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Article by DailyStocks_admin    (03-10-08 09:53 AM)

Filed with the SEC from Feb 28 to Mar 5:

Packeteer
Elliott Associates said that it is prepared to acquire Packeteer for $5.50 a share in cash -- more than 40% above the company's recent share price. Elliott said that its offer is "compelling" and provides shareholders "immediate, quantifiable value," which it doesn't believe Packeteer could achieve in today's challenging economic environment. Packeteer makes wide-area application delivery systems for wireless-computer networks. Elliott holds 3,559,117 shares (9.8% of the total outstanding).

BUSINESS OVERVIEW

OVERVIEW

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

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

INDUSTRY BACKGROUND

Networked computing has created new challenges for Information Technology, or IT, managers. As more core business applications, such as SAP and Oracle, become distributed and Web-enabled, and the use of video over IP and voice over IP, or VoIP, increases, the amount of network data increases dramatically. This increase in data makes it difficult for businesses to ensure the performance of their applications. Further, enterprise users access graphic-intensive web sites, download large files, view streaming media presentations, monitor news and stock quotes and access peer-to-peer applications, instant messaging and other critical and non-critical information over the Internet.

The resulting traffic deluge impacts network resources that serve point-of-sale, order processing, enterprise resource planning, supply-chain management and other vital business functions.

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

The WAN/Application Bottleneck

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

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

The Packeteer Solution

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

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


• gain application and network performance visibility and insight,

• ensure proper performance for mission-critical applications,

• permit easy deployment,

• increase effective and available bandwidth,

• enable time-sensitive interactive services,

• enable server consolidation,

• increase network efficiency and

• reduce operational cost.

OUR KEY STRATEGIES

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

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

Continue to Build Indirect Distribution Channels. We currently have over 1,000 value-added resellers, distributors and systems integrators that sell our products in over 50 countries. We intend to continue to develop and support new reseller and distribution relationships, as well as to establish additional indirect channels with service providers and systems integrators. We believe this strategy will enable us to increase the worldwide deployment of our products.

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

Focus on a Comprehensive Solution for Branch Office IT Services Where Applications Have Been Consolidated Into Data Centers. Our iShaper and iShared products are designed to provide optimal solutions for organizations that have consolidated applications for branch offices at centralized data centers. The appliances that are implemented in the branch allow for consolidation of link optimization and general-purpose IT services that are fully compatible with the Microsoft file system and Windows operating system services. These products provide improvement to end user access to files using the CIFS protocol, while being compliant with Microsoft’s file handling methodologies. In addition, the iShaper product adds a complete set of visibility, QoS, control, compression and application acceleration features while also supporting Microsoft services like DHCP and print services all within a single branch office appliance.

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

PRODUCTS

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

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

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

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

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

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

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

IntelligenceCenter is a management framework and reporting tool that is designed to allow centralized management of all Packeteer appliances from a single location, aggregate metrics from large deployments and create organization-wide reports to manage trends and provide support for capacity planning and usage analysis. IntelligenceCenter lowers the cost of ownership for large deployments of PacketShaper appliances, improves the quality of information and eases administrative overhead.

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

iShaper combines the capabilities of iShared and PacketShaper into a single appliance. It is well suited for enterprises that have consolidated applications used in branch offices into a centralized data center, where the goal is to have as few appliances as possible in each branch office location.

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

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

CUSTOMERS

We sell all of our products primarily through an established network of more than 1,000 distributors, value-added resellers and system integrators in more than 50 countries, complemented by our direct sales organization. In 2007, sales to Alternative Technology, Inc. and Westcon, Inc. accounted for 25% and 16% of net revenues, respectively. These customers are distributors, who in turn sell to a large number of value-added resellers, system integrators and other resellers.

MANUFACTURING

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

MARKETING AND SALES

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

We have a number of marketing programs to support the sale and distribution of our products and educate existing and potential enterprise and service provider customers about the benefits of our products. Our marketing efforts include publication of technical, educational and business articles in industry magazines, participation in tradeshows, conferences and technology seminars, electronic marketing, including web site- based communication programs, electronic newsletters and on-line end user seminars; and focused advertising, direct mail, public relations and analyst outreach.

As of December 31, 2007, our worldwide sales and marketing organization consisted of 181 individuals, including managers, sales representatives and technical and administrative support personnel. We have domestic sales offices located throughout the United States. In addition, we have international sales offices located throughout Europe and the Asia Pacific region, and in Japan, Canada, Brazil and Mexico.

We believe there is a strong international market for our products. Our international sales are conducted primarily through our overseas offices. Sales to customers outside of the Americas accounted for 55%, 53%, and 53% of net revenues in 2007, 2006, and 2005, respectively.

RESEARCH AND DEVELOPMENT

As of December 31, 2007, our research and development organization consisted of 136 employees providing expertise in different areas of our software control and compression technologies, classification, central management, user interface, platform engineering and protocol acceleration. Since inception, we have focused our research and development efforts on developing and enhancing our WAN Application Delivery solutions. In 2007, 2006, and 2005, we spent $37.5 million, $30.6 million, and $21.8 million, respectively, on research and development efforts. During 2007, our major research and development programs included creating a unified branch office appliance, iShaper, a unified central management system, IntelligenceCenter, and a high speed product architecture, of which the Talon TC30, launching in 2008, will be the first product. In addition, we released new versions of iShared, Mobiliti, SkyX, and PacketShaper products, which included new features and capabilities.

CUSTOMER SERVICE AND TECHNICAL SUPPORT

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

COMPETITION

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

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


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

• products to suit every required delivery point;

• expertise and in-depth knowledge of applications;

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

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

• timeliness of new product introductions;

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

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

• compatibility with industry standards.

INTELLECTUAL PROPERTY

We rely on a combination of patent, copyright and trademark laws, and on trade secrets, confidentiality provisions and other contractual provisions to protect our proprietary rights. These measures afford only limited protection. As of December 31, 2007, we have 43 issued U.S. patents and 78 pending U.S. patent applications. We cannot assure you that our means of protecting our proprietary rights in the U.S. or abroad will be adequate or that competitors will not independently develop similar technologies. Our future success depends in part on our ability to protect our proprietary rights to the technologies used in our principal products. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use trade secrets or other information that we regard as proprietary. In addition, the laws of some foreign countries do not protect our proprietary rights as fully as do the laws of the U.S. We cannot assure you that any issued patent will preserve our proprietary position, or that competitors or others will not develop technologies similar to or superior to our technology. Our failure to enforce and protect our intellectual property rights could harm our business, operating results and financial condition.

