SONICWALL INC - FORM 10-K

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EX-31.1 - EXHIBIT 31.1 - SONICWALL INC	ex311.htm
EX-23.1 - EXHIBIT 23.1 - SONICWALL INC	ex231.htm
EX-21.1 - EXHIBIT 21.1 - SONICWALL INC	ex211.htm
EX-31.2 - EXHIBIT 31.2 - SONICWALL INC	ex312.htm
EX-32.1 - EXHIBIT 32.1 - SONICWALL INC	ex321.htm

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

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

For the year ended December 31, 2009

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

For the transition period from to .

Commission File Number 000-27723

SonicWALL, Inc.

(Exact name of registrant as specified in its charter)


California		77-0270079
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

2001 Logic Drive

San Jose, CA 95124

(Address of Principal Executive Offices, including zip code)

(408) 745-9600

(Registrant’s Telephone Number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Name of each exchange on which registered
Common Stock, no par value	The NASDAQ Stock Market LLC
	(The Nasdaq Global Select Market)

Securities registered pursuant to Section 12(g) of the Act:

None

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

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

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

Large accelerated filer ¨ Accelerated filer x

Non-accelerated filer ¨ Smaller reporting company ¨

(Do not check if a smaller reporting company)

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

As of June 30, 2009, the aggregate market value of Common Stock held by non-affiliates of the registrant (based upon the closing sale price on the NASDAQ Global Market on that date) was approximately $225,880,586. Shares held by each executive officer, director and by each person who owns 10% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

As of February 28, 2010, there were 54,577,511 shares of the Registrant’s Common Stock outstanding. This is the only outstanding class of common stock of the Registrant.

DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of the registrant’s proxy statement for its 2009 annual meeting of shareholders, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, are incorporated by reference into Part III of this Form 10-K.

EXPLANATORY NOTE

The Consolidated Financial Statements of SonicWALL, Inc. as of and for the fiscal years ended December 31, 2008 and 2007, and related financial information, have been restated to correct errors in the accounting for deferred tax assets related to unrealized gains and losses on available-for-sale securities as discussed in Note 5 of the Consolidated Financial Statements included in Part II, Item 8 of this Annual Report. As the net unrealized losses from available-for-sale securities are recognized through Other Comprehensive Income, the impacts of these errors do not affect tax expense and are recorded in Other Comprehensive Income. Consequently, the Company has restated the Consolidated Balance Sheet as of December 31, 2008 and the Consolidated Statement of Shareholder’s Equity for the years ended December 31, 2008 and December 31, 2007. The errors have no effect on the previously reported Consolidated Statements of Operations or Consolidated Statements of Cash Flows. Restated balances have been identified where appropriate.

We are filing this comprehensive Annual Report on Form 10-K for the fiscal year ended December 31, 2009 with expanded financial and other disclosures in lieu of filing a separate amended Annual Report on Form 10-K/A for the fiscal years ended December 31, 2008 and 2007. This comprehensive report is being filed to facilitate the dissemination of current financial and other information to investors. The Company does not intend to file a separate amended Annual Report on Form 10-K/A for the fiscal years ended December 31, 2008 and 2007 to reflect restated financial information. The financial information that has been previously filed or otherwise reported for these periods is superseded by the information in this Annual report on Form 10-K, and the financial statements and related financial information contained in those previously filed reports should no longer be relied upon.

TABLE OF CONTENTS

		Page

PART I		5
	ITEM 1. Business	5
	ITEM 1A. Risk Factors	16
	ITEM 1B. Unresolved Staff Comments	27
	ITEM 2. Properties	27
	ITEM 3. Legal Proceedings	28
	ITEM 4. Submission of Matters to a Vote of Security Holders	28
PART II		29
	ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters	29
	ITEM 6. Selected Consolidated Financial Data	31
	ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations	32
	ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk	55
	ITEM 8. Financial Statements and Supplementary Data	57
	ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	93
	ITEM 9A. Controls and Procedures	93
	ITEM 9B. Other Information	94
PART III		95
	ITEM 10. Directors, Executive Officers and Corporate Governance	95
	ITEM 11. Executive Compensation	95
	ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	95
	ITEM 13. Certain Relationships and Related Transactions, and Director Independence	95
	ITEM 14. Principal Accounting Fees and Services	95
PART IV		96
	ITEM 15. Exhibits and Financial Statement Schedules	96
SIGNATURES		102

CAUTIONARY NOTE ON FORWARD-LOOKING STATEMENTS

This Annual Report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the 1934 Act. We intend that the forward-looking statements be covered by the safe harbor provisions for forward-looking statements in these sections. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “intend,” or “continue,” the negative of such terms or other comparable terminology. These statements are only predictions, reflecting our expectations for future events or our future financial performance. Actual events or results may differ materially. In evaluating these statements you should specifically consider various factors, including the risks outlined under “Risk Factors.” These factors may cause our actual results to differ materially from any forward-looking statement.

We cannot guarantee future results, levels of activity, performance, or achievements. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Annual Report.

PART I

ITEM 1. Business

Overview

SonicWALL designs, develops, manufactures, and sells network security, content security, and business continuity solutions for businesses of all sizes. Our products are designed to provide secure Internet access to both wired and wireless broadband customers, enable secure Internet-based connectivity for distributed organizations, inspect the content entering and leaving our customers’ networks, protect organizations against inbound and outbound email threats, and provide business continuity in the case of data or connectivity loss. We believe our security appliances and software provide high-performance, robust, reliable, easy-to-use, and affordable security solutions for our customers. Additionally, our Internet security products are designed to make our customers more productive and more mobile, while still maintaining a high level of security. As of December 31, 2009, we have sold more than 1.5 million of our Internet security appliance platforms worldwide. We also sell value-added services for our security appliances, including content filtering, anti-spam protection, client anti-virus protection, integrated gateway anti-virus, anti-spyware, email protection, offsite data backup, and intrusion prevention on a subscription basis and license software packages such as our Global Management System (“GMS”), our Global Virtual Private Networks (“VPN”) Client, and our email security licenses. Our GMS solutions enable distributed enterprises and service providers to manage and monitor a large number of SonicWALL Internet security appliances and deploy our security software and services from a central location thereby reducing staffing requirements, increasing the speed of deployment and lowering costs. Our Global VPN Client provides mobile users with a simple, easy-to-use solution for securely accessing the network.

Our products and services are sold, and software licensed, through a two tiered distribution model: first to distributors and then to resellers, who provide solutions using our products, services, and software to end-user customers.

SonicWALL, Inc. was incorporated in California in 1991 as Sonic Systems. The company name was changed to SonicWALL, Inc. in August 1999. References in this report to “we,” “our,” “us,” and “the Company” refer to SonicWALL, Inc. Our principal executive offices are located at 2001 Logic Drive, San Jose, California 95124, and our telephone number is (408) 745-9600.

Industry Background

Businesses access the Internet for a wide variety of uses including communications, information gathering, and commerce. Businesses and enterprises of all sizes have accepted the Internet as a critical yet affordable means of achieving global reach and brand awareness, allowing access and shared information among a large number of geographically dispersed employees, customers, suppliers, and business partners. The Internet has become a particularly attractive solution for small and medium size businesses due to its cost effectiveness and ease-of-use. Larger enterprises also connect their internal networks to the Internet allowing for greater and quicker communications and expanded operations. Many of today’s larger enterprises also have branch offices, mobile workers, and telecommuters who connect electronically through the Internet to the corporate office and each other. The Internet has also become a vital tool of information access and communication for schools, libraries, government agencies, and other institutions.

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Increasing Use of Broadband Access Technologies

The connection speed by which individuals, businesses and enterprises of all sizes connect to the Internet is increasing. Small to medium enterprises, branch offices, and consumers are benefiting from increasingly faster and always connected internet connections such as digital subscriber lines (“DSL”) and cable Internet access. Larger enterprises are moving from T1 connectivity to T3 connectivity and in some cases to OC-3 or Ethernet connectivity. These “broadband” connections allow for substantially faster Internet access among many simultaneous users. Additionally, as Internet access speeds increase, both network bandwidth and network traffic speeds have significantly increased, further reflecting the ubiquity and the importance of the Internet to business operations.

Importance of Data Security

We believe Internet security is essential for businesses and enterprises due to the large amount of confidential information transmitted or accessible over the Internet. Broadband technologies, including DSL and cable, are always connected to the Internet. This constant connectivity increases the risk that confidential information, information controlled by privacy regulations, and other sensitive business information might be compromised by computer hackers, identity thieves, disgruntled employees, contractors, or competitors. In addition, business or enterprise data and networks become increasingly vulnerable to security threats and sophisticated attacks as the number of connections to the Internet and the volume of confidential information accessible through the Internet increases. Breaches of network security are costly to a business, both financially and as a source of lost productivity resulting from network and computer downtime.

The productivity gains of network use are also threatened by large volumes of unsolicited email (“spam”), which can overload mail servers and applications as well as consuming employee time. Additionally, some types of unsolicited e-mail are conduits for network attacks, or attempt to deceive the recipient into disclosing confidential information.

As networks and the data carried on them become more essential to the conduct of business, the financial risk associated with data loss also increases. Network security breaches can cause data loss, as can cause disk drive failures and accidental or intentional deletion of critical files.

The market for security and productivity products includes a variety of applications to address vulnerabilities and protect critical data both during transmission and at rest. These applications include, among others, firewalls, VPN access products, anti-virus solutions, intrusion prevention, content filtering, backup and restore systems, and e-mail security products.

Integrated Solutions for Internet Security

As network connection speeds and bandwidth have increased, and as more complex forms of data are transmitted by and within enterprises, reliable solutions have developed that emphasize high rates of data transfer while maintaining the integrity and security of network data. Enterprises of all sizes require a broad array of high performance, cost-effective products to protect their networks, delivering security and productivity not only for the central office headquarters and for perimeter branch offices but also for telecommuters and other employees working from remote locations.

We believe solutions that integrate hardware, software, and service elements overcome many of the shortcomings of solutions based upon software alone. Software based security solutions can be difficult to install and manage, often requiring dedicated and highly skilled in-house information technology (“IT”) personnel. Additionally, software only security solutions can also be difficult to integrate within networks, often requiring installation of dedicated server equipment and the use of complex load balancing switches to provide reliable, high-speed performance. Our integrated solution approach can overcome many of these limitations by integrating multiple security and productivity functions into easy-to-deploy devices that are interoperable with many industry standards. These integrated solutions can remain current through automatic update services.

The Advent of Secure Virtual Private Networks

Large and small enterprises utilize VPNs in the place of more costly private, dedicated networks or leased lines. VPNs allow for two or more individual networks to be linked creating one large private network. The private network is “virtual” because it leverages the public Internet as the network infrastructure. Enterprises use VPNs to achieve a variety of objectives. Telecommuters and traveling workers can access a corporate network to work from their out-of-office locations using remote

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access VPN. Satellite and branch offices can connect to the home office network using site-to-site VPNs. An enterprise can connect with its business partners, suppliers, and customers utilizing an Extranet VPN. These VPN connections must be secure from unauthorized access and safe from unauthorized alteration. To secure a VPN, information traveling between the locations is encrypted and authenticated. To help deliver the desired quality and security levels, businesses can monitor and prioritize network traffic for business-critical applications and allocate bandwidth for specific traffic, typically using customer premises equipment encryption and authentication products.

In a distributed business model, branch offices and point-of-sale (“POS”) and other locations extend a company’s reach into key markets. To realize these benefits, the communication link must be available at all times and be able to support the application. VPN solutions help companies establish centralized control over branch offices, POS locations, or remote kiosks by providing the robust security and performance needed for business continuity. A traditional site-to-site connection often requires the leasing of expensive, dedicated data lines that are difficult to deploy and manage. With the advent of affordable broadband and standards-based VPN, organizations can deploy secure remote access via Internet connections. With today’s VPN technology and broadband connections, enterprises of any size may use the Internet to securely communicate with their multiple locations.

Changing Mobile Computing Environment and Demand for SSL-VPN

In today’s mobile environment, information needs to be accessed by a highly diverse community of users from essentially anywhere an internet connection exists and through access devices that are not always owned or controlled by the IT organization. For large enterprises with in-house IT personnel and higher IT spending budgets, these challenges are more easily addressable than for the more IT constrained small and mid-sized business (“SMB”).

SSL-VPN allows any user in any location where internet connectivity is available to connect to any network resource reliably and conveniently, with enhanced levels of security. The Web browser on the user’s device provides the means for establishing an encrypted tunnel between the user’s device and the SSL-VPN gateway. Through a Web browser, users can access applications and resources behind the gateway. SSL-VPN solutions were originally designed for large enterprises with a feature set and price that exceeded SMB needs and means. This situation is changing with a new generation of SSL-VPN product offerings specifically designed to meet the remote access needs of SMBs at affordable prices.

Need for Anti-Virus, Intrusion Prevention and Content Filtering Solutions

In addition to lost productivity, companies, their partners, and customers are vulnerable to severe financial losses. This reality has been underscored by the rapid infection of many users through widespread and highly publicized virus outbreaks affecting business networks around the globe. At the same time, we believe that issues such as loss of employee productivity, liability concerns, and network bandwidth constraints continue to fuel the growth of content filtering. Enterprises are deploying anti-virus protection, content filtering, and intrusion prevention solutions across the enterprise and expending technical resources to keep these defenses updated against the latest virus threats and objectionable or inappropriate content.

Rising Value of Data and Demand for Business Continuity

As enterprises increase their reliance on networked computer systems to develop products, maintain relationships with customers, and conduct commerce, the data stored on the networked systems become increasingly critical to the productivity and success of the business. Loss of important files or data can result in significant interruptions in the ability of a company to conduct business. To counter this risk and to meet emerging and existing regulatory requirements, companies have traditionally turned to tape-based backup and restoration technologies. Increasing performance of hard disk drives and the speed of internet connectivity coupled with reduced costs have given rise to alternatives to tape-based solutions. These solutions offer continuous, rather than point-in-time, data protection as well as higher performance.

Increases in Unsolicited E-Mail

Email is one of the most critical business applications making use of the Internet. Recent years have seen a dramatic rise in the amount of unsolicited email (“spam”) directed to both consumers and business Internet users. This unsolicited email can be a nuisance at best, consuming employee productivity. In more extreme cases, spam can cause email servers to slow down or even stop working, causing delays or interruptions in business operations. Aside from the employee and network

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productivity degradations, some forms of unsolicited mail may be conduits for network attacks or may contain other types of threats, including attempts to cause recipient computers to execute malicious code, or attempts to mislead recipients into disclosing confidential information to criminal enterprises engaged in fraud or theft.

Strategy

Our goal is to build on our leadership position in Internet security by continuing the transition of our company to a comprehensive provider of integrated network security, content security, and business continuity solutions. We plan to accomplish our goal by focusing on value innovation, the process whereby we deliver solutions with price-performance advantages.

Key elements of our strategy include:

•

Global Growth. We plan to focus our investment in those geographical areas that can sustain rates of growth consistent with our business objectives. Part of our global growth initiative also includes taking advantage of supply chain improvements wherever possible. We believe that this type of alignment of our resources will strengthen our global position.

•	Continue to Bring New Products to the Market. We use our internal product design and development and integration expertise to produce solutions that deliver value to our end-users.

•

Cost Reduction. We intend to be vigorous in our pursuit to lower costs in all aspects of our business. Supply chain improvements and continual business process improvement are key components of this initiative. We believe that the associated cost reductions will strengthen our market position and assist us in penetrating new markets.

•

Strengthen Our Indirect Channel. Our global target markets are generally served by a two-tier distribution model. We have achieved varying degrees of regional penetration in these markets with large-scale distributors at the hub of our model fulfilling the needs of authorized resellers and systems integrators and creating a distribution web that covers over 50 countries. We intend to continue to implement programs designed to enhance our competitive position through distributors and authorized resellers.

•

Increase Services and Software Revenue. We intend to continue to develop new services and licensed software offerings to generate additional revenue from our installed base and to provide additional sources of revenue ancillary to our product sales. We currently offer a selection of integrated functionality including gateway anti-virus, client anti-virus, anti-spyware, anti-spam protection, intrusion prevention, offsite data backup, email security, and content filtering subscription services. We also offer fee-based customer support services and training. We have dedicated sales and marketing personnel and programs that focus on selling these services, as well as add-on products to our existing base of customers.

•

Inorganic Growth. We intend to continue to explore corporate opportunities to enhance our ability to broaden the product range that we bring to the market. Where appropriate, we may license, OEM, or acquire technologies in order to better address the current and future requirements of our customers.

The SonicWALL Solutions

SonicWALL provides comprehensive Internet security solutions that include network security, business continuity and content security, training and support services. Our Internet gateways serve as platforms for which SonicWALL sells additional software and services to enhance customer security and productivity. Our solutions provide cost effective and high performance Internet security solutions to small, medium, and large enterprise users in commercial, healthcare, education, and government markets.

SonicWALL products are designed to provide comprehensive Internet security solutions for (1) networks ranging in size from one to many thousands of end points; (2) enterprises having branch offices, telecommuting employees or POS locations; and (3) e-commerce applications that handle millions of secure transactions daily. Our security appliances span a wide range of requirements, from single-user appliances to rack-mounted enterprise-class units capable of supporting thousands of users. Our products offer substantial flexibility in the number of supported users, the number of ports, and a variety of software

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options such as gateway anti-virus, anti-spyware, intrusion prevention and content filtering, protection against spam, phishing, virus, and other attacks, as well as management and reporting tools that enable our customers to easily manage SonicWALL appliances installed throughout their networks.

Security Appliances

SonicWALL’s current generation line of security appliances can be categorized into the following groups. Each group provides appliances for small, medium, and large networks and businesses.

SonicWALL Unified Threat Management (UTM) Appliances. The UTM products consist of the TZ, NSA, and NSA E-class appliance series. The TZ series is a security platform for home, small and remote/branch offices. The TZ series offerings include wireless features. The Network Security Appliance (NSA) and the NSA E-class appliance series represent our higher performance UTM appliances and are designed to provide a comprehensive security platform for complex networks.

SonicWALL SSL VPN Appliances. The SSL-VPN products are designed to provide a secure remote network and application access solution that requires no pre-installed client software. Utilizing only a standard Web browser, users can access e-mail, files, intranets, remote desktops (including both full desktop and individual application access), and other resources on the corporate LAN from any location.

SonicWALL Email Security Appliances. The Email Security products are designed to provide inbound and outbound email threat protection for the small to medium size business by protecting against spam, virus, and phishing attacks.

SonicWALL Data Backup Appliances. The Continuous Data Protection (CDP) Backup and Recovery products are integrated, end-to-end backup and recovery solutions for businesses and remote offices that are designed to provide automatic, real-time, disk-based data backup for productivity files, Microsoft Exchange, SQL Server, and business applications, as well as remote laptops and desktops. These solutions also integrate “bare metal restore” capability, allowing full data restoration in circumstances where a catastrophic disk failure has occurred.

Security Application and Services

SonicWALL Internet security appliances are designed to integrate seamlessly with our line of value-added security applications to provide a comprehensive Internet security solution. With SonicWALL’s integrated security applications and services, we believe users can reduce the integration and maintenance problems that often result from sourcing, installing, and maintaining security products and services from multiple vendors. Our security applications and services include:

SonicWALL Global VPN Client. Our virtual private networking capabilities enable communications over the Internet between geographically dispersed offices, workers, and partners.

SonicWALL Content Filtering Service. Our content filtering service enables businesses, families, schools and libraries to control access to objectionable or inappropriate web sites by uniform resource locator (“URL”), keyword or application type. We offer a content filtering subscription service that provides a list of objectionable web sites that is automatically updated.

SonicWALL Enforced Anti-Virus and Anti-Spyware Client. Our enforced anti-virus and anti-spyware subscription service for desktops and laptops integrates with our security appliances to deploy and maintain anti-virus and anti-spyware software for each user on the network without the need for desktop-by-desktop installation, configuration, and maintenance. Users of this service receive automatic anti-virus and anti-spyware updates to all network nodes.

SonicWALL Gateway Anti-Virus, Anti-Spyware, and Intrusion Prevention. SonicWALL Gateway Anti-Virus, Anti-Spyware, and Intrusion Prevention Service is a bundled offering designed to provide a fully integrated approach against sophisticated application layer and content-based attacks. Utilizing a deep packet inspection architecture, SonicWALL Gateway Anti-Virus, Anti-Spyware, and Intrusion Prevention Service is designed to secure the network from the core to the perimeter against a comprehensive array of dynamic threats and software vulnerabilities.

SonicWALL Anti-Virus, Email Security. SonicWALL Anti-Spam / Email Security solutions provide effective, high-performance and easy-to-use inbound and outbound email threat protection. This self-running, self-updating solution, delivers powerful protection against spam, virus and phishing attacks in addition to preventing leaks of confidential

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information. Combining anti-spam, anti-phishing, content filtering, policy management and content compliance capabilities in a single seamlessly integrated solution, SonicWALL Anti-Spam / Email Security solutions provide powerful protection without complexity.

SonicWALL Backup and Recovery Offsite Services. Coupled with SonicWALL CDP, we provide offsite data protection at our secure offsite data centers. Data replicated to SonicWALL data centers is transmitted and stored with an encryption key that is designed to be known only to the end user or SonicWALL channel partner. This service is designed to enable customers to recover data lost in the event of natural disasters such as floods, fires, and electrical power surges, or from a theft in the business.

Global Security Management Applications

Today, enterprises and service providers face an increasing security management challenge resulting from geographically distributed networks. As a distributed network grows and branches into multiple sub-networks linked by the Internet, so does the complexity of managing security policies. A weakness in security implementation at any remote location can expose the entire network infrastructure to attack.

For network administrators, managing security for distributed networks on a site-by-site basis places a strain on resources. Visits to remote sites to setup security, inspect security installations, or provide training to local personnel is time consuming, expensive, and impractical. Administrators cannot be certain that every installation in the distributed network is complying with company security policies. To address these realities, SonicWALL’s Global Management System (“GMS”) is designed to provide network administrators with configuration and management tools to globally define, distribute, enforce, and deploy the full range of security application services and upgrades for thousands of SonicWALL Internet security appliances. GMS is available as either software or as an integrated appliance.

Value Proposition

The SonicWALL product line of Internet security solutions provides our customers with the following key benefits:

•

High-Performance, Scalable, and Robust Access Security. We offer our customers a comprehensive integrated security solution that includes firewall, VPN, gateway anti-virus, anti-spyware, intrusion prevention, content security, and content filtering. Specifically, we offer the following values:

Our access security products protect private networks against Internet-based theft, destruction, or modification of data, and can automatically notify customers if their network is under certain types of attack. SonicWALL has been awarded the internationally recognized International Computer Security Association (“ICSA”) Firewall and VPN Certification.

-	Our SSL-VPN product family provides organizations of various sizes with an affordable, simple and secure clientless remote network and application access solution that requires no pre-installed client software.

-	Our client anti-virus services provide comprehensive virus protection with automatic updates and minimal administration.

-	Our gateway anti-virus, anti-spyware, and intrusion prevention services shield networks from infection from malicious code by blocking transmissions through the gateway and disrupting background communications from existing spyware programs that transmit confidential data.

-	Our content filtering service enables customers such as businesses, schools, government agencies, and libraries to restrict access to objectionable or inappropriate web sites.

•

Ease of Installation and Use. The SonicWALL product line of Internet security solutions delivers “plug-and-play” appliances designed for easy installation and use. SonicWALL products are configured and managed through a web browser-based interface or through our GMS and do not require reconfiguration of personal computer applications.

•

Low Total Cost of Ownership. The SonicWALL product design minimizes the purchase, installation, and maintenance costs of Internet security. The suggested retail prices of our security solutions start below $300 and scale up to over $100,000.

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•

Reliability. The SonicWALL products are designed for reliability and uptime. Our products use an embedded single purpose operating system.

Technology

We have designed our SonicWALL products using a unique combination of hardware and software that delivers Internet security with what we believe is excellent ease-of-use and industry-leading price/performance.

Appliance Platforms

SonicWALL’s TZ, NSA and NSA E-class products are based on a new, highly efficient processor technology, allowing us to offer a level of performance beyond any of our previous designs. The processor technology scales from 1 to 16 cores in the current product line and is capable of expanding further to create an entire scalable product line based on this one design.

The SonicWALL’s UTM appliance solutions provide the following core features:

•

Deep Packet Inspection UTM and IPSec VPN. The core technology is the deep packet inspection UTM software that examines all layers of the packet (from the physical layer up to application layer) and determines whether to accept or reject the requested communication based on information derived from previous communications and the applications in use. Deep packet inspection dynamically adjusts based on the changing state of the communication running across the firewall and is invisible to users on the protected network.

•

IP Address Management. Our appliances manage the complexity of IP addressing through Network Address Translation (“NAT”) tools which allow networks to share a small number of valid public IP addresses with an equal or larger number of client computers on the LAN.

The SonicWALL security solutions offer the following options for device management:

•

Web Browser-Based Management Interface. This interface is designed to provide an intuitive and easy-to-use web-based management interface for rapid installation, configuration, and maintenance. This interface can be accessed from any web browser on the internal, private network. This interface can also be accessed remotely in a secure manner.

•

SonicWALL Global Management System. Our global management system, SonicWALL GMS, is an enterprise software application or integrated appliance designed to enable service providers and distributed enterprises to manage their SonicWALL appliances from a central location. SonicWALL GMS software is available to use in Windows and Sun Solaris operating environments. SonicWALL GMS is also compatible with leading relational database management systems such as Oracle and Microsoft SQL Server.

•

Logging and Reporting. SonicWALL appliances maintain an event log of potential security concerns, which can be viewed with a web browser or automatically sent on a periodic basis to any e-mail address. SonicWALL appliances notify the administrator of high-priority security issues, such as an attack on a server, by immediately sending an alert message to a priority e-mail account such as an e-mail pager. SonicWALL appliances also provide pre-defined reports that show different views of Internet usage, such as the most commonly accessed web sites.

The SonicWALL SSL-VPN solutions provide the following core features:

•	The SonicWALL Aventail E-Class Secure Remote Access offerings are clientless SSL-VPN solutions that deliver secure, easy-to-manage remote access for mobile enterprise organizations, supporting up to thousands of concurrent users from a single appliance.

•	The SonicWALL SSL-VPN Series provides organizations of all sizes with an affordable, simple and secure remote network and application access solution that requires no pre-installed client software.

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The SonicWALL content security solutions provide the following core features:

•	SonicWALL Email Security solutions provide inbound and outbound e-mail management, content compliance capabilities, anti-spam and Time Zero anti-virus technology, DHA, DoS and Zombie attack protection, end-user spam management, seamless LDAP integration, and robust reporting.

The SonicWALL CDP solutions provide the following core features:

•

SonicWALL CDP is a proprietary software / hardware appliance that continuously searches servers, mobile laptops, and connected desktops for file changes, coordinates protection of multiple networked client PCs and servers, updates client servers with latest versions, and coordinates updates with the SonicWALL web infrastructure.

Applications and Services

SonicWALL Internet security appliances are designed to integrate with a complete line of value-added security services to provide comprehensive Internet security. With SonicWALL’s integrated security services, we believe that integration and maintenance problems that often result from sourcing, installing, and maintaining security products from multiple vendors are minimized. Our security services are enabled on the base hardware platform via a software key.

•	Content Filtering. Our Internet content filter blocks objectionable content using a list of prohibited URLs and keywords as well as cookies, Java and ActiveX scripts.

•

Gateway Anti-Virus. Our gateway anti-virus service is intended to provide anti-virus protection throughout a business and across a distributed network and delivers protection for high threat viruses and malware by conducting inspections over the most common protocols used in today's networked environments. Automatic anti-virus updates are available for all network nodes to protect them from new virus outbreaks.

•

Anti-Spyware. Our gateway anti-spyware service is intended to provide anti-spyware protection throughout a business and across a distributed network and delivers protection for intrusive and unwanted applications, from being loaded onto user’s computers without their knowledge. Automatic anti-spyware updates are available for all network nodes to protect them from new virus outbreaks.

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Instrusion Prevention. Our intrusion prevention service utilizes a configurable, ultra-high performance deep packet inspection engine to deliver network protection while preventing known buffer overflow vulnerabilities in software. This service also defends against various worms, Trojans, and backdoor exploits. The service not only protects networks from attacks originating outside the network (WAN), but also from internal attacks targeting network segments (LANs), and provides a robust database of attack and vulnerability signatures that is dynamically updated as new exploits and vulnerabilities are discovered.

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Anti-Spam Protection. Our anti-spam protection service offers end-to-end attack monitoring through a response network consisting of over one million nodes worldwide. Feedback from this service provides SonicWALL with daily information on the latest spam attacks, new spam domains and other e-mail threats, which in turn is used to deliver the most current, updated anti-spam engine on the market.

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Offsite Data Backup. Our offsite data backup service uses SSL encryption, advanced compression, and backup of only binary differences. Data can be sent to a secure datacenter, via SonicWALL CDP Offsite Service, or to another CDP Appliance, via SonicWALL CDP Site-to-Site Backup. This offsite feature protects data against the risks of fire, theft, misplacement and other issues relating to tape or CD-based backup.

Competition

The market for Internet security solutions is global and highly competitive. Competition in the markets in which we participate continues to increase. There are few substantial barriers to entry. Additional competition from existing competitors and new market entrants will likely occur in the future.

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Our competitors may be able to respond more quickly than we can to new or emerging technologies and changes in customer requirements. In addition, our current and future competitors may integrate security solutions into the infrastructure of their existing product lines, including operating systems, routers, and browsers, in a manner that may discourage users from purchasing the products and services we offer. Many of our current and potential competitors have greater name recognition, larger customer bases to leverage, and greater access to proprietary technology, and could therefore gain market share to our detriment. In addition, our current and potential competitors may consolidate through mergers or acquisitions or establish cooperative relationships among themselves or with third parties. These actions may further enhance their financial, technical, and other resources. We expect additional competition as other established and emerging companies enter the Internet security market and new products and technologies are introduced.

