Form 10-Q

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 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.

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

There were 42,277,462 shares of the registrant’s Common Stock issued and outstanding as of August 26, 2011.

This Quarterly Report on Form 10-Q contains 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, management 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 Quarterly Report on Form 10-Q 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 under Part II, Item 1A of this Quarterly Report on Form 10-Q. 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 Quarterly Report on Form 10-Q, except as may be required by applicable law.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The unaudited condensed 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 acquisition.

In management’s opinion, the accompanying condensed consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation of the results for the interim periods presented. The condensed consolidated balance sheet as of April 30, 2011 is derived from the April 30, 2011 audited consolidated financial statements. 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 revenue, operating income or net income. Interim financial results are not necessarily indicative of results anticipated for the full year. These unaudited financial statements should be read in conjunction with our fiscal 2011 audited financial statements and footnotes included in our Annual Report on Form 10-K for the year ended April 30, 2011, as filed with the Securities and Exchange Commission (“SEC”) on June 8, 2011.

The preparation of condensed 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 condensed consolidated financial statements, and the reported amounts of net revenue and expenses during the reporting period. Actual results may differ from these estimates, and such differences could be material to our consolidated financial condition and results of operations.

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 income (expense), net, in the accompanying condensed consolidated statements of operations.

There have been no material changes to our significant accounting policies, as compared to the significant accounting policies described in our Annual Report on Form 10-K for the fiscal year ended April 30, 2011.

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 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. The revenue recognition guidance for multiple deliverable arrangements requires 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. Under the guidance, 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. We account for multiple element arrangements that contain only software and software-related elements under the software revenue recognition guidance.

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, current market trends, 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.

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 condensed 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.

Presentation of Comprehensive Income: In June 2011, the FASB issued Accounting Standards Update No. 2011-05, Comprehensive Income (Topic 220) — Presentation of Comprehensive Income (“ASU 2011-05”), to require an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of stockholders’ equity. ASU 2011-05 will be effective for us in our first quarter of fiscal 2013 and will be applied retrospectively.

Our convertible senior notes, discussed in Note 5, 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 5, 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 5 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.

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 condensed consolidated statements of operations reconciled to basic and diluted per share amounts available to common stockholders:

For the three months ended July 31, 2011, outstanding stock options, restricted stock awards and restricted stock units covering an aggregate of 2.5 million shares 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 three months ended July 31, 2010, outstanding stock options, restricted stock awards and restricted stock units covering an aggregate of 2.0 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.

Warrants to purchase 385,356 shares of our common stock were outstanding at July 31, 2011 and 2010. The warrants were included in the computation of the diluted net income per share for the three months ended July 31, 2011 and 2010, respectively, because the exercise price of the warrants was less than the average market price of our common stock during the period.

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 condensed 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.

There were no changes in the carrying amount of goodwill, which generally is not deductible for tax purposes, for the three months ended July 31, 2011.

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

Amortization expense for our identifiable acquisition-related intangible assets for the three months ended July 31, 2011 and 2010 was allocated as follows:

As of July 31, 2011, we had no identifiable acquisition-related intangible assets with indefinite lives. The weighted average remaining life of identifiable acquisition-related intangible assets was 1.9 years and 2.1 years as of July 31, 2011 and April 30, 2011, respectively.

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

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 July 31, 2011, the Convertible Senior Notes were reported on our condensed consolidated balance sheet at $78.4 million, net of a discount of $1.6 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:

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.

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:

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 July 31, 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.

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 July 31, 2011 was determined based on an internal valuation model that utilized quoted market prices and interest rates for similar instruments, and is approximately $86.9 million. See Note 5 for further information regarding the Convertible Senior Notes and Warrants.

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 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.

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 July 31, 2011 and April 30, 2011 (in thousands):

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 the quarter ended July 31, 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.

On November 16, 2010, our Board of Directors approved a program to repurchase up to $50 million of our common stock. Under the program, 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 are 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 it may be modified or discontinued at any time. During the quarter ended July 31, 2011, we repurchased 1.9 million shares of common stock for $43.0 million under the program.

The following table summarizes the stock-based compensation expense for stock options, our Employee Stock Purchase Plan (“ESPP”), restricted stock awards and restricted stock unit awards that we recorded in our condensed consolidated statements of operations for the three months ended July 31, 2011 and 2010:

We use the Black-Scholes option valuation model to calculate compensation expense. We estimate the expected term based on our historical experience of grants, exercise pattern and post-vesting cancellations. We considered our historical volatility over the expected term and implied volatility of traded stock options in developing our estimate of volatility.

For the three months ended July 31, 2011 and 2010, we used the following assumptions to estimate the fair value of options granted:

For the three months ended July 31, 2011 and 2010, we used the following assumptions to estimate the fair value of shares purchased under our ESPP:

During the three months ended July 31, 2011, options to purchase 161,042 shares were exercised. As of July 31, 2011, there was approximately $15.2 million and $0.2 million of unrecognized stock-based compensation expense related to stock option grants and ESPP awards, respectively, which will be recognized over the remaining weighted average vesting period of approximately 2.8 years and 0.2 years, respectively.

The cost of awards of restricted stock and restricted stock units is determined using the fair value of our common stock on the date of the grant, and compensation expense is recognized over the vesting period, which

generally is four years. During the first quarter of fiscal 2012, we awarded 752,096 restricted stock units and canceled 24,295 shares of restricted stock and 151,095 restricted stock units. As of July 31, 2011, we had approximately $0.7 million and $19.6 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to restricted stock awards and restricted stock unit awards, respectively, which we will recognize over the remaining weighted average vesting period of approximately 1.2 years and 3.6 years, respectively.

