, 1996, and completed our initial public offering on November 19, 1999. On August 21, 2002, we changed our name to Blue Coat Systems, Inc., and our ticker symbol for our common stock from CFLO to BCSI.

On June 6, 2008, we acquired Packeteer Inc. (“Packeteer”), a pioneer in delivering sophisticated WAN traffic prioritization through the development and sale of application classification and performance management technologies and products. As a consequence of that acquisition, we added the PacketShaper® product formerly sold by Packeteer to our product line.

 

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On January 25, 2010, we acquired 84.5% of the outstanding shares of S7 Software Solutions Pvt. Ltd. (“S7”), an IT research and development outsourcing firm based in Bangalore, India. We acquired an additional 15.5% of the outstanding shares of S7 in fiscal 2011. We acquired S7 to serve as our new development center in India and to provide expertise in software development, code migration and network security.

Available Information

Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on our Investor Relations Web site at www.bluecoat.com as soon as reasonably practicable after we file such material with the SEC. The other information posted on our Web site is not incorporated into this Annual Report.

 

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Item 1A. Risk Factors

In addition to the other information contained in this Annual Report on Form 10-K, the following risk factors should be carefully considered by investors before making an investment decision. Our business, financial condition and results of operations could be seriously harmed as a consequence of any of the following risks and uncertainties. The trading price of our common stock could decline due to any of these risks and uncertainties, and investors may lose all or part of their investment. These risks and uncertainties are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem less significant also may impair our business, financial condition and results of operations, or result in a decline in the trading price of our common stock.

Our quarterly operating results fluctuate significantly, are difficult to predict and may not meet our guidance or third party expectations.

Our net revenue and operating results have in the past, and may in the future, vary significantly from quarter to quarter and year over year due to a number of factors, many of which are outside of our control, including the macroeconomic environment. These factors limit our ability to accurately predict our operating results on a quarterly basis and include factors discussed throughout this “Risk Factors” section, including the following:

 

   

Macroeconomic conditions in our markets, both domestic and international, as well as the level of discretionary IT spending;

 

   

The timing, size and mix of orders from customers, including the timing of large orders, and nonlinear sales and shipping patterns;

 

   

Fluctuations in demand for our products and services;

 

   

Evolving conditions in the markets in which we compete;

 

   

Variability and unpredictability in the rate of growth in the markets in which we compete;

 

   

Our ability to continue to increase our market share consistent with past rates of increase;

 

   

Our variable sales cycles, which may lengthen as the complexity of products and competition in our markets increases and in response to macroeconomic conditions;

 

   

The level of competition in our markets, including the effect of new entrants, consolidation, technological innovation and substantial price discounting;

 

   

Market acceptance of our new products and product enhancements and our services;

 

   

Product announcements, introductions, transitions and enhancements by us or our competitors, which could result in deferrals of customer orders;

 

   

Technological changes in our markets;

 

   

The quality and level of our execution of our business strategy and operating plan, and the effectiveness of our sales and marketing programs;

 

   

The level of industry consolidation among our competitors and customers;

 

   

The impact of future acquisitions or divestitures;

 

   

Changes in accounting rules and policies; and

 

   

The need to recognize certain revenue ratably over a defined period or to defer recognition of revenue to a later period.

A high percentage of our expenses, including those related to manufacturing overhead, service and maintenance, research and development, sales and marketing, and general and administrative functions are

 

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generally fixed in nature in the short term. As a result, if our net revenue is less than forecasted, such expenses cannot effectively be reduced to compensate for the revenue shortfall and our quarterly operating results will be adversely affected.

We believe that quarter-to-quarter comparisons of our operating results should not necessarily be relied upon as indicators of our future performance. In the past, our quarterly results have on occasion failed to meet our quarterly guidance and the expectations of public market analysts or investors, and it is likely that this will occur in the future. If this occurs our stock price likely will decline, and may decline significantly. Such a decline may also occur even when we meet our published guidance, but our results or future guidance fail to meet third party expectations.

The markets in which we compete are intensely competitive and certain of our competitors have greater resources and experience.

Our products and services currently focus on the markets for Web Security and WAN Optimization products and services, together with our newly available Cloud Service, which provides security-as-a-service on a subscription basis over the Internet.

Each of these markets is intensely competitive, and the intensity of this competition is expected to increase, particularly given current economic pressures and industry consolidation. As well, the market for cloud computing services is characterized by extreme competition and we are new to that market. Sales to the service provider markets are especially volatile and typically have longer sales cycles. Competition in these markets may result in price reductions, reduced margins, loss of market share and inability to gain market share, any one of which could seriously impact our business, financial condition and results of operations. We may not be able to compete successfully against current or future competitors, including those resulting from consolidation in our historical and new markets and we cannot be certain that the competitive pressures we face will not seriously impact our business.

Our participation in different and diverse markets requires careful resource allocation. To the extent we concentrate our investment in one market, we are required to decrease our investment in our other markets, which could make us more vulnerable to our competitors in those markets. Some of our current and potential competitors have longer operating histories; significantly greater financial, technical, sales and marketing resources; significantly greater name recognition; and a larger installed base of customers than we do. Such competitors also may have well-established relationships with our current and potential customers and extensive knowledge of our industry and the markets in which we compete and intend to compete. As a result, those competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the development, marketing, promotion and sale of their products than we can. They also may make strategic acquisitions or establish cooperative relationships among themselves or with other providers, thereby increasing their ability to provide a broader suite of products, and potentially causing customers to defer purchasing decisions. Finally, they may engage in aggressive pricing strategies or discounting. Any of the foregoing may limit our ability to compete effectively in the market and adversely affect our business, financial condition and results of operations.

Our gross margin is affected by a number of factors, and we may not be able to sustain it at present levels.

Our gross margin percentage has been and will continue to be affected by a variety of factors, including:

 

   

market acceptance of our products and fluctuations in demand;

 

   

the timing, size and mix of customer orders and product implementations;

 

   

increased price competition and changes in product pricing;

 

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actions taken by our competitors;

 

   

new product introductions and enhancements;

 

   

manufacturing and component costs;

 

   

availability of sufficient inventory to meet demand;

 

   

purchase of inventory in excess of demand;

 

   

our execution of our strategy and operating plans;

 

   

changes in our sales model;

 

   

geographies in which sales are made; and

 

   

revenue recognition rules.

For example, we have in the past entered into large revenue transactions with certain customers that, because of the product mix and discounting, have decreased our gross margin percentage. We may, in the future, enter into similar transactions. Macroeconomic factors and competitive developments could put further pressure on our gross margin.

We expect that our recent entry into the cloud computing business will put negative pressure on our gross margins, both as a consequence of our need to invest in infrastructure and the ratable recognition of subscription revenue for such services when received.

Even if we achieve our net revenue and operating expense objectives, our net income and operating results may be below our expectations and the expectations of investors and analysts if our gross margins are below expectations.

We must attract, assimilate and retain key personnel on a cost-effective basis.

We depend on our ability to attract and retain highly qualified and skilled personnel on an ongoing basis. Our success will depend in part on our ability to recruit and retain key personnel. Changes in our executives and other high-level personnel may disrupt our business and could result in other employees leaving the Company. In fiscal 2011, we hired a new Chief Executive Officer and a new Chief Marketing Officer. We also experienced substantial employee attrition in fiscal 2011, particularly in our sales and marketing groups.

We presently compensate our key and our high performing employees in part through awards of equity in the Company, including stock options and restricted stock units. We need to provide equity awards that are competitive with awards offered by those companies with whom we compete for talent in order to attract and retain top personnel; however, our ability to make such awards is constrained by the shares available for issuance under our 2007 Stock Incentive Plan. Increases to the reserve of our 2007 Stock Incentive Plan require stockholder approval, and there is no assurance that we will obtain the necessary stockholder approval for an increase to the reserve of our 2007 Stock Incentive Plan when we believe it is required. The failure to obtain such approval could limit our future ability to grant equity awards, or sufficiently substantial equity awards, to our employees for the purposes of retention of those employees.

The majority of our U.S.-based employees, including our senior management, are employed on an “at-will” basis, which may make it easier for key employees to move to new employment. Our inability to timely hire replacement or additional employees may impact our operations, since new hires, particularly sales personnel, frequently require extensive training before they achieve desired levels of productivity. As well, we may be unable to address market opportunities in a timely fashion. This may affect our ability to grow our net revenue. In addition, we may increase our hiring in locations outside of the U.S., such as in connection with our research and development facility in India, which could subject us to additional geopolitical and exchange rate risks.

 

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We rely significantly on third party sales channel partners to sell our products.

Substantially all of our revenue is generated through sales by our channel partners, which include distributors, global systems integrators, managed service providers and value-added resellers. During fiscal 2011, approximately 99% of our sales were made through our channel partners, and 55% of our sales were made through 3 distributors. Although we provide support to these channel partners through our direct sales and marketing activities, we depend upon these partners to generate sales opportunities and to independently manage the sales process for opportunities with which they are involved. In order to increase our net revenue, we will need to maintain our existing sales channel partners and to continue to train and support them, and we will need to add new sales channel partners and effectively train, support and integrate them with our sales process. As well, our entry into new markets, such as our entry into the security-as-a-service market with our new Cloud Service, requires us to develop appropriate channel partners and to train them to effectively address these markets. If we are unsuccessful in these efforts, this will limit our ability to grow our business and our business, financial condition and results of operations will be adversely affected.

Our current system of channel distribution may not prove effective in maximizing sales of our products and services. Our products are complex and certain sales can require substantial effort. It is possible that our channel partners will be unable or unwilling to dedicate appropriate resources to support those sales. As well, most of our sales channel partners do not have minimum purchase or resale requirements, and may cease selling our products at any time. They also may market, sell and support products and services that are competitive with ours, and may devote more resources to the marketing, sales and support of those products. There is no assurance that we will retain these sales channel partners, or that we will be able to secure additional or replacement sales channel partners in the future. The loss of one or more of our key sales channel partners in a given geographic area could harm our operating results within that area, as new sales channel partners typically require extensive training and take several months to achieve acceptable productivity.

We also depend on some of our sales channel partners to deliver first line service and support for our products. Any significant failure on their part to provide such service and support could impact customer satisfaction and future sales of our products.

While we require that our third party sales channel partners comply with applicable laws and regulations, they could engage in behavior or practices that expose us to legal or reputational risk.

Our international operations expose us to risks.

We currently have operations in a number of foreign countries and make sales to customers throughout the world. In fiscal 2011, 54.7% of our total net revenue was derived from customers outside of the Americas; thus, our business is substantially dependent on economic conditions and IT spending in markets outside of the Americas. As well, we currently perform certain of our research and development and other operations offshore in lower cost geographies and we maintain data centers for our Cloud Service in geographically dispersed locations outside of the United States. Our international operations and sales into international markets require significant management attention and financial resources, and subject us to certain inherent risks including:

 

   

technical difficulties and costs associated with product localization;

 

   

challenges associated with coordinating product development efforts among geographically dispersed areas;

 

   

potential loss of proprietary information due to piracy, misappropriation or laws that may inadequately protect our intellectual property rights;

 

   

our limited experience in establishing a sales and marketing presence, and research and development operations, together with the appropriate internal systems, processes and controls, in certain geographic markets;

 

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political unrest or economic instability, regulatory changes, war or terrorism, and other unpredictable and potentially long-term events in the countries or regions where we or our customers do business, which could result in delayed or lost sales or interruption in our business operations;

 

   

longer payment cycles for sales in certain foreign countries;

 

   

seasonal reductions in business activity in the summer months in Europe and at other times in various countries;

 

   

the significant presence of some of our competitors in some international markets;

 

   

potentially adverse tax consequences or changes in applicable tax laws;

 

   

import and export restrictions and tariffs and other trade protection initiatives;

 

   

potential failures of our foreign employees and channel partners to comply with both U.S. and foreign laws, including antitrust laws, trade regulations and anti-bribery and corruption laws, including the Foreign Corrupt Practices Act;

 

   

compliance with foreign laws and other government controls, such as those affecting trade, privacy, the environment, corporations and employment;

 

   

management, staffing, legal and other costs of operating a distributed enterprise spread over various countries;

 

   

fluctuations in foreign exchange rates, which we currently do not hedge against; and

 

   

fears concerning travel or health risks that may adversely affect our ability to sell our products and services in any country in which the business sales culture encourages face-to-face interactions.

To the extent we are unable to effectively manage our international operations and these risks, our international sales or operations may be adversely affected, we may incur additional and unanticipated costs, and we may be subject to litigation or regulatory action. As a consequence, our business, financial condition and results of operations could be seriously harmed.

Economic uncertainty and adverse macroeconomic conditions may harm our business.

Our revenues and margins are dependent on various economic factors, including rates of inflation, currency fluctuations, energy costs, levels of consumer sentiment and other macroeconomic factors, which may impact levels of business spending. These conditions may adversely affect corporate spending for IT products and services in specific geographies or more broadly, and could result in:

 

   

a significant reduction in our net revenue, gross margin and operating margin;

 

   

increased price competition for our products and services;

 

   

risk of excess and obsolete inventory;

 

   

higher overhead costs as a percentage of net revenue;

 

   

difficulty in accurately forecasting demand for our products and services;

 

   

insolvency or credit difficulties confronting our customers and channel partners, affecting their ability to purchase or pay for our products and services; and

 

   

insolvency or credit difficulties confronting our key suppliers, which could disrupt our supply chain.

In addition, a significant percentage of our operating expenses are generally fixed in nature, particularly in the short term, which could limit our ability to mitigate any negative impact on our profit margins.

 

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Our new Cloud Service offering presents financial, market, security, legal and operational risks.

We recently released our Blue Coat Cloud Service offering, which presents certain financial, market, security, legal and operational risks different from the risks present in marketing and selling our traditional product offerings. We have invested considerable resources in developing the Cloud Service and in building out its infrastructure, including amounts spent on internal research and development, equipment purchases and long-term leases or service agreements associated with acquiring space for the data centers that support the service, and there is no assurance that we will generate sufficient revenue from sales of subscriptions to recoup this investment. Moreover, our entry into the cloud computing business may adversely affect our gross margin, revenue and expense as a consequence of the ratable recognition of subscription revenue for our Cloud Service. We will need to create new sales and marketing programs and channels to effectively market our Cloud Service, and there is no assurance that our Cloud Service will achieve a significant degree of market acceptance with either end users or our channel partners.

The customer data that is electronically transmitted through our Cloud Service also subjects us to new security and legal compliance risks. While we believe our cloud product complies with current regulatory and security requirements in the jurisdictions in which we operate the service, there can be no assurance that such requirements will not change or that we will not otherwise be subject to legal or regulatory actions. Additionally, we must maintain high availability of our Cloud Service, which is subject to risks arising from hardware or software problems, connectivity or networking issues, scalability problems, human error, issues with third party data centers, natural disasters and hacker attacks. Should any of the foregoing risks related to our Cloud Service materialize, it may damage our reputation and result in the loss of customers and potential customers.

We must continue to develop market awareness of our company and our products and services.

We focused our business strategy and investments on the markets for Web Security and WAN Optimization products and services during the past fiscal year. We have also moved into the market for the delivery of Web Security functionality as a service, or security-as-a-service with our new Cloud Service.

Market awareness of our brand and of the products and services that we offer is essential to our continued growth and our success in the markets in which we compete and intend to compete. If our advertising and marketing programs are not successful in creating market awareness of our participation and positioning in these markets, the need for our products and services, and the value and capabilities of our specific products and services, we may not be able to achieve sustained growth. Moreover, if the markets for our products and services fail to grow as we anticipate, we may not be able to sell as many of our products and services as we currently project, which would reduce our anticipated net revenue and could result in a decline in our stock price.

We must anticipate market needs, and develop and introduce new products and enhancements to rapidly meet those needs.

To maintain our competitive position in markets characterized by rapid rates of technological advancement, we must correctly anticipate market requirements and invest our research and development resources to meet those requirements. The introduction of new products by others, market acceptance of products based on new or alternative technologies, or the emergence of new industry standards, could render our existing products obsolete or make it easier for other products to compete with our products. Our future success will depend in part upon our ability to:

 

   

develop and maintain competitive products;

 

   

enhance our products by adding innovative features that differentiate our products from those of our competitors;

 

   

bring products to market on a timely basis at competitive prices;

 

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

 

   

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

There is no guarantee that we will accurately predict the direction in which the markets in which we compete or intend to compete will evolve. Failure on our part to anticipate the direction of our markets and to develop products, enhancements and service offerings that meet the demands of those markets will significantly impair our business, financial condition and results of operations.

Our internal investments in research and development may not yield the benefits we anticipate.

The success of our business is predicated on our ability to create new products and technologies and to anticipate future market requirements and applicable industry standards. We presently are investing in enhancing our Web Security products, our WAN Optimization products and our Cloud Service. To accomplish these investments, we intend to continue to add personnel and other resources to our research and development function. We will likely recognize costs associated with these investments earlier than the anticipated benefits. If we do not achieve the anticipated benefits from these investments, or if the achievement of these benefits is delayed, our business, financial condition and results of operations may be adversely affected.

The process of developing new technologies is time consuming, complex and uncertain, and requires commitment of significant resources well in advance of being able to fully determine market requirements and industry standards. Furthermore, we may not be able to timely execute new product or technical initiatives because of errors in product planning or timing, technical difficulties that we cannot timely resolve, or a lack of appropriate resources. This could result in competitors bringing products to market before we do and a consequent decrease in our market share and net revenue. Our inability to timely and cost-effectively introduce new products and product enhancements, or the failure of these new products or enhancements to achieve market acceptance and comply with industry standards, could seriously harm our business, financial condition and results of operations. Additionally, our introduction of new products and product enhancements could result in the obsolescence of previously purchased or committed inventory, which would reduce our net income.

We are subject to various governmental regulations that could subject us to liability or impair our ability to sell our products or services.

Our products and services are subject to various governmental regulations. Our ability to sell our products internationally is subject to U.S. and foreign import and export control laws and various environmental regulations, including the Waste Electrical and Electronic Equipment (WEEE) and Restriction of the Use of Certain Hazardous Substances in Electrical and Electric Equipment (RoHS) regulations adopted by the European Union. In addition, our products contain encryption technology and various countries regulate the import or export of certain encryption technology and have enacted laws that could limit our ability to distribute our products or could limit our customers’ ability to implement our products in those countries. As well, the failure to comply with these regulations could result in the assessment of fines or penalties or other relief against us.

Certain of our products enable the filtering of Internet content and provide the end user customer with the ability to selectively block access to certain Web sites. It is possible that our end user customers may filter content in a manner that is unlawful or that is believed or found to be contrary to the exercise of personal rights. If this occurs, our ability to distribute and sell those products as presently designed or as customers desire to use them may be affected and our reputation may be harmed.

Changes in our products or changes in applicable regulations or enforcement may create delays in the introduction of our products, prevent our customers with international operations from deploying our products globally or, in some cases, prevent the export or import of our products to certain countries altogether. Any decreased use of our products, limitation on our ability to distribute our products or services in specific jurisdictions, or limitation on our customers’ ability to use our products or services could adversely affect our business, financial condition and results of operations.

 

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Our business operations and the use of our technology are subject to evolving legal regulation regarding privacy.

We currently operate our business in a number of jurisdictions where our operations are subject to evolving privacy-related or data protection laws and regulations. As well, our new Blue Coat Cloud Service transmits and stores customer data in various jurisdictions, which subjects the operation of that service to privacy-related or data protection laws and regulations in those jurisdictions. In addition, our appliances, when configured by our end user customers, may intercept data or content in a manner that may subject the use of those appliances to privacy-related or data protection laws and regulations in those jurisdictions in which our end user customers operate.

Any failure or perceived failure by us or by our products or services to comply with these laws and regulations may subject us to legal or regulatory actions, damage our reputation or adversely affect our ability to sell our products or services in the jurisdiction that has enacted the law or regulation. Moreover, if these laws and regulations change, or are interpreted and applied in a manner that is inconsistent with our data practices or the operation of our products and services, we may need to expend resources in order to change our business operations, data practices or the manner in which our products or services operate. This could adversely affect our business, financial condition and results of operations.

The security of our computer systems may be compromised and harm our business.

A significant portion of our business operations is conducted through use of our computer network. As well, we offer security-as-a-service to our customers through computer systems located at third party data centers in geographically dispersed areas. Although we have implemented security systems and procedures to protect the confidential information stored on these computer systems, experienced computer programmers and hackers may be able to penetrate our network security and misappropriate our confidential information or that of third parties. As well, they may be able to create system disruptions, shutdowns or effect denial of service attacks. Computer programmers and hackers also may be able to develop and deploy viruses, worms, and other malicious software programs that attack our networks or client computers, or otherwise exploit any security vulnerabilities, or that misappropriate and distribute confidential information stored on these computer systems. Any of the foregoing could result in damage to our reputation and customer confidence in the security of our Cloud Service and other products and services, and could require us to incur significant costs to eliminate or alleviate the problem. Additionally, our ability to transact business may be affected. Such damage, expenditures and business interruption could seriously impact our business, financial condition and results of operations.

We may not be able to successfully manage the growth of our business and may suffer other losses if we are unable to improve our systems and processes.

