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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(MARK ONE)

FOR THE FISCAL YEAR ENDED APRIL 30, 2004

OR

FOR THE TRANSITION PERIOD FROM                      TO                     

COMMISSION FILE NUMBER 000-28139

BLUE COAT SYSTEMS, INC.

(Exact Name of Registrant as Specified In Its Charter)

(408) 220-2200

Registrant’s Telephone Number, Including Area Code:

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

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

Common Stock, $.0001 Par Value

(Title of Class)

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes  x    No  ¨

The aggregate market value of the Common Stock held by non-affiliates of the Registrant (based on the closing price for the Common Stock on the Nasdaq National Market on October 31, 2003) was approximately $136,819,246.

As of June 30, 2004, there were 11,117,724 shares of the Registrant’s Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The information called for by Part III is incorporated by reference from specified portions of the Registrant’s definitive Proxy Statement to be issued in conjunction with the Registrant’s 2004 Annual Meeting of Stockholders, which is expected to be filed not later than 120 days after the Registrant’s fiscal year ended April 30, 2004.

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BLUE COAT SYSTEMS, INC.

ANNUAL REPORT ON FORM 10-K

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PART I.

Item 1.    Business

The discussion in this Annual Report on Form 10-K contains forward-looking statements that involve risks and uncertainties. The statements contained in this Report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements on revenue expectations, product acceptance, product and sales development, operating results, and cash usage, as well as statements on our expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements included in this document are based on information available to us on the date hereof. We assume no obligation to update any such forward-looking statements. Our actual results could differ materially from those indicated in such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, our limited ability to forecast quarterly operating results and meet analyst or investor expectations, uncertainty in the secure proxy appliance market, technological changes, increased competition, foreign currency exchange rate movements, large volume discount sales affecting gross margin percentage, inability to implement our distribution strategy, inability to increase sales productivity or attract new sales personnel, inability to utilize our net operating loss and tax credit carryforwards, inability to improve our infrastructure and implement new systems, inability to sublease existing facilities, future acquisitions, uncertainty in future operating results, volatile stock price, inability to capitalize on new manufacturing and distribution processes such as outsourcing, product concentration, undetected product errors, product liability claims, supply shortages, unpredictable macroeconomic conditions, inability to defend our intellectual property rights, inability to generate increased international sales, unpredictable sales cycles, increased litigation, inability to attract and retain key employees, unpredictable demand for our products, disclosure of non-GAAP financial information, unpredictable internet usage, inability to raise additional capital, inability to integrate acquired companies, occurrence of a natural disaster, and other risks discussed in this item under the heading “Factors Affecting Future Operating Results” and the risks discussed in our other recent Securities and Exchange Commission filings.

Blue Coat^™ Systems, Inc., also referred to in this report as “we” or the “Company”, was incorporated in Delaware on March 16, 1996 as CacheFlow^® Inc. On August 21, 2002, we changed our name from CacheFlow Inc. to Blue Coat Systems, Inc. and this filing and all future SEC filings will be under the name Blue Coat Systems, Inc. The ticker symbol for our common stock was also changed from CFLO to BCSI.

On September 16, 2002, we filed an amendment to our Certificate of Incorporation, implementing a one-for-five reverse split of our outstanding common stock. Our common stock began trading under the split adjustment at the opening of the NASDAQ Stock Market on September 16, 2002. Our number of authorized shares of common stock, however, remains at 200 million. We continue to have 10 million authorized but unissued shares of preferred stock. All share and per share amounts in this Annual Report on Form 10-K and in the accompanying consolidated financial statements and notes thereto reflect the reverse stock split for all periods presented.

Overview

As organizations grow increasingly dependent on the Internet to communicate with customers, partners and employees, the Web browser is fast becoming the universal window into mission-critical communications and information. This has many advantages for the enterprise: Web-based applications and protocols are fast, inexpensive and easy to deploy and manage. But these benefits come at a price. When every user on the network has a Web browser, every user also has the means to negatively affect the network infrastructure, whether intentionally or not. Despite their ability to help users communicate more efficiently, evolving applications such as Web browsing, instant messaging (IM), Web-based email, and peer-to-peer (P2P) file sharing bring numerous risks to the enterprise. The solution is to use a proxy appliance designed to manage and control user communication over the Internet.

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Blue Coat proxy appliances provide organizations with visibility and control of Web communications. Proxy appliances act as a “middle-man” between users on a network and the Internet. Proxy appliances do not replace existing perimeter security devices; rather, proxy appliances complement network firewalls by providing granular policy-based controls over Web traffic in ways that firewalls and other externally focused devices cannot.

The Blue Coat family of proxy appliances, called ProxySG, is designed to address today’s new business risks, which can include the risk of being sued by employees who witness inappropriate Web surfing by their coworkers, viruses brought in via back door channels such as instant messaging and Web-based email, and network resource abuse due to peer-to-peer (P2P) file sharing and video streaming. The Blue Coat ProxySG appliances, and new ProxyAV appliances, are designed to enable organizations to minimize security risks and reduce the management costs and complexity of their Web infrastructure.

