10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

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

FOR THE QUARTERLY PERIOD ENDED JULY 31, 2007

OR

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

FOR THE TRANSITION PERIOD FROM              TO             

COMMISSION FILE NUMBER 000-28139

BLUE COAT SYSTEMS, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE	91-1715963
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION)	(IRS EMPLOYER IDENTIFICATION)

420 NORTH MARY AVENUE SUNNYVALE, CALIFORNIA	94085
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)	(ZIP CODE)

REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 220-2200

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

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act of 1934).    Yes  ¨    No  x

Indicate the number of shares outstanding of the issuer’s class of common stock, as of the latest practicable date.

CLASS	OUTSTANDING AT AUGUST 31, 2007
Common Stock, par value $.0001	16,179,723

TABLE OF CONTENTS

		PAGE
PART I. FINANCIAL INFORMATION		4
Item 1.	Condensed Consolidated Financial Statements	4
	Condensed Consolidated Balance Sheets as of July 31, 2007 and April 30, 2007	4
	Condensed Consolidated Statements of Operations for the three months ended July 31, 2007 and July 31, 2006	5
	Condensed Consolidated Statements of Cash Flows for the three months ended July 31, 2007 and July 31, 2006	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	27
Item 4.	Controls and Procedures	28
PART II. OTHER INFORMATION		29
Item 1.	Legal Proceedings	29
Item 1A.	Risk Factors	29
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	41
Item 3.	Defaults Upon Senior Securities	41
Item 4.	Submission of Matters to a Vote of Security Holders	41
Item 5.	Other Information	41
Item 6.	Exhibits	42
	Signatures	43

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CAUTIONARY STATEMENT

This Quarterly Report on Form 10-Q, and other materials accompanying this quarterly Report on Form 10-Q contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements relate to our future plans, objectives, expectations, intentions and financial performance and the assumptions that underlie these statements. These forward-looking statements include, but are not limited to, statements concerning the following: expectations with respect to future market growth opportunities; changes in and expectations with respect to revenues and gross margins; future operating expense levels; the impact of quarterly fluctuations of revenue and operating results; 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 expansion of our direct and indirect sales forces and marketing activities; the recording of amortization of acquired technology and stock-based compensation; 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.

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PART I: FINANCIAL INFORMATION

Item 1: Condensed Consolidated Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value and shares)

	July 31, 2007			April 30, 2007
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	76,201		$	50,013
Short-term investments		36,758			43,874
Restricted cash equivalents		4,168			4,120
Accounts receivable, net of allowance of $124 and $160, respectively		33,055			32,079
Inventories		317			489
Prepaid expenses and other current assets		6,830			7,536
Total current assets		157,329			138,111
Property and equipment, net		10,584			9,309
Restricted cash		861			861
Goodwill		92,243			92,243
Identifiable intangible assets, net		6,240			6,650
Other assets		1,452			1,500
Total assets	$	268,709		$	248,674
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	7,714		$	12,051
Accrued payroll and related benefits		17,938			11,710
Deferred revenue		45,912			41,910
Accrued restructuring		163			238
Other accrued liabilities		4,706			5,808
Total current liabilities		76,433			71,717
Deferred revenue, less current portion		14,887			13,858
Deferred rent, less current portion		1,453			1,585
Deferred income tax liabilities		546			483
Other non-current liabilities		569			563
Series A redeemable convertible preferred stock; $0.0001 par value; 42 authorized; 42 issued and outstanding at July 31, 2007 and April 30, 2007, respectively (Aggregate liquidation preference: $42,060)		41,879			41,879
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; 15,863 and 15,109 shares issued and outstanding at July 31, 2007 and April 30, 2007, respectively		2			2
Additional paid-in capital		1,040,109			1,028,409
Treasury stock, at cost; 138 shares held at July 31, 2007 and April 30, 2007, respectively		(903	)		(903	)
Accumulated deficit		(906,288	)		(908,930	)
Accumulated other comprehensive income		22			11
Total stockholders’ equity		132,942			118,589
Total liabilities, redeemable convertible preferred stock and stockholders’ equity	$	268,709		$	248,674

See accompanying notes to Condensed Consolidated Financial Statements.

4

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

	Three Months Ended July 31,
	2007			2006
Net revenue:
Product	$	48,076		$	27,260
Service		14,327			9,155
Total net revenue		62,403			36,415
Cost of net revenue:
Product		9,819			7,217
Service		4,792			3,033
Total cost of net revenue		14,611			10,250
Gross profit		47,792			26,165
Operating expenses:
Research and development		11,615			9,180
Sales and marketing		28,614			14,419
General and administrative		5,682			6,174
Amortization of intangible assets		112			188
Total operating expenses		46,023			29,961
Operating income (loss)		1,769			(3,796	)
Interest income		1,247			897
Other expense		(43	)		(120	)
Income (loss) before income taxes		2,973			(3,019	)
Provision for income taxes		331			118
Net income (loss)	$	2,642		$	(3,137	)
Net income (loss) per common share:
Basic	$	0.17		$	(0.22	)
Diluted	$	0.14		$	(0.22	)
Weighted average shares used in computing net income (loss) per common share:
Basic		15,212			14,340
Diluted		19,410			14,340

See accompanying Notes to Condensed Consolidated Financial Statements.

5

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Three Months Ended July 31,
	2007			2006
Operating Activities
Net income (loss)	$	2,642		$	(3,137	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation		1,238			853
Amortization		493			531
Stock-based compensation		4,840			2,944
Gain on disposition of equipment		—			(69	)
Changes in operating assets and liabilities:
Accounts receivable, net		(976	)		(7,853	)
Inventories		172			13
Prepaid expenses and other current assets		706			(1,091	)
Other assets		(35	)		—
Accounts payable		(4,337	)		436
Accrued payroll and related benefits		3,545			(728	)
Other accrued liabilities		(1,117	)		1,791
Restructuring accrual		(75	)		(272	)
Deferred rent		(111	)		79
Deferred income tax liabilities		63			—
Deferred revenue		5,031			8,075
Net cash provided by operating activities		12,079			1,572
Investing Activities
Purchases of investment securities		(29,077	)		(45,834	)
Sales and maturities of investment securities		36,156			6,196
Purchases of property and equipment		(2,513	)		(1,668	)
Sales of property and equipment		—			70
Net cash provided by (used in) investing activities		4,566			(41,236	)
Financing Activities
Net proceeds from issuance of common stock		9,543			35
Net proceeds from sales of Series A redeemable convertible preferred stock		—			41,843
Net cash provided by financing activities		9,543			41,878
Net increase in cash and cash equivalents		26,188			2,214
Cash and cash equivalents at beginning of period		50,013			46,990
Cash and cash equivalents at end of period	$	76,201		$	49,204

See accompanying Notes to Condensed Consolidated Financial Statements.

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Notes to Condensed Consolidated Financial Statements

Note 1. Significant Accounting Policies

Basis of Presentation

The condensed consolidated financial statements include the accounts of Blue Coat Systems, Inc. and those of our subsidiaries, all of which are wholly owned. All inter-company balances and transactions have been eliminated.

The functional currency of our domestic and foreign operations is the United States 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)” in the accompanying condensed consolidated statements of operations. These amounts were not material during three months ended July 31, 2007 and 2006, respectively.

The condensed consolidated financial statements for the three months ended July 31, 2007 and 2006, respectively, include the accounts and operating results of the NetCache business acquired from Network Appliance Inc., beginning September 11, 2006.

Use of Estimates

The preparation of condensed consolidated financial statements and related disclosures in conformity with accounting principles generally accepted in the United States 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 periods. Actual results may differ from these estimates, and such differences could be material to our condensed consolidated financial condition and results of operations.

Revenue Recognition

Our products include software that is essential to the functionality of the appliances. Additionally, we provide unspecified software upgrades and enhancements related to the appliances through our maintenance contracts for most of our products. Accordingly, we account for revenue in accordance with Statement of Position No. 97-2, “Software Revenue Recognition,” and all related interpretations. We recognize revenue when all of the following criteria are met as set forth in paragraph 8 of SOP 97-2: persuasive evidence of an arrangement exists; delivery or performance has occurred; the sales price is fixed or determinable and collectibility is reasonably assured.

We define each of the four criteria above as follows:

Persuasive evidence of an arrangement exists. Evidence of an arrangement generally consists of customer purchase orders and, in certain instances, sales contracts or agreements. Shipping terms and related documents, or written evidence of customer acceptance, when applicable, are used to verify delivery or performance.

Delivery or performance has occurred. Sales are made through distributors under agreements allowing for certain stock rotation rights. Net revenue and the related cost of net revenue, resulting from shipments to distributors are deferred until the distributors report that our products have been sold to a customer. Product revenue in China is deferred until the customer registers the proxy appliance.

For sales made direct to end-users and value-added resellers, we recognize product revenue upon transfer of title and risk of loss, which is generally upon shipment. We do not accept orders from these value-added resellers when we are aware that the value-added reseller does not have an order from a customer. For the end-users and value-added resellers, we do not have significant obligations for future performance such as rights of return or pricing credits.

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.

Collectibility is reasonably assured. Probability of collection is assessed on a customer-by-customer basis. Our customers are subjected to a credit review process that evaluates the customers’ financial condition and ability to pay for our products and services. If it is determined from the outset of an arrangement that collection is not probable based upon the review process, revenue is not recognized until cash receipt.

For products in an arrangement that includes multiple elements, such as appliances, maintenance, content filtering software or anti-virus software, we use the residual method to recognize revenue for the delivered elements. Under the residual method, the amount of revenue allocated to delivered elements equals the total arrangement consideration less the aggregate fair value of any undelivered elements. Vendor specific objective evidence of fair value is based on the price

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charged when the element is sold separately. In some cases, vendor specific objective evidence of fair value is based on management determined prices. For multiple element arrangements in which vendor specific evidence of fair value of the undelivered items, such as maintenance, is not available, the entire arrangement is recognized ratably over the performance period.

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

Cash Equivalents and Short-Term Investments

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

Short-term investments consist primarily of debt securities with original maturities between three months and one year. 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 ability to use such funds for current operations. To date, all of our investments have been classified as available-for-sale and are carried at fair value, with unrealized gains and losses, if any, included in accumulated other comprehensive income (loss) in stockholders’ equity. The fair value of these securities is based on quoted market prices. Realized gains and losses and declines in value of securities judged to be other than temporary are included in other income (expenses). Interest and dividends on all securities are included in interest income.

Inventories

Inventories consist of raw materials and finished goods. Inventories are recorded at the lower of cost or market using the first-in, first-out method, after appropriate consideration has been given to obsolescence and inventory in excess of anticipated future demand. In assessing the ultimate recoverability of inventories, we are required to make estimates regarding future customer demand and market conditions.

Inventories, net, consisted of the following (in thousands):

	July 31, 2007		April 30, 2007
Raw materials	$	118	$	262
Finished goods		199		227
Total	$	317	$	489

Valuation of Goodwill

We perform annual goodwill impairment tests in accordance with Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets, (“SFAS No. 142”) during our fourth fiscal quarter, or whenever events or changes in circumstances indicate that the carrying amount of goodwill may not be recoverable. The first step of the test identifies if potential impairment may have occurred, while the second step of the test measures the amount of the impairment, if any. Impairment is recognized when the carrying amount of goodwill exceeds its fair value. The process of evaluating the potential impairment of goodwill is highly subjective and requires significant judgment. For purposes of the annual impairment test, we consider our market capitalization on the date of the impairment test since we have only one reporting unit. We performed our recurring annual review of goodwill in the fourth quarter of fiscal 2007 and concluded that no impairment existed at April 30, 2007. For the three months ended July 31, 2007, there have been no significant events or change of circumstances affecting the valuation of goodwill.

Valuation of Long-Lived and Identifiable Intangible Assets

We periodically evaluate potential impairments of our long-lived assets, including identifiable intangible assets, in accordance with FASB SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. 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.

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Restructuring Liabilities

Restructuring activities were initiated prior to December 31, 2002 and were recorded in accordance with Emerging Issues Task Force (“EITF”) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring). We have accrued through charges to “Restructuring” various restructuring liabilities related to employee severance costs, facilities closure and lease abandonment costs, and contract termination costs in our condensed consolidated financial statements. The restructuring liabilities for facilities closure and lease abandonment costs include various assumptions, such as the time period over which abandoned facilities will be vacant, expected sublease terms, and expected sublease rates. Such assumptions are routinely assessed and any changes in these assumptions may result in a substantial increase or decrease to restructuring expense should different conditions prevail than were anticipated in original estimates.