Principal competitors in our markets include, but are not limited to the following, all of which sell worldwide or have a presence in most of the major markets for such products:

•	Enterprise firewall software providers such as Check Point, Microsoft, and Symantec;

•	Network equipment providers such as Cisco Systems, Lucent Technologies, and Check Point;

•	Security appliance providers such as WatchGuard Technologies, Fortinet, and Juniper Networks;

•	Content security providers such as Barracuda Networks and McAfee.

Our primary competitors in the backup / recovery market are tape drive manufacturers, software providers whose software points to tape devices, and offsite backup providers. Competitive tape manufacturers include Sony, Hewlett-Packard, and Quantum, while software competitors include Symantec, CA, Seagate, and Iron Mountain.

Customer Service and Technical Support

We offer our customers a complete range of support programs that include electronic support, product maintenance, and personalized technical support services on a worldwide basis. We offer direct support to customers in North America, Europe, Japan, and selected countries in Asia Pacific. Support services in other locations are provided through SonicWALL distributors. We now have customer support centers located in California, Arizona, Washington, United Kingdom, Japan, and India. A small portion of our technical support function is outsourced to third party service providers under agreements having an initial term of one (1) year subject to six (6) month extensions thereafter unless terminated upon 90 days prior written notice.

Our standard service offerings include support which is available during normal business hours, as well as an enhanced offering providing access to support services 24 hours a day, seven days a week. These support offerings provide problem identification, problem resolution, replacement for failing hardware, telephone or web-based technical support, and firmware updates. For certain large customers, SonicWALL offers custom support agreements that may include additional features including dedicated technical account management, accelerated escalation, and logistical support.

Customers

We sell our products primarily through distributors who resell the products to authorized resellers who in turn market and sell our products to end-user customers. Our top worldwide distributors based on revenues in the year ended December 31, 2009 were Ingram Micro, Inc. (“Ingram Micro”), Tech Data Product Management, Inc. (“Tech Data”), and Alternative Technology, Inc. In November 2006, Alternative Technology was acquired by Arrow Electronics, Inc. As of June 1, 2009, Alternative Technology was absorbed into Arrow Enterprise Computing Solutions, Inc. “(Arrow”), a subsidiary of Arrow Electronics, Inc.

Sales and Marketing

Our sales and marketing efforts focus on generating and fulfilling demand for our products in the small to mid-sized business, enterprise and government markets. Our marketing programs promote SonicWALL brand awareness and reputation as a provider of reliable, high-performance, easy-to-use, and affordable Internet security solutions including a suite of value added support, service, and software offerings. We try to strengthen our brand through a variety of marketing programs including

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on-going public relations, our web site, advertising, direct mail, industry and regional trade shows, and seminars. We intend to continue expanding and strengthening our indirect channel relationships through additional marketing programs and increased promotional activities.

We believe that SonicWALL solutions are ideally suited for the indirect channel business model. We market and sell our solutions in this indirect channel through a two-tiered distribution structure consisting of distributors and authorized resellers in the United States and over 50 other countries. Distributors and authorized resellers accounted for approximately 99% of our total revenue for the year ended December 31, 2009. Authorized resellers, including systems integrators, ISPs, dealers, and mail order online catalogs, generally purchase our products from our distributors and then sell our products to end-users in our target markets.

We divide our sales organization regionally into the following territories: the Americas; Asia Pacific (“APAC”); and Europe, the Middle East and Africa (“EMEA”). Regional sales representatives manage our relationships with our network of distributors, value-added resellers, and customers, help our value-added reseller network sell and support key customer accounts, and act as a liaison between our value-added reseller network and our marketing organization. The regional sales representative’s primary responsibility is to help the indirect channel succeed and grow within the territory. We also have an internal sales staff that supports the indirect channel.

Domestic Channel. In the Americas, the primary distributors of our products to resellers are Ingram Micro, Tech Data, and Arrow. Ingram Micro accounted for approximately 18%, 16%, and 16% of total revenue in 2009, 2008, and 2007, respectively. Tech Data accounted for approximately 17%, 17%, and 17% of total revenue in 2009, 2008, and 2007, respectively. Arrow accounted for 11%, 16%, and 18%, of total revenue in 2009, 2008, and 2007, respectively.

Domestic resellers receive various benefits and product discounts, generally depending on the level of purchase commitment and achievement. Our standard reseller program offers access to sales and marketing materials. Certain of our resellers qualify for our Medallion program, which extends those benefits by adding access to an expanded set of partnership benefits including sales and marketing tools, priority technical support and other benefits.

International Channel. We believe there is a strong international market for our products. International sales represented approximately 33%, 34%, and 32%, of our total revenue in 2009, 2008, and 2007. We direct substantially all of our international resellers to an appropriate distributor in each territory. We support our international distributors by offering localized marketing materials, sales tools, leads, co-operative marketing funds, joint advertising, discounted demonstration units, and training. We also participate in regional press tours, trade shows, and seminars.

Original Equipment Manufacturer Channel. From time to time we may enter into select original equipment manufacturer relationships in order to take advantage of opportunities to rapidly penetrate certain target markets. We believe these opportunities expand our overall market while having a minor impact on our own indirect channel sales.

Research and Development

We believe that our future success will depend in large part on our ability to develop new and enhanced Internet security solutions and our ability to meet the rapidly changing needs of our target customers who have broadband access to the Internet. We focus our research and development on evolving Internet security needs. We have made substantial investments in hardware, firmware, and software, which are critical to drive product cost reductions and higher performance solutions. Our research and development activities are primarily conducted at our headquarters facilities in San Jose, California as well as in Seattle, Washington, Shanghai, China and Bangalore, India.

Intellectual Property

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may not result in the issuance of any patents. Even if we obtain the patents we are seeking, we cannot guarantee that our patent rights will be valuable, create a competitive barrier, or will not be infringed by others. Furthermore, if any patent is issued, it might be invalidated or circumvented or otherwise fail to provide us any meaningful protection. We face additional risk of adequately protecting our intellectual property when conducting business in countries that have poorly developed or inadequately enforced intellectual property laws. In addition, competitors may independently develop similar or superior technologies or duplicate the technologies we have developed, which could substantially limit the value of our intellectual property.

U.S. Government Export Regulation Compliance

Our products are subject to federal export restrictions on encryption strength. Federal legal requirements allow the export of any-strength encryption to designated business sectors overseas, including U.S. subsidiaries, banks, financial institutions, insurance companies, and health and medical end-users. We have federal export authorization that allows us to export encryption technology to commercial entities in approved countries. In certain instances, we are required to obtain individual export licenses as a prerequisite to the exportation of the technology. With appropriate approvals, we are able to export strong encryption to a wide range of foreign end-users, subject to certain limitations and record-keeping requirements. Our agreements with our distributors require them to understand and comply with these export requirements in the sale and distribution of our products.

Manufacturing

We currently outsource our hardware manufacturing and assembly to contract manufacturers in the U.S. and Taiwan. Typically, the agreements with our contract manufacturers specify an initial term of one (1) year with automatic yearly renewal terms unless terminated by either party upon 90 days prior written notice. Outsourcing our manufacturing and assembly enables us to reduce fixed overhead and personnel costs and to provide flexibility in meeting market demand.

We design and develop the key components for the majority of our products. In addition, we generally determine the components that are incorporated in our products and select the appropriate suppliers of these components. Product testing and burn-in are performed by our contract manufacturer using tests that we typically specify.

As part of our design and development activity, we constantly review environmental and safety regulations in the jurisdictions in which we do business. Working with our contract manufacturers, we review the applicability of these regulations to our products and the established timetables for implementation of the regulations to position us to meet various environmental and safety restrictions on product content.

Information about Segments and Geographic Areas

Financial information relating to our segments and information on revenues generated in different geographic areas are set forth in Note 10, entitled “Segment Reporting,” of the Notes to Consolidated Financial Statements in Part II, Item 8 of this report. In addition, information regarding risks attendant to our foreign operations is set forth under the heading “RISK FACTORS” included later in this report.

Employees

As of December 31, 2009, we had 819 employees. Of these, 220 were employed in sales and marketing, 62 in finance and administration, 295 in research and development and 242 in support and operations. We are not party to any collective bargaining agreements with our employees and we have not experienced any work stoppages. We believe we have excellent relations with our employees.

Where You Can Find More Information

We make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to such reports filed pursuant to Section 13(a) or 15(d) of the Exchange Act, available free of charge on or through our Internet website located at www.sonicwall.com, as soon as reasonably practicable after they are filed with or furnished to the SEC.

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We also make available on our Internet website our Corporate Governance Principles and other corporate governance related documents including the charters of the Audit Committee, Compensation Committee, and Nominations and Corporate Governance Committee of our Board of Directors, the Code of Conduct for all employees and directors, and our Code of Ethics for Principal Executive and Senior Financial Officers. Such information is also available in print to shareholders upon request.

ITEM 1A. Risk Factors

You should carefully review the following risks associated with owning our common stock. Our business, operating results or financial condition could be materially adversely affected in the event any of the following risks were to be realized. You should also refer to the other information set forth in this report and incorporated by reference herein, including our financial statements and the related notes. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

Rapid changes in technology, regulatory requirements and industry standards could render our products, software and services unmarketable or obsolete, and we may be unable to successfully introduce new products and services.

To succeed, we must continually introduce new products, software and services and change and improve our solutions in response to new competitive product introductions, rapid technological developments, changes in regulatory requirements, and changes in operating systems, Internet access, application and networking software, computer and communications hardware, programming tools, computer language technology and other security threats. Product and service development for security, productivity, mobility, and data protection solutions requires substantial engineering time and testing. The disparities between the laws and administrative measures adopted by various jurisdictions in which we do business create uncertainty over the applicability, scope, and form of the regulations affecting our products and services and the timing for compliance with applicable regulations. Releasing new products, software and services prematurely may result in quality problems, and delays may result in loss of customer confidence and market share. In the past, we have on occasion experienced delays in the scheduled introduction of new and enhanced products, software and services, and we may experience delays in the future. We may be unable to develop new products, software, and services or achieve and maintain market acceptance of them once they have come to market. Furthermore, when we do introduce new or enhanced products, software and services, we may be unable to manage the transition from previous generations of products or previous versions of software and services to minimize disruption in customer ordering patterns, avoid excessive inventories of older products, and deliver enough new products, software, and services to meet customer demand. If any of the foregoing were to occur, our business could be adversely affected.

Sales to three major distributors account for a significant amount of our revenue, and if they or others cancel or delay purchase orders or fail to pay us in a timely fashion, and we are unable to offset these factors our revenue may decline and the price of our stock may fall.

Sales through Ingram Micro, Tech Data, and Arrow account for a significant portion of our revenue. For the fiscal years ended December 31, 2009, 2008, and 2007, substantially all of our sales were to distributors and authorized resellers as shown in the following table, expressed as a percentage of total revenue:

		2009				2008				2007
Distributors/Resellers			99%				99%				98%

Sales through Ingram Micro, Tech Data, and Arrow for the fiscal years ended December 31, 2009, 2008, and 2007 represented the following percentages of total revenue:

	2009		2008		2007
Ingram Micro		18%		16%		16%
Tech Data		17%		17%		17%
Arrow		11%		16%		18%

For the fiscal year ended December 31, 2009, 2008, and 2007, our top 10 distributors and resellers accounted for 74%, 67%, and 67% of our total revenue, respectively.

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We anticipate that sales of our solutions to relatively few distributors will continue to account for a significant portion of our revenue. Although we have renewable one-year agreements with Ingram Micro, Tech Data, Arrow and certain other large distributors, these contracts are subject to termination at any time. We cannot assure you that any of these distributors will continue to place orders with us, that orders will continue at the levels of previous periods, or that we will be able to obtain large orders from new distributors or resellers. We also anticipate that sales of our solutions to certain enterprise customers will account for an increasing portion of our revenue. We cannot assure you that sales to enterprise customers will materialize at anticipated levels. The financial turmoil impacting the banking systems and financial markets worldwide may continue to result in tight credit markets. The lowering of the level of liquidity in the credit markets may impact the ability of our distributors to obtain credit to finance purchases of our products and services. If any of the foregoing should occur, our rate of revenue growth will suffer, our revenue may decline and our business will be adversely affected.

In addition, Ingram Micro, Tech Data, and Arrow represented the following dollar amount and percentages of our accounts receivable balance (in millions, except for percentages):

	December 31,
	2009			2008			2007
Ingram Micro		$5.5M	22%		$2.5M	12%		$3.6M	14%
Tech Data		$1.6M	6%		$2.0M	10%		$3.1M	12%
Arrow		$0.9M	4%		$2.8M	13%		$1.1M	4%

In the event the liquidity of our distributors or enterprise customers is adversely impacted by uncertainties in the financial markets, they may be unable to pay us in a timely manner. The failure to receive timely payment from our distributors or enterprise customers could adversely affect our balance sheet, our results of operations and our creditworthiness.

If we are unable to compete successfully in the highly competitive market for Internet security products, software, and services, our business could be adversely affected.

The market for Internet security products, software, and services is global and highly competitive. Competition in markets in which we compete continues to increase, and we expect competition to intensify in the future. There are few substantial barriers to entry and additional competition from existing competitors and new market entrants will likely occur in the future. Current and potential competitors in our markets include, but are not limited to, Check Point, Microsoft, Symantec, Cisco Systems, Lucent Technologies, Nokia, Fortinet, WatchGuard Technologies, Barracuda Networks, and Juniper Networks, all of which sell worldwide or have a presence in most of the major markets for such products.

Competitors to date have generally targeted the security needs of enterprises of every size with firewall and VPN products that range in price starting from below $300 to more than $100,000. We may experience increased competitive pressure for some of our products, software, and services. This increased competitive pressure may result in both lower prices and gross profits. Many of our current or potential competitors have longer operating histories, greater name recognition, larger customer bases, and significantly greater financial, technical, marketing, and other resources than we do. Some of our competitors focus all of their attention on a single market area rather than offering a comprehensive suite of security solutions and services. In addition, our competitors may bundle products, software and services that are competitive to ours with other products, software and services that they may sell to our current or potential customers. These customers may accept these bundled offerings rather than separately purchasing our offerings. If any of the foregoing were to occur, our business could be adversely affected.

The current global economic slowdown can adversely affect our revenue, results of operations and overall financial strength.

The continuing global economic slowdown and the uncertainty over its breadth, depth and duration may continue to have a negative effect on our business. The shortage of liquidity and credit may result in an extended period of slow economic growth in the United States and worldwide. Governments have taken unprecedented actions intended to stimulate economic growth. There can be no assurance that these macro economic conditions will not impair our operating results. If conditions in the global economy, United States economy or other key vertical or geographic markets remain uncertain or weaken further, we could experience material adverse impacts on our business, overall financial condition, results of operations, cash flow, capital resources and liquidity.

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Difficulty predicting our future operating results or profitability due to volatility in general economic conditions and in the security, productivity, mobility, and data protection markets may result in a misallocation in spending, and a shortfall in revenue which would harm our operating results.

Changes in general economic conditions and the volatility in the demand for network security, content security, and business continuity solutions are two of the many factors underlying our inability to predict our revenue for a given period. Our operating results may be affected by uncertain or changing economic conditions impacting particular customer and geographic segments of our business. A large proportion of our expenses for product development, sales and marketing are fixed for a particular quarter or year, and therefore, we may be unable to implement an immediate decrease in our spending in time to compensate for any unexpected quarterly or annual shortfall in revenue. As a result, any shortfall in revenue would likely adversely affect our operating results. For the year ended December 31, 2009, we reported a net income of $13.2 million. For the year ended December 31, 2008, we reported a net income of $4.9 million. For the year ended December 31, 2007, we reported a net income of $28.6 million. Our accumulated deficit as of December 31, 2009 is $108.1 million. We do not know if we will be able to sustain profitability in the future.

The selling prices of our solution offerings may decrease, which may reduce our gross profits.

The average selling prices for our solution offerings may decline as a result of competitive pricing pressures, an overall reduction in demand for our products and services, a change in our mix of products, software, and services, anticipation of introduction of new functionality in our products or software, promotional programs and customers who negotiate price reductions in exchange for longer-term purchase commitments. In addition, competition continues to increase in the market segments in which we participate and we expect competition to further increase in the future, thereby leading to increased pricing pressures. Furthermore, we anticipate that the average selling prices and gross profits for our products will decrease over product life cycles. We cannot assure you that we will be successful in developing and introducing new offerings with enhanced functionality on a timely basis, or that our product, software and service offerings, if introduced, will enable us to maintain our prices and gross profits at current levels. If the price of individual products, software, or services decline or if the price of our solution offerings decline, our overall revenue may decline and our operating results may be adversely affected.

We offer retroactive price protection to our major distributors and if we fail to balance their inventory with end- user demand for our products, our allowance for price protection may be inadequate. This could adversely affect our results of operations.

We provide our major distributors with price protection rights for inventories of our products held by them. If we reduce the list price of our products, our major distributors receive refunds or credits from us that reduce the price of such products held in their inventory based upon the new list price. As of December 31, 2009, we estimated that approximately $24.0 million of our products in our distributors’ inventory were subject to price protection. We have issued credits of approximately $646,000, $1,040,000, and $494,000 under our price protection policies in 2009, 2008, and 2007, respectively. Future credits for price protection will depend on the percentage of our price reductions for the products in inventory and our ability to manage the level of our major distributors’ inventory. If future price protection adjustments are higher than expected, our future results of operations could be materially adversely affected.

We are dependent on international sales for a substantial amount of our revenue. We face the risk of international business and associated currency fluctuations, which might adversely affect our operating results.

International revenue represented 33%, 34%, and 32% of total revenue in 2009, 2008, and 2007, respectively. We expect that international revenue will continue to represent a substantial portion of our total revenue in the foreseeable future. Our performance depends significantly on worldwide economic conditions. Our risks of doing business abroad include the impact of global economic conditions on the demand for our products and services, the ability of our international channel partners to pay us in a timely fashion, the ability of our international channel partners to obtain credit to finance purchases of our products and services, and our ability to structure our distribution relationships in a manner consistent with marketplace requirements and on favorable terms. Our sales are denominated in U.S. dollars. As a result, the strengthening of the U.S. dollar against a local foreign currency will increase the price of our products, software, and services in such country and may reduce our sales by making our products, software, and services more expensive in the local currency. A weakened dollar could increase the cost of local operating expenses and procurement of raw materials. We are subject to other risks of operating a global business, including potential foreign government regulation of our technology, geopolitical risks

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associated with political and economic instability, changes in diplomatic and trade relationships, and changes in foreign countries’ laws affecting such areas as employment relationships, environmental and safety regulation, intellectual property protection and the Internet generally.

Delays in deliveries from our suppliers could cause our revenue to decline and adversely affect our results of operations.

Our products incorporate certain components, component subassemblies, or technologies, including our highly integrated system-on-a-chip architecture, that are available from single or limited sources of supply. Specifically, our products rely upon components from companies such as Intel, Cavium, and Marvell. We do not have long-term supply arrangements with any vendor, and any disruption in the supply of these products or technologies may adversely affect our ability to obtain necessary components or technology for our products. If this were to happen, our product shipments may be delayed and business lost, resulting in a decline in sales. In addition, our products utilize components that have in the past been subject to market shortages and price fluctuations. If we experience price increases in our product components, we will experience declines in our gross profit.

We license intellectual property, including certain databases and software, and if our licensors experience delays in product updates or provide us with products of substandard quality, the revenue we receive from our products and services that use this intellectual property would be at risk.

We have agreements to license intellectual property, including databases and software, which we incorporate as part of certain of our products and services. Licensors of such databases and software may fail to provide us with updated products or may experience delays in providing us with updated products. In addition, our licensors may provide us with products of substandard quality. If either of these events happens, we may be unable to provide our customers with the appropriate level of functionality in our solution offerings. In that event, our customers may purchase similar offerings from one of our competitors, or sales to our customers may be delayed. In either case, our revenue would be adversely affected.

We rely primarily on contract manufacturers for our product manufacturing and assembly, and if these operations are disrupted for any reason, we may not be able to ship our products.

We currently outsource our hardware manufacturing and assembly to contract manufacturers in the U.S. and Taiwan. Typically, the agreement with our contract manufacturers specify an initial term of one (1) year with automatic yearly renewal terms unless terminated by either party upon 90 days prior written notice. Our operations could be disrupted if we have to switch to a replacement vendor or if our hardware supply is interrupted for any reason. In addition, we provide forecasts of our demand to our contract manufacturers nine months prior to scheduled delivery of products to our customers. If we overestimate our requirements, our contract manufacturers may have excess inventory, which would increase our costs. If we underestimate our requirements, our contract manufacturers may have an inadequate component inventory, which could interrupt manufacturing of our products and result in delays in shipments and revenue. In addition, lead times for materials and components that we order vary significantly and depend on factors such as the specific supplier, contract terms and demand for each component at a given time. Liquidity or other financial problems of our contract manufacturers or reservation of manufacturing capacity by other companies, inside or outside of our industry, could either limit supply or increase costs. We may also experience shortages of components from time to time, which also could delay the manufacturing of our products. If any of the foregoing occurs we could lose customer orders and revenue could decline.

Sales of our solutions may be adversely affected by various factors which would adversely affect our revenue.

Sales of our solutions may be adversely affected in the future by changes in the geopolitical environment including the financial stability of our customers and supply chain; sales and implementation cycles; changes in our product mix; structural variations in sales channels; ability of our channel to absorb new product, software and service introductions; ability of our sales organization to sell into enterprise level accounts; acceptance of our solutions in the market place; and changes in our supply chain model. These changes may result in corresponding variations in order backlog. A variation in backlog levels could result in less predictability in our quarter-to-quarter net sales and operating results. Sales may also be adversely affected by fluctuations in demand, price and product competition in the markets we service, introduction and market acceptance of new technologies and new product, software or service offerings, and financial difficulties experienced by our distributors, resellers or end-users. We may, from time to time, experience manufacturing issues that create a delay in our suppliers’ ability to provide specific components resulting in delayed shipments. To the extent that manufacturing issues and any related component shortages result in delayed shipments in the future, and particularly in periods when we and our

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suppliers are operating at higher levels of capacity, it is possible that revenue could be adversely affected for a quarter or longer.

The failure to successfully conduct offshore activities could adversely affect results of operations.

To better align our costs with market conditions, increase its presence in growing markets, and enhance productivity and operational efficiency, we conduct engineering, development and certain technical support activities in the United Kingdom, India and China. We have undertaken a transition of certain technical support activities to facilities located in India and United Kingdom. In addition, we conduct certain engineering and development activities in Shanghai, China. As part of these offshore activities we have established a corporate presence and have hired employees in the United Kingdom, India and China, entered into a long-term lease for facilities to support these offshore efforts. If we are unable to effectively develop and implement our offshore strategies, including the ability to recruit or retain qualified technical personnel, or are unable to build the necessary corporate infrastructure in a timely and efficient manner, or are unable to effectively integrate certain technical support and engineering functions, the costs associated with the these offshore activities may be greater than anticipated and we may not realize anticipated productivity improvements and may experience other operational difficulties, and or all of which could materially and adversely affect our business, financial condition and results of operations.

Environmental and safety regulations enacted in various jurisdictions in which we do business may increase the component costs of our products and if we experience delays in shipment of compliant products our revenue would decline and our operating results would be adversely affected.

We are subject to environmental and safety regulations in connection with out global business operations, including but not limited to regulations relating to the development, manufacture, and use of its products and, the safe use of chemicals, and recycling and disposal of material used in its products. Various jurisdictions in which we do business are implementing environmental and safety directives that impact manufacturers doing business in those jurisdictions. The disparities between the regulatory frameworks adopted create uncertainty over the applicability, scope, and form of the regulations affecting our products and the timing for compliance with the applicable regulations. Our inability to comply with applicable environmental and safety regulations in a timely fashion may subject us to fines and penalties levied by appropriate regulatory authorities. Certain of these regulations may necessitate changes to the components used in our products which could result in an increase in product cost and a decrease in our gross profit. Further, while we and our contract manufacturers constantly review environmental and safety regulations in the jurisdictions in which we do business, the timetable for implementation of these regulations may result in delays in our ability to provide compliant products in a timely manner to those markets which would cause our revenues to decline and our operating results to be adversely affected.

If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results. As a result, current and potential shareholders could lose confidence in our financial reporting which would harm our business and the trading price of our stock.

Section 404 of the Sarbanes-Oxley Act of 2002 requires our management to report on, and our independent registered public accounting firm to attest to, the effectiveness of our internal control over financial reporting. We have an ongoing program to perform the system and process evaluation and testing necessary to comply with these requirements. We have incurred considerable expense and have devoted additional management resources to on going Section 404 compliance activity. Effective internal controls are necessary for us to provide reliable financial reports. If we cannot provide reliable financial reports, our business and operating results could be harmed.

Acquisitions could be difficult to integrate, disrupt our business, dilute shareholder value and the products and services acquired may not be accepted by the market. As a result, our operating results would be adversely affected.

We are continually reviewing the market for possible corporate opportunities and we may announce acquisitions or investments in other companies, products, or technologies in the future. As part of each transaction, we will be required to integrate operations, train, retain, and motivate the personnel of these entities. We may be unable to maintain uniform standards, controls, information technology systems, procedures and policies across our entire enterprise and if the products and services released as a result of these acquisitions experience quality problems or are otherwise not accepted by the market, we may suffer a loss of confidence by our distributors, resellers and end users and sales of these products and services will not meet expectations. As a consequence, these acquisitions may cause disruptions in our operations and divert

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management’s attention from day-to-day operations, which could impair our relationships with our current employees, customers, and strategic partners.

We may have to incur debt or issue equity securities to pay for any future acquisitions. The issuance of equity securities for any acquisition could be substantially dilutive to our shareholders. In addition, due to acquisitions made in the past, our profitability has suffered because of acquisition-related costs, amortization costs, and impairment losses for acquired goodwill and other intangible assets.

We cannot be certain that our internal controls over financial reporting will be effective or sufficient when tested by increased scale of growth or the impact of acquisitions.

It may be difficult to design and implement effective internal controls over financial reporting for combined operations and differences in existing controls of acquired businesses may result in weaknesses that require remediation when internal controls over financial reporting are combined. Our ability to manage our operations and growth will require us to improve our operations, financial and management controls, as well as our internal reporting systems and controls. We may not be able to implement improvements to our internal reporting systems and controls in an efficient and timely manner and may discover deficiencies and weaknesses in existing systems and controls especially when such systems and controls are tested by increased scale of growth or the impact of acquisitions.

Our Financial Statements could be affected by the need to restate previously issued annual or interim financial statements.

In the event an error in our financial statements requires us to report that previously reported financial statements should no longer be relied upon, amended financial statements for such previously reported periods would be required. In such an event, we may be unable to file our current interim or annual reports with the Securities and Exchange Commission in a timely fashion and may be subject to delisting by the NASDAQ Global Market. Furthermore, we may be unable to certify the adequacy of our internal controls over financial reporting and our independent registered public accounting firm may be unable to attest thereto. In such circumstances, investors could lose confidence in our internal controls over financial reporting, our disclosure controls, and the reliability of our financial statements, which could result in a decrease in the value of our common stock and could cause serious harm to our business, financial condition, and results of operations.

Changes in our effective tax rate or tax liability may have an adverse effect on our results of operations.

As a global company, we are subject to taxation in the United States and various other countries. Significant judgment is required to determine and estimate worldwide tax liabilities. Our future effective tax rates may be adversely affected by a number of factors including changes in the valuation of our deferred tax assets; our ability to use net operating losses of acquired companies to the fullest extent; increases in expenses not deductible for tax purposes, including write-offs of acquired in-process research and development and impairment of goodwill in connection with acquisitions; changes in share-based compensation expense; and changes in tax laws in the countries in which we operate or the interpretation of such tax laws and changes in generally accepted accounting principles. Any significant change in our future effective tax rates could adversely impact our consolidated financial position, results of operations, and cash flows.

If our estimates or judgments relating to our critical accounting policies based on assumptions change or prove to be incorrect, our operating results could fall below expectations of securities analysts and investors, resulting in a decline in our stock price.

Our discussion and analysis of financial condition and results of operations in this report is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. On an ongoing basis, we evaluate significant estimates used in preparing our financial statements, including those related to: the valuation and recognition of investments, the valuation of the revenue and accounts receivable, the valuation of inventory, the assessment of recoverability of intangible assets and their estimated useful lives, the valuation and recognition of stock based compensation and the recognition and measurement of current and deferred income tax assets and liabilities.

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We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, as provided in our discussion and analysis of financial condition and results of operations in this annual report, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The current volatility in the financial markets and overall economic uncertainty increases the risk that actual amounts realized from the sale or exchange of certain of our financial instruments may differ significantly from those in our assumptions. In any such case, our operating results could fall below the expectations of securities analysts and investors, resulting in a decline in our stock price.

Changes to our senior management may have an adverse effect on our ability to execute our business strategy.

Our future success will depend largely on the efforts and abilities of our senior management to execute our business plan. Changes in our senior management and any future departures of key employees may be disruptive to our business and may adversely affect our operations. Experienced senior management in the technology industry is in high demand and competition for their talents is intense, especially in Silicon Valley, where many of our senior management reside. Historically, we have relied on equity awards in the form of stock options as one means of recruiting and retaining senior management. If the quantity of equity awards we are able to make to our senior management under our equity plans falls below what is available to our senior management from other potential employers or if a stock option’s exercise price exceeds the underlying stock’s market value, the effectiveness of our equity awards as a means for retaining senior management will lessen.