Blue Coat Solutions

The Blue Coat family of high-performance proxy appliances is designed to provide comprehensive visibility and control of Web communications. Based on Blue Coat SGOS^™, a custom, object-based operating system with integrated caching, these proxy appliances leverage existing authentication systems to enable flexible policy enforcement down to the individual user. The Blue Coat ProxySG appliances combine comprehensive proxy support of most Web protocols with integrated URL filtering, content security, Web virus scanning, instant messaging control, peer-to-peer (P2P) control, and streaming control. Blue Coat’s product portfolio includes powerful reporting, policy creation and configuration management software—offering organizations a scalable proxy solution for centralized or distributed enterprise environments. Each of these features is described in more detail below.

Web Proxy

First generation proxy servers—software-based applications running on general-purpose operating systems—offered a point of control for securing network access, but their performance degrades under today’s heavy Internet and intranet usage. Blue Coat’s proxy appliances are designed to provide next-generation proxy functionality that delivers business and technology benefits to Web-dependent enterprises.

Configured as a proxy server deployed between corporate users and the Internet, our appliances intelligently manage user requests for content. When a user selects a URL, the request first goes to the Blue Coat proxy appliance for authentication and authorization. If the objects from the requested page are already “cached,” or stored, on the Blue Coat appliance, they are immediately served to the user. If the objects are not stored locally, the Blue Coat appliance acts as a proxy for the user by communicating to the origin server via the Internet. When the objects are returned from the origin server a copy is delivered to the user and also stored in the system’s cache to serve all subsequent requests. The entire transaction is monitored and logged for reporting and analyses purposes.

Blue Coat allows enterprises to proxy most Web protocols, including HTTP and HTTPS which are commonly used for Web browsing, FTP which is used for file transfers, streaming media protocols from Microsoft, Real and Quicktime, and instant messaging protocols by the public IM vendors, AOL, Microsoft and Yahoo.

URL Content Filtering

To realize the benefits the Internet offers, companies need to enforce Internet access policies to prevent employees from accessing inappropriate or unproductive content. The first step in implementing company-wide Internet access policy is Web usage monitoring, or understanding what users are doing with their company-provided Web access. This monitoring is achieved through the use of the flexible logging features of the

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ProxySG. These logs can be made available both in real time and on a scheduled basis. Once security and network management personnel have an understanding of what kinds of use and misuse are occurring on the network, the next step is to provide enforcement for corporate Web access policy. Our ProxySG appliances provide a robust and flexible way to enforce Internet access policies based on content categories (gambling, sex, etc.), content type (http, ftp, streaming, etc.), identity (user, group, etc.), or network conditions. And unlike slower performing software-only solutions, our ProxySG appliances make it possible to turn on these multiple combinations of policy by integrating our policy architecture, custom operating system, and caching technology that stores commonly accessed content for reuse. Blue Coat integrates visibility, performance and control with comprehensive URL databases from leading partners such as Secure Computing, SurfControl and Websense, enabling organizations to effectively manage and control Web access.

Web Content Security

Our ProxySG appliances give security professionals the tools necessary to protect and control the network from a variety of new Web-based threats. Our ProxySG appliances also provide the visibility and flexible content policy control needed to respond in cases where a security breach has occurred. With our ProxySG appliances, security administrators can:

Web Virus Scanning

Gateway Web anti-virus has not been widely deployed in organizations due to unacceptable throughput and latency experienced with existing products. Web anti-virus solutions that slow down response times for browser-based traffic force IT staff to compromise between the performance users demand, and the security required by the business. This has been the situation with Web anti-virus, which has created open back doors in the security infrastructure that have allowed Web-based viruses to infect enterprise systems. These open doors include employee use of Web-based personal email and Internet file downloads.

Blue Coat now enables organizations to deploy Web anti-virus with scalable, high-performance options designed to meet the “real-time” requirements of Web traffic. Blue Coat has developed the ProxyAV^™ appliance, a high-performance Web anti-virus appliance that delivers up to 249 Mbps throughput and 4 millisecond average latency for “real-time” Web traffic virus scanning. Our ProxyAV appliance works in concert with Blue Coat’s ProxySG^™ platform, which quickly and intelligently processes Web objects to determine which objects should be scanned for viruses. Web objects are then sent to the ProxyAV appliance where they are scanned for viruses, and sent back to the ProxySG where they can be cached for an additional performance benefit.

Blue Coat offers customers the flexibility to choose which anti-virus engines to run on our ProxyAV, among industry-leaders McAfee, Panda, Sophos and Trend Micro, each providing automated updates. This flexibility of ProxyAV allows customers to implement a layered anti-virus defense across the distributed enterprise, where a different anti-virus engine can be deployed at the Web gateway to complement email servers and desktops.

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Instant Messaging Control

Instant Messaging (IM) usage has become commonplace within the enterprise and continues to increase. Employees can freely install public IM software from AOL, Microsoft or Yahoo to “chat” with peers, business colleagues and friends using the company network. Unauthorized use of these applications raises many valid security and productivity concerns among IT managers and security officers. Blue Coat ProxySG appliances allow organizations to gain control of public IM applications already in use. By applying access control, logging and reporting to public IM, organizations are able to turn public IM products into enterprise-safe messaging solutions. ProxySG appliances can specify which IM protocols and clients can be used on the network, and who can use them. The appliances allow administrators to configure IM for internal or external use, establish authentication rules for using IM, allow or deny attachments by file type, control use of status modes such as “idle” or “away,” and allow or deny chat room access or voice chat.