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

EMPLOYEES

As of December 31, 2007, we employed a total of 428 full-time equivalent employees. Of the total number of employees, 136 were in research and development, 162 in sales and system engineering, 19 in marketing, 73 in customer support and operations and 38 in administration. Our employees are not represented by any collective bargaining agreement with respect to their employment by us.

CEO BACKGROUND

Dave Côté has served as our President, Chief Executive Officer and director since October 2002. From April 1997 to October 2002, Mr. Côté served as Vice President of Worldwide Marketing and Communication ASSPs (Application-Specific Standard Products) for Integrated Device Technology, Inc., a semiconductor company. From January 1995 to November 1996, Mr. Côté served as Vice President of Marketing and Customer Support for ZeitNet Inc., which was acquired by Cabletron in 1996. From 1979 to 1995, he served in various marketing and sales positions, most recently as Director of Marketing at SynOptics, Inc. (now Nortel Networks). Mr. Côté holds a B.S. from the University of California at Davis and an M.B.A. from California State University at Sacramento.

Arturo Cázares has served as our Vice President, Worldwide Sales since January 2004. Previously, he served as Senior Vice President, Worldwide Sales and Marketing at Menlo Worldwide, a supply chain logistics and transportation company, from September 2002 to January 2004. From July 1992 through August 2002, Mr. Cázares served in various executive management positions at 3Com Corporation. Most recently, Mr. Cázares was Vice President, Sales, Service & Marketing for 3Com’s Business Connectivity Company from June 2001 through September 2002 and as Vice-President of Worldwide Services of 3Com from April 2001 to June 2001. Mr. Cázares served as Vice President for 3Com EMEA from April 1999 through April 2001, and prior to that Mr. Cázares was Vice President for 3Com Americas International. Prior to 3Com, Mr. Cázares worked at Sun Microsystems and Fujitsu America. Mr. Cázares holds a B.S. in electrical engineering and an M.B.A. from Stanford University.

Manuel R. Freitas has served as our Vice President, Operations and Customer Support since May 2000. Mr. Freitas served as an independent operations management consultant from April 1999 until November 1999 and then again from February 2000 through May 2000. From November 1999 to February 2000, he served as Vice President of Customer Operations for Vividence Corporation, an Internet services company. From February 1990 to March 1999, Mr. Freitas served in various positions at Adobe Systems, Inc., including Vice President of Worldwide Customer Operations from October 1995 to March 1999, interim Vice President of Sales and Support for the Americas from April 1998 to November 1998 and Director of OEM and Developer Support from February 1990 to September 1995. Prior to joining Adobe, Mr. Freitas served in product management, field operations management, and sales management positions at Schlumberger Technologies from 1980 to 1989. Mr. Freitas holds a B.A. in business administration from William Patterson College.

Alan Menezes has served as our Vice President of Marketing since February 2007. From August 2005 through February 2007, Mr. Menezes served as Corporate Vice President, Marketing and Business Development at Wavion , a Wi-Fi (wireless fidelity) company. Prior to joining Wavion, he was Vice President of Marketing at Aperto Networks, a WiMAX (worldwide interoperability for microwave access) equipment provider, from November 1999 through August 2005. From 1983 through 1998, Mr. Menezes held various marketing and engineering positions at AccessLan Communications, Allied Telesyn International, 3Com, DSC and Nortel. In 1989, Mr. Menzes also co-founded OnStream Networks, a provider of broadband access solutions which was subsequently acquired by 3Com. He holds a B.S. in electrical engineering from the University of Alberta, Canada.

Nelu Mihai has served as our Vice President, Engineering since January 2006. Mr. Mihai served as Senior Vice President of Engineering and Operations at Cloudshield Technologies, a provider of servers for network traffic inspection, from April 2003 to March 2004. From April 2004 to January 2006, Mr. Mihai was a consultant for early stage private software, telecom, security and network semiconductor companies. In 2002, he co-founded SLA partners, an international consulting firm. From December 1999 to December 2001 he served as Chief Executive Officer and Chief Operating Officer of CPlane Inc, a telecommunication software company. Prior to 1999, he worked for six years at Bell Labs and AT&T, his last position there being Division Manager. Before 1994, he served in different positions at various Silicon Valley startup companies specializing in real time operating systems and at nuclear research institutes in Western Europe. Mr. Mihai holds a M.S. in computer engineering from Polytechnic University of Bucharest and a Ph.D in computer science from the Institute of Atomic Physics, Bucharest, with the doctorate work done at CERN Geneva, Switzerland.

Greg Pappas has served as our Vice President of Human Resources since November 2005. From July 2004 through October 2005, Mr. Pappas served as Vice President of Human Resources of Extended Systems, Inc., a mobility software company. From June 2000 through July 2004, Mr. Pappas served as Vice President of Human Resources for GlobalEnglish Corporation, an Internet e-learning company. Prior to joining GlobalEnglish, from November 1998 through June 2000 Mr. Pappas served as Vice President of Human Resources for Inference Corporation, a knowledge management software company acquired by E-Gain Corporation. Mr. Pappas holds a B.S. in human resource administration from Kennedy-Western University.

David C. Yntema has served as our Chief Financial Officer and Secretary since January 1999. From May 1994 through August 1998, Mr. Yntema served as Chief Financial Officer and Vice President, Finance and Administration of VIVUS, Inc., a pharmaceutical company. Prior to joining VIVUS, Mr. Yntema served as Chief Financial Officer for EO, Inc., a handheld computer company; MasPar Computer Corporation, a massively parallel computer company; and System Industries, a storage subsystem company; and has held a variety of other financial and general management positions. Mr. Yntema holds a B.A. in economics and business administration from Hope College and an M.B.A. from the University of Michigan and is a certified public accountant.