Guarantees, Indemnifications and Warranty Obligations

Our customer agreements generally include certain provisions for indemnifying such customers against liabilities if our products infringe a third party’s intellectual property rights. To date, we have not incurred any material costs as a result of such indemnification provisions and 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 with certain of our officers and directors containing 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 expect to have indemnification obligations to certain current and former officers and directors in connection with matters relating to the stock option investigation, as well as with certain of our outstanding litigation matters. We accrue for warranty expenses in our cost of revenue at the time revenue is recognized and maintain an accrual for estimated future warranty obligations based upon the relationship between historical and anticipated warranty costs and revenue volumes. If actual warranty expenses are greater than those projected, additional charges against earnings would be required. If actual warranty expenses are less than projected, obligations would be reduced, providing a positive impact on our reported results. We generally provide a one-year warranty on hardware products and a 90-day warranty on software products.

Changes in our warranty obligations, which are included in “Other accrued liabilities,” for the three months ended July 31, 2007 and 2006, respectively, were as follows (in thousands):

	Three Months Ended July 31,
	2007			2006
Beginning balances	$	459		$	319
Warranties issued during the period		472			319
Settlements made during the period		(459	)		(319	)
Ending balances	$	472		$	319

Income Taxes

On May 1, 2007, the Company adopted Financial Accounting Standards Board Interpretation No. 48 “Accounting for Uncertainty in Income Taxes” (FIN 48). FIN 48 prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition issues.

We record a valuation allowance to reduce our 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 deem that it is more likely than not that all tax attributes will be fully supportable by either refundable income taxes or future taxable income, the reduction in valuation allowance will result in a discrete event during the quarter that it occurs. Likewise, should we determine that we are not able to realize all or part of our deferred tax assets in the future, an adjustment to deferred tax assets would be charged to earnings in the period such determination was made.

9

Stock-Based Compensation

Effective May 1, 2006, we adopted the fair value recognition provisions of SFAS No.123(R), “Share-Based Payment,” using the modified prospective transition method. Under that transition method, compensation cost recognized in the three months ended July 31, 2006 included: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of May 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No.123, and (b) compensation cost for all share-based payments granted on or after May 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No.123(R). Because we elected to use the modified prospective transition method, results for prior periods have not been restated. In March 2005, the SEC issued Staff Accounting Bulletin (SAB) No. 107, which provides supplemental implementation guidance for SFAS No.123(R). We have applied the provisions of SAB No.107 in its adoption of SFAS No.123(R).

We estimate the fair value of stock options granted using the Black-Scholes option valuation model. For options granted before May 1, 2006, we amortize the fair value on an accelerated basis. For options granted on or after May 1, 2006, we amortize the fair value on a straight-line basis. All options are amortized over the requisite service periods of the awards, which are generally the vesting periods.

In November 2005, the FASB issued FASB Staff Position No. FAS123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards” (“FAS 123(R)-3”). We have adopted the simplified method to calculate the beginning balance of the additional paid-in-capital (“APIC”) pool of the excess tax benefit, and to determine the subsequent impact on the APIC pool and our Statements of Cash Flows of the tax effects of employee stock-based compensation awards that were outstanding upon our adoption of SFAS No.123(R).

Concentration and Other Risks

Financial instruments that potentially subject us to credit risk consist of demand deposit accounts, money market accounts, commercial paper, corporate debt securities and trade receivables. We maintain demand deposit and money market accounts with financial institutions of high credit standing. We invest only in high-quality, investment grade securities and limit investment exposure in any one issue. Investments are classified as cash equivalents and short-term investments in our condensed consolidated balance sheets as of July 31, 2007 and April 30, 2007, respectively. We believe the financial risks associated with these financial instruments are minimal. We have not experienced material losses from our investments in these securities.

Generally, we do not require collateral for sales to customers. However, we perform on-going credit valuations of our customers’ financial condition and maintain an allowance for doubtful accounts. Westcon Group Inc. is a distributor that accounted for 11.4% of our net revenue during the three months ended July 31, 2007. No customer accounted for more than 10.0% of our net revenue during the three months ended July 31, 2006. As of July 31, 2007 and April 30, 2007, no customer accounted for more than 10.0% of gross accounts receivable, respectively.

We currently purchase several key parts and components used in the manufacture of our products from a limited number of suppliers. Generally we have been able to obtain an adequate supply of such parts and components. However, an extended interruption in the supply of parts and components currently obtained from our suppliers could adversely affect our business and condensed consolidated financial statements.

Contingencies

From time to time we are involved in various claims and legal proceedings. If management believes that a loss arising from these matters is probable and can reasonably be estimated, we record the amount of the loss, or the minimum estimated liability when the loss is estimated using a range, and no point within the range is more probable than any other. As additional information becomes available, any potential liability related to these matters is assessed and the estimates are revised, if necessary. Litigation is subject to inherent uncertainties, and unfavorable rulings could occur. An unfavorable ruling could result in a material adverse impact on the results of operations for the period in which the ruling occurs, or future periods.

Comprehensive Income

We report comprehensive income in accordance with FASB SFAS No. 130, Reporting Comprehensive Income. Included in other comprehensive income are adjustments to record unrealized gains and losses on available-for-sale securities. These adjustments are accumulated in “Accumulated other comprehensive income (loss)” in the stockholders’ equity section of the balance sheet.

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Significant components of our comprehensive income (loss) are as follows (in thousands):

	Three Months Ended July 31,
	2007		2006
Net income (loss)	$	2,642	$	(3,137	)
Unrealized gain on available-for-sale securities		11		1
Comprehensive income (loss)	$	2,653	$	(3,136	)

Recent Accounting Pronouncements

In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115. SFAS No. 159 allows measurement at fair value of eligible financial assets and liabilities that are not otherwise measured at fair value. If the fair value option for an eligible item is elected, unrealized gains and losses for that item shall be reported in current earnings at each subsequent reporting date. SFAS No. 159 also establishes presentation and disclosure requirements designed to draw comparison between the different measurement attributes the company elects for similar types of assets and liabilities. This statement is effective for our fiscal year beginning May 1, 2008. We are currently evaluating the effect, if any, that the adoption of SFAS No. 159 will have on our condensed consolidated financial statements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements. SFAS No. 157 provides a framework for measuring fair value, clarifies the definition of fair value, and expands disclosures regarding fair value measurements. SFAS No. 157 does not require any new fair value measurements and eliminates inconsistencies in guidance found in various prior accounting pronouncements. We are required to adopt SFAS No. 157 for our fiscal year beginning May 1, 2008. We are currently evaluating the effect that the adoption of SFAS No. 157 will have on our condensed consolidated results of operations and financial condition, but do not expect it to have a material impact.

Note 2. Stock-based Compensation

We have adopted several stock incentive plans providing stock-based awards to employees, directors, advisors and consultants, including stock options and restricted stock awards. We also have an Employee Stock Purchase Plan (“ESPP”), which enables employees to purchase shares of our common stock.

Impact of the Adoption of SFAS 123(R)

See Note 1 for a description of our adoption of SFAS 123(R), “Share-Based Payment,” on May 1, 2006. The following table summarizes the stock-based compensation expense for stock options, restricted stock awards and our ESPP that we recorded in the condensed consolidated statements of operations in accordance with SFAS 123(R) for the three months ended July 31, 2007 and 2006, respectively (in thousands):

	Three Months Ended July 31, 2007		Three Months Ended July 31, 2006
Stock-based compensation expense:
Cost of product	$	268	$	134
Cost of service		227		137
Research and development		1,686		939
Sales and marketing		1,637		1,023
General and administrative		1,022		711
Total	$	4,840	$	2,944

As a result of our investigation into our historical stock option granting practices, we determined that the measurement dates for a number of stock option grants made by us during the period from November 1999 to May 2006 differed from the measurement dates previously used to account for such grants, which resulted in a lower exercise price for those options than the fair market value on the actual grant date. As such, certain affected stock options were deemed, for accounting purposes, to have been issued at a discount, which could expose the holders of those options to potentially adverse tax consequences under Section 409A of the Internal Revenue Code and state law equivalents. We offered certain individuals the opportunity

11

to increase the exercise price of the discounted options to the fair market value on the actual grant date of that option in order to avoid the potentially adverse tax consequences. As a result of the offer, we amended outstanding options covering 894,040 shares of our common stock. In addition, the participants whose options were amended are now eligible for special cash bonuses in the aggregate amount of $2.7 million to compensate them for the higher exercise prices per share in effect for their amended options. The impact of the bonus, which was recorded during the first quarter of fiscal 2008, resulted in a decrease to additional paid-in capital of $1.2 million, an increase in stock-based compensation expense of $1.5 million and an increase in payroll tax expenses of $0.2 million. Under Section 409A, the cash bonus cannot be paid in the same calendar year in which the options are amended. As a result, the cash bonus will be paid in January 2008.

Determining Fair Value

• Valuation and Amortization Method. We estimate the fair value of stock options granted using the Black-Scholes option valuation model. For options granted before May 1, 2006, we amortize the fair value on a graded basis. For options granted on or after May 1, 2006, we amortize the fair value of stock-based compensation on a straight-line basis for options expected to vest. All options are amortized over the requisite service periods of the awards, which are generally the vesting periods.

• Expected Term. The expected term of options granted represents the period of time that they are expected to be outstanding. We estimate the expected term of options granted based on our historical experience of grants, exercises and post-vesting cancellations. Contractual term expirations have not been significant.

• Expected Volatility. We estimate the volatility of our stock options at the date of grant using a combination of historical and implied volatilities, consistent with SFAS No. 123(R) and SEC Staff Accounting Bulletin No. 107. Historical volatilities are calculated based on the historical prices of our common stock over a period equal to the expected term of our option grants, while implied volatilities are derived from publicly traded options of our common stock. Prior to the adoption of SFAS No. 123(R), we relied exclusively on the historical prices of our common stock in the calculation of expected volatility.

• Expected Forfeitures. Stock-based compensation expense under SFAS No. 123(R) is based on awards ultimately expected to vest, and requires that forfeitures be estimated at the time of grant and revised, if necessary, if actual forfeitures differ from those estimates. We estimated our forfeiture rate at 10% based on an analysis of historical pre-vesting forfeitures, and have reduced stock-based compensation expense accordingly.

• Risk-Free Rate. The risk-free interest rate that we use in the Black-Scholes option valuation model is the implied yield in effect at the time of option grant based on U.S. Treasury zero-coupon issues with a remaining term equivalent to the expected term of our option grants.

• Dividends. We have never paid any cash dividends on our common stock and we do not anticipate paying any cash dividends in the foreseeable future. Consequently, we use an expected dividend yield of zero in the Black-Scholes option valuation model

We used the following assumptions to estimate the fair value of options granted and shares purchased under our employee stock purchase plan for the three months ended July 31, 2007 and 2006:

	Stock Options Three months ended July 31,				Employee Stock Purchase Plan Three months ended July 31,
	2007		2006		2007		2006
Risk-free rate	4.98	%	5.22	%	5.06	%	—
Expected dividend yield	—		—		—		—
Expected life (in years)	4.63		4.63		0.5		—
Expected volatility	0.61		0.76		0.41		—
Expected forfeitures	10	%	10	%	—		—

As of July 31, 2007, there was approximately $27.8 million and $0.2 million of unrecognized stock-based compensation expense, related to stock option grants and ESPP awards, which will be recognized over the remaining weighted average vesting period of approximately 2.56 years and 0.1 years, respectively.

The cost of restricted stock 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 is generally four years. As of July 31, 2007, there was

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approximately $5.7 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to restricted stock, which will be recognized over the remaining weighted average vesting period of approximately 3.8 years.

2007 New Employee Stock Incentive Plan

On June 12, 2007, the Board of Directors approved the 2007 New Employee Stock Incentive Plan (the “2007 Plan”), under which 400,000 shares of common stock were reserved for issuance. The Plan was adopted for the purpose of granting employment inducement awards to newly hired employees. In accordance with the exemption provided by NASDAQ Marketplace Rule 4350(i)(l)(A)(iv), the Plan was adopted without shareholder approval. The Plan automatically will terminate on the tenth anniversary of the adoption of the Plan. We have announced our intention to terminate the Plan in the event a new employee equity incentive plan is approved by our stockholders at our next annual meeting.

Note 3. Balance Sheet Details

Cash Equivalents and Investments

The carrying amount of cash and cash equivalents reported on the balance sheet approximates its fair value. Short-term investments consist of marketable debt securities. The fair values of investments are based upon quoted market prices.