Peer-to-Peer (P2P) Control

P2P traffic, often characterized as file sharing music or movie files, is consuming valuable bandwidth on most networks today and can have an adverse impact on legitimate mission-critical applications. Additionally, P2P traffic opens the door for viruses and a host of legal concerns that can be counterproductive to any business. P2P may be contributing to some of the following issues:

P2P file sharing services allow an employee to circumvent corporate security measures. The very nature of the P2P client design is to evade firewalls and general network security. Blocking P2P at the firewall has proven to be extremely difficult because the application is capable of port-hopping, or finding open ports on the firewall. Because of the agile nature of P2P applications, P2P file sharing can be very difficult for administrators to detect, much less control. P2P packets cannot be classified simply by looking at packet headers such as IP address and port number. Controlling the use of P2P in the enterprise requires a solution that is as dynamic as the problem itself. This means that an administrator must be able to evaluate the P2P problem from their own network perspective and apply controls that relate to their company’s policy needs. Blue Coat provides the architecture for immediate and dynamic P2P control. The ProxySG allows an administrator to log and control P2P traffic to the degree required. Additionally, as P2P clients change, the ProxySG policy can be adjusted to capture new clients, blocking P2P communications to and from the Internet.

Streaming Control

Many organizations benefit from deploying and allowing streaming media applications on their networks, often used to provide “real-time” audio and video communication with employees, suppliers and customers. Streaming audio and video, in the corporate environment, not only enhances static communications, but also enables important information to be simultaneously transmitted to multiple locations within a company. The result can be savings of time and reduction in travel costs when streaming media replaces face-to-face meetings.

Streaming media can also be used for non-business (and generally non-productive) purposes. For example, radio over the web is finding its way into the workplace. The availability of streamed music and movie trailers are increasing dramatically. Video news streams provoke massive peaks in bandwidth demand whenever a

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popular story breaks. Streaming media can consume significant bandwidth because it demands constant transmissions of data, placing a strain on the performance of Web traffic throughout the corporate network. The solution to streaming bandwidth control is to deploy a proxy service that can regulate and enhance business streaming, while blocking or reducing the traffic load introduced from non-business streams.

By integrating content filtering categories with streaming services, rules can de defined on the ProxySG appliance to effectively manage streaming traffic. For example, all streams from business partners can be allowed with no restrictions. Streams from news sites, however, can employ bandwidth limitations and streams from sports sites can be blocked entirely. Integration with existing corporate authentication systems allows management to determine stream access and quality by user and group. The ProxySG can also report on all individual usage.

Our ProxySG appliances manage streaming media content in the same manner as other Web traffic protocols such as IM and HTTP. This means that the powerful policy features, including over 40 cross-referenced attributes and multiple actions, can be applied to streaming media just like other supported protocols. For example, IT administrators can create a detailed policy that permits access to multimedia content only to users in the group “Marketing”, using Microsoft Media Player, requesting an .asp file from sites other than “Sports”, between 8:00am and 5:00pm, and using the HTTP protocol.

Products

Our ProxySG family of appliances includes the ProxySG 400 Series, the ProxySG 800 Series and the ProxySG 8000 Series. These three models of ProxySG appliances are very similar in terms of functionality, and differ mainly in terms of their performance characteristics and scalability. Our ProxyAV Web anti-virus appliances include the ProxyAV 400 Series and the ProxyAV 2000 Series. These two models are also similar in functionality and differ primarily in terms of performance and scalability. We currently license to our customers three separate software products, which are used in conjunction with our ProxySG and ProxyAV appliances, third party URL filtering software, third party anti-virus software and Blue Coat Reporter. We also manufacture an appliance called Director, which is used primarily to manage large numbers of ProxySG appliances in a customer’s environment.

ProxySG

The ProxySG family of proxy appliances includes the 400 Series, 800 Series and 8000 Series. Each appliance contains Blue Coat SGOS^™, a custom, object-based operating system with integrated caching, these proxy appliances leverage an organization’s existing authentication system to enable granular policy controls down to the individual user. Blue Coat’s end-to-end product portfolio includes powerful reporting and policy and configuration management software—delivering a scalable proxy solution for centralized or distributed enterprise environments. Delivered as a rack mountable appliance for simple installation and management, these solutions easily integrate with existing security and network infrastructure.

Our ProxySG appliances are comprised of a specialized hardware platform and our operating system (SGOS). List prices for our ProxySG and associated products range from $3,695 to $100,000.

ProxySG 400 Series

The ProxySG 400 Series are specifically designed to increase security and reduce costs associated with regional and branch office Web protection. Delivered as a rack mountable or desktop device, the ProxySG 400 platform easily drops into remote environments where technical support staff is not always available. The ProxySG 400 is available in two fixed configurations, one with a single 40gigabyte (GB) disk drive and 256 megabytes (MB) of random access memory (RAM), and the other with two 40 GB disk drives and 512 MB of RAM.