MANAGEMENT DISCUSSION FROM LATEST 10K
OVERVIEW

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

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

Net revenues for 2007 were $144.5 million, a slight decrease from net revenues for 2006 of $145.1 million. Product revenues decreased to $97.8 million from $110.1 million, or 11%, in 2007 compared to 2006. We believe the shortfalls in product revenues were primarily the result of a changing and increasingly competitive environment. In addition, during 2007 we experienced product transition issues associated with our greater focus on acceleration related technologies and new product introductions, including our new iShaper products, as well as delayed completion of several product enhancements to our acceleration products prior to the end of the three months ended March 31, 2007.

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

CRITICAL ACCOUNTING POLICIES

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

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

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


• persuasive evidence of an arrangement exists,

• delivery has occurred,

• the fee is fixed or determinable, and

• collectibility is probable.

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

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

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

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

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

We defer recognition of revenue on inventory in the distribution channel in excess of a certain number of days. On the same basis, we reduce the associated cost of revenues, which is primarily related to materials, and include this amount in inventory. We recognize these revenues and associated cost of revenues when the inventory levels no longer exceed expected supply. We obtain channel inventory data from our distributors and have developed a history of our product returns upon which we base our estimate. No amounts were deferred under this policy as of December 31, 2007 or 2006.

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

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

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

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

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

Sales return reserve. In accordance with SFAS 48, “Revenue Recognition When Right of Return Exists,” management must use judgment and make estimates of potential future product returns related to current period product revenue. When providing for sales return reserves, we analyze historical return rates, as we believe they are the primary indicator of possible future returns. Material differences may result in the amount and timing of our revenues if for any period actual returns differ from our judgments or estimates. The sales return reserve balances at December 31, 2007 and 2006 were $2.4 million and $2.5 million, respectively.

Rebate reserves. Certain distributors and resellers can earn rebates under several of our programs. The rebates earned are recorded in accordance with Emerging Issues Task Force 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendors Products)”. For established programs, our estimates for rebates are based on historical usage rates. For new programs, rebate reserves are calculated to cover our maximum exposure until such time as historical usage rates are developed. When sufficient historical experience is established, there may be a reversal of previously accrued rebates if actual rebate claims are less than the maximum exposure. Additionally, there may be a reversal of previously accrued rebate reserves if rebates are not claimed before the expiration dates established for each program. Rebate reserves at December 31, 2007 and 2006 were $1.7 million and $2.3 million, respectively.

Stock Based Compensation. Effective January 1, 2006, we began accounting for stock-based awards under the provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (SFAS 123R), which requires the recognition of the fair value of equity-based compensation. The fair value of stock options and ESPP shares was estimated using a Black-Scholes option valuation model. This model requires the input of subjective assumptions, including expected stock price volatility and estimated life of each award. The fair value of equity-based awards is amortized over the vesting period of the award, net of estimated forfeitures, and we have elected to use the graded-option method. We make quarterly assessments of the adequacy of the tax credit pool to determine if there are any deficiencies that require recognition in the consolidated statements of operations. Prior to the implementation of SFAS 123(R), we accounted for stock options and Employee Stock Purchase Plan, or ESPP, shares under the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and made pro forma footnote disclosures as required by SFAS No. 148, “Accounting For Stock-Based Compensation — Transition and Disclosure,” which amended SFAS No. 123, “Accounting For Stock-Based Compensation.” Pro forma net income and pro forma net income per share disclosed in the footnotes to the consolidated financial statements were estimated using a Black-Scholes option valuation model. The fair value of restricted shares issued in connection with an acquisition was calculated based upon the fair market value of our common stock at the date of grant. See Notes 1 and 7 of the Notes to the Consolidated Financial Statements for additional information and related disclosures.

Accounting for Income Taxes. We utilize the asset and liability method of accounting for income taxes pursuant to Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes , (SFAS 109). Accordingly, we are required to estimate our income taxes in each of the jurisdictions in which we operate as part of the process of preparing our consolidated financial statements. This process involves estimating our actual current tax exposure, including assessing the risks associated with tax audits, together with assessing temporary differences resulting from the different treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. Due to the evolving nature of tax rules combined with the large number of jurisdictions in which we operate, it is possible that our estimates of our tax liability could change in the future, which may result in additional tax liabilities and adversely affect our results of operations, financial condition and cash flows. SFAS 109 provides for the recognition of deferred tax assets if it is more likely than not that those deferred tax assets will be realized. Management reviews deferred tax assets periodically for recoverability and makes estimates and judgments regarding the expected geographic sources of taxable income in assessing the need for a valuation allowance to reduce deferred tax assets to their estimated realizable value.

Factors such as our cumulative profitability in the U.S. and our projected future taxable income were the key criteria in deciding to release a portion of the valuation allowance in 2007, 2006 and 2005. If the estimates and assumptions used in our determination change in the future, we could be required to revise our estimates of the valuation allowances against our deferred tax assets and adjust our provisions for additional income taxes.

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109”, (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS 109. FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return that results in a tax benefit. Additionally, FIN 48 provides guidance on de-recognition, statement of operations classification of interest and penalties, accounting in interim periods, disclosure, and transition. We adopted FIN 48 on January 1, 2007, and the provisions of FIN 48 have been applied to all income tax positions commencing from that date. We recognize potential accrued interest and penalties related to unrecognized tax benefits within operations as income tax expense. The cumulative effect of the implementation was accounted for as an adjustment to the January 1, 2007 balance of accumulated deficit.

We record liabilities for uncertain tax positions that could be challenged by taxing authorities that, in the Company’s judgment, do not meet the more likely than not threshold of being sustained upon examination, based on the facts, circumstances, and information available at the reporting date. The Company estimates and records the liability for uncertain tax positions considering the probabilities of the outcomes that could be realized upon settlement using the facts, circumstances and information available at the reporting date. It is often difficult to predict the final outcome or timing of resolution of any particular tax matter. Various events, some of which cannot be predicted, may occur that would affect our recognition of liabilities for uncertain tax positions.

RESULTS OF OPERATIONS

OVERVIEW OF RESULTS OF OPERATIONS FOR 2007

Net revenues for 2007 were $144.5 million, a slight decrease from net revenues for 2006 of $145.1 million. Product revenues decreased to $97.8 million from $110.1 million, or 11%, during 2007 compared to 2006. We believe the shortfalls in product revenues were primarily the result of a changing and increasingly competitive environment. In addition, during 2007, we experienced product transition issues associated with our greater focus on acceleration related technologies and new product introductions, including our new iShaper products, as well as delayed completion of several product enhancements to our acceleration products prior to the end of the three months ended March 31, 2007.