The provision for income taxes for the three months ended July 31, 2011 was $1.5 million compared with $5.0 million the three months ended July 31, 2010. The provision primarily reflects current and deferred U.S. federal and state taxes and foreign income taxes in taxable foreign jurisdictions. The primary difference between the effective tax rate and the federal statutory tax rate relates to taxes in foreign jurisdictions with a tax rate different than the U.S. federal statutory rate, and non-deductible stock-based compensation expense.

Our total gross unrecognized tax benefits as of July 31, 2011 and April 30, 2011 were $46.3 million and $43.3 million, respectively. The increase was primarily related to uncertainties with respect to the taxation of cross-border arrangements within the group that were recorded in the period. Included in our gross unrecognized tax benefits as of July 31, 2011 are approximately $43.8 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 uncertain tax positions as a component of our provision for income taxes. Accrued interest and penalties relating to our unrecognized tax benefits was approximately $2.6 million as of July 31, 2011, including approximately $0.3 million charged to provision for income taxes for the three months ended July 31, 2011, respectively.

Due to our taxable loss position from inception through fiscal year 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.

Our customer agreements generally include certain provisions for indemnifying such customers against certain liabilities, including if our products infringe a third party’s intellectual property rights. We have also agreed in certain circumstances to indemnify for customer costs that would be incurred in connection with a product recall and to indemnify certain suppliers in connection with liabilities they may incur in connection with the provision of services to us. To date, we have not incurred any material costs as a result of such indemnification provisions and we have not accrued any liabilities related to such obligations in the accompanying condensed consolidated financial statements.

Our Bylaws provide that we shall indemnify our directors and officers to the fullest extent permitted by Delaware law, including in circumstances in which indemnification is otherwise discretionary under Delaware law. We have also entered into indemnification agreements or other contractual arrangements with current and former executive officers and directors of our company and of certain of our subsidiaries, which contain provisions that may require us, among other things, to indemnify such officers and directors against certain liabilities that may arise by reason of their status or service as directors or officers and to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified. We were required to indemnify certain current and former officers and directors and other employees for their attorneys’ fees and related expenses incurred in connection with the internal investigations, regulatory investigations and derivative

litigation relating to our historical stock option grant practices, and may be required to indemnify certain current and former officers in connection with the recently filed class action lawsuit.

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.

Changes in our warranty obligations, which are included in other current liabilities in our condensed consolidated balance sheets for the three months ended July 31, 2011, were as follows (in thousands):

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

Rent expense was $2.5 million and $2.4 million for the three months ended July 31, 2011 and 2010, respectively.

As of July 31, 2011, future minimum lease payments under non-cancelable operating leases with initial or remaining terms in excess of one year are as follows:

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 July 31, 2011 our total purchase commitments for inventory were $7.8 million.

Beginning on May 16, 2001, a series of putative securities class actions were filed in the United States District Court for the Southern District of New York against the firms that underwrote our initial public offering, us, and some of our officers and directors. These cases have been consolidated under the case captioned In re CacheFlow, Inc. Initial Public Offering Securities Litigation, Civil Action No. 1-01-CV-5143. In November 2001, a putative class action lawsuit was filed in the United States District Court for the Southern District of New York against the firms that underwrote Packeteer’s initial public offering, Packeteer, and some of its officers and directors. An amended complaint, captioned In re Packeteer, Inc. Initial Public Offering Securities Litigation, Civil Action No. 01-CV-10185, was filed on April 20, 2002.

These are two of a number of actions coordinated for pretrial purposes as In re Initial Public Offering Securities Litigation, 21 MC 92, with the first action filed on January 12, 2001. Plaintiffs in the coordinated proceeding are bringing claims under the federal securities laws against numerous underwriters, companies, and individuals, alleging generally that defendant underwriters engaged in improper and undisclosed activities concerning the allocation of shares in the IPOs of more than 300 companies during late 1998 through 2000. Among other things, the plaintiffs allege that the underwriters’ customers had to pay excessive brokerage commissions and purchase additional shares of stock in the aftermarket in order to receive favorable allocations of shares in an IPO.

The consolidated amended complaint in our case seeks unspecified damages on behalf of a purported class of purchasers of our common stock between December 9, 1999 and December 6, 2000. Pursuant to a tolling agreement, the individual defendants were dismissed without prejudice. On February 19, 2003, the Court denied our motion to dismiss the claims against us.

The amended complaint in the Packeteer case seeks unspecified damages on behalf of a purported class of purchasers of Packeteer’s common stock between July 27, 1999 and December 6, 2000.

In June 2004, a stipulation of settlement and release of claims against the issuer defendants, including us and Packeteer, was submitted to the Court for approval. On August 31, 2005, the Court preliminarily approved the settlement. In December 2006, the appellate court overturned the certification of classes in six test cases that were selected by the underwriter defendants and plaintiffs in the coordinated proceedings. Because class certification was a condition of the settlement, it was deemed unlikely that the settlement would receive final Court approval. On June 25, 2007, the Court entered an order terminating the proposed settlement based upon a stipulation among the parties to the settlement. Plaintiffs have filed amended master allegations and amended complaints in the six focus cases. On March 26, 2008, the Court denied the defendants’ motion to dismiss the amended complaints.