The following is a summary of cash, cash equivalents and available-for-sale securities as of July 31, 2007 and April 30, 2007, respectively (in thousands):

	As of July 31, 2007						As of April 30, 2007
	Amortized Cost		Unrealized Gain		Estimated Fair Value		Amortized Cost		Unrealized Loss		Estimated Fair Value
Cash	$	1,161	$	—	$	1,161	$	737	$	—	$	737
Money market funds		52,305		—		52,305		37,500		—		37,500
Commercial paper		44,362		1		44,363		33,675		—		33,675
Corporate securities		12,456		3		12,459		16,244		1		16,245
Government securities		3,976		16		3,992		2,977		9		2,986
Auction rate preferred securities		3,706		2		3,708		7,724		1		7,725
	$	117,966	$	22	$	117,988	$	98,857	$	11	$	98,868
Reported as:
Cash and cash equivalents					$	76,201					$	50,013
Short-term investments						36,758						43,874
Short-term restricted cash equivalents						4,168						4,120
Long-term restricted cash						861						861
					$	117,988					$	98,868

The following is a summary of the cost and estimated fair value of cash, cash equivalents and available-for-sale securities at July 31, 2007, by contractual maturity (in thousands):

	July 31, 2007
	Amortized Cost		Estimated Fair value
Mature in one year or less	$	117,966	$	117,988

In the table above, we reflected the duration of $3.7 million of auction rate securities based on their reset feature. Rates in these securities typically reset in one year or less.

To date we have not recorded any impairment charges on marketable securities related to other-than-temporary declines in market value. We recognize an impairment charge when the decline in the estimated fair value of a marketable security below the amortized cost is determined to be other-than-temporary. We consider various factors in determining whether to recognize an impairment charge, including the duration of time and the severity to which the fair value has been less than our amortized cost, any adverse changes in the investees’ financial condition and our intent and ability to hold the marketable security for a period of time sufficient to allow for any anticipated recovery in market value.

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Intangible Assets

Our acquired intangible assets are as follows (in thousands):

July 31, 2007	Amortization period	Gross Amount		Accumulated Amortization			Net Carrying Value
Developed technology	3-7 years	$	6,031	$	(2,282	)	$	3,749
Core technology	5 years		2,929		(1,657	)		1,272
Customer relationships	5-7 years		2,023		(804	)		1,219
Total		$	10,983	$	(4,743	)	$	6,240
April 30, 2007	Amortization period	Gross Amount		Accumulated Amortization			Net Carrying Value
Developed technology	3-7 years	$	6,031	$	(2,114	)	$	3,917
Core technology	5 years		2,929		(1,511	)		1,418
Customer relationships	5-7 years		2,023		(708	)		1,315
Total		$	10,983	$	(4,333	)	$	6,650

Total amortization expense for the identifiable intangible assets was approximately $0.4 million and $0.5 million for the three months ended July 31, 2007 and 2006, respectively. As of July 31, 2007, we had no identifiable intangible assets with indefinite lives. The weighted average life of identifiable intangible assets was 6.3 years as of July 31, 2007 and 2006, respectively.

Amortization expense related to intangible assets in future periods is as follows (in thousands):

Year Ended April 30,	Amortization
2008 (remaining nine months)	$	1,229
2009		1,557
2010		1,197
2011		869
2012		781
Thereafter		607
	$	6,240

Restructuring Accrual

As of July 31, 2007, substantially all actions under the February 2002, August 2001, and February 2001 restructuring plans were completed, except for payment of future rent obligations of $0.2 million, which are to be paid in cash through fiscal year 2008. We incurred restructuring charges, comprised of employee severance costs, facilities closures and lease abandonment costs, and contract termination costs, to significantly reduce operating expenses and to further align our cost structure with market conditions, future revenue expectations and planned future product direction. Various adjustments to the restructuring accrual have been made to date for abandoned space as a result of changes to market information included in our original estimates. There were no significant changes in estimates on sublease income related to these facilities during the three month ended July 31, 2007.

The following table summarizes restructuring activity during the three months ended July 31, 2007:

	Abandoned Lease Space Accrual
Balances as of April 30, 2007	$	238
Cash payments		(75	)
Balances as of July 31, 2007		163
Less: current portion		163
Long-term restructuring accrual	$	—

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Note 4. Per Share Amounts

Basic net income per common share and diluted net income per common share are presented in conformity with FASB SFAS No. 128, Earnings Per Share, for all periods presented. Basic net income per share is computed by dividing net income (loss) by the weighted-average number of shares outstanding during the period. 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 assuming the (i) exercise of dilutive stock options and warrants using the treasury stock method; (ii) issuance of committed but unissued stock awards; and (iii) shares issuable upon the assumed conversion of outstanding Series A Preferred Stock. For periods for which there is a net loss, the numbers of shares used in the computation of diluted net loss per share are the same as those used for the computation of basic net loss per share as the inclusion of dilutive securities would be anti-dilutive.

For the three months ended July 31, 2007 and 2006, approximately 0.4 million and 1.9 million shares, respectively, attributable to outstanding stock options were excluded from the calculation of diluted net income per share because their inclusion would have been anti-dilutive as their exercise prices were greater than or equal to the average market price of the common shares during the respective periods.

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 (in thousands, except per share amounts):

	Three Months Ended July 31,
	2007		2006
Net income (loss) available to common stockholders	$	2,642	$	(3,137	)
Basic:
Weighted average common shares used in computing basic net income per common share		15,212		14,340
Basic income (loss) per common share	$	0.17	$	(0.22	)
Diluted:
Weighted average common shares used in computing basic net income per common share		15,212		14,340
Add: Weighted average employee stock options, and warrants		1,742		—
Add: Other weighted average dilutive potential common stock		56		—
Add: Series A Redeemable Convertible Preferred Stock ( as converted)		2,400		—
Weighted average common shares used in computing diluted net income per common share		19,410		14,340
Diluted income (loss) per common share	$	0.14	$	(0.22	)

Note 5. Commitments

Leases

We lease certain equipment and office facilities under non-cancelable operating leases that expire at various dates through 2011. 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 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.

As of July 31, 2007, future minimum lease payments under non-cancelable operating leases with initial or remaining terms in excess of one year are as follows (in thousands):

Year ending April 30,	Abandoned		In Use		Total
2008 (remaining nine months)	$	124	$	2,687	$	2,811
2009		—		3,194		3,194
2010		—		2,737		2,737
2011		—		1,003		1,003
2012		—		233		233

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Year ending April 30,	Abandoned		In Use		Total
Thereafter		—		320		320
Total minimum lease payments	$	124	$	10,174	$	10,298

Rent expense was $1.0 million and $0.8 million for the three months ended July 31, 2007 and 2006, respectively. For the total operating lease commitments for abandoned facilities, as summarized above, a reserve for $0.2 million has been provided and is included in the captions “Accrued restructuring reserve” in the accompanying condensed consolidated balance sheet at July 31, 2007.

In September 2005, we commenced a five-year operating lease of a building that serves as our headquarters in Sunnyvale, California. As part of this agreement, we are required to maintain a $0.4 million irrevocable standby letter of credit with a major financial institution as a form of security. The letter of credit is secured by deposits and provides for automatic annual extensions, without amendment, through the end of the lease term in August 2010. During the fiscal year 2007, the letter of credit was increased by $0.5 million due to a leasehold improvement, resulting in a balance of $0.9 million as of April 30, 2007. There was no change incurred for the three months ended July 31, 2007. The deposits securing the letter of credit are classified as “Long-term restricted cash” in the accompanying condensed consolidated balance sheets as of July 31, 2007 and April 30, 2007, respectively.

Other

In connection with our NetCache asset acquisition in September 2006, we entered into an escrow agreement pursuant to which we deposited in escrow $4.0 million, primarily to secure certain indemnification obligations of Network Appliance related to this transaction until December 2008. As of July 31, 2007 and April 30, 2007, the balance in this escrow account grew to $4.2 million and $4.1 million, respectively, due to accumulating interest. Such amount is classified as “Short-term restricted cash equivalents” in the accompanying condensed consolidated balance sheets as of July 31, 2007 and April 30, 2007, respectively.

As a result of our investigation into our historical stock option granting practices, we determined that the measurement dates for a number of stock option grants made by us during the period from November 1999 to May 2006 differed from the measurement dates previously used to account for such grants, which resulted in a lower exercise price for those options than the fair market value on the actual grant date. As such, for certain, affected stock options were deemed, for accounting purposes, to have been issued at a discount, which could expose the holders of those options to potentially adverse tax consequences under Section 409A of the Internal Revenue Code and state law equivalents. We offered certain individuals the opportunity to increase the exercise price of the discounted options to the fair market value on the actual grant date of that option, in order to avoid the potentially adverse tax consequences. As a result of the offer, we amended outstanding options covering 894,040 shares of our common stock. In addition, the participants whose options were amended are now eligible for special cash bonuses in the aggregate amount of $2.7 million to compensate them for the higher exercise prices per share in effect for their amended options. The impact of the bonus, which was recorded during the first quarter of fiscal 2008, resulted in a decrease to additional paid-in capital of $1.2 million, an increase in stock-based compensation expense of $1.5 million and an increase in payroll tax expenses of $0.2 million. Under Section 409A, the cash bonus can not be paid in the same calendar year in which the options are amended. As a result, the cash bonus will be paid in January 2008.

In addition, we have firm purchase and other commitments with various suppliers and contract manufacturers to purchase component inventory, manufacturing material and equipment. These agreements are enforceable and legally binding against us in the short-term and all amounts under these arrangements are due in fiscal 2009. Our minimum obligation at July 31, 2007 under these arrangements was $7.1 million.

Note 6. Income Taxes

The estimated annual effective tax rate for fiscal 2008 is expected be approximately 7.5%. The provision is primarily foreign corporate income taxes currently due, U.S. taxes related to the acquisition of the NetCache business from Network Appliance, Inc. and U.S. alternative minimum taxes. The primary difference between the estimated annual effective tax rate of 7.5% and the federal statutory tax rate relates to the projected utilization of net operating loss carryforwards. The provision for income taxes for the three months ended July 31, 2007 was $331,000.

In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“FAS 109”). This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition of tax benefits, classification on the balance sheet, interest and penalties, accounting in interim periods, disclosure, and transition.

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We adopted FIN 48 effective May 1, 2007. As a result of the implementation of FIN 48, we did not recognize a cumulative adjustment to the May 1, 2007 balance of retained earnings as the amount was deemed immaterial.

As of May 1, 2007, we have unrecognized tax benefits of approximately $2.2 million. Included in the balance of unrecognized tax benefits as of May 1, 2007, is approximately $1.4 million of tax benefits that, if recognized, would result in an adjustment to our effective tax rate and approximately $200k of tax benefits that, if recognized, would result in an adjustment to goodwill.

In accordance with FIN 48, paragraph 19, we have decided to classify interest and penalties related to uncertain tax positions as a component of its provision for income taxes. Accrued interest and penalties relating to the income tax on the unrecognized tax benefits as of April 30, 2007 and July 31, 2007, was approximately $19,000 and $23,000, respectively, with approximately $4,000 being included as a component of provision for income taxes in the quarter ended July 31, 2007.

Due to our taxable loss position since inception, all tax years are subject to examination in the U.S. and state jurisdictions. We are also subject to examination in various foreign jurisdictions for tax years 2000 forward, none of which were individually material. We do not expect that the amounts of unrecognized tax benefits will change significantly within the next twelve months.

Note 7. Litigation

With regard to the matters discussed below, although we cannot predict whether the IPO allocation cases will settle as proposed, and cannot predict the outcome of the derivative litigation, the SEC and other regulatory investigations, or the eSoft patent litigation, the costs of defending these matters (including, as applicable, our obligations to indemnify current or former officers, directors, or employees) could have a material adverse effect on our results of operations and financial condition.

Periodically, we review the status of each significant matter and assess potential financial exposure. Because of the uncertainties related to the (i) determination of the probability of an unfavorable outcome and (ii) amount and range of loss in the event of an unfavorable outcome, we are unable to make a reasonable estimate of the liability that could result from any pending litigation described below and no accrual has been recorded in our balance sheet as of April 30, 2007. As additional information becomes available, we will reassess the probability and potential liability related to pending litigation, which could materially impact our results of operations and financial condition.

From time to time and in the ordinary course of business, we may be subject to various other claims and litigation. Such claims could result in the expenditure of significant financial and other resources.

eSoft, Inc. v. Blue Coat Systems, Inc.

On March 13, 2006, eSoft, Inc. filed a complaint for patent infringement against us in the U.S. District Court for the District of Colorado. The complaint alleges infringement of eSoft’s U.S. Patent 6,961,773 (the “‘773 Patent”), and seeks unspecified monetary damages as well as an injunction against future infringements. eSoft’s amended complaint, filed on June 9, 2006, identified our ProxySG and ProxyAV products as the alleged infringing products. eSoft has subsequently alleged damages in the form of lost profits and/or a reasonable royalty for use of its patented technology.