Our growth together with evolving regulatory requirements, our expanded international operations and changes in financial accounting and reporting standards, has placed increased demands on our management and our business infrastructure. We need to continue to improve our systems and processes to effectively manage our operations and growth, including our growth into new geographies. We may not be able to successfully implement improvements to these systems and processes in a timely or efficient manner. As well, our systems and processes may not prevent or detect all errors, omissions or fraud. Our failure to improve our systems and processes, or their failure to operate in the intended manner, may result in our inability to manage the growth of our business, to accurately forecast our revenue, expenses and earnings, or to prevent certain losses. This could adversely affect our business, financial condition and results of operations.

If the protection of our proprietary technology is inadequate, our competitors may gain access to our technology.

Our success is heavily dependent on our ability to create proprietary technology and to protect and enforce our intellectual property rights in that technology, as well as our ability to defend against adverse claims of third

 

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parties with respect to our technology and intellectual property. To protect our proprietary technology, we rely primarily on a combination of contractual provisions, confidentiality procedures, trade secrets, copyright and trademark laws, and patents. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or obtain and use information that we regard as proprietary. Policing unauthorized use of our products is difficult. In addition, the laws of some foreign countries, including countries where we sell products and have operations, do not protect our proprietary rights to as great an extent as do the laws of the United States. Our means of protecting our proprietary rights may not be adequate and unauthorized third parties, including current and future competitors, may independently develop similar or superior technology, duplicate or reverse engineer aspects of our products, or design around our patented technology or other intellectual property.

As of April 30, 2011, we had 128 issued U.S. patents, 63 pending U.S. patent applications (provisional and non-provisional) and 4 foreign-issued patents. There can be no assurance that any of our pending patent applications will issue or that the patent examination process will not result in our narrowing the claims applied for. Furthermore, there can be no assurance that we will be able to detect any infringement of our existing or future patents (if any) or, if infringement is detected, that our patents will be enforceable or that any damages awarded to us will be sufficient to adequately compensate us for the infringement.

There can be no assurance or guarantee that any products, services or technologies that we are presently developing, or will develop in the future, will result in intellectual property that is subject to legal protection under the laws of the United States or a foreign jurisdiction and that produces a competitive advantage for us.

Third parties may assert that our products or services infringe their intellectual property rights.

Third parties have in the past and may in the future claim that our current or future products or services infringe their intellectual property rights, and these claims, even if without merit, could harm our business by increasing our costs, reducing our net revenue or by creating customer concerns that result in delayed or reduced sales. This is particularly true in the patent area, as an increasing number of U.S. patents covering computer networking and Internet technology have been issued in recent years. Patent owners, including those that do not commercially manufacture or sell products, may claim that one or more of our products infringes a patent they own.

We expect that companies in the Internet and networking industries will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in different industry segments overlaps. The defense or settlement of any such claims, even if unmeritorious, could be time-consuming and costly. As well, such claims may require us to enter into royalty or licensing agreements, or to develop non-infringing technology. As well, injunctive relief could be entered against us or trade restrictions could be imposed. Any of the foregoing could seriously harm our business, financial condition and results of operations.

Third parties may bring legal actions against us.

In the past third parties have brought legal actions against us and other parties to whom we provided indemnification. We incurred substantial costs to defend those lawsuits and related legal proceedings. It is likely that in the future other parties may bring legal actions against us. Such actions, even if without merit, could harm our business. Any material litigation or arbitration inevitably results in the diversion of the attention of our management and other relevant personnel. To the extent uninsured, such claims further require the expenditure of our resources for defense costs for us and for parties to whom we may have indemnification obligations. We also may be required to pay material amounts in settlement costs or damages. As well, if the matter relates to intellectual property infringement, we may be required to enter into royalty or licensing agreements or to develop non-infringing technology, and injunctive relief could be entered against us. Customer concerns with respect to material litigation can result in delayed or lost sales. Any of the foregoing could seriously harm our business and have a material adverse effect on our business, financial condition and results of operations.

 

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If we fail to accurately predict our manufacturing requirements and manage our supply chain we could incur additional costs or experience manufacturing delays that could harm our business.

We provide forecasts of our requirements to our supply chain partners on a rolling 12-month basis. If our forecast exceeds our actual requirements, a supply chain partner may assess additional charges or we may have liability for excess inventory, each of which could negatively affect our gross margin. If our forecast is less than our actual requirements, the applicable supply chain partner may have insufficient time or components to produce or fulfill our product requirements, which could delay or interrupt manufacturing of our products or fulfillment of orders for our products, and result in delays in shipments, customer dissatisfaction, and deferral or loss of revenue. As well, we may be required to purchase sufficient inventory to satisfy our future needs in situations where a component or product is being discontinued. If we fail to accurately predict our requirements, we may be unable to fulfill those orders or we may be required to record charges for excess inventory. Any of the foregoing could adversely affect our business, financial condition and results of operations.

We depend on single and, in some cases, limited source suppliers for several key products and components of products.

We have limited sources of supply for certain key components of our products, which exposes us to the risk of component shortages or unavailability. In addition, we are unable to rapidly change quantities and delivery schedules because the procurement of certain components is subject to lengthy lead times and the qualification of additional or alternate sources is time consuming, costly and difficult. In the event our business growth exceeds our projections, or required components are otherwise in scarce supply, we may be subject to shortages, delays or unavailability of such components, or potential price increases, which may be substantial. If we are unable to secure sufficient components at reasonable prices in order to timely build our products, customer shipments may be delayed. This would adversely affect both our relationships with those customers and our net revenue. Alternatively, we may pay increased prices, which would impact our gross margin. Any of the foregoing could adversely affect our business, financial condition and results of operations.

We are dependent on original design manufacturers, contract manufacturers and third party logistics providers to design and manufacture our products and to fulfill orders for our products.

We depend primarily on original design manufacturers (each of which is a third party original design manufacturer for numerous companies) to co-design and co-develop the hardware platform for our products. We also depend on independent contract manufacturers (each of which is a third party manufacturer for numerous companies) to manufacture and fulfill our products. These supply chain partners are not committed to design or manufacture our products, or to fulfill orders for our products, on a long-term basis in any specific quantity or at any specific price. Also, from time to time, we may be required to add new supply chain partner relationships or new manufacturing or fulfillment sites to accommodate growth in orders or the addition of new products. It is time consuming and costly to qualify and implement new supply chain partner relationships and new manufacturing or fulfillment sites, and such additions increase the complexity of our supply chain management. Our ability to ship products to our customers could be delayed if we fail to effectively manage our supply chain partner relationships; if one or more of our design manufacturers does not meet our development schedules; if one or more of our contract manufacturers experiences delays, disruptions or quality control problems in manufacturing our products; or if one or more of our third party logistics providers experiences delays or disruptions or otherwise fails to meet our fulfillment schedules; or if we are required to add or replace design manufacturers, contract manufacturers, third party logistics providers or fulfillment sites. In addition, these supply chain partners have access to certain of our critical confidential information and could wrongly disclose such information. Moreover, an increasing portion of our manufacturing is performed outside the United States, primarily in China, and is, therefore, subject to risks associated with doing business in foreign countries. This includes risks resulting from the perception that certain jurisdictions, including China, do not comply with internationally recognized rights of freedom of expression and privacy and may permit labor practices that are deemed unacceptable under evolving standards of social responsibility. If manufacturing or logistics in these

 

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foreign countries is disrupted for any reason, including natural disasters, information technology system failures, military or government actions or economic, business, labor, environmental, public health, or political issues, or if the purchase or sale of products from such foreign countries is prohibited or disfavored our business, financial condition and results of operations could be adversely affected.

If our products do not interoperate with our customers’ infrastructures, or if customers implement certain proprietary protocols, sales of our products could be adversely affected.

Our products must interoperate with our customers’ existing infrastructures, which often have different specifications, utilize multiple protocol standards, deploy products and applications from multiple vendors, and contain multiple generations of products that have been added to that infrastructure over time. As well, our customers may implement proprietary encryption protocols that our products are unable to recognize, de-crypt or otherwise manage. If we are unable to successfully manage and interpret new protocol standards and versions, if we encounter problematic network configurations or settings, or if we encounter proprietary encryption protocols, we may have to modify our software or hardware so that our products will interoperate with our customers’ infrastructures and can address and manage our customers’ traffic in the manner intended. It may be necessary for us to obtain a license to implement proprietary encryption or other protocols, and there can be no assurance that we will be able to obtain such a license. As a consequence of any of the foregoing, we may suffer delays in development or installation or our products or may be unable to provide performance improvements for applications deployed in our customers’ infrastructures, which could affect our ability to sell or install our products, and adversely affect our business, financial condition and results of operations.

Forecasting our estimated annual effective tax rate is complex and subject to uncertainty, and there may be material differences between our forecasted and actual tax rates.

Forecasts of our income tax position and effective tax rate are complex and subject to uncertainty because our income tax position for each year combines the effects of a mix of profits and losses earned by us and our subsidiaries in various tax jurisdictions with a broad range of income tax rates, as well as changes in the valuation of deferred tax assets and liabilities, the impact of various accounting rules and changes to these rules and tax laws, the results of examinations by various tax authorities, and the impact of any acquisition, business combination or other reorganization or financing transaction. To forecast our global tax rate, we estimate our pre-tax profits and losses by jurisdiction and forecast our tax expense by jurisdiction. If the mix of profits and losses, our ability to use tax credits, or effective tax rates by jurisdiction is different than those estimated, our actual tax rate could be materially different than forecasted, which could have a material impact on our financial condition and results of operations.

As a multinational corporation, we conduct our business in many countries and are subject to taxation in many jurisdictions. The taxation of our business is subject to the application of multiple and conflicting tax laws and regulations as well as multinational tax conventions. Our effective tax rate is highly dependent upon the geographic distribution of our worldwide earnings or losses, the tax regulations and tax holidays in each geographic region, the availability of tax credits and carryforwards, and the effectiveness of our tax planning strategies. The application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Tax laws themselves are subject to change as a result of changes in fiscal policy, changes in legislation, and the evolution of regulations and court rulings. Consequently, taxing authorities may impose tax assessments or judgments against us that could materially impact our tax liability and/or our effective income tax rate.

In addition, we may be subject to examination of our income tax returns by the Internal Revenue Service and other tax authorities. If tax authorities challenge the relative mix of U.S. and international income, our future effective income tax rates could be adversely affected. While we regularly assess the likelihood of adverse outcomes from such examinations and the adequacy of our provision for income taxes, there can be no assurance that such provision is sufficient and that a determination by a tax authority will not have an adverse effect on our business, financial condition and results of operations.

 

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Our ability to sell our products depends on the quality of our support and services offerings.

Our end user customers look to us and, as applicable, to our channel partners to ensure that our products are properly configured and installed, and efficiently and effectively operate within their networks. To the extent we or our channel partners fail to effectively assist our end user customers in their efforts to deploy and operate our products, or fail to timely and adequately address product problems, it may adversely affect our ability to sell our products to those customers in the future and could harm our business and product reputation and impact other sales. Any failure to maintain high quality support and services may harm our business, financial condition and results of operations.

Our acquisitions may not provide the benefits we anticipate and may disrupt our existing business.

In the past, we have acquired other businesses or assets, and it is likely we will acquire additional businesses or assets in the future. There is no guaranty that such acquisitions will yield the benefits we anticipate. The success of any acquisition is impacted by a number of factors, and may be subject to the following risks:

 

   

inability to successfully integrate the operations, technologies, products and personnel of the acquired companies;

 

   

diversion of management’s attention from normal daily operations of the business;

 

   

loss of key employees; and

 

   

substantial transaction costs.

 

   

acquisitions may also result in risks to our existing business, including:

 

   

dilution of our current stockholders’ percentage ownership to the extent we issue new equity;

 

   

assumption of additional liabilities;

 

   

incurrence of additional debt or a decline in available cash;

 

   

adverse effects to our financial statements, such as the need to make large and immediate write-offs or the incurrence of restructuring and other related expenses;

 

   

liability for intellectual property infringement and other litigation claims, which we may or may not be aware of at the time of acquisition;

 

   

creation of goodwill or other intangible assets that could result in significant amortization expense or impairment charges; and

 

   

incurrence of tax expense related to the effect of acquisitions on our intercompany research and development cost sharing arrangements and legal structure.

The occurrence of any of the above risks could seriously impact our business, financial condition and results of operations.

We rely on technology that we license from third parties, including software that is integrated with internally developed software and used with our products.

We rely on technology that we license from third parties, including third party commercial software and open source software that is used with certain of our products. If we are unable to continue to license any of this software on commercially reasonable terms, we will face delays in releases of our software or we will be required to delete this functionality from our software until equivalent technology can be licensed or developed and integrated into our current product. In addition, the inability to obtain certain licenses or other rights might require us to engage in litigation regarding these matters, which could have a material adverse effect on our business, financial condition and results of operations.

 

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Product quality problems may result in delayed market acceptance, additional costs, reduced sales or litigation.

Our products are highly complex and may contain undetected operating errors or quality problems, particularly when first introduced or as new versions or upgrades are released. Despite testing by us and by current and potential customers, errors or quality problems may not be found in new products or new versions until after commencement of commercial shipments, resulting in customer dissatisfaction and loss of or delay in market acceptance and sales opportunities. This could materially adversely affect our operating results. These errors and quality problems could also cause us to incur significant repair or replacement costs, divert the attention of our engineering personnel from our product development efforts and cause significant customer relations problems. We may also incur significant costs in connection with a product recall and any related indemnification obligations, which could materially adversely affect our operating results. In addition, many of our products operate on our internally developed operating system, and any error in the operating system may affect those products. We have experienced errors or quality problems in the past in connection with new products and enhancements to existing products. We expect that errors or quality problems will be found from time to time in new or enhanced products after commencement of commercial shipments, which could seriously harm our business.

Since our end user customers install our appliances directly into their network infrastructures, any errors, defects or other problems with our products could negatively impact their networks or other Internet users, resulting in financial or other losses. While we typically seek by contract to limit our exposure to damages, it is possible that such limitations might not exist or might not be enforced in the event of a product liability claim. Moreover, a product liability claim brought against us, even if not successful, would likely be time-consuming and costly to defend or settle, and could seriously harm the reputation of our business and products.

Our operations could be significantly hindered by the occurrence of a natural disaster, terrorist attack or other catastrophic event.

Our business operations are susceptible to outages due to fire, floods, power loss, telecommunications failures, terrorist attacks and other events beyond our control, and our sales opportunities may also be affected by such events. In addition, a substantial portion of our facilities, including our headquarters, are located in Northern California, an area susceptible to earthquakes. We do not carry earthquake insurance for earthquake-related losses. 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. We may not carry sufficient business interruption insurance to compensate us for losses that may occur as a result of any of these events. To the extent that such events disrupt our business or the business of our current or prospective customers, or adversely impact our reputation, such events could adversely affect our business, financial condition and results of operations.

We may be unable to raise additional capital.

We believe that our available cash, cash equivalents and short term investments will enable us to meet our liquidity and capital requirements for at least the next 12 months. However, if cash is required for unanticipated needs, including in connection with a proposed acquisition of a company or technology, we may need additional capital during that period. The development and marketing of new products and our investment in sales and marketing efforts require a significant commitment of resources. If the markets for our products develop at a slower pace than anticipated, we could be required to raise additional capital. We cannot guarantee that, should it be required, sufficient debt or equity capital will be available to us under acceptable terms, if at all. If we were unable to raise additional capital when required, our business, financial condition and results of operations could be seriously harmed.

The market price of our stock is volatile, and is likely to be volatile in the future.

The market price of our common stock has experienced significant fluctuations and may continue to fluctuate significantly. Such volatility in the trading price of our stock can occur in response to general market

 

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conditions, changes in the IT or technology market generally or changes in the specific markets in which we operate, and cause an increase or decline in our stock price without regard to our operating performance. The market price of our common stock could decline quickly and significantly if we fail to achieve our guidance or if our performance fails to meet the expectation of public market analysts or investors.

The market price of our common stock may fluctuate significantly in response to the following factors, among others:

 

   

variations in our quarterly operating results;

 

   

changes in financial estimates or investment recommendations by securities analysts;

 

   

changes in macroeconomic conditions;

 

   

the introduction of new products by our competitors;

 

   

our ability to keep pace with changing technological requirements;

 

   

changes in market valuations of information technology companies;

 

   

announcements by us or our competitors of significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments, or other significant transactions;

 

   

loss of customers who represent a significant portion of our revenues;

 

   

additions or departures of key personnel;

 

   

fluctuations in stock market volumes;

 

   

investor confidence in our stock, technology stocks and the stock market in general;

 

   

speculation in the press or investment community about our strategic position, financial condition, results of operations or business; and

 

   

regulatory or litigation matters.

It is not uncommon for securities class actions or other litigation to be brought against a company after periods of volatility in the market price of a company’s stock, and we have been subject to such litigation in the past. Such actions could result in management distraction and expense and could result in a decline in our stock price.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

We are headquartered in Sunnyvale, California, where we lease two buildings consisting of an aggregate of approximately 234,000 square feet of office space pursuant to leases effective through November 2015. We also lease space for research and development in Draper, Utah; Waterloo, Ontario in Canada and Bangalore, India. In addition, we lease space for sales and support in several metropolitan areas in North America and in a number of countries outside the United States.

We believe that our existing facilities are adequate to meet our current requirements, and that suitable additional or substitute space will be available, if necessary.

Item 3. Legal Proceedings

The information set forth under Note 13 of Notes to Consolidated Financial Statements, included in Part II, Item 8 of this Report, is incorporated herein by reference. For an additional discussion of certain risks associated with legal proceedings, see the section entitled “Risk Factors” in Item 1A of this Report.

 

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PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Price Range of Common Stock

Our common stock is currently traded on the NASDAQ Global Select Market under the symbol “BCSI” and has been traded on NASDAQ since November 19, 1999. The following table sets forth, for the periods indicated, the high and low closing prices of our common stock as reported on the NASDAQ Global Select Market.

 

     High      Low  

For the year ended April 30, 2011:

     

First Quarter

   $ 33.38       $ 20.10   

Second Quarter

   $ 27.03       $ 17.50   

Third Quarter

   $ 32.04       $ 26.17   

Fourth Quarter

   $ 31.07       $ 26.25   

For the year ended April 30, 2010:

     

First Quarter

   $ 20.75       $ 13.32   

Second Quarter

   $ 25.62       $ 17.26   

Third Quarter

   $ 30.65       $ 22.06   

Fourth Quarter

   $ 35.47       $ 24.53   

At April 30, 2011, there were 381 stockholders of record and the price of our common stock was $28.80. We believe that a significant number of beneficial owners of our common stock hold shares in street name.

Recent Sales of Unregistered Securities

On November 15, 2010 we entered into a stipulation of settlement with respect to the derivative actions related to our historical stock option granting practices. In connection with the settlement, which was approved by the federal district court on January 20, 2011, we became obligated as of February 23, 2011 (the effective date of the settlement) to issue to plaintiffs’ counsel, within ten business days following such effective date, shares of our common stock valued at approximately $1.8 million. On March 3, 2011, we issued 59,444 shares of our common stock to plaintiffs’ counsel in connection with such settlement, with the number of shares determined by dividing $1.8 million by the average daily closing price of our common stock for the ten trading days immediately preceding February 23, 2011, in accordance with the settlement terms. The common stock was issued pursuant to the exemption from registration provided by Section 3(a)(10) of the Securities Act of 1933, as amended, because the federal district court approved the fairness of the terms of the settlement, including the issuance of those securities.

Dividend Policy

Our present policy is to retain earnings, if any, to finance future growth. We have never paid cash dividends and have no present intention to pay cash dividends.

 

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Stock Performance Graph

The following graph compares the cumulative five-year total return provided shareholders on our common stock relative to the cumulative total returns of the NASDAQ Composite index and the NASDAQ Computer Manufacturers index. This graph assumes that an investment of $100 (with reinvestment of all dividends) was made in our common stock and in each of the indexes on April 30, 2006 and its relative performance is tracked through April 30, 2011.

LOGO

 

     4/06      4/07      4/08      4/09      4/10      4/11  

Blue Coat Systems, Inc.  

   $ 100.00       $ 161.12       $ 194.03       $ 121.88       $ 298.99       $ 264.71   

NASDAQ Composite

     100.00         111.24         107.01         75.98         109.83         129.57   

NASDAQ Computer Manufacturers

     100.00         108.95         130.35         90.03         177.59         232.00   

 

The stock price performance included in this graph is not necessarily indicative of future stock price performance.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

None

 

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Item 6. Selected Financial Data

The following table sets forth selected financial data as of and for the last five fiscal years. This selected financial data should be read in conjunction with our historical financial statements, including the notes thereto, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included elsewhere in this report. The consolidated financial statement data include the results of operations of acquired businesses commencing on their respective acquisition dates.