The parties reached a global settlement of the litigation and the plaintiffs filed a motion for preliminary settlement approval with the Court on April 2, 2009. Under the settlement, the insurers will pay the full amount of settlement share allocated to the Company and Packeteer, and the Company and Packeteer would not bear any financial liability. On October 5, 2009, the Court entered an order granting final approval of the settlement. Certain objectors appealed that order to the Court of Appeals for the Second Circuit and submitted their opening briefs in fall 2010. In December 2010, the plaintiffs moved to dismiss certain appeals and in May 2011, the Second Circuit issued an order granting the motion to dismiss as to one set of appeals and remanding the remaining set of appeals to the Court for further action. On August 25, 2011, the Court ruled that the objector that submitted the remaining set of appeals is not a class member, and therefore does not have standing to object to the settlement.

On or about October 10, 2007, Vanessa Simmonds, a purported shareholder of Packeteer, filed a complaint in the United States District Court, Western District of Washington, against the underwriters of Packeteer’s 1999

initial public offering of its common stock, seeking recovery in the name of Packeteer for alleged violation by those underwriters of Section 16(b) of the Securities Exchange Act of 1934, as amended. The complaint seeks to recover from the underwriters any “short-swing profits” obtained by them in violation of Section 16(b). Packeteer is named as a nominal defendant. On February 28, 2008, the plaintiff filed an amended complaint asserting substantially similar claims as those set forth in the initial complaint and naming three additional underwriters as defendants.

This is one of 54 actions that were coordinated for pretrial purposes as In re Section 16(b) Litigation, Master Case No. 07-1549 JLR, with the first action filed on October 2, 2007. In July 2008, Packeteer and 29 other nominal defendants moved to dismiss the amended complaint. Packeteer also separately moved to dismiss the action brought against it on the ground that the plaintiff lacks standing to pursue the action because her interest was extinguished when Packeteer merged into our wholly-owned subsidiary on June 6, 2008. The Court heard the motions to dismiss in January 2009. On March 12, 2009, as a consequence of those motions, the court issued an Order Dismissing Cases and entered judgment dismissing the actions, including the action brought against Packeteer. The court denied as moot, Packeteer’s separate motion to dismiss.

On March 31, 2009, Simmonds appealed the judgment to the Court of Appeals for the Ninth Circuit, and thereafter filed an amended notice of appeal on April 10, 2009 at the appellate court’s request. The underwriter defendants filed a cross-appeal in each of the cases wherein the issuers moved for dismissal (including the appeal relating to Packeteer’s IPO). The appellate court heard oral argument on October 5, 2010 and, on December 2, 2010, issued an order dismissing with prejudice the amended complaint against the moving defendants, including Packeteer, but reversed and remanded the district court’s decision on the underwriter defendants’ motion to dismiss the claims arising from the non-moving issuers’ IPOs.

On December 16, 2010, the underwriter defendants filed a petition for panel rehearing and petition for rehearing en banc. Appellant Simmonds also filed a petition for rehearing en banc. On January 18, 2011, the court denied the petition for rehearing and petitions for rehearing en banc. It further ordered that no further petitions for rehearing may be filed.

On April 5, 2011, Simmonds filed a Petition for Writ of Certiorari with the U.S. Supreme Court seeking reversal of the Ninth Circuit’s December 2, 2010 decision. That petition was docketed by the Supreme Court on April 7, 2011, and Packeteer’s opposition to the petition was filed on May 26, 2011. On June 27, 2011, the Supreme Court denied Simmonds’ petition and granted the petition of the underwriter defendants.

We do not believe that any of the above mentioned legal matters will have a material effect on our consolidated financial position, results of operations or cash flows.

On August 30, 2011, a purported securities class action complaint was filed in the Unites States District Court for the Northern District of California against us and certain of our current and former officers by an individual on behalf of a putative class of persons who purchased our common stock between November 24, 2009 and May 27, 2010. The complaint alleges that the defendants made false or misleading statements about our business and prospects in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. The complaint seeks compensatory damages, attorneys’ fees and costs, and such other relief as the court deems proper. Due to the recent filing of the complaint, management has not yet assessed the potential impact of the outcome of the claim.

We conduct business in one operating segment that designs, develops and sells products and services that optimize, accelerate and secure the delivery of business applications and other information to distributed users

over a WAN or across an enterprise’s Internet gateway. Our chief operating decision maker, our chief executive officer, allocates resources and makes operating decisions based on financial data consistent with the presentation in the accompanying condensed consolidated financial statements. Our revenue consists of two categories: product and service.

Net revenue is attributed to three geographic areas based on the location of the customers. The following is a summary of net revenue by geographic area:

At July 31, 2011, substantially all of our long-lived assets were located in the United States.

Certain of our global distributors, including their various affiliates, may account for more than 10% of our net revenue in certain periods. In the first quarter of fiscal 2012, ComputerLinks, Westcon Group, Inc. and Arrow Enterprise Computing Solutions, Inc. accounted for 23.5%, 14.7% and 13.7% of our total net revenue, respectively. In the first quarter of fiscal 2011, ComputerLinks, Westcon Group, Inc. and Arrow Enterprise Computing Solutions, Inc. accounted for 23.2%, 17.8% and 11.9% of our total net revenue, respectively.

On August 16, 2011, we announced the departure of Michael J. Borman, our President and Chief Executive Officer and his resignation as a member of our Board of Directors, the appointment of an Interim Chief Executive Officer, and the appointment of a new President and Chief Executive Officer, who is expected to commence employment in the second quarter of fiscal 2012. In connection with the departure of Mr. Borman and the termination of his employment, the Company and Mr. Borman entered into a separation agreement. Consistent with the terms of his offer letter agreement dated August 30, 2010, the separation agreement provides for a lump sum severance payment of $1,170,000 to Mr. Borman to be paid in the second quarter of fiscal 2012.