During 2007 gross profit was $99.2 million, or 69% of net revenues, loss from operations was $23.3 million and net loss was $25.6 million. During 2006 gross profit was $106.0 million, or 73% of net revenues, income from operations was $1.8 million and net income was $4.9 million. Included in cost of revenues and operating expenses for 2007 and 2006 was stock-based compensation expense of $11.9 million and $13.8 million, respectively, related to stock-based awards as determined in accordance with SFAS 123(R) and amortization of intangible assets of $3.8 million and $2.9 million, respectively. Also included in operating expenses for 2006 was $1.8 million of in-process research and development (IPR&D).

During 2007, we continued to invest in our operations, with operating expenses of $122.4 million. This represents an increase of $18.2 million, or 17%, from $104.3 million reported in 2006. Headcount at December 31, 2007 was 428, representing an increase of 7, or 2%, compared to 421 at December 31, 2006. Average headcount for 2007 was 452, representing an increase of 18%, compared to an average headcount of 382 for 2006. The primary reason for the increase in average headcount in the years was the May 2006 acquisition of Tacit.

During 2007, we used $1.7 million of cash in operating activities, compared to $20.4 million generated in the prior year. At December 31, 2007, we had cash, cash equivalents and investments of $77.8 million, accounts receivable of $27.4 million and deferred revenues of $31.9 million.

The following table sets forth certain financial data as a percentage of net revenues for the periods indicated. The financial data for the periods indicated includes the results of Tacit subsequent to May 16, 2006

NET REVENUES

We derive our revenue from two sources, product revenues and service revenues. Product revenues consist primarily of sales of our WAN Application Delivery systems. Product revenues accounted for 68%, 76% and 76% of our net revenues in 2007, 2006 and 2005, respectively. Product revenues were $97.8 million in 2007, compared to $110.1 million in 2006 and $85.6 million in 2005. The decrease in product revenues from 2006 to 2007 of $12.4 million, or 11%, is primarily the result of a slight decrease in the number of hardware units shipped and a decrease in weighted average selling prices, partially offset by an increase in software units and upgrades sold. We believe the shortfalls in product revenues were primarily the result of a changing and increasingly competitive environment. In addition, during the first six months of 2007, we experienced product transition issues associated with our greater focus on acceleration related technologies and new product introductions, including our new iShaper products, as well as delayed completion of several product enhancements to our acceleration products prior to the end of the three months ended March 31, 2007. The increase in product revenues from 2005 to 2006 of $24.6 million, or 29%, was primarily the result of an increase in the number of units shipped and a slight increase in weighted average selling prices. In addition, $6.8 million of the increase in 2006 compared to 2005 related to revenue recognized from the sale of Tacit products.

Service revenues consist primarily of maintenance revenues and, to a lesser extent, training revenues. Maintenance revenues, which are included in service revenues, are recognized on a daily basis over the life of the contract. The typical support term is twelve months, although multi-year contracts of up to five years are also sold. Service revenues increased to $46.7 million in 2007 from $35.0 million in 2006 and from $27.4 million in 2005, and accounted for 32%, 24%, and 24% of net revenues in 2007, 2006 and 2005, respectively. The increase from 2006 to 2007 of $11.7 million, or 34%, was due primarily to increases in the number of units under maintenance contracts. The increase from 2006 to 2005 of $7.6 million, or 28%, was due primarily to an increase in the number of units under maintenance contracts, as well as revenue from Tacit maintenance contracts of $1 million.

At December 31, 2007, Alternative Technology and Westcon accounted for 18% and 15% of accounts receivable, respectively. At December 31, 2006, Alternative Technology and Westcon accounted for 18% and 23% of accounts receivable, respectively.

COST OF REVENUES

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

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

Cost of revenues was $45.3 million for 2007, an increase of $6.2 million, or 16%, from $39.1 million for 2006, compared to $29.3 million for 2005. Excluding the amortization of intangibles, the cost of revenues represented 30% of total net revenues for 2007, compared to 25% in 2006 and 26% in 2005.

Product costs increased $2.6 million, or 10%, to $28.6 million in 2007 from $26.0 million in 2006, compared to $19.6 million in 2005. Other product costs increased $3.0 million in 2007 from 2006, primarily as a result of inventory write-downs of $1.3 million, mostly related to excess inventory levels of certain products. During 2007 we recorded an inventory write-down of $0.7 million as a result of a reduction in market demand for one of our PacketShaper products. In addition, we identified $0.2 million of inventory that was determined to be obsolete due to design changes that resulted from changes in regulatory standards in certain European markets that impacted certain of our products. In addition, fulfillment costs increased $0.8 million and freight charges increased $0.4 million during 2007. Product manufacturing costs were slightly less in 2007 compared to 2006, reflecting a slight decrease in the number of hardware units shipped. The increase in product costs in 2006 from 2005 was primarily related to an increase in manufacturing costs of $4.1 million from 2005 due to increases in the number of units shipped, and to a lesser extent an increase in weighted average component cost. Other product costs increased $2.4 million in 2006 from 2005, primarily for overhead costs. Product costs for 2006 also included $0.4 million of stock-based compensation related to stock-based awards and an increase of $0.5 million in other personnel related costs due to increased headcount, as well as increases of $0.5 million in inventory write-downs, $0.3 million in warranty expense and $0.3 million in freight costs. Our gross margin on product revenues was 71% in 2007 compared to 76% in 2006 and 77% in 2005. The decrease in product margin in 2007 was primarily due to the increase in other product costs in both absolute dollar amounts and as a percentage of product revenues.

Service costs increased $3.2 million, or 30%, to $14.1 million for 2007 from $10.9 million in 2006 and $8.2 million in 2005. The increase in 2007 from 2006 includes an increase of $0.8 million in personnel costs due to increased headcount, $0.6 million in expensed support materials primarily related to new products, $0.5 million in increased facilities costs, and $0.8 million in third party logistics support costs. The increase in 2006 from 2005 includes $0.7 million of stock-based compensation related to stock option plans and the ESPP and increases of $1.2 million in other personnel costs due to increased headcount, and $0.2 million in expensed support materials. Our gross margin on service revenues was 70% in 2007 compared to 69% in 2006 and 70% in 2005.