 

    Year Ended April 30,  
    2011     2010     2009     2008     2007  
    (in thousands, except per share data)  

Consolidated Statements of Operations

         

Total net revenue

  $   487,113      $   496,137      $   444,745      $   305,439      $   177,700   

Total cost of net revenue

    106,483        125,633        131,135        71,445        45,748   

Gross profit

    380,630        370,504        313,610        233,994        131,952   

Total operating expenses

    314,774        331,505        311,042        208,873        141,637   

Operating income (loss)

    65,856        38,999        2,568        25,121        (9,685

Income (loss) before income taxes

    65,056        37,351        623        30,530        (6,074

Provision (benefit) for income taxes

    18,032        (5,528     9,131        (2,038     1,124   

Net income (loss)

  $ 47,024      $ 42,879      $ (8,508   $ 32,568      $ (7,198

Net income (loss) per share (1):

         

Basic

  $ 1.00      $ 0.97      $ (0.22   $ 0.93      $ (0.25

Diluted

  $ 0.98      $ 0.93      $ (0.22   $ 0.82      $ (0.25

Weighted average shares used in computing net income (loss) per share:

         

Basic

    46,920        44,326        38,493        35,179        29,188   

Diluted

    48,198        45,980        38,493        39,659        29,188   
    As of April 30,  
    2011     2010     2009     2008     2007  
    (in thousands)  

Consolidated Balance Sheet Data

         

Cash, cash equivalents and short-term investments

  $ 375,939      $ 236,347      $ 114,163      $ 162,178      $ 93,887   

Working capital

    309,152        184,842        66,644        123,561        66,394   

Total assets

    819,408        696,038        562,293        387,768        248,674   

Other long-term liabilities

    97,887        83,781        52,903        23,915        16,489   

Convertible senior notes

    78,136        77,241        76,347        —          —     

Series A redeemable convertible preferred stock

    —          —          —          —          41,879   

Total Blue Coat stockholders’ equity

    474,348        386,009        281,609        251,461        118,589   

 

(1) For more information on earnings per share including the two class method see Note 2 in the Notes to Consolidated Financial Statements.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Annual Report on Form 10-K, and other materials accompanying this Annual Report on Form 10-K contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements relate to our future plans, objectives, expectations, intentions and financial performance and the assumptions that underlie these statements. These forward-looking statements include, but are not limited to, statements concerning the following: plans to develop and offer new products and services and enter new markets; expectations with respect to future market growth opportunities; changes in and expectations with respect to revenues, gross margins and income tax provisions; future operating expense levels and operating margins; the impact of quarterly fluctuations of revenue and operating results; the success of our business strategy and changes in our business model and operations;; the impact of macroeconomic conditions on our business; the adequacy of our capital resources to fund operations and growth; investments or potential investments in acquired businesses and technologies, as well as internally developed technologies; the effectiveness of our sales force, distribution channel, and marketing activities; the impact of recent changes in accounting standards and assumptions underlying any of the foregoing. In some cases, forward-looking statements are identified by the use of terminology such as “anticipate,” “expect,” “intend,” “plan,” “predict,” “believe,” “estimate,” “may,” “will,” “should,” “would,” “could,” “potential,” “continue,” “ongoing,” or negatives or derivatives of the foregoing, or other comparable terminology.

The forward-looking statements in this Annual Report on Form 10-K involve known and unknown risks, uncertainties and other factors that may cause industry and market trends, or our actual results, level of activity, performance or achievements, to be materially different from any future trends, results, level of activity, performance or achievements expressed or implied by these statements. For a detailed discussion of these risks, uncertainties and other factors, see the “Risk Factors” section in Item 1A of this Annual Report on Form 10-K. We undertake no obligation to revise or update forward-looking statements to reflect new information or events or circumstances occurring after the date of this Annual Report on Form 10-K.

Overview

We design, develop and sell a family of proxy and other appliances, and related software and services that secure, accelerate and optimize the delivery of business applications, Web content and other information to distributed users over a Wide Area Network (“WAN”) or across an enterprise’s gateway to the public Internet (also known as the Web). Our products are based on three core functionalities: 1) security of the delivery of applications and content; 2) acceleration and optimization of the delivery of applications and content; and 3) visibility of the applications, content and users on the network. Our business strategy includes offering the core functionality of our products to new markets and through new delivery models and strategic relationships. At the end of fiscal 2011, we reorganized our product-oriented and development resources into three product groups to better support this strategy in a more focused manner. Each of these three product groups, Web Security, WAN Optimization and Cloud Service, is headed by a General Manager, each of whom reports directly to our Chief Executive Officer. As well, we established a core engineering and technologies group, also headed by a General Manager, to support our common code, platforms and the individual product groups.

During fiscal 2011 and continuing into fiscal 2012, we saw considerable executive transition. On September 1, 2010, we appointed Michael J. Borman as President and Chief Executive Officer of the Company, replacing Brian M. NeSmith, who had served as President and Chief Executive Officer since 1999. Mr. NeSmith was appointed to the newly created role of Chief Product Officer on September 1, 2010, and held that position until May 5, 2011. On December 13, 2010, Steve Daheb was appointed Chief Marketing Officer. On May 5, 2011, both Mr. NeSmith and David de Simone, who then served as Senior Vice President, Products & Technology, ceased to serve as executive officers. As consequence of our reorganization into three product groups, the positions formerly held by Mr. NeSmith and Mr. de Simone have now been eliminated.

We believe that continued growth of our net revenue, particularly from sales of products and new services, will be a key driver of future improvement in our financial condition and business success. We experienced a

 

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decline in product revenue in fiscal 2011 compared with fiscal 2010, which primarily related to a decrease in sales of our Web Security products to our mid-enterprise customers. We believe that this decline in product revenue resulted from several factors including the need to strengthen our go-to-market strategy and implement new channel and customer marketing programs; the need to improve our sales productivity and execution, after significant attrition and transition in our sales force and leadership that occurred in fiscal 2011; the need to drive new customer acquisition; and various budget and macro factors that impacted key transactions in fiscal 2011.

We believe that our operating margin and cash flow from operations are also important to our financial condition and business success. During fiscal 2011, we continued efforts begun in fiscal 2010 to improve our operational efficiency and cost structure to drive improvement in these metrics. While we generally were successful in maintaining operating profitability at our projected levels in fiscal 2011, the decline in our product revenue together with expenditures related to our go-to-market initiatives adversely affected our operating margin during the second half of fiscal 2011. Despite the decline in our product revenue, our cash flow from operations increased to $131.0 million in fiscal 2011, compared with $96.8 million in fiscal 2010.

Although we intend to continue to focus on our operational efficiency, cost structure and profitability in fiscal 2012, we also intend to make continued investments designed to drive increased net revenue and market penetration, including expenditures on sales, marketing and research and development. As well, we will continue to invest in our Cloud Service, although revenue from this subscription based product will be recognized ratably over a period of a year or more and accordingly will have a lessened impact on current revenue, even as our sales of that service increase. We anticipate that these expenditures will put pressure on our operating margins until we can increase our product revenue, and may impact our ability to achieve our desired level of profitability during fiscal 2012.

We track many financial metrics as key measures of our business performance, including net revenue, operating margin, deferred revenue, cash flow from operations and cash position.

Net Revenue

Net revenue, which includes product and service revenue, decreased to $487.1 million in fiscal 2011 from $496.1 million in fiscal 2010. Net product revenue in fiscal 2011 was $291.8 million, a $30.2 million decrease compared with fiscal 2010. Net product revenue primarily consists of revenue from sales of our Web Security and WAN Optimization products. We experienced a decline in product revenue in fiscal 2011 compared with fiscal 2010, which primarily related to a decrease in sales of our Web Security products to our mid-enterprise customers. We believe that this decline in product revenue resulted from several factors including the need to strengthen our go-to-market strategy and implement new channel and customer marketing programs; the need to improve our sales productivity and execution, after significant attrition and transition in our sales force and leadership that occurred in fiscal 2011; the need to drive new customer acquisition; and various budget and macro factors that impacted key transactions in fiscal 2011. We recognized $195.3 million in service revenue in fiscal 2011, a $21.2 million increase compared with fiscal 2010. Net service revenue primarily consists of revenue related to support and maintenance contracts. The increase in service revenue was the result of continued growth in our installed base and increase in revenue from renewal service contracts.

Operating Margin

Our operating income increased $26.9 million to $65.9 million in fiscal 2011 compared with fiscal 2010. This increase was attributable to an increase in our gross profit margin from 74.7% in fiscal 2010 to 78.1% in fiscal 2011 and a decrease in operating expenses of $16.7 million in fiscal 2011 compared with fiscal 2010. The gross profit margin increase primarily resulted from higher service gross margins associated with the improved efficiency of our worldwide support delivery model, partially offset by a decrease in net product revenue in fiscal 2011 compared with fiscal 2010. The decrease in operating expenses primarily resulted from decreased

 

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restructuring charges (as our 2010 restructuring plan was substantially complete), lower general and administrative expenses and lower research and development expenses, partially offset by increased sales and marketing expenses.

Operating expenses consist of sales and marketing expenses, research and development expenses, general and administrative expenses, amortization of acquisition-related intangible assets and restructuring charges. Personnel-related costs, including stock-based compensation, are the primary driver of the operating expenses in each functional area. As of April 30, 2011 and 2010 we had 1,333 and 1,261 full-time equivalent employees, respectively.

Deferred Revenue

Net deferred revenue was $178.1 million at April 30, 2011 compared with $154.2 million at April 30, 2010. The increase was primarily due to an increase in the sales of renewal service contracts to our customers, which was the result of continued growth in our installed base and higher renewal rates for our maintenance contracts.

Cash Flow from Operations and Cash Position

During fiscal 2011, we generated cash flow from operations of $131.0 million compared with $96.8 million generated during fiscal 2010. The increase in operating cash flow in fiscal 2011 was primarily driven by higher net income, after excluding the impact of non-cash charges such as stock-based compensation, depreciation, amortization expense and issuance of common shares in connection with the derivative litigation settlement, as well as an increase in working capital sources of cash from higher deferred revenue primarily as a result of our strong service renewals during the fiscal 2011, and increase in accounts payable balances primarily due to timing of payments to vendors, partially offset by working capital uses of cash from higher inventory and accounts receivable balances at April 30, 2011. Our cash and cash equivalents and restricted cash were $377.0 million at April 30, 2011 compared with $237.3 million at April 30, 2010. The overall increase in our cash and cash equivalents balance was primarily due to higher cash generated by operations offset by purchases of technology licenses and acquisitions, net of cash acquired in fiscal 2010 with no comparable activity in fiscal 2011.

Critical Accounting Policies and Estimates

Our discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of our consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, net revenue and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to Revenue Recognition, Allowance for Doubtful Accounts, Stock-Based Compensation, Supply Chain Liabilities and Valuation of Inventory, Acquisitions, Goodwill and Identifiable Intangible Assets, Income Taxes, and Legal and Other Contingencies. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, 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. Actual results may differ from these estimates under different assumptions or conditions, and such differences could be material.

We have discussed the development and selection of critical accounting policies and estimates with the audit committee of our board of directors. We believe the accounting policies described below are those that most frequently require us to make estimates and judgments that materially affect our financial statements and that are critical to the understanding of our financial condition and results of operations:

 

   

Revenue Recognition

 

   

Allowance for Doubtful Accounts

 

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Stock-Based Compensation

 

   

Supply Chain Liabilities and Valuation of Inventory

 

   

Acquisitions, Goodwill and Identifiable Intangible Assets

 

   

Income Taxes

 

   

Legal and Other Contingencies

Revenue Recognition

In October 2009, the Financial Accounting Standards Board (“FASB”) amended the accounting standards for revenue recognition to remove from the scope of industry-specific software revenue recognition guidance any tangible products containing software components and non-software components that operate together to deliver the product’s essential functionality. In addition, the FASB amended the accounting standards for certain multiple element revenue arrangements to:

 

   

provide updated guidance on whether multiple elements exist, how the elements in an arrangement should be separated, and how the arrangement consideration should be allocated to the separate elements;

 

   

require an entity to allocate arrangement consideration to each element based on a selling price hierarchy, where the selling price for an element is based on vendor-specific objective evidence (“VSOE”), if available; third-party evidence (“TPE”), if available and VSOE is not available; or the best estimate of selling price (“BESP”), if neither VSOE or TPE is available; and

 

   

eliminate the use of the residual method and require an entity to allocate arrangement consideration using the selling price hierarchy.

Although the amended standards were not required to be adopted by us until May 1, 2011, the beginning of our fiscal year 2012, we elected to early adopt this accounting guidance at the beginning of our first quarter of fiscal 2011 on a prospective basis for transactions entered into or materially modified after April 30, 2010.

The majority of our products are hardware appliances containing software components that operate together to provide the essential functionality of the product. Therefore, our hardware appliances are considered non-software deliverables and are no longer accounted for under the industry-specific software revenue recognition guidance.

Our product revenue also includes stand-alone software products. Stand-alone software may operate on our hardware appliances, but is not considered essential to the functionality of the hardware and continues to be subject to the industry-specific software revenue recognition guidance, which remains unchanged. This includes the use of the residual method. Certain of our stand-alone software when sold with our appliances is considered essential to its functionality and as a result is no longer accounted for under industry-specific software revenue recognition guidance; however, this same software when sold separately is accounted for under the industry-specific software revenue recognition guidance.

We design, develop and sell products and services that secure, accelerate and optimize the delivery of business applications and other information to distributed users over a Wide Area Network (“WAN”), or across an enterprise’s gateway to the public Internet (also known as the Web). Our products provide our end user customers with information about the applications and Web traffic running on their networks, including the ability to discover, classify, manage and control communications between users and applications across internal networks, the WAN and the Internet. Our products are also designed to optimize the performance of our end users’ business applications and content, whether used internally or hosted by external providers. In addition to

 

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optimizing the performance and delivery of applications, our products enable our end user customers to secure their Internet gateways and remote computer systems by providing protection from malicious code, or malware, and objectionable content.

We operate a multiple tier channel distribution model that includes both distributors and value-added resellers. In most cases, we sell our products to distributors, who in turn sell to value-added resellers and ultimately end users. In these cases, we generally ship our products from our fulfillment centers to value-added resellers who provide configuration services for end users. In some cases, we sell directly to value-added resellers, who in turn sell to end users. In these cases, we generally ship our products from our fulfillment centers directly to end users. We generally do not accept orders from distributors or value-added resellers when we are aware that they do not have an identified firm end user. Additionally, we provide unspecified software upgrades for most of our products, on a when-and-if available basis, through post contract customer support (“maintenance”) contracts.

We recognize revenue when all of the following criteria are met: persuasive evidence of an arrangement exists; delivery or performance has occurred; the sales price is fixed or determinable; and collection is probable. We define each of those four criteria as follows:

Persuasive evidence of an arrangement exists. Evidence of an arrangement generally consists of a purchase order issued pursuant to the terms and conditions of a distributor or value-added reseller agreement and, in limited cases, an end user agreement.

Delivery or performance has occurred. We use shipping and related documents, or written evidence of customer acceptance, when applicable, to verify delivery or performance. We do not recognize product revenue until transfer of title and risk of loss, which generally is upon shipment to distributors, value-added resellers or end users as our customers do not carry stock and therefore do not have stock rotation rights. We generally do not have significant obligations for future performance, such as rights of return or pricing credits, associated with our sales.

The sales price is fixed or determinable. We assess whether the sales price is fixed or determinable based on payment terms and whether the sales price is subject to refund or adjustment.

Collection is probable. We assess probability of collection on a customer-by-customer basis. We subject our customers to a credit review process that evaluates their financial condition and ability to pay for our products and services. If we conclude that collection is not probable based upon our initial review, we do not recognize revenue until cash is received.

We enter into multiple element revenue arrangements in which a customer may purchase a combination of hardware, software, hardware and software upgrades, hardware and software maintenance, and professional services.

For transactions entered into prior to our adoption of the amended revenue standards in the first quarter of fiscal 2011, we allocated revenues for arrangements with multiple elements, such as appliances, maintenance or software, to each element using the residual method. Under the residual method, the amount of revenue allocated to delivered elements equals the total arrangement consideration less the aggregate fair value of any undelivered elements, provided VSOE of fair value exists for all undelivered elements. If evidence of the fair value of one or more undelivered elements does not exist, all revenue generally is deferred and recognized at the earlier of delivery of those elements or establishment of fair value for the remaining undelivered elements. When VSOE of fair value cannot be determined for any undelivered maintenance, subscription or service element, revenue for the entire arrangement is recognized ratably over the maintenance, subscription or service period.

For transactions entered into subsequent to the adoption of the amended revenue recognition standards that are multiple element arrangements, we allocate the arrangement fee to each element based upon the relative selling price of such element and, if software and software-related (e.g. maintenance for the software element)

 

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elements are also included in the arrangement, we allocate the arrangement fee to each of those software and software-related elements as a group based upon our BESP for those elements. After such allocation is made, the amount of the arrangement fee allocated to the software and software-related elements is accounted for using the residual method. When applying the relative selling price method, we determine the selling price for each element using VSOE of selling price, if it exists, or if not, TPE of selling price, if it exists. If neither VSOE nor TPE of selling price exist for an element, we use our BESP for that element. The revenue allocated to each element is then recognized when the basic revenue recognition criteria are met for that element. The manner in which we account for multiple element arrangements that contain only software and software-related elements remains unchanged.

Consistent with our methodology under previous accounting guidance, we determine VSOE for each element based on historical stand-alone sales to third parties.

VSOE of fair value is based on the price charged when the element is sold separately. We analyze our stand-alone hardware and software maintenance renewals by stratification of sales channel and service offering. We determine the VSOE of fair value for hardware and software maintenance by analyzing our stand-alone maintenance renewals and noting that a substantial majority of transactions fall within a narrow range for each stratum. In limited cases, VSOE of fair value has been based on management determined prices.

We typically are not able to determine TPE for our products maintenance or professional services. TPE is determined based on competitor prices for similar elements when sold separately. Generally, our offerings contain a significant level of differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, our go-to-market strategy differs from that of our peers and we are unable to reliably determine what similar competitor products’ selling prices are on a stand-alone basis.

When we are unable to establish the selling price of an element using VSOE or TPE, we use BESP in our allocation of arrangement consideration. The objective of BESP is to determine the price at which we would transact a sale if the product or service were sold on a stand-alone basis. We determine BESP for a product or service by considering multiple factors including, but not limited to, historical pricing practices by geography, customer class and distribution channel, and gross margin objectives.

For our hardware and software elements, we allocate the arrangement consideration based on the relative selling price of the element. For these elements, we use BESP as our selling price. For our hardware and software maintenance and professional services, we generally use VSOE as our selling price. When we are unable to establish selling price using VSOE for our hardware and software maintenance and professional services, we use BESP in our allocation of arrangement consideration.

We regularly review VSOE and BESP and maintain internal controls over the establishment and updates of these estimates. There was no material impact during the quarter from changes in either VSOE or BESP.

The impact from the adoption of the amended revenue recognition rules to total revenue, net income, and deferred revenue was not material for fiscal 2011. The new accounting guidance for revenue recognition is not expected to have a significant effect on total net revenue in periods after initial adoption, although the impact on the timing and pattern of revenue will vary depending on the nature and volume of new or materially modified contracts in any given period. However, we expect that this new accounting guidance will facilitate our efforts to optimize the sales and marketing of our offerings due to better alignment between the economics of an arrangement and the accounting for that arrangement. This may lead us to engage in new go-to-market practices. In particular, we expect that the new accounting standards will enable us to better combine products and services for which VSOE does not exist with other offerings and solutions. As these go-to-market strategies evolve, we may modify our pricing practices, which could result in changes in the relative selling prices of our elements, including both VSOE and BESP. As a result, the timing of revenue recognition on our future multiple element arrangements could differ materially from the recognition in the current period. Changes in the allocation of the

 

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sales price between elements may impact the timing of revenue recognition, but will not change the total revenue recognized with respect to the arrangement. We currently are unable to determine the impact that the newly adopted accounting principles could have on the timing of our revenue as these go-to-market strategies evolve.

Maintenance and subscription revenue is initially deferred and recognized ratably over the life of the contract, with the related expenses recognized as incurred. Maintenance and subscription contracts usually have a term of one to three years. Unearned maintenance and subscription revenue is included in deferred revenue.

We recognize revenue from the sale of third party anti-virus software net of royalties paid and classify this revenue as net service revenue in our consolidated statements of operations.

When we bill customers for shipping, we record shipping costs in both net revenue and cost of net revenue. If we do not charge customers for shipping, the costs incurred for shipping are reflected in cost of net revenue.

Allowance for Doubtful Accounts

We make judgments as to our ability to collect outstanding receivables and provide an allowance when collection of a receivable becomes doubtful. We analyze accounts receivable and historical bad debts, customer geographic concentrations, customer solvency, current economic and geographic trends, and changes in customer payment terms and practices when evaluating the adequacy of such allowance, and record any required changes in the allowance account to general and administrative expense. We write off accounts receivable when they are deemed to be uncollectible.

Stock-Based Compensation

We utilize the Black-Scholes option valuation model to calculate compensation expense. The Black-Scholes option valuation model requires the input of highly subjective assumptions, including the expected term of options, the expected price volatility of the stock underlying such options, the risk-free interest rate, and the expected dividend yield. We are required to estimate the stock awards that we ultimately expect to vest and to reduce compensation expense for the effects of estimated forfeitures of awards over the expense recognition period. To the extent our actual forfeitures are different than our estimates, we record a true-up for the difference in the period that the awards vest.