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ProxySG 800 Series

The ProxySG 800 Series are easy to manage appliances that install in minutes with little ongoing maintenance, optimized for regional and corporate office installations. The systems include removable, hot-swappable disk drives. Specific configurations range from systems with a single 36 GB disk drive and 512 MB of RAM, to systems with four 73 GB disk drives and 2 GB of RAM.

ProxySG 8000 Series

The ProxySG 8000 Series provides a high-end solution with greater expandability for locations where high bandwidth and throughput are required. Specific configurations range from systems with two 73 GB disk drives and 1 GB of RAM to systems with eight 73 GB disk drives and 4 GB of RAM.

Visual Policy Manager

Blue Coat’s Visual Policy Manager provides a graphical way to develop and implement an organization’s Web security policies. With Visual Policy Manager, security and network administrators can quickly create policy rules that leverage the flexible policy architecture of the ProxySG. The Visual Policy Manager software is included as part of SGOS.

ProxyAV

The ProxyAV family of Web anti-virus appliances includes the 400 Series and 2000 Series. The Blue Coat ProxyAV enables organizations to scan for viruses, worms and trojans entering through Web-based backdoors including personal Web email accounts where a majority of viruses and worms propagate, Web spam or email spam which unknowingly activate trojan downloads, and browser-based file downloads that bypass existing virus scanning defenses. The ProxyAV combined with the ProxySG provides scalability for virus scanning, plus comprehensive visibility and control of enterprise Web communications. The ProxyAV leverages virus scanning engines from McAfee, Panda, Sophos, and Trend Micro.

Our ProxyAV appliances are comprised of a specialized hardware platform and list prices for our ProxyAV range from $4,495 to $20,995.

ProxyAV 400 Series

The ProxyAV 400 Series represents the next generation in appliance platforms for enterprise Web virus scanning. The ProxyAV 400 Series is a purpose-built Web anti-virus appliance designed for quick integration with the ProxySG 800 for deployment in medium enterprise or distributed environments. The ProxyAV is delivered in two fixed configurations, one with a single 850 megahertz (MHz) processor and 512 megabytes (MB) of random access memory (RAM), and the other with a single 1.26 gigahertz (GHz) processor and 512 MB of RAM.

ProxyAV 2000 Series

The ProxyAV 2000 Series represents the next generation in high-end appliance platforms for enterprise Web virus scanning. The 2000 series is a purpose-built appliance designed for scalable performance and simple integration with the Blue Coat ProxySG. The ProxyAV 2000 Series is available is four different configurations ranging from systems with a single 2.0 gigahertz (GHz) Intel P4 Xeon processor with 768 megabytes (MB) of random access memory (RAM), to dual 2.4 gigahertz (GHz) Intel P4 Xeon processors with 3.0 gigabytes of RAM.

Blue Coat Reporter

The Blue Coat Reporter is a log processing and reporting product that generates out-of-the-box reports tailored for the ProxySG appliance. Reporter provides identity-based user and network reporting that helps

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evaluate Web security policies and resource management. Because it is Web-based and cross-platform, it gives companies the flexibility to view Web usage reports from anywhere administrators or managers have access to a network connection and a Web browser.

Blue Coat Director

The Blue Coat Director delivers scalable change management for ProxySG appliances. Built as an extensible management appliance, Director provides configuration management, security and policy management, and resource management for enterprises deploying a large number of ProxySG appliances in their Web security infrastructure. Director enables administrators to:

WinProxy Software

The Blue Coat WinProxy SecureSuite is an Internet sharing software package. The software allows small organizations and users to share an Internet connection without having Internet sharing expertise. The WinProxy software starts at $59.95 for three users

Our Key Strategies

Our objective is to be the leading provider of proxy appliances. Key elements of our strategy include the following:

Focus on the Mid/Large Enterprise Market Segment.    We are focused on developing proxy appliances for the mid-to-large size enterprises, which might include organizations with several thousand users to organizations with tens-of-thousands of users. We believe this focus helps us to rapidly identify and target attractive market opportunities. We are directing our product development, marketing and sales activities at the enterprise market segment, which we believe represents the most attractive opportunity based on a demonstrated need for proxy appliances, the opportunity to sell to numerous customers and the level of existing competition.

Enhance Capabilities of our ProxySG.    We intend to use our technological expertise to keep pace with the needs of the evolving proxy appliance market. We plan to continue to develop both the software and hardware elements of our solution to gain and maintain a competitive advantage and expand the market for our products. Our additional efforts to enhance the capabilities of our ProxySG appliances include adding more functionality to secure and control new emerging applications, enhancing security for emerging Web threats and increasing the price performance of our appliances.

Continue to Leverage Indirect Distribution Channels.    We aim to focus our product distribution strategy around the use of distributors and resellers rather than a direct sales force. Enterprises have historically purchased security products from distributors and resellers, and we believe that we can improve our sales coverage and sales force productivity through continued expansion of distributors and resellers as distribution channels.