As discussed in Note 11, a purported securities class action complaint was filed against us and certain of our current and former officers on August 30, 2011.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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. We are working to improve the alignment of these new product and engineering groups, and the efficiency of the allocation of resources among them.

We have seen considerable executive transition during the past 12 months. On August 16, 2011, we announced that Gregory S. Clark would assume the position of President and Chief Executive Officer in the second quarter of fiscal 2012, and that Carol G. Mills, a director of the Company, would serve as Interim Chief Executive Officer, pending Mr. Clark’s arrival. On August 16, 2011, we also announced the departure of Michael J. Borman as President and Chief Executive Officer of the Company. Mr. Borman was appointed on September 1, 2011 to replace Brian M. NeSmith, who had served as President and Chief Executive Officer since

1999. On May 5, 2011, Mr. NeSmith, who had served as Chief Product Officer since Mr. Borman arrived on September 1, 2010, and David de Simone, who then served as Senior Vice President, Products & Technology, each ceased to serve as executive officers. They subsequently left the Company on June 30, 2011, although Mr. NeSmith continues to serve on our Board of Directors. The positions held by each of Messrs. NeSmith and de Simone were eliminated. On August 18, 2011, we announced that Kevin T. Biggs, Senior Vice President of Worldwide Field Operations, left the Company.

While we believe that growth of our product revenue is a key driver of our profitability, we have been unsuccessful in growing that revenue during the past four quarters. We experienced a decline in product revenue in fiscal 2011 and that decline continued in the first quarter of fiscal 2012. We believe that this has resulted from several factors, including: the need to continue to strengthen our go-to-market strategy and better engage our channel partners; increased competition in our core markets with respect to both pricing and products; the need to improve our sales productivity and execution, and to stem attrition in our sales force; the need to drive new customer acquisition; the need to better focus and execute on product development initiatives; the need to strengthen our executive leadership; and various budget and macro factors that impacted key transactions in the first quarter of fiscal 2012. While we have taken steps to address these issues, they have not yet yielded the improvement required to reinvigorate revenue growth.

Although we intend to take steps to improve our operational efficiency, cost structure and profitability during this fiscal year, we also intend to make investments designed to drive increased net revenue and market penetration, including continued expenditures on sales and marketing and research and development. As well, we intend to 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 continue to 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, which includes product and service revenue, decreased to $109.5 million in the first quarter of fiscal 2012 from $122.5 million in the first quarter of fiscal 2011. Net product revenue in the first quarter of fiscal 2012 was $58.6 million, a $17.0 million decrease compared with the first quarter of fiscal 2011. Net product revenue primarily consists of revenue from sales of our Web Security and WAN Optimization products. We experienced a 23% decline in product revenue in the first quarter of fiscal 2012 compared with the first quarter fiscal 2011, which primarily related to decreased sales of our Web Security products. Sales to the federal government were materially lower than in the comparable quarter of fiscal 2011, as was the number of large transactions closed in the quarter. We believe that adverse macro-economic conditions in the quarter and the need to improve our go-to-market strategy also contributed to the decline in our product revenue. We recognized $50.9 million in service revenue in the first quarter of fiscal 2012, a $4.0 million increase compared with the first quarter of fiscal 2011. Net service revenue primarily consists of revenue related to support and maintenance contracts. The increase in service revenue was primarily a result of increased revenue from the sales of renewal services contracts, partially offset by a decrease in service revenue from the sales of new service contracts.

Our operating income decreased to $4.7 million in the first quarter of fiscal 2012 from $19.3 million in the first quarter of fiscal 2011. This decrease was attributable to a decrease in our gross profit margin from 78.5% in the first quarter of fiscal 2011 to 76.2% in the first quarter of fiscal 2012 and an increase in operating expenses of $1.9 million in the first quarter of fiscal 2012 compared with the same quarter in fiscal 2011. Our decrease in

gross profit margin in the first quarter of fiscal 2012 compared with the same period in fiscal 2011 was primarily the result of additional costs associated with the launch of our Cloud Service business as well as a shift in product mix to lower margin products in the current quarter. The quarter-over-quarter increase in operating expenses was primarily driven by increases in our sales and marketing expenses partially offset by restructuring charges in the first quarter of fiscal 2011 with no comparable activity in the first quarter of fiscal 2012.

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 our operating expenses in each functional area. As of July 31, 2011 and 2010 we had 1,331 and 1,305 full-time equivalent employees, respectively.

Net deferred revenue was $174.4 million at July 31, 2011 compared with $178.1 million at April 30, 2011. The decrease was primarily due to a decrease in the sales of new service contracts and the recognition of deferred product revenue in the quarter, partially offset by an increase in the sales of renewal service contracts.

During the first three months of fiscal 2012, we generated cash flow from operations of $9.5 million compared with $28.6 million generated in the same period in fiscal 2011. The decrease in operating cash flow in fiscal 2012 was primarily driven by lower net income, after excluding the impact of non-cash charges such as stock-based compensation, depreciation and amortization expense, as well as working capital uses of cash from lower accounts payable and deferred revenue balances at July 31, 2011. Our cash and cash equivalents and restricted cash were $342.4 million at July 31, 2011 compared with $377.0 million at April 30, 2011. The overall decrease in our cash and cash equivalents balance was primarily due to the expenditure of $43.0 million to repurchase our shares in the first quarter of fiscal 2012, partially offset by cash flows generated from operations in the current quarter.