Supply Chain Liabilities and Valuation of Inventory

We outsource our manufacturing, product fulfillment and repair operations to contract manufacturers and third party logistics providers, and a significant portion of our cost of net revenue results from these activities. We currently purchase several key parts and components used in the manufacture of our products from a limited number of suppliers. Our contract manufacturers procure components and manufacture our products based on demand forecasts that we prepare. These forecasts are based on estimates of future product demand and are adjusted for overall market conditions. If the actual product demand is significantly lower than forecasted, we may be required to write down our inventory or accrue for excess supply chain liability, which could have an adverse impact on our gross margins and profitability.

Inventory consists of raw materials and finished goods. Inventory is recorded at the lower of cost (using the first-in, first-out method) or market, after obsolescence and inventory in excess of anticipated future demand is considered. In assessing the ultimate recoverability of inventory, we are required to make estimates regarding future customer demand, last time buy decisions, the timing of new product introductions, economic trends and market conditions.

Acquisitions, Goodwill and Identifiable Intangible Assets

We account for acquired businesses using the purchase method of accounting, which requires that the assets acquired, liabilities assumed, contractual contingencies and contingent consideration be recorded at the date of

 

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acquisition at their respective fair values. Goodwill is measured as a residual as of the acquisition date, which in most cases, results in measuring goodwill as an excess of the purchase consideration transferred plus the fair value of any noncontrolling interest in the acquiree over the fair value of the net assets acquired, including any contingent consideration. It further requires acquisition-related costs to be recognized separately from the acquisition and expensed as incurred, restructuring costs to be expensed in periods subsequent to the acquisition date, and changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period to impact the provision for income taxes. In addition, acquired in-process research and development is capitalized as an intangible asset and amortized over its estimated useful life.

The fair value of identifiable intangible assets is based on significant judgments made by management. We typically engage third party valuation appraisal firms to assist us in determining the fair values and useful lives of the assets acquired. Such valuations and useful life determinations require us to make significant estimates and assumptions. These estimates and assumptions are based on historical experience and information obtained from the management of the acquired companies, and also include, but are not limited to, future expected cash flows to be earned from the product-related technology and discount rates applied in determining the present value of those cash flows. Unanticipated events and circumstances may occur that could affect the accuracy or validity of such assumptions, estimates or actual results. Acquisition-related identifiable intangible assets are amortized on a straight-line basis over their estimated economic lives, which are three to seven years for developed technology and patents, five years for core technology, four to seven years for customer relationships and two years for trade name.

We perform goodwill impairment tests annually during our fourth fiscal quarter, and whenever events or changes in circumstances indicate that the carrying amount of goodwill may not be recoverable. The first step of the test identifies whether potential impairment may have occurred, and the second step of the test measures the amount of the impairment, if any. An impairment of goodwill is recognized when the carrying amount of the assets exceeds their fair value. The process of evaluating the potential impairment of goodwill is highly subjective and requires the application of significant judgment. For purposes of the annual impairment test, we consider our market capitalization compared with the carrying amount of our net assets on the date of the test, since we have only one reporting unit. We performed our annual review of goodwill in the fourth quarter of fiscal 2011 and concluded that no impairment existed at April 30, 2011.

We evaluate long-lived assets, including identifiable intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Events or changes in circumstances that could result in an impairment review include, but are not limited to, significant underperformance relative to historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for our overall business, and significant negative industry or economic trends. Impairment is recognized when the carrying amount of an asset exceeds its fair value as calculated on a discounted cash flow basis.

Income Taxes

We use the liability method to account for income taxes. As part of the process of preparing our consolidated financial statements, we are required to estimate income taxes in each of the jurisdictions in which we operate. This process involves determining our income tax expense and calculating the deferred income tax expense related to temporary differences resulting from the differing treatment of items for tax and accounting purposes, such as deferred revenue or deductibility of the amortization of certain intangible assets. These temporary differences result in deferred tax assets or liabilities, which are included within the consolidated balance sheets.

We record a valuation allowance to reduce certain deferred tax assets to an amount that we estimate is more likely than not to be realized. We consider estimated future taxable income and prudent tax planning strategies in determining the need for a valuation allowance. When we determine that it is more likely than not that some or

 

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all of our deferred tax assets will be realized by either refundable income taxes or future taxable income, the valuation allowance will be reduced and the related tax impact will be recorded as a reduction to the tax provision in that period. Likewise, should we determine that we are not likely to realize all or part of our deferred tax assets in the future, an increase to the valuation allowance would be recorded as an increase to the tax provision in the period in which such determination was made.

As a multinational corporation, we conduct our business in many countries and are subject to taxation in many jurisdictions. The taxation of our business is subject to the application of multiple and conflicting tax laws and regulations, as well as multinational tax conventions. Our effective tax rate is highly dependent upon the geographic distribution of our worldwide earnings or losses, the tax regulations and tax holidays in each geographic region, the availability of tax credits and carryforwards, and the effectiveness of our tax planning strategies. The application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Tax laws themselves are subject to change as a result of changes in fiscal policy, changes in legislation, and the evolution of regulations and court rulings. Consequently, tax authorities may impose tax assessments or judgments against us that could materially impact our tax liability and/or our effective income tax rate.

We use a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation, if any. The second step is to measure the tax benefit as the largest amount that is more likely than not to be realized upon settlement. We review our uncertain tax benefits quarterly, and we may adjust such uncertain tax benefits as a consequence of proposed assessments by tax authorities, changes in facts and circumstances, issuance of new regulations or new case law, previously unavailable information obtained during the course of an examination, negotiations with tax authorities of different countries concerning our transfer pricing, resolution with respect to individual audit issues/audit years, or the expiration of statutes of limitations. In addition, our tax contingency reserve includes certain amounts for potential tax assessments for pre-acquisition tax years of acquired companies, which, if recognized, will be recorded to our provision for income taxes.

Legal and Other Contingencies

We are currently involved in various claims and legal proceedings. We review the status of each significant matter and assess our potential financial exposure on a quarterly basis. We record a charge equal to at least the minimum estimated liability for damages arising from litigation or other loss contingencies only when both of the following conditions are met: (i) information available prior to issuance of our consolidated financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements and (ii) the range of loss can be reasonably estimated. As additional information becomes available, we reassess the potential liability related to pending loss contingencies and may revise our estimates. Such revisions in the estimates of the potential liabilities could have a material impact on our results of operations and financial position.

 

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Results of Operations

The following table sets forth, as a percentage of net revenue, consolidated statements of operations data for the periods indicated:

 

     Year Ended April 30,  
     2011     2010     2009  

Net revenue:

      

Product

             59.9             64.9             68.7

Service

     40.1     35.1     31.3
                        

Total net revenue

     100.0     100.0     100.0

Cost of net revenue:

      

Product

     12.9     15.5     19.3

Service

     9.0     9.8     10.2
                        

Total cost of net revenue

     21.9     25.3     29.5

Gross profit

     78.1     74.7     70.5

Operating expenses:

      

Sales and marketing

     38.3     36.2     40.1

Research and development

     16.9     17.1     17.2

General and administrative

     7.9     9.5     10.7

Amortization of intangible assets

     1.5     1.5     1.5

Restructuring

     —          2.5     0.4
                        

Total operating expenses

     64.6     66.8     69.9
                        

Operating income

     13.5     7.9     0.6

Interest income

     0.1     0.1     0.3

Interest expense

     (0.2 )%      (0.2 )%      (0.2 )% 

Other expense, net

     —          (0.3 )%      (0.5 )% 
                        

Income before income taxes

     13.4     7.5     0.2

Provision (benefit) for income taxes

     3.7     (1.1 )%      2.1
                        

Net income (loss)

     9.7     8.6     (1.9 )% 
                        

Net Revenue

Net revenue consists of product and service revenue. Net product revenue primarily consists of revenue from sales of our Web Security and WAN Optimization products. Net service revenue primarily consists of sales of new and renewal service contracts and sales of third party software. Although it is generally our practice to promptly ship products upon receipt of properly finalized purchase orders based on our published shipping lead times, we occasionally have orders that have not shipped or have otherwise not met all the required criteria for revenue recognition at the end of the quarter. In some of these cases, we may exercise discretion over the timing of shipments, which affects the timing of revenue recognition for those orders. In such cases, we consider a number of factors, including: our operational capacity to fulfill orders at the end of the quarter; our published shipment lead times; the delivery dates requested by customers and resellers; the amount of orders shipped in the quarter; and the concentration of orders received at the end of the quarter.

The following is a summary of net revenue and the changes in net revenue by fiscal year:

 

     Year Ended April 30,  
     2011     2010     2009  
     (dollars in thousands)  

Total net revenue

   $   487,113      $   496,137      $   444,745   

Change from prior fiscal year ($)

   $ (9,024   $ 51,392      $ 139,306   

Change from prior fiscal year (%)

     (1.8 )%      11.6     45.6

 

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Fiscal 2011 compared with Fiscal 2010: Net revenue, which includes product and service revenue, decreased $9.0 million, or 1.8%, in fiscal 2011 compared with fiscal 2010. Net product revenue in fiscal 2011 was $291.8 million, a $30.2 million decrease compared with fiscal 2010, which primarily related to a decrease in sales of our Web Security products to our mid-enterprise customers. We believe that this decline in product revenue resulted from several factors including the need to strengthen our go-to-market strategy and implement new channel and customer marketing programs; the need to improve our sales productivity and execution, after significant attrition and transition in our sales force and leadership that occurred in fiscal 2011; the need to drive new customer acquisition; and various budget and macro factors that impacted key transactions in fiscal 2011. Net service revenue in fiscal 2011 was $195.3 million, a $21.2 million increase compared with fiscal 2010. The increase in service revenue was the result of continued growth in our installed base and higher renewal rates from our maintenance contracts.

Fiscal 2010 compared with Fiscal 2009: Net revenue, which includes product and service revenue, increased $51.4 million, or 11.6%, in fiscal 2010 compared with fiscal 2009. Net product revenue in fiscal 2010 was $322.1 million, a $16.5 million increase compared with fiscal 2009, due to increased demand for our products, which we believe primarily resulted from an improvement in the economic environment and enterprise IT spending. Net service revenue in fiscal 2010 was $174.0 million, a $34.9 million increase compared with fiscal 2009. The increase in service revenue was the result of sales of new service contracts sold with our appliance in addition to continued growth in our installed base and increase in revenue from renewal service contracts.

The following is a summary of net revenue by geographic area:

 

     Year Ended April 30,  
     2011     2010     2009  
     (dollars in thousands)  

Americas (1)

   $   220,497         45.3   $   220,465         44.5   $   199,899         45.0

EMEA (2)

     170,261         34.9        185,163         37.3        162,493         36.5   

APAC (3)

     96,355         19.8        90,509         18.2        82,353         18.5   
                                                   

Total net revenue

   $ 487,113         100.0   $ 496,137         100.0   $ 444,745         100.0
                                                   

 

(1) North America, Central America and Latin America (“Americas”)
(2) Europe, Middle East and Africa (“EMEA”)
(3) Asia and Pacific regions (“APAC”)

Revenues from sales to customers outside of the Americas are a significant part of our revenue mix. Since all of our sales are currently invoiced in U.S. dollars, a change in the value of the dollar relative to foreign currencies could affect the demand for our products and therefore impact our revenues in foreign markets. For fiscal 2011, approximately 54.7% of our total net revenue was derived from customers outside of the Americas compared with 55.5% and 55.0% for fiscal 2010 and 2009, respectively.

Net revenue in the Americas was essentially flat in fiscal 2011 compared with fiscal 2010. This was driven by an $8.4 million increase in service revenue, due to an increase in revenue from both new and renewal service contracts. This increase in service revenue was offset by an $8.4 million decrease in product revenue in the Americas in fiscal 2011 compared with fiscal 2010, driven primarily by a decrease in product revenue related to our Web Security products, partially offset by an increase in product revenue related primarily to our WAN Optimization products. Net revenue in the Americas increased $20.6 million in fiscal 2010, up 10.3% from fiscal 2009.

Net revenue in EMEA decreased $14.9 million in fiscal 2011, down 8.0% from fiscal 2010. This decrease was primarily driven by a $24.6 million decrease in product revenue in EMEA in fiscal 2011 compared with fiscal 2010, due to a decrease in product revenue related to our Web Security products, partially offset by an

 

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increase in product revenue related to our WAN Optimization products. The decrease in product revenue was partially offset by a $9.7 million increase in service revenue from both new and renewal service contracts. Net revenue in EMEA increased $22.7 million in fiscal 2010, up 14.0% from fiscal 2009.

Net revenue in APAC increased $5.8 million in fiscal 2011, up 6.5% from fiscal 2010. This increase was driven by a $2.8 million increase in product revenue in APAC in fiscal 2011 compared with fiscal 2010, primarily due to an increase in product revenue related to sales of our WAN Optimization products and a $3.0 million increase in service revenue from both new and renewal service contracts. Net revenue in APAC increased $8.2 million in fiscal 2010, up 9.9% from fiscal 2009.

Gross Profit

The following is a summary of gross profit by fiscal year:

 

     Year Ended April 30,  
     2011     2010     2009  
     (dollars in thousands)  

Gross profit

   $   380,630      $   370,504      $   313,610   

Gross profit margin

     78.1     74.7     70.5

Fiscal 2011 compared with Fiscal 2010: Gross profit increased $10.1 million, or 2.7%, in fiscal 2011 compared with fiscal 2010. Gross profit margin in fiscal 2011 increased to 78.1% from 74.7% in fiscal 2010, primarily as a result of higher service gross margins associated with the improved efficiency of our worldwide support delivery model.

Fiscal 2010 compared with Fiscal 2009: Gross profit increased $56.9 million, or 18.1%, in fiscal 2010 compared with fiscal 2009, as a result of an increase in net revenue and related gross profit margin. Gross profit margin in fiscal 2010 increased to 74.7% from 70.5% in fiscal 2009, primarily as a result of favorable product mix, decreased product discounting and a decreased impact from the application of fair value purchase accounting on Packeteer inventory and deferred revenue, which negatively impacted the cost of product revenue and net service revenue by $28.1 million for fiscal 2009 compared with a negative impact of $5.3 million for fiscal 2010.

Sales and Marketing

Sales and marketing expense consists primarily of salaries and benefits, commissions, travel, advertising and promotional expenses. The following is a summary of sales and marketing expense by fiscal year:

 

     Year Ended April 30,  
     2011     2010     2009  
     (dollars in thousands)  

Sales and marketing

   $   186,332      $   179,725      $   178,470   

Sales and marketing as a percentage of net revenue

     38.3     36.2     40.1

Fiscal 2011 compared with Fiscal 2010: Sales and marketing expense increased $6.6 million, or 3.7%, in fiscal 2011 compared with fiscal 2010. The increase in sales and marketing expense was primarily attributable to a $4.7 million increase in commission payments, including additional commission accelerators that are part of our annual sales commission plan, recruiting fees and severance costs, and a $5.4 million increase in various other sales expenses, including travel and sales events, partially offset by a $2.0 million decrease in salaries and stock compensation expenses due to lower average headcount during fiscal 2011 and a $1.5 million decrease in marketing program costs.

 

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Sales and marketing headcount was 491 at April 30, 2011 compared with 480 at April 30, 2010. We currently expect sales and marketing expense during fiscal 2012 to increase slightly in absolute dollars and increase as a percentage of net revenue, as a consequence of continued investments designed to drive increased net revenue and market penetration, and expansion of new and existing marketing programs.

Fiscal 2010 compared with Fiscal 2009: Sales and marketing expense increased $1.2 million, or 0.7%, in fiscal 2010 compared with fiscal 2009. The increase in sales and marketing expense was primarily attributable to a $4.3 million increase in salaries and benefits as a result of higher headcount during fiscal 2010 compared with fiscal 2009, increased commission payments and increases in various other sales and marketing expenses to promote our strategy and market position, partially offset by a $3.1 million decrease in recruitment and travel related costs. Fiscal 2009 sales and marketing expense included $3.6 million of Packeteer integration and transition-related costs.

Research and Development

Research and development expense consists primarily of salaries and benefits, prototype costs, and testing equipment costs. The following is a summary of research and development expense by fiscal year:

 

     Year Ended April 30,  
     2011     2010     2009  
     (dollars in thousands)  

Research and development

   $   82,186      $   84,930      $   76,680   

Research and development as a percentage of net revenue

     16.9     17.1     17.2

Fiscal 2011 compared with Fiscal 2010: Research and development expense decreased $2.7 million, or 3.2%, in fiscal 2011 compared with fiscal 2010. The decrease in research and development expense was largely attributable to decreased personnel-related charges as a result of lower average headcount during the fiscal 2011 compared with fiscal 2010 related to our Fiscal 2010 Restructuring Plan and savings in workforce costs associated with the movement of certain of our research and development activities to India, partially offset by spending on equipment and other new and ongoing research and development projects and increased profit sharing expense in fiscal 2011 compared with fiscal 2010.

Research and development headcount was 366 at April 30, 2011 compared with 334 at April 30, 2010. We believe that continued investment in product enhancements and new product development is critical to achieving our strategic objectives in fiscal 2012 and beyond. We currently expect research and development expense to be approximately flat in absolute dollars and increase as a percentage of net revenue due to our continued investment in the development of new products and services and enhancement of existing products.

Fiscal 2010 compared with Fiscal 2009: Research and development expense increased $8.3 million, or 10.8%, in fiscal 2010 compared with fiscal 2009. The increase was primarily attributable to a $7.4 million increase in salaries and benefits, including profit sharing, as a result of higher headcount during fiscal 2010. Fiscal 2009 research and development expense included $3.0 million of Packeteer integration and transition-related costs.

 

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General and Administrative

General and administrative expense consists primarily of salaries and benefits, legal services, accounting and audit services, and other general corporate expenses. The following is a summary of general and administrative expense by fiscal year:

 

     Year Ended April 30,  
     2011     2010     2009  
     (dollars in thousands)  

General and administrative

   $   38,691      $   47,010      $   47,679   

General and administrative as a percentage of net revenue

     7.9     9.5     10.7

Fiscal 2011 compared with Fiscal 2010: General and administrative expense decreased $8.3 million, or 17.7%, in fiscal 2011 compared with fiscal 2010. The decrease was primarily due to decreases in legal expenses and professional services fees and personnel-related charges, including severance costs, and the $2.2 million net gain related to the settlement of the derivative litigation, partially offset by an increase in profit sharing expense.

Fiscal 2010 compared with Fiscal 2009: General and administrative expense decreased $0.7 million, or 1.4%, in fiscal 2010 compared with fiscal 2009. The decrease was primarily due to the incurrence of $1.7 million of Packeteer integration and transition-related costs, as well as a $1.0 million charge for bad debt expense in fiscal 2009, each of which did not reoccur in fiscal 2010, partially offset by a $1.9 million increase in personnel-related charges, including profit sharing, in fiscal 2010.

Amortization of Intangible Assets

Amortization expense for our intangible assets by fiscal year was allocated as follows:

 

     Year Ended April 30,  
     2011      2010      2009  
     (in thousands)  

Included in cost of net revenue

   $     4,691       $     5,152       $     4,969   

Included in operating expenses

     7,372         7,289         6,667   
                          

Total

   $ 12,063       $ 12,441       $ 11,636   
                          

On January 25, 2010, we acquired 84.5% of the outstanding shares of S7. We acquired an additional 15.5% of the outstanding shares of S7 in fiscal 2011.The acquisition-related intangible assets associated with our acquisition of S7 consisted of assumed customer contracts, which represented S7’s underlying relationships with its customers at the time of the initial acquisition. The fair value assigned to customer relationships was $0.7 million, which will be amortized on a straight-line basis over the expected useful life of 4 years, consistent with the number of periods of prospective cash flow utilized to estimate the fair value of the assets.

We completed the acquisition of Packeteer on June 6, 2008. The acquisition-related intangible assets consist of developed technology and patents, customer relationships and trade name. The amounts assigned to customer relationships, developed technology and patents, and trade name were $35.0 million, $20.0 million, and $0.4 million, respectively.

For fiscal years 2011, 2010 and 2009, the amortization of intangible assets was related to our acquisitions of S7, Packeteer, certain assets of the NetCache business from Network Appliance, Permeo, Inc., Cerberian, Inc. and Ositis Software, Inc. The amortization of developed technology, core technology, patents and trade name is charged to cost of net revenue, while the amortization of customer relationships is charged to operating expense. We amortize customer relationships, developed technology and patents, and trade name on a straight-line basis over their weighted average expected useful lives of 5, 5, and 2 years, respectively. Total amortization expense for our identifiable intangible assets for fiscal years ended April 30, 2011, 2010 and 2009 was $12.1 million, $12.4 million and $11.6 million, respectively.