We answered the amended complaint denying infringement and contending that eSoft’s patent was invalid. In addition, we have requested the United States Patent Office to initiate inter partes reexamination proceedings for the ‘773 Patent in light of a number of prior art references not considered by the patent examiner during the original prosecution of the patent application. That request has been granted and the reexamination proceedings are now underway. The District Court has stayed the litigation pending the outcome of these proceedings and no trial date has been set.

On October 31, 2006, eSoft filed a complaint for declaratory relief seeking a determination that our U.S. Patent 7,103,794 was invalid and/or that eSoft’s products did not infringe same. We answered this complaint on November 22, 2006, denying eSoft’s contentions, and, in a counterclaim, asserted our ‘794 Patent against eSoft’s InstaGate and ThreatWall Security Gateways. This case is also pending in the U.S. District Court for the District of Colorado and likewise has been stayed pending the outcome of the reexamination of the ‘773 Patent. No trial date has been set.

IPO Allocation Litigation.

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

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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. This is one 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 IPO’s 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 litigation is now in discovery. In June 2004, a stipulation of settlement and release of claims against the issuer defendants, including us, was submitted to the court for approval. The terms of the settlement, if approved, would dismiss and release all claims against the issuer and individual defendants (including us). In exchange for this dismissal, D&O insurance carriers for the issuer and individual defendants would agree to guarantee a recovery by the plaintiffs from the underwriter defendants of at least $1 billion, and the issuer defendants would agree to an assignment or surrender to the plaintiffs of certain claims the issuer defendants may have against the underwriters. On August 31, 2005, the court confirmed preliminary approval of the settlement. On April 24, 2006, the court held a fairness hearing in connection with the motion for final approval of the settlement. The court has yet to issue a ruling on the motion for final approval. The settlement remains subject to a number of conditions, including final court approval. On December 5, 2006, the Court of Appeals for the Second Circuit reversed the court’s October 2004 order certifying a class in six test cases that were selected by the underwriter defendants and plaintiffs in the coordinated proceeding. On April 6, 2007, the Court of Appeals issued an Order denying rehearing, but stating that the Court’s prior decision did not “preclude … the [plaintiffs] from returning to the District Court to seek certification of a more modest class.” We are not one of the test cases and it is unclear what impact this will have on the class certified in our case or upon the agreed settlement.

Derivative Litigation.

On May 18, 2005, a purported shareholder derivative action was filed in the Superior Court of California, Santa Clara County, alleging that certain of our officers and directors violated their fiduciary duties to the Company by making false or misleading statements about our prospects between February 20, 2004 and May 27, 2004. On July 17, 2006, plaintiffs filed a consolidated amended complaint, adding allegations that certain current and former officers and directors violated their fiduciary duties to us since our initial public offering by granting and failing to account correctly for stock options. The amended complaint seeks various relief on our behalf from the individual defendants. On September 8, 2006, another and substantively identical purported shareholder derivative action was filed against certain of our current and former officers and directors. Both of these state derivative cases have been consolidated.

On August 8 and September 5, 2006, two purported shareholder derivative actions were filed in the United States District Court for the Northern District of California against certain of our current and former officers and directors. Like the state derivative actions, the federal derivative actions allege that certain of our current and former officers and directors violated their fiduciary duties since our initial public offering by granting and failing to account correctly for stock options and seek various relief on our behalf from the individual defendants. Both of these federal cases have been consolidated.

Regulatory Investigations.

In July 2006, we were advised that the SEC was conducting an informal inquiry into our historical stock option grants and accounting practices, In the Matter of Blue Coat Systems, Inc., SF-3165. We are cooperating with the investigation. We are also voluntarily cooperating with requests for information from the U.S. Attorney’s Office for the Northern District of California.

In late 2005, the SEC informed us of its formal investigation into trading in certain securities, In the Matter of Trading in Certain Securities, H0-9818, including trading in our securities, prior to our public announcement on May 27, 2004 of our financial results for the fourth quarter and fiscal year 2004. The SEC also informed us that we are the subject of a formal order of private investigation, In the Matter of Blue Coat Systems, Inc., HO-10096, concerning whether certain present or former officers, directors, employees, affiliates or others made intentional or non-intentional selective disclosures of material nonpublic information in connection with our May 27, 2004 announcement, traded in our stock while in possession of such information, or communicated such information to others who thereafter traded in our stock. The SEC subpoenaed information from us and took testimony from certain current and former officers in the summer of 2005.

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Note 8. Geographic and Product Category Information Reporting

We conduct business in one operating segment to design, develop, market and support proxy appliances in support of the Secure Web Gateway and Wide Area Network (“WAN”) Application Delivery markets. 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 product categories: product and service. Total international revenue consists of sales from our U.S. operations to non-affiliated customers in other geographic regions. During the three months ended July 31, 2007 and 2006, there were no intra-company sales, and no material long-lived assets were located in our foreign subsidiaries.

Operating decisions regarding the costs of our products and services are made with information that is consistent with the presentation in the accompanying condensed consolidated statements of operations. Therefore, we currently believe it is impractical to separately present such costs.

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

	Three months ended July 31,
	2007				2006(1)
	$		%		$		%
North America	$	30,802	49.4	%	$	17,732	48.7	%
EMEA (2)		22,557	36.1			13,087	35.9
CALA (3)		241	0.4			238	0.7
Asia		8,803	14.1			5,357	14.7
Total net revenue	$	62,403	100.0	%	$	36,415	100.0	%

(1) Amounts for the three months ended July 31, 2006 have been reclassified to conform to current period presentation.

(2) Europe, Middle East, and Africa (“EMEA”)

(3) Central America and Latin America (“CALA”)

The following is a summary of net revenue by product category (in thousands):

	Three months ended July 31,
	2007				2006
	$		%		$		%
Product	$	48,076	77.0	%	$	27,260	74.9	%
Service		14,327	23.0			9,155	25.1
Total net revenue	$	62,403	100.0	%	$	36,415	100.0	%

Substantially all of our long-lived assets are located in the United States.

Note 9. Subsequent event

On August 16, 2007, our Board of Directors approved a two-for-one forward stock split of our common stock. The stock split will be effected by the issuance of a stock dividend of one share of our common stock for each share of our common stock issued and outstanding as of the record date of September 13, 2007. The shares of our common stock resulting from the stock split will be issued by our transfer agent. Following the stock split, we will have approximately 36.3 million shares outstanding, on an as converted basis, based on the number of shares outstanding as of August 21, 2007. We will begin trading on the NASDAQ Global Market on a split-adjusted basis on October 3, 2007.

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

This Quarterly Report on Form 10-Q, and other materials accompanying this quarterly Report on Form 10-Q contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements relate to our future plans, objectives, expectations, intentions and financial performance and the assumptions that underlie these statements. These forward-looking statements include, but are not limited to, statements concerning the following: expectations with respect to future market growth opportunities; changes in and expectations with respect to revenues and gross margins; future operating expense levels; the impact of quarterly fluctuations of revenue and operating results; 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 expansion of our direct and indirect sales forces and marketing activities; the recording of amortization of acquired technology and stock-based compensation; 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.

Recent Events

On August 16, 2007, our Board of Directors approved a two-for-one forward stock split of our common stock. The stock split will be effected by the issuance of a stock dividend of one share of our common stock for each share of our common stock issued and outstanding as of the record date of September 13, 2007. The shares of our common stock resulting from the stock split will be issued by our transfer agent. We will begin trading on the NASDAQ Global Market on a split-adjusted basis on October 3, 2007. All share numbers in this document reflect the capital structure as of the end of the fiscal quarter and are therefore on a pre-split basis.

Overview

We sell a family of products, including both intelligent hardware appliances and software, that secure and accelerate the delivery of business applications and other information over a Wide Area Network (“WAN”), or the public Internet (also known as the Web). Our products accelerate the performance of our customers’ business applications, and work with both applications on a customer’s computer systems and applications hosted by external providers. In addition to enhancing the performance of applications, our products also allow customers to more safely use the Internet by providing security from malicious code and inappropriate content. Our appliances also enable policy-based control and centralized management of communications between users and applications across the WAN, Internet and customers’ internal networks.

We were incorporated in Delaware on March 13, 1996 as Web Appliance Inc. We changed our name to CacheFlow, Inc. on March 25, 1996, and completed our initial public offering on November 19, 1999. When we began trading in the public market in November 1999 as CacheFlow, Inc., our business was focused on Web application and content caching, a technology designed to enhance the performance of Web-based applications. Over time we augmented our proxy appliances with the ability to implement customer-defined policies, together with enhanced proxy capabilities, to enable them to also control and secure Web-based communications and applications. We changed our name to Blue Coat Systems, Inc. in 2002 to reflect the change in our business strategy.

Today, we are a leader in the Secure Web Gateway market (a market category defined by Gartner, Inc., a leading information and technology research and advisory firm). We aspire to be the leader in the WAN Application Delivery market (a new market category defined by IDC, a leading information and technology research and advisory firm). The WAN Application Delivery market addresses the convergence of the Web security and control market with the WAN optimization and acceleration markets, as IT departments are increasingly required to manage both functions. The WAN Application Delivery market is projected to grow substantially. We believe that our leadership position in the Secure Web Gateway market, together with our underlying caching and acceleration technologies and expertise, can effectively be leveraged in the WAN Application Delivery market and that our existing installed base of proxy appliances, together with the technical capabilities of those appliances, provides a strong foundation from which to achieve a leadership position in the WAN Application Delivery market.

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While we are a leader in the Secure Web Gateway market and anticipate continued growth and strong revenue from this business, we believe that we will not be able to sustain our prior rates of revenue growth by focusing principally on this market. Therefore, we have focused our research and development activities on development of WAN optimization functionality in order to support products for the WAN Application Delivery market. This provides us an opportunity to sell our appliances for use in branch and remote offices, mobile and telecommuter employees, as well as for use at the Internet gateway locations inside a company’s headquarters or data center. We commercially released our first generation WAN Application Delivery product with our ProxySG^® 5.1.1 release in May 2006, and in April 2007 we released our first WAN Application Delivery software client, SG Client. In fiscal 2008, we are renewing our focus to further enhance our ProxySG appliance and our SG Client software. We intend to commit the majority of our research and development activities to the development of our WAN Application Delivery products, including adding functionality to remain competitive with products offered by others and adding and enhancing functionality which differentiates our products.

We believe that our established reputation in the security and policy control field, our past work with video or Content Distribution Networks (known as CDNs) and our experience with large scale deployments, differentiates us from our competitors in the WAN Application Delivery market. Although we are a relatively new entrant in the WAN optimization market, we believe that the market is evolving to a greater focus on WAN Application Delivery. We have substantial application acceleration capabilities through our past focus on caching technology and application protocol optimization—which are two of the techniques we currently use to improve WAN performance. We also believe that our Mach5 acceleration technologies integrated with our overall product architecture provides us with a key competitive advantage in growing our revenue in this market. However, in order for us to be successful in the WAN Application Delivery market, which is populated by better known companies and brands, some of which were early entrants into the WAN optimization market, it will be imperative that we build market awareness of our products and our participation in the market, both with respect to our installed base and with respect to potential new customers. As well, it is critical to our success that our efforts to expand our sales force and to create incentives to drive sales of WAN Application Delivery products result in increased sales productivity and revenue. We intend to commit substantial resources in fiscal 2008 to directed sales and marketing activities designed to create increased brand awareness and recognition of our capabilities in the WAN Application Delivery market and to increase our market share in the WAN Application Delivery market.

The growth of our business is dependent on growth in our target markets, particularly growth in the WAN Application Delivery market. This, in turn, is dependent on continued growth in IT discretionary spending on a global basis. In fiscal year 2007, 47% of our sales were in North America and 53% of our sales were in countries outside of North America; and in the fourth quarter of 2007, 44% of our sales were in North America and 56% of our sales were in countries outside of North America. Some analysts have predicted a softening in IT spending and, should that occur, it will be difficult for us to achieve our projected revenue growth.

We believe that the Web will increasingly become the central means of communication for business enterprises, both with respect to use of the Internet and for business application use and delivery, and that the continued growth of the Web as a means of business communication will drive the need for better security and speed of Web based transmission. We have built our business model and strategy and our product architecture based on those premises.

We believe that we will see continued convergence in the markets for products that provide Web security and policy control with those that provide WAN acceleration or WAN optimization. We believe that over time this convergence will provide us with a competitive advantage over our competitors. However, we also expect that we will see increasing competition in the WAN Application Delivery market, particularly from larger competitors with well-established brands and reputations, and that this competition may adversely impact our prices and margins.