In connection with the May 2006 acquisition of Tacit, we recorded $3.5 million of purchased intangible assets related to developed technology that are being amortized over their estimated useful lives of three years. In 2007 and 2006, amortization expense of $1.2 million and $0.8 million, respectively, related to these intangibles was included in cost of revenues. In connection with the acquisition of Mentat in 2004, we recorded $7.2 million of purchased intangible assets that are being amortized over their estimated useful lives of one to six years. Included in cost of revenues during 2007, 2006 and 2005 was $1.3 million, $1.4 million and $1.6 million, respectively, of amortization of these intangible assets.

RESEARCH AND DEVELOPMENT

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

Research and development expenses of $37.5 million in 2007 increased from $30.6 million in 2006 and from $21.8 million in 2005. The increased costs in 2007 from 2006 of $6.9 million were primarily due to personnel related expenses, consisting of salaries, employee benefits and stock-based compensation, which increased $3.6 million as a result of an increase in average headcount partially offset by a decrease in bonuses of $0.8 million. Research and development headcount was 136 at December 31, 2007 compared to 146 at December 31, 2006 and 105 at December 31, 2005. Average headcount in 2007 increased 14% to 150, compared to 132 in 2006. The increase in average headcount for 2007 compared to the prior year was primarily due to the acquisition of Tacit. In addition, allocated corporate services and facilities costs increased $1.0 million due to increased headcount, hardware, software, prototype and beta test costs related to new product development increased $1.3 million and outside services increased $1.2 million from 2006.

Research and development expenses of $30.6 million in 2006 increased from $21.8 million in 2005. The increased costs in 2006 from 2005 were primarily due to increased personnel related expenses of $7.7 million, including amortization of stock-based compensation related to stock option plans and the ESPP of $3.9 million, and $3.8 million related to an increase in headcount, primarily resulting from the Tacit acquisition. In addition, allocated corporate services and facilities costs increased $0.8 million due to increased headcount and consulting fees increased $0.5 million from 2005. Research and development expenses represented 26%, 21% and 19% of net revenues in 2007, 2006 and 2005, respectively.

We believe that continued investment in research and development is critical to attaining our strategic product and cost control objectives. We intend to continue to develop and maintain competitive products and enhance our current products by adding innovative features that differentiate our products from those of our competitors.

SALES AND MARKETING

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

Sales and marketing expenses increased to $67.9 million in 2007 from $57.9 million in 2006. Personnel related expenses, consisting of salaries, employee benefits and stock-based compensation, increased $3.4 million as a result of an increase in average headcount. Sales and marketing headcount was 181 at December 31, 2007 compared to 164 at December 31, 2006 and 122 at December 31, 2005. Average headcount in 2007 increased 23% to 191, compared to 155 in 2006. The increase in average headcount for the year compared to the prior year was due to the May 2006 acquisition of Tacit, as well as the hiring of additional sales personnel in 2007. In addition, commissions expense increased $1.0 million in 2007 as a result of the increase in headcount as well as the implementation of new sales incentive programs. Travel and entertainment costs increased $2.5 million due to increased headcount and sales and marketing activities. Evaluation unit costs, primarily related to new product releases, increased $0.8 million and marketing communication program costs increased $0.7 million due to increased activities. Partially offsetting these increases was a $1.4 million decrease in various marketing programs as we introduced changes to our channel marketing programs in the second half of 2007. Additionally, in 2007, amortization expense of $1.3 million related to intangible assets purchased in the Tacit acquisition was included in sales and marketing expense, compared to $0.8 million in 2006.

Sales and marketing expenses increased to $57.9 million in 2006 from $38.3 million in 2005. The increase reflected personnel related costs and various marketing program related costs. Personnel related costs in 2006 included an increase in stock-based compensation related to stock option plans and the ESPP of $5.2 million and an increase in salaries, commissions, bonuses and employee benefits of $7.6 million due primarily to the increase in headcount and increased sales commissions. This reflects an increase in sales and marketing headcount, primarily resulting from the Tacit acquisition. Also included in personnel related costs in 2006 were severance costs of $0.6 million. The increase in 2006 from 2005 also reflected increases in travel and entertainment of $1.8 million, consulting and outside service costs of $1.6 million, demonstration unit costs of $0.8 million, and channel marketing program costs of $0.8 million, resulting from increased headcount and sales and marketing activities. Additionally, in 2006, amortization expense of $0.8 million related to intangible assets purchased in the Tacit acquisition was included in sales and marketing expense. Sales and marketing expenses represented 47%, 40% and 34% of net revenues in 2007, 2006 and 2005, respectively.

We intend to continue to invest in appropriate sales and marketing campaigns, aimed at building awareness and demand for our products. In addition, we plan to aggressively invest in the ongoing launch of our new products.

GENERAL AND ADMINISTRATIVE

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

General and administrative expenses increased to $17.0 million in 2007 from $13.9 million in 2006. The increase was primarily due to an increase in personnel related expenses, consisting of salaries, temporary help, employee benefits and stock-based compensation of $1.7 million. General and administrative headcount was 38 at December 31, 2007, compared to 35 at December 31, 2006 and 28 at December 31, 2005. Average headcount in 2007 increased 15% to 38, compared to 33 in 2006. In addition, professional and consulting fees increased $2.3 million, primarily for accounting, legal, human resource and tax related matters. Depreciation expense increased $0.7 million, due to property and equipment acquisitions, and facilities related expenses increased $1.0 million, primarily due to increased rent expense related to the renewal of the lease on our Cupertino headquarters. Partially offsetting these increases were a decrease in bad debt expense of $0.4 million and an increase of $2.0 million in corporate services and facilities costs allocated out to other departments as a result of changes in the departmental headcount mix.