 

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Restructuring Charges

Restructuring charges consist primarily of personnel-related severance costs, contract termination costs and stock-based compensation expense. Stock-based compensation included in restructuring resulted primarily from the additional vesting of unvested option shares, restricted shares and restricted stock units upon termination of the employment of those employees pursuant to the terms of their separation agreements. The following is a summary of restructuring charges by fiscal year:

 

     Year Ended April 30,  
     2011      2010     2009  
     (dollars in thousands)  

Restructuring charges

   $       193      $   12,551     $   1,546   

Restructuring charges as a percentage of net revenue

     —           2.5     0.4

Restructuring expenses in fiscal 2011 and fiscal 2010 consisted of expenses associated with the Fiscal 2010 Restructuring Plan (“the 2010 Plan”), which was committed to and initiated in third quarter of fiscal 2010. The 2010 Plan included a reduction of approximately 10% of our then current headcount and the closure of three facilities in order to restructure and further improve efficiencies in our operations. The total estimated restructuring charges associated with the 2010 Plan were $12.7 million. Of the total restructuring charges, $10.8 million in charges related to severance and related benefits for 265 employees and $1.9 million in charges related to facility closures and consolidations. We recorded $12.7 million of restructuring charges through the fourth quarter of fiscal 2011, including $0.1 million of stock-based compensation and do not expect to incur any charges in the future related to the 2010 Plan.

Restructuring expenses in fiscal 2009 consisted of expenses associated with our Fiscal 2009 Restructuring Plan, which was commenced in connection with our acquisition of Packeteer. The Fiscal 2009 Restructuring Plan expenses primarily consisted of severance-related costs and stock-based compensation charges. The Fiscal 2009 Restructuring Plan was completed in the first quarter of fiscal 2010 and no further charges under that plan were incurred after that quarter.

Interest Income, Interest Expense and Other Expense, Net

Interest income consists of interest income earned on our cash and marketable securities. Our cash historically has been invested in highly liquid investments such as time deposits held at major banks, commercial paper, U.S. government agency discount notes, money market mutual funds and other money market securities with maturities of 90 days or less at the date of purchase. At April 30, 2011, our cash was invested in money market mutual funds and a money market savings account. Interest expense primarily relates to amortization of the fair value of warrants and a beneficial conversion feature associated with our convertible senior notes. Other expense, net, consists primarily of foreign currency exchange gains or losses, and non-recurring gains or losses realized outside our normal course of business. The following is a summary of interest income, interest expense and other expense, net, by fiscal year:

 

     Year Ended April 30,  
     2011     2010     2009  
     (in thousands)  

Interest income

   $       629      $     303      $    1,302   

Interest expense

   $ (911   $ (918   $ (885

Other expense, net

   $ (518   $ (1,033   $ (2,362

Fiscal 2011 compared with Fiscal 2010: Interest income increased in fiscal 2011 compared with fiscal 2010 as a result of interest paid on our higher cash balances. Interest expense was essentially flat in fiscal 2011 compared with fiscal 2010. During both periods interest expense related to the amortization of the fair value of warrants and a beneficial conversion feature associated with our convertible senior notes. Other expense, net decreased in fiscal 2011 compared with fiscal 2010 due to decreased foreign exchange losses during fiscal 2011.

 

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Fiscal 2010 compared with Fiscal 2009: Interest income decreased in fiscal 2010 compared with fiscal 2009 as a result of a significant decrease in our average investment yield due to lower interest rates on the money market funds in which the majority of our cash and cash equivalents was invested, partially offset by interest paid on our higher cash balances. Interest expense increased in fiscal 2010 due to the recognition of twelve months of amortization of the fair value of our warrants and the beneficial conversion feature associated with the convertible senior notes compared with eleven months of amortization in fiscal 2009. Other expense, net, decreased in fiscal 2010 compared with fiscal 2009, because of a reduction in foreign exchange losses in fiscal 2010 as compared with fiscal 2009.

Provision (Benefit) for Income Taxes

The following is a summary of provision (benefit) for income taxes by fiscal year:

 

     Year Ended April 30,  
     2011      2010     2009  
     (dollars in thousands)  

Provision (benefit) for income taxes

   $   18,032       $   (5,528   $   9,131   

The provision (benefit) for income taxes primarily reflects current and deferred U.S. federal and state taxes and foreign income taxes in taxable foreign jurisdictions. The provision (benefit) for income taxes for the fiscal year ended April 30, 2011 was $18.0 million compared with $(5.5) million and $9.1 million for fiscal years ended April 30, 2010 and 2009, respectively.

Our provision (benefit) for income taxes for the year ended April 30, 2011 differs from the year ended April 30, 2010, primarily due to a change in the distribution of profits across foreign jurisdictions with tax rates different than the U.S. federal statutory rate and the absence of valuation allowance release. Our provision (benefit) for income taxes decreased for the fiscal year ended April 30, 2010 compared with the fiscal year ended April 30, 2009, primarily due to recognition of deferred tax assets in fiscal 2010. We released our valuation allowance against $10.6 million of previously unrecognized deferred tax assets during the fourth quarter of fiscal 2010. In addition, we recognized an additional $14.5 million of deferred tax assets during fiscal 2010, which primarily related to the utilization of previously unbenefitted tax attributes, to offset current taxable income in the U.S.

On December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, which retroactively extended the R&D tax credit for tax years beginning after December 31, 2009 through December 31, 2011. As a result of this change in federal tax law, we recorded a net federal R&D credit of $0.6 million benefit for fiscal 2011 and $0.8 million benefit for fiscal 2010.

As of April 30, 2011, we had net operating loss carryforwards for federal income tax purposes of approximately $199.0 million, which will expire in fiscal years ending in 2013 through 2030, if not utilized. We also had net operating loss carryforwards for state income tax purposes of approximately $59.6 million, which will expire in fiscal years 2012 through 2030 if not utilized. Of the total tax attributes, we have $97.8 million of federal net operating loss carryforwards and $59.0 million of state net operating loss carryforwards for which no deferred tax asset has or will be recorded until the tax benefit relating to excess stock compensation deduction is realized. We also had federal and California tax credit carryforwards of approximately $16.9 million and $13.8 million, respectively. The federal research credit carryforwards will expire starting in 2027, if not utilized. The federal alternative minimum tax credit and California credit carryforwards are not subject to expiration.

Utilization of our net operating loss and credit carryforwards are subject to substantial annual limitations due to the ownership change provisions of the Internal Revenue Code and similar state provisions. To date, these annual limitations have resulted in the expiration of net operating loss and tax credit carryforwards before utilization of approximately $21.0 million and $3.6 million, respectively. Utilization of federal and state net

 

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operating losses of approximately $178.0 million and $59.6 million, respectively, as well as $13.3 million and $13.8 million of federal and state credits, respectively, are subject to annual limitations ranging from approximately $7.0 million to $8.0 million. See Note 10 in the Notes to Consolidated Financial Statements for additional information.

Our total gross unrecognized tax benefits as of April 30, 2011, 2010 and 2009 were $43.3 million, $33.9 million and $18.8 million, respectively. Included in our gross unrecognized tax benefits as of April 30, 2011 is approximately $40.9 million of tax benefits that, if recognized, would result in an adjustment to our effective tax rate.

We have elected to classify interest and penalties related to unrecognized tax benefits as a component of our provision for income taxes. Accrued interest and penalties relating to our unrecognized tax benefits was approximately $2.3 million, $1.3 million and $1.0 million as of April 30, 2011, 2010 and 2009, respectively, including approximately $1.0 million, $0.3 million and $0.3 million charged to provision for income taxes for fiscal years 2011, 2010 and 2009, respectively.

Due to our taxable loss position from inception through fiscal 2010, all tax years are subject to examination in U.S. federal and state jurisdictions. We are also subject to examination in various foreign jurisdictions for tax years 2004 forward, none of which are individually material. We are unable to anticipate the change to the balance of our unrecognized tax benefits in the next twelve months due to the possibility of tax examinations and our continued assessment of potential contingencies.

Acquisitions

On January 25, 2010, we acquired 84.5% of the outstanding shares of S7, an IT research and development outsourcing firm based in Bangalore, India. We acquired an additional 15.5% of the outstanding shares of S7 in fiscal 2011. We acquired S7 to serve as the Company’s new development center in India and to provide expertise in software development, code migration and network security. The total purchase price was $6.4 million in cash, consisting of $4.3 million for the shares initially acquired and $0.8 million of noncontrolling interest subsequently acquired (which amounts include an allocation of $1.1 million for excess working capital remaining as of the closing date), and $1.3 million payable over the 30 months subsequent to the closing date. Under the stock purchase agreement, the selling shareholders will indemnify us for up to $1.3 million for damages caused by inaccuracies in, breaches or violations of or defaults under representations, warranties, covenants or agreements. Any such amounts may be withheld from the $1.3 million remaining due under the purchase agreement. In connection with the acquisition, we recognized $0.1 million of transaction costs, which were included in general and administrative expenses in our consolidated statement of operations. In addition, we agreed to pay potential retention bonuses up to an aggregate amount of $2.0 million to certain S7 shareholders who were also employees. Payment of these bonuses is contingent upon the performance of post-acquisition services by those shareholders over the 30 months subsequent to the initial closing date. Accordingly, the potential bonus amounts will be accrued as compensation expense over that period. Our acquisition of S7 did not result in the creation of a new business segment.

Liquidity and Capital Resources

Since our inception, we have financed our operations and capital expenditures through cash provided by operating activities, private sales of preferred and common stock, bank loans, equipment leases, private sales of convertible notes and warrants and an initial public offering of our common stock.

Cash and Cash Equivalents and Restricted Cash

We consider all highly liquid investments with insignificant interest rate risk and original maturities of three months or less to be cash equivalents. We determine the appropriate classification of our investments at the time

 

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of purchase and evaluate such designation as of each balance sheet date based on our intent and whether it is more likely than not that we will be required to sell the instrument before recovery of its amortized cost basis. To date, all of our investments have been classified as available-for-sale and are carried at fair value, with unrealized gains and losses, excluding the portion relating to credit loss, if any, included in accumulated other comprehensive income (loss) in stockholders’ equity. The fair value of these securities is determined based on quoted market prices in active markets.

As of April 30, 2011, we had cash and cash equivalents of $376.0 million and restricted cash of $1.0 million, and approximately 50% of our total cash and cash equivalents was held outside of the United States in various foreign subsidiaries. If our cash and cash equivalents held outside the United States are distributed to the United States in the form of dividends or otherwise, we may be subject to additional U.S. income taxes (subject to an adjustment for foreign tax credits) and foreign withholding taxes. We believe our existing cash and cash equivalents and anticipated cash from operations will be sufficient to meet our operating requirements for at least the next twelve months, including working capital requirements and capital expenditures. We may seek to raise additional capital to strengthen our financial condition, facilitate expansion and pursue strategic acquisitions or investments, or to take advantage of other business opportunities as they arise.

The following summarizes our cash and cash equivalents and restricted cash:

 

     April 30,  
     2011     2010     2009  
     (dollars in thousands)  

Cash and cash equivalents

   $ 375,939      $ 236,347      $ 114,163   

Restricted cash

     1,031        986        850   
                        
   $   376,970      $   237,333      $   115,013   
                        

Percentage of total assets

     46.0     34.1     20.5
                        

Cash Flows

 

     Year Ended April 30,  
     2011     2010     2009  
     (in thousands)  

Cash provided by operating activities

   $ 130,971      $ 96,783      $ 57,710   

Cash used in investing activities

     (11,776     (21,692     (196,650

Cash provided by financing activities

     20,397        47,093        92,129   
                        

Net increase (decrease) in cash and cash equivalents

   $   139,592      $   122,184      $   (46,811
                        

Cash Flows from Operating Activities: Our largest source of operating cash is cash collected from our customers who purchase our products and services. Our primary uses of cash from operating activities are for personnel-related costs, product costs, and facility costs.

Fiscal 2011 compared with Fiscal 2010: Net cash provided by operating activities was $131.0 million in fiscal 2011 compared with $96.8 million in fiscal 2010. The increase in operating cash flow in fiscal 2011 was primarily driven by higher net income after excluding the impact of non-cash charges such as stock-based compensation, depreciation, amortization expense and issuance of common shares in connection with the derivative litigation settlement, as well as an increase in working capital sources of cash from higher deferred revenue primarily as a result of our strong service renewals during the fiscal 2011, and increase in accounts payable balances primarily due to timing of payments to vendors, partially offset by working capital uses of cash from higher inventory and accounts receivable balances at April 30, 2011. Our cash and cash equivalents and restricted cash were $377.0 million at April 30, 2011 compared with $237.3 million at April 30, 2010.

 

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Fiscal 2010 compared with Fiscal 2009: Net cash provided by operating activities was $96.8 million in fiscal 2010 compared with $57.7 million in fiscal 2009. In fiscal 2010, we had significantly higher net income after excluding the impact of non-cash charges such as stock-based compensation, depreciation and amortization expense, partially offset by lower working capital sources of cash compared to the prior fiscal year. Net working capital sources of cash resulted from higher cash collections, higher accrued liabilities and higher deferred revenue. Higher cash collections were reflected by our decrease in days sales outstanding from 57 at April 30, 2009 to 44 at April 30, 2010. The increase in deferred revenue was a result of an increase in both new and renewal service contracts. Accrued liabilities increased primarily due to an increase in long-term income taxes payable as a result of our significantly higher net income in fiscal 2010. These sources of cash were partially offset by working capital uses of cash, including a decrease in accounts payable primarily due to timing of payments to vendors.

Cash Flows from Investing Activities: The changes in cash flows from investing activities primarily related to acquisitions and purchases of property and equipment, and technology licenses.

Fiscal 2011 compared with Fiscal 2010: Net cash used by investing activities was $11.8 million in fiscal 2011 compared with $21.7 million in fiscal 2010, a decrease of $9.9 million. This decrease was primarily due to expenditures made in fiscal 2010 for purchases of technology licenses, and cash used to purchase the initial shares of S7 in the amount of $3.8 million, net of cash acquired in fiscal 2010, with no comparable activity in fiscal 2011.

Fiscal 2010 compared with Fiscal 2009: Net cash used by investing activities was $21.7 million in fiscal 2010 compared with $196.7 million in fiscal 2009. The net cash used by our investing activities in fiscal 2010 primarily consisted of purchases of property and equipment, and technology licenses and cash used to purchase S7 of $3.8 million, net of cash acquired. The net cash used by investing activities in fiscal 2009 primarily related to cash used to acquire Packeteer of $170.6 million, net of cash acquired, and $27.3 million of purchases of property and equipment.

Cash Flows from Financing Activities: The changes in cash flows from financing activities primarily related to proceeds from issuance of debt obligations, proceeds from issuances of common stock and acquisition of noncontrolling interest.

Fiscal 2011 compared with Fiscal 2010: Net cash provided by financing activities was $20.4 million in fiscal 2011 compared with $47.1 million in fiscal 2010. The net cash provided by our financing activities in fiscal 2011 primarily consisted of proceeds from purchases of our stock under our employee stock purchase plan and proceeds from the exercise of employee stock options, which were significantly lower in fiscal 2011 than in fiscal 2010, partially offset by cash used to purchase the remaining shares of S7 for $0.8 million. The decrease in option exercises was coupled with an increase in our tax withholding obligations in connection with the vesting of restricted stock and restricted stock units compared with fiscal 2010.

Fiscal 2010 compared with Fiscal 2009: Net cash provided by financing activities was $47.1 million in fiscal 2010 compared with $92.1 million provided in fiscal 2009. The net cash provided by our financing activities in fiscal 2010 primarily consisted of the proceeds from the exercise of employee stock options, which were significantly higher compared with the prior period due to increases in our stock price during fiscal 2010, and purchases of our stock under our employee stock purchase plan.

Stock Repurchases

On November 16, 2010, our Board of Directors approved a program to repurchase up to $50 million of our common stock. Repurchases may be made from time to time in the open market or in negotiated transactions and are expected to comply with Rule 10b-18 under the Securities Exchange Act of 1934 and other legal

 

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requirements. The timing and amount of the repurchase transactions will be determined by management and may depend on a variety of factors, including the trading price of the stock, market conditions, alternative investment opportunities, and other corporate and regulatory considerations. The program does not obligate us to acquire any particular amount of common stock and the program may be modified or discontinued at any time. The repurchases will be funded from available working capital. During the fiscal year ended April 30, 2011, we did not repurchase any shares of common stock under the program. On May 31, 2011, we commenced the repurchase of shares of our common stock under the program and as of June 3, 2011, we had repurchased shares of our common stock valued at approximately $20 million. We anticipate that we will complete the repurchase of shares of our common stock valued at approximately $50 million by the end of our first quarter of fiscal 2012.

Convertible Senior Notes

On June 2, 2008, we issued $80.0 million aggregate principal amount of Zero Coupon Convertible Senior Notes due June 2, 2013 (the “Convertible Senior Notes”) and warrants (the “Warrants”) to purchase an aggregate of 385,356 shares of our common stock at an exercise price of $20.76 to Manchester Securities Corp., an affiliate of Elliott Associates, L.P. (“Manchester”) and Francisco Partners II, L.P. and Francisco Partners Parallel Fund II, L.P. (together, the “FP Entities”) in a private placement. As of April 30, 2011, the Convertible Senior Notes were reported on our consolidated balance sheet at $78.1 million, net of a discount of $1.9 million primarily related to the value assigned to the Warrants, which is being amortized to interest expense over the life of the Convertible Senior Notes.

Our long-term liquidity strategy is to maintain a minimum amount of cash and cash equivalents for operational purposes and to invest the remaining amount of our cash in interest bearing and highly liquid cash equivalents.

Contractual Obligations

Below is a summary of fixed payments related to certain contractual obligations as of April 30, 2011:

 

     Year Ended April 30,  
     2012      2013      2014      2015      2016      Thereafter      Total  
     (in thousands)  

Convertible Senior Notes

   $ —         $ —         $ 80,000       $ —         $ —         $ —         $ 80,000   

Future minimum operating lease payments

     10,760         10,483         8,812         7,957         4,468         1,531         44,011   

Purchase obligations and other commitments

     6,335         —           —           —           —           —           6,335   
                                                              

Total

   $  17,095       $  10,483       $  88,812       $  7,957       $  4,468       $  1,531       $  130,346   
                                                              

We lease certain office equipment and office facilities under non-cancelable operating leases that expire at various dates through 2020. The facility leases generally require us to pay operating costs, including property taxes, insurance and maintenance, and contain scheduled rent increases and certain other rent escalation clauses. Rent expense is recognized in our consolidated financial statements on a straight-line basis over the terms of the respective leases after consideration of rent holidays and improvement allowances, if applicable. Any assets purchased using a lessee improvement allowance are capitalized as fixed assets and depreciated over the shorter of their useful lives or the lease term.

At April 30, 2011, we had a liability for unrecognized tax benefits of $35.2 million. Due to uncertainties with respect to the timing of future cash flows associated with our unrecognized tax benefits at April 30, 2011, we are unable to make reasonably reliable estimates of the period of cash settlement with the applicable taxing

 

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authority. Therefore, $35.2 million of unrecognized tax benefits have been excluded from the contractual obligations table above. See Note 10 in the Notes to Consolidated Financial Statements for a discussion of income taxes.

We purchase components from a variety of suppliers and use several contract manufacturers to provide manufacturing services for our products. During the normal course of business, in order to manage manufacturing lead times and help ensure adequate component supply, we enter into agreements with contract manufacturers and suppliers that either allow them to procure inventory based upon criteria as defined by us or that establish the parameters defining our requirements. A significant portion of our reported purchase commitments arising from these agreements consists of firm, noncancelable, and unconditional commitments. In certain instances, these agreements allow us the option to cancel, reschedule, and adjust our requirements based on our business needs prior to firm orders being placed. These agreements are enforceable and legally binding against us in the short term and all amounts under these arrangements are due to be paid by the end of fiscal 2012. As of April 30, 2011 our total purchase commitments for inventory were $6.3 million.

Off-Balance Sheet Arrangements

As of April 30, 2011, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or for other contractually narrow or limited purposes. Further, we have not guaranteed any obligations of unconsolidated entities, nor do we have any commitment or intent to provide funding to any such entities. As such, we are not materially exposed to any market, credit, liquidity or financing risk that could arise if we had engaged in such relationships.

As of April 30, 2011, we did not have any off-balance sheet transactions, arrangements, or obligations that are reasonably likely to have a material current or future effect on our financial condition, results of operations, liquidity, or capital resources.

Recent Accounting Pronouncements

For information with respect to recent accounting pronouncements and the impact of these pronouncements on our consolidated financial statements, see Note  1 of Notes to Consolidated Financial Statements.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

We are subject to certain market risks, including changes in exchange rates and interest rates. We do not undertake any specific actions to cover our exposures to exchange and interest rate risks, and we are not a party to any risk management transactions. We also do not purchase or hold any derivative financial instruments for hedging, speculative or trading purposes.

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. As of April 30, 2011, we had cash and cash equivalents of $376.0 million and restricted cash of $1.0 million. These amounts were primarily held in money market funds. We maintain a conservative investment policy, which is intended to enhance the safety and preservation of our invested funds by limiting default risk, market risk and reinvestment risk. The fair value of our investment portfolio would not be significantly impacted by either a 100 basis point increase or decrease in market interest rates, given the short-term nature of the majority of our investment portfolio.