We are focused on developing products for mid-to-large size enterprises, which we define to include organizations with several thousand users to organizations with tens-of-thousand of users. We believe this focus helps us to rapidly identify and target attractive market opportunities. In support of this focus, we are directing our principal product development, marketing and sales activities to that enterprise market segment. We believe the market for these enterprises represents our most attractive revenue growth opportunity, given the demonstrated need for WAN Application Delivery products, the opportunity to sell to numerous customers, and the level of existing competition.

Critical Accounting Policies and Estimates

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

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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 and Related Receivables Allowance, Stock-Based Compensation, Inventories, Valuation of Goodwill, Valuation of Long-Lived Assets and Income Taxes. 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. For the three months ended July 31, 2007 there were no changes to the our critical accounting policies as disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended April 30, 2007.

Results of Operations

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

	Three Months Ended July 31,
	2007		2006
Net revenue:
Product	77.0	%	74.9	%
Service	23.0		25.1
Total net revenue	100.0		100.0
Cost of revenue
Product	15.7		19.8
Service	7.7		8.3
Total cost of revenue	23.4		28.1
Gross profit	76.6		71.9
Operating expenses:
Research and development	18.6		25.2
Sales and marketing	45.9		39.6
General and administrative	9.1		17.0
Amortization of intangible assets	0.2		0.5
Total operating expenses	73.8		82.3
Operating income (loss)	2.8		(10.4	)
Interest income	2.0		2.5
Other income (expense)	(0.1	)	(0.4	)
Income (loss) before income taxes	4.7		(8.3	)
Provision for income taxes	0.5		0.3
Net income (loss)	4.2	%	(8.6	)%

Net Revenue

The following is a summary of net revenue and the changes in net revenue (in thousands):

	Three Months Ended July 31,
	2007			2006
Total net revenue	$	62,403		$	36,415
Change from same period prior year ($)	$	25,988		$	3,047
Change from same period prior year (%)		71.4	%		9.1	%

Demand for our products and related services continued to be strong in the first quarter of fiscal 2008. Net revenue was $62.4 million and $36.4 million for the first quarter of fiscal 2008 and fiscal 2007, respectively. The increase in net

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revenue of 71.4% was primarily attributable to continued market acceptance of our products. We experienced increased demand for our appliances in the WAN Application Delivery market, in part as a result of our ability to addresses a customer’s WAN optimization requirements in addition to their security needs. This increase in demand, coupled with increased sales and marketing efforts to broaden our market presence and expand our distribution channels, contributed to the high level of growth in net revenue over the comparable prior year period. Net product revenue increased 76.4% from $27.3 million for the first quarter of fiscal 2007 to $48.1 million for the first quarter of fiscal 2008, while net service revenue increased 56.5% from $9.2 million for the first quarter of fiscal 2007 to $14.3 million for the first quarter of fiscal 2008.

The following is a summary of net revenue by geographic area (in thousands):

	Three months ended July 31,
	2007				2006(1)
	$		%		$		%
North America	$	30,802	49.4	%	$	17,732	48.7	%
EMEA (2)		22,557	36.1			13,087	35.9
CALA (3)		241	0.4			238	0.7
Asia		8,803	14.1			5,357	14.7
Total net revenue	$	62,403	100.0	%	$	36,415	100.0	%

(1) Amounts for the three months ended July 31, 2006 have been reclassified to conform to current period presentation.

(2) Europe, Middle East, and Africa (“EMEA”)

(3) Central America and Latin America (“CALA”)

Net revenue grew in all geographies in the three months ended July 31, 2007, compared to the same periods of fiscal 2007. Net revenue in North America increased $13.1 million, or 73.7%, net revenue in EMEA increased $9.5 million, or 72.4%, net revenue in CALA remained flat and net revenue in Asia increased $3.4 million, or 64.3%.

Gross Profit

The following is a summary of gross profit (in thousands):

	Three Months Ended July 31,
	2007			2006
Gross profit	$	47,792		$	26,165
Gross profit as a percentage of net revenue		76.6	%		71.9	%

Gross profit was $47.8 million in the first quarter of fiscal 2008 compared to $26.2 million for the first quarter of fiscal 2007. As a percentage of net revenue, gross profit for the first quarter of fiscal 2008 and 2007 was 76.6% and 71.9%, respectively. The increase in gross profit was primarily due to the increase in net revenue. The improvement in gross profit as a percentage of net revenue for the first quarter of fiscal 2008 as compared to the same period in the prior year was primarily attributable to higher average selling prices on appliances and a product mix favoring higher margin products such as Blue Coat WebFilter.

Research and Development

The following is a summary of research and development expense (in thousands):

	Three Months Ended July 31,
	2007			2006
Research and development	$	11,615		$	9,180
Research and development as a percentage of net revenue		18.6	%		25.2	%

Research and development expense consists primarily of salaries and benefits, prototype costs, and testing equipment costs.

Research and development expense increased $2.4 million to $11.6 million in the first quarter of fiscal 2008 from $9.2 million for the first quarter of fiscal 2007. These amounts represented 18.6% and 25.2% of net revenue for the first

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quarters of fiscal 2008 and 2007, respectively. The increase in research and development expense was primarily due to increased headcount and related expenses of $1.6 million. Stock based compensation expense recognized under SFAS 123(R) related to research and development personnel was $1.7 million and $0.9 million for the three months ended July 31, 2007 and 2006, respectively.

We expect research and development expense to continue to increase in absolute dollars and to decline as a percentage of net revenues for the remaining of fiscal year 2008.

Sales and Marketing

The following is a summary of sales and marketing expense (in thousands):

	Three Months Ended July 31,
	2007			2006
Sales and marketing	$	28,614		$	14,419
Sales and marketing as a percentage of net revenue		45.9	%		39.6	%

Sales and marketing expense consists primarily of salaries and benefits, commissions, travel, advertising and promotional expenses.

Sales and marketing expense increased $14.2 million to $28.6 million for the first quarter of fiscal 2008 from $14.4 million for the first quarter of fiscal 2007. These amounts represented 45.9% and 39.6% of net revenue for the first quarters of fiscal 2008 and 2007, respectively. In addition to an increase in spending on marketing programs of $0.6 million, the increase in sales and marketing expense was due to higher commission expense of $5.5 million associated with higher net revenue and increased sales headcount and related expenses of $4.8 million. The increase in sales and marketing expense was consistent with our plans to expand our sales force and increase our market share in the growing WAN Application Delivery market. Stock based compensation expense recognized under SFAS No. 123(R) related to sales and marketing personnel was $1.6 million and $1.0 million for the three months ended July 31, 2007 and 2006, respectively.

We expect sales and marketing expense to increase in absolute dollars for the remaining of fiscal year 2008 because we intend to seek to increase sales in both domestic and international markets, establish and expand new distribution channels, and introduce new products.

General and Administrative

The following is a summary of general and administrative expense (in thousands):

	Three Months Ended July 31,
	2007			2006
General and administrative	$	5,682		$	6,174
General and administrative as a percentage of net revenue		9.1	%		17.0	%

General and administrative expense consists primarily of salaries and benefits, legal services, accounting and audit services, and other general corporate expenses.

General and administrative expense decreased $0.5 million to $5.7 million for the first quarter of fiscal 2008 from $6.2 million for the first quarter of fiscal 2007. These amounts represented 9.1% and 17.0% of net revenue for the first quarters of fiscal 2008 and 2007, respectively. The decrease in general and administrative expense was primarily due to decreased legal and accounting fees of $2.0 million related to the stock option investigation and related restatement of our financial statements, partially offset by an increase in general and administrative headcount and related expenses of $1.2 million. Stock based compensation expense recognized under SFAS 123(R) related to general and administrative personnel was $1.0 million and $0.7 million for the three months ended July 31, 2007 and 2006, respectively.

We expect that general and administrative expense will increase for the remaining of fiscal year 2008 in absolute dollars as a result of increases in headcount and infrastructure to manage our increased business volumes, but will remain consistent as a percentage of net revenue. Legal and accounting fees were significant in fiscal 2007 due to the stock option investigation and related restatement of our financial statements, and we do not expect such fees to recur at such levels.

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Amortization of Intangible Assets

Amortization of intangible assets reflects the amortization of developed technology, core technology, and customer relationships, all related to our September 11, 2006 acquisition of certain assets of the NetCache business from Network Appliance, our March 3, 2006 acquisition of Permeo, Inc., our November 16, 2004 acquisition of Cerberian, Inc. and our November 14, 2003 acquisition of Ositis Software, Inc. The amortization of developed technology is charged to cost of goods sold. The amortization of core technology and customer relationships is recorded as an operating expense. Total amortization expense for the identifiable intangible assets was $0.4 million and $0.5 million for the three months ended July 31, 2007 and 2006, respectively.

Interest Income and Other Income

The following summarizes interest income and other expense (in thousands):

	Three Months Ended July 31,
	2007			2006
Interest income	$	1,247		$	897
Other income (expense)	$	(43	)	$	(120	)

For the three months ended July 31, 2007, compared with the three months ended July 31, 2006, interest income increased as a result of increased cash and investments balances earning interest at higher rates. Other expense consists primarily of foreign currency exchange gains or losses.

Provision for Income Taxes

The provision for income taxes for the three months ended July 31, 2007 was $331,000. As compared to $118,000 at July 31, 2006, the increase in 2007 is primarily the result of increased income and the amortization of goodwill related to the NetCache acquisition.

Section 409(A) Tender Offer

As a result of our investigation into our historical stock option granting practices, we determined that the measurement dates for a number of stock option grants made by us during the period from November 1999 to May 2006 differed from the measurement dates previously used to account for such grants, which resulted in a lower exercise price for those options than the fair market value on the actual grant date. As such, certain affected stock options were deemed, for accounting purposes, to have been issued at a discount, which could expose the holders of those options to potentially adverse tax consequences under Section 409A of the Internal Revenue Code and state law equivalents. We offered certain individuals the opportunity to increase the exercise price of the discounted options to the fair market value on the actual grant date of that option in order to avoid the potentially adverse tax consequences. As a result of the offer, we amended outstanding options covering 894,040 shares of our common stock. In addition, the participants whose options were amended are now eligible for special cash bonuses in the aggregate amount of $2.7 million to compensate them for the higher exercise prices per share in effect for their amended options. The impact of the bonus, which was recorded during the first quarter of fiscal 2008, resulted in a decrease to additional paid-in capital of $1.2 million, an increase in stock-based compensation expense of $1.5 million and an increase in payroll tax expenses of $0.2 million. Under Section 409A, the cash bonus cannot be paid in the same calendar year in which the options are amended. As a result, the cash bonus will be paid in January 2008.

Recent Accounting Pronouncements

In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115. SFAS No. 159 allows measurement at fair value of eligible financial assets and liabilities that are not otherwise measured at fair value. If the fair value option for an eligible item is elected, unrealized gains and losses for that item shall be reported in current earnings at each subsequent reporting date. SFAS No. 159 also establishes presentation and disclosure requirements designed to draw comparison between the different measurement attributes the company elects for similar types of assets and liabilities. This statement is effective for our fiscal year beginning May 1, 2008. We are currently evaluating the effect, if any, that the adoption of SFAS No. 159 will have on our condensed consolidated financial statements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements. SFAS No. 157 provides a framework for measuring fair value,

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clarifies the definition of fair value, and expands disclosures regarding fair value measurements. SFAS No. 157 does not require any new fair value measurements and eliminates inconsistencies in guidance found in various prior accounting pronouncements. We are required to adopt SFAS No. 157 for our fiscal year beginning May 1, 2008. We are currently evaluating the effect that the adoption of SFAS No. 157 will have on our condensed consolidated results of operations and financial condition, but do not expect it to have a material impact.

Liquidity and Capital Resources

Since our inception, we have financed our operations and capital expenditures through cash provided by operating activities, private sales of preferred and common stock, bank loans, equipment leases, and an initial public offering of our common stock. We believe our existing cash, cash equivalents, short-term investments and cash generated from operations, if any, will be sufficient to meet our operating requirements for at least the next twelve months, including working capital requirements and capital expenditures. We may choose at any time to raise additional capital to strengthen our financial condition, facilitate expansion and pursue strategic investments, or to take advantage of business opportunities as they arise.

However, should prevailing economic conditions and/or financial, business and other factors beyond our control adversely affect our estimates of our future cash requirements, or if cash is used for unanticipated purposes, we may need additional capital sooner than expected. Although we cannot guarantee that planned results will be obtained in fiscal 2009 or that sufficient debt or equity capital will be available to us under acceptable terms, if at all, we believe that our planned cash flow assumptions for fiscal 2009 can be realized. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our existing stockholders will be reduced.