Our discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of our condensed 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, 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:

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.

services. The revenue recognition guidance for multiple deliverable arrangements requires 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. Under the guidance, 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. We account for multiple element arrangements that contain only software and software-related elements under the software revenue recognition 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.

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 condensed consolidated statements of operations.

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.

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.

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 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. During the first three months of fiscal 2012, there were no significant events or changes in circumstances that affect our valuation of goodwill.

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.

We use the liability method to account for income taxes. As part of the process of preparing our condensed 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 condensed 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 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.

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 condensed 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.

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

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.

Quarter Ended July 31, 2011 compared with Quarter Ended July 31, 2010: Net revenue, which includes product and service revenue, decreased $13.0 million, or 10.6%, in the first quarter of fiscal 2012 compared with the same period in fiscal 2011. Net product revenue in the first quarter of fiscal 2011 was $58.6 million, a $17.0 million decrease compared with the same period in fiscal 2011, which primarily related to a decrease in sales of our Web Security products sales to the federal government were materially lower than in the comparable quarter of fiscal 2011, as was the number of large transactions closed in the quarter. We believe that adverse macro-economic conditions in the quarter and the need to improve our go-to-market strategy also contributed to the decline in our product revenue. Net service revenue in the first quarter of fiscal 2012 was $50.9 million, a $4.0 million increase compared with the same period in fiscal 2011. The increase in service revenue was primarily a result of increased revenue from the sales of renewal services contracts, partially offset by a decrease in the sales of new service contracts.

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 the three months ended July 31, 2011, approximately 56.3% of our total net revenue was derived from customers outside of the Americas compared with 55.4% for the three months ended July 31, 2010.

Net revenue in the Americas decreased $6.8 million in the first quarter of fiscal 2012, a 12.4% decrease from the same period in fiscal 2011. Product revenue in the Americas decreased $8.4 million in first quarter of fiscal 2012 compared with the same period in fiscal 2011, 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. This decrease in product revenue was partially offset by a $1.6 million increase in service revenue driven primarily from the sales of renewal service contracts.

Net revenue in EMEA decreased $4.1 million in the first quarter of fiscal 2012, down 9.6% from the same period in fiscal 2011, primarily driven by a $5.5 million decrease in product revenue related to our Web Security products and, to a lesser extent, our WAN Optimization products. This decrease in product revenue was partially offset by a $1.4 million increase in service revenue driven primarily from the sales of renewal service contracts, partially offset by a decrease in service revenue from the sales of new service contracts.

Net revenue in APAC decreased $2.2 million in the first quarter of fiscal 2012, down 8.4% from the same period in fiscal 2011. This decrease was primarily driven by a $3.1 million decrease in product revenue related to sales of our Web Security and WAN Optimization products, partially offset by a $0.9 million increase in service revenue from the sales of renewal service contracts, partially offset by a decrease in service revenue from the sales of new service contracts.

Quarter Ended July 31, 2011 compared with Quarter Ended July 31, 2010: Gross profit decreased $12.7 million, or 13.2%, in the first quarter of fiscal 2012 compared with the same period in fiscal 2011, as the result of a decrease in net product revenue in the first quarter of fiscal 2012 compared with the same quarter in fiscal 2011. Gross profit margin decreased 2.3% in the first quarter of fiscal 2012 compared with the same period in fiscal 2011, primarily as a result of additional costs associated with the launch of our Cloud Service business as well as a shift in product mix to lower margin products in the current quarter.

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:

Quarter Ended July 31, 2011 compared with Quarter Ended July 31, 2010: Sales and marketing expense increased $2.9 million, or 6.5%, in the first quarter of fiscal 2012 compared with the same period in fiscal 2011. The increase in sales and marketing expense was primarily attributable to a $3.2 million increase in salaries and benefits, including commission payments, and increases in various other sales expenses, including travel and sales events, partially offset by a $0.5 million decrease in bonus and profit sharing expense. Sales and marketing

headcount was 501 at July 31, 2011 compared with 496 at July 31, 2010. We currently expect sales and marketing expense during the second quarter of fiscal 2012 to remain flat in absolute dollars and increase slightly as a percentage of net revenue as a consequence of our continued investments designed to drive increased net revenue and market penetration, and our expansion of new and existing marketing programs.

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:

Quarter Ended July 31, 2011 compared with Quarter Ended July 31, 2010: Research and development expense decreased $0.6 million, or 3.3%, in the first quarter of fiscal 2012 compared with the same period in fiscal 2011. The decrease in research and development expense was largely attributable to a decrease in bonus and profit sharing expense, partially offset by increases in salaries due to increased headcount and increased severance payments due to certain executive departures. Research and development headcount was 363 at July 31, 2011, compared with 346 at July 31, 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 during the second quarter of fiscal 2012 to increase slightly in absolute dollars and as a percentage of net revenue due to our continued investment in the development of new products and services and enhancement of existing products.

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:

Quarter Ended July 31, 2011 compared with Quarter Ended July 31, 2010: General and administrative expense decreased $0.2 million, or 1.6%, in the first quarter of fiscal 2012 compared with the same period in fiscal 2011. The decrease was primarily due to a decrease in bonus and profit sharing expense and a decrease in professional services fees. General and administrative headcount was 186 at July 31, 2011 compared with 183 at July 31, 2010. We currently expect general and administrative expense during the second quarter of fiscal 2012 to increase in absolute dollars and as a percentage of net revenue due to expenses associated with the departure of our former Chief Executive Officer.