General and administrative expenses increased to $13.9 million in 2006 from $7.2 million in 2005. The increase in 2006 of $6.7 million, or 93%, from 2005 was primarily due to personnel related costs, including an increase in stock-based compensation related to stock option plans and the ESPP of $3.0 million, and an increase in salaries and employee benefits of $1.2 million, due primarily to an increase in headcount. In addition, professional fees increased $2.0 million, primarily for accounting, legal and tax related matters. In addition, depreciation and other facilities related expenses increased $0.7 million. General and administrative expenses represented 12%, 10% and 6% of net revenues in 2007, 2006 and 2005, respectively.

IN-PROCESS RESEARCH AND DEVELOPMENT

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

The IPR&D expense for 2006 related primarily to projects associated with Tacit’s iShared WAN optimization technology (including the hardware appliance and the related software) enhancements and upgrades. The projects identified as in-process technology are those that were underway at the time of the Tacit acquisition and, at the date of acquisition, required additional effort to establish technological feasibility. The successful completion of these projects was a significant risk at the date of acquisition due to the remaining efforts to achieve technical viability, rapidly changing customer markets, uncertain standards for new products, and significant competitive threats. If an identified project is not successfully completed, there is no alternative future use for the project and the expected future income will not be realized. The technologies were successfully completed in 2006. We incurred approximately $1 million in costs to complete the project as compared to our initial estimate of $0.2 million.

Interest and other income, net, consists primarily of investment income from our cash, cash equivalents and investments. The decrease in 2007 from 2006 was primarily due to lower average balances of invested funds, partially offset by increased investment yields. The increase in 2006 from 2005 was due to increased investment yields, partially offset by lower average balances of invested funds. Our cash equivalents and investments were $71.6 million, $67.1 million and $119.6 million at December 31, 2007, 2006 and 2005, respectively. The average interest rates earned for 2007, 2006 and 2005 were 5.11%, 4.84% and 3.04%, respectively.

INCOME TAX PROVISION

The 2007 tax provision of $5.7 million included a charge of $9.7 million related to the settlement of our IRS tax examination, which was finalized in the three months ended December 31, 2007. Absent this item, we would have recorded a tax benefit of approximately $4 million, (or 20% of the loss before provision for income taxes,) primarily as a result of the generation of tax losses and tax credits.

We recorded a tax provision for 2006 of $0.8 million, reflecting an effective tax rate for the year of 14%. The tax provision for 2006 reflected a $2.6 million increase in income tax reserves relating to transfer pricing exposure, the impact of $1.8 million of non-deductible IPR&D, and a $1 million tax benefit resulting from our revision of our original estimate of the 2005 tax provision upon preparation of the related tax return in 2006, partially offset by other adjustments. Absent these items, we would have recorded a tax benefit of approximately $1.4 million, which is primarily related to the generation of tax credits. Our tax provision for 2007 was impacted by a relative increase in losses subject to taxation in countries that have lower statutory rates, compared to 2006.

For 2005, we recorded a tax provision of $0.1 million reflecting the release of $3.2 million of our valuation allowance on deferred tax assets. Without the release, our effective rate would have been approximately 17% instead of the 1% provision that we reported. Our tax provision in 2006 was also impacted by a relative decrease in earnings subject to taxation in countries that have lower statutory tax rates and an increase in non-deductible stock compensation, compared to 2005.

For a full reconciliation of our effective tax rate to the U.S. federal statutory rate of 35% and further explanation of our provision for taxes, see Note 6 to our Consolidated Financial Statements.

As of December 31, 2007, we had approximately $3.7 million of total unrecognized tax benefits, all of which would favorably affect our effective tax rate, if recognized. In the three months ended December 31, 2007, we entered into an agreement with the IRS related to its examination of the 2003 and 2004 tax returns as well as certain issues impacting the 2005 tax year, and we subsequently completely resolved the IRS tax examination for 2005. As a result of these resolutions, we utilized certain pre-existing federal net operating loss carryforwards to offset essentially all of the increase in taxable income. In addition, in connection with these resolutions, we paid approximately $0.5 million relating to federal alternative minimum tax, certain state taxes and associated interest. See Note 6 to the accompanying Consolidated Financial Statement for additional information. We currently do not expect any additional material changes to unrecognized tax positions within the next twelve months.

Our future effective income tax rate depends on various factors, such as tax legislation, the geographic composition of our pre-tax income, and non-tax deductible stock compensation expenses. We carefully monitor these factors and timely adjust the effective income tax rate accordingly.

RECENT ACCOUNTING PRONOUNCEMENTS

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurement”, (SFAS 157). This Standard defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007 for financial assets and liabilities, as well as for any other assets and liabilities that are carried at fair value on a recurring basis, and should be applied prospectively. Subsequently, the FASB provided for a one-year deferral of the provisions of Statement No. 157 for non-financial assets and liabilities that are recognized or disclosed at fair value in the consolidated financial statements on a non-recurring basis. We have not determined the effect that the adoption of SFAS 157 will have on our consolidated results of operations, financial condition or cash flows.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS 159), which permits companies to elect to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. This election is irrevocable. SFAS 159 will be effective for us on January 1, 2008. We have not determined the effect that the adoption of FAS 159 will have on our consolidated results of operations, financial condition or cash flows.

In December 2007 the FASB issued SFAS No. 141R, Business Combinations , or SFAS 141R. SFAS 141R establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. The statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statement to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for financial statements issued for fiscal years beginning after December 15, 2008. Accordingly, any business combinations we engage in will be recorded and disclosed following existing GAAP until January 1, 2009. We expect SFAS No. 141R will have an impact on our consolidated financial statements when effective, but the nature and magnitude of the specific effects will depend upon the nature, terms and size of the acquisitions we consummate after the effective date.