Our ability to attract, retain, and motivate key qualified employees is vital to our success.

Our success depends in part on our ability to attract, retain, and motivate key engineering, operations, finance, information systems, customer support, and sales and marketing personnel. Our employees may leave us at any time, and we have continuing challenges in retaining employees from acquired companies. The loss of services of any of our key personnel, the inability to attract, retain, and motivate qualified personnel in the future, or delays in hiring required personnel, particularly engineering and sales personnel, could delay the development and introduction of, and negatively impact our ability to sell our products, software and services. Historically, we have relied on equity awards in the form of stock options as one means of recruiting and retaining key employees. If the quantity of equity awards we are able to make to our key employees under our equity plans falls below what is available to our key employees from other potential employers or if a stock option’s exercise price exceeds the underlying stock’s market value, the effectiveness of our equity awards as a means of retaining key employees will lessen. If we are not successful in attracting, retaining, and motivating key employees, our ability to capitalize on our business opportunities and our operating results may be materially and adversely affected.

We may be unable to adequately protect our intellectual property proprietary rights, which may limit our ability to compete effectively.

We currently rely on a combination of patent, trademark, copyright, and trade secret laws, confidentiality provisions and other contractual provisions to protect our intellectual property. Our intellectual property program consists of an on-going patent disclosure and application process, the purchase of intellectual property assets including intellectual property assets from acquisition activity, and the licensing of intellectual property from others. We plan to continue our aggressive plan to build our intellectual property portfolio. Despite our efforts to protect our intellectual property, unauthorized parties may misappropriate or infringe our intellectual property. We plan to aggressively pursue any such misappropriation or infringement of our intellectual property. Our patent applications may not result in the issuance of any patents. Even if we obtain the patents we are seeking, that will not guarantee that our patent rights will be valuable, create a competitive barrier, or will be free from infringement. Furthermore, if any patent is issued, it might be invalidated or circumvented or otherwise fail to provide us any meaningful protection. We face additional risk of adequately protecting our intellectual property when conducting business in countries that have poorly developed or inadequately enforced intellectual property laws. In addition, competitors may independently develop similar or superior technologies or duplicate the technologies we have developed, which could substantially limit the value of our intellectual property.

Potential intellectual property claims and litigation could subject us to significant liability for damages and invalidation of our proprietary rights.

Litigation over intellectual property rights is not uncommon in our industry. We face infringement claims from third parties. We may have to resort to litigation to protect our intellectual property rights. We expect that infringement or

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misappropriation claims will be more frequent as the number of products, feature sets in software and services, and the number of competitors grows in the market segments in which we do business. Any litigation, regardless of its success, is costly and requires significant time and attention of our key management and technical personnel. An adverse result in litigation could also force us to:

·	stop or delay selling, incorporating or using products that incorporate the challenged intellectual property;

·	pay damages;

·	enter into licensing or royalty agreements, which may be unavailable on acceptable terms; or

·	redesign products or services that incorporate infringing technology.

If any of the above occurs, our revenue could decline and our business could suffer.

We have been named as defendant in litigation matters that could subject us to liability for significant damages.

We are a defendant in on-going litigation matters. No estimate can be made of the possible loss or possible range of loss, if any, associated with the resolution of these litigation matters. Failure to prevail in these matters could have a material adverse effect on our consolidated financial position, results of operations, and cash flows in the future.

In addition, the results of litigation are uncertain and the litigation process may utilize a significant portion of our cash resources and divert management’s attention from the day-to-day operations, all of which could harm our business.

Any alleged or actual failure of our products, software or services to operate as warranted may require us to defend product liability or breach of warranty claims.

Our products, software, and services provide network security, business continuity and content security. Networks protected by our products, software and services may be vulnerable to electronic break-ins. Because the techniques used by computer hackers to access or sabotage networks change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques. If a third party were able to successfully overcome our security measures, such a person or entity could misappropriate customer data, third party data stored by our customers and other information, including intellectual property. In addition, the operations of our end user customers may be interrupted. If that happens, affected end-users or others may file actions against us alleging product liability, tort, or breach of warranty claims. Although we attempt to reduce the risk of losses from claims through contractual warranty disclaimers and liability limitations, these provisions may not be enforceable. Some courts, for example, have found contractual limitations of liability in standard computer and software contracts to be unenforceable in some circumstances. Defending a lawsuit, regardless of its merit, could be costly and could divert management attention. Although we currently maintain business liability insurance, this coverage may be inadequate or may be unavailable in the future on acceptable terms, if at all. In addition, the market perception of our products, software, and services would likely be adversely affected which could cause us to lose current and potential customers, resellers, distributors or other business partners. If any of the above occurs, our revenue could decline and our business would suffer.

A security breach of our internal systems could harm our business.

Because we provide Internet security, we may be a more attractive target for attacks by computer hackers. We will not succeed unless the marketplace is confident that we provide effective Internet security protection. Although we have not experienced significant damages from acts of sabotage or unauthorized access by a third party of our internal network, if an actual or perceived breach of Internet security occurs in our internal systems it could adversely affect the market perception of our products, software and services. In addition, such a security breach may impact the ability of our company to operate, including the ability to adequately support our customers. If this happens, our revenue could decline and our business could suffer.

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If our solutions do not interoperate with our end customers’ networks, installations could be delayed or cancelled, which could significantly reduce our revenue.

Our solutions are designed to interface with existing networks of our end-users, each of which have different specifications and utilize multiple protocol standards. Many of the networks of our end-user’s contain multiple generations of products that have been added over time as these networks have grown and evolved. Our solutions must interoperate with the products within these networks as well as with future products that might be added to these networks in order to meet the requirements of our end-users. If we find errors in the existing software used in the networks of our end-users, we may elect to modify our software to fix or overcome these errors so that our solutions will interoperate and scale with their existing software and hardware. If our solutions do not interoperate properly, installations could be delayed or orders for our solutions could be cancelled, which could significantly reduce our revenue.

Product errors or defects could result in loss of revenue, delayed market acceptance, and claims against us.

We offer one and two year warranty periods on our products. During the warranty period end users may receive a refurbished or replacement product for any defective unit subject to completion of certain procedural requirements. Our products may contain undetected errors or defects. If there is a product failure, we may have to replace all affected products without being able to record revenue for the replacement units, or we may have to refund the purchase price for such units if the defect cannot be resolved. Despite extensive testing, some errors are discovered only after a product has been installed and used by customers. Any errors discovered after commercial release could result in loss of revenue and an increase in warranty related claims against us. Such product defects can negatively impact our products’ reputation and result in reduced sales.

Industry consolidation may lead to increased competition and may harm our operating results.

There has been a trend toward industry consolidation in our market. We expect this trend toward industry consolidation to continue as companies attempt to strengthen or hold their market positions in an evolving industry and as companies are acquired or are unable to continue operations. We believe that industry consolidation may result in stronger competitors that are better able to compete with us. This could lead to more variability in operating results and could have a material adverse effect on our business, operating results, and financial condition.

If we are unable to meet our future capital requirements, our business will be harmed.

We expect our cash on hand, cash equivalents and short-term investments to meet our working capital and capital expenditure needs for at least the next twelve months. However, at any time, we may decide to raise additional capital to take advantage of strategic opportunities available or attractive financing terms. If we issue equity securities, shareholders may experience additional dilution or the new equity securities may have rights, preferences, or privileges senior to those of existing holders of common stock. If we cannot raise funds, if needed, on acceptable terms, we may not be able to develop or enhance our products, software or services, take advantage of future opportunities, or respond to competitive pressures or unanticipated requirements, which could have a material adverse effect on our business, operating results, and financial condition.

Governmental regulations of imports or exports affecting Internet security could affect our revenue.

Any additional governmental regulation of imports or exports or failure to obtain required export approval of our encryption technologies could adversely affect our international and domestic sales. The United States and various foreign governments have imposed controls, export license requirements, and restrictions on the import or export of some technologies, especially encryption technology. In addition, from time to time, governmental agencies have proposed additional regulation of encryption technology, such as requiring the escrow and governmental recovery of private encryption keys. In response to terrorist activity, governments could enact additional regulation or restriction on the use, import, or export of encryption technology. This additional regulation of encryption technology could delay or prevent the acceptance and use of encryption products and public networks for secure communications resulting in decreased demand for our products and services. In addition, some foreign competitors are subject to less stringent controls on exporting their encryption technologies. As a result, they may be able to compete more effectively than we can in the United States and the international Internet security market.

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Our stock price may be volatile.

The market price of our common stock has been highly volatile and has fluctuated significantly in the past. We believe that it may continue to fluctuate significantly in the future in response to the following factors, some of which are beyond our control:

·	general economic conditions and the effect that such conditions have upon customers’ purchasing decisions;

·	variations in quarterly operating results;

·	changes in financial estimates by securities analysts;

·	changes in market valuations of technology and Internet infrastructure companies;

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

·	the accretive or dilutive effects of acquisitions on operating results;

·	loss of a major client or failure to complete significant license transactions;

·	additions or departures of key personnel;

·	our ability to remediate material weaknesses and/or significant deficiencies, if any, in internal controls over financial reporting in an effective and timely manner;

·	receipt of an adverse or qualified opinion from our independent auditors regarding our internal controls over financial reporting;

·	sales of common stock in the future; and

·	fluctuations in stock market price and volume, which are particularly common among highly volatile securities of Internet-related companies.

The long sales and implementation cycles for our solutions may cause revenue and operating results to vary significantly.

The decision of an end-user to purchase our solutions often involves a significant commitment of resources and a lengthy evaluation and qualification process. Throughout the sales cycle, we often spend considerable time educating our channel partners and providing information for prospective end-users regarding the use and benefits of our products, software, and services. Budget constraints, the availability of credit, and the need for multiple approvals within enterprises, carriers, and government entities may delay purchase decisions. Failure to obtain the required approval for a particular project or purchase decision may delay the purchase of our solutions from our channel partners. As a result, the sales cycle for our security solutions could be longer than 90 days.

Even after making the decision to purchase our solutions end-users may not deploy these solutions broadly within their networks. The timing of implementation can vary widely and depends on the skill set of the end-user, the size of the network deployment, the complexity of the network environment, and the degree of specialized hardware and software configuration necessary to deploy. End-users with large networks usually expand their networks in large increments on a periodic basis. Large deployments and purchases of our security solutions also require a significant outlay of capital by the end-user. If the deployment of our solutions in these complex network environments is slower than expected, sales through our distributors to our resellers would slow, our revenue could be below our expectations, and our operating results could be adversely affected.

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The inability to obtain any third-party license required to developing new products or software or enhancements to our products or software could require us to obtain substitute technology of lower quality or performance standards or at greater cost, which could seriously harm our business, financial condition, and results of operations.

We license intellectual property from third parties to develop new products or software or enhancements to existing products or software. Third-party licenses may not be available to us on commercially reasonable terms or at all. The inability to obtain third-party licenses required developing new products or software or enhancements to existing products or software could require us to obtain substitute technology of lower quality or performance standards or at greater cost, any of which could seriously harm our business, financial condition, and results of operations.

Seasonality and concentration of revenue at the end of the quarter could cause our revenue to fall below the expectations of securities analysts and investors, resulting in a decline in our stock price.

The rate of our domestic and international sales has been and may continue to be lower in the summer months or be adversely affected by other seasonal factors, both domestically and internationally. During these periods, businesses often defer purchasing decisions. As a result of customer buying patterns and the efforts of our sales force to meet or exceed quarterly and year-end quotas, we have historically received a substantial portion of a quarter’s sales orders and earned a substantial portion of a quarter’s revenue during our last month of each quarter. If expected revenue at the end of any quarter is delayed, our revenue for that quarter could fall below the expectations of securities analysts and investors, resulting in a decline in our stock price.

Our business is especially subject to the risks of earthquakes, floods and other natural catastrophic events, and to interruption by manmade problems such as computer viruses or terrorism.

Our corporate headquarters, including certain of our research and development operations and some of our contract manufacturer’s facilities, are located in the Silicon Valley area of Northern California, a region known for seismic activity. Additionally, certain of our facilities, which including contracted manufacturing facilities, are located in areas that are subject to typhoons and other natural disasters. A significant natural disaster, such as an earthquake or a flood, could have a material adverse impact on our business, operating results, and financial condition. In addition, despite our implementation of network security measures, our servers are vulnerable to computer viruses, break-ins, and similar disruptions from unauthorized tampering with our computer systems. Any such event could have a material adverse effect on our business, operating results, and financial condition. In addition, the effects of war or acts of terrorism could have a material adverse effect on our business, operating results, and financial condition. The continued threat of terrorism and heightened security and military action in response to this threat, or any future acts of terrorism, may cause further disruptions to these economies and create further uncertainties. To the extent that such disruptions or uncertainties result in delays, curtailment or cancellations of customer orders, or the manufacture or shipment of our products, our revenue, gross profits and operating profits may decline and we may not achieve our financial goals and achieve or maintain profitability.

We face risks associated with changes in telecommunications regulation and tariffs.

Changes in telecommunications requirements in the United States or other countries could affect the sales of our products. We believe it is possible that there may be changes in U.S. telecommunications regulations in the future that could slow the expansion of the service providers’ network infrastructures and materially adversely affect our business, operating results, and financial condition. Future changes in tariffs by regulatory agencies or application of tariff requirements to currently untariffed services could affect the sales of our products for certain classes of customers. Additionally, in the United States, our products must comply with various Federal Communications Commission requirements and regulations. In countries outside of the United States, our products must meet various requirements of local telecommunications authorities. Changes in tariffs or failure by us to obtain timely approval of products could have a material adverse effect on our business, operating results, and financial condition.

Due to the global nature of our business, economic or social conditions or changes in a particular country or region could adversely affect our sales or increase our costs and expenses, which would have a material adverse impact on our financial condition.

We conduct significant sales, research and development, and customer support operations in countries outside of the United States. Accordingly, our future results could be materially adversely affected by a variety of uncontrollable and changing

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factors including, among others, political or social unrest or economic instability or terrorist activity in a specific country or region; macro economic conditions adversely affecting geographies where we do business; trade protection measures; environmental and safety directives and other regulatory requirements which may affect our ability to import or export our products from various countries; government spending patterns affected by political considerations; and difficulties in staffing and managing international operations. Any or all of these factors could have a material adverse impact on our revenue, costs, expenses, and financial condition.

We are exposed to various risks associated with the credit and capital markets.

Included within our investment portfolio at December 31, 2009 were auction rate securities (ARS) and asset backed securities (ABS). In connection with the liquidity issues experienced in the global credit and capital markets, our ARS and ABS holdings have experienced failed auctions or thinly traded markets. The Company has recognized unrealized losses in its consolidated financial statements as of December 31, 2009. If the credit ratings of these investments continue to deteriorate, the fair value of these securities may decline further. If uncertainties in the credit and capital markets continue or if the Company experiences any rating downgrades on any investments in its portfolio, the Company may incur impairment charges to its investment portfolio, which would negatively affect our financial condition, cash flow, and reported earnings.

ITEM 1B. Unresolved Staff Comments

None.

ITEM 2. Properties

The Company leases office space in several U.S. locations including California, Washington, and Arizona. Additional facilities are leased worldwide under leases that expire at various dates ranging from 2010 to 2015.

The Company’s corporate headquarters and executive offices are located in approximately 72,000 square feet of office space in San Jose, California under a lease that expires in September 2014. The lease provides for a one year renewal option. In addition, the Company leases office space of approximately 32,000 square feet in Tempe, Arizona. The lease term is for 7.5 years and expires in August 2015. The base rent for this lease escalates annually at 3%.

In July 2007, the Company assumed a five-year lease for approximately 20,000 square feet of office space located in Seattle, Washington. This lease expires in February 2012. In September 2008, the Company closed approximately half of its leased facility and recorded a liability of approximately $0.9 million equivalent to the net present value of the expected future lease costs, net of estimated future sublease.

In February 2008, the Company entered into a lease agreement to lease approximately 36,000 square feet of office space in Bangalore, India to carry out certain research and development and technical support activities. The lease term is for a period of five years commencing in March 2008 and requires a lock in period of 4 years, after which either party to the contract can terminate the lease with notice duly given. The base rent for this lease escalates annually at 5%.

In November 2008, the Company expanded its existing facility in Shanghai, China to a total of approximately 16,000 square feet of office space to carry out our research and development activities. The lease term is for a period of three years and expires in November 2011.

In December 2009, the Company expanded its existing facility in London, United Kingdom to a total of approximately 7,000 square feet of office space to carry out our sales and technical support activities. The lease term will expire in February 2013.

We believe that our existing facilities are suitable and adequate for our current needs and that the capacity of such facilities is substantially being utilized or we have plans to utilize it.

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ITEM 3. Legal Proceedings

The information set forth under Note 11 of the Notes to Consolidated Financial Statements, included in Part II, Item 8 of this Form 10-K, is incorporated herein by reference. For an additional discussion of certain risks associated with legal proceedings, see the section entitled “Risk Factors” in Part I, Item 1A of this Form 10-K.

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

None.

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PART II

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

Price Range of Common Stock

Our common stock commenced trading on the NASDAQ Global Market on November 11, 1999 and is traded under the symbol “SNWL”. As of December 31, 2009, there were approximately 83 shareholders of record of the common stock. The high and low sale prices for the common stock as reported on the NASDAQ Global Market were:

	High		Low
Fiscal 2008
First Quarter		$10.91		$7.51
Second Quarter		$ 8.74		$6.45
Third Quarter		$ 6.82		$4.78
Fourth Quarter		$ 5.23		$2.90
Fiscal 2009
First Quarter		$ 4.88		$3.38
Second Quarter		$ 6.07		$4.32
Third Quarter		$ 8.53		$5.34
Fourth Quarter		$ 8.80		$7.32

Dividend Policy

We have never paid a cash dividend on our capital stock. We currently anticipate that we will retain all available funds, for use in our business and we do not currently anticipate paying any cash dividends.

Stock Performance Graph

Below is a line graph comparing relative performance in the cumulative return to shareholders of our common stock with the cumulative return on the Nasdaq Composite Index, Russell 2000 Index and RDG Technology Composite Index over a 60-month period commencing December 31, 2004 and ending on December 31, 2009. This graph assumes the investment of $100 on December 31, 2004 and the reinvestment of dividends, if any, through December 31, 2009.

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The comparisons shown in the graph below are based upon historical data. We consistently caution that the stock price performance shown in the graph below is not indicative of, nor intended to forecast, the potential future performance of our common stock.

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*

Among SonicWALL, Inc.

* $100 invested on 12/31/04 in stock or index, including reinvestment of dividends.

Fiscal year ending December 31.

Recent Sales of Unregistered Securities

None.

Issuer Purchases of Equity Securities

None.

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ITEM 6. Selected Consolidated Financial Data

The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and related notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this Form 10-K.

	Year Ended December 31,
	2009			2008			2007			2006			2005
Statements of Operations Data:	(In thousands, except per share data)
Revenue:
Product	$	73,847		$	90,857		$	98,936		$	92,797		$	75,525
License and service		126,728			127,787			100,263			82,741			59,799
Total revenue		200,575			218,644			199,199			175,538			135,324
Cost of revenue:
Product		39,038			43,507			40,555			39,164			27,699
License and service		15,857			20,102			15,894			12,287			8,031
Amortization of purchased technology		3,017			3,017			2,232			5,387			4,552
Total cost of revenue		57,912			66,626			58,681			56,838			40,282
Gross profit		142,663			152,018			140,518			118,700			95,042
Operating expenses:
Research and development		37,858			44,176			39,410			33,670			22,768
Sales and marketing		70,000			82,348			77,741			71,256			53,403
General and administrative		17,134			18,613			21,473			20,324			15,535
Amortization of purchased intangible assets		1,095			1,114			715			2,721			2,893
Restructuring charges		-			1,683			-			1,409			-
In-process research and development		-			-			1,930			1,580			-
Total operating expenses		126,087			147,934			141,269			130,960			94,599
Income (loss) from operations		16,576			4,084			(751	)		(12,260	)		443
Interest income and other expense, net		3,164			6,368			11,771			9,713			6,867
Income (loss) before income taxes		19,740			10,452			11,020			(2,547	)		7,310
Benefit (provision) for income taxes		(6,586	)		(5,571	)		17,601			(8,206	)		(1,034	)
Net income (loss)	$	13,154		$	4,881		$	28,621		$	(10,753	)	$	6,276
Net income (loss) per share:
Basic	$	0.24		$	0.09		$	0.45		$	(0.17	)	$	0.10
Diluted	$	0.24		$	0.08		$	0.43		$	(0.17	)	$	0.09
Shares used in computing net income (loss) per share:
Basic		53,914			56,069			64,305			65,117			64,684
Diluted		55,568			57,897			67,099			65,117			66,797

	As of December 31,
		2009			2008			2007			2006			2005
	(In thousands, except per share data)
Consolidated Balance Sheet Data:
Cash and cash equivalents	$	39,071		$	45,127		$	33,324		$	25,927		$	42,593
Short-term investments		161,079			60,327			195,647			209,251			197,849
Total assets		450,557			401,836			472,635			416,291			387,683
Total shareholders’ equity		301,265			265,771			327,704			318,068			320,170
Long-term liabilities		24,920			15,072			17,495			6,269			636

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

This Form 10-K contains forward-looking statements which relate to future events or our future financial performance. In many cases you can identify forward-looking statements by terminology such as “may”, “will”, “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “intend” or “continue,” or the negative of such terms and other comparable terminology. In addition, forward-looking statements in this document include, but are not limited to, those regarding the dedication of resources to develop new products and services and marketing those products and services to channel partners and customers; the introduction of more service offerings on our platforms as a vehicle to generate additional revenue from our installed base of products; our ability to deliver comprehensive and profitable solutions to our channel partners; the growth opportunity associated with sales through our indirect channel to larger distributed enterprises; weakening economic conditions that could lead to decreases in IT spending that could adversely impact operating results; the level of comfort of our channel partners in offering our solutions to their customers; the growth of the Network Security, Secure Content Management and Business Continuity markets; the impact of a failure to achieve greater international sales; our ability to maintain and enhance current product lines, develop new products, maintain technological competitiveness and meet the expanding range of customer requirements; the market opportunity for license and service revenue growth; our ability to deliver comprehensive solutions to channel partners, the positive characteristics of our software license and service revenue model on future revenue growth and the predictability of our revenue stream; the impact on revenue of the combination of subscription services sold in conjunction with new product offerings; expected competition in the Internet security market and our ability to compete in markets in which we participate; impact of service renewal rates on lowering selling and marketing expense; our ability to achieve increased incremental revenue per transaction through success of our software license and service revenue model; the impact of IT spending on demand for our products and services; the current and likely future impact of share-based compensation expense on reported operating results; the impact of changes in tax laws and rates on the Company’s operating results, cash flows or financial position; anticipated revenue contributions of new products including continuous data protection, email security and SSL-VPN products and related services; the impact of growth in international operations on our exposure to foreign currency fluctuations; the possible impact of uncertainties in the auction rate and asset backed securities markets on the Company’s financial performance; our ability to access funds held as auction rate securities in our investment portfolio; the impact of significant fluctuations in the exchange rate of some foreign currencies in relation to the US Dollar; diverging economic conditions in foreign markets in which we do business; pricing pressures on our solution based offerings; anticipated higher gross margins associated with our license and service offerings; the probability of realization of all deferred tax assets; assessment of future effective tax rates and the continued need for a partial tax valuation allowance; the expected impact on reported revenue associated with the adoption of amendments to FASB 605 and FASB ASC 985; the potential for product gross margins to erode based upon changes in product mix; downward pressure on product pricing or upward pressure on production costs; the impact of product mix on product gross profits; the impact of the completion of “in sourcing” certain technical support functions on period over period comparisons of cost of license and service revenue and gross margin; the implementation of a second phase of technical support “in sourcing” activity; our ability to maintain investment in current and future product development and enhancement efforts; the introduction of new products and the broadening of existing product offerings; planned investments and expenses in current and future product development; production costs and sales volume comparisons between the NSA and SSL-VPN products and other hardware appliances; the rate of change of general and administrative expenses; the impact of geopolitical and macro-economic conditions on demand for our offerings; the ability of our contract manufacturers to meet our requirements; the belief that existing cash, cash equivalents and short-term investments will be sufficient to meet our cash requirements at least through the next twelve months; factors potentially impacting operating cash flows in future periods; and expected fluctuations in days sales outstanding. These statements are only predictions, and they are subject to risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors, including, but not limited to, those set forth herein under the heading “Risk Factors”. References to “we,” “our,” and “us” refer to SonicWALL, Inc. and its subsidiaries.

Overview

SonicWALL provides network security, secure remote access, content security, and business continuity solutions for businesses of all sizes. Our solutions are typically deployed at the edges of networks. These networks are often aggregated into broader distributed deployments to support companies that do business in multiple physical locations, interconnect their networks with trading partners, or support a mobile or remote workforce. Our solutions are sold in over 50 countries worldwide. Our descriptions of regions of the world in which we do business specifically excludes Cuba, Iran, Syria, Sudan and any other country identified by the United States Government as being state sponsors of terrorism and subject to economic sanctions or export controls.

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The Company groups revenue into the following primary product categories of similar products:

(1)

Unified Threat Management (“UTM”) including both NSA and TZ products; subscription services such as Comprehensive Gateway Security Suite, Comprehensive Anti-Spam Service, integrated Gateway Anti-Virus, and Intrusion Prevention; software licenses such as our enhanced “SonicOS” operating system, node upgrades, and other services such as extended warranty and service contracts, training, consulting and engineering services.

(2)	Secure Content Management (“SCM”) including CSM and email security appliances, subscription services such as internet filtering and email protection term and perpetual licenses, and other services such as extended warranty and service contracts, training, consulting and engineering services.

(3)	SSL VPN Secure Remote Access (“SSL”) including SSL-VPN appliances, add-on software licenses and other services such as extended warranty and service contracts, training, consulting and engineering services.

(4)	Continuous Data Protection (“CDP”) including the CDP appliances, off-site data backup subscription services, site-to-site back-up licenses, and other services such as extended warranty and service contracts, training, consulting and engineering services.

We generate revenue within these product categories primarily from the sale of: (1) products, (2) software licenses, (3) subscriptions for services such as content filtering, anti-virus protection and intrusion prevention, offsite data backup, email protection, and (4) other services such as extended warranty and service contracts, training, consulting and engineering services.

We currently outsource our hardware manufacturing and assembly to third party contract manufacturers and some of the key components in the Company’s products come from a single or limited number of suppliers. Outsourcing our manufacturing and assembly enables us to reduce fixed overhead and personnel costs and to provide flexibility in meeting market demand.

We sell our solutions primarily through distributors and value-added resellers, who in turn sell our products to end-users. Some of our resellers are carriers or service providers who provide solutions to the end-user customers as managed services. Channel sales accounted for approximately 99%, 99%, and 98% of total revenue in 2009, 2008, and 2007, respectively. Ingram Micro, Tech Data, and Arrow, all of whom are technology product distributors, collectively accounted for approximately 46%, 49%, and 50% of our revenue during 2009, 2008, and 2007, respectively.

We seek to provide our channel partners and customers with differentiated solutions that are innovative, easy to use, reliable, and provide good value. To support this commitment, we dedicate significant resources to developing new products and marketing our products to our channel partners and customers.

Key Success Factors of our Business

We believe that there are several key success factors of our business, and that we create value in our business by focusing on our execution in these areas.

Channel

Our distributors and authorized resellers provide a valuable service in assisting end-users in the design, implementation, and service of our network security, content security, and business continuity solutions. We support our distribution and channel partners with sales, marketing, and technical support to help them create and fulfill demand for our offerings. We also focus on helping our channel partners succeed with our solutions by concentrating on comprehensive reseller training and certification, and support for our channel’s sales activities.

Product and Service Platform

Our products serve as a platform for revenue generation for both us and our channel partners. Most product sales can result in additional revenue through the simultaneous or subsequent acquisition of software licenses, such as our Global Management System, or through the sale of additional value-added subscription services, such as Content Filtering; client

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Anti-Virus and integrated Gateway Anti-Virus; Anti-Spyware and Intrusion Prevention Services; email protection and off-site data backup.

Distributed Architecture

Our security solutions are based on a distributed architecture, which we believe allows our offerings to be deployed and managed at the most efficient location in the network. We are providing our customers and their service providers with mechanisms to enforce the networking and security policies they have defined for their business. We also use the flexibility of a distributed architecture to allow us to enable new functionality in already-deployed platforms through the provisioning of an electronic key, which may be distributed through the Internet.

Market Acceptance

We began offering integrated security appliances in 1997, and since that time we have shipped over 1.5 million revenue units. Our experience in serving a broad market and our installed base of customers provides us with opportunities to sell our new network security, content security, and business continuity solutions as they become available. The market acceptance of our current solutions provides our current and prospective channel partners with an increased level of comfort when deciding to offer our new solutions to their customers.

Integrated Design

Our platforms utilize a highly integrated design in order to improve ease-of-use, lower acquisition and operational costs for our customers, and enhance performance. Various models also integrate functionality to support different internet connection alternatives. Every appliance also ships with pre-loaded firmware to provide for rapid set up and easy installation. Each of these tasks can be managed through a simple web-browser session.

Our Opportunities, Challenges, and Risks

We serve substantial markets for network security, content security, and business continuity. Our goal is to deliver comprehensive and profitable solutions to our channel partners which address their customers' needs. We pursue the creation of these solutions through a blend of organic and inorganic growth strategies including internal development efforts, licensing and OEM opportunities, and acquisition of other companies. To the extent that these efforts result in solutions which fit well with our channel and end-users, we would expect to generate increasing sales. To the extent that these efforts are not successful, we would expect to see loss of sales and/or increased expenses without commensurate return.