Amortization expense for our intangible assets for the three months ended July 31, 2011 and 2010 was allocated as follows:

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 consist 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.

For the three months ended July 31, 2011 and 2010, the amortization of intangible assets was related to our acquisitions of S7, Packeteer, Inc., certain assets of the NetCache business from Network Appliance, Permeo, Inc., Cerberian, Inc. and Ositis Software, Inc. The amortization of developed technology and trade name is charged to cost of net revenue, while the amortization of customer relationships is charged to operating expense. Our core technology intangible assets prior to being fully amortized were also charged to cost of net revenue. We amortize customer relationships, developed technology 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 the three months ended July 31, 2011 and 2010 was $3.0 million, respectively. Amortization expense related to our identifiable intangible assets for the remainder of fiscal 2012 is expected to be $8.9 million.

Restructuring charges consist primarily of personnel-related severance costs, contract termination costs and stock-based compensation expense. Stock-based compensation expense included in restructuring charges 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:

Restructuring charges in the first three months of fiscal 2011 consisted of expenses associated with the Fiscal 2010 Restructuring Plan that was completed in fiscal 2011.

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 at the date of purchase of 90 days or less. At July 31, 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:

Quarter Ended July 31, 2011 compared with Quarter Ended July 31, 2010: Interest income decreased in the first quarter of fiscal 2012 compared with the same period in fiscal 2011 as a result of a 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. Interest expense was essentially flat in the first quarter of fiscal 2012 compared with the same period in fiscal 2011 and during both periods related to the amortization of the fair value of warrants and a beneficial conversion feature associated with our Convertible Senior Notes (as defined in “Liquidity and Capital Resources”). Other expense, net was essentially flat in the first quarter of fiscal 2012 compared with the same period in fiscal 2011 related to foreign exchange losses incurred during both periods.

The provision for income taxes primarily reflects current and deferred U.S. federal and state taxes and foreign income taxes in taxable foreign jurisdictions. The provision for income taxes for the three months ended July 31, 2011 was $1.5 million compared to $5.0 million for the three months ended July 31, 2010.

Our total gross unrecognized tax benefits as of July 31, 2011 and April 30, 2011 were $46.3 million and $43.3 million, respectively. The increase is primarily related to uncertainties with respect to the taxation of cross-border arrangements within the group that were recorded in the period. Included in our gross unrecognized tax benefits as of July 31, 2011 is approximately $43.8 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 uncertain tax positions as a component of our provision for income taxes. Accrued interest and penalties relating to our unrecognized tax benefits were approximately $2.6 million as of July 31, 2011, including approximately $0.3 million charged to provision for income taxes for the three months ended July 31, 2011.

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.

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.

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 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 short-term 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 July 31, 2011, we had cash and cash equivalents of $341.4 million and restricted cash of $1.0 million, and approximately 54% 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 were 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.

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.

Net cash provided by operating activities was $9.5 million for the first three months of fiscal 2012 compared with $28.6 million for the same period in fiscal 2011. The decrease in operating cash flow in fiscal 2012 was primarily driven by lower net income, after excluding the impact of non-cash charges such as stock-based compensation, depreciation and amortization expense, as well as working capital uses of cash from lower accounts payable and deferred revenue balances at July 31, 2011.

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.

Net cash used by investing activities was $2.9 million for the first three months of fiscal 2012 compared with $3.6 million for the same period in fiscal 2011, a decrease of $0.7 million. This decrease was primarily due to fiscal 2011 purchases of technology licenses with no comparable activity in fiscal 2012.

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, stock repurchases and acquisition of noncontrolling interest.

Net cash used for financing activities was $41.2 million for the first three months of fiscal 2012 compared with net cash provided by financing activities of $0.3 million for the same period in fiscal 2011. The net cash used for our financing activities in the first three months of fiscal 2012 primarily related to $43.0 million of cash used to repurchase our common stock, partially offset by cash proceeds from purchases of our stock under our employee stock purchase plan and proceeds from the exercise of employee stock options.

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 are 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 are funded from available working capital. During the quarter ended July 31, 2011, we commenced the repurchase of shares of our common stock and repurchased 1.9 million shares of common stock for $43.0 million under the program. Approximately $7.0 million remains authorized under the program and could be used for additional stock repurchases in the future.

We lease certain office facilities and office equipment 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 condensed consolidated financial statements on a straight-line basis over the terms of the respective leases after consideration of rent increases, 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.

As of July 31, 2011, future minimum lease payments under non-cancelable operating leases with initial or remaining terms in excess of one year are as follows:

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 July 31, 2011 our total purchase commitments for inventory were $7.8 million.

As of July 31, 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 July 31, 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.

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

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.

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. As of July 31, 2011, we had cash and cash equivalents of $341.4 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.

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 the three months ended July 31, 2011, approximately 56.3% 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.

Under the supervision and with the participation of our management, including our Principal Executive Officer and Principal Financial and Accounting Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report (the “Evaluation Date”). Based on this evaluation, our Principal Executive Officer and Principal Financial and Accounting Officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective such that the information relating to Blue Coat, including our consolidated subsidiaries, required to be disclosed in the reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to Blue Coat’s management, including our Principal Executive Officer and Principal Financial and Accounting Officer, as appropriate to allow timely decisions regarding required disclosure.