 

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Foreign Currency Exchange Rate Risk

We primarily develop products in the United States and sell them throughout the world. As a result, our financial results are affected by factors such as changes in foreign currency exchange rates and economic conditions in foreign markets. Since all of our sales are currently invoiced and collected in U.S. dollars, a strengthening of the dollar could potentially make our products less price-competitive in foreign markets. As a significant portion of our net revenue and earnings are derived from international operations, this could adversely affect our net revenue and earnings. For fiscal years 2011, 2010 and 2009, approximately 54.7%, 55.5%, and 55.0%, respectively, of our total net revenue was derived from customers outside of the Americas. In contrast, substantially all of the expenses of operating our foreign subsidiaries are incurred in foreign currencies, which to date have constituted an insignificant portion of our total operating expenses. As a result, our U.S. dollar earnings and net cash flows from international operations may be affected by changes in foreign currency exchange rates. The foreign currency translation risk associated with our international operations has been material in the past and could be material in the future.

 

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Item 8. Financial Statements and Supplementary Data

Index to Consolidated Financial Statements

 

     Page  

Report of Independent Registered Public Accounting Firm

     55   

Consolidated Balance Sheets as of April 30, 2011 and 2010

     56   

Consolidated Statements of Operations for the years ended April 30, 2011, 2010 and 2009

     57   

Consolidated Statements of Stockholders’ Equity for the years ended April  30, 2011, 2010 and 2009

     58   

Consolidated Statements of Cash Flows for the years ended April 30, 2011, 2010 and 2009

     59   

Notes to Consolidated Financial Statements

     60   

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of Blue Coat Systems, Inc.

We have audited the accompanying consolidated balance sheets of Blue Coat Systems, Inc. as of April 30, 2011 and 2010, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended April 30, 2011. Our audits also included the financial statement schedule listed in the index at Item 15(2). 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 audits.

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

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Blue Coat Systems, Inc. at April 30, 2011 and 2010, and the consolidated results of its operations and its cash flows for each of the three years in the period ended April 30, 2011, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic 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), Blue Coat Systems, Inc.’s internal control over financial reporting as of April 30, 2011, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated June 8, 2011 expressed an unqualified opinion thereon.

/s/ ERNST & YOUNG LLP

San Jose, California

June 8, 2011

 

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BLUE COAT SYSTEMS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except par value)

 

    April 30,
2011
    April 30,
2010
 

ASSETS

   

Current assets:

   

Cash and cash equivalents

  $ 375,939      $ 236,347   

Accounts receivable, net of allowance of $0 and $235 as of April 30, 2011 and 2010, respectively

    67,626        64,204   

Inventory

    10,134        6,010   

Prepaid expenses and other current assets

    14,091        15,526   

Current portion of deferred income tax assets

    10,399        10,980   
               

Total current assets

    478,189        333,067   

Property and equipment, net

    31,745        33,684   

Restricted cash

    1,031        986   

Goodwill

    242,611        242,611   

Identifiable intangible assets, net

    24,970        37,033   

Non-current portion of deferred income tax assets

    34,650        41,517   

Other assets

    6,212        7,140   
               

Total assets

  $ 819,408      $ 696,038   
               

LIABILITIES AND STOCKHOLDERS’ EQUITY

   

Current liabilities:

   

Accounts payable

  $ 20,806      $ 15,000   

Accrued payroll and related benefits

    15,947        16,254   

Deferred revenue

    121,526        104,050   

Other current liabilities

    10,758        12,921   
               

Total current liabilities

    169,037        148,225   

Deferred revenue, less current portion

    56,546        50,172   

Deferred rent, less current portion

    5,501        6,427   

Long-term income taxes payable

    35,152        25,989   

Other non-current liabilities

    688        1,193   

Convertible senior notes

    78,136        77,241   

Commitments and contingencies

   

Blue Coat stockholders’ equity:

   

Preferred stock: $0.0001 par value; issuable in series; 9,958 shares authorized; none issued and outstanding

    —          —     

Common stock: $0.0001 par value; 200,000 shares authorized; 44,064 and 42,662 shares issued and outstanding at April 30, 2011 and 2010, respectively

    4        3   

Additional paid-in capital

    1,273,934        1,231,032   

Treasury stock, at cost; 463 and 397 shares held at April 30, 2011 and 2010, respectively

    (4,623     (3,035

Accumulated deficit

    (794,967     (841,991
               

Total Blue Coat stockholders’ equity

    474,348        386,009   
               

Noncontrolling interest

    —          782   
               

Total stockholders’ equity

    474,348        386,791   
               

Total liabilities and stockholders’ equity

  $ 819,408      $ 696,038   
               

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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BLUE COAT SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

 

     Year Ended April 30,  
     2011     2010     2009  

Net revenue:

      

Product

   $ 291,848      $ 322,101      $ 305,601   

Service

     195,265        174,036        139,144   
                        

Total net revenue

     487,113        496,137        444,745   

Cost of net revenue:

      

Product

     62,615        76,979        85,825   

Service

     43,868        48,654        45,310   
                        

Total cost of net revenue

       106,483          125,633          131,135   

Gross profit

     380,630        370,504        313,610   

Operating expenses:

      

Sales and marketing

     186,332        179,725        178,470   

Research and development

     82,186        84,930        76,680   

General and administrative

     38,691        47,010        47,679   

Amortization of intangible assets

     7,372        7,289        6,667   

Restructuring

     193        12,551        1,546   
                        

Total operating expenses

     314,774        331,505        311,042   
                        

Operating income

     65,856        38,999        2,568   

Interest income

     629        303        1,302   

Interest expense

     (911     (918     (885

Other expense, net

     (518     (1,033     (2,362
                        

Income before income taxes

     65,056        37,351        623   

Provision (benefit) for income taxes

     18,032        (5,528     9,131   
                        

Net income (loss)

   $ 47,024      $ 42,879      $ (8,508
                        

Net income (loss) per share:

      

Basic

   $ 1.00      $ 0.97      $ (0.22
                        

Diluted

   $ 0.98      $ 0.93      $ (0.22
                        

Weighted average shares used in computing net income (loss) per share:

      

Basic

     46,920        44,326        38,493   
                        

Diluted

     48,198        45,980        38,493   
                        

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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BLUE COAT SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands)

 

    Common Stock     Additional
Paid-In
Capital
    Treasury Stock     Accumulated
Deficit
    Accumulated
Other
Comprehensive
Income (Loss)
    Noncontrolling
interest
    Total  
    Shares     Amount       Shares     Amount          

Balances at April 30, 2008

    38,543      $ 2      $ 1,128,903        (276   $ (903   $ (876,362   $ (179     —        $ 251,461   

Components of comprehensive loss:

                 

Net loss

    —          —          —          —          —          (8,508     —          —          (8,508

Net unrealized gain on available for sale securities

    —          —          —          —          —               179        —          179   
                       

Total comprehensive loss

                    (8,329
                       

Common shares issued under stock option and stock purchase plans

    1,500        —          12,943        (54     (726     —          —          —          12,217   

Fair value of equity awards assumed in connection with Packeteer acquisition

    —          —          4,610        —          —          —          —          —          4,610   

Issuance of Convertible Senior Notes and Warrants, including beneficial conversion feature

    —          —          4,055        —          —          —          —          —          4,055   

Tax benefit from stock-based awards

    —          —          (890     —          —          —          —          —          (890

Stock-based compensation expenses

    —          —          18,485        —          —          —          —          —          18,485   
                                                                       

Balances at April 30, 2009

    40,043        2          1,168,106        (330       (1,629       (884,870     —          —            281,609   

Components of comprehensive income:

                 

Net income

    —          —          —          —          —          42,879        —          —          42,879   
                       

Total comprehensive income

                    42,879   

Common shares issued under stock option and stock purchase plans

    3,016        1       41,687        (67     (1,406     —          —          —          40,282   

Noncontrolling interest in connection with S7 acquisition

    —          —          —          —          —          —          —          782        782  

Tax benefit from stock-based awards

    —          —          1,897        —          —          —          —          —          1,897   

Stock-based compensation expenses

    —          —          19,342        —          —          —          —          —          19,342   
                                                                       

Balances at April 30, 2010

    43,059        3        1,231,032        (397     (3,035     (841,991     —          782        386,791   

Components of comprehensive income:

                 

Net income

    —          —          —          —          —          47,024        —          —          47,024   
                       

Total comprehensive income

                    47,024   
                       

Common shares issued under stock option and stock purchase plans

    1,409        —          20,556        (66     (1,588     —          —          —          18,968   

Noncontrolling interest in connection with S7 acquisition

    —          —          —          —          —          —          —          (782     (782 )

Issuance of common shares in connection with the derivative litigation settlement

    59        1       1,644        —          —          —          —          —          1,645   

Tax benefit from stock-based awards

    —          —          2,149        —          —          —          —          —          2,149   

Stock-based compensation expenses

    —          —          18,553        —          —              —          18,553   
                                                                       

Balances at April 30, 2011

    44,527      $ 4      $ 1,273,934        (463   $ (4,623   $ (794,967   $ —        $ —        $ 474,348   
                                                                       

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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BLUE COAT SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

     Year Ended April 30,  
     2011     2010     2009  

Operating Activities

      

Net income (loss)

   $ 47,024      $ 42,879      $ (8,508

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

      

Depreciation

     13,676        14,651        10,429   

Amortization

     13,651        13,736        12,610   

Stock-based compensation

     18,553        19,342        18,485   

Deferred income taxes

     7,448        (25,200     3,463   

Tax benefit (expense) of stock option deduction

     2,149        1,897        (890

Excess tax benefit from stock-based compensation

     (2,211     (6,811     (255

Issuance of common shares in connection with the derivative litigation settlement

     1,645        —          —     

(Loss) gain on disposition of equipment

     (6     555        300   

Changes in operating assets and liabilities:

      

Accounts receivable, net

     (3,422     13,642        (6,883

Inventory

     (4,124     (310     20,221   

Prepaid expenses and other assets

     1,670        (4,036     (3,667

Accounts payable

     5,806        (9,105     3,209   

Accrued expenses and other liabilities

     5,262        11,900        (15,823

Deferred revenue

     23,850        23,643        25,019   
                        

Net cash provided by operating activities

     130,971        96,783        57,710   

Investing Activities

      

Purchases of property and equipment, and technology licenses

     (11,731     (17,793     (27,286

Restricted cash

     (45     (136     —     

Proceeds from sale and maturities of short-term investments

     —          —          1,216   

Acquisitions, net of cash acquired and prior investment

     —          (3,763     (170,580
                        

Net cash used by investing activities

     (11,776     (21,692     (196,650

Financing Activities

      

Net proceeds from issuance of common stock

     18,968        40,282        12,217   

Excess tax benefit from stock-based compensation

     2,211        6,811        255   

Acquisition of noncontrolling interest

     (782     —          —     

Net proceeds from issuance of convertible senior notes

     —          —          79,657   
                        

Net cash provided by financing activities

     20,397        47,093        92,129   
                        

Net increase (decrease) in cash and cash equivalents

       139,592          122,184        (46,811

Cash and cash equivalents at beginning of period

     236,347        114,163          160,974   
                        

Cash and cash equivalents at end of period

   $ 375,939      $ 236,347      $ 114,163   
                        

Non-cash investing and financing activities:

      

Fair value of equity awards assumed in connection with acquisitions

   $ —        $ —        $ 4,610   

Issuance of Convertible Senior Notes and Warrants

   $ —        $ —        $ 4,055   

Supplemental schedule of cash flow data:

      

Cash paid for interest

   $ 16      $ 23      $ 65   

Cash paid for income taxes, net of refunds

   $ 1,504      $ 4,214      $ 9,065   

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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Note 1. Business Description and Significant Accounting Policies

Description of Business

We design, develop and sell a family of proxy and other appliances and related software and services that secure, accelerate and optimize the delivery of business applications, Web content and other information to distributed users over a Wide Area Network (“WAN”), or across an enterprise’s gateway to the public Internet (also known as the Web). Our products provide our end user customers with information about the applications and Web traffic running on their networks, including the ability to discover, classify, manage and control communications between users and applications across internal networks, the WAN and the Internet. Our products are also designed to accelerate and optimize the performance of our end users’ business applications and content, whether used internally or hosted by external providers. In addition to accelerating and optimizing the performance and delivery of applications, our products enable our end user customers to secure their Internet gateways and remote computer systems by providing protection from malicious code, or malware, and objectionable content.

Our products are based upon three core functionalities:

 

   

Security: Security of the delivery of business applications and content and protection from malware, spyware or other malicious threats, together with centrally managed policy enforcement that enables an enterprise to set, enforce and measure compliance with its corporate IT policies. When combined with visibility, policy controls offer enterprises multiple layers of network security from malicious threats and content.

 

   

Acceleration: Acceleration and optimization of the delivery of internal, external, real-time and customized applications and content across the networks of distributed enterprises. Optimizing the delivery of business-critical applications to provide faster response times enables an enterprise to more efficiently utilize existing bandwidth and to increase its users’ productivity.

 

   

Visibility: Visibility of applications, content and users on the network to enable distributed enterprises to discover, classify, prioritize and monitor applications, content and users according to their corporate IT policies. With centralized visibility into its application traffic, an enterprise can more efficiently monitor end user application response times and align its network investments with changing business requirements.

Basis of Presentation

Our consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The consolidated financial statements include the accounts of Blue Coat Systems, Inc. and our subsidiaries, which are each wholly owned. All inter-company balances and transactions have been eliminated. We record all acquisitions using the purchase method of accounting and, accordingly, include the acquired company’s results of operations in our consolidated results from the date of each acquisition. Certain prior fiscal year amounts have been reclassified to conform to the current period’s presentation. Such reclassifications were not material and did not affect net revenues, operating income or net income.

The preparation of consolidated financial statements and related disclosures in conformity with GAAP 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 dates of the consolidated financial statements, and the reported amounts of net revenue and expenses during the reporting periods. Actual results may differ from these estimates, and such differences could be material to our consolidated financial condition and results of operations.

 

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Revenue Recognition

In October 2009, the Financial Accounting Standards Board (“FASB”) amended the accounting standards for revenue recognition to remove from the scope of industry-specific software revenue recognition guidance any tangible products containing software components and non-software components that operate together to deliver the product’s essential functionality. In addition, the FASB amended the accounting standards for certain multiple element revenue arrangements to:

 

   

provide updated guidance on whether multiple elements exist, how the elements in an arrangement should be separated, and how the arrangement consideration should be allocated to the separate elements;

 

   

require an entity to allocate arrangement consideration to each element based on a selling price hierarchy, where the selling price for an element is based on vendor-specific objective evidence (“VSOE”), if available; third-party evidence (“TPE”), if available and VSOE is not available; or the best estimate of selling price (“BESP”), if neither VSOE or TPE is available; and

 

   

eliminate the use of the residual method and require an entity to allocate arrangement consideration using the selling price hierarchy.

Although the amended standards were not required to be adopted by us until May 1, 2011, the beginning of our fiscal year 2012, we elected to early adopt this accounting guidance at the beginning of our first quarter of fiscal 2011 on a prospective basis for transactions entered into or materially modified after April 30, 2010.

The majority of our products are hardware appliances containing software components that operate together to provide the essential functionality of the product. Therefore, our hardware appliances are considered non-software deliverables and are no longer accounted for under the industry-specific software revenue recognition guidance.

Our product revenue also includes stand-alone software products. Stand-alone software may operate on our hardware appliances, but is not considered essential to the functionality of the hardware and continues to be subject to the industry-specific software revenue recognition guidance, which remains unchanged. This includes the use of the residual method. Certain of our stand-alone software when sold with our appliances is considered essential to its functionality and as a result is no longer accounted for under industry-specific software revenue recognition guidance; however, this same software when sold separately is accounted for under the industry-specific software revenue recognition guidance.

We design, develop and sell products and services that secure and optimize the delivery of business applications and other information to distributed users over a Wide Area Network (“WAN”), or across an enterprise’s gateway to the public Internet (also known as the Web). Our products provide our end user customers with information about the applications and Web traffic running on their networks, including the ability to discover, classify, manage and control communications between users and applications across internal networks, the WAN and the Internet. Our products are also designed to optimize the performance of our end users’ business applications and content, whether used internally or hosted by external providers. In addition to optimizing the performance and delivery of applications, our products enable our end user customers to secure their Internet gateways and remote computer systems by providing protection from malicious code, or malware, and objectionable content.

We operate a multiple tier channel distribution model that includes both distributors and value-added resellers. In most cases, we sell our products to distributors, who in turn sell to value-added resellers and ultimately end users. In these cases, we generally ship our products from our fulfillment centers to value-added resellers who provide configuration services for end users. In some cases, we sell directly to value-added resellers, who in turn sell to end users. In these cases, we generally ship our products from our fulfillment centers directly to end users. We generally do not accept orders from distributors or value-added resellers when we are

 

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aware that they do not have an order from an end user. Additionally, we provide unspecified software upgrades for most of our products, on a when-and-if available basis, through post contract customer support (“maintenance”) contracts.

We recognize revenue when all of the following criteria are met: persuasive evidence of an arrangement exists; delivery or performance has occurred; the sales price is fixed or determinable; and collection is probable. We define each of those four criteria as follows:

Persuasive evidence of an arrangement exists. Evidence of an arrangement generally consists of a purchase order issued pursuant to the terms and conditions of a distributor or value-added reseller agreement and, in limited cases, an end user agreement.

Delivery or performance has occurred. We use shipping and related documents, or written evidence of customer acceptance, when applicable, to verify delivery or performance. We do not recognize product revenue until transfer of title and risk of loss, which generally is upon shipment to distributors, value-added resellers or end users as our customers do not carry stock and therefore do not have stock rotation rights. We generally do not have significant obligations for future performance, such as rights of return or pricing credits, associated with our sales.

The sales price is fixed or determinable. We assess whether the sales price is fixed or determinable based on payment terms and whether the sales price is subject to refund or adjustment.

Collection is probable. We assess probability of collection on a customer-by-customer basis. We subject our customers to a credit review process that evaluates their financial condition and ability to pay for our products and services. If we conclude that collection is not probable based upon our initial review, we do not recognize revenue until cash is received.

We enter into multiple element revenue arrangements in which a customer may purchase a combination of hardware, software, hardware and software upgrades, hardware and software maintenance, and professional services.

For transactions entered into prior to our adoption of the amended revenue standards in the first quarter of fiscal 2011, we allocated revenue for arrangements with multiple elements, such as appliances, maintenance or software, to each element using the residual method. Under the residual method, the amount of revenue allocated to delivered elements equals the total arrangement consideration less the aggregate fair value of any undelivered elements, provided VSOE of fair value exists for all undelivered elements. If evidence of the fair value of one or more undelivered elements does not exist, all revenue generally is deferred and recognized at the earlier of delivery of those elements or establishment of fair value for the remaining undelivered elements. When VSOE of fair value cannot be determined for any undelivered maintenance, subscription or service element, revenue for the entire arrangement is recognized ratably over the maintenance, subscription or service period.

For transactions entered into subsequent to the adoption of the amended revenue recognition standards that are multiple element arrangements, we allocate the arrangement fee to each element based upon the relative selling price of such element and, if software and software-related (e.g. maintenance for the software element) elements are also included in the arrangement, we allocate the arrangement fee to each of those software and software-related elements as a group based upon our BESP for those elements. After such allocation is made, the amount of the arrangement fee allocated to the software and software-related elements is accounted for using the residual method. When applying the relative selling price method, we determine the selling price for each element using VSOE of selling price, if it exists, or if not, TPE of selling price, if it exists. If neither VSOE nor TPE of selling price exist for an element, we use our BESP for that element. The revenue allocated to each element is then recognized when the basic revenue recognition criteria are met for that element. The manner in which we account for multiple element arrangements that contain only software and software-related elements remains unchanged.

 

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Consistent with our methodology under previous accounting guidance, we determine VSOE for each element based on historical stand-alone sales to third parties.

VSOE of fair value is based on the price charged when the element is sold separately. We analyze our stand-alone hardware and software maintenance renewals by stratification of sales channel and service offering. We determine the VSOE of fair value for hardware and software maintenance by analyzing our stand-alone maintenance renewals and noting that a substantial majority of transactions fall within a narrow range for each stratum. In limited cases, VSOE of fair value has been based on management determined prices.

We typically are not able to determine TPE for our products, maintenance or professional services. TPE is determined based on competitor prices for similar elements when sold separately. Generally, our offerings contain a significant level of differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, our go-to-market strategy differs from that of our peers and we are unable to reliably determine what similar competitor products’ selling prices are on a stand-alone basis.

When we are unable to establish the selling price of an element using VSOE or TPE, we use BESP in our allocation of arrangement consideration. The objective of BESP is to determine the price at which we would transact a sale if the product or service were sold on a stand-alone basis. We determine BESP for a product or service by considering multiple factors including, but not limited to, historical pricing practices by geography, customer class and distribution channel, and gross margin objectives.

For our hardware and software elements, we allocate the arrangement consideration based on the relative selling price of the element. For these elements, we use BESP as our selling price. For our hardware and software maintenance and professional services, we generally use VSOE as our selling price. When we are unable to establish selling price using VSOE for our hardware and software maintenance and professional services, we use BESP in our allocation of arrangement consideration.