Sales and Marketing

We utilize a combination of our territory-based sales teams, resellers, systems integrators and distributors as appropriate for each of our target markets. We support our distribution channels with systems engineers and

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customer support personnel that provide technical service and support to our customers. We have entered into agreements with resellers and distributors such as Westcon, Allasso, Nissho Electronics, Alternative Technologies and others.

Our marketing efforts focus on increasing market awareness and demand creation for our products and technology and on promoting the Blue Coat brand. We have a number of marketing programs to support the sale and distribution of our products and to inform existing and potential customers within our target market segments about the capabilities and benefits of our products. Our marketing efforts include participation in industry tradeshows, informational seminars, preparation of competitive analyses, sales training, maintenance of our Web site, advertising and public relations.

Research and Development

We believe that strong product development capabilities are essential to our continued success and growth. Our research and development efforts are focused on developing new products as well as improvements and enhancements to our existing products. Research and development expenses were $11.5 million, $11.4 million and $35.1 million for the fiscal years ended April 30, 2004, 2003 and 2002, respectively.

Our research and development team consists of engineers with extensive backgrounds in operating systems, algorithms, computer science, streaming media and network engineering. We believe that the experience and capabilities of our research and development professionals represents a competitive advantage for us. We also work closely with our customers in developing and enhancing our products. Our current research and development efforts are primarily focused on enhancing the capabilities of our current proxy appliances by adding new features and strengthening existing features.

The market for proxy appliances is evolving rapidly. In order to stay competitive, we must make significant investments in research and development based on what we perceive to be the direction of the market. We currently spend a significant amount of our resources on research and development projects and plan to continue to do so for the foreseeable future. Current research and development projects will enhance the Company’s position in the marketplace only if the proxy appliance market matures as we anticipate. Failure on our part to anticipate the direction of the market and develop product that meets those emerging needs will seriously impair our business, financial condition, and results of operations.

We expect that most of the enhancements to our existing and future products will be accomplished by internal development. However, we currently license some technologies and will continue to evaluate externally developed solutions for integration into our products.

Manufacturing

We currently outsource, to third parties, the manufacturing of our ProxySG products, except that we perform final assembly and testing ourselves for our ProxySG 800. This approach allows us to reduce our investment in manufacturing capital and to take advantage of the expertise of our vendors. Our internal manufacturing operations consist primarily of prototype development, materials planning and procurement, some final assembly, testing and quality control. Our standard parts and components are generally available from more than one vendor, while our custom parts are usually single sourced. We typically obtain these components through purchase orders and currently do not have contractual relationships or guaranteed supply arrangements with these suppliers. If one of these vendors ceased to provide us with necessary parts and components, we would likely encounter delays in product production as we make the transition to another vendor, which would seriously harm our business. Furthermore, if actual orders do not match our forecasts (as we have experienced in the past), we may have excess or inadequate inventory of some materials and components or we could incur cancellation charges or penalties, which would increase our costs or prevent or delay product shipments and could seriously harm our business.

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Backlog

We do not believe that a backlog as of any particular date is indicative of future results. Our sales are made primarily pursuant to standard purchase orders for delivery of standard products. We believe that only a small portion of our order backlog is non-cancelable and that the dollar amount associated with the non-cancelable portion is not significant.

Competition

The market for proxy appliances is intensely competitive, evolving and subject to rapid technological change. Primary competitive factors that have typically affected our market include product characteristics such as reliability, scalability and ease of use, as well as price and customer support. The intensity of this competition is expected to increase in the future. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any one of which could seriously harm our business. We may not be able to compete successfully against current or future competitors and we cannot be certain that competitive pressures we face will not seriously harm our business. Our competitors vary in size and in the scope and breadth of the products and services they offer. We encounter competition from a variety of companies, including Cisco Systems, Network Appliance, Microsoft and various others. In addition, we expect additional competition from other established and emerging companies as the market for proxy appliances continues to develop and expand.

Many of our current and potential competitors have longer operating histories, significantly greater financial, technical, marketing and other resources, significantly greater name recognition and a larger installed base of customers than we do. In addition, many of our competitors have well-established relationships with our current and potential customers and have extensive knowledge of our industry. As a result, our competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the development, marketing, promotion and sale of their products than we can. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the market acceptance of their products. In addition, our competitors may be able to replicate our products, make more attractive offers to existing and potential employees and strategic partners, more quickly develop new products or enhance existing products and services, or bundle proxy appliances in a manner that we cannot provide. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. We also expect that competition will increase as a result of industry consolidation.

Intellectual Property and Other Proprietary Rights

We depend significantly on our ability to develop and maintain the proprietary aspects of our technology. To protect our proprietary technology, we rely primarily on a combination of contractual provisions, confidentiality procedures, trade secrets, copyright and trademark laws and patents. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or obtain and use information that we regard as proprietary. Policing unauthorized use of our products is difficult. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States. Our means of protecting our proprietary rights may not be adequate and our competitors may independently develop similar technology, duplicate our products or design around patents that may be issued to us or our other intellectual property.

We presently have several issued patents and pending United States patent applications. Even if patents are issued, we cannot assure you that we will be able to detect any infringement or, if infringement is detected, that patents issued will be enforceable or that any damages awarded to us will be sufficient to adequately compensate us.