Under the supervision and with the participation of our management, including our Principal Executive Officer and Principal Financial and Accounting Officer, we conducted an evaluation of any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during our most recently completed fiscal quarter. Based on that evaluation, our Principal Executive Officer and Principal Financial and Accounting Officer concluded that there has not been any change in our internal control over financial reporting during that quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

The information set forth above under Note 11 contained in the “Notes to Condensed Consolidated Financial Statements” is incorporated herein by reference.

In addition to the other information contained in this Quarterly Report on Form 10-Q, the following risk factors should be carefully considered by investors before making an investment decision. We have updated a risk factor relating to personnel from that presented in our Annual Report on Form 10-K, Part I, Item 1A, for the fiscal year ended April 30, 2011. That risk factor is set forth at the end of this section and addresses certain management changes and transitions during fiscal 2012.

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:

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 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 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:

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 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. During the first three months of fiscal 2012, approximately 99% of our sales were made through our channel partners, and 52% 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.

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 and during the first three months of fiscal 2012, 56.3% 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:

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:

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.

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:

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.

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 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 July 31, 2011, we had 129 issued U.S. patents, 66 pending U.S. patent applications (provisional and non-provisional) and 5 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. Injunctive relief could also 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.

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.

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 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.

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:

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.

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 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 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:

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.

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. During fiscal 2012, four executive officers have departed the Company, including: our President and Chief Executive Officer; our Senior Vice President, Field Operations; our Chief Product Officer; and our Senior Vice President, Products and Operations. We also experienced substantial employee attrition in fiscal 2011, particularly in our sales organization. This attrition continued, at a lower rate, in the first quarter of fiscal 2012.

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 executives, 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.

The following table summarizes the stock repurchase activity for the three months ended July 31, 2011 and the approximate dollar value of shares that may yet be purchased under the program:

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

BLUE COAT SYSTEMS, INC.

/s/ Gordon C. Brooks

Gordon C. Brooks

Senior Vice President and Chief Financial Officer

(Principal Financial and Accounting Officer)


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


		Page

Item 1.	Financial Statements		4

	Condensed Consolidated Balance Sheets as of July 31, 2011 and April 30, 2011		4

	Condensed Consolidated Statements of Operations for the Three Months Ended July 31, 2011 and 2010		5

	Condensed Consolidated Statements of Cash Flows for the Three Months Ended July 31, 2011 and 2010		6

	Notes to Condensed Consolidated Financial Statements		7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		22

Item 3.	Quantitative and Qualitative Disclosures about Market Risk		38

Item 4.	Controls and Procedures		39

PART II. OTHER INFORMATION			40

Item 1.	Legal Proceedings		40

Item 1A.	Risk Factors		40

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		54

Item 6.	Exhibits		55

	Signatures		56


	July 31, 2011			April 30, 2011
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	341,399		$	375,939
Accounts receivable, net of allowance of $0 as of July 31, 2011 and April 30, 2011, respectively		67,380			67,626
Inventory		9,904			10,134
Prepaid expenses and other current assets		11,674			14,091
Current portion of deferred income tax assets		10,926			10,399

Total current assets		441,283			478,189
Property and equipment, net		31,092			31,745
Restricted cash		1,031			1,031
Goodwill		242,611			242,611
Identifiable intangible assets, net		21,959			24,970
Non-current portion of deferred income tax assets		36,902			34,650
Other assets		5,902			6,212

Total assets	$	780,780		$	819,408

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	17,315		$	20,806
Accrued payroll and related benefits		15,732			15,947
Deferred revenue		117,208			121,526
Other current liabilities		10,362			10,758

Total current liabilities		160,617			169,037
Deferred revenue, less current portion		57,211			56,546
Deferred rent, less current portion		5,227			5,501
Long-term income taxes payable		38,441			35,152
Other non-current liabilities		734			688
Convertible senior notes		78,360			78,136
Commitments and contingencies
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; 44,686 and 44,527 shares issued and 42,283 and 44,064 shares outstanding at July 31, 2011 and April 30, 2011, respectively		4			4
Additional paid-in capital		1,232,458			1,269,311
Accumulated deficit		(792,272	)		(794,967	)

Total stockholders’ equity		440,190			474,348

Total liabilities and stockholders’ equity	$	780,780		$	819,408


	Three Months Ended July 31,
	2011			2010
Net revenue:
Product	$	58,556		$	75,568
Service		50,953			46,912

Total net revenue		109,509			122,480
Cost of net revenue:
Product		13,764			15,964
Service		12,268			10,388

Total cost of net revenue		26,032			26,352
Gross profit		83,477			96,128
Operating expenses:
Sales and marketing		47,557			44,655
Research and development		19,209			19,855
General and administrative		10,173			10,343
Amortization of intangible assets		1,843			1,843
Restructuring		—			140

Total operating expenses		78,782			76,836

Operating income		4,695			19,292
Interest income		113			164
Interest expense		(235	)		(224	)
Other expense, net		(346	)		(323	)

Income before income taxes		4,227			18,909
Provision for income taxes		1,532			4,984

Net income	$	2,695		$	13,925

Net income per share:
Basic	$	0.06		$	0.30

Diluted	$	0.06		$	0.29

Weighted average shares used in computing net income per share:
Basic		46,718			46,329