MANAGEMENT DISCUSSION FOR LATEST QUARTER
RESULTS OF OPERATIONS
During the three months ended September 30, 2007, net revenues were $36.4 million, gross profit was $24.8 million, or 68%, loss from operations was $4.0 million and net loss was $1.9 million. During the comparable period a year ago, net revenues were $36.0 million, gross profit was $26.1 million, or 72%, loss from operations was $1.4 million and net income was $0.3 million. Included in cost of revenues and operating expenses for the three months ended September 30, 2007 and 2006 was stock-based compensation expense of $2.8 million and $3.9 million, respectively, related to stock-related awards as determined in accordance with SFAS 123(R) and amortization of intangible assets of $1.0 million in each of the three month periods.
During the nine months ended September 30, 2007, net revenues were $103.6 million, gross profit was $70.0 million, or 68%, loss from operations was $20.0 million and net loss was $13.6 million. During the comparable period a year ago, net revenues were $102.4 million, gross profit was $76.1 million, or 74%, income from operations was $2.4 million and net income was $4.0 million. Included in cost of revenues and operating expenses for the nine months ended September 30, 2007 and 2006 was stock-based compensation expense of $9.0 million and $9.7 million, respectively, related to stock-related awards as determined in accordance with Statement of Financial Accounting Standards No. 123(R), “Share-Based Payments” (SFAS 123(R)) and amortization of intangible assets of $2.8 million and $2.0 million, respectively. Also included in operating expenses for the nine months ended September 30, 2006 was $1.8 million of IPR&D.
During the three months ended September 30, 2007, we continued to invest in our operations, with operating expenses of $28.8 million. This represents an increase of $1.3 million, or 5%, from $27.4 million reported in the comparable period of 2006. During the nine months ended September 30, 2007, operating expenses were $90.1 million, which represents an increase of $18.1 million, or 20%, from $71.9 million reported in the comparable period of 2006, excluding $1.8 million of IPR&D. Headcount at September 30, 2007 was 456, representing an increase of 34, or 8%, compared to 422 at September 30, 2006, primarily in sales and marketing. Average headcount for the nine months ended September 30, 2007 was 456, representing an increase of 18%, compared to an average headcount of 384 for the comparable period in 2006. The primary reason for the increase in average headcount in the nine month periods was the May 2006 acquisition of Tacit.
During the nine months ended September 30, 2007, we used $0.6 million of cash in operating activities, compared to $17.6 million generated in the comparable period a year ago. At September 30, 2007, we had cash, cash equivalents and investments of $79.7 million, accounts receivable of $21.8 million and deferred revenues of $32.1 million.
The following table sets forth certain financial data as a percentage of net revenues for the periods indicated.

NET REVENUES
We derive our revenue from two sources, product revenues and service revenues. Product revenues consist primarily of sales of our WAN Application Delivery systems. Product revenues accounted for 68% and 74% of our net revenues in the three months ended September 30, 2007 and 2006, respectively, and 67% and 75% of our net revenues in the nine months ended September 30, 2007 and 2006, respectively. Product revenues decreased to $24.7 million from $26.8 million, or 8%, during the three months ended September 30, 2007 compared to the comparable period in 2006, and decreased to $69.3 million from $77.3 million, or 10%, during the nine months ended September 30, 2007 compared to the comparable period in 2006. We believe the shortfalls in product revenues were primarily the result of a changing and increasingly competitive environment. In addition, during the nine months ended September 30, 2007, we experienced product transition issues associated with our greater focus on acceleration related technologies and new product introductions, including our new iShaper products, as well as delayed completion of several product enhancements to our acceleration products prior to the end of the three months ended March 31, 2007. Additionally, product revenues were adversely impacted to a lesser extent, by a decrease in the number of units sold in the three months ended September 30, 2007 relative to the comparable period in 2006 and by change in product mix, which resulted in a lower weighted average selling price for the nine months ended September 30, 2007 relative to the comparable period in 2006.
Service revenues consist primarily of maintenance revenues and, to a lesser extent, training revenues. Maintenance revenues, which are included in service revenues, are recognized on a monthly basis over the life of the contract. The typical subscription and support term is twelve months, although multi-year contracts of up to three years are also sold. Service revenues accounted for 32% and 26% of net revenues in the three months ended September 30, 2007 and 2006, respectively, and 33% and 25% of net revenues in the nine months ended September 30, 2007 and 2006, respectively. Service revenues increased to $11.7 million and $34.2 million in the three and nine months ended September 30, 2007, respectively, from $9.2 million and $25.2 million in the three and nine months ended September 30, 2006, respectively. The increase was due primarily to an increase in the number of units under maintenance contracts.

At September 30, 2007, Alternative Technologies, Inc., and Westcon, Inc. accounted for 17% and 13% of gross accounts receivable, respectively. At December 31, 2006, Alternative Technologies and Westcon accounted for 18% and 23% of gross accounts receivable, respectively.
COST OF REVENUES
Our cost of revenues consists of the cost of finished products purchased from our contract manufacturers, overhead costs, inventory reserves, service support costs and amortization of purchased intangible assets.
We outsource all of our manufacturing. We design and develop a majority of the key components of our products, including printed circuit boards and software. In addition, we determine the components that are incorporated into our products and select the appropriate suppliers of these components. Our overhead costs consist primarily of personnel related costs for our product operations and order fulfillment groups and other product costs such as warranty and fulfillment charges. Service support costs consist primarily of personnel related costs for our customer support and training groups, as well as fees paid to third-party service providers to facilitate next business day replacement for end user customers located outside the United States. Additionally, we allocate overhead such as facilities, depreciation and IT costs to all departments based on headcount and usage. As such, general overhead costs are reflected in each cost of revenue and operating expense category. We must continue to work closely with our contract manufacturers as we develop and introduce new products and try to reduce production costs for existing products. To the extent our customer base continues to grow, we intend to continue to invest additional resources in our customer support group and expect that our fees to third-party services providers will continue to increase as our international base grows.
Cost of revenues was $11.6 million for the three months ended September 30, 2007, an increase of $1.7 million, or 17%, from $9.9 million for the three months ended September 30, 2006. Excluding the amortization of intangibles, the cost of revenues represented 30% of total net revenues for the three months ended September 30, 2007, compared to 26% in the comparable period of 2006. Cost of revenues was $33.4 million for the nine months ended September 30, 2007, an increase of $7.1 million, or 27%, from $26.3 million for the nine months ended September 30, 2006. Excluding the amortization of intangibles, the cost of revenues represented 30% of total net revenues for the nine months ended September 30, 2007, compared to 24% in the comparable period of 2006.
Product costs increased $0.9 million, or 14%, to $7.2 million in the three months ended September 30, 2007 from $6.3 million in the three months ended September 30, 2006. The increase was primarily related to inventory write-downs of $1.2 million, mostly related to excess inventory levels of certain products. In addition, manufacturing costs increased slightly due to an increase in the weighted average unit cost related to a change in product mix.
Product costs increased $3.8 million, or 22%, to $21.0 million in the nine months ended September 30, 2007 from $17.1 million in the nine months ended September 30, 2006. The increase was primarily related to inventory write-downs of $1.5 million. In addition, overhead costs increased $0.6 million, which included $0.3 million of increased personnel related cost due to increased headcount, as well as increased fulfillment costs of $0.6 million and freight charges of $0.5 million. In addition, manufacturing costs increased $0.4 million from the comparable period in 2006 primarily due to an increase in the number of units shipped, partially offset by a decrease in weighted average unit cost, which was primarily due to a change in product mix .
Service costs increased $0.8 million, or 26%, to $3.7 million for the three months ended September 30, 2007 from $2.9 million for the three months ended September 30, 2006. The increase includes an increase of $0.3 million in expensed support material and $0.4 million in third party logistics support costs.
Service costs increased $2.9 million, or 37%, to $10.6 million for the nine months ended September 30, 2007 from $7.7 million for the nine months ended September 30, 2006. The increase includes an increase of $0.8 million in personnel costs due to increased headcount, $0.2 million in shipping costs, $0.8 million in expensed support materials primarily related to new products and $0.4 million in third party logistics support costs.
In connection with the May 2006 acquisition of Tacit, we recorded $3.5 million of purchased intangible assets related to developed technology that are being amortized over their estimated useful lives of three years. In the three and nine months ended September 30, 2007, amortization expense of $0.3 million and $0.9 million related to these intangibles was included in cost of revenues, and in the three and nine months ended September 30, 2006, $0.3 million and $0.4 million, respectively, of amortization expense was recorded related to these intangible assets. In connection with the acquisition of Mentat in 2004, we recorded $7.2 million of purchased intangible assets that are being amortized over their estimated useful lives of one to six years. Included in cost of revenues was $0.3 million of amortization expenses related to these intangibles for each of the three months ended September 30, 2007 and 2006 and $0.9 million and $1.1 million for the nine months ended September 30, 2007 and 2006, respectively.