There can be no assurance or guarantee that any products, services or technologies that we are presently developing, or will develop in the future, will result in intellectual property that is protectable under law, whether

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in the United States or a foreign jurisdiction, that this intellectual property will produce competitive advantage for us, or that the intellectual property of competitors will not restrict our freedom to operate or put us at a competitive disadvantage.

We rely on technology that we license from third parties, including software that is integrated with internally developed software and used in our products to perform key functions. If we are unable to continue to license any of this software on commercially reasonable terms, we will face delays in releases of our software or will be required to drop this functionality from our software until equivalent technology can be identified, licensed or developed, and integrated into our current product. Any of these delays could seriously harm our business.

There has been a substantial amount of litigation in the technology industry regarding intellectual property rights and we recently settled a suit, which alleged infringement of certain United States patents by us (See Item 8, Note 13 “Litigation” of the consolidated financial statements included in this Annual Report on Form 10-K). Third parties may claim that we, or our current or potential future products, infringe their intellectual property. We expect that companies in the Internet and networking industries will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in different industry segments overlaps. Any claims, with or without merit, could be time-consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. Royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all, which could seriously harm our business.

Acquisitions

On November 14, 2003, we completed an acquisition of Ositis Software, Inc. (“Ositis”). The purchase price of approximately $8.7 million consisted of approximately 0.4 million shares of Blue Coat common stock valued at $6.7 million, approximately $1.1 million in cash, and approximately $0.9 million in direct transaction costs.

Employees

As of April 30, 2004, we had a total of 251 employees, comprised of 82 in research and development, 79 in sales, 14 in marketing, 29 in customer support, 15 in manufacturing and 32 in general and administrative. Of these employees, 192 were located in North America and 59 located internationally. None of our employees are represented by collective bargaining agreements, nor have we experienced any work stoppages. We consider our relations with our employees to be good.

Our future operating results depend significantly upon the continued service of our senior management, and key technical and sales personnel, most of whom are not bound by an employment agreement. Competition for these personnel is intense, and we may not be able to retain them in the future. Our future success also depends upon our continuing ability to attract and retain highly qualified individuals. We may experience difficulties managing our financial and operating performance if we are unable to attract and retain qualified personnel.

Available Information

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

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FACTORS AFFECTING FUTURE OPERATING RESULTS

The discussion in this Annual Report on Form 10-K contains forward-looking statements that involve risks and uncertainties. The statements contained in this Report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements on revenue expectations, product acceptance, product and sales development, operating results, and cash usage, as well as statements on our expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements included in this document are based on information available to us on the date hereof. We assume no obligation to update any such forward-looking statements. Our actual results could differ materially from those indicated in such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, our limited ability to forecast quarterly operating results and meet analyst or investor expectations, uncertainty in the secure proxy appliance market, technological changes, increased competition, foreign currency exchange rate movements, large volume discount sales affecting gross margin percentage, inability to implement our distribution strategy, inability to increase sales productivity or attract new sales personnel, inability to utilize our net operating loss and tax credit carryforwards, inability to improve our infrastructure and implement new systems, inability to sublease existing facilities, future acquisitions, uncertainty in future operating results, volatile stock price, inability to capitalize on new manufacturing and distribution processes such as outsourcing, product concentration, undetected product errors, product liability claims, supply shortages, unpredictable macroeconomic conditions, inability to defend our intellectual property rights, inability to generate increased international sales, unpredictable sales cycles, increased litigation, inability to attract and retain key employees, unpredictable demand for our products, disclosure of non-GAAP financial information, unpredictable internet usage, inability to raise additional capital, inability to integrate acquired companies, occurrence of a natural disaster, and other risks discussed in this item under the heading “Factors Affecting Future Operating Results” and the risks discussed in our other recent Securities and Exchange Commission filings.

Our business, financial condition and results of operations could be seriously harmed by any of the following risks. The trading price of our common stock could decline due to any of these risks.

Because we expect our sales to fluctuate and our costs are relatively fixed in the short term, our ability to forecast our quarterly operating results is limited, and if our quarterly operating results are below the expectations of analysts or investors, the market price of our common stock may decline.

Our net sales and operating results are likely to vary significantly from quarter to quarter. We believe that quarter-to-quarter comparisons of our operating results should not be relied upon as indicators of future performance. It is likely that in some future quarter or quarters, our operating results will be below the expectations of public market analysts or investors. When this occurs, the price of our common stock could decrease significantly. A number of factors are likely to cause variations in our net sales and operating results, including factors described elsewhere in this “Factors Affecting Future Operating Results” section.

We cannot reliably forecast our future quarterly sales for several reasons, including:

A high percentage of our expenses, including those related to manufacturing overhead, technical support, research and development, sales and marketing, general and administrative functions, amortization of intangible assets and amortization of deferred compensation, are essentially fixed in the short term. As a result, if our net sales are less than forecasted, our quarterly operating results are likely to be seriously harmed and our stock price would likely decline.

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The market for proxy appliance solutions is relatively new, unknown and evolving. If this market does not develop as we anticipate, our sales may not grow and may decline.