Diluted		47,692			47,650


	Three Months Ended July 31,
	2011			2010
Operating Activities
Net income	$	2,695		$	13,925
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		3,515			3,335
Amortization		3,408			3,428
Stock-based compensation		4,478			4,072
Deferred income taxes		(2,779	)		2,264
Tax benefit of stock option deduction		180			137
Excess tax benefit from stock-based compensation		(291	)		(304	)
Loss on disposition of equipment		—			14
Changes in operating assets and liabilities:
Accounts receivable, net		246			(11,364	)
Inventory		230			(4,389	)
Prepaid expenses and other assets		2,554			1,837
Accounts payable		(3,491	)		6,379
Accrued expenses and other liabilities		2,450			3,547
Deferred revenue		(3,653	)		5,670

Net cash provided by operating activities		9,542			28,551
Investing Activities
Purchases of property and equipment, and technology licenses		(2,862	)		(3,599	)
Restricted cash		—			(45	)

Net cash used in investing activities		(2,862	)		(3,644	)
Financing Activities
Net proceeds from issuance of common stock		1,509			443
Payments for repurchases of common stock		(43,020	)		—
Excess tax benefit from stock-based compensation		291			304
Acquisition of noncontrolling interest		—			(427	)

Net cash (used in) provided by financing activities		(41,220	)		320

Net (decrease) increase in cash and cash equivalents		(34,540	)		25,227
Cash and cash equivalents at beginning of period		375,939			236,347

Cash and cash equivalents at end of period	$	341,399		$	261,574


July 31, 2011	Amortization period		Gross Amount		Accumulated Amortization		Net Carrying Value
Developed technology and patents		3-7 years	$	26,031	$	(17,569)	$	8,462
Core technology		5 years		2,929		(2,929)		—
Customer relationships		4-7 years		37,723		(24,226)		13,497
Trade name		2 years		400		(400)		—

Total			$	67,083	$	(45,124)	$	21,959



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


Year Ended April 30,	Amortization
	(in thousands)
Remainder of 2012	$	8,945
2013		11,782
2014		1,232

	$	21,959


	As of
	July 31, 2011		April 30, 2011
	(in thousands)
Deferred product revenue, current	$	885	$	2,286
Deferred service revenue, current		116,323		119,240

Total deferred revenue, current		117,208		121,526
Deferred service revenue, non-current		57,211		56,546

Total deferred revenue	$	174,419	$	178,072


	Level 1		Level 2		Level 3		Total
July 31, 2011:
Money market funds (1)	$	302,910	$	—	$	—	$	302,910
April 30, 2011:
Money market funds (1)	$	315,837	$	—	$	—	$	315,837


Warranty obligation at April 30, 2011	$	521
Warranties issued during the period		532
Warranty costs incurred during the period		(521	)

Warranty obligation at July 31, 2011	$	532


Year ending April 30,	Total
	(in thousands)
Remainder of 2012	$	8,324
2013		10,788
2014		9,032
2015		8,011
2016		4,461
Thereafter		1,510

Total future minimum lease payments, net	$	42,126


	Three Months Ended July 31,
	2011				2010
	(dollars in thousands)
Americas (1)	$	47,852	43.7	%	$	54,612	44.6	%
EMEA (2)		38,157	34.8			42,207	34.4
APAC (3)		23,500	21.5			25,661	21.0

Total net revenue	$	109,509	100.0	%	$	122,480	100.0	%


	Three Months Ended July 31,
	2011		2010
Included in cost of net revenue	$	1,168	$	1,188
Included in operating expenses		1,843		1,843

Total	$	3,011	$	3,031


	As of July 31, 2011			As of April 30, 2011
	(dollars in thousands)
Cash and cash equivalents	$	341,399		$	375,939
Restricted cash		1,031			1,031

Total cash and cash equivalents and restricted cash	$	342,430		$	376,970

Percentage of total assets		43.9	%		46.0	%


(in thousands, except per share amounts)	Total Number of Shares Purchased		Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Programs		Approximate Dollar Value of Shares that May Yet Be Purchased Under the Programs
May 1, 2011 – May 31, 2011		211	$	22.79		211	$	45,200
June 1, 2011 – June 30, 2011		1,709	$	22.36		1,709	$	6,979
July 1, 2011 – July 31, 2011		—	$	—		—	$	6,979

Total		1,920	$	22.41		1,920


Number		Description

10.82		Offer Letter Agreement by and between Blue Coat Systems, Inc. and Gregory S. Clark dated August 10, 2011 (which is incorporated herein by reference to Exhibit 10.1 of Form 8-K filed by the Registrant with the Commission on August 16, 2011).

10.83		CEO Change in Control Severance Agreement, between the Company and its Chief Executive Officer, effective August 10, 2011 (which is incorporated herein by reference to Exhibit 10.2 of Form 8-K filed by the Registrant with the Commission on August 16, 2011).

10.84		Separation agreement, dated August 17, 2011, between Michael J. Borman and Blue Coat Systems, Inc. (which is incorporated by reference to Exhibit 10.1 of Respondent’s 8-K filed with the Commission on August 18, 2011)

10.85		Separation agreement, dated August 17, 2011, between Kevin T. Biggs and Blue Coat Systems, Inc. (which is incorporated by reference to Exhibit 10.1 of Respondent’s 8-K filed with the Commission on August 22, 2011)

31.1		Principal Executive Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Principal Financial and Accounting Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Principal Executive Officer and Principal Financial and Accounting Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS*		XBRL Instance Document

101.SCH*		XBRL Taxonomy Extension Schema Document

101.CAL*		XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF*		XBRL Taxonomy Extension Definition Linkbase Document

101.LAB*		XBRL Taxonomy Extension Label Linkbase Document

101.PRE*		XBRL Taxonomy Extension Presentation Linkbase Document