	As of July 31,
	2007			2006
Cash and cash equivalents	$	76,201		$	49,204
Short-term investment		36,758			8,275
Restricted investments		5,029			42,921
Subtotal	$	117,988		$	100,400
Total assets	$	268,709		$	214,883
Percentage of Total assets		43.9	%		46.7	%

	Three Months Ended July 31,
	2007		2006
Cash provided by operating activities	$	12,079	$	1,572
Cash provided by (used in) investing activities		4,566		(41,236	)
Cash provided by financing activities		9,543		41,878
Net increase in cash and cash equivalents	$	26,188	$	2,214

Net cash provided by operating activities was $12.1 million for the first three months ended July 31, 2007 compared to $1.6 million in the comparable prior year period. The increase in cash provided by operating activities was largely attributable to higher net income resulting from a significant increase in net revenue from $36.4 million in the first quarter of fiscal 2007 to $62.4 million in the first quarter of fiscal 2008, coupled with a decrease in operating expenses as a % of net revenue from 82.3% of net revenue in the first quarter of fiscal 2007 to 73.8% of net revenue in the first quarter of fiscal 2008.

Working capital sources of cash for the first quarter of fiscal 2008 mainly included increases in deferred revenue of $5.0 million and accrued payroll and related benefits of $3.5 million. Deferred revenue increased primarily as a result of increased maintenance revenue. Accrued payroll and related benefits increased primarily due to an increase in accrued salaries of $2.7 million related to our obligation from the tender offer consummated on May 29, 2007. Working capital uses of cash for the first quarter of fiscal 2008 included a decrease in accounts payable of $4.3 million, a decrease in other accrued liabilities of $1.1 million and an increase in accounts receivable of $1.0 million. The decrease in accounts payable resulted primarily from the timing of invoices for a few of our significant vendors. Other accrued liabilities decreased as a result of lower legal and accounting fees related to the stock option investigation and related restatement of our financial statements. Accounts receivable increased as a result of higher net revenue for the first quarter of fiscal 2008, partially offset by a decrease in our days of sales outstanding from 65.5 days at July 31, 2006 to 47.5 days at July 31, 2007.

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Net cash provided by investing activities was $4.6 million for the first three months ended July 31, 2007, compared to $41.2 million used in the comparable prior year period. The increase in net cash provided by investing activities for the first quarter of fiscal 2008 was primarily due to the maturities of investment securities of $36.2 million. The net cash used in investing activities for the first quarter of fiscal 2007 was primarily due to the purchase of investment securities of $45.8 million with the $41.9 million in net proceeds from the issuance of Series A Redeemable Convertible Preferred Stock.

Net cash provided by financing activities was $9.5 million for the first quarter of fiscal 2008, compared to $41.9 million used in the same period last year. The net cash provided by our financing activities for the first quarter of fiscal 2008 was primarily due to the issuance of common stock from the exercise of employee stock options. The net cash provided by our financing activities for the first quarter of fiscal 2007 was primarily related to the net proceeds of $41.9 million received from the sale of Series A Redeemable Convertible Preferred Stock.

Our long-term strategy is to maintain a minimum amount of cash and cash equivalents for operational purposes and to invest the remaining amount of our cash in interest bearing and highly liquid cash equivalents and marketable debt securities. As of July 31, 2007, cash, cash equivalents and investments totaled $118.0 million, $5.0 million of which is classified as restricted.

Off-Balance Sheet Arrangements

As of July 31, 2007, 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.

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.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

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

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. As of July 31, 2007, cash, cash equivalents and investments totaled $118.0 million, $5.0 million of which is classified as restricted. They are primarily in money market funds, commercial paper, corporate securities, government securities and auction rate preferred securities. We maintain a strict investment policy, which is intended to ensure 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 due mainly to the short-term nature of the majority of our investment portfolio.

Foreign Currency Exchange Rate Risk

We develop products in the United States (“U.S.”) and sell them throughout the world. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Because all of our sales are currently billed and collected in U.S. dollars, a strengthening of the dollar could make our products less price-competitive in foreign markets. If the events described above were to occur, our net revenue and earnings could be seriously impacted, since a significant portion of our net revenue and earnings are derived from international operations. For the three months ended July 31, 2007 and 2006, approximately 50.6% and 51.3%, respectively, of our total net revenue were derived from customers outside of North America. In contrast, substantially all of the expenses of operating our foreign subsidiaries are incurred in foreign currencies. 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. However, we do not consider the market risk associated with our international operations to be material. We do not currently use derivative financial instruments for hedging or speculative purposes.

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Item 4. Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of 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 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 our SEC reports (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 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 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 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.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

The information set forth above under Note 7 contained in the “Notes to Condensed Consolidated Financial Statements” is incorporated herein by reference.

Item 1A. Risk Factors

FACTORS AFFECTING FUTURE OPERATING RESULTS

In addition to the other information contained in this Annual Report on Form 10-K, the following risk factors should be carefully considered by investors before making an investment decision. Our business, financial condition and results of operations could be seriously harmed, and the trading price of our common stock could decline, 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 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 and our ability to forecast our quarterly operating results is limited, so our operating results 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 due to a number of factors, many of which are outside of our control. These factors limit our ability to accurately predict our operating results on a quarterly basis, and include factors discussed elsewhere in this “Risk Factors” section together with the following:

• The timing, size, and mix of orders from customers;

• Fluctuations in demand for our products and services;

• Certain markets in which we compete are relatively new and are evolving;

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

• Our ability to continue to increase our respective market shares consistent with past rates of increase;

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

• The level of competition in our target product markets, including new entrants or substantial discounting;

• Market acceptance of our new products and product enhancements;

• Announcements, introductions and transitions of new products or product enhancements by us or our competitors, and deferrals of customer orders which may result from such announcements, introductions and transitions;

• Technological changes in our target product markets;

• Future accounting pronouncements and changes in accounting policies;

• Volatility in our stock price which may lead to higher stock compensation expense pursuant to Statement of Financial Standards No. 123(R);

• Our recognition of revenue in accordance with Statement of Position (“SOP”) 97-2 requires that some revenue be recognized ratably over a defined period or otherwise deferred to a future period; and

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• Future macroeconomic conditions in our domestic and international markets, as well as the level of discretionary IT spending generally.

A high percentage of our expenses, including those related to manufacturing overhead, technical support, research and development, sales and marketing, and general and administrative functions are essentially fixed in the short term. As a result, if our net revenue is less than forecasted, such expenses cannot effectively be reduced 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 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 will likely decline, and may decline significantly. Such a decline may also occur even where we meet our guidance, but our results or future guidance fail to meet third party expectations.

We must anticipate market needs, and develop and introduce new products and enhance existing products to rapidly meet those needs, or we will lose market share and our operating results will be adversely affected.

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

• develop and maintain competitive products;

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

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

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

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

There is no guarantee that we will accurately predict the direction in which the Secure Internet Gateway and WAN Application Delivery markets will evolve. Failure on our part to anticipate the direction of our markets and develop products and enhancements that meet the needs 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 anticipated benefits.

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. 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 providing those products before we do and a 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 operating results. Additionally, our introduction of new products and product enhancements could result in the obsolescence of previously purchased or committed inventory, potentially requiring the recording of material charges, which would reduce net income.

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Unless we develop better market awareness of our company and our product our net revenue will not grow as anticipated.

We are a new entrant in the WAN Application Delivery market and, in our opinion, have not yet established sufficient market awareness of our participation in that market. Market awareness of our capabilities and products is essential to our continued growth and our success in all of our markets, particularly in the WAN Application Delivery market. If our advertising and marketing programs are not successful in creating market awareness of our company and products, our business, financial condition and results of operations will be adversely affected, and we will not be able to achieve sustained growth.

If the market for WAN Application Delivery products does not develop as we anticipate, we may not be able to achieve an acceptable increase of our net revenue, and the price of our stock may decline.

We have increasingly invested in and focused on the WAN Application Delivery market. However, that is a new and rapidly evolving market. If this market fails to grow as we anticipate, or grows more slowly than we anticipate, we may not be able to sell as many of our WAN Application Delivery products as we currently project, which would result in a decline in our anticipated net revenue and could result in a decline in our stock price.

The WAN Applications Delivery market is intensely competitive and certain of our competitors have greater financial, technical, sales and marketing resources and may take actions that could weaken our competitive position or reduce our net revenue.

We have increasingly invested in and focused on the WAN Application Delivery market. This market is intensely competitive, and the intensity of this competition is expected to increase in the future. Such increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any one of which could seriously harm our business, financial condition and operating results. We may not be able to compete successfully against current or future competitors and we cannot be certain that competitive pressures we face will not seriously harm our business. Our competitors vary in size and in the scope and breadth of the products and services they offer. In addition, we expect additional competition from other established and emerging companies as the market for WAN Application Delivery products continues to develop and expand.

Many 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. 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. As well, larger competitors may be able to integrate some of the functionality of our products into existing infrastructure products or to bundle WAN Application Delivery products with other product offerings. 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 operating results.

We have a history of losses and profitability could be difficult to sustain.

While we have been profitable in certain quarters, we have not been able to maintain consistent profitability on a quarterly basis. Although we were profitable in the first quarter of fiscal 2008, we were not profitable in three of the four fiscal quarters in fiscal 2007, and may not be profitable on a quarterly or annual basis in the future. Our ability to achieve, sustain or increase profitability on a quarterly or annual basis will be affected by changes in our business and the demand for our products and

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services. We expect our operating expenses to increase as our revenues grow, and we anticipate that we will make investments in our business. Consequently, our results of operations will be harmed if our sales do not increase at a rate commensurate with the rate of increase in our expenses. If our sales are less than anticipated or if operating expenditures exceed our expectations or cannot be adjusted accordingly, we may continue to experience losses on a quarterly and annual basis.

We must attract, assimilate and retain key personnel on a cost-effective basis, or our ability to execute our business strategy and generate sales could be harmed.

We depend on key management, research and development, and sales personnel, and our ability to attract and retain highly qualified and skilled personnel. During the past six months we have experienced significant changes in our senior management team, including with respect to our senior sales, legal and marketing officers, and we may continue to experience transition in our management team in the future. Our success will depend in part on our ability to assimilate these changes to our leadership team, as well as our ability to recruit and retain other key personnel.

We have seen an increase in competition with respect to cash and equity compensation offered by employers in the Silicon Valley, and in other areas where we have operations, that may make it more difficult to attract and retain highly qualified employees. Furthermore, we have a very limited pool of shares available for issuance to employees under our equity award plans. While we intend to seek stockholder approval of a new equity award plan that will enable us to offer additional equity to our employees, there is no assurance that such approval will be obtained. If we do not obtain stockholder approval of a new equity plan, we will be limited in our ability to offer equity awards to our existing employees, which may affect our ability to retain qualified employees.

The majority of our employees, including our senior management personnel, are employed on an “at-will” basis, which may make it easier for key employees to leave us and move to new employment. Our inability to timely hire replacement or additional employees may impact our operations, since new hires frequently require extensive training before they achieve desired levels of productivity. This may affect our ability to grow our net revenue. In particular, new sales personnel typically take a number of months to achieve acceptable productivity and generate the expected level of sales.

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

A significant amount of our revenue is generated through sales by our sales channel partners, which include distributors and resellers. During the year ended April 30, 2007, approximately 96.2% of our revenue was generated through our indirect sales channels. 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 add new sales channel partners and effectively train and integrate them with our sales process. If we are unsuccessful in those efforts, our business will not grow and our operating results will be adversely affected.

Our products are complex, and there can be no assurance that our sales training programs that are offered to our sales channel partners will be effective. In addition, our sales channel partners may be unsuccessful in marketing, selling and supporting our products and services for reasons unrelated to training. Most of our sales channel partners do not have minimum purchase or resale requirements, and may cease selling our products at any time. They may also market, sell and support products and services that are competitive with ours, and may devote more resources to the marketing, sales and support of products competitive to ours. 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.

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We also depend on many 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. In addition, we recognize a portion of our revenue based on a sell-through model using information provided by our sales channel partners. If we are provided with inaccurate or untimely information, the amount or timing of our reported net revenue could be affected.

If we are unable to establish fair value for any undelivered element of a customer order, revenue relating to the entire order will be deferred until the revenue recognition criteria for all elements of the customer order are met. This could lower our net revenue in one period and increase it in future periods resulting in greater variability in net revenue and income period to period.