Sales of our products depend on increased demand for proxy appliances. The market for proxy appliances is a new and rapidly evolving market. If the market for proxy appliances fails to grow as we anticipate, or grows more slowly than we anticipate, our business will be seriously harmed. In addition, our business will be harmed if the market for proxy appliances continues to be negatively impacted by uncertainty surrounding macro-economic growth.

Market awareness of our product is essential to the growth and success of our company. One of our goals is to increasingly market and advertise our company and our products. If our advertising and marketing programs are not successful in creating market awareness of our company and products, our revenues and results of operations could be substantially impacted.

We must maintain a competitive position in the proxy appliance market by developing and introducing new products while enhancing existing products to match the needs of our customers or else we will lose market share and our operating results will be adversely affected.

To maintain our competitive position in a market characterized by rapid rates of technological advancement, we must continue to invest significant resources in research and development. We need to develop and introduce new products and enhancements to existing products on a timely basis that keep pace with technological developments and emerging industry standards and address the increasingly sophisticated needs of our customers. We intend to extend the offerings under our product family in the future, both by introducing new products and by introducing enhancements to our existing products. However, we may experience difficulties in doing so, and our inability to timely and cost-effectively introduce new products and product enhancements, or the failure of these new products or enhancements to achieve market acceptance, could seriously harm our business. Life cycles of our products are difficult to predict because the market for our products is new and evolving and characterized by rapid technological change, frequent enhancements to existing products and new product introductions, changing customer needs and evolving industry standards. The emergence of new industry standards might require us to redesign our products. If our products are not in compliance with industry standards, our customers and potential customers may not purchase our products. There is no guarantee that we will accurately predict the direction in which the proxy appliance market will evolve. Failure on our part to anticipate the direction of the market and develop products that meet those emerging needs will significantly impair our business and operating results and our financial condition will be materially adversely affected.

We expect increased competition and, if we do not compete effectively, we could experience a loss in our market share and sales.

The market for proxy appliances is intensely competitive. Primary competitive factors that have typically affected our market include product characteristics such as reliability, scalability and ease of use, as well as price and customer support. The intensity of competition is expected to increase in the future. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any one of which could seriously harm our business. We may not be able to compete successfully against current or future competitors and we cannot be certain that competitive pressures we face will not seriously harm our business. Our competitors vary in size and in the scope and breadth of the products and services they offer. We encounter competition from a variety of companies, including Cisco Systems, Network Appliance, Microsoft and various others. In addition, we expect additional competition from other established and emerging companies as the market for proxy appliances continues to develop and expand.

Many of our current and potential competitors have longer operating histories, significantly greater financial, technical, marketing and other resources, significantly greater name recognition and a larger installed base of customers than we do. In addition, many of our competitors have well-established relationships with our

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current and potential customers and have extensive knowledge of our industry. As a result, our competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the development, marketing, promotion and sale of their products than we can. The products of our competitors may have features and functionality that our products do not have. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the market acceptance of their products. In addition, our competitors may be able to replicate our products, make more attractive offers to existing and potential employees and strategic partners, develop new products or enhance existing products and services more quickly, or bundle proxy appliances in a manner that we cannot provide. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. We also expect that competition will increase as a result of industry consolidation.

We develop products in the United States and sell them throughout the world. As a result, changes in foreign currency exchange rates and/or weak economic conditions in foreign markets could negatively impact our financial results.

Because we develop products in the United States and sell them throughout the world, our financial results could be negatively affected by factors such as changes in foreign currency exchange rates and weak economic conditions in foreign markets. All of our sales are currently made in United States dollars and a strengthening of the dollar could make our products less competitive in foreign countries. Should the dollars strength increase in foreign markets, and/or weak economic conditions prevail in these markets, our net sales could be seriously impacted, since a significant portion of our nets sales are derived from international operations.

All of our foreign subsidiaries operating expenses are incurred in foreign currencies. As a result, should the dollar strengthen our foreign operating expenses would decrease and should the dollar weaken our foreign operating expenses would increase. Should foreign currency exchange rates fluctuate, our earnings and net cash flows from international operations may be adversely affected.

We may enter into large sales deals with certain customers, which, because of the product mix and volume discount, may decrease our total gross margin percentages.

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

If we fail to create additional sales through our sales channel partners, our business will be seriously harmed.

For the fiscal year 2004, a significant amount of our revenue was generated through sales to our sales channel partners, which include distributors, resellers and system integrators. We increasingly depend upon these partners to generate sales opportunities and to independently manage the entire sales process. We provide our sales channel partners with specific programs to assist them in this process, but there can be no assurance that these programs will be effective or that our sales channel partners will be able to generate increasing revenues to us without significant additional investment on our part. In addition, our sales channel partners may be unsuccessful in selling our products and services, may sell products and services that are competitive with ours, may devote more resources to competitive products and may cease selling our products and services altogether. Any new sales channel partner will require extensive training and typically take several months to achieve productivity. If we fail to manage existing sales channels, our business will be seriously harmed. Many of our sales channel partners do not have minimum purchase or resale requirements and carry products that are competitive with our products. These sales channel partners may not give a high priority to the marketing of our

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products or may not continue to carry our products. They may give a higher priority to other products, including the products of competitors.