International Growth

We expect that international revenue will continue to represent a substantial portion of our total revenue in the foreseeable future. Our percentage of sales from international territories does not represent the same degree of penetration of those markets as we have achieved domestically. We believe that a significant opportunity exists to grow our revenue by increasing our international penetration rate to match our penetration rate in the domestic market.

If we fail to structure our distribution relationships in a manner consistent with marketplace requirements and on favorable terms, the percentage of sales from international territories will decline and the revenue from our international operations may decrease.

Growth in Enterprises

We believe that sales through our indirect channel to enterprise class customers represent a growth opportunity for the Company. Our percentage of revenues from such customers does not represent the same degree of penetration of that segment as we have achieved with small to medium sized businesses. We believe that a significant opportunity exists to grow our revenue by increasing our penetration rate with this segment by leveraging the company’s technological and channel strengths.

If we fail to establish competitive products and services for this segment, or fail to develop the correct channel partners and resources, the percentage of our revenue derived from enterprise class customers will not increase, and may, in fact, decrease.

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License and Services Revenue

We believe that the software license and services component of our revenue has several characteristics that are positive for our business as a whole: our license and services revenue is associated with a higher gross profit than our product revenue; the subscription services component of license and services revenue is recognized ratably over the services period, and thus provides, in the aggregate, a more predictable revenue stream than product or license revenue, which are generally recognized at the time of the sale; and to the extent that we are able to achieve good renewal rates, we have the opportunity to lower our selling and marketing expenses attributable to that segment. We expect our revenue from software licenses and services to continue to represent the majority of our total revenue subject to (1) continuing demand from our installed base of customers for the renewal and upgrading of such service, (2) the number of new hardware appliances sold, and (3) the demand for such services as attached to new hardware appliances sold.

Macro-Economic Factors Affecting IT Spending

We believe that our products and services are subject to the macro-economic factors that affect much of the information technology (“IT”) market. Growing IT budgets and an increased funding for projects to provide security, mobility, data protection, and productivity could drive product upgrade cycles and/or create demand for new applications of our solutions. Contractions in IT spending can affect our revenue by causing projects incorporating our products and services to be delayed and/or canceled. We believe that demand for our solutions correlate with increases or decreases in global IT spending and we believe that economic uncertainties, including fluctuating energy prices, difficulties in the financial sector, the availability of credit, softness in the housing market, underlying market liquidity, and geopolitical uncertainties may continue to have an adverse impact on IT spending in the markets in which we do business.

Critical Accounting Policies and Critical Accounting Estimates

The preparation of our financial statements and related disclosures in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) requires us to make judgments, assumptions, and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. We believe that the judgments, assumptions and estimates upon which we rely are reasonable based upon information available to us at the time that these judgments, assumptions and estimates are made. However, any differences between these judgments, assumptions and estimates and actual results could have a material impact on our statement of operations and financial condition. The current volatility in the financial markets and associated general economic uncertainty increase the risk that such differences may be realized. The accounting policies that reflect our most significant judgments, assumptions and estimates and which we believe are critical in understanding and evaluating our reported financial results include: (1) revenue recognition; (2) sales returns and other allowances, allowance for doubtful accounts and warranty reserve; (3) valuation of inventory; (4) accounting for income taxes; (5) valuation of long-lived and intangible assets and goodwill, (6) share-based compensation, and (7) fair value of investments.

Revenue Recognition

The Company derives its revenue primarily from the sale of: (1) products, (2) software licenses, (3) subscriptions for services, and (4) other services such as extended warranty and service contracts, training, consulting and engineering services. As described below, significant management judgments and estimates must be made and used in connection with the revenue recognized in any accounting period. The Company may experience material differences in the amount and timing of its revenue for any period if management makes different judgments or utilizes different estimates.

The Company recognizes revenue for products when persuasive evidence of an arrangement exists, the product has been delivered, title and risk of loss have been transferred to the customer, the fee is fixed or determinable, and collection of the resulting receivable is reasonably assured. While the Company’s sales agreements contain standard terms and conditions, there are agreements that contain non-standard terms and conditions. In these cases, interpretation of non-standard provisions is required to determine the appropriate accounting for the transaction.

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provision required for sales to these distributors. In general, retroactive price adjustments are not significant. At December 31, 2009, 2008, and 2007, the Company recorded a provision for price protection on sales to the Company’s channel partners in the amounts of $0, $200,000, and $985,000, respectively.

Delivery to customers is generally deemed to occur when we deliver the product to a common carrier. Certain distributor agreements provide customers with rights of return for stock rotation. These stock rotation rights are generally limited to 15% to 25% of the distributor's purchases for the immediately prior 3 to 6 months period or contain other measurable restrictions, and we estimate reserves for these return rights as discussed below. Certain distributors, have rights of return under certain circumstances that are not limited, therefore, we do not deem delivery to have occurred for any sales to these distributors until they sell the product to their customers.

Evidence of an arrangement is manifested by a master distribution or OEM (Original Equipment Manufacturer) agreement, an individual binding purchase order, or a signed license agreement. In most cases, sales through our distributors and OEM partners are governed by a master agreement against which individual binding purchase orders are placed on a transaction-by-transaction basis.

At the time of the transaction, the Company assesses whether the fee associated with the transaction is fixed or determinable, and whether or not collection is reasonably assured. The Company assesses whether the fee is fixed or determinable based upon the terms of the binding purchase order, including the payment terms associated with the transaction. If a significant portion of a fee is due beyond the Company’s normal payment terms, typically 30 to 90 days from invoice date, the Company accounts for the fee as not being fixed or determinable and recognizes revenue as the fees become due.

The Company assesses probability of collection based on a number of factors, including past transaction history with and the credit-worthiness of the customer. The Company does not request collateral from its customers. If the Company determines that collection of a fee is not reasonably assured, it defers the fee and recognizes revenue at the time collection becomes reasonably assured, which is generally upon receipt of cash.

For arrangements with multiple elements (for example, the sale of an appliance which includes a year of maintenance or a subscription based product), the Company allocates revenue first to undelivered components of the arrangement based on the vendor specific objective evidence of fair value of the undelivered elements, which is generally the average selling price of each element when sold separately. This allocation process means that the Company defers revenue from the arrangement equal to the fair value of the undelivered elements and recognizes such amounts as revenue when the elements are delivered.

The Company’s arrangements do not generally include acceptance clauses. However, if an arrangement includes an acceptance provision, recognition of revenue occurs upon the earlier of receipt of a written customer acceptance or expiration of the acceptance period.

License and service revenue includes revenue from subscription service licenses, technical support services and perpetual software licenses. The Company recognizes revenue for subscriptions and services such as content filtering, anti-virus protection and intrusion prevention, and extended warranty and service contracts, ratably over the contract term. The Company’s training, consulting and engineering services are generally billed and recognized as revenue as these services are performed.

The Company collects and remits sales taxes on products and services that it purchases and sells under its contracts with customers, and reports such amounts under the net method in its consolidated statements of operations. Accordingly, there are no sales taxes included in revenue.

In October 2009, the FASB issued Accounting Standard Update (“ASU”) No. 2009-13, Multiple-Deliverable Revenue Arrangements (“ASU 2009-13”) and No. 2009-14, Certain Revenue Arrangements that include Software Elements (“ASU 2009-14”). These standards update FASB ASC 605, Revenue Recognition (“ASC 605”) and FASB ASC 985, Software (“ASC 985”). The amendments to ASC 605 requires entities to allocate revenue in an arrangement using estimated selling prices of the delivered goods and services based on a selling price hierarchy. The amendments to ASC 985 remove tangible products from the scope of software revenue guidance and provide guidance on determining whether software deliverables in an arrangement that includes a tangible product are covered by the scope of the software revenue guidance. These amendments to ASC 605 and ASC 985 should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. The Company adopted these amendments on January 1, 2010. Management estimates that the impact of the adoption on the Company’s consolidated financial statements will be a 2% increase in revenue recognized in the fiscal year with a corresponding decrease in deferred revenue.

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Sales Returns and Other Allowances, Allowance for Doubtful Accounts, and Warranty Reserve

The preparation of financial statements in accordance with U.S. GAAP requires us to make estimates and assumptions that affect the reported amount of assets and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Specifically, we must make estimates of potential future product returns and price changes related to current period product revenue. We analyze historical returns, current economic trends, and changes in customer demand and acceptance of our products when evaluating the adequacy of the sales returns and other allowances. Significant management judgments and estimates must be made and used in connection with establishing the sales returns and other allowances in any accounting period. We may experience material differences in the amount and timing of our revenue for any period if management makes different judgments or utilizes different estimates.

In addition, we must make estimates based upon a combination of factors to ensure that our accounts receivable balances are not overstated due to uncollectibility. We specifically analyze accounts receivable and historical bad debts, the length of time receivables are past due, macroeconomic conditions including liquidity and the availability of credit facilities, deterioration in customer’s operating results or financial position, customer concentrations, and customer credit-worthiness, when evaluating the adequacy of the allowance for doubtful accounts.

Our appliance products are generally covered by a warranty period of one or two years. We accrue a warranty reserve for estimated costs to provide warranty services, including the cost of technical support, product repairs, and product replacement for units that cannot be repaired. Our estimate of costs to fulfill our warranty obligations is based on historical experience and expectation of future conditions. To the extent we experience increased warranty claim activity or increased costs associated with servicing those claims, our warranty accrual will increase, resulting in decreased gross profit.

Valuation of Inventory

We continually assess the valuation of our inventory and periodically write-down the value for estimated excess and obsolete inventory based upon assumptions about future demand and market conditions. Such estimates are difficult to make since they are based, in part, on estimates of current and future economic conditions. Reviews for excess inventory are done on a quarterly basis and required reserve levels are calculated with reference to our projected ultimate usage of that inventory. In order to determine the ultimate usage, we take into account forecasted demand, rapid technological changes, product life cycles, projected obsolescence, current inventory levels, and purchase commitments. The excess balance determined by this analysis becomes the basis for our excess inventory charge. If actual demand is lower than our forecasted demand, and we fail to reduce manufacturing output accordingly, we could be required to record additional inventory write-downs, which would have a negative effect on our gross profit and earnings.

Accounting for Income Taxes

As part of the process of preparing our consolidated financial statements we are required to estimate our taxes in each of the jurisdictions in which we operate. We must make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of tax credits, benefits, and deductions, and in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes, as well as the interest and penalties related to these uncertain tax positions. Significant changes to these estimates may result in an increase or decrease to our tax provision in a subsequent period.

We must assess the likelihood that we will be able to recover our deferred tax assets. If recovery is not likely, we must increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. We believe that we will ultimately recover a substantial majority of the deferred tax assets recorded on our consolidated balance sheets. However, should there be a change in our ability to recover our deferred tax assets, our tax provision would increase in the period in which we determined that the recovery was not likely.

The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities for uncertain tax positions based on the two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step requires us to

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estimate and measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. It is inherently difficult and subjective to estimate such amounts, as we have to determine the probability of various possible outcomes. We reevaluate these uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit, and new audit activity. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision.

Valuation of Long-Lived Assets, Intangible Assets and Goodwill

Purchased intangibles consist of purchased technology, customer installed base/relationships, customer backlog and other intangibles. Intangible assets are amortized on a straight-line basis over their estimated useful lives which range from 3 months to eight years. We periodically evaluate our intangible assets for indications of impairment. If this evaluation indicates that the value of the intangible asset may be impaired, we make an assessment of the recoverability of the net carrying value of the asset over its remaining useful life. If this assessment indicates that the intangible asset is not recoverable, based on the estimated undiscounted future cash flows of the technology over the remaining amortization period, we reduce the net carrying value of the related intangible asset to fair value and may adjust the remaining amortization period.

Goodwill represents the excess of the aggregate purchase price over the fair market value of the net tangible and intangible assets acquired by the Company. Goodwill is tested for impairment on December 31st of each fiscal year or more often if an event or circumstances indicate that an impairment loss has been incurred. An impairment charge is recognized if a reporting unit’s goodwill carrying amount exceeds its implied fair value. Goodwill impairment is determined using a two-step approach and one or more of the following fair value measures including: present value techniques of estimated future cash flows; or valuation techniques based on multiples of earnings or revenue, or a similar performance measure. Any such impairment charge could be significant and could have a material adverse effect on our reported financial statements. Based on the impairment tests performed, there was no impairment of goodwill in 2009, 2008, and 2007. The goodwill recorded as a result of the business combinations in the years presented is not deductible for tax purposes.

We continually monitor events and changes in circumstances that could indicate carrying amounts of long-lived assets, including intangible assets, may not be recoverable. When such events or changes in circumstances occur, we assess the recoverability of long-lived assets by determining whether the carrying value of such assets will be recovered through undiscounted expected future cash flows. If the total of the future cash flows is less than the carrying amount of those assets, we record an impairment charge based on the excess of the carrying amount over the fair value of the assets.

Share-Based Compensation

The Company measures and recognizes the compensation expenses for all share-based payment awards made to employees and directors including employee stock options and employee stock purchases related to the Employee Stock Purchase Plan based on the grant date fair value estimated using a Black-Scholes option-pricing model. The Company estimates the forfeiture rate at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Share-based compensation expense recognized in the Consolidated Statements of Operations are based on awards ultimately expected to vest and has been reduced for estimated forfeitures. The value of the portion of the award that is ultimately expected to vest is recognized as expenses using the straight-line single option method over the requisite service periods in the Company’s Consolidated Statements of Operations.

Share-based compensation expenses recognized in the Company’s Consolidated Statements of Operations for the years ended December 31, 2009, 2008, and 2007 included compensation expenses for share-based payment awards granted prior to, but not yet vested as of December 31, 2005 based on the grant date fair value estimated in accordance with the pro forma provisions and compensation expenses for the share-based payment awards granted subsequent to December 31, 2005 based on the grant date fair value estimated using a Black-Scholes option-pricing model.

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Fair Value of Investments

Fair Value

Our investments consist of U.S. Treasury and U.S. government agency securities, municipal notes and bonds, auction rate securities (“ARS”), asset backed securities (“ABS”), corporate notes and bonds, commercial paper, and money market funds. In the current market environment, the assessment of the fair value of the debt securities can be difficult and subjective. The volume of trading activity of certain debt instruments has declined, and the rapid changes occurring in the financial markets can lead to changes in the fair value of financial instruments in a relatively short period of time. The Company designated all investments, except for ARS held by UBS, as available-for-sale and therefore these investments are reported at fair value, with unrealized gains and losses recorded in accumulated other comprehensive income. During the fourth quarter of fiscal 2008, the Company reclassified ARS from UBS, one of its investment providers, from available-for-sale to trading securities. Investments that the Company designates as trading assets are reported at fair value, with gains or losses resulting from changes in fair value recognized in earnings. The information contained in Note 2 and Note 4 of the Company’s Consolidated Financial Statements is hereby incorporated by reference.

Other-Than-Temporary Impairment. All of the Company’s available-for-sale investments are subject to a periodic impairment review. The Company recognizes an impairment charge when a decline in the fair value of its investments below the cost basis is judged to be other-than-temporary. The Company considers various factors in determining whether to recognize an impairment charge, including the length of time and extent to which the fair value has been less than the Company’s cost basis, the financial condition and near-term prospects of the investee, and the Company’s intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in the market value. During the years ended December 31, 2009, 2008 and 2007 the Company did not record any other-than-temporary impairment charges on its available-for-sale securities.

Significant Transactions

Acquisitions

On July 10, 2007, the Company completed the acquisition of 100% of the outstanding shares of Aventail Corporation (“Aventail”) for approximately $25.6 million in purchase consideration, consisting of cash of approximately $23.6 million, $2.0 million in direct transaction costs incurred in connection with the acquisition, and stock options assumed. The Company acquired Aventail to complement and extend its current SSL-VPN product offering. Of the total purchase price of $25.6 million, approximately $1.9 million was allocated to in-process research and development, approximately $6.9 million was allocated to purchased technology that will be amortized over its estimated useful life of six years, approximately $7.9 million was allocated to customer relationship that will be amortized over eight years, approximately $2.6 million was used to pay off an assumed loan, and approximately $4.0 million was recorded for net liabilities assumed. The remaining $15.4 million was allocated to goodwill. In addition, pursuant to the terms of the Merger Agreement, 744,043 stock options held by employees of Aventail were assumed by SonicWALL. The fair value as of the acquisition date of these stock options assumed, using the Black-Scholes valuation method, was $2.2 million. There were no options vested as of the acquisition date thus the purchase price component related to the assumption was zero. The total fair value of $2.2 million is being recognized as compensation cost over the requisite service period.

The Consolidated Financial Statements include the operating results of each business from the date of acquisition. The above transaction was accounted for as a purchase business combination. The Company allocated the purchase price based upon the fair value of the assets acquired and liabilities assumed. The excess of the purchase price over the fair value of the assets acquired and liabilities assumed has been allocated to the identified intangible assets.

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Restructuring

The information contained in Note 8 to the Consolidated Financial Statements is hereby incorporated by reference into this Part II, Item 7.

Results of Operations

The following table sets forth financial data for the years indicated as a percentage of total revenue:

	Year Ended December 31,
	2009		2008		2007
Revenue:
Product		36.8%		41.6%		49.7%
License and service		63.2		58.4		50.3
Total revenue		100.0		100.0		100.0
Cost of revenue:
Product		19.5		19.9		20.4
License and service		7.9		9.2		8.0
Amortization of purchased technology		1.5		1.4		1.1
Total cost of revenue		28.9		30.5		29.5
Gross profit		71.1		69.5		70.5
Operating expenses:
Research and development		18.9		20.2		19.8
Sales and marketing		34.9		37.7		38.9
General and administrative		8.5		8.5		10.8
Amortization of purchased intangible assets		0.5		0.5		0.4
Restructuring charges		-		0.8		-
In-process research and development		-		-		1.0
Total operating expenses		62.8		67.7		70.9
Income (loss) from operations		8.3		1.8		(0.4)
Interest income and other expense, net		1.6		2.9		5.9
Income before income taxes		9.9		4.7		5.5
Benefit (provision) for income taxes		(3.3)		(2.5)		8.9
Net income		6.6%		2.2%		14.4%

The following table shows share-based compensation cost before taxes as a percent of total revenues for the periods indicated:

	Year Ended December 31,
	2009		2008		2007
Cost of sales		0.2%		0.2%		0.3%
Research and development		1.4%		1.5%		2.3%
Sales and marketing		1.6%		1.7%		2.4%
General and administrative		1.3%		1.4%		2.0%
Total share-based compensation expenses		4.5%		4.8%		7.0%

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Total Revenue

Total Revenue by Product Category (in thousands, except for percentage data)

	Year Ended December 31,						Dollar Change						Percent Change
	2009		2008		2007		2009 vs. 2008			2008 vs. 2007			2009 vs. 2008		2008 vs. 2007
UTM	$	155,052	$	164,788	$	147,696	$	(9,736	)	$	17,092			(6%)		12%
% of total revenue		77%		75%		74%
SCM		19,805		22,988		23,604		(3,183	)		(616	)		(14%)		(3%)
% of total revenue		10%		11%		12%
SSL		17,160		20,668		15,706		(3,508	)		4,962			(17%)		32%
% of total revenue		9%		9%		8%
CDP		8,558		10,200		12,193		(1,642	)		(1,993	)		(16%)		(16%)
% of total revenue		4%		5%		6%
Total revenue	$	200,575	$	218,644	$	199,199	$	(18,069	)	$	19,445			(8%)		10%

The 6% decline in revenue in the UTM product category in 2009 compared to 2008 was due to the combination of a 12% decrease in product revenue and a 1% decrease in revenue from software license and subscription services. The decline in product revenue was due to the combination of a 10% decrease in average net revenue per unit and a 2% decrease in units sold. The decrease in software license and subscription services revenue was offset by a 16% increase in revenue from our CGSS subscription services. The 14% decline in revenue in the SCM product category in 2009 compared to 2008 was due to the combination of a 47% decrease in product revenue and a 10% decrease in revenue from software license and subscription services. The decline in product revenue was due to the combination of a 42% decrease in units sold and a 9% decrease in average net revenue per unit. The 17% decline in revenue in the SSL product category in 2009 compared to 2008 was due to the combination of a 47% decrease in product revenue and a 4% decrease in subscription services revenue, offset by an 81% increase in software license revenue. The decrease in product revenue was due to the combination of a 22% decrease in units sold and a 32% decrease in average net revenue per unit. The increase in software license revenue was primarily due to a change that was effected in the fourth quarter of 2008 to the pricing structure of Aventail SSL-VPN solutions that offered end user licenses separately from the base appliances. The 16% decline in revenue in the CDP product category in 2009 compared to 2008 was due to a 31% decrease in product revenue, offset by a 7% increase in revenue from software license and subscription services. The decline in product revenue was primarily due to a 33% decrease in units sold.

The 12% increase in revenue in the UTM product category in 2008 compared to 2007 was due to a 29% increase in revenue from software license and subscription services, offset by a 5% decrease in product revenue. The increase in software license and subscription services revenue was primarily due to a 99% increase in revenue from our CGSS subscription services. The decline in product revenue was primarily due to a 6% decrease in units sold. The 3% decline in revenue in the SCM product category in 2008 compared to 2007 was due to a 42% decrease in product revenue, offset by a 7% increase in revenue from software license and subscription services. The decline in product revenue was due to the combination of a 38% decrease in units sold and a 7% decrease in average net revenue per unit. The 32% increase in revenue in the SSL product category in 2008 compared to 2007 was primarily due to a 100% increase in software license revenue. The 16% decline in revenue in the CDP product category in 2008 compared to 2007 was due to a 28% decrease in product revenue, offset by a 13% increase in revenue from software license and subscription services. The decline in product revenue was primarily due to a 28% decrease in units sold.

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Total Revenue by Geographic Area (in thousands, except for percentage data)

	Year Ended December 31,						Dollar Change					Percent Change
	2009		2008		2007		2009 vs. 2008			2008 vs. 2007		2009 vs. 2008		2008 vs. 2007
Americas	$	139,458	$	149,986	$	138,678	$	(10,528	)	$	11,308		(7%)		8%
% of total revenue		70%		69%		70%
EMEA		40,949		46,144		40,420		(5,195	)		5,724		(11%)		14%
% of total revenue		20%		21%		20%
APAC		20,168		22,514		20,101		(2,346	)		2,413		(10%)		12%
% of total revenue		10%		10%		10%
Total revenue	$	200,575	$	218,644	$	199,199	$	(18,069	)	$	19,445		(8%)		10%

Revenue in the Americas included sales from regions outside the United States and Canada of $4.3 million and $5.6 million for 2009 and 2008, respectively. The decline in revenue in the Americas for 2009 compared to 2008 was primarily due to the combination of decreases in the units sold in the SCM, SSL and CDP product categories, average net revenue per unit in the UTM and SSL product categories, and sales of software license and subscription services in the UTM and SCM product categories, offset by increased sales of software license and subscription services in the SSL product category. The decline in revenue in EMEA for 2009 compared to 2008 was primarily due to the combination of decreases in the units sold in the UTM, SSL and CDP product categories and average net revenue per unit in the UTM and SSL product categories, offset by increased sales of software licenses and subscription services in the SSL product category. The decline in revenue in APAC for 2009 compared to 2008 was primarily due to the combination of decreases in average net revenue per unit in the UTM, SCM and SSL product categories, offset by increases in the units sold in the UTM product category.

Revenue in the Americas included sales from regions outside the United States and Canada of $5.6 million and $3.0 million for 2008 and 2007, respectively. The increase in revenue in the Americas for 2008 compared to 2007 was primarily due to increases in sales of software license and subscription services in the UTM and SSL product categories, offset by the combination of decreases in the units sold in the UTM, SCM and CDP product categories and average net revenue per unit in the UTM product category. The increase in revenue in EMEA for 2008 compared to 2007 was primarily due to the combination of increased sales of software license and subscription services in the UTM, SCM and SSL product categories and average net revenue per unit in the UTM product category, offset by decreases in the units sold in the UTM product category. The increase in revenue in APAC for 2008 compared to 2007 was primarily due to the combination of increased sales of software license and subscription services in the UTM and SSL product categories and average net revenue per unit in the UTM product category, offset by decreases in the units sold in the UTM and CDP product categories.

Product and License and Service Revenue (in thousands, except for percentage data)

	Year Ended December 31,						Dollar Change						Percent Change
	2009		2008		2007		2009 vs. 2008			2008 vs. 2007			2009 vs. 2008		2008 vs. 2007
Product	$	73,847	$	90,857	$	98,936	$	(17,010	)	$	(8,079	)		(19%)		(8%)
% of total revenue		37%		42%		50%
License and service		126,728		127,787		100,263		(1,059	)		27,524			(1%)		27%
% of total revenue		63%		58%		50%
Total revenue	$	200,575	$	218,644	$	199,199	$	(18,069	)	$	19,445			(8%)		10%

Product Revenue

We shipped approximately 174,000, 182,000, and 196,000 total units, respectively, during fiscal 2009, 2008, and 2007.

The decrease in product revenue in 2009 compared to 2008 was primarily due to the combination of decreases in units sold in all product categories and average net revenue per unit in UTM and SSL product categories.

The decrease in product revenue in 2008 compared to 2007 was primarily due to decreases in units sold in all product categories, offset by increases in average net revenue per unit in the UTM and SSL product categories.

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License and Service Revenue

License and service revenue includes revenue from subscription service licenses, technical support services and perpetual software licenses.

The decline in license and service revenue in 2009 compared to 2008 was primarily due to (1) a decrease in sales of software licenses associated with our UTM solution, and (2) a decrease in sales of subscription services associated with our SCM solutions. These decreases were offset by (1) an increase in sales of subscription services associated with our UTM solutions, and (2) an increase in sales of software licenses associated with our SSL and CDP solutions.

The increase in license and service revenue in 2008 compared to 2007 was primarily due to (1) an increase in sales of software licenses associated with our SSL solution; and (2) an increase in sales of subscription services associated with our UTM and SCM solutions. These increases were offset by a decrease in sales of software licenses associated with our UTM and SCM solutions.

Cost of Revenue and Gross Profit

The following table shows the cost of revenue for product and the cost of revenue for license and service (in thousands, except for percentage data):

	Year Ended December 31,						Percent Variance
	2009		2008		2007		2009 vs. 2008		2008 vs. 2007
Product	$	39,038	$	43,507	$	40,555		(10%)		7%
License and service		15,857		20,102		15,894		(21%)		26%
Amortization of purchased technology		3,017		3,017		2,232		-		35%
Total cost of revenue	$	57,912	$	66,626	$	58,681		(13%)		14%

Note – Effect of amortization of purchased technology has been excluded from product and license and service gross profit discussions below.

The following table shows the gross profit for product and the gross profit for license and service (in thousands, except for percentage data):

	Year Ended December 31,
	Gross Profit Amount									Gross Margin
	2009			2008			2007			2009		2008		2007
Product	$	34,809		$	47,350		$	58,381			47%		52%		59%
License and service		110,871			107,685			84,369			87%		84%		84%
Amortization of purchased technology		(3,017	)		(3,017	)		(2,232	)
Total gross profit	$	142,663		$	152,018		$	140,518			71%		70%		71%

Cost of Product Revenue and Gross Profit/Margin

Cost of product revenue includes costs associated with the production of our products, including cost of materials, manufacturing and assembly costs paid to contract manufacturers, freight, related fulfillment cost, and overhead costs associated with our manufacturing operations. Additionally, warranty costs and inventory provisions or write-downs are included in cost of product revenue.

In 2009 compared to 2008, the cost of product revenue decreased in all product categories. The 10% decline was primarily due to the combination of a 2% decrease in the units sold from the UTM product category, a 42% decrease in units sold from the SCM product category, a 22% decrease in units sold from the SSL product category, a 33% decrease in units sold from the CDP product category and a 5% decrease in the average production cost per unit in the UTM product category, offset by a 21% increase in the average production cost per unit in the CDP product category. Compared to 2008, 2009 average production cost per unit for all product categories decreased by approximately 6%.

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In 2008 compared to 2007, the cost of product revenue increased in the UTM product category, but decreased in the SCM, SSL, and CDP product categories. The 7% increase was primarily due to a 23% increase in the average production cost per unit in the UTM product category, offset by a 6% decrease in the units sold in the UTM product category, a 38% decrease in the SCM product category and a 28% decrease in the CDP product category. Compared to 2007, 2008 average production cost per unit for all product categories increased by approximately 16%.

In 2009 compared to 2008, gross profit and gross profit percentage from product sales decreased in all four product categories. In the UTM product category, an 18% decline in gross profit was primarily due to the combination of a 10% decrease in the average net revenue per unit and a 2% decrease in the units sold, offset by a 5% decrease in the average production cost per unit. In the SCM product category, a 59% decline in gross profit was due to the combination of a 9% decrease in the average net revenue per unit and a 42% decrease in the units sold. In the SSL product category, a 55% decline in gross profit was primarily due to the combination of a 32% decrease in the average net revenue per unit and a 22% decrease in the units sold. In the CDP product category, a 40% decline in gross profit was due to the combination of a 33% decrease in the units sold and a 21% increase in the average production cost per unit.

In 2008 compared to 2007, gross profit and gross profit percentage from product sales decreased in the UTM, SCM and CDP product categories. In the UTM product category, a 19% decline in gross profit was primarily due to the combination of a 23% increase in the average production cost per unit and a 6% decrease in the units sold, offset by a 1% increase in the average net revenue per unit. In the SCM product category, a 52% decline in gross profit was due to the combination of a 7% decrease in the average net revenue per unit, a 38% decrease in the units sold, and a 5% increase in the average production cost per unit. In the CDP product category, a 31% decline in gross profit was due to the combination of a 28% decrease in the units sold and a 6% increase in the average production cost per unit.