In the course of our selling efforts, we often enter into arrangements with our customers that require us to deliver a combination of different appliances, software products or services. We refer to each individual appliance, software product or service as an “element” of the overall arrangement with our customer. In some cases, these arrangements may require us to deliver particular elements in a future period. We do not recognize revenue on any elements until it has been delivered. In addition, we do not recognize revenue on any delivered element until we can determine the fair value of all undelivered elements in the arrangement. In the event we are unable to determine the fair value of any undelivered elements, we defer the revenue from the entire arrangement rather than just the undelivered elements. As a result, a portion of the revenue we recognize in each quarter could relate to previously delivered products. As such, an increase in the number of multiple element arrangements for which we cannot determine the fair value of any undelivered elements would negatively impact our net revenue in the current period, while increasing net revenue in future periods. In addition, we may not adjust our cost structure to reflect this reduction in net revenue recognized in the current period, which would reduce our income for the current period. If sales related to multiple element arrangements for which we cannot determine the fair value of any undelivered elements increase significantly, we may not meet current revenue expectations since revenue associated with such arrangements will be recognized in future periods.

We are dependent on contract manufacturers to manufacture our products, and changes to those relationships, expected or unexpected, may result in delays or disruptions that could cause us to lose revenue and damage our customer relationships.

We depend primarily on independent contract manufacturers (each of whom is a third party manufacturer for numerous companies) to manufacture our products and the assemblies and components contained in our products. These manufacturers are not committed to manufacture our products on a long-term basis in any specific quantity or at any specific price. As well, from time to time, we may be required to add new manufacturers or manufacturing sites to accommodate growth in orders or the addition of new products. It is time consuming and costly to qualify and implement new contract manufacturer relationships and sites, and such additions increase the complexity of our supply chain management. Therefore, if we fail to effectively manage our contract manufacturer relationships or if one or more of our contract manufacturers experiences delays, disruptions or quality control problems in manufacturing our products, or if we are otherwise required to add or replace contract manufacturers or sites, our ability to ship products to our customers could be delayed. Moreover, an increasing portion of our manufacturing is performed in China and other countries and is, therefore, subject to risks associated with doing business in those countries. Each of these factors could adversely affect our business, financial condition and operating results.

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 contract manufacturers on a rolling 12-month basis. If our forecast is in excess of our actual requirements, the contract manufacturers may assess charges or we may have liabilities for excess inventory, each of which could negatively affect our gross margins. If our forecast is less

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than our actual requirements, the contract manufacturers may have insufficient time and components to produce our product requirements, which could delay or interrupt manufacturing of our products and result in delays in shipments, customer dissatisfaction, and deferral or loss of revenues. Any of the foregoing could adversely affect our business, financial condition and operating results.

We depend on single and, in some cases, sole and limited source suppliers for several key components, which makes us susceptible to shortages, unavailability or price fluctuations.

We have limited sources of supply for certain key components of our products, which exposes us to component shortages or unavailability. In addition, 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, each of which precludes rapid changes in quantities and delivery schedules. In the event our business grows in excess of 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 to timely build our products, we may be unable to timely ship product to our customers, which would adversely affect our relationships with customers and our net revenue, or we may be subject to substantially increased pricing, which will impact our gross margin. Any of the foregoing could adversely affect our business, financial condition and operating results.

Our gross margin is affected by a number of factors, and may be below our expectations or the expectations of investors and analysts, which could cause a decline in our stock price.

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

• market acceptance of our products and fluctuations in demand;

• the timing and size of customer orders and product implementations;

• increased price competition and changes in product pricing;

• actions taken by our competitors;

• the mix of direct and indirect sales;

• new product introductions and enhancements;

• manufacturing and component costs;

• availability of sufficient inventory to meet demand;

• purchase of inventory in excess of demand;

• how well we execute on our strategy and operating plans;

• changes in our sales model; and

• revenue recognition rules.

For example, we have in the past entered into large revenue transactions with certain customers that, because of the product mix and volume discount, have decreased our total gross margin percentage. We may, in the future, enter into similar transactions. As well, our lower end appliances have poorer margins than our higher end appliances, and if our customers submit a large order or orders for our lower end appliances, the combination of smaller margins and volume discount provided to those customers would result in a negative impact to our gross margin percentage.

Even if we achieve our net revenue and operating expense objectives, if our gross margins are below expectations we may fail to meet our net income objectives and our operating results may be below our expectations and the expectations of investors and analysts, which might cause our stock price to decline.

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Our international operations expose us to risks.

We currently have operations in a number of foreign countries, including 18 international subsidiaries, 3 branch offices and 7 international representative offices. In fiscal 2007, 53.4% of our total net revenue was derived from customers outside of North America; thus, our business is substantially dependent on economic conditions and IT spending in markets outside North America. The expansion of our international operations and entry into additional international markets requires significant management attention and financial resources, and subjects us to certain inherent risks including:

• technical difficulties and costs associated with product localization;

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

• potential loss of proprietary information due to piracy, misappropriation, or laws that may be less protective of our intellectual property rights;

• our limited experience in establishing a sales and marketing presence and the appropriate internal systems, processes and controls in certain geographic markets;

• longer payment cycles for sales in certain foreign countries;

• seasonal reductions in business activity in the summer months in Europe and certain other countries;

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

• potentially adverse tax consequences;

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

• risk of failure of our foreign employees to comply with both U.S. and foreign laws, including antitrust laws, trade regulations and the Foreign Corrupt Practices Act;

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

• management, staffing, legal and other costs of operating an enterprise spread over various countries;

• political or economic instability, war or terrorism in the countries where we are doing business; and

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

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

The matters relating to our historical stock granting practices and the restatement of our consolidated financial statements in March 2007 have required us to incur substantial expenses, have resulted in litigation and regulatory inquiries, and may result in additional litigation, regulatory proceedings and governmental enforcement actions.

Our historical stock granting practices and the consequent restatement of our financial statements have exposed us to greater risks associated with litigation, regulatory and government enforcement actions. On March 28, 2007, in our Form 10-K for the year ended April 30, 2006 we restated our consolidated financial statements as of April 30, 2005, and for the years ended April 30, 2005 and 2004, to correctly account for stock option grants for which we had determined that the measurement date for accounting purposes was different from the stated grant (the “March 2007 Restatement”). In addition, we also restated our selected consolidated financial

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data as of and for the years ended April 30, 2005, 2004, 2003 and 2002, and the unaudited quarterly financial data for each of the quarters in the years ended April 30, 2006 and 2005, with the exception of the fourth quarter of fiscal 2006 (which had not then been filed). For more information on these matters, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Background of the Stock Option Investigation, Findings, Restatement of Consolidated Financial Statements, Remedial Measures and Related Proceedings,” and Item 9A, “Controls and Procedures” in our Annual Report on Form 10-K for the year ended April 30, 2006, and Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Background of the Stock Option Investigation, Findings, Restatement of Consolidated Financial Statements, Remedial Measures and Related Proceedings,” and Item 4, “Controls and Procedures,” on Form 10-Q for the quarter ended January 31, 2007, each of which was filed with the SEC on March 28, 2007.

The internal review, the independent investigation, and related activities which led to our March 2007 Restatement have required us to incur substantial expenses for legal, accounting, tax and other professional services, and have diverted management’s attention from our business. As of April 30, 2007, these expenses totaled approximately $13.0 million, and certain of these expenses and activities have continued. Such continued expenses and activities include those relating to our May 2007 tender offer; resolution of international issues, including taxes; and our continued representation in connection with the litigation and investigatory proceedings.

The matters addressed in the March 2007 Restatement have exposed us to greater risks associated with litigation, regulatory proceedings and government enforcement actions. As described in Note 7 of Notes to Consolidated Financial Statements, multiple derivative complaints have been filed in state and federal courts against our directors and certain of our executive officers pertaining to allegations relating to stock option grants, and certain proceedings with respect to such matters are ongoing at the SEC and the U.S. Attorney’s Office for the Northern District of California. We may become the subject of, or otherwise required to incur legal fees and costs in connection with, additional private litigation, regulatory proceedings, or government enforcement actions in connection with the March 2007 Restatement. No assurance can be given regarding the outcomes from such activities or that such outcomes will be consistent with the findings of our Special Committee reported in our Annual Report on Form 10-K for the year ended April 30, 2006. The resolution of these matters has been and will continue to be, time consuming, expensive, and will distract management from the conduct of our business. Our available directors’ and officers’ liability insurance may not be sufficient to cover our legal expenses or those of persons we are obligated to indemnify. Furthermore, if we are subject to adverse findings in litigation, regulatory proceedings or government enforcement actions, we could be required to pay damages or penalties or have other remedies imposed, which could harm our business, financial condition, results of operations and cash flows. In addition, the March 2007 Restatement and the related litigation and regulatory proceedings and any negative outcome that may occur from them could impact our relationships with customers and our ability to generate future net revenue.

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

We have acquired businesses in the past, such as our acquisition of Permeo Technologies, Inc. (“Permeo”), on March 3, 2006, and our acquisition of certain assets of the NetCache business from Network Appliance, on September 11, 2006, and likely will acquire other businesses in the future. There is no guaranty that such acquisitions will yield the anticipated benefits. The success of any acquisition is impacted by a number of factors, and may be subject to the following risks:

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

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

• loss of key employees of acquired companies; and

• substantial transaction costs.

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

• dilution of our current stockholders’ percentage ownership through the issuance of new equity;

• assumption of additional liabilities;

• incurrence of additional debt or a decline in available cash;

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

• liability for intellectual property infringement and other litigation claims; and

• creation of goodwill or other intangible assets that could result in significant amortization expense.

The occurrence of any of the above risks could seriously harm our business.

We issued a combination of stock and cash in the Permeo and NetCache transactions, and in the private placement of preferred stock from which we funded a portion of the NetCache transaction. The issuance of stock in these transactions diluted our existing stockholders. We also used $15.0 million and $23.9 million in cash as consideration in the Permeo and NetCache transactions, respectively.

We may not be able to successfully manage the growth of our business if we are unable to improve our internal systems, processes and controls.

Our growth, as well as recent regulatory requirements and changes in financial standards, has placed demands on our management and our infrastructure. We need to continue to improve our internal systems, processes and controls to effectively manage our operations and growth, including our international growth into new geographies. We may not be able to successfully implement improvements to these systems, processes and controls in a timely or efficient manner, and we may discover deficiencies in existing systems, processes and controls. Our failure to improve our systems, processes and controls may result in our inability to manage the growth of our business and adversely affect our business, financial condition and operating results.

Our products protect Web-based applications and content, and are focused on the Internet gateway as the point of entry into the network. Our target customers may not wish to purchase our appliances without protection for non-Web based applications and content or may not use the Internet gateway as a principal point of network entry.

Our appliances are specially designed to secure Web-based protocols, such as http, https, ftp and streaming and focus on the Internet gateway as the point of entry into the network. While we believe that the majority of traffic traveling over the networks of our target customers is Web-based, a significant amount of our target customers’ network traffic may not be Web-based. Our products do not protect non-Web protocols. If our target customers do not wish to purchase a product that handles network traffic that utilizes Web-based protocols or do not wish to use the Internet gateway as a principal point of entry into their respective networks, our target customers may not purchase our products and our growth could be limited.

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 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 financial condition. Any of these delays could seriously harm our business.

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Undetected product errors, or failures found in new products may result in a loss of or delay in market acceptance of our products, which could cause us to incur significant costs, reduce our sales or result in litigation.

Our products may contain undetected operating errors when first introduced or as new versions are released. Despite testing by us and by current and potential customers, errors may not be found in new products or new versions until after commencement of commercial shipments, resulting in loss of or delay in market acceptance, which could materially adversely affect our operating results. These errors may cause us to incur significant warranty and repair costs, divert the attention of our engineering personnel from our product development efforts and cause significant customer relations problems. In addition, all of our products operate on our internally developed operating system. As a result, any error in the operating system will affect all of our products. We have experienced minor errors in the past in connection with new products and enhancements to existing products. We expect that errors 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 performance 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 and could seriously harm our business reputation.

We are the target of various litigation and regulatory proceedings, which could result in substantial costs, divert management attention and resources, and have a material adverse effect on our results of operations or financial position.

As described in Note 7 of Notes to Consolidated Financial Statements, we are a party to various litigation, including class action litigation arising out of our initial public offering in 1999 and derivative actions arising out of allegedly misleading statements about our prospects made between February 20, 2004 and May 27, 2004, which actions were subsequently amended to seek relief on our behalf from certain defendants with respect to our historical stock option practices.

As described in Note 7 of Notes to Consolidated Financial Statements, in July 2006, we are, or have been, the subject of various inquiries and investigations conducted by the SEC, the U.S. Attorney’s Office for the Northern District of California, the NASD, and a Chicago Board Options Exchange.