RESEARCH AND DEVELOPMENT
Research and development expenses consist primarily of salaries and related personnel expenses, allocated overhead, consultant fees and prototype expenses related to the design, development, testing and enhancement of our products and software. To date, all research and development costs have been expensed as incurred. We have historically focused our research and development efforts on developing and enhancing our WAN Application Delivery solutions.
Research and development expenses of $9.0 million for the three months ended September 30, 2007 increased from $8.3 million for the comparable period of 2006. The increased costs were primarily due to increased prototype and expensed beta test units related to new product development of $0.2 million and increased facilities allocations for $0.2 million from the comparable period in 2006. Headcount increased 2% from 148 at September 30, 2007 compared to 145 at September 30, 2006. Research and development expenses represented 25% of net revenues for the three months ended September 30, 2007 compared to 23% for the comparable period in 2006.
Research and development expenses of $27.8 million for the nine months ended September 30, 2007 increased from $22.1 million for the comparable period of 2006. Personnel related expenses, consisting of salaries, employee benefits and stock-based compensation, increased $3.6 million as a result of a 16% increase in average headcount, which was partially offset by a decrease in bonuses of $0.7 million. The increase in average headcount for the nine months compared to the prior year was primarily due to the acquisition of Tacit. In addition, allocated corporate services and facilities costs increased $0.8 million due to increased headcount, prototype and beta test costs related to new product development increased $1.2 million and outside development services increased $0.6 million from the comparable period in 2006. Research and development expenses represented 27% of net revenues for the nine months ended September 30, 2007 compared to 22% for the comparable period in 2006.
We believe that continued investment in research and development is critical to attaining our strategic product and cost control objectives. We intend to continue to develop and maintain competitive products and enhance our current products by adding innovative features that differentiate our products from those of our competitors.
SALES AND MARKETING
Sales and marketing expenses consist primarily of salaries, commissions and related personnel expenses for those engaged in the sales, marketing and support of our products, as well as related trade show, promotional and public relations expenses and allocated overhead. Our sales force and marketing efforts are used to develop brand awareness, drive demand for system solutions and support our indirect channels.
Sales and marketing expenses increased to $15.9 million in the three months ended September 30, 2007 from $15.3 million in the comparable period of 2006. Travel and entertainment costs increased $0.4 million reflecting increased headcount and sales and marketing activities. In addition, the cost of evaluation units increased $0.6 million, primarily due to new product releases. Despite a 13% increase in headcount to 195 at September 30, 2007, compared to 173 at September 30, 2006, there was no significant change in personnel related expenses as increased salary costs were offset by decreases in bonuses, employee benefits and stock-based compensation. The cost of various marketing programs decreased $0.8 million as we introduced changes to our channel marketing programs. Sales and marketing expenses represented 44% of net revenues for the three months ended September 30, 2007 compared to 43% for the comparable period in 2006.

Sales and marketing expenses increased to $50.0 million in the nine months ended September 30, 2007 from $40.0 million in the comparable period of 2006. The increased costs were primarily due to increased personnel related expenses, consisting of salaries, employee benefits and stock-based compensation, of $4.0 million resulting from a 21% increase in average headcount. The increase in average headcount for the nine months compared to the prior year was primarily due to the acquisition of Tacit. In addition, commission expense increased $1.5 million during the period due to the increase in average headcount. Travel and entertainment costs increased $2.2 million due to increased headcount and sales and marketing activities. Evaluation unit costs, primarily related to new product releases, increased $1.0 million and marketing communication program costs increased $0.8 million due to increased activities. Partially offsetting these increases was a $0.7 million decrease in various marketing programs as we introduced changes to our channel marketing programs. Additionally, in the nine months ended September 30, 2007, amortization expense of $0.9 million related to intangible assets purchased in the Tacit acquisition was included in sales and marketing expense, compared to $0.5 million in the nine months ended September 30, 2006. Sales and marketing expenses represented 48% of net revenues for the nine months ended September 30, 2007 compared to 39% for the comparable period in 2006.
We intend to continue to invest in appropriate sales and marketing campaigns, aimed at building awareness and demand for our products. In addition, we plan to aggressively invest in the ongoing launch of our new products.



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