We expect future product gross profit to erode to the extent that we experience downward pressure on product pricing or upward pressure on production costs. A change in the mix of product sold could also change product gross profit and gross profit percentage.

Cost of License and Service Revenue and Gross Profit

Cost of license and service revenue includes costs associated with the production and delivery of our license and service offerings, including technical support costs related to our service contracts, royalty costs related to certain subscription offerings, personnel costs related to the delivery of training, consulting, and professional services; and cost of packaging materials and related costs paid to contract manufacturers.

In 2009 compared to 2008, gross profit from license and service increased in the UTM, SSL and CDP product categories and gross profit percentage from license and service increased in all product categories. These increases were primarily due to decreased costs. Cost of license and service revenue decreased by 21% in 2009 compared to 2008. This decrease was primarily due to decreased technical support costs. In 2007, the Company started a process to “in-source” a portion of our technical support delivery to centers located in the United States and India. That phase of the “in-sourcing” process was completed in mid 2008 and has resulted in a decline in our technical support costs for 2009 compared to 2008. The Company has also completed the implementation of a second phase of technical support “in sourcing” activity for certain other regions in the fourth quarter of 2009.

In 2008 compared to 2007, gross profit from license and service increased in all product categories and gross profit percentage from license and service increased in the UTM and SCM product categories. These increases were primarily due to a 28% increase in net revenue, offset by a 27% increase in the cost of license and service revenue. The increase in the cost of license and service was primarily due to the technical support costs associated with a larger base of license and subscription service customers. In addition, in 2007, the Company started a process to “in-source” a portion of our technical support delivery to centers located in the United States and India. That phase of the “in-sourcing” process was completed in mid 2008. The planning and other ramp up costs associated with these centers, without a corresponding decrease in costs associated with existing third party service providers, resulted in duplicate or redundant technical support expenses for a period of time.

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Amortization of Purchased Technology

	Year Ended December 31,
	2009		2008		2007
	(in thousands)
Expenses	$	3,017	$	3,017	$	2,232
% of total revenue		2%		1%		1%
Year over year change in dollars		-		785
Year over year change in percent		-		35%

Amortization of purchased technology represents the amortization of existing technology acquired in our business combinations accounted for using the purchase method. Purchased technology is being amortized over the estimated useful lives of four to eight years. The increase in amortization for the year ended December 31, 2008 as compared to the same period last year is primarily due to the timing difference of the amortization of the purchased technology from Aventail.

The amounts for the year ended December 31, 2009, 2008 and 2007 represent amortization of purchased intangibles associated with our acquisitions of enKoo, Lasso Logic, MailFrontier, and Aventail.

Future amortization to be included in cost of revenue based on the current balance of purchased technology absent any additional investment is as follows (in thousands):

Fiscal Year	Amortization Amount to Cost of Revenue
2010	$	2,374
2011		1,382
2012		1,382
2013		803
2014		225
Thereafter		206
Total	$	6,372

Our gross profit has been and will continue to be affected by a variety of factors, including competition, the mix of products and services, new product introductions and enhancements, fluctuations in manufacturing volumes, and the cost of components and manufacturing labor.

Operating Expenses

Research and Development

	Year Ended December 31,
	2009			2008		2007
	(in thousands)
Expenses	$	37,858		$	44,176	$	39,410
% of total revenue		19%			20%		20%
Year over year change in dollars		(6,318	)		4,766
Year over year change in percent		(14%)			12%

Research and development expenses primarily consist of personnel costs, contract consultants, outside testing services and equipment and supplies associated with enhancing existing products and developing new products.

During 2009, the decrease in research and development costs in comparison to the same period last year was primarily due to the following: (1) a decrease in personnel costs, including salaries, contract labor, variable compensation and benefit expenses of approximately $3.9 million; (2) a decrease in contract services of $0.5 million; (3) a decrease in share-based compensation expense related to employee stock options and rights granted under the Employee Stock Purchase Program (“ESPP”) of approximately $0.5 million; (4) a decrease in travel related costs of approximately $0.4 million; and (5) a decrease in information service and facilities costs allocated to product development of approximately $0.7 million.

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During 2008, the increase in research and development costs in comparison to the same period last year was primarily due to the following: (1) an increase in salary, variable compensation and benefit expenses of approximately $3.1 million resulting primarily from increased headcount related to the Aventail acquisition; and (2) an increase in information service and facilities costs allocated to product development of approximately $2.7 million. These increases in research and development expenses were partially offset by a decrease in share-based compensation expense related to employee stock options and rights granted under the ESPP of approximately $1.4 million.

We believe that our future performance will depend in large part on our ability to maintain and enhance our current product line, develop new products that achieve market acceptance, maintain technological competitiveness, and meet an expanding range of customer requirements. We plan to maintain our investments in current and future product development and enhancement efforts, and incur expenses associated with these initiatives, such as prototyping expense and non-recurring engineering charges associated with the development of new products and technologies.

Sales and Marketing

	Year Ended December 31,
	2009			2008		2007
	(in thousands)
Expenses	$	70,000		$	82,348	$	77,741
% of total revenue		35%			38%		39%
Year over year change in dollars		(12,348	)		4,607
Year over year change in percent		(15%)			6%

Sales and marketing expenses primarily consist of personnel costs, including commissions, costs associated with the development of our business and corporate identification, costs related to customer support, travel, tradeshows, promotional and advertising costs, and related facilities costs.

During 2009, the decrease in sales and marketing expenses compared to the same period in 2008 is primarily due to (1) a decrease in personnel costs, including salaries, contract labor, and other related employee benefits, of approximately $5.9 million; (2) a decrease in share-based compensation expense related to employee stock options and rights granted under the ESPP of approximately $0.5 million; (3) a decrease of $1.4 million in travel related costs; (4) a decrease in marketing program, advertising, channel marketing and promotional costs of approximately $4.0 million; and (5) a decrease of approximately $0.3 million in expenses associated with our sales and marketing facilities including rent, maintenance costs, telephone, and internet connectivity.

During 2008, the increase in sales and marketing expenses compared to the same period in 2007 is primarily due to (1) increased personnel costs, including commissions, contract labor, and other related employee benefits, of approximately $3.7 million resulting from the acquisition of Aventail and the “in-sourcing” of our technical support services; (2) an increase of approximately $3.9 million in expenses associated with our sales and marketing facilities including rent, maintenance costs, telephone, and internet connectivity primarily due to the “in-sourcing” of our technical support services; and (3) an increase of approximately $0.3 million in travel related expenses. These increases in sales and marketing expenses were partially offset by (1) a decrease in marketing program, advertising, channel marketing and promotional costs of approximately $2.2 million; and (2) a decrease in the cost of share-based compensation expense related to employee stock options and rights granted under the ESPP of approximately $1.0 million.

We expect to direct our sales and marketing expenses toward the expansion of domestic and international markets, introduction of new products and establishment and expansion of new distribution channels.

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General and Administrative

	Year Ended December 31,
	2009			2008			2007
	(in thousands)
Expenses	$	17,134		$	18,613		$	21,473
% of total revenue		9%			9%			11%
Year over year change in dollars		(1,479	)		(2,860	)
Year over year change in percent		(8%)			(13%)

General and administrative expenses consist primarily of personnel costs, business insurance, corporate governance costs, professional fees, travel expense, and related facilities costs.

During 2009, the decrease in G&A expenses was primarily related to (1) a decrease in share-based compensation expense related to employee stock options and rights granted under the ESPP of approximately $0.4 million; (2) a decrease of approximately $0.2 million in personnel costs; (3) a decrease in accounting related expenses of approximately $0.7 million; (4) a decrease in bad debt expenses of approximately $0.2 million; and (5) a decrease of approximately $0.1 million in office supplies expenses. These decreases were partially offset by an increase in litigation related expenses of approximately $0.4 million.

During 2008, the decrease in G&A expenses was primarily related to (1) a decrease in personnel costs of approximately $1.2 million primarily due to decreased performance based bonus expenses; (2) a decrease in share-based compensation expense related to employee stock options and rights granted under the ESPP of approximately $1 million; (3) a decrease of approximately $0.4 million in allocated facilities expenses including rent, maintenance costs, depreciation, telephone, and internet connectivity; (4) a decrease in litigation related expenses of approximately $0.3 million; and (5) a decrease of approximately $0.1 million in travel related expenses.

We believe that general and administrative expenses will increase in absolute dollars and remain relatively stable as a percentage of total revenue as we incur costs related to corporate governance matters and the pursuit of various corporate opportunities.

Amortization of Purchased Intangible Assets Included in Operating Expenses

	Year Ended December 31,
	2009			2008		2007
	(in thousands)
Expenses	$	1,095		$	1,114	$	715
% of total revenue		0.5%			0.5%		0.4%
Year over year change in dollars		(19	)		399
Year over year change in percent		(2%)			56%

Amortization of purchased intangibles included in operating expenses represents the amortization of assets arising from contractual or other legal rights acquired in business combinations and excludes for amortization of acquired developed technology which is included in cost of revenue. Purchased intangible assets are being amortized over their estimated useful lives of three to eight years.

The reduction in amortization expense included in operating expenses in 2009 compared to 2008 was the result of the completion of the amortization of certain intangibles associated with the acquisition of MailFrontier.

The increase in amortization expense included in operating expense in 2008 compared to 2007 was the result of an increase in the amortization of intangibles associated with the acquisition of Aventail. This increase was partially offset by a decrease in the amortization of intangibles associated with the acquisition of MailFrontier.

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Future amortization to be included in operating expenses based on current balance of purchased intangibles absent any additional investment is as follows (in thousands):

Fiscal Year	Amortization Amount to Operating Expenses
2010	$	1,095
2011		1,095
2012		1,008
2013		990
2014		990
Thereafter		495
Total	$	5,673

Restructuring Charges

	Year Ended December 31,
	2009			2008		2007
	(in thousands)
Expenses	$	-		$	1,683	$	-
% of total revenue		-			0.8%		-
Year over year change in dollars		(1,683	)		1,683
Year over year change in percent		(100%)			100%

During the first quarter of fiscal year 2008, the Company commenced the 2008 restructuring plan associated primarily with the relocation of support activities, the closure of facilities in Pune, India and Sunnyvale, California, and other employee reductions for the purpose of better integration and alignment of Company functions. The Company recorded $1.0 million in restructuring expenses related to costs associated with the termination of 21 employees across multiple geographic regions and functions, primarily related to severance, benefits and related costs. Furthermore, the Company recorded additional restructuring costs of $0.8 million in connection with facilities and property and equipment that was disposed of or removed from service. At December 31, 2008, the Company’s restructuring accrual was $72,000 and included as a component of “Other accrued liabilities” in the Company’s Condensed Consolidated Balance Sheets. As of December 31, 2009, the Company has no remaining liability relating to the restructuring activities.

In-Process Research and Development

	Year Ended December 31,
	2009		2008			2007
	(in thousands)
Expenses	$	-	$	-		$	1,930
% of total revenue		-		-			1.0%
Year over year change in dollars		-		(1,930	)
Year over year change in percent		-		(100%)

Our methodology for allocating the purchase price for purchase acquisitions to in-process research and development (“IPR&D”) is determined through established valuation techniques and analysis, as applied in the high-technology internet security industry.

The IPR&D expense in 2007, which is related to the acquisition of Aventail, was primarily for the development of Aventail’s next generation product. This IPR&D was expensed upon the acquisition of Aventail because technological feasibility had not been established and no future alternative uses existed. Total IPR&D expense of $1.9 million was charged to product development expenses on the date the assets were acquired.

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The fair value of the existing purchased technology, as well as the technology under development, is determined using the income approach, which discounts expected future cash flows to present value. The discount rate used in the present value calculation was derived from a weighted average cost of capital analysis. We consider this pricing model for acquired products and technology to be standard within the high-technology internet security industry. We do not expect to achieve a material amount of expense reductions as a result of integrating the acquired in-process technology. Therefore, the valuation assumptions do not include significant anticipated cost savings.

The key assumptions underlying the valuation of our 2007 Aventail purchase acquisition for which in-process research and development was recorded were as follows: (1) estimated cost to complete technology at time of acquisition was approximately $1.3 million; and (2) risk adjusted discount rate of 22%. Other key assumptions include an expected completion date of approximately one year and revenue and expense projections, assuming that the product has entered the market.

Interest Income and Other Expense, Net

Interest income and other expense (net) were $3.2 million, $6.4 million, and $11.8 million in the years ended December 31, 2009, 2008 and 2007, respectively, and primarily consists of interest income on our cash, cash equivalents, and investments. The fluctuations in the short-term interest rates directly influence the interest income we recognize. The decrease in 2009 as compared to 2008 was caused by lower investment yields. The decrease in 2008 as compared to 2007 was caused by a combination of a significantly lower overall balance in our investment portfolio due to our share repurchase program and lower investment yields.

Benefit (Provision) for Income Taxes

	Year Ended December 31,
	2009			2008			2007
	(in thousands)
Benefit (provision) for income taxes	$	(6,586	)	$	(5,571	)	$	17,601
% of income before taxes		(33%)			(53%)			160%
% of total revenue		(3%)			(3%)			9%
Year over year change in dollars		(1,015	)		(23,172	)
Year over year change in percent		18%			(132%)

The effective tax rate was 33%, 53%, and (160%) in fiscal years 2009, 2008 and 2007, respectively.

Our effective tax rate differs from the statutory federal and state tax rates for the fiscal year ended December 31, 2009 primarily due to the tax benefit from the partial release of the valuation allowance, other non-deductible book/tax differences, state income taxes which were offset by state research and development credits, and the effect of share-based compensation expense related to incentive stock options and ESPP.

Our effective tax rate differs from the statutory federal and state tax rates for the fiscal year ended December 31, 2008 primarily due to non-deductible share-based compensation expense and state income taxes which were offset by state research and development tax credits.

In 2007, we released a substantial portion of our valuation allowance considering all available evidence. The available positive evidence at December 31, 2007, included three years of cumulative historical operating profits, a projection of future income sufficient to realize most of the remaining deferred tax assets, and other evidence. The Company recorded a partial valuation allowance release of $23.5 million in fiscal year 2007, because as of December 31, 2007, it was considered more likely than not that the Company’s deferred tax assets would be realized with the exception of certain acquired net operating losses due to the annual “change in ownership” limitation by the Internal Revenue Code of 1986, as amended.

Changes in tax laws and rates could also affect recorded deferred tax assets and liabilities in the future. Management is not aware of any such changes that would have a material effect on the Company’s results of operations, cash flows or financial position.

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Quarterly Results of Operations

The following table sets forth our unaudited quarterly results of operations, in dollars for the eight quarters ended December 31, 2009. You should read the following table in conjunction with the financial statements and related notes contained elsewhere in this Form 10-K. We have prepared this unaudited information on the same basis as our audited financial statements. This table includes all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the quarters presented. You should not draw any conclusions about our future results from the results of operations for any quarter.

	Year Ended December 31, 2009												Year Ended December 31, 2008
		Q4			Q3			Q2			Q1			Q4			Q3			Q2			Q1
	(in thousands, except per share data)
Revenue:
Product	$	22,628		$	19,248		$	16,507		$	15,464		$	21,867		$	21,439		$	23,810		$	23,741
License and service		31,519			31,471			32,054			31,684			32,389			31,839			31,989			31,570
Total revenue		54,147			50,719			48,561			47,148			54,256			53,278			55,799			55,311
Cost of revenue:
Product		11,917			9,916			8,948			8,257			11,028			10,627			10,811			11,041
License and service		4,079			3,733			3,905			4,140			4,689			5,150			5,441			4,822
Amortization of purchased technology		755			754			754			754			755			754			754			754
Total cost of revenue		16,751			14,403			13,607			13,151			16,472			16,531			17,006			16,617
Gross profit		37,396			36,316			34,954			33,997			37,784			36,747			38,793			38,694
Operating expenses:
Research and development		9,705			9,416			8,910			9,827			9,807			11,411			11,414			11,544
Sales and marketing		18,002			17,357			17,399			17,242			18,395			19,472			21,756			22,725
General and administrative		4,546			4,406			3,935			4,247			4,479			3,957			5,032			5,145
Amortization of purchased intangible assets		273			274			274			274			273			274			274			293
Restructuring charges (reversal)		-			-			-			-			-			(87	)		(35	)		1,805
Total operating expenses		32,526			31,453			30,518			31,590			32,954			35,027			38,441			41,512
Income (loss) from operations		4,870			4,863			4,436			2,407			4,830			1,720			352			(2,818	)
Interest income and other expense, net		787			573			1,013			791			1,041			1,122			1,585			2,620
Income (loss) before income taxes		5,657			5,436			5,449			3,198			5,871			2,842			1,937			(198	)
Benefit (provision) for income taxes		(698	)		(2,396	)		(2,037	)		(1,455	)		(2,418	)		(2,273	)		(1,012	)		132
Net income (loss)	$	4,959		$	3,040		$	3,412		$	1,743		$	3,453		$	569		$	925		$	(66	)
Net income (loss) per share:
Basic	$	0.09		$	0.06		$	0.06		$	0.03		$	0.06		$	0.01		$	0.02		$	(0.00	)
Diluted	$	0.09		$	0.05		$	0.06		$	0.03		$	0.06		$	0.01		$	0.02		$	(0.00	)
Shares used in computing net income (loss) per share:
Basic		54,236			53,946			53,816			53,654			53,575			53,412			56,356			60,988
Diluted		56,888			56,012			55,033			54,537			54,459			54,928			58,605			60,988

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Liquidity and Capital Resources

We ended December 31, 2009 with $200.2 million in cash, cash equivalents, and short-term investments, consisting principally of corporate bonds, U.S. government securities, auction rate securities, and money market funds, an increase of $94.7 million as compared to prior year ending balance. Our primary source of cash is receipts from sales of our products, license and services, and issuance of common stock under employee stock option and purchase plans. The primary uses of cash during 2009 are related to payments for the production of our products, payroll (salaries and related benefits), and general operating expenses (marketing, travel, office rent).

Operating Activities

Cash provided by operating activities for fiscal 2009 totaled $35.8 million, a $16.6 million increase in comparison to the prior year. Cash provided by operating activities was primarily the result of the net income of $13.2 million adjusted by non-cash items such as share-based compensation expense of $9.2 million, depreciation and amortization expense of $9.1 million, income tax benefit from the exercise of employee stock options of $7.8 million, deferred income taxes of $5.4 million, and changes in our operating assets and liabilities of $17.9 million. The main drivers of the changes in operating assets and liabilities are as follows:

Accounts receivable increased due to the timing of collections. Our DSO in accounts receivable was 41 days at December 31, 2009 compared to 34 days at December 31, 2008. The increase in DSO at December 31, 2009 as compared to December 31, 2008 was primarily due to the timing of shipments and billings combined with certain customers electing to forgo early payment discounts. Collection of accounts receivable and related DSO will continue to fluctuate in future periods due to the timing and amount of our future shipments and billings, the payment terms that we extend to our customers, and the effectiveness of our collection efforts.

§	The decrease in inventories was primarily related to a reduction in inventory in transit related to a change in terms on purchased inventory from FOB shipping point to FOB destination in 2009.

The increase in prepaid expenses and other current assets was primarily due to (1) an increase in our deferred compensation asset primarily driven by participant activities, and (2) an increase in the amount of deferred cost of goods sold associated with products shipped on deferred revenue arrangements.

§	The decrease in accounts payable is primarily due to a decrease in the payables from our operating expenses and the timing of payments to vendors.

The increase in accrued payroll and related benefits was primarily attributed to (1) an increase in the accrual related to our deferred compensation plan, and (2) an increase in amount accrued under payroll, bonuses, commissions, and payroll taxes payable, offset by a decrease in our vacation accrual.

§	Deferred revenue increased primarily because of increased sales of subscription services for multi-year periods as well as an increase related to shipments to distributors whereby revenue is recognized on a sell-through basis.

§	The increase in other accrued liabilities was primarily due to an increase in accrued taxes offset by one final settlement of the restricted cash in escrow in connection with the acquisition of Aventail.

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Cash provided by operating activities for fiscal 2008 totaled $19.2 million, a $42.9 million decrease in comparison to the prior year. Cash provided by operating activities was primarily the result of the net income of $4.9 million adjusted by non-cash items such as share-based compensation expense of $10.6 million, depreciation and amortization expense of $8.9 million, income tax benefit from the exercise of employee stock options of $3.6 million, deferred income taxes of $355,000, adjustment to goodwill of $283,000, and changes in our operating assets and liabilities of $1.7 million. The main drivers of the changes in operating assets and liabilities are as follows:

Accounts receivable decreased due to the timing of collections. Our DSO in accounts receivable was 34 days at December 31, 2008 compared to 42 days at December 31, 2007. The decrease in DSO at December 31, 2008 as compared to December 31, 2007 was primarily due to the timing of shipments and billings, combined with certain customers taking advantage of early payment discounts.

§	The increase in inventories was primarily related to the expansion of our product line with the release of E-Class NSA and NSA UTM products.

The decrease in prepaid expenses and other current assets was primarily due to (1) a decrease in our deferred compensation asset primarily driven by participant activities, and (2) a decrease in the amount of deferred cost of goods sold associated with products shipped on deferred revenue arrangements.

§	The decrease in accounts payable is primarily due to a decrease in the payables related to cost of goods sold and partially offset by an increase in the payables from our operating expenses.

The decrease in accrued payroll and related benefits was primarily attributed to (1) a decrease in the accrual related to our deferred compensation plan, (2) a decrease in amount accrued under payroll, commissions, and payroll taxes payable, (3) a decrease in our ESPP withholding, and (4) a decrease in our vacation accrual.

§	Deferred revenue increased due to increased sales of subscription services as well as an increase related to shipments to distributors whereby revenue is recognized on a sell-through basis.

§	The decrease in other accrued liabilities was primarily due to one final settlement of the restricted cash in escrow in connection with the acquisition of MailFrontier.

Cash provided by operating activities for fiscal 2007 totaled $63.7 million, a $30.1 million increase in comparison to the prior year. Cash provided by operating activities was primarily the result of the net income of $28.6 million adjusted by non-cash items such as deferred income taxes of ($27.5) million, share-based compensation expense of $13.5 million, adjustment to goodwill of $7.1 million, depreciation and amortization expense of $6.0 million, in-process research and development expense of $1.9 million, income tax benefit from the exercise of employee stock options of $1.5 million, and changes in our operating assets and liabilities of $34.2 million. The main drivers of the changes in operating assets and liabilities are as follows:

Accounts receivable decreased due to the timing of collections. Our DSO in accounts receivable was 42 days at December 31, 2007 compared to 45 days at December 31, 2006. The decrease in DSO at December 31, 2007 as compared to December 31, 2006 was primarily due to the timing of shipments and billings, combined with an increase in revenue.

The increase in prepaid expenses and other current assets was primarily due to (1) an increase in our deferred compensation asset primarily from participant contributions, and (2) an increase in the amount of deferred cost of goods sold associated with products shipped on deferred revenue arrangements.

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§	The increase in accounts payable is primarily due to an increase in the level of cost of goods sold and operating expenses and the timing of payments to our vendors.

§	The increase in accrued payroll and related benefits was primarily attributed to (1) an increase in the accrual related to our deferred compensation plan, (2) an increase in amount accrued under payroll, commissions, and payroll taxes payable, and (3) an increase in our vacation accrual.

Deferred revenue increased due to increased sales of subscription services as well as an increase related to shipments to distributors whereby revenue is recognized on a sell-through basis. In addition, as of December 31, 2007 there was approximately $3.7 million remaining in deferred revenue derived through the acquisition of Aventail.

§	The decrease in other accrued liabilities was primarily due to final settlement of the restricted cash in escrow in connection with the acquisition of MailFrontier.

In addition, our operating cash flows may be impacted in the future as a result of a number of factors, including fluctuations in our operating results, accounts receivable collections, inventory management, expensing stock options, and the timing and amount of income tax and the timing of payments to our vendors for accounts payable. For additional discussion, see the section entitled “Risk Factors” in this Form 10-K.

Investing Activities

Net cash used in investing activities in 2009 was $52.9 million, principally as a result of (1) the net purchase of $52.7 million in investments, (2) the purchase of $5.3 million in property and equipment, and (3) a net decrease in restricted cash in escrow of $5.1 million primarily due to the final payment of amounts held in escrow in connection with the Aventail acquisition.

Net cash provided by investing activities in 2008 was $63.1 million, principally as a result of (1) the net sale and maturity of $66.7 million in investments, (2) a net decrease in restricted cash in escrow of $1.4 million primarily due to the final settlement of the MailFrontier escrow, and (3) the purchase of $5.0 million in property and equipment.

Net cash used in investing activities in 2007 was $23.4 million, principally as a result of (1) the acquisition of Aventail Corporation for $25.3 million, net of cash acquired, (2) the net sale and maturity of $12.5 million in short-term investments, (3) the purchase of $7.5 million in property and equipment and $1.8 million in intangible assets related to a license agreement for certain intellectual property, and (4) a net increase in restricted cash in escrow of $1.4 million primarily due to the final settlement of the MailFrontier escrow, partially offset by the creation of a new escrow related to the Aventail acquisition.

Financing Activities

Net cash provided by financing activities in 2009 was $11.0 million due to (1) $3.1 million provided by common stock issuances through employee stock option exercises or purchase of shares under the employee stock purchase plan, and (2) $7.8 million provided by income tax benefit from the exercise of employee stock options.

Net cash used in financing activities in 2008 was $70.5 million, of which $79.4 million was used to repurchase common stock under the Company’s stock repurchase program, partially offset by (1) $5.3 million provided by common stock issuances through employee stock option exercises or purchase of shares under the employee stock purchase plan; and (2) $3.6 million provided by income tax benefit from the exercise of employee stock options.

Net cash used in financing activities in 2007 was $32.9 million, of which $49.9 million was used to repurchase common stock under the Company’s stock repurchase program, partially offset by (1) $17.0 million provided by common stock issuances through employee stock option exercises or purchase of shares under the employee stock purchase plan; and (2) $1.5 million provided by income tax benefit from the exercise of employee stock options.

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Liquidity and Capital Resource Requirements

We believe our existing cash, cash equivalents, and short-term investments will be sufficient to meet our cash requirements at least through the next twelve months. However, we could elect to seek additional funding prior to that time. Our future capital requirements will depend on many factors, including our rate of revenue growth, the timing and extent of spending to support product development efforts and expansion of sales, marketing, and support operations, the timing of introductions of new products and enhancements to existing products, market acceptance of our products, and pursuit of corporate opportunities. We cannot assure you that additional equity or debt financing will be available on acceptable terms or at all. Our sources of liquidity beyond twelve months, in management’s opinion, will be our then current cash balances, funds from operations and whatever long-term credit facilities we can arrange. We have no agreements or arrangements with third parties to provide us with sources of liquidity and capital resources beyond twelve months. We believe that future liquidity and capital resources will not be materially affected in the event we are not able to prevail in litigation for which we have been named a defendant as described in Note 11 of the Consolidated Financial Statements.

Off-Balance Sheet Arrangements

As of December 31, 2009, we did not have any significant off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

Contractual Obligations

We do not have any debt, long-term obligations, or long-term capital commitments. The following summarizes our principal contractual commitments as of December 31, 2009 (in thousands):

			Payments Due by Period
			Less Than		1 to 3		3 to 5
	Total		One Year		Years		Years		Thereafter
Operating lease obligations	$	15,323	$	4,265	$	6,888	$	3,764	$	406
Non-cancelable purchase obligations	$	17,273	$	17,273	$	-	$	-	$	-

We outsource our manufacturing function to third party contract manufacturers and at December 31, 2009 we have purchase obligations totaling $19.6 million. Of this amount, $16.7 million cannot be cancelled and is payable within one year. We are contingently liable for any inventory owned by a contract manufacturer that becomes excess and obsolete. As of December 31, 2009, $21,000 had been accrued for excess and obsolete inventory held by our contract manufacturers. In addition, as of December 31, 2009 in the normal course of business, we had $0.6 million in non-cancelable purchase commitments.

Stock Repurchase Program

In November 2004, the Company’s Board of Directors authorized a stock repurchase program to reacquire up to $50 million of common stock. The term of the stock repurchase plan was set at twelve (12) months from the date of authorization. In February 2005, the Company’s Board of Directors increased the amount authorized for repurchase from $50 million to $75 million, extended the term of the program from twelve (12) to twenty-four (24) months following the date of original authorization and increased certain predetermined pricing formulas. In April 2005, the Company’s Board of Directors authorized a modification to the stock repurchase program to delete certain elements that provided for systematic repurchases.

In February 2006, the Company’s Board of Directors approved an increase in the amount authorized for repurchase under the Company’s share repurchase program from $75.0 million to $100.0 million and extended the term of the program from twenty-four (24) months to thirty-six (36) months following the date of original authorization.

On July 24, 2007, the Company’s Board of Directors approved a follow-on program for the repurchase of the Company’s common stock. The authorization under the follow-on share repurchase program was $100 million plus approximately $19.6 million remaining under the share repurchase program originally authorized by the Company’s Board of Directors in November 2004. The term of the follow-on program was one year from the date of approval. As of September 30, 2008, the Company had completed the Stock Repurchase Plan and repurchased and retired 25.9 million shares of our common stock at an average price of $7.73 per share for an aggregate purchase price of $200.0 million. There was no stock repurchase activity in 2009.

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Recent Accounting Pronouncements

The information contained in Note 2 to the Consolidated Financial Statements under the heading recent accounting pronouncements is hereby incorporated by reference into this Part II, Item 7.

ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates primarily to our cash, cash equivalents, and investment portfolio. We classified our investments as available-for-sale except the auction rate securities in one of our investment firms. Refer to Note 4 of the Consolidated Financial Statements for further detailed discussion. The available-for-sale investments are recorded on the balance sheet at the fair value with unrealized gains and losses reported as a separate component of accumulated other comprehensive income (loss), net of tax. As of December 31, 2009, our cash, cash equivalents and investment portfolio included money-markets securities, corporate bonds, municipal bonds, auction rate securities, asset backed securities, and commercial papers which are generally subject to no interest rate risk when held to maturity, but may increase or decrease in value if interest rates change prior to maturity. A hypothetical 100 basis point change in the floating interest rates applicable to the December 31, 2009 balance would result in a change in annual interest income of approximately $2.2 million.

Fixed-rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating-rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if we are forced to sell securities which have declined in market value due to changes in interest rates.

As stated in our investment policy, we are adverse to principal loss and further the goal of preservation of our invested funds by limiting default and market risk. We mitigate default risk by investing in only investment-grade instruments. As of December 31, 2009, we do not have any derivative financial instruments in our investment portfolio.

Principal amounts by expected year of maturity in U.S. dollars as of December 31, 2009 are as follows (in thousands, except percentages):

	Maturing in
	2010		2011		2012		2013		2014		Thereafter		Total		Fair Value
Corporate debt securities	$	38,104	$	21,003	$	-	$	-	$	-	$	-	$	59,107	$	59,648
Weighted average interest rate		1.6%		2.2%		-		-		-		-		1.8%
U.S. government securities		37,422		17,535		-		-		-		-		54,957		55,004
Weighted average interest rate		1.0%		0.7%		-		-		-		-		0.9%
Local government securities		1,003		-		-		-		-		-		1,003		1,004
Weighted average interest rate		0.7%		-		-		-		-		-		0.7%
Asset backed securities		-		123		-		219		58		19,691		20,091		16,470
Weighted average interest rate		-		5.7%		-		6.4%		5.2%		5.3%		5.3%
Auction rate securities		41,975		-		-		-		-		10,000		51,975		43,823
Weighted average interest rate		1.7%		-		-		-		-		3.3%		2.0%
Total marketable securities	$	118,504	$	38,661	$	-	$	219	$	58	$	29,691	$	187,133	$	175,949

At December 31, 2009, included within our investment portfolio are $52.0 million of investments in auction rate securities and $20.1 million of assets backed securities. The information contained in Note 4 to the Consolidated Financial Statements is hereby incorporated by reference.

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Foreign Currency Risk

We consider our exposure to foreign currency exchange rate fluctuations in general to be moderate. We invoice substantially all of our foreign customers from the United States in U.S. dollars and substantially all revenue is collected in U.S. dollars. For the year ended December 31, 2009, we earned approximately 33% of our revenue from international markets. We may, in the future, denominate these transactions in various local currencies. Because our sales are currently denominated in U.S. dollars, the weakness of a foreign country’s currency against the dollar could increase the price of our products in such country and reduce our product unit sales by making our products more expensive in the local currency. A weakened dollar could increase the cost of local operating expenses and procurement of raw materials to the extent we must purchase components in foreign currencies. As our base of international operations expands, a greater percentage of our employee base will be paid in local currency. As a result, our operating results may become subject to significant fluctuations based upon changes in the exchange rates of some currencies in relation to the U.S. dollar and diverging economic conditions in foreign markets in which we do business. We do not enter into forward exchange contracts to hedge exposures denominated in foreign currencies and do not use derivative financial instruments for trading or speculative purposes.

As our business model changes to include greater international participation, our exposure to foreign currency risk increases. We will continue to monitor our exposure to currency transactions. We cannot, however, assure you that exchange rate fluctuations will not adversely affect our financial results in the future.

Financial Market Risk

Included within our investment portfolio at December 31, 2009 were ARS that we purchased for $52.0 million whose underlying assets are primarily student loans which are substantially backed by the federal government and ABS that were purchased for $20.1 million whose underlying assets are all prime mortgages of which approximately 37% are backed by the federal government. In 2008, we accepted an offer from one of our investment banks under which the bank would purchase over 80% of our ARS at par anytime during a two-year period beginning June 30, 2010. In the event the liquidity of our investment bank is adversely impacted by the current uncertainties in the financial market, they may be unable to pay us when their payment option comes due. We may not be able to access these funds until our investment bank is able to pay us the offered amount, future auctions for the ARS in our portfolio are successful or until we sell the securities in a secondary market which currently is volatile. As of December 31, 2009, $42.0 million ARS from one investment firm continues to be classified as current investment due to the offer described above. The remaining $10.0 million ARS from another investment firm and non-government backed ABS investments currently lack short term liquidity and therefore remain classified as non-current on our December 31, 2009 balance sheet. We will continue to evaluate any changes in the market for ARS and ABS. Depending upon future market conditions, we may be required to record an other-than-temporary decline in market value. In such an event, the Company’s financial condition, cash flow and reported earnings could be negatively affected.

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ITEM 8. Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE

	Page
Report of Independent Registered Public Accounting Firm	58
Consolidated Balance Sheets	59
Consolidated Statements of Operations	60
Consolidated Statements of Shareholders’ Equity	61
Consolidated Statements of Cash Flows	62
Notes to Consolidated Financial Statements	63
Financial Statement Schedule – Valuation and Qualifying Accounts	103

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REPORT OF ARMANINO McKENNA LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders, SonicWALL, Inc.

We have audited the accompanying balance sheets of SonicWALL, Inc. and subsidiaries (“the Company”) as of December 31, 2009 and 2008, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2009. We also have audited the Company’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Our audits also included the financial statement schedule listed in the Index at Part IV, Item 15. The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control Over Financial Reporting, appearing under Item 9A. Our responsibility is to express an opinion on these financial statements and schedule and an opinion on the company’s internal control over financial reporting based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the consolidated financial statements and schedule referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2009 and 2008, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by COSO.

/s/ ARMANINO McKENNA LLP

San Ramon, California

March 5, 2010

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SONICWALL, INC.

CONSOLIDATED BALANCE SHEETS

	December 31,
	2009			2008
	(In thousands, except share data)
ASSETS
Current Assets:
Cash and cash equivalents	$	39,071		$	45,127
Short-term investments		161,079			60,327
Accounts receivable, net of allowance for doubtful accounts of
$86 and $113 in 2009 and 2008, respectively		24,909			20,945
Inventories, net		6,814			8,956
Deferred tax assets		12,937			9,300	(1)
Prepaid expenses and other current assets		8,071			11,861
Total current assets		252,881			156,516

Property and equipment, net		9,819			9,543
Goodwill		138,470			138,470
Long-term investments		15,746			61,450
Deferred tax assets, non-current		23,082			22,143	(1)
Purchased intangibles and other assets, net		13,309			17,328
Total assets	$	453,307		$	405,450

LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable	$	5,393		$	10,717
Accrued payroll and related benefits		13,457			11,554
Other accrued liabilities		6,270			10,307
Deferred revenue		99,252			88,415
Total current liabilities		124,372			120,993

Deferred revenue, non-current		24,920			15,072
Total liabilities		149,292			136,065

Commitments and contingencies (Note 11)

Shareholders' Equity:
Common stock, no par value; 200,000,000 shares authorized; 54,311,926 and
53,575,371 shares issued and outstanding in 2009 and 2008, respectively		416,388			396,223
Accumulated other comprehensive loss		(4,284	)		(5,595	)(1)
Accumulated deficit		(108,089	)		(121,243	)
Total shareholders' equity		304,015			269,385
Total liabilities and shareholders' equity	$	453,307		$	405,450

(1) As restated. See Note 5 for restatement details.

The accompanying notes are an integral part of these consolidated financial statements.

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SONICWALL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

	Year Ended December 31,
	2009			2008			2007
	(In thousands, except per share data)

Revenue:
Product	$	73,847		$	90,857		$	98,936
License and service		126,728			127,787			100,263
Total revenue		200,575			218,644			199,199
Cost of revenue:
Product		39,038			43,507			40,555
License and service		15,857			20,102			15,894
Amortization of purchased technology		3,017			3,017			2,232
Total cost of revenue		57,912			66,626			58,681
Gross profit		142,663			152,018			140,518
Operating expenses:
Research and development		37,858			44,176			39,410
Sales and marketing		70,000			82,348			77,741
General and administrative		17,134			18,613			21,473
Amortization of purchased intangible assets		1,095			1,114			715
Restructuring charges		-			1,683			-
In-process research and development		-			-			1,930
Total operating expenses		126,087			147,934			141,269
Income (loss) from operations		16,576			4,084			(751	)
Interest income and other expense, net		3,164			6,368			11,771
Income before income taxes		19,740			10,452			11,020
Benefit (provision) for income taxes		(6,586	)		(5,571	)		17,601
Net income	$	13,154		$	4,881		$	28,621
Net income per share:
Basic	$	0.24		$	0.09		$	0.45
Diluted	$	0.24		$	0.08		$	0.43
Shares used in computing net income per share:
Basic		53,914			56,069			64,305
Diluted		55,568			57,897			67,099

The accompanying notes are an integral part of these consolidated financial statements.

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SONICWALL, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(In thousands, except for share data)

	Common Stock
	Shares			Amount			Accumulated Other Comprehensive Loss				Accumulated Deficit			Total Shareholders' Equity
BALANCE AT DECEMBER 31, 2006		65,385,629			453,409			(718	)	(1)		(134,233	)		318,458
Issuance of common stock upon exercise of stock options		2,269,940			14,305										14,305
Issuance of common stock in connection with the Employee Stock Purchase Plan (ESPP)		378,908			2,730										2,730
Share-based compensation					13,542										13,542
Repurchase of common stock		(5,556,887	)		(39,085	)						(10,831	)		(49,916	)
Excess tax benefit from share-based compensation					1,530										1,530
Comprehensive income:
Change in unrealized loss on investment securities, net of tax								(652	)	(1)					(652	)
Net income												28,621			28,621
Total comprehensive income															27,969
BALANCE AT DECEMBER 31, 2007		62,477,590			446,431			(1,370	)			(116,443	)		328,618

Issuance of common stock upon exercise of stock options		446,923			2,878										2,878
Issuance of common stock in connection with ESPP		376,728			2,428										2,428
Share-based compensation					10,617										10,617
Repurchase of common stock		(9,725,870	)		(69,727	)						(9,681	)		(79,408	)
Excess tax benefit from share-based compensation					3,596										3,596
Comprehensive loss:
Change in unrealized loss on investment securities, net of tax								(4,225	)	(1)					(4,225	)
Net income												4,881			4,881
Total comprehensive loss															(656	)
BALANCE AT DECEMBER 31, 2008		53,575,371			396,223			(5,595	)			(121,243	)		269,385

Issuance of common stock upon exercise of stock options		362,177			1,737										1,737
Issuance of common stock in connection with ESPP		374,378			1,407										1,407
Share-based compensation					9,186										9,186
Excess tax benefit from share-based compensation					7,835										7,835
Comprehensive income:
Change in unrealized loss on investment securities, net of tax								1,311							1,311
Net income												13,154			13,154
Total comprehensive income															14,465
BALANCE AT DECEMBER 31, 2009		54,311,926		$	416,388		$	(4,284	)		$	(108,089	)	$	304,015

(1) As restated. See Note 5 for restatement details.

The accompanying notes are an integral part of these consolidated financial statements.

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CONSOLIDATED STATEMENTS OF CASH FLOWS

	Year Ended December 31,
	2009			2008			2007
	(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	13,154		$	4,881		$	28,621
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization		9,146			8,939			5,961
Adjustment of goodwill		-			283			7,100
In-process research and development		-			-			1,930
Share-based compensation expense related to employee stock options and ESPP		9,186			10,617			13,542
Excess tax benefits from share-based compensation		(7,835	)		(3,596	)		(1,530	)
Change in fair value of financial instruments		(190	)		210			-
Change in allowance for doubtful accounts and others		(37	)		(24	)		(169	)
Deferred income taxes		(5,440	)		(355	)		(27,474	)
Changes in operating assets and liabilities, net of effects of businesses acquired:
Accounts receivable		(3,937	)		5,374			902
Inventories		2,142			(2,899	)		(606	)
Prepaid expenses and other current assets		(1,314	)		1,283			(1,596	)
Other assets		(91	)		(215	)		28
Accounts payable		(5,324	)		(158	)		3,781
Accrued payroll and related benefits		1,903			(8,833	)		3,366
Other accrued liabilities		3,798			1,477			103
Deferred revenue		20,685			2,249			28,201
Net cash provided by operating activities		35,846			19,233			62,160
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment		(5,299	)		(5,035	)		(7,481	)
Purchase of intangible asset		-			-			(1,800	)
Cash paid for acquisitions, net of cash acquired		-			-			(25,269	)
Change in restricted cash in escrow		5,104			1,375			(1,379	)
Maturity and sale of investments		104,023			183,224			325,747
Purchase of investments		(156,709	)		(116,488	)		(313,230	)
Net cash provided by (used in) investing activities		(52,881	)		63,076			(23,412	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock under employee stock option and purchase plans		3,144			5,306			17,035
Repurchase of common stock		-			(79,408	)		(49,916	)
Excess tax benefits from share-based compensation		7,835			3,596			1,530
Net cash provided by (used in) financing activities		10,979			(70,506	)		(31,351	)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		(6,056	)		11,803			7,397
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		45,127			33,324			25,927
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	39,071		$	45,127		$	33,324

SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for income taxes, net of refunds received	$	2,221		$	1,339		$	1,700

The accompanying notes are an integral part of these consolidated financial statements.

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Note 1—Description of Business

SonicWALL, Inc. (the “Company”) was incorporated in California in February 1991 as Sonic Systems, Inc. The name of the Company was changed to SonicWALL, Inc. in August, 1999. SonicWALL, Inc. designs, develops, and manufactures comprehensive network security, secure remote access, Web and e-mail security, backup and recovery, and policy and management solutions, which enable organizations to maximize network security without compromising network performance.

Note 2—Summary of Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements have been prepared in accordance with Generally Accepted Accounting Principles in the United States of America (U.S. GAAP) and include the accounts of the Company and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The accounting estimates that require management’s most significant and subjective judgments include the valuation of investments, the valuation and recognition of revenue and accounts receivable, the valuation of inventory, the assessment of recoverability of intangible assets and their estimated useful lives, the valuation and recognition of share-based compensation and the recognition and measurement of current and deferred income tax assets and liabilities. Actual results could differ materially from these estimates.

Foreign Currencies

The functional currency for all of the Company’s foreign subsidiaries is the U.S. dollar, and accordingly, the foreign subsidiaries’ assets and liabilities are remeasured into U.S. dollars using exchange rates at the period end or historical exchange rate, as appropriate. The results of operations are remeasured at the average exchange rate during each reporting period. Currency remeasurement gains (losses) for the years ended December 31, 2009, 2008, and 2007 amounted to $(186,000), $(361,000), and $14,000, respectively, and are included in interest income and other expense, net.

Cash and Cash Equivalents

The Company considers all highly liquid investments purchased with an original maturity or remaining maturity at the date of purchase of three months or less to be cash equivalents.

Investments

Available-For-Sale and Trading Investments. The Company’s investments consist of U.S. Treasury and U.S. government agency securities, municipal notes and bonds, auction rate securities (“ARS”), asset backed securities (“ABS”), corporate notes and bonds, commercial paper, and money market funds. The Company designated all investments, except for ARS held by UBS, as available-for-sale and therefore these investments are reported at fair value, with unrealized gains and losses recorded in accumulated other comprehensive loss. During the fourth quarter of fiscal 2008, the Company reclassified ARS held by UBS, one of its investment providers, from available-for-sale to trading securities. Investments that the Company designates as trading securities are reported at fair value, with gains or losses resulting from changes in fair value recognized in earnings. See Note 4 of the Company’s consolidated financial statements for further detailed discussion. For securities sold prior to maturity, the cost of securities sold is based on the specific identification method. Realized gains and losses on the sale of investments are recorded in interest income and other expense, net. Investments that are readily convertible to cash are classified as short-term investments. Investments that are not readily convertible to cash are classified as long-term investments. At December 31, 2009, all ARS except the ARS held by UBS and the non-government backed ABS are classified as long-term investments.

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Fair Value of Financial Instruments

The carrying value of the Company’s financial instruments, including cash and cash equivalents, short-term investments, accounts receivable, and accounts payable, approximates their fair values due to their relatively short maturities. The Company does not hold or issue financial instruments for trading purposes other than the UBS auction rate securities.

Allowance for Doubtful Accounts

Trade accounts receivable is recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is based on the Company’s assessment of the collectability of customer accounts. The Company reviews the allowance monthly by considering factors such as historical experience, type of receivables, credit quality, the age of the accounts receivable balances, and the current economic conditions that may affect a customer’s ability to pay. Account balances are charged off against the allowance when it is probable the receivable will not be recovered.

Concentration of Credit Risk, Foreign Operations, and Significant Customers

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents, investments and accounts receivable. The Company maintains its cash, cash equivalents, and investments with high quality financial institutions and limits its investment in individual securities based on the type and credit quality of each such security. Cash balances held with banks periodically exceed the amount of insurance provided on such balances.

The Company’s customer base consists of international businesses, and the Company performs ongoing credit evaluations of its customers’ financial condition and requires no collateral from its customers. Sales to foreign customers for the years ended December 31, 2009, 2008, and 2007, all of which were denominated in U.S. dollars, accounted for 33%, 34%, and 32% of total revenue, respectively.

Sales through our three largest distributors, Ingram Micro, Tech Data, and Arrow represented the following percentages of total revenue:

	Year Ended December 31,
	2009		2008		2007
Ingram Micro		18%		16%		16%
Tech Data		17%		17%		17%
Arrow		11%		16%		18%

In addition, Ingram Micro, Tech Data, and Arrow represented the following percentages of our accounts receivable balance:

	December 31,
	2009		2008		2007
Ingram Micro		22%		12%		14%
Tech Data		6%		10%		12%
Arrow		4%		13%		4%

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While a reduction in sales by any of these distributors could be offset by an increase in sales to either of the other two distributors or by the addition of other distributors, a material reduction in sales to any of these distributors, would likely result in a temporary decline in overall sales. Uncertainties in the banking system and financial markets may continue to impact the availability of credit. The lowering of the level of liquidity in the credit markets may impact the ability of our distributors to obtain credit to finance purchases of our products and services. If the liquidity of our distributors is adversely impacted by the uncertainties in the financial markets, they may be unable to pay us in a timely manner. If any of the foregoing should occur, our rate of revenue growth will suffer, our revenue may decline and our business will be adversely affected.

The Company outsources its manufacturing to third party contract manufacturers and some of the key components in the Company’s products come from a single or limited number of suppliers. The inability of any supplier or manufacturer to fulfill supply requirements of the Company could materially impact future operating results.

Inventories

Inventories are stated at the lower of standard cost (which approximates cost determined on a first-in, first-out basis) or market. The Company writes down the value of inventories for estimated excess and obsolete inventories based upon assumptions about future demand and market conditions. Inventories consist primarily of finished systems. Inventory reserves, once established, are only reversed upon sale or disposition of related inventories.

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets, which range from three to five years. Leasehold improvements are amortized over the lesser of the related lease term or the estimated useful life of the improvement, which ranges from one to five years. Depreciation and amortization expenses for the years ended December 31, 2009, 2008 and 2007 were $5.0 million, $4.8 million, and $3.0 million, respectively. Gains or losses on disposals are included in the results of operations at amounts equal to the difference between the net book value of the disposed assets and the proceeds received upon disposal. Costs for replacements and betterments are capitalized, while the costs of repairs and maintenance are charged against earnings as incurred.

Purchased Intangibles and Other Long-Lived Assets

Purchased intangibles consist of purchased technology, customer installed base/relationships, customer backlog and other intangibles. Intangible assets are amortized on a straight-line basis over their estimated useful lives which range from 3 months to eight years. Amortization of intangible assets was $4.1 million, $4.1 million, and $2.9 million in fiscal 2009, 2008, and 2007, respectively. The Company periodically evaluates its intangible and other long-lived assets for indications of impairment. If this evaluation indicates that the value of the asset may be impaired, the Company makes an assessment of the recoverability of the net carrying value of the asset over its remaining useful life. If this assessment indicates that the intangible or other long-lived asset is not recoverable, based on the estimated undiscounted future cash flows of the technology over the remaining amortization period, the Company reduces the net carrying value of the related asset to fair value and may adjust the remaining amortization period.

Goodwill and Impairment of Goodwill

Goodwill represents the excess of the aggregate purchase price over the fair market value of the net tangible and intangible assets acquired by the Company. Goodwill is tested for impairment on December 31st of each fiscal year or more often if an event or circumstances indicate that an impairment loss has been incurred. An impairment charge is recognized if a reporting unit’s goodwill carrying amount exceeds its implied fair value. Goodwill impairment is determined using a two-step approach with one or more of the following fair value measures including: present value techniques of estimated future cash flows; or valuation techniques based on multiples of earnings or revenue; or a similar performance measure. Any such impairment charge could be significant and could have a material adverse effect on the Company’s reported financial statements. The goodwill recorded as a result of the business combinations in the years presented is not deductible for tax purposes.

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The Company operates as one reportable segment, which is also the only reporting unit. On December 31, 2009, based on the Public Share Price Methodology, the fair value exceeded the carrying value of the single reporting unit by over 72%. The impairment test on December 31, 2009 indicated that the goodwill was not impaired. The Company also performed the annual assessment on December 31, 2008 and no indication of impairment was noted. Goodwill as of December 31, 2009 was $138 million. There can be no assurances that future goodwill impairments will not occur.

Interest Income and Other Expense, Net

Interest income and other expense, net consist primarily of interest income in the amount of $3.1 million, $7.0 million, and $11.9 million for the years ended December 31, 2009, 2008 and 2007, respectively.

Share-Based Compensation

The Company measures and recognizes the compensation expenses for all share-based payment awards made to employees and directors including employee stock options and employee stock purchases related to the Employee Stock Purchase Plan (“employee stock purchases”) based on the grant date fair value estimated using a Black-Scholes option-pricing model. The Company estimates the forfeiture rate at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Share-based compensation expense recognized in the Consolidated Statements of Operations are based on awards ultimately expected to vest and has been reduced for estimated forfeitures. The value of the portion of the award that is ultimately expected to vest is recognized as expenses using the straight-line single option method over the requisite service periods in the Company’s Consolidated Statements of Operations.

Share-based compensation expenses recognized in the Company’s Consolidated Statements of Operations for the years ended December 31, 2009, 2008, and 2007 included compensation expenses for share-based payment awards granted prior to, but not yet vested as of December 31, 2005 and compensation expenses for the share-based payment awards granted subsequent to December 31, 2005. The grant date fair value for share-based payment awards granted has been estimated using a Black-Scholes option-pricing model.

See Note 12 for additional information on share-based compensation.

Revenue Recognition

The Company derives its revenue primarily from the sale of: (1) products, (2) software licenses, (3) subscriptions for services; and (4) other services such as extended warranty and service contracts, training, consulting and engineering services. As described below, significant management judgments and estimates must be made and used in connection with the revenue recognized in any accounting period. The Company may experience material differences in the amount and timing of its revenue for any period if management makes different judgments or utilizes different estimates.

The Company recognizes revenue for products when persuasive evidence of an arrangement exists, the product has been delivered, title and risk of loss have been transferred to the customer, the fee is fixed or determinable, and collection of the resulting receivable is reasonably assured. While the Company’s sales agreements contain standard terms and conditions, some agreements include non-standard terms and conditions. In these cases, interpretation of non-standard provisions is required to determine the appropriate accounting for the transaction.

Retroactive price protection rights resulting from price reductions on products previously sold to customers are contractually offered to the Company’s channel partners. The Company evaluates the revenue impact of these rights carefully based on stock on hand in the channels and records a provision for estimated future price protection credit. Revenue from certain distributors is not recognized until these distributors sell the product to their customers. As a consequence, there is no provision required for sales to these distributors. In general, retroactive price adjustments are not significant. At December 31, 2009, 2008, and 2007, the Company recorded a provision for price protection on sales to the Company’s channel partners in the amounts of $0, $200,000, and $985,000, respectively.

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Delivery to customers is generally deemed to occur when we deliver the product to a common carrier. Certain distributor agreements provide customers with rights of return for stock rotation. These stock rotation rights are generally limited to 15% to 25% of the distributor's purchases for the immediately prior 3 to 6 months period or contain other measurable restrictions, and we estimate reserves for these return rights as discussed below. Certain distributors have rights of return under certain circumstances that are not limited; therefore, we do not deem delivery to have occurred for any sales to these distributors until they sell the product to their customers.

The Company assesses probability of collection based on a number of factors, including past transaction history with, and the credit-worthiness of, the customer. The Company does not request collateral from its customers. If the Company determines that collection of a fee is not reasonably assured, it defers the fee and recognizes revenue at the time collection becomes reasonably assured, which is generally upon receipt of cash.

For arrangements with multiple obligations (for example, the sale of an appliance which includes a year of maintenance or a subscription based product), the Company allocates revenue first to undelivered components of the arrangement based on the vendor specific objective evidence of fair value of the undelivered elements, which is generally the average selling price of each element when sold separately. This allocation process means that the Company defers revenue from the arrangement equal to the fair value of the undelivered elements and recognizes such amounts as revenue when the elements are delivered.

Sales Returns, Other Allowances, and Warranty Reserve

The preparation of financial statements in accordance with U.S. GAAP requires the Company to make estimates and assumptions that affect the reported amount of assets and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported period. Specifically, the Company must make estimates of potential future product returns and price changes related to current period product revenue. The Company analyzes historical returns, current economic trends, and changes in customer demand and acceptance of its products when evaluating the adequacy of the sales returns and other allowances. Significant management judgments and estimates must be made and used in connection with establishing the sales returns and other allowances in any accounting period. The Company may experience material differences in the amount and timing of its revenue for any period if management makes different judgments or utilizes different estimates.

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The Company’s appliance products are generally covered by a warranty for a one year period. The Company accrues a warranty reserve for estimated costs to provide warranty services, including the cost of technical support, product repairs, and product replacement for units that cannot be repaired. The estimate of costs to fulfill the Company’s warranty obligations is based on historical experience and expectation of future conditions. To the extent the Company experiences increased warranty claim activity or increased costs associated with servicing those claims, its warranty accrual will increase, resulting in decreased gross profit.

Shipping and Handling Costs

The Company records costs related to shipping and handling of products in cost of revenue for all periods presented.

Income Taxes

The Company accounts for income taxes under the liability method, which requires, among other things, that deferred income taxes be provided for temporary differences between the tax basis of the Company’s assets and liabilities and their financial statement reported amounts. Deferred tax assets are recorded for the future benefit of utilizing net operating losses, research and development credit carry forwards and temporary differences. A valuation allowance is provided to reduce deferred tax assets to an amount for which realization is more likely than not. For unrealized losses on debt securities held as available-for-sale, the Company records the tax impact in comprehensive income. Valuation allowances relative to deferred tax assets established for unrealized losses on debt securities held as available-for-sale are evaluated separately from other deferred tax assets. A valuation allowance is not recorded on such deferred tax assets as the company has the intent and ability to hold the underlying debt security until recovery, which may be maturity.

Research and Development and Capitalized Software Development Costs

Software development costs incurred prior to the establishment of technological feasibility are charged to research and development expense as incurred. Technological feasibility is established upon completion of a working model, which is typically demonstrated by initial beta shipment. Software development costs incurred subsequent to the time a product’s technological feasibility has been established, through the time the product is available for general release to customers, are capitalized if material. To date, software development costs incurred subsequent to the establishment of technological feasibility have been immaterial and accordingly have not been capitalized.

Advertising Costs

The Company expenses advertising costs as incurred. Advertising expense totaled $1.2 million, $4.4 million, and $5.8 million for the years ended December 31, 2009, 2008 and 2007, respectively.

The Company has agreements with certain of its distributors to provide marketing development funds. In 2008 and 2007, the Company accounted for such fees as a reduction in revenue, unless there is an identifiable benefit and the fair value of the charges can be reasonably estimated in which case the Company records these transactions as marketing expense. In the years ended December 31, 2008, and 2007, the Company incurred operating expense for marketing development funds of $2.9 million, and $4.1 million, respectively. In 2009, the Company accounts for such funds as a reduction in revenue.

Computation of Net Income Per Share

Basic net income per share is computed by dividing the net income for the period by the weighted average number of common shares outstanding during the period. Weighted average shares exclude shares subject to repurchase (“restricted shares”). Diluted net income per share is computed by dividing the net income for the period by the weighted average number of common and potential dilutive securities outstanding during the period. Potential dilutive securities are composed of incremental common shares issuable upon the exercise of stock options.

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The following table sets forth the computation of basic and diluted net income per share for the periods indicated (in thousands, except per share amounts):

	Year Ended December 31,
	2009		2008		2007
Numerator:
Net income	$	13,154	$	4,881	$	28,621
Denominator:
Weighted average shares used to compute basic EPS		53,914		56,069		64,305
Effect of dilutive securities:
Dilutive common stock equivalents		1,654		1,828		2,794
Weighted average shares used to compute diluted EPS		55,568		57,897		67,099
Net income per share:
Basic	$	0.24	$	0.09	$	0.45
Diluted	$	0.24	$	0.08	$	0.43

For the years ended December 31, 2009, 2008, and 2007, 15,000,856, 13,697,705, and 838,437 stock options with a weighted average exercise price of $8.49, $8.59, and $16.22, respectively, were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares for the period and therefore, the effect would be anti-dilutive.