Any material litigation and regulatory proceedings inevitably result in the diversion of our management’s attention and an expenditure of our resources. As well, any adverse result could have a material adverse effect on our results of operations and financial condition.

If the protection of our proprietary technology is inadequate, our competitors may gain access to our technology, and our market share could decline.

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 do not protect our proprietary rights to as great an extent as do the laws of the United States. Our means of protecting our proprietary rights may not be adequate and unauthorized third parties, including our competitors, may independently develop similar or superior technology, duplicate or reverse engineer aspects of our products, or design around our patented technology or other intellectual property.

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We presently have 16 issued U.S. patents, 29 pending U.S. patent applications (provisional and non-provisional), and 1 pending foreign patent application. 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.

There can be no assurance or guarantee that any products, services or technologies that we are presently developing, or will develop in the future, will result in intellectual property that is protectable under law, whether in the United States or a foreign jurisdiction, that such intellectual property will produce competitive advantage for us, or that the intellectual property of competitors will not restrict our freedom to operate or put us at a competitive disadvantage.

Third parties could assert that our products infringe their intellectual property rights.

Third parties may claim that our current or future products infringe their intellectual property rights, and these claims, whether they have merit or not, could harm our business by increasing our costs, reducing our net revenue or by creating customer concerns that result in 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 may claim that one or more of our products infringes a patent held by the claimant. For example, as discussed in Note 7 of Notes to Consolidated Financial Statements, on March 13, 2006, eSoft, Inc. filed a complaint for patent infringement against us in the U.S. District Court for the District of Colorado, alleging infringement of its U.S. Patent 6,961,773, (the “773 Patent”) and seeking unspecified monetary damages, as well as an injunction against future infringements.

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. Any claims, including the eSoft claim, with or without merit, could be time-consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. Royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all, which could seriously harm our business.

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

Since our initial public offering, the market price of our common stock has experienced significant fluctuations and is likely to continue to fluctuate significantly. Such volatility in the trading price of our stock can occur in response to general market conditions and cause an increase or decline in our stock price without regard to our operating performance, as well as in response to changes in our business or the IT or technology market generally. The market price of our common stock could decline quickly and significantly if we fail to achieve our guidance or if our performance fails to meet the expectation of public market analysts or investors.

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

• variations in our quarterly operating results;

• changes in financial estimates or investment recommendations by securities analysts;

• changes in macroeconomic conditions;

• the introduction of new products by our competitors;

• our ability to keep pace with changing technological requirements;

• changes in market valuations of Internet-related and networking companies;

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

• loss of a major customer;

• additions or departures of key personnel;

• fluctuations in stock market volumes;

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

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

• significant transactions.

It is not uncommon for securities class action 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, further, result in a decline in our stock price.

Our business is subject to increasingly complex corporate governance, public disclosure, accounting, and tax requirements that have increased both our costs and the risk of noncompliance.

Because our common stock is publicly traded, we are subject to certain rules and regulations of federal, state, and other entities charged with the protection of investors and the oversight of companies whose securities are publicly traded. These entities, including the Public Company Accounting Oversight Board, the SEC, and NASDAQ, have implemented new requirements and regulations and are continuing to develop additional regulations and requirements in response to recent corporate scandals and laws enacted by Congress, most notably the Sarbanes-Oxley Act of 2002. Our efforts to comply with these new regulations have resulted in, and are likely to continue resulting in, increased general and administrative expenses and diversion of management time and attention from revenue-generating activities to compliance activities.

We recently completed our evaluation of our internal controls over financial reporting as required by Section 404 of the Sarbanes-Oxley Act of 2002. Although our assessment, testing, and evaluation resulted in our conclusion that, as of April 27, 2007, our internal controls over financial reporting were effective, we cannot predict the outcome of our testing in future periods. If our internal controls are ineffective in future periods, our business and reputation could be harmed. We may incur additional expenses and commitment of management’s time in connection with further evaluations, which could materially increase our operating expenses and, accordingly, reduce our net income.

The interpretation and application of new and modified laws, regulations, and standards may evolve over time, as new guidance is provided by regulatory and governing bodies and by court decisions. This evolution may result in continuing uncertainty regarding compliance matters and additional costs necessitated by ongoing revisions to our disclosure and governance practices.

We are subject to governmental export and import controls that could subject us to liability or impair our ability to compete in international markets.

Our products are subject to U.S. export controls and may be exported outside the U.S. only with the required level of export license or through an export license exception, because we incorporate encryption technology into our products. In addition, various countries regulate the import 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. Changes in our products or changes in export and import regulations may create delays in the introduction of our products in international markets, 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 change in export or import regulations or related legislation,

40

shift in the enforcement or scope of existing regulations, or change in the countries, persons or technologies targeted by such regulations, could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential customers with international operations. Any decreased use of our products or limitation on our ability to export or sell our products would likely adversely affect our business, financial condition and operating results.

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. 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 adversely impact our reputation, such events could adversely affect our operating results and financial condition.

The legal environment in which we operate is uncertain and claims against us could cause our business to suffer.

Our products operate in part by storing material available on the Internet and making this material available to end users from our appliance. As well, our appliance may be used to block content from being accessed. This creates the potential for claims to be made against us, either directly or through contractual indemnification provisions with our customers, for defamation, negligence, copyright or trademark infringement, personal injury, censorship, invasion of privacy or other legal theories based on the nature, content or copying of this content. As of April 30, 2007, we have not accrued any liabilities relating to indemnification provisions with our customers. It is also possible that if any information provided through any of our products contains errors, third parties could make claims against us for losses incurred in reliance on this information. Our insurance may not cover potential claims of this type or be adequate to protect us from all liability that may be imposed.

We have incurred and may continue to incur, in future periods, significant stock-based compensation charges under SFAS No. 123(R), which may adversely affect our reported financial results.

On May 1, 2006, we adopted the Statement of Financial Accounting Standards (“SFAS”) No. 123(R), issued by the Financial Accounting Standards Board (“FASB”), which requires the measurement of all share-based payments to employees, including grants of employee stock options, using a fair-value-based method and the recording of such expense in our consolidated statements of income. The adoption of the SFAS No. 123(R) fair value method resulted in our recording of $9.5 million in non-cash stock-based compensation expense in Fiscal 2007. Although we anticipate that our adoption of SFAS No. 123(R) will continue to adversely impact our reported results of operations, future changes to the assumptions used to determine the fair value of our equity awards, and the amount and type of those equity awards, will impact the expense recorded in any given period.

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

None

Item 3. Defaults Upon Senior Securities

None

Item 4. Submission of Matters to a Vote of Security Holders

None

Item 5. Other Information

None

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Item 6. Exhibits

Number	Description
10.31	2007 New Employee Stock Incentive Plan (which is incorporated by reference to Exhibit 10.1 of Form 8-K filed by the Registrant with the Commission on June 18, 2007)
10.32	Form of Notice of Grant of Stock Option and Stock Option Agreement used to evidence options granted under Blue Coat Systems, Inc. 2007 New Employee Stock Incentive Plan (which is incorporated by reference to Exhibit 10.2 of Form 8-K filed by the Registrant with the Commission on June 18, 2007)
10.33	Form of Notice of Award of Restricted Stock and Restricted Stock Agreement used to evidence restricted stock awarded under Blue Coat Systems, Inc. 2007 New Employee Stock Incentive Plan (which is incorporated by reference to Exhibit 10.3 of Form 8-K filed by the Registrant with the Commission on June 18, 2007)
10.37	Offer Letter with Bethany Mayer, dated as of May 8, 2007
31.1	Chief Executive Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Chief Financial Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Chief Executive Officer and Chief Financial Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

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

BLUE COAT SYSTEMS, INC.

/s/ Kevin S. Royal

Kevin S. Royal

Senior Vice President and Chief Financial Officer

(Principal Financial and Accounting Officer)

Dated: September 10, 2007

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EX-10.37

Exhibit 10.37

May 8, 2007

Bethany Mayer

Dear Bethany:

I am pleased to extend to you an offer to join Blue Coat Systems, Inc. as SVP, Marketing, reporting to Brian NeSmith, President and CEO.

We have structured an offer package for you that consists of the following components:

• An annual base salary of $230,000 paid according to standard company payroll policies.

• Eligibility to participate in the company’s Executive quarterly profit sharing bonus plan. This plan pays you 20% of your quarterly base pay, when the company meets its quarterly profitability goals. Bonus payments to executives are paid in installments, subject to the executive’s continued employment with the Company.

• We will recommend that you receive an option to purchase 30,000 shares of the Company’s Common Stock reserved under the Company’s option plan. The exercise price per share will be equal to the fair market value per share on the date the option is granted. You will vest in 25% of the option shares after 12 months of service, and the balance will vest in monthly installments over the next 36 months of service, as described in the applicable stock option agreement. This grant is subject to approval of the Company’s Compensation Committee in accordance with procedures established by the Company’s Board of Directors and your execution of the appropriate stock option agreement.

• In addition, we will recommend that you receive an award of 3,000 restricted shares of the Company’s Common Stock. Restrictions are removed as the restricted shares vest. You will vest 25% of the restricted shares after 12 months of service, and the balance will vest in quarterly installments over the next 3 years of service, as described in the applicable restricted stock agreement. This award is subject to approval of the Company’s Compensation Committee in accordance with procedures established by the Company’s Board of Directors and your execution of the appropriate restricted stock agreement.

• Eligibility for all standard benefits according to the Company’s U.S. benefits plan. Information on benefits will be supplied to you as soon as possible.

• You will be designated as an executive officer of the Company under Section 16 of the Securities Act of 1934. Under Section 16, you are required to make various filings with the Securities and Exchange Commission (SEC) in connection with your assumption of your position and any trades you may make in the Company’s securities. As an executive officer, you and other members of your family and household will be subject to certain restrictions with respect to trading in the Company’s securities, including, but not limited to, the restrictions imposed by the Company’s Insider Trading Policy and Pre-Clearance Procedures.

Page 2

Like all Company employees, you will be required, as a condition of your employment with the Company, to sign the Company’s standard Proprietary Information and Inventions Agreement, a copy of which is enclosed. While you render services to the Company, you will not engage in any other gainful employment, business or activity without the written consent of the Company. While you render services to the Company, you also will not assist any person or organization in competing with the Company, in preparing to compete with the Company or in hiring any employees or consultants of the Company.

In accordance with the requirements of the Immigration Reform and Control Act of 1986, you will be required to provide verification of your identity and your legal right to work in the United States. This offer is contingent upon your ability to provide us with such documentation.

You will be required to complete an application form and a reference and background check authorization form. Your offer of employment is contingent upon your execution of the application form and satisfactory completion of the reference and background check.

Your employment with the Company will be “at will,” meaning that either you or the Company will be entitled to terminate your employment at any time and for any reason, with or without cause. Any contrary representations, which may have been made to you, are superseded by this offer. This is the full and complete agreement between you and the Company on this term. Although your job duties, title, compensation and benefits, as well as the Company’s personnel policies and procedures, may change from time to time, the “at will” nature of your employment may only be changed in an express written agreement signed by you and the Company’s President and CEO.

This letter and the enclosed Proprietary Information and Inventions Agreement supersede any prior understandings or agreements, whether oral or written, between you and the Company. These documents may not be amended or modified except by an express written agreement signed by you and the Company’s President and CEO. The terms of this offer and the resolution of any disputes will be governed by California law.

We look forward to your joining Blue Coat and believe that you will find this organization to be a truly exciting and fulfilling place to work!

This offer stands until the end of business on 5/14/2007 and your signature below acknowledges your acceptance of these terms.

Best Regards,

David Powell	Bethany Mayer
Director, Human Resources
Blue Coat Systems, Inc.	My start date will be

EX-31.1

Exhibit 31.1

CERTIFICATION

I, Brian M. NeSmith, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of Blue Coat Systems, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: September 10, 2007

/s/ Brian M. NeSmith

Brian M. NeSmith

President and Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Kevin S. Royal, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of Blue Coat Systems, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: September 10, 2007

/s/ Kevin S. Royal

Kevin S. Royal

Senior Vice President and Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

(18 U.S.C. SECTION 1350)

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350), Brian M. NeSmith, President and Chief Executive Officer of Blue Coat Systems, Inc. (the “Company”), and Kevin Royal, Chief Financial Officer of the Company, each hereby certifies that, to the best of his knowledge:

1. Our Quarterly Report on Form 10-Q for the quarter ended July 31, 2007, to which this Certification is attached as Exhibit 32.1 (the “Report”), fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, and

2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: September 10, 2007

/s/ Brian M. NeSmith	/s/ Kevin S. Royal
Brian M. NeSmith	Kevin S. Royal
President and Chief Executive Officer	Senior Vice President and Chief Financial Officer