We regularly review VSOE and BESP and maintain internal controls over the establishment and updates of these estimates. There was no material impact during the quarter from changes in either VSOE or BESP.

The impact from the adoption of the amended revenue recognition rules to total revenue, net income, and deferred revenue was not material in fiscal 2011. The new accounting guidance for revenue recognition is not expected to have a significant effect on total net revenue in periods after initial adoption, although the impact on the timing and pattern of revenue will vary depending on the nature and volume of new or materially modified contracts in any given period.

Maintenance and subscription revenue is initially deferred and recognized ratably over the life of the contract, with the related expenses recognized as incurred. Maintenance and subscription contracts usually have a term of one to three years. Unearned maintenance and subscription revenue is included in deferred revenue.

We recognize revenue from the sale of third party anti-virus software net of royalties paid and classify this revenue as net service revenue in our consolidated statements of operations.

When we bill customers for shipping, we record shipping costs in both net revenue and cost of net revenue. If we do not charge customers for shipping, the costs incurred for shipping are reflected in cost of net revenue.

Allowance for Doubtful Accounts

We perform ongoing credit evaluations of our customers’ financial condition and record an allowance when collection of a receivable becomes doubtful. We analyze accounts receivable and historical bad debts, customer geographic concentrations, customer solvency, current economic and geographic trends, and changes in customer

 

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payment terms and practices when evaluating the adequacy of such allowance, and record any required changes in the allowance account to general and administrative expense. We write off accounts receivable when they are deemed to be uncollectible.

Stock-Based Compensation

We utilize the Black-Scholes option valuation model to calculate compensation expense. The Black-Scholes option valuation model requires the input of highly subjective assumptions, including the expected term of options, the expected price volatility of the stock underlying such options, the risk-free interest rate, and the expected dividend rate. We are required to estimate the stock awards that we ultimately expect to vest and to reduce compensation expense for the effects of estimated forfeitures of awards over the expense recognition period. To the extent our actual forfeitures are different than our estimates, we record a true-up for the difference in the period that the awards vest. See Note 9 in the Notes to Consolidated Financial Statements for additional information.

Cash and Cash Equivalents and Restricted Cash

We consider all highly liquid investments with insignificant interest rate risk and original maturities of three months or less to be cash equivalents.

Restricted cash is comprised of $1.0 million in cash and cash equivalents pledged as collateral for four separate irrevocable letters of credit. These letters of credit currently expire in June 2012 and March 2012. The time deposits securing these letters of credit are classified as restricted cash in the accompanying consolidated balance sheets as of April 30, 2011 and 2010, respectively.

Fair Value of Financial Instruments

Financial instruments consist of cash and cash equivalents, restricted cash, accounts receivable and payable, accrued liabilities and Convertible Senior Notes. The carrying amounts of cash and cash equivalents, restricted cash, accounts receivable and payable and accrued liabilities approximate their respective fair values because of the short-term nature of those instruments. The fair value of the Convertible Senior Notes is determined based on a valuation model, which utilizes quoted market prices and interest rates for similar instruments. See Note 8 for further information regarding the fair value measurements.

Concentration and Other Risks

Financial instruments that potentially subject us to credit risk consist of money market accounts and trade receivables. We maintain demand deposit and money market accounts with financial institutions of high credit standing. Such deposits generally are in excess of insured limits. We invest only in high-quality, investment grade securities and limit investment exposure in any one issue. Such investments are classified as cash equivalents in our consolidated balance sheets at April 30, 2011 and 2010, respectively. We believe the financial risks associated with these financial instruments are not material, and we have not experienced material losses from our investments in these instruments.

We do not require collateral for sales to customers. However, we perform on-going credit evaluations of our customers’ financial condition and maintain an allowance for doubtful accounts. Certain of our global distributors, including their various affiliates, account for more than 10% of our net revenue. In fiscal 2011, ComputerLinks, Westcon Group, Inc. and Arrow Enterprise Computing Solutions, Inc. accounted for 25.5%, 16.2% and 13.7% of our total net revenue, respectively. In fiscal 2010, ComputerLinks, Westcon Group, Inc. and Arrow Enterprise Computing Solutions, Inc. accounted for 23.0%, 17.3% and 13.3% of our total net revenue, respectively. In fiscal 2009, ComputerLinks, Westcon Group, Inc. and Arrow Enterprise Computing Solutions, Inc. accounted for 20.0%, 16.0% and 12.5% of our total net revenue, respectively.

 

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Supply Chain Liabilities and Valuation of Inventory

We outsource our manufacturing, product fulfillment and repair operations to contract manufacturers and third party logistics providers, and a significant portion of our cost of net revenue is a result of these activities. We currently purchase several key parts and components used in the manufacture of our products from a limited number of suppliers. Generally, we have been able to obtain an adequate supply of such parts and components. Our contract manufacturers procure components and manufacture our products based on demand forecasts that we prepare. These forecasts are based on estimates of future product demand.

Inventory consists of raw materials and finished goods. Inventory is recorded at the lower of cost (using the first-in, first-out method) or market, after obsolescence and inventory in excess of anticipated future demand is considered. In assessing the ultimate recoverability of inventory, we are required to make estimates regarding future customer demand, last time buy decisions, the timing of new product introductions, economic trends and market conditions.

Property and Equipment

Property and equipment are stated at cost, subject to adjustments for impairment, less accumulated depreciation and amortization. Depreciation and amortization are provided on a straight-line basis over the following estimated useful lives:

 

Software

   3 years

Computer and office equipment

   3-5 years

Furniture and fixtures

   5 years

Leasehold improvements

   Shorter of facility life or remaining lease term

Acquisitions, Goodwill and Identifiable Intangible Assets

We account for acquired businesses using the purchase method of accounting, which requires that the assets acquired, liabilities assumed, contractual contingencies and contingent consideration be recorded at the date of acquisition at their respective fair values. Goodwill is measured as a residual as of the acquisition date, which in most cases, results in measuring goodwill as an excess of the purchase consideration transferred plus the fair value of any noncontrolling interest in the acquiree over the fair value of net assets acquired, including any contingent consideration. It further requires acquisition-related costs to be recognized separately from the acquisition and expensed as incurred, restructuring costs to be expensed in periods subsequent to the acquisition date, and changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period to impact the provision for income taxes. In addition, acquired in-process research and development is capitalized as an intangible asset and amortized over its estimated useful life.

The fair value of identifiable intangible assets is based on significant judgments made by management. We typically engage third party valuation appraisal firms to assist us in determining the fair values and useful lives of the assets acquired. Such valuations and useful life determinations require us to make significant estimates and assumptions. These estimates and assumptions are based on historical experience and information obtained from the management of the acquired companies, and also include, but are not limited to, future expected cash flows earned from the product-related technology and discount rates applied in determining the present value of those cash flows. Unanticipated events and circumstances may occur that could affect the accuracy or validity of such assumptions, estimates or actual results. Acquisition-related identifiable intangible assets are amortized on a straight-line basis over their estimated economic lives, which are three to seven years for developed technology and patents, five years for core technology, five to seven years for customer relationships and two years for trade name. Developed technology is comprised of products that have reached technological feasibility and are a part of the acquisition’s product lines, and patents related to the design and development of those products. Customer relationships represent the acquisition’s underlying relationships with its customers. Trade name represents the fair value of brand and name recognition associated with the marketing of the acquisition’s products and services.

 

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We perform goodwill impairment tests annually during our fourth fiscal quarter, and whenever events or changes in circumstances indicate that the carrying amount of goodwill may not be recoverable. The first step of the test identifies whether potential impairment may have occurred, and the second step of the test measures the amount of the impairment, if any. An impairment of goodwill is recognized when the carrying amount of the assets exceeds their fair value. The process of evaluating the potential impairment of goodwill is highly subjective and requires the application of significant judgment. For purposes of the annual impairment test, we consider our market capitalization compared with the carrying amount of our net assets on the date of the test, since we have only one reporting unit. We performed our annual review of goodwill in the fourth quarter of fiscal 2011 and concluded that no impairment existed at April 30, 2011.

We evaluate long-lived assets, including identifiable intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Events or changes in circumstances that could result in an impairment review include, but are not limited to, significant underperformance relative to historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for our overall business, and significant negative industry or economic trends. Impairment is recognized when the carrying amount of an asset exceeds its fair value as calculated on a discounted cash flow basis.

Research and Development

Costs related to research, design and development of our products are expensed as incurred. When significant, software development costs are capitalized after establishment of technological feasibility and marketability until product is available for general release to customers. Generally, our products are released soon after technological feasibility has been established. Costs subsequent to achieving technological feasibility were not material to our consolidated financial statements and all software development costs were expensed as incurred in fiscal 2011, 2010 and 2009, respectively.

Foreign Currency

The functional currency of our domestic and foreign operations is the U.S. dollar. Accordingly, the effects of foreign currency transactions, and of remeasuring the financial condition and results of operations from local currencies into the functional currency, are included in other expense, net in the accompanying consolidated statements of operations. Remeasurement and foreign currency transaction losses, net, for fiscal years ended April 30, 2011, 2010 and 2009 were $0.4 million, $1.2 million and $2.3 million, respectively.

Warranty Obligations

We maintain a warranty accrual for estimated future warranty obligations based on the historical warranty costs and revenue volumes together with anticipated future warranty costs. We generally provide a one-year warranty on hardware products.

Legal and Other Contingencies

We are currently involved in various claims and legal proceedings. We review the status of each significant matter and assess our potential financial exposure on a quarterly basis. We record a charge equal to at least the minimum estimated liability for damages arising from litigation or other loss contingencies only when both of the following conditions are met: (i) information available prior to issuance of our consolidated financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements and (ii) the range of loss can be reasonably estimated. As additional information becomes available, we reassess the potential liability related to pending loss contingencies and may revise our estimates. Such revisions in the estimates of the potential liabilities could have a material impact on our results of operations and financial position.

 

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Advertising Costs

Advertising costs are charged to sales and marketing expense as incurred. Advertising costs were $1.1 million, $5.6 million and $5.6 million for fiscal years ended April 30, 2011, 2010 and 2009, respectively.

Income Taxes

We use the liability method to account for income taxes. As part of the process of preparing our consolidated financial statements, we are required to estimate income taxes in each of the jurisdictions in which we operate. This process involves determining our income tax expense and calculating the deferred income tax expense related to temporary difference resulting from the differing treatment of items for tax and accounting purposes, such as deferred revenue or deductibility of the amortization of certain intangible assets. These temporary differences result in deferred tax assets or liabilities, which are included within the consolidated balance sheets.

We record a valuation allowance to reduce certain deferred tax assets to an amount that we estimate is more likely than not to be realized. We consider estimated future taxable income and prudent tax planning strategies in determining the need for a valuation allowance. When we determine that it is more likely than not that some or all of our deferred tax assets will be realizable by either refundable income taxes or future taxable income, the valuation allowance will be reduced and the related tax impact will be recorded as a reduction to the tax provision in that period. Likewise, should we determine that we are not likely to realize all or part of our deferred tax assets in the future, an increase to the valuation allowance would be recorded as an increase to the tax provision in the period such determination was made.

As a multinational corporation, we conduct our business in many countries and are subject to taxation in many jurisdictions. The taxation of our business is subject to the application of multiple and conflicting tax laws and regulations, as well as multinational tax conventions. Our effective tax rate is highly dependent upon the geographic distribution of our worldwide earnings or losses, the tax regulations and tax holidays in each geographic region, the availability of tax credits and carryforwards, and the effectiveness of our tax planning strategies. The application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Tax laws themselves are subject to change as a result of changes in fiscal policy, changes in legislation, and the evolution of regulations and court rulings. Consequently, tax authorities may impose tax assessments or judgments against us that could materially impact our tax liability and/or our effective income tax rate.

We use a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more likely than not to be realized upon settlement. We review our uncertain tax benefits quarterly, and we may adjust such uncertain tax benefits because of proposed assessments by tax authorities, changes in facts and circumstances, issuance of new regulations or new case law, previously unavailable information obtained during the course of an examination, negotiations with tax authorities of different countries concerning our transfer pricing, resolution with respect to individual audit issues/audit years, or the expiration of statutes of limitations. In addition, our tax contingency reserve includes certain amounts for potential tax assessments for pre-acquisition tax years of acquired companies, which, if recognized, will be recorded to our provision for income taxes.

Recent Accounting Pronouncements

Fair Value Measurement: In May 2011, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) (collectively, the Boards) issued Accounting Standards Update (“ASU”) No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value

 

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Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”). ASU 2011-04 created a uniform framework for applying fair value measurement principles for companies around the world and clarified existing guidance in US GAAP. ASU 2011-04 is effective for the first reporting annual period beginning after December 15, 2011 and shall be applied prospectively. We do not expect the implementation of this standard to have a material impact on our consolidated financial statements.

Note 2. Per Share Amounts

Our convertible senior notes, discussed in Note 6, are participating securities whereby the holder would participate equally in any future dividends and in undistributed earnings with common stockholders; therefore, we calculated basic and diluted net income per share using the two-class method. Certain of our unvested restricted stock awards and the warrants, discussed in Note 6, are also considered participating securities; however, the number of unvested restricted stock awards and the number of shares covered by the warrants are immaterial and therefore not included in our calculation under the two-class method. See Note 6 for further information regarding the convertible senior notes and warrants.

Under the two-class method, basic net income per share is computed by dividing the net income available to common stockholders by the weighted-average number of common shares outstanding for the period. Net income available to common stockholders is determined after allocating undistributed earnings to convertible senior note holders. Diluted net income per share is computed using the weighted-average number of shares of common stock outstanding, including dilutive common shares subject to repurchase and potential shares issuable assuming the (i) dilutive effect of outstanding stock options, restricted stock awards and restricted stock units, warrants and shares issuable under our employee stock purchase plan using the treasury stock method, and (ii) conversion of convertible senior notes. For periods for which there is a net loss, the number of shares used in the computation of diluted net loss per share are the same as those used for the computation of basic net loss per share as the inclusion of dilutive securities would be anti-dilutive. No portion of the loss for fiscal 2009 was allocated to the participating securities under the two-class method since there is no contractual obligation under the convertible senior notes for the note holders to share in our losses.

 

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The following table presents the calculation of weighted average common shares used in the computations of basic and diluted per share amounts presented in the accompanying consolidated statements of operations reconciled to basic and diluted per share amounts available to common stockholders:

 

     Year Ended April 30,  
     2011     2010     2009  
     (in thousands, except per share
amounts)
 
Basic net income (loss) per share       

Numerator:

      

Net income (loss)

   $   47,024      $   42,879      $ (8,508

Less: undistributed earnings allocated to convertible senior note holders

     (3,862 )     (3,728 )     —     
                        

Net income (loss) available to common stockholders

   $ 43,162      $ 39,151      $ (8,508

Denominator:

      

Basic weighted average common shares used in computing basic net income (loss) per share

     46,920        44,326        38,493   

Effect of participating convertible senior notes

     (3,854 )     (3,854 )     —     
                        

Weighted average common shares outstanding using the two-class method

     43,066        40,472        38,493   
                        

Basic income (loss) per share available to common stockholders

   $ 1.00      $ 0.97      $ (0.22
                        
Diluted net income (loss) per share       

Numerator:

      

Net income (loss)

   $ 47,024      $ 42,879      $ (8,508

Less: undistributed earnings allocated to convertible senior note holders

     (3,760 )     (3,594 )     —     
                        

Net income (loss) available to common stockholders

   $ 43,264      $ 39,285      $ (8,508

Denominator:

      

Basic weighted average common shares used in computing basic net income (loss) per share

     46,920        44,326        38,493   

Add: Weighted average employee stock options

     962       1,318       —     

Add: Other weighted average dilutive potential common stock

     316       336       —     
                        

Weighted average common shares used in computing diluted net income (loss) per share

     48,198        45,980        38,493   

Effect of participating convertible senior notes

     (3,854     (3,854     —     
                        

Weighted average common shares outstanding using the two-class method

     44,344        42,126        38,493   
                        

Diluted income (loss) per share available to common stockholders

   $ 0.98      $ 0.93      $ (0.22
                        

For fiscal years ended April 30, 2011 and 2010, outstanding stock options and restricted stock units covering an aggregate of 1.9 million shares and 2.5 million shares, respectively, were excluded from the calculation of diluted net income per share as their inclusion would have been anti-dilutive under the treasury stock method.

For the fiscal year ended April 30, 2009, outstanding stock options, employee stock purchase plan shares, restricted stock units and restricted stock awards were excluded from the calculation of diluted net income per share because their inclusion would have been anti-dilutive due to our net loss for the period.

At April 30, 2011, 2010 and 2009, there were outstanding warrants to purchase 385,356 shares of our common stock. The Warrants were included in the computation of the diluted net income per share for fiscal years ended April 30, 2011 and 2010, because the exercise price of the Warrants was less than the average

 

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market price of our common stock during those periods. The Warrants were not included in the computation of diluted net loss per share for the fiscal year ended April 30, 2009 because their inclusion would have been anti-dilutive.

Shares of our common stock issuable upon the assumed conversion of the convertible senior notes in the amount of 3,853,564 were not included in the computation of diluted net income per share for the fiscal year ended April 30, 2009, due to our net loss for the period.

Note 3. Acquisitions

Fiscal 2010 Acquisition

S7 Software Solutions Pvt. Ltd.

On January 25, 2010, we acquired 84.5% of the outstanding shares of S7 Software Solutions Pvt. Ltd. (“S7”), an IT research and development outsourcing firm based in Bangalore, India. We acquired an additional 15.5% of the outstanding shares of S7 in fiscal 2011. We acquired S7 to serve as our new development center in India and to provide expertise in software development, code migration and network security. We have included the operating results of S7 in our consolidated financial results since the January 25, 2010 acquisition date.

The total purchase price was $6.4 million in cash, consisting of $4.3 million for the initial shares acquired and $0.8 million for the noncontrolling interest subsequently acquired (which amounts include an allocation of $1.1 million for excess working capital remaining as of the closing date), and $1.3 million payable over the 30 months subsequent to the initial closing date. Under the stock purchase agreement, the selling shareholders will indemnify us for up to $1.3 million for damages caused by inaccuracies in, breaches or violations of or defaults under representations, warranties, covenants or agreements. Any such amounts may be withheld from the $1.3 million in remaining payments due under the purchase agreement. In allocating the purchase price based on estimated fair values, we recorded approximately $4.5 million of goodwill, $0.7 million of identifiable intangible assets for customer relationships and $1.2 million of net tangible assets. In connection with the acquisition, we recognized $0.1 million of transaction costs which were included in general and administrative expenses in our consolidated statement of operations. In addition, we agreed to pay potential retention bonuses up to an aggregate amount of $2.0 million to certain S7 shareholders who were also employees. Payment of these bonuses is contingent upon the performance of post-acquisition services by those shareholders over the 30 months subsequent to the initial closing date. Accordingly, the potential bonus amounts are accrued as compensation expense over the assumed retention period. Our acquisition of S7 did not result in the creation of a new business segment.

The fair value of the acquisition-related intangible assets was calculated considering market participant expectations and using an income approach with estimates and assumptions provided by S7 and our management. We used a discount rate reflective of the risk of the respective cash flows. The acquisition-related intangible assets consist of assumed customer contracts, which represent S7’s underlying relationships with its customers at the time of the acquisition of the initial shares. The fair value assigned to customer relationships was $0.7 million which is amortized on a straight-line basis over the expected useful life of 4 years, consistent with the number of periods of prospective cash flow and other benefits utilized to estimate the fair values of the assets.

Fiscal 2009 Acquisition

Packeteer

We acquired Packeteer, a provider of sophisticated Wide Area Network traffic prioritization technologies, on June 6, 2008, by means of a merger of our wholly-owned subsidiary with and into Packeteer, such that Packeteer became our wholly-owned subsidiary. We acquired Packeteer, among other things, to add to our

 

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product portfolio products that identify and classify the applications on the network and monitor application response times and utilization. We have included the operating results of Packeteer in our consolidated financial results since the June 6, 2008 acquisition date.

The total purchase price was $278.6 million, which consisted of $264.0 million in cash paid to acquire the outstanding common stock of Packeteer, $4.6 million for the fair value of vested Packeteer equity awards assumed and $10.0 million in cash for direct transaction costs. In allocating the purchase price based on estimated fair values, we recorded approximately $145.8 million of goodwill, $55.4 million of identifiable intangible assets, $77.5 million of cash and short-term investments, $25.7 million of inventory, $16.0 million of deferred revenues and $9.8 million of other net tangible liabilities. Our acquisition of Packeteer did not result in the creation of a new business segment.

Note 4. Goodwill and Identifiable Acquisition-Related Intangible Assets

Goodwill

The changes in the carrying amount of goodwill, which generally is not deductible for tax purposes, for fiscal years ended April 30, 2011 and 2010 were as follows:

 

     Year Ended April 30,  
     2011      2010  
     (in thousands)  

Balance, beginning of year

   $ 242,611       $ 238,466   

Addition to goodwill related to S7 acquisition

     —           4,529   

Goodwill adjustments related to Packeteer acquisition

     —           (384
                 

Balance, end of year

   $     242,611       $     242,611   
                 

The goodwill adjustment related to Packeteer acquisition was recorded during the first quarter of fiscal 2010 and related to the settlement of a lease liability for less than originally provided for in our purchase price allocation.