Recent Accounting Pronouncements

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (“ASU 2010-06”). This standard updates FASB ASC 820, Fair Value Measurements (“ASC 820”). ASU 2010-06 requires additional disclosures about fair value measurements including transfers in and out of Levels 1 and 2 and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurements. It also clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. The standard is effective for interim and annual reporting periods beginning after December 15, 2009 except for the disclosures about purchases, sales, issuances and settlements which is effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The Company adopted ASU 2010-06 on January 1, 2010, which had no material impact on the Company’s consolidated financial statements.

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Note 3—Balance Sheet Components

The following table presents more information related to our balance sheet accounts.

	December 31,
	2009			2008
	(in thousands)
Prepaid expenses and other current assets:
Cash in escrow	$	-		$	5,104
Deferred compensation asset		4,150			3,430
Other prepaid expenses		3,921			3,327
	$	8,071		$	11,861

Property and equipment, net:
Equipment	$	16,465		$	19,787
Office equipment and furniture		4,923			5,371
Leasehold improvements		1,940			2,364
Software		5,330			10,824
		28,658			38,346
Less: accumulated depreciation		(18,839	)		(28,803	)
	$	9,819		$	9,543

Purchased intangibles and other assets, net:
Purchased intangible assets	$	77,650		$	77,650
Other assets		1,264			1,171
		78,914			78,821
Less: accumulated amortization		(65,605	)		(61,493	)
	$	13,309		$	17,328

Other accrued liabilities:
Accrued acquisition costs	$	-		$	5,104
Warranty reserves		537			575
Income taxes payable		2,177			97
Other accrued liabilities		3,556			4,531
	$	6,270		$	10,307

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Note 4—Financial Instruments

Available-for-sale securities

The following is a summary of our available-for-sale securities (in thousands):

As of December 31, 2009	Fair Value		Gross Unrealized Gains		Gross Unrealized (Losses)			Amortized Cost
Corporate debt securities
Auction rate securities	$	6,713	$	-	$	(3,296	)	$	10,009
Asset backed securities		16,470		15		(3,725	)		20,180
Corporate bonds		59,648		68		(75	)		59,655
Total corporate debt securities		82,831		83		(7,096	)		89,844
Local government securities		1,004		-		-			1,004
U.S. government securities		55,004		3		(24	)		55,025
Total available-for-sale securities	$	138,839	$	86	$	(7,120	)	$	145,873

Included in cash equivalent	$	3,999	$	-	$	-		$	3,999
Included in short-term investments		119,094		86		(133	)		119,141
Included in long-term investments		15,746		-		(6,987	)		22,733
Total available-for-sale securities	$	138,839	$	86	$	(7,120	)	$	145,873

As of December 31, 2008	Fair Value		Gross Unrealized Gains		Gross Unrealized (Losses)			Amortized Cost
Corporate debt securities
Auction rate securities	$	6,565	$	-	$	(3,444	)	$	10,009
Asset backed securities		34,905		60		(5,809	)		40,654
Corporate bonds		12,816		26		(5	)		12,795
Total corporate debt securities		54,286		86		(9,258	)		63,458
U.S. government securities		22,336		35		(72	)		22,373
Total available-for-sale securities	$	76,622	$	121	$	(9,330	)	$	85,831

Included in short-term investments	$	60,288	$	116	$	(248	)	$	60,420
Included in long-term investments		16,334		5		(9,082	)		25,411
Total available-for-sale securities	$	76,622	$	121	$	(9,330	)	$	85,831

The estimated fair value and amortized cost of available-for-sale securities by contractual maturity as of December 31, 2009 and 2008 were as follows (in thousands):

	As of December 31, 2009				As of December 31, 2008
	Fair Value		Amortized Cost		Fair Value		Amortized Cost
Due within one year	$	71,793	$	71,754	$	29,320	$	29,265
Due between one and five years		44,280		44,333		6,450		6,502
Due between five and ten years		-		-		1,697		1,687
Due after ten years		22,766		29,786		39,155		48,377
Total available-for-sale securities	$	138,839	$	145,873	$	76,622	$	85,831

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The proceeds and realized gains and losses from sales of available-for-sale securities, and the amount of the net unrealized gains and losses on available-for-sale securities that has been included in other comprehensive income for 2009, 2008, and 2007 were as follows (in thousands):

	Year Ended December 31,
	2009			2008			2007
Proceeds from sales	$	103,783		$	183,296		$	326,660
Realized gains		28			67			-
Realized losses		(2	)		(13	)		-
Net unrealized gains (losses)
included in other comprehensive income	$	2,175		$	(6,925	)	$	(1,087	)

The following tables provide the breakdown of the investments with unrealized losses for which other-than-temporary impairments have not been recognized in earnings at December 31, 2009 and 2008 (in thousands):

December 31, 2009	Unrealized Losses Less Than 12 Months					Unrealized Losses 12 Months or Greater					Total
Available-for-sale securities	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
Corporate debt securities
Auction rate securities	$	-	$	-		$	6,713	$	(3,296	)	$	6,713	$	(3,296	)
Asset backed securities		6,794		(34	)		9,317		(3,692	)		16,111		(3,726	)
Corporate bonds		22,097		(75	)		-		-			22,097		(75	)
Total corporate debt securities		28,891		(109	)		16,030		(6,988	)		44,921		(7,097	)
U.S. government securities		28,636		(23	)		3,354		(1	)		31,990		(24	)
Total marketable securities	$	57,527	$	(132	)	$	19,384	$	(6,989	)	$	76,911	$	(7,121	)

December 31, 2008	Unrealized Losses Less Than 12 Months					Unrealized Losses 12 Months or Greater					Total
Available-for-sale securities	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
Corporate debt securities
Auction rate securities	$	6,565	$	(3,444	)	$	-	$	-		$	6,565	$	(3,444	)
Asset backed securities		-		-			22,230		(5,809	)		22,230		(5,809	)
Corporate bonds		618		(5	)		-		-			618		(5	)
Total corporate debt securities		7,183		(3,449	)		22,230		(5,809	)		29,413		(9,258	)
U.S. government securities		8,232		(72	)		-		-			8,232		(72	)
Total marketable securities	$	15,415	$	(3,521	)	$	22,230	$	(5,809	)	$	37,645	$	(9,330	)

As of December 31, 2009, the Company had 43 investments with unrealized losses for which other-than-temporary impairments have not been recognized in earnings.

In February 2008, auctions began to fail for the ARS. Since auctions for ARS continue to fail, the investments are not currently liquid. The Company does not expect the need to access these funds in the short-term, however, in the event the Company needs to access these funds, they are not expected to be accessible until one of the following occurs: a successful auction occurs, the issuer redeems the issue, a buyer is found outside of the auction process or the underlying securities mature. Based on these factors, along with the underlying maturities of the securities, a portion of which is greater than 20 years, the Company has classified these ARS except the ARS from UBS as long-term assets on its Consolidated Balance Sheet as of December 31, 2009. As of December 31, 2008, the Company classified all ARS as long-term assets in its Consolidated Balance Sheet. The failures of these auctions do not affect the value of the collateral underlying the ARS, and the Company continues to earn and receive interest on its ARS based on a pre-determined formula. The Company intends to

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retain its investment in these ARS until the earlier of anticipated recovery in market value or maturity and as a result has not recorded an other-than-temporary loss on these ARS.

As of December 31, 2009, the Company had $7.4 million in ABS backed by agencies of the U.S. Government. These securities could be generally liquidated within a timeframe of three to nine months and are included in short-term investments on the consolidated balance sheet. For the remaining $9.0 million in non-government backed ABS, the market continues to be illiquid. As a result, the Company has classified these as long-term investments. The Company has both the intent and the ability to hold these investments until a recovery of the fair value occurs, which may be at maturity, evidenced by its cash and short-term investment position and the ability to generate positive cash flows from its operations.

The unrealized losses on U.S. corporate debt and U.S. government agency securities were the result of overall market risk aversion, lack of demand for securities that are not government guaranteed, and the relative widening of credit spreads relative to the U.S. treasuries. The Company believes that it will be able to collect all principal and interest amounts due at maturity given the high credit quality of these investments. Since the decline in the market value is attributable to changes in market conditions and not credit quality, and since the Company has the ability and intent to hold these investments until a recovery of par value, which may be maturity, the Company does not consider these investments to be other-than temporarily impaired as of December 31, 2009.

Trading securities

In November 2008, the Company accepted an offer (the “Right”) from UBS entitling the Company to sell to UBS at par value ARS originally purchased from UBS (approximately $45.3 million, par value) at anytime during the period June 30, 2010 through July 2, 2012. In accepting the Right, the Company also granted UBS the authority to sell or auction the ARS at par at any time after accepting the offer until the expiration date of the offer provided that the Company receive par value of their ARS. As part of the offer, the Company released UBS from any claims relating to the marketing and sale of ARS. Although the Company expects to sell its ARS under the Right, if the Right is not exercised before July 2, 2012, the Right will expire and UBS will have no further right or obligation to buy the Company’s ARS. UBS’s obligations under the Right are not secured by its assets and do not require UBS to obtain any financing to support its performance obligations under the Right. UBS has disclaimed any assurance that it will have sufficient financial resources to satisfy its obligations under the Right.

The Company believes the enforceability of the Right results in a put option and should be recognized as a separate freestanding asset and accounted for separately from the ARS investment. The Company valued the Right using a discounted cash flow approach including estimates of interest rates, timing and amount of cash flows, adjusted for any bearer risk associated with UBS’s financial ability to repurchase the ARS beginning June 30, 2010. These assumptions are volatile and subject to change if the underlying sources of these assumptions and market conditions change. As of December 31, 2009 and 2008, the Company recorded $4.9 million and $7.6 million, respectively, as the fair value of the put option asset.

Prior to accepting the UBS offer, the Company recorded its ARS as available-for-sale investments. In connection with the acceptance of the UBS offer in November 2008, resulting in a right to require UBS to purchase the ARS at par value beginning on June 30, 2010, the Company has reclassified the related portion of its ARS subject to the Right and held by UBS from available-for-sale securities to trading securities. The transfer to trading securities reflects management’s intent to exercise its put option during the period from June 30, 2010 to July 3, 2012. Upon the reclassification of the related ARS to trading securities as of December 31, 2008, the Company immediately recognized a loss of $7.8 million, included in Interest and other income, net, for the amount of the unrealized loss not previously recognized in earnings. This loss was offset against the fair value of the put option asset, which was $7.6 million.

As of December 31, 2009, the ARS from UBS and its related Right are still held as trading securities and the unrealized gains on trading securities that have been included in net income for the year ended December 31, 2009, were $190,000, net of losses on the related offer from UBS.

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Fair Value of Financial Instruments

The following table represents the Company’s assets and liabilities required to be measured at fair value on a recurring basis as of December 31, 2009 (in thousands):

			Fair Value Measurements at December 31, 2009 Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
Money market funds (1)	$	23,981	$	23,981	$	-	$	-
Asset backed securities (2)		16,470		-		7,429		9,041
Auction rate securities (3)		43,823		-		-		43,823
Auction rate securities right (4)		4,875		-		-		4,875
Other available-for-sale securities (5)		115,656		115,656		-		-
Total	$	204,805	$	139,637	$	7,429	$	57,739

The following table represents the Company’s financial assets (cash equivalents and investments) measured at fair value on a recurring basis as of December 31, 2008 (in thousands):

			Fair Value Measurements at December 31, 2008 Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
Money Market Funds (1)	$	25,211	$	25,211	$	-	$	-
Asset Backed Securities (2)		34,905		-		-		34,905
Auction Rate Securities (3)		44,079		-		-		44,079
Auction Rate Securities Right (4)		7,640		-		-		7,640
Other available-for-sale Securities (5)		35,152		35,152		-		-
Total	$	146,987	$	60,363	$	-	$	86,624

_______________

Note:

(1)	Classified as cash and cash equivalents.

(2)	The balance at December 31, 2009 consists of $7.4 million classified as short-term investments and $9.0 million classified as long-term investments. The balance at December 31, 2008 consists of $25.1 million classified as short-term investments and $9.8 million classified as long-term investments.

(3)	The balance at December 31, 2009 consists of $37.1 million classified as short-term investments and $6.7 million classified as long-term investments. The balance at December 31, 2008 consists totally of long-term investments.

(4)	Classified as short-term investments in 2009 and long-term investments in 2008.

(5)	Classified as short-term investments.

Historically, the fair value of the ARS and the ABS investments approximated par value due to the frequent resets through the auction process. While the Company continues to earn interest on its ARS and ABS investments at the contractual rate, these investments are not currently trading and therefore do not have a readily determinable market value.

For ABS backed by the U.S. Government, the securities were valued using a matrix pricing methodology which was derived from sales of similar bonds in the market. Some of the observable inputs used in this methodology include prepayment speeds, loss severities, credit risks, maturities, and collateral. The Company considers the fair value was derived from level 2 inputs.

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For ABS not backed by the U.S. Government, the investment firm holding the securities valued the investments at $8.6 million. The Company engaged an independent investment firm’s trading desk to go into the market and solicit actual bids for the securities. The bids received aggregated to a fair value of $9.0 million. The Company determined the fair value of these securities should be $9.0 million and the fair value was derived from level 3 inputs.

For ARS, the Company used a discounted cash flow model to determine the value at each reporting period. The assumptions used in preparing the discounted cash flow model include estimates of, based on data available as of December 31, 2009, interest rates, timing and amount of cash flows, credit and illiquidity premiums, and expected holding periods of the ARS. The Company valued the Right as a put option asset using a discounted cash flow approach including estimates of interest rates, timing and amount of cash flow, adjusted for any bearer risk associated with UBS’s financial ability to repurchase the ARS beginning June 30, 2010.

The assumptions used in valuing the ARS, the ABS, and the right are volatile and subject to change as the underlying sources of these assumptions and market conditions change.

The other available-for-sale securities consist of U.S. Treasury and U.S. government agency securities, municipal notes and bonds, corporate notes and bonds, and commercial paper. These are all high quality investments. The Company values these securities based on pricing from its brokers, which use quoted prices in active markets for identical assets.

The following table presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as of December 31, 2009 and 2008 (in thousands):

	Asset Backed Securities			Auction Rate Securities			Auction Rate Securities Right			Total (1)
Balance at December 31, 2007	$	-		$	-		$	-		$	-
Transfers to Level 3		40,655			79,100			-			119,755
Purchases, sales, issuances and settlements, net		-			(23,727	)		-			(23,727	)
Total realized or unrealized gains or (losses)
Included in other comprehensive loss		(5,750	)		(3,444	)		-			(9,194	)
Included in earnings		-			(7,850	)		7,640			(210	)
Balance at December 31, 2008	$	34,905		$	44,079		$	7,640		$	86,624
Transfers out of Level 3		(7,429	)								(7,429	)
Purchases, sales, issuances and settlements, net		(20,374	)		(3,351	)					(23,725	)
Total realized or unrealized gains or (losses)
Included in other comprehensive income		2,038			148						2,186
Included in earnings		(99	)		2,947			(2,765	)		83
Balance at December 31, 2009	$	9,041		$	43,823		$	4,875		$	57,739

The amount of total gains or (losses) for the period
included in earnings attributable to the change
in unrealized gains or losses relating to assets
still held at December 31, 2009	$	-		$	2,955		$	(2,765	)	$	190

_______________

Note:

(1)	The balance at December 31, 2008 consists entirely of long-term investments. The balance at December 31, 2009 consists of $49.4 million classified as short-term investments and $15.7 million classified as long-term investments.

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Note 5—Income Taxes

The benefit (provision) for income taxes consists of the following (in thousands):

	Year Ended December 31,
	2009			2008			2007
Current tax expense:
Federal	$	(9,927	)	$	(4,541	)	$	(1,710	)
State		(1,513	)		(805	)		(583	)
Foreign		(653	)		(484	)		(399	)
		(12,093	)		(5,830	)		(2,692	)
Deferred tax benefit (expense):
Federal		4,502			(269	)		11,920
State		1,005			528			8,373
		5,507			259			20,293
Total	$	(6,586	)	$	(5,571	)	$	17,601

As part of the process of preparing the Company’s consolidated financial statements, the Company is required to estimate its income taxes in each of the jurisdictions in which it operates. This process involves determining the Company’s income tax benefit (expense) together with calculating the deferred income tax benefit (expense) related to temporary differences resulting from differing treatment of items, such as deferred revenue or deductibility of certain intangible assets, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the consolidated balance sheet. The Company must then assess the likelihood that the deferred tax assets will be recovered through the generation of future taxable income.

The Company considers all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. If it is not more likely than not that SonicWALL will recover its deferred tax assets, the Company will increase its provision for taxes by recording a valuation allowance against the deferred tax assets that the Company estimates will not ultimately be recoverable.

The available positive evidence at December 31, 2007, included three years of cumulative historical operating profits, a projection of future income sufficient to realize most of the remaining deferred tax assets, and other evidence. The Company recorded a partial valuation allowance release of $23.5 million in fiscal year 2007, because as of December 31, 2007, it was considered more likely than not that the Company’s deferred tax assets would be realized with the exception of certain acquired net operating losses due to the annual “change in ownership” limitation by the Internal Revenue Code of 1986, as amended. The Company does not forecast future income beyond a 5-year time horizon to determine if these deferred tax assets can be realized. At December 31, 2009, the Company continues to believe that a valuation allowance is not necessary with the exception of certain acquired net operating losses. The change in valuation allowance in fiscal 2009 was primarily related to positive future income sufficient to realize a portion of these acquired net operating losses. The remaining valuation allowance of approximately $8.6 million as of December 31, 2009, would result in a credit to income tax expense if and when the Company concludes it is more likely than not that the related deferred tax assets will be realized.

As of December 31, 2009, the Company believed that the amount of deferred tax assets recorded on our balance sheet would ultimately be recovered. However, should there be a change in the Company’s ability to recover the deferred tax assets, the tax provision would increase in the period in which SonicWALL determines that it is more likely than not that the Company cannot recover the deferred tax assets. If the Company has to re-establish a full valuation allowance against the deferred tax assets, it would result in an increase of $33.3 million to income tax expense.

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Significant components of the deferred tax assets and liabilities are as follows (in thousands):

	December 31,
	2009			2008
Deferred tax assets:
Net operating loss carryforwards	$	15,581		$	17,190
Inventory reserves		1,697			1,137
Deferred revenue		6,706			2,434
Tax credits		5,701			5,951
Share-based compensation		7,061			5,469
Unrealized loss on available-for-sale securities		2,750			3,614	(1)
Other reserves and accruals		10,144			12,322
		49,640			48,117
Deferred tax liabilities:
Intangible assets		(5,032	)		(6,490	)
Net deferred tax assets before valuation allowance		44,608			41,627
Valuation allowance		(8,589	)		(10,184	)
Net deferred tax assets	$	36,019		$	31,443

(1) As restated.

As of December 31, 2009, the Company had cumulative net operating loss carry-forwards for federal and state income tax reporting purposes of approximately $38.5 million and $52.8 million, respectively. The federal net operating loss carry-forwards expire through the year 2027 and the state net operating loss carry-forwards expire at various dates through the year 2019.

As of December 31, 2009, the Company had cumulative carry-forwards for research and development credits for federal and state income tax purposes of approximately $4.5 million and $9.8 million, respectively. These state research and development credits can be carried forward indefinitely.

The utilization of certain acquired net operating losses and tax credits are subject to substantial annual limitation due to the “change in ownership” provisions of the Internal Revenue Code of 1986, as amended, and similar state provisions. As a result, the annual limitation may result in the expiration of net operating losses and tax credits before utilization.

Additionally, the Company determined that certain gross deferred tax assets related to the acquired companies as of December 31, 2009, required a valuation allowance. At December 31, 2009, a partial valuation allowance of $8.6 million had been recorded for a portion of the acquired deferred tax assets as a result of the uncertainties regarding realization of the assets based upon the limitation on the use of the net operating losses in the future. If and when such deferred tax assets become realizable, the benefit will be credited to income tax expense. In fiscal year 2008, the Company utilized $283,000 of the deferred tax assets related to the acquired companies resulting in a reduction in goodwill. The Company’s overall change in valuation allowance was $(1.6) million, $(0.5) million, and $(25.7) million for the years ended December 31, 2009, 2008 and 2007, respectively.

Restatement

During the preparation of the Annual Report on Form 10-K for the year ended December 31, 2009, the Company determined there was an omission in recording deferred tax assets associated with net unrealized losses on available for sale securities in fiscal years 2008 and 2007. As the net unrealized losses from available-for-sale securities are recognized through Other Comprehensive Income, the impacts of these errors do not affect tax expense and are recorded in Other Comprehensive Income. Consequently, the Company has restated the Consolidated Balance Sheet as of December 31, 2008 and the Consolidated Statement of Shareholder’s Equity for the years ended December 31, 2008 and December 31, 2007. The errors have no effect on the previously reported Consolidated Statements of Operations or Consolidated Statements of Cash Flows.

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The adjustments had the effect of increasing our deferred tax assets by $3.6 million, $0.9 million and $0.5 million as of December 31, 2008, 2007 and 2006, respectively, with corresponding increases to other comprehensive income for the same amounts.

The Company’s effective tax rate on income differs from the U.S. Federal statutory regular tax rate as follows:

	Year Ended December 31,
	2009		2008		2007
Federal statutory rate		35%		35%		35%
State taxes, net of federal benefit		5%		8%		5%
IPR&D		-		-		7%
Share-based compensation		9%		23%		22%
Tax credits		(8%)		(22%)		(21%)
Change in valuation allowance		(8%)		-		(213%)
Other		-		9%		5%
		33%		53%		(160%)

Undistributed earnings of the Company’s foreign subsidiaries of approximately $5.0 million at December 31, 2009, are considered to be indefinitely reinvested and, accordingly, no provisions for federal and state income taxes have been provided thereon. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to various foreign countries.

The Company’s income before income taxes was earned in the following jurisdictions (in thousands):

	Year Ended December 31,
	2009		2008		2007
Domestic	$	17,638	$	8,497	$	9,529
Foreign		2,102		1,955		1,491
Total	$	19,740	$	10,452	$	11,020

In July 2006, the FASB issued Financial Interpretation 48, “Accounting for Uncertainty in Income Taxes,” (“FIN 48”) (codified primarily in FASB ASC Topic 740, “Income Taxes”) which clarifies the accounting for uncertainty in income taxes recognized in the financial statements. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition of tax benefits, classification on the balance sheet, interest and penalties, accounting in interim periods, disclosure, and transition. The Company adopted FIN 48 effective January 1, 2007. In accordance with ASC 740-10-45 (formerly known as FIN 48, paragraph 19), the Company recognizes interest and penalties related to unrecognized tax benefits within the income tax expense line in the accompanying consolidated statement of operations. As a result of the implementation of FIN 48, the Company recognized an $89,000 increase in liability for unrecognized tax benefits, which was accounted for as a reduction to the January 1, 2007 balance of retained earnings.

The Company recognizes tax liabilities in accordance with FASB ASC Topic 740 and adjusts these liabilities when judgment changes as a result of the evaluation of new information not previously available. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from the current estimate of the tax liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which they are determined.

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A reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits is as follows (in thousands):

	2009			2008			2007
At January 1	$	1,696		$	1,657		$	3,124
Increases in tax positions for prior years		145			86			726
Decreases in tax positions for prior years		(131	)		(406	)		(2,443	)
Increases in tax positions for current years		512			359			250
Settlements		-			-			-
Lapse in statute of limitations		-			-			-
At December 31	$	2,222		$	1,696		$	1,657

The Company recognizes interest and penalties related to unrecognized tax benefits within the income tax expense line in the accompanying consolidated statement of operations.

The Company had unrecognized tax benefits of approximately $2.2 million as of December 31, 2009. Included in the balance of unrecognized tax benefits at December 31, 2009, 2008 and 2007 respectively, are $2.2 million, $1.7 million and $0.4 million of tax benefits that, if recognized, would affect the effective tax rate. Accrued interest and penalties are immaterial as of December 31, 2009 and 2008 and included in the unrecognized tax benefits.

The Company’s unrecognized tax benefits include state exposures from not filing state tax returns. The Company does not expect any material changes in unrecognized tax benefits within the next 12 months.

The Company is subject to taxation in the United States and various states and foreign jurisdictions. As of December 31, 2009, the Company’s tax years from 2006 through 2009 are subject to examination by the tax authorities. With few exceptions, as of December 31, 2009, the Company is no longer subject to U.S. federal, state, local or foreign examinations by tax authorities for years before 2006.

Note 6—Acquisitions

The Company allocated the purchase price based upon the fair value of the assets acquired and liabilities assumed. The excess of the purchase price over the fair value of the assets acquired and liabilities assumed has been allocated to the identified intangible assets. The following is the final allocation of the purchase consideration (in thousands):

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Fair Market Values (in thousands)
Cash and cash equivalents	$	352
Accounts receivable, net		3,764
Inventories		241
Prepaid expenses and other current assets		661
Property and equipment, net		825
In-process research and development		1,930
Goodwill		15,454
Intangible assets:
Existing technology		6,940
Customer relationships		7,920
Other Assets		235
Total assets acquired		38,322

Accounts payable and other current liabilities		1,253
Accrued compensation		3,695
Deferred revenue		5,146
Loan payable		2,607
Total liabilities assumed		12,701
Net assets acquired	$	25,621

Pursuant to the terms of the Merger Agreement, options held by employees of Aventail to acquire 744,043 shares of common stock were assumed by SonicWALL. The fair value as of the acquisition date of these stock options assumed, using the Black-Scholes valuation method, was $2.2 million. There were no options vested as of the acquisition date, therefore the purchase price component related to the assumption was zero. The total fair value of $2.2 million is being recognized as compensation cost over the requisite service period.

The acquired purchased technology and customer relationships are being amortized over their estimated useful life of six and eight years, respectively.

The Company's methodology for allocating a portion of the purchase price for purchase acquisitions to in-process research and development (“IPR&D”) is determined through established valuation techniques in the high-technology internet security industry. IPR&D is expensed upon acquisition because technological feasibility had not been established and no future alternative use exists. Total IPR&D expense of $1.9 million was charged to product development expenses on the date the assets were acquired.

The results of operations of Aventail have been included in the Company’s consolidated financial statements subsequent to the date of acquisition.

Note 7—Goodwill and Purchased Intangibles

The following table presents the changes in goodwill (in thousands):

	December 31,
	2009		2008
Balance as of beginning of the year	$	138,470	$	138,753
Tax adjustment related to acquisitions (see Note 5)		-		(283	)
Balance at the end of the year	$	138,470	$	138,470

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Intangible assets for the year ended December 31, 2009 and 2008 consist of the following (in thousands):

		December 31, 2009							December 31, 2008
	Weighted Average Amortization Period	Gross Carrying Amount		Accumulated Amortization			Net		Gross Carrying Amount		Accumulated Amortization			Net
Purchased technology	70 month	$	43,211	$	(36,839	)	$	6,372	$	43,211	$	(33,822	)	$	9,389
Non-compete agreements	36 month		7,249		(7,249	)		-		7,249		(7,249	)		-
Customer base	77 month		26,690		(21,017	)		5,673		26,690		(19,922	)		6,768
Other	16 month		500		(500	)		-		500		(500	)		-
Total intangibles	69 month	$	77,650	$	(65,605	)	$	12,045	$	77,650	$	(61,493	)	$	16,157

On December 14, 2007, the Company entered into a perpetual license agreement with Linkbit, Inc. for certain intellectual property for $1.8 million, which will be amortized over the estimated useful life of the technology of eight years.

All of the Company’s intangible assets excluding goodwill are subject to amortization. Estimated future amortization expense to be included in cost of revenue and in operating expenses is as follows (in thousands):

Fiscal Year	Amortization Amount to Cost of Revenue		Amortization Amount to Operating Expenses
2010	$	2,374	$	1,095
2011		1,382		1,095
2012		1,382		1,008
2013		803		990
2014		225		990
Thereafter		206		495
Total	$	6,372	$	5,673

Note 8—Restructuring Charges

During the first quarter of fiscal year 2008, the Company commenced the implementation of a 2008 restructuring plan associated primarily with the relocation of support activities, the closure of facilities in Pune, India and Sunnyvale, California, and other employee reductions for the purpose of better integration and alignment of Company functions. The Company recorded $1.0 million in restructuring expenses related to costs associated with the termination of 21 employees across multiple geographic regions and functions, primarily related to severance, benefits and related costs. Furthermore, the Company recorded additional restructuring costs of $0.8 million in connection with facilities and property and equipment that was disposed of or removed from service. As of December 31, 2009, the Company had no remaining liability relating to the restructuring activities.

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The following tables set forth an analysis of the components of the 2008 restructuring plan and the payments made in 2008 and 2009 (in thousands):

	Employee Severance Benefits			Facility Costs			Total
Accrual balance at December 31, 2007	$	-		$	-		$	-
Restructuring charges incurred		1,042			762			1,804
Impairment charges recorded		-			(56	)		(56	)
Adjustment		(125	)		-			(125	)
Cash paid		(917	)		(634	)		(1,551	)
Accrual balance at December 31, 2008		-			72			72
Cash paid		-			(72	)		(72	)
Accrual balance at December 31, 2009	$	-		$	-		$	-

Note 9—Shareholders’ Equity

Stock Repurchase Program

In November 2004, the Company’s Board of Directors authorized a stock repurchase program to acquire up to $50 million of common stock. The term of the stock repurchase plan was set at twelve (12) months from the date of authorization. In February 2005, the Company’s Board of Directors increased the amount authorized for repurchase from $50 million to $75 million, extended the term of the program from twelve (12) to twenty-four (24) months following the date of original authorization and increased certain predetermined pricing formulas. In April 2005, the Company’s Board of Directors authorized a modification to the stock repurchase program to delete certain elements that provided for systematic repurchases.