If we are unable to hire additional sales territory managers or increase productivity of our existing sales territory managers our revenue will not be able to grow.

During the second half of the fiscal year ended April 30, 2004, the productivity rate of our sales territory managers was at or close to our Company’s expected full capacity. In order to meet anticipated increased sales levels in the future, we need to hire additional sales personnel or increase sales productivity per person. If we cannot hire additional sales personnel or increase sales productivity, our ability to increase sales amounts in the future will be seriously hindered.

Initially the addition of new sales territory managers could result in increased cost without a commensurate growth in revenue because of time needed for these new managers to become proficient with our products and processes. This loss of productivity could negatively impact our results from operations and operating margins.

We have a significant amount of net operating loss and tax credit carryforwards, which may not be utilized. If we are unable to utilize these net operating loss and tax credit carryforwards we will incur considerable tax liabilities if we ever achieve significant profitability.

Utilization of our net operating loss and tax credit carryforwards may be subject to substantial annual limitations due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such annual limitations could result in the expiration of the net operating loss and tax credit carryforward before utilization. Should we be unable to utilize our net operating loss and tax credit carryforwards we will incur considerable tax liabilities negatively impacting our total net income after tax if we ever achieve significant profitability.

Failure to improve our infrastructure may adversely affect our business. We will need to improve and implement new systems, procedures and controls, which could be time-consuming and costly.

We must continue to implement and maintain a variety of operational, financial and management information systems, procedures and controls. The enactment of the Sarbanes-Oxley Act of 2002 and other recent and anticipated Securities and Exchange Commission and NASDAQ regulations will require us to devote additional resources to our operational, financial and management information systems, procedures and controls to ensure our continued compliance with current and future laws and regulations. We also expect these new rules and regulations may make it more difficult and more expensive for us to obtain director and officer liability insurance and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors or as executive officers. We are currently evaluating and monitoring developments with respect to these new rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs, although we do expect such costs to be substantial. If we are unable to implement and maintain appropriate operational, financial and management information systems, procedures and controls, this could have a material adverse effect on our business, results of operations and financial condition. Our ability to successfully implement our business plan requires an effective planning and management process.

We may incur net losses or increased net losses if we are required to record additional significant accounting charges related to excess facilities that we are unable to sublease.

We have existing commitments to lease office space in Sunnyvale, California and Redmond, Washington in excess of our needs for the foreseeable future. We believe we will be unable to sublease a substantial portion of our excess office space in the near future. In the fourth quarter of fiscal 2002, we recorded a restructuring charge

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of $9.5 million, which represented the remaining lease commitments for vacant facilities, net of expected sublease income at that time. In December 2002, our facility in Redmond, Washington was subleased for the remainder of the term of the original lease at a rental price consistent with our initial estimates. In July 2002, one of our facilities in Sunnyvale, California was subleased for the remainder of the lease term at a rental price that was consistent with our initial estimates. Due to its financial difficulties, our tenant in Sunnyvale, California surrendered the premises and vacated the property in January 2003. The facility in Sunnyvale, California is currently vacant and available for subleasing. We revised and increased our restructuring accrual for abandoned space for our Sunnyvale, CA facility by approximately $1.6 million during fiscal 2003 based on then available market trend information provided by a commercial real estate broker. During the second and fourth quarter of fiscal 2004, we further increased our restructuring accruals for abandoned space by a total of $1.5 million to reflect another downward revision of market trend information provided by a commercial real estate broker. As of April 30, 2004, $6.6 million of this accrued liability remains on the balance sheet. We may be required to record additional charges if our existing tenant defaults on its lease obligation or if we are unable to sublease the vacant facilities as currently anticipated.

We may make acquisitions in the future, which could affect our operations.

We may make acquisitions in the future. Acquisitions of companies, products or technologies entail numerous risks, including an inability to successfully assimilate acquired operations and products, diversion of management’s attention, loss of key employees of acquired companies and substantial transaction costs. Some of the products acquired may require significant additional development before they can be marketed and may not generate revenue at levels anticipated by us. Moreover, future acquisitions by us may result in dilutive issuances of equity securities, the incurrence of additional debt, large one-time write-offs and the creation of goodwill or other intangible assets that could result in significant amortization expense. Any of these problems or factors could seriously harm our business.

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

Although we have achieved profitability during the second half of the fiscal year ended April 30, 2004, we incurred losses for the year in total, and in each quarter prior to the third quarter of fiscal 2004. Furthermore, we may not be able to maintain quarterly profitability in the future. If our revenue growth, if any, is less than anticipated or if operating expenditures exceed our expectations or cannot be adjusted accordingly, we may experience additional losses on a quarterly and annual basis.

Our stock price is volatile and, as a result, you may have difficulty evaluating the value of our stock, and the market price of our stock may decline.

Since our initial public offering in November 1999 through July 10, 2004, the closing market price of our common stock has fluctuated significantly, ranging from $2.25 to $823.45. The market price of our common stock may fluctuate significantly in response to the following factors:

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