Identifiable Intangible Assets

Our identifiable acquisition-related intangible assets are as follows (in thousands):

 

April 30, 2011

  Amortization
period
    Gross
Amount
    Accumulated
Amortization
    Net Carrying
Value
 

Developed technology and patents

    3-7 years      $ 26,031     

$

  (16,401

  $ 9,630   

Core technology

    5 years        2,929        (2,929     —     

Customer relationships

    4-7 years        37,723        (22,383     15,340   

Trade name

    2 years        400        (400     —     
                         

Total

    $ 67,083      $ (42,113   $   24,970   
                         

April 30, 2010

  Amortization
period
    Gross
Amount
    Accumulated
Amortization
    Net Carrying
Value
 

Developed technology and patents

    3-7 years      $ 26,031      $ (11,730   $ 14,301   

Core technology

    5 years        2,929        (2,929     —     

Customer relationships

    5-7 years        37,723        (15,011     22,712   

Trade name

    2 years        400        (380     20   
                         

Total

    $   67,083      $ (30,050   $ 37,033   
                         

 

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Amortization expense for our identifiable acquisition-related intangible assets for fiscal years ended April 30, 2011, 2010 and 2009 were allocated as follows:

 

     Year Ended April 30,  
     2011      2010      2009  
     (in thousands)  

Included in cost of net revenue

   $ 4,691       $ 5,152       $ 4,969   

Included in operating expenses

     7,372         7,289         6,667   
                          

Total

   $   12,063       $   12,441       $   11,636   
                          

As of April 30, 2011, we had no identifiable acquisition-related intangible assets with indefinite lives. The weighted average remaining life of identifiable acquisition-related intangible assets was 2.1 years and 3.1 years as of April 30, 2011 and 2010, respectively.

Estimated amortization expense related to our identifiable acquisition-related intangible assets in future periods is as follows:

 

Year Ended April 30,

   Amortization  
     (in thousands)  

2012

   $ 11,956   

2013

     11,783   

2014

     1,231   
        
   $       24,970   
        

Note 5. Restructuring Activities

Fiscal 2010 Restructuring Plan

On November 3, 2009, we committed to a restructuring plan, which included a net reduction of approximately 10% of our headcount through the first quarter of fiscal 2011 and the closure of three facilities, including two research and development facilities located in Riga, Latvia, and South Plainfield, New Jersey (the “2010 Plan”). We consolidated our research and development work at three existing locationsSunnyvale, California, Draper, Utah and Waterloo, Ontario, Canada—and opened a new location in Bangalore, India. The restructuring activities commenced on November 3, 2009, and were substantially complete by the end of the first quarter of fiscal 2011.

These actions were approved as part of our continuing effort to improve our profitability, to realign our research and development activity and resources, and to drive greater productivity throughout our organization.

Restructuring charges consist primarily of personnel-related severance costs, contract termination costs and stock-based compensation expenses. Stock-based compensation included in restructuring charges resulted primarily from the additional vesting of unvested option shares and restricted stock awards and restricted stock units upon termination of the employment of employees under the 2010 Plan and pursuant to the terms of their separation agreements. The total estimated restructuring costs associated with the 2010 Plan were $12.7 million. Of the total restructuring charges, $10.8 million in charges related to severance and related benefits for 265 employees and $1.9 million in charges related to facility closures and consolidations. We recorded a total of $12.7 million of restructuring charges through the fourth quarter of fiscal 2011, including $0.1 million of stock-based compensation. We do not expect to incur any charges in the future.

Fiscal 2009 Restructuring Plan

In connection with our acquisition of Packeteer, we committed to a plan that resulted in the termination of the employment of 33 employees of Blue Coat (the “2009 Plan”). Restructuring charges related to the 2009 Plan

 

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consist primarily of personnel-related severance costs and stock-based compensation expenses. Stock-based compensation included in restructuring resulted primarily from the additional vesting of unvested option shares and restricted shares upon termination of the employment of those employees pursuant to the terms of their separation agreements. The termination of employment of all 33 employees occurred during the first quarter of fiscal 2009, and we recorded a restructuring charge of $1.5 million in our consolidated statements of operations, including $0.1 million of stock-based compensation. We paid severance related costs in the amount of $1.5 million under the 2009 Plan. The 2009 Plan was completed in the first quarter of fiscal 2010, and no further charges under the 2009 plan were incurred.

We also planned to exit certain Packeteer facilities, discontinue certain Packeteer products, and involuntarily terminate the employment of certain Packeteer employees. On the acquisition date of June 6, 2008, we accrued $11.6 million related to employee severance costs and $1.9 million related to lease termination costs. From the acquisition date of June 6, 2008 through April 30, 2011, we paid $11.3 million related to employee severance costs and $3.5 million related to lease termination costs, and we decreased the employee severance accrual by $0.3 million and increased the lease termination accrual by $1.6 million. The increase to the lease termination accrual primarily related to a real estate commission paid in fiscal 2009 in connection with the termination of an assumed lease.

Summary of Restructuring Plans

The following tables summarize the activity related to our restructuring plans for fiscal years ended April 30, 2011 and 2010:

Fiscal 2011 Activity

 

(in thousands)

   Balance,
April  30,
2010
     Charges to
Expense
     Cash
Payments
    Non-cash
settlements
and other
adjustments
     Balance,
April  30,
2011
 

Fiscal 2010 Restructuring Plan

             

Severance

   $ 989       $ 80       $   (1,069   $ —         $ —     

Facilities

     1,255         113         (1,368     —           —     
                                           

Total

   $   2,244       $   193       $ (2,437   $   —         $   —     
                                           

Fiscal 2010 Activity

 

(in thousands)

   Balance,
April  30,
2009
     Charges to
Expense
     Cash
Payments
    Non-cash
settlements
and other
adjustments
    Balance,
April  30,
2010
 

Fiscal 2010 Restructuring Plan

            

Severance

   $ —         $ 10,736       $ (9,639   $ (108   $ 989   

Facilities

     —           1,815         (84     (476 )     1,255   
                                          

Total

   $ —         $ 12,551       $ (9,723   $ (584   $ 2,244   
                                          

Fiscal 2009 Restructuring Plan

            

Severance

   $ 101      $ —         $ (101   $ —        $ —     
                                          

Packeteer Restructuring Activities

            

Severance

   $ 79       $ —         $ (79   $ —        $ —     

Facilities

     893         —           (492     (401     —     
                                          

Total

   $ 972       $ —         $ (571   $ (401   $ —     
                                          

Total Restructuring Plans

   $   1,073       $   12,551       $   (10,395   $   (985   $   2,244   
                                          

 

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At April 30, 2011 and 2010, accrued restructuring was included in other current liabilities in our consolidated balance sheets.

Note 6. Convertible Senior Notes

On June 2, 2008, we issued $80.0 million aggregate principal amount of Zero Coupon Convertible Senior Notes due June 2, 2013 (the “Convertible Senior Notes”) and warrants (the “Warrants”) to purchase an aggregate of 385,356 shares of our common stock at an exercise price of $20.76 to Manchester Securities Corp., an affiliate of Elliott Associates, L.L.P. (“Manchester”) and Francisco Partners II, L.P. and Francisco Partners Parallel Fund II, L.P. (together, the “FP Entities”) in a private placement. As of April 30, 2011, the Convertible Senior Notes were reported on our consolidated balance sheet at $78.1 million, net of a discount of $1.9 million primarily related to the value assigned to the Warrants, which is being amortized to interest expense over the life of the Convertible Senior Notes.

The Convertible Senior Notes rank equal in right of payment to any of our other existing and future senior unsecured indebtedness. The Convertible Senior Notes are initially convertible into 3,853,564 shares of our common stock at the holders’ option at any time prior to maturity at the initial conversion price of $20.76. The Convertible Senior Notes do not bear interest. The conversion price of the Convertible Senior Notes and the exercise price of the Warrants are subject to adjustment, if we:

 

   

issue shares of our common stock as a dividend or distribution on our shares of common stock;

 

   

effect a stock split or stock combination;

 

   

issue shares of capital stock in the event of a reclassification; or

 

   

purchase shares of our common stock pursuant to a tender offer or exchange offer at a premium to market.

If we issue rights, options, warrants or pay a cash dividend or otherwise make a distribution of cash or other assets to all holders of our common stock, such right, option, warrant, dividend or distribution shall also be issued to the holders of the Convertible Senior Notes and the Warrants on an as-converted or as-exercised basis.

Subject to certain exceptions, the holders of the Convertible Senior Notes, at their option, may require us to repurchase for cash all or a portion of the Convertible Senior Notes at a purchase price equal to 100% of the outstanding principal amount of the Convertible Senior Notes, if our common stock is suspended from trading or ceases to be listed on an eligible market for a period of 5 consecutive trading days or for more than 15 trading days in any 365-day period.

On June 2, 2008, we and the FP Entities entered into a Registration Rights Agreement, (the “Registration Rights Agreement”) containing customary terms and conditions providing for the registration of our common stock underlying the Convertible Senior Notes and the Warrants issued to the FP Entities. Pursuant to the Registration Rights Agreement, we filed an automatically effective resale shelf registration statement on August 4, 2008. We filed amendments to that registration statement on June 23, 2009 and October 2, 2009.

Keith Geeslin, a partner of Francisco Partners II, L.P., has served as a member of our Board of Directors since June 2006.

 

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Note 7. Consolidated Balance Sheet Data

Inventory

Inventory consisted of the following:

 

     April 30,  
     2011      2010  
     (in thousands)  

Raw materials

   $ 4,048       $ 3,573   

Finished goods

     6,086         2,437   
                 

Total

   $         10,134       $         6,010   
                 

Property and Equipment

Property and equipment, net consisted of the following:

 

     April 30,  
     2011     2010  
     (in thousands)  

Computer and office equipment

   $ 28,055      $ 20,701   

Software

     16,764        15,694   

Furniture and fixtures

     5,788        5,312   

Leasehold improvements

     19,831        17,790   

Construction in progress

     2,139        349   
                
     72,577        59,846   

Less accumulated depreciation and amortization

     (40,832     (26,162
                
   $         31,745      $         33,684   
                

Depreciation expense was $13.7 million, $14.7 million and $10.4 million for fiscal years ended April 30, 2011, 2010 and 2009, respectively.

Other assets

We periodically enter into license agreements under which we receive nonexclusive, perpetual, worldwide license rights. We capitalize these license rights and amortize them over their respective estimated useful lives. For fiscal years ended April 30, 2011, 2010 and 2009, amortization expense related to these license rights was $0.7 million, $0.4 million, $0.2 million, respectively and was included in cost of product revenue in our consolidated statements of operations. The unamortized balance related to these license rights was $3.7 million and $4.4 million at April 30, 2011 and 2010, respectively.

As of April 30, 2011, amortization expense in future periods for these license rights is expected to be as follows:

 

Year Ended April 30,

   Amortization  
     (in thousands)  

2012

   $ 692   

2013

     667   

2014

     579   

2015

     361   

2016

     314   

Thereafter

     1,066   
        
   $         3,679   
        

 

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Other Current Liabilities

Other current liabilities consisted of the following:

 

     April 30,  
     2011      2010  
     (in thousands)  

Professional and consulting fees

   $ 463       $ 541   

Accrued royalty

     2,242         1,771   

Warranty obligations

     521         648   

Supply chain liability

     183         288   

Sales and marketing costs

     709         388   

Accrued restructuring costs

     —           2,244   

Foreign income taxes payable

     1,600         3,258   

Deferred rent, current portion

     1,196         146   

Other

     3,844         3,637   
                 

Total other current liabilities

   $         10,758       $         12,921   
                 

Deferred revenue

Deferred revenue consisted of the following:

 

     April 30,  
     2011      2010  
     (in thousands)  

Deferred product revenue, current

   $ 2,286       $ 787   

Deferred service revenue, current

     119,240         103,263   
                 

Total deferred revenue, current

     121,526         104,050   

Deferred service revenue, non-current

     56,546         50,172   
                 

Total deferred revenue

   $       178,072       $       154,222   
                 

Note 8. Fair Value of Assets and Liabilities

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and Cash Equivalents and Restricted Cash

Our cash historically has been invested in highly liquid investments such as time deposits held at major banks, commercial paper, U.S. government agency discount notes, money market mutual funds and other money market securities with maturities at the date of purchase of 90 days or less. Our restricted cash is invested in time deposits with maturity dates consistent with the maturity dates of the letters of credit they collateralize. At April 30, 2011, our cash was invested in money market mutual funds and a money market savings account. The carrying amount of cash and cash equivalents and restricted cash reported on the balance sheet approximates its fair value. The fair values of cash equivalents are based upon quoted market prices.

Convertible Senior Notes

The carrying amount of the Convertible Senior Notes is net of discounts, primarily related to the associated Warrants. The fair value of the Convertible Senior Notes as of April 30, 2011 was determined based on an internal valuation model that utilized quoted market prices and interest rates for similar instruments, and is approximately $114.2 million. See Note 6 for further information regarding the Convertible Senior Notes and Warrants.

 

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The estimated fair values of our financial instruments are as follows:

 

     As of April 30,  
     2011      2010  
     Amortized
Cost
     Estimated
Fair  Value
     Amortized
Cost
     Estimated
Fair  Value
 

Assets:

           

Cash

   $ 61,133       $ 61,133       $ 38,609       $ 38,609   

Money market funds

     315,837         315,837         198,724         198,724   
                                   
   $   376,970       $   376,970       $   237,333       $   237,333   

Reported as:

           

Assets:

           

Cash and cash equivalents

      $ 375,939          $ 236,347   

Long-term restricted cash

        1,031            986   
                       
      $ 376,970          $ 237,333   
                       

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts business. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value hierarchy is based on three levels of inputs that may be used to measure fair value, of which the first two are considered observable and the last is considered unobservable. These levels of inputs are the following:

Level 1—Quoted prices in active markets for identical assets or liabilities.

Level 2—Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

Fair Value Measurements

Our financial instruments are valued using quoted prices in active markets. The following table sets forth the fair value of our financial assets and liabilities that were measured on a recurring basis as of April 30, 2011 and 2010 (in thousands):

 

     Level 1      Level 2      Level 3      Total  

April 30, 2011:

           

Money Market Funds (1)

   $   315,837       $ —         $ —         $   315,837   

April 30, 2010:

           

Money Market Funds (1)

   $ 198,724       $ —         $ —         $ 198,724   

 

(1) Included in cash and cash equivalents on our consolidated balance sheets as of April 30, 2011 and 2010.

Our investments in money market funds are measured at fair value on a recurring basis. Our money market funds are targeted to be priced and have a value of $1 net asset value per share. These money market funds are actively traded and reported daily through a variety of sources. The fair value of the money market fund investments are classified as Level 1.

During fiscal 2011, we did not remeasure any nonfinancial assets and liabilities measured at fair value on a nonrecurring basis, such as goodwill, intangible assets, property and equipment and nonfinancial assets and liabilities initially measured at fair value in a business combination.

 

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Note 9. Stockholders’ Equity

Stock Repurchases

On November 16, 2010, our Board of Directors approved a program to repurchase up to $50 million of our common stock. Repurchases may be made from time to time in the open market or in negotiated transactions and are expected to comply with Rule 10b-18 under the Securities Exchange Act of 1934 and other legal requirements. The timing and amount of the repurchase transactions will be determined by management and may depend on a variety of factors, including the trading price of the stock, market conditions, alternative investment opportunities, and other corporate and regulatory considerations. The program does not obligate us to acquire any particular amount of common stock and the program may be modified or discontinued at any time. The repurchases will be funded from available working capital. During the fiscal year ended April 30, 2011, we did not repurchase any shares of common stock under the program. On May 31, 2011, we commenced the repurchase of shares of our common stock under the program and as of June 3, 2011, we had repurchased shares of our common stock valued at approximately $20 million.

Preferred Stock

As of April 30, 2011, we have 9,958,000 shares of preferred stock authorized. The preferred stock is undesignated and the Board of Directors has the authority to issue new series of preferred stock and determine the rights, preferences and privileges of such preferred stock.

Warrants and Convertible Senior Notes

In connection with the acquisition of Packeteer in June 2008, we issued Convertible Senior Notes convertible into 3,853,564 shares of our common stock at the holders’ option at any time prior to maturity at the initial conversion price of $20.76 and Warrants to purchase an aggregate of 385,356 shares of our common stock at an exercise price of $20.76. See Note 6 for further information regarding the Convertible Senior Notes and Warrants.

Stock-Based Compensation Plans

2010 New Employee Stock Incentive Plan

On April 22, 2010, our Board of Directors approved the 2010 New Employee Stock Incentive Plan (the “2010 Stock Incentive Plan”), under which 300,000 shares of common stock initially were reserved for issuance. The 2010 Stock Incentive Plan was designed to attract new employees by providing for equity awards in the form of restricted shares, stock units or options. The 2010 Stock Incentive Plan was amended effective September 1, 2010 to increase the maximum aggregate number of shares that could be issued under it by 512,500 shares. On October 7, 2010, we terminated the 2010 Stock Incentive Plan upon obtaining shareholder approval to increase the share reserve under the 2007 Stock Incentive Plan. As of April 30, 2011, 622,465 shares of our common stock were subject to outstanding equity awards under the 2010 Stock Incentive Plan.

Employee Stock Purchase Plan

In September 1999, our Board of Directors adopted the Employee Stock Purchase Plan (“ESPP”), which became effective upon our initial public offering and was most recently amended on October 30, 2009 to increase the maximum aggregate number of shares that may be issued under the ESPP by 3,000,000 shares. Under the ESPP, eligible employees may purchase common stock through payroll deductions, not to exceed the greater of 25% of an employee’s compensation or $10,000 per six-month offering period, at a price equal to 85% of the closing fair market value of our common stock on the lower of the first day of the offering or the last day of the applicable six-month purchase period. As of April 30, 2011, 2,772,367 shares of common stock were available for future purchase and 3,027,633 shares of common stock had been issued under the ESPP.

 

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There were 475,340, 692,964 and 609,301 shares purchased under the ESPP during the fiscal years ended April 30, 2011, 2010 and 2009, respectively.

2007 Stock Incentive Plan

On August 27, 2007, our Board of Directors approved the 2007 Stock Incentive Plan (the “2007 Stock Incentive Plan”). As adjusted for the Company’s stock dividend on October 4, 2007, a total of 4,000,000 shares of common stock were initially reserved for issuance, together with shares reserved against options or awards made under the 1999 Stock Incentive Plan, 2000 Supplemental Stock Option Plan, 1999 Director Option Plan or 2007 New Employee Stock Incentive Plan (the “Prior Plans”) as of the date of effectiveness of the 2007 Stock Incentive Plan. The 2007 Stock Incentive Plan provides for four different types of equity compensation awards: stock options, stock appreciation rights, restricted stock awards; and restricted stock units. The 2007 Stock Incentive Plan was approved by our stockholders on October 2, 2007, and became effective at that time. The Prior Plans were terminated upon the effectiveness of the 2007 Stock Incentive Plan and options and awards made under the Prior Plans are deemed incorporated into the 2007 Stock Incentive Plan, but shall remain outstanding in accordance with their original terms. On October 7, 2010, the 2007 Stock Incentive Plan was amended and the share reserve under plan was increased by an additional 2,400,000 shares to 6,400,000 shares. The 2007 Stock Incentive Plan will automatically terminate on the tenth anniversary of the adoption of the 2007 Stock Incentive Plan by the Board of Directors (August 27, 2017).

As of April 30, 2011, 3,234,693 shares of our common stock were available for future equity awards under the 2007 Stock Incentive Plan and 5,269,612 shares of our common stock were subject to outstanding equity awards under the 2007 Stock Incentive Plan and the Prior Plans.

Plans Assumed Upon Acquisition

As a result of our acquisition of Packeteer, we assumed the outstanding options and restricted stock units granted by Packeteer under the Packeteer, Inc. 1999 Stock Incentive Plan (the “Packeteer Plan”), the Workfire Technologies International, Inc. 2000 Stock Option Plan and the Tacit Networks, Inc. 2000 Equity Incentive Plan (the “Assumed Awards”). At April 30, 2011, with respect to the Assumed Awards, the number of shares of common stock subject to outstanding stock options was 232,883 and the number of shares of common stock subject to outstanding restricted stock units was 14,976. We also assumed the Packeteer Plan (the “Assumed Plan”) and issued stock options and restricted stock units to former Packeteer employees under the Assumed Plan, consistent with its terms prior to May 19, 2009, at which time the Assumed Plan terminated. At April 30, 2011, the number of shares of common stock subject to outstanding stock options granted by us under the Assumed Plan was 119,827 and the number of outstanding restricted stock units of common stock issued by us under the Assumed Plan was 4,746.

 

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Restricted Stock Awards

A summary of restricted stock awards activity during the fiscal years ended April 30, 2011, 2010 and 2009 is as follows:

 

     Shares     Weighted Average
Grant Date Fair Value
 

Balance at April 30, 2008

     300,416      $  23.15   

Granted

     347,821      $ 14.97   

Vested

     (83,672   $ 22.38   

Cancelled

     (70,478   $ 23.02