During fiscal year 2008, the Company repurchased 9.7 million shares of SonicWALL common stock at an average price of $8.16 for an aggregate purchase price of $79.4 million. During fiscal year 2007, the Company repurchased 5.6 million shares of SonicWALL common stock at an average price of $8.98 for an aggregate purchase price of $49.9 million. During fiscal year 2006, the Company repurchased 2.4 million shares of SonicWALL common stock at an average price of $8.73 for an aggregate purchase price of $21.1 million. The Company’s Stock Repurchase Program was completed as of September 30, 2008.

The purchase price for the shares of the Company’s common stock repurchased was reflected as a reduction to shareholders’ equity and allocated as a reduction to retained earnings and common stock and additional paid-in capital.

Note 10—Segment Reporting

The Company conducts its business within one business segment. The Company has determined that the Chief Operating Decision Maker (“CODM”) is the Chief Executive Officer (“CEO”). The CODM allocates resources and assesses the performance of the Company as a whole by functional area.

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Revenue by product category is as follows (in thousands):

	Year Ended December 31,
	2009		2008		2007
UTM	$	155,052	$	164,788	$	147,696
SCM		19,805		22,988		23,604
SSL		17,160		20,668		15,706
CDP		8,558		10,200		12,193
Total	$	200,575	$	218,644	$	199,199

Revenue by geographic region, based on ship-to address, is as follows (in thousands):

	Year Ended December 31,
	2009		2008		2007
United States	$	135,102	$	143,913	$	135,000
All other countries		65,473		74,731		64,199
Total	$	200,575	$	218,644	$	199,199

Long-lived assets, which consist primarily of property and equipment, by geographic region based on the location of the assets, are presented as follows (in thousands):

	Year Ended December 31,
	2009		2008		2007
United States	$	8,658	$	8,301	$	8,558
All other countries		2,426		2,414		1,756
Total	$	11,084	$	10,715	$	10,314

The following three customers accounted for 10% or more of the Company’s revenue:

	Year Ended December 31,
	2009		2008		2007
Ingram Micro		18%		16%		16%
Tech Data		17%		17%		17%
Arrow		11%		16%		18%

Revenue derived from Ingram Micro, Tech Data, and Arrow is solely in the Americas. No other customer represented more than 10% of our sales in those years.

Note 11—Commitments and Contingencies

Lease Commitments

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In December 2009, the Company expanded its existing facility in the United Kingdom to a total of approximately 7,000 square feet of office space to carry out our sales and technical support activities. The lease term will expire in February 2013.

Rent expense for the Company was approximately $3.4 million, $4.1 million, and $ 2.1 million for the years ended December 31, 2009, 2008 and 2007, respectively.

Future annual minimum lease payments under all non-cancelable operating leases with an initial term in excess of one year as of December 31, 2009 were as follows (in thousands):

Year Ending December 31,
2010	$	4,265
2011		3,833
2012		3,055
2013		2,150
2014		1,614
Thereafter		406
Total	$	15,323

Purchase Commitments (Unaudited)

The Company outsources its manufacturing function to third party contract manufacturers, and at December 31, 2009 it had purchase obligations totaling $19.6 million. Of this amount, $16.7 million cannot be cancelled and is payable within one year. The Company is contingently liable for any inventory owned by a contract manufacturer that becomes excess and obsolete. As of December 31, 2009, $21,000 had been accrued for excess and obsolete inventory held by our contract manufacturers. In addition, as of December 31, 2009, in the normal course of business, the Company had $0.6 million in non-cancelable purchase commitments.

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Product Warranties

The Company's standard warranty period for its products is one year and includes repair or replacement obligations for units with product defects. The Company estimates the accrual for future warranty costs based upon its historical cost experience and its current and anticipated product failure rates. If actual product failure rates or replacement costs differ from its estimates, revisions to the estimated warranty obligations would be required. However, the Company concluded that no adjustment to pre- existing warranty accruals were necessary for the years ended December 31, 2009, 2008 or 2007, respectively. A reconciliation of the changes to the Company's warranty accrual is as follows (in thousands):

	Year Ended December 31,
	2009			2008			2007
Beginning balance	$	575		$	741		$	811
Accruals for warranties issued		356			919			854
Settlements made during the period		(394	)		(1,085	)		(924	)
Ending balance	$	537		$	575		$	741

Guarantees and Indemnification Agreements

The Company enters into standard indemnification agreements in its ordinary course of business. As part of its standard distribution agreements, the Company indemnifies, holds harmless, and agrees to reimburse the indemnified parties for losses suffered or incurred by the indemnified party, in connection with any U.S. patent or any copyright or other intellectual property infringement claim by any third party with respect to the Company's products, software, or services. The indemnification agreements commence upon execution of the agreement and do not have specific terms. The maximum potential amount of future payments the Company could be required to make under these agreements is not limited. The Company has never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the Company believes the estimated exposure from these agreements is minimal.

The Company's articles of incorporation limit the liability of directors to the full extent permitted by California law. In addition, the Company's bylaws provide that the Company will indemnify its directors and officers to the fullest extent permitted by California law, including circumstances in which indemnification is otherwise discretionary under California law. The Company has entered into indemnification agreements with its directors and officers that may require the Company: to indemnify its directors and officers against liabilities that may arise by reason of their status or service as directors or officers, other than liabilities arising from willful misconduct of a culpable nature; to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified; and to obtain directors' and officers' insurance if available on reasonable terms. The Company currently has directors and officers insurance in place. The Company has not incurred costs related to these indemnification agreements.

The Company has entered into agreements with certain executives where the Company may be required to pay severance benefits up to 24 months of salary, bonuses and accelerate vesting of stock options in the event of termination of employment under certain circumstances, including a change of control. In October 2008, the Compensation Committee of the Board of Directors authorized modifications to these agreements designed to comply with Section 409A of the Internal Revenue Code of 1986, as amended.

In 2007, the Company paid severance benefits to certain of its former executives in the amount of $41,000.

In January 2008, Mr. John DiLullo, Vice President of Worldwide Sales and a named executive officer, ceased to be employed by the Company. Under the terms of Mr. DiLullo’s retention and severance agreement entered into at the time of his employment in January 2006, the Company paid severance benefits and bonuses, in compliance with Internal Revenue Code Section 409A, in the amount of approximately $258,000.

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Legal Proceedings

On December 5, 2001, a securities class action complaint was filed in the U.S. District Court for the Southern District of New York against the Company, three of its officers and directors, and certain of the underwriters in the Company’s initial public offering in November 1999 and its follow-on offering in March 2000. Similar complaints were filed in the same court against numerous public companies that conducted initial public offerings (“IPOs”) of their common stock since the mid-1990s. All of these lawsuits were consolidated for pretrial purposes before Judge Shira Scheindlin. On April 19, 2002, plaintiffs filed an amended complaint. The amended complaint alleged claims under the Securities Act of 1933 and the Securities Exchange Act of 1934, and sought damages or rescission for misrepresentations or omissions in the prospectuses relating to, among other things, the alleged receipt of excessive and undisclosed commissions by the underwriters in connection with the allocation of shares of common stock in the Company’s public offerings. After more than seven (7) years after the filing of the initial compliant, the parties filed formal settlement papers with the Count on April 2, 2009. On June 9, 2009, the Court, without altering any of the terms of the proposed settlement, issued an order granting preliminary approval of the settlement. On October 5, 2009 the Court issued an order of final approval of the settlement. Under the terms of the settlement, the insurers will pay the full amount of the settlement share allocated to the Company, and the Company will not be required to make any payments. The Company, as well as the officer and director defendants who were previously dismissed from the action without prejudice pursuant to tolling agreements, receive complete dismissals from the case. Subsequent to the court order, several groups of objectors indicated their intent to appeal once judgments have been entered. Judgments were entered and the case in now before the appeals court. These developments will, at a minimum, delay the effective date of the settlement. Under the terms of the settlement, the settlement does not become effective until final judgment in each case is either upheld on appeal or is no longer subject to appeal. If the settlement is overturned on appeal and the litigation against the Company continues, the Company believes it has a meritorious defense and intends to defend the case vigorously. No estimate can be made of the possible loss or possible range of loss, if any, associated with the resolution of this matter. As a result, no loss has been accrued in the Company’s financial statements as of December 31, 2009.

On October 8, 2008, Northpeak Wireless, LLC filed a complaint captioned Northpeak Wireless, LLC v. 3Com Corporation, et al, No. CV-08-J-1813-NE, in the United States District Court for the Northern District of Alabama. The complaint names thirty one (31) defendants, including the Company. The complaint alleges that the Company makes, uses, sells, offers to sell, and/or imports products that incorporate and/or utilize direct sequence spread spectrum wireless technology that infringes U.S. Patent No. 4,977,577 (the “577 Patent”) and U.S. Patent No. 5,987,058 (the “058 Patent”) and seeks a judgment that the Company has infringed, actively induced infringement and/or contributorily infringed the 577 Patent and the 058 Patent. The complaint seeks an award of unspecified damages, pre-judgment and post-judgment interest together with costs, expenses and attorneys’ fees. On January 21, 2009, the Court granted the motion made by the defendants, including SonicWALL, to transfer the case to the Northern District of California. On August 28, 2009, the Court granted a stay in this case pending the results of a request for reexamination filed on behalf of certain of the defendants, not including the Company. The Company intends to defend the case vigorously. No estimate can be made at this time of the possible loss or possible range of loss, if any, associated with the resolution of this matter. As a result, no loss has been accrued in the Company’s financial statements as of December 31, 2009.

On May 29, 2009, Enhanced Security Research, LLC filed a complaint captioned Enhanced Security Research LLC v. Cisco Systems, Inc., et al, C.A. No. 09-390 in the United States District Court for the District of Delaware. The complaint names ten (10) defendants, including the Company. The complaint alleges that the Company makes, uses, offers to sell within the United States past, present, and future versions of products and/or methods that use intrusion detection and prevention systems that infringe or contribute to the infringement of U.S. Patent No. 6,119,236 (the “236 Patent”) and U.S. Patent No. 6,304,975 B1 (the “975 Patent”). The complaint seeks a declaration that the Company has infringed the 236 Patent and the 975 Patent, a permanent injunction against further infringement and contributory infringement, unspecified damages, pre-judgment and post-judgment interest together with costs and attorneys’ fees. The Company intends to defend the case vigorously. No estimate can be made at this time of the possible loss or possible range of loss, if any, associated with the resolution of this matter. As a result, no loss has been accrued in the Company’s financial statements as of December 31, 2009.

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On July 9, 2009, Southwest Technology Innovations LLC filed a complaint captioned Southwest Technology Innovations LLC v. St. Bernard Software, Inc., et al, 09-CV-1487-JAH-JMA in the United States District Court for the Southern District of California. The complaint names six (6) defendants, including the Company. The complaint alleges that the Company makes, uses, imports, sells, offers to sell, induces, aids and abets, encourages others or contributes to other use of certain products of the Company that infringe or contribute to the infringement of U.S. Patent No. 6,952,719 (the “719 Patent”) via its update functions that update software and/or firmware. The complaint seeks a judgment that the Company infringes the 719 Patent, unspecified damages, prejudgment interest not less than a reasonable royalty, and such other further relief as the court or jury may deem proper. The Company intends to defend the case vigorously. No estimate can be made at this time of the possible loss or possible range of loss, if any, associated with the resolution of this matter. As a result, no loss has been accrued in the Company’s financial statements as of December 31, 2009.

On August 28, 2009, Meteora, LLC filed a complaint captioned Meteora, LLC v. Marshal8E6, et al, CV09-6293-PSG (JEMx) in the United States District Court for the Central District of California. The complaint names twenty three (23) defendants, including the Company. The complaint alleges that the Company has been and now is infringing, inducing and/or contributing to others’ infringement of U.S. Patent No. 6,782,510 (the “510 Patent”) literally and/or under the doctrine of equivalents, by making, using, importing, selling, offering to sell word checking products, including, but not limited to, its email security products. The complaint seeks a judgment that the Company infringes, contributed and/or actively induced others’ infringement of the 510 Patent, a preliminary and permanent injunction from further acts of infringement of the 510 Patent, unspecified damages, prejudgment interest and post-judgment interest at the maximum rate allowed by law, attorneys’ fees, enhanced damages pursuant to 35 U.S.C. Section 284, compulsory future royalties, court costs and such other and further relief as the Court deems proper. On February 5, 2010, the parties reached a settlement, including customary releases and covenants. The settlement did not have a material impact on the Company’s financial condition or results of operations and has been recognized in the Company’s consolidated financial statements as of December 31, 2009. On February 10, 2010, the Court issued an order of dismissal with prejudice.

Additionally, the Company is, from time to time, a party to routine litigation incidental to its business. The Company believes that none of these legal proceedings will have a material adverse effect on the Company’s consolidated financial statements taken as a whole or its results of operations, financial position, and cash flows.

Note 12—Employee Benefits

1999 Employee Stock Purchase Plan

The 1999 Employee Stock Purchase Plan (“ESPP”) is designed to enable eligible employees to purchase shares of the Company’s common stock at a discount. Each offering period is for one year and consists of two six-month purchase periods. The purchase price for shares of common stock under the ESPP is 85% of the lesser of the fair market value of the Company’s common stock on the first day of the applicable offering period or the last day of each purchase period.

At their annual meeting on June 14, 2007, the Company’s shareholders voted to increase the number of shares authorized for issuance under the ESPP by 1,500,000 shares and extend the term of the ESPP to July 31, 2017. The cumulative total shares authorized for issuance under the ESPP is 4,025,000 shares.

For the years ended December 31, 2009, 2008, and 2007, the Company issued approximately 374,000, 377,000, and 379,000 shares, respectively, under the ESPP. At December 31, 2009, 937,126 shares were available for future issuance under the ESPP. The weighted average purchase price of the shares issued under the ESPP in 2009, 2008, and 2007 was $3.76, $6.45, and $7.21 per share, respectively. The weighted average fair value of shares issued under the ESPP was $1.54, $2.03, and $2.34 per share, respectively, for 2009, 2008, and 2007.

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Employee Stock Incentive Plans

As of December 31, 2009, the Company had two stock incentive plans (together the “Equity Incentive Plans”): the shareholder approved 2008 Equity Incentive Plan (the “2008 Plan”) and the Board approved 2008 Inducement Equity Incentive Plan (the “2008 Inducement Plan”). The 2008 Plan was approved by the Company’s shareholders on June 10, 2008. In connection with the acquisitions of various companies, the Company assumed the share-based awards granted under stock incentive plans of the acquired companies. Share-based awards are designed to reward employees for their long-term contributions to the Company and provide incentives for them to remain with the Company. The number and frequency of share-based awards are based on competitive practices, operating results of the Company, government regulations and the other factors disclosed by the Company in its filings under the Securities Exchange Act of 1934, as amended. The Company’s primary stock incentive plans are summarized as follows:

2008 Plan

The 2008 Plan permits the granting of stock options, restricted stock, restricted stock units (“RSUs”), stock appreciation rights, and performance shares to employees, consultants of the Company and its subsidiaries and affiliates, and non-employee directors of the Company. As approved by the shareholders on June 10, 2008, the maximum number of shares issuable over the term of the 2008 Plan is 800,000 shares. In addition, shares subject to stock options or similar awards granted under the Company’s expired 1998 Stock Option Plan (the “1998 Plan”) that expire or otherwise terminate without having been exercised in full and shares issued pursuant to awards granted under the 1998 Plan that are forfeited to, or repurchased by the Company, up to a maximum of 5,000,000 shares may be added to the 2008 Plan. Stock options granted under the 2008 Plan have an exercise price of at least 100% of the fair market value of the underlying stock on the grant date and expire no later than seven years from the grant date. Stock options granted under the 2008 Plan will generally become exercisable either (1) for 25% of the option shares one year from the date of grant and then ratably over the following 36 months or (2) as to 1/48th of the option shares on the one month anniversary of the grant date and on each one-month anniversary thereafter. Subject to the annual per-person limit, shares granted under the 2008 Plan, including applicable vesting schedules, shall be granted as determined by the Board of Directors, or any of its committees administering the 2008 Plan, in its sole discretion.

2008 Inducement Plan

The 2008 Inducement Plan permits the granting of nonstatutory stock options, restricted stock, restricted stock units, performance shares, and stock appreciation rights to new employees of the Company, its subsidiaries and affiliates, as material inducements to accept an offer of employment. As adopted by the Board on June 10, 2008, the maximum number of shares issuable over the term of the 2008 Inducement Plan is 500,000 shares. Nonqualified stock options granted under the 2008 Inducement Plan have an exercise price of at least 100% of the fair market value of the underlying stock on the grant date and expire no later than seven years from the grant date. The stock options awarded under the 2008 Inducement Plan will generally become exercisable as to 25% of the option shares, one year after the date of grant and then ratably over the following 36 months. The Board of Directors or other committees administering the plan, have the discretion to use a different vesting schedule.

1998 Plan

The 1998 Plan expired on June 10, 2008 upon shareholder approval of the 2008 Plan, and the Company can no longer make equity awards under the 1998 Plan. As amended on August 24, 1999 and October 12, 2000, the maximum number of shares issuable over the term of the 1998 Plan was 38.9 million shares. Incentive stock options granted under the 1998 Plan have an exercise price of at least 100% of the fair market value of the underlying stock on the grant date and expire no later than ten years from the grant date. Nonqualified stock options are granted at a price that is not to be less than 85% of the fair market value of the common stock on the date of grant, as determined by the Board of Directors or other committees administering the plan, and expire no later than ten years from the date of grant. The stock options generally become exercisable for 25% of the option shares one year from the date of grant, and then ratably over the following 36 months. The Board of Directors or other committees administering the plan had the discretion to use a different vesting schedule and did so from time to time.

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Employee Stock Incentive Plans

Stock Option Awards

The following table summarizes the Company’s stock option activities under the Equity Incentive Plans:

	Number of Shares Outstanding			Weighted Average Exercise Price per Share
Balance at December 31, 2006		16,657,520		$	6.85
Options assumed related to acquisition		744,043		$	8.44
Granted		3,295,880		$	8.82
Exercised		(2,269,940	)	$	6.30
Canceled		(1,234,350	)	$	7.74
Balance at December 31, 2007		17,193,153		$	7.30
Granted		4,752,037		$	7.94
Exercised		(446,923	)	$	6.44
Canceled		(1,939,787	)	$	8.36
Balance at December 31, 2008		19,558,480		$	7.30
Granted		1,445,300		$	7.94
Exercised		(362,177	)	$	4.80
Canceled		(599,052	)	$	7.66
Balance at December 31, 2009		20,042,551		$	7.45

The following table summarizes significant ranges of outstanding and exercisable options as of December 31, 2009:

		Options Outstanding								Options Exercisable
Range of Exercise Prices		Number of Shares Outstanding		Weighted Average Remaining Contractual Life (in Years)		Weighted Average Exercise Price per Share		Aggregate Intrinsic Value		Number of Shares Exercisable		Weighted Average Exercise Price per Share		Aggregate Intrinsic Value
	$ 0.30 – $ 0.45		38		5.6	$	0.30	$	278		38	$	0.30	$	278
	$ 1.41 – $ 2.12		6,859		0.6		1.41		42,526		6,859		1.41		42,526
	$ 2.87 – $ 4.31		2,817,020		3.2		3.44		11,745,077		2,774,618		3.43		11,586,882
	$ 4.32 – $ 6.48		2,615,167		4.5		5.66		5,104,292		2,562,051		5.66		4,998,344
	$ 6.49 – $ 9.74		13,867,813		6.9		8.10		555,532		8,744,316		8.07		549,740
	$ 9.75 – $14.63		497,044		6.3		10.53		-		369,415		10.60		-
	$14.64 – $21.96		118,610		1.5		17.67		-		118,610		17.67		-
	$21.97 – $32.96		20,000		0.4		29.75		-		20,000		29.75		-
	$32.97 – $49.46		100,000		0.5		45.56		-		100,000		45.56		-
Total			20,042,551		6.0	$	7.45	$	17,447,705		14,695,907	$	7.20	$	17,177,770

The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value, based on options with an exercise price less than the Company’s closing stock price of $7.61 as of December 31, 2009, which would have been received by the option holders had all option holders exercised their options as of that date. The total number of in-the-money options exercisable as of December 31, 2009 was 7.9 million.

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Restricted Stock Unit Awards

The Company grants RSUs under the 2008 Plan. Each RSU issued is counted as two shares toward the limit of shares available under the 2008 Plan. The Company issues new shares of common stock upon the vesting of RSUs.

The following table summarizes the Company’s RSU activities as of December 31, 2009 under the Equity Incentive Plans:

	Restricted Stock Units		Weighted Average Price per Share
Balance at December 31, 2008		-	$	-
Granted		52,500	$	5.82
Balance at December 31, 2009		52,500	$	5.82

Share-Based Awards Available for Grant

A summary of share-based awards available for grant are as follows:

	Share-Based Awards Available for Grant
Balance at December 31, 2006		791,563
Authorized		2,615,425
Options granted		(3,295,880	)
Options canceled/expired		1,186,970
Balance at December 31, 2007		1,298,078
Authorized		3,799,104
Options granted		(4,752,037	)
Options canceled/expired		1,529,422
Option Retired		(89	)
Balance at December 31, 2008		1,874,478
Options granted		(1,445,300	)
Restricted stock units granted		(105,000	)
Options canceled/expired		544,155
Balance at December 31, 2009		868,333

Fair Value Disclosure

The share-based compensation expenses recognized for the years ended December 31, 2009, 2008, and 2007 were as follows (in thousands):

	2009		2008		2007
Cost of sales	$	501	$	532	$	524
Research and development		2,763		3,290		4,642
Sales and marketing		3,285		3,802		4,824
General and administrative		2,637		2,993		3,987
Share-based compensation expense	$	9,186	$	10,617	$	13,977

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The weighted average grant-date fair value of options granted for the year ended December 31, 2009, 2008, and 2007 was $3.17, $2.68, and $2.92 per share, respectively. The total fair value of options vested during the year-ended December 31, 2009 was $9.4 million. The total intrinsic value of options exercised during the year-ended December 31, 2009 was $0.9 million. The total cash received from employees as a result of employee stock option exercises and employee stock purchase plan during the year ended December 31, 2009 was $3.1 million. In connection with these exercises, there was a tax benefit of $124,000 realized by the Company due to the Company’s current tax position. The weighted average remaining contractual term for options exercisable at December 31, 2009 was 5.38 years. The Company issues new shares of common stock upon exercise of stock options. The total compensation cost (gross) related to non-vested options not yet recognized at December 31, 2009 was $14.4 million and the weighted-average period over which this amount is expected to be recognized is 2.70 years.

The Company has assumed certain option plans in connection with business combinations. Generally, the options granted under these plans have terms similar to the Company’s own options. The exercise prices of such options have been adjusted to reflect the relative exchange ratios.

The Company estimates the fair value of stock options using a Black-Scholes option-pricing model to determine the fair value of share-based awards, and consistent with that used pro forma disclosures for grants awarded prior to December 31, 2005. The Black-Scholes option-pricing model incorporates various and highly subjective assumptions including expected volatility, expected term and interest rates. Although the fair value of employee stock options is determined using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.

Expected Volatility: The Company used a combination of historical and implied volatility (“blended volatility”) in deriving its expected volatility assumption. Implied volatility was derived based on traded options on the Company’s common stock with a minimum term of six months. The selection of the blended volatility approach was based upon the availability of traded options on the Company’s stock and the Company’s assessment that blended volatility is more representative of future stock price trends than historical volatility alone. In calculating blended volatility, historical and implied volatility were weighted equally.

Risk-Free Interest Rate: The risk-free interest rate is based on the market yield currently available on U.S. Treasury securities with an equivalent remaining term.

Expected Term: The Company’s expected term represents the period that the Company’s share-based awards are expected to be outstanding and was determined based on historical experience of similar awards, giving consideration to the contractual terms of the share-based awards, vesting schedules and expectations of future employee behavior as influenced by changes to the terms of its share-based awards.

Expected Dividend: The Black-Scholes valuation model calls for a single expected dividend yield as an input. The Company has not paid and does not anticipate paying any dividends in the near future.

The assumptions used to estimate the fair value of stock options granted under the Company’s Stock Option Plans using the Black-Scholes option pricing model for the year ended December 31, 2009, 2008 and 2007 are as follows:

2009

2008

2007

Expected volatility

44.6% to 58.3%

40.6% to 46.6%

39.4% to 43.9%

Risk-free interest rate

1.3% to 2.3%

1.2% to 3.0%

3.2% to 5.1%

Expected life

3.5 to 4.6 years

3.5 to 3.7 years

2.9 to 3.5 years

Dividend yield

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

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The fair value of purchase rights issued under the Employee Stock Purchase Plan was estimated using the following assumptions for the year ended December 31, 2009, 2008 and 2007:

2009

2008

2007

Expected volatility

56.3% to 73.9%

42.8% to 43.3%

30.3% to 34.3%

Risk-free interest rate

0.3% to 0.6%

2.0% to 2.8%

4.1% to 5.2%

Expected life

0.5 to 1 year

Dividend yield

Pension Plan

The Company has a defined contribution retirement plan covering substantially all of its eligible United States employees. The Company’s contribution to this plan is discretionary. The Company provided for a discretionary matching contribution in an amount equal to 50% of the employee contribution up to a maximum of $2,000 annually for each participant. All such employer contributions vested immediately. Effective April 24, 2009, the discretionary matching contribution made by the Company was discontinued. The Company has expensed approximately $403,000, $758,000, and $678,000 of employer contributions for the years ended December 31, 2009, 2008 and 2007, respectively.

Deferred Compensation Plan

SonicWALL has a deferred compensation plan (“DCP”) to provide specified benefits to, and help retain, a select group of management and highly compensated employees and directors (“Participants”) who contribute materially to the Company’s continued growth, development, and future business success. Under the DCP, Participants may defer up to 80% of their salary and up to 100% of their annual bonus and commission. Each Participant’s deferral account is credited with an amount equal to the net investment return of one or more equity or bond funds selected by the Participant. Amounts in a Participant’s deferral account represent an unsecured claim against the Company’s assets and are paid, pursuant to the Participant’s election, in a lump sum or in quarterly installments at a specified date during the participant’s employment or upon the Participant’s termination of employment with the Company. The Company pays for the insurance coverage provided under this plan, but does not make any contributions to this plan. In August 2008, the Compensation Committee of the Board of Directors (“Committee”) approved an amended and restated DCP designed to comply with Section 409A of the Internal Revenue Code of 1986, as amended. In October 2008, the Committee adopted certain clerical modifications to the DCP which are all in accordance with the requirements of Section 409A of the Internal Revenue Code of 1986, as amended. At December 31, 2009, the trust assets and the corresponding deferred compensation liabilities were $4,150,000 and $4,101,000, respectively, and are included in other current assets and other current liabilities, respectively.

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ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

ITEM 9A. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company, with the participation of our Chief Executive Officer (CEO), Chief Financial Officer (CFO), and Chief Accounting Officer (CAO), has evaluated the effectiveness of the design and operation of its disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of December 31, 2009. Based on the evaluation, the CEO, CFO and CAO have concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2009 for the information required to be disclosed in the reports we file or submit under the Exchange Act to be recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms and such information is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure.

Management Report on Internal Control over Financial Reporting

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). The management, under the supervision and with the participation of its CEO, CFO, and CAO, assessed the effectiveness of our internal controls over financial reporting based on the criteria established in “Internal Control – Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Management’s assessment included evaluation of such elements as the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies and our overall control environment. This assessment is supported by testing and monitoring performed by our internal finance organization and our retained internal audit organization. Based upon the assessment performed, management believes that, as of

December 31, 2009, the Company’s internal control over financial reporting is effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles. We review with the Audit Committee of the Board of Directors on a regular basis our assessment of our internal controls over financial reporting including the evaluation of any changes in our internal control over financial reporting environment to determine if material changes have occurred.

Armanino McKenna LLP, the independent registered public accounting firm that audited our financial statements included in this Annual Report on Form 10-K, has also assessed the effectiveness of internal control over financial reporting as of December 31, 2009. Armanino McKenna LLP has issued an attestation report with an unqualified opinion. This attestation report is included herein under Part II, Item 8.

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Changes in Internal Control over Financial Reporting

During the fourth quarter ended December 31, 2009, there have not been any changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d – 15(f) under the Exchange Act) that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls

The Company’s management, including the Chief Executive Officer and the Chief Financial Officer, believe that our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives and concluded that our disclosure controls and procedures were effective at that reasonable assurance level as of December 31, 2009. We also believe that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

ITEM 9B. Other Information

None.

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PART III

ITEM 10. Directors, Executive Officers and Corporate Governance

You will find information regarding our Directors and Executive Officers appearing under the headings “Proposal No. 1 ---Election of Directors”, “Section 16(a) Beneficial Ownership Reporting Compliance” and “Corporate Governance and Other Matters” in the Proxy Statement which we will deliver to our shareholders in connection with our Annual Meeting of Shareholders to be held on June 17, 2010. We are incorporating the information contained in those sections of our Proxy Statement here by reference.

The Company maintains a set of Corporate Governance Principles, a Code of Ethics for Principle Executive Officers and Senior Financial Officers, and a Code of Conduct. Our Code of Conduct is applicable to all employees, including all officers and our independent directors. The full text of our Corporate Governance Principles, our Code of Ethics for Principle Executive Officers and Senior Financial Officers and our Code of Conduct are published on our corporate website www.sonicwall.com under the tab Corporate Governance.

ITEM 11. Executive Compensation

You will find this information in the sections captioned “Compensation Discussion and Analysis,” “Report of the Compensation Committee”, “Executive Compensation”, and “Director Compensation” which will appear in the 2009 Proxy Statement we will deliver to our shareholders in connection with our Annual Meeting of Shareholders to be held on June 17, 2010. We are incorporating the information contained in those sections here by reference.

ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

You will find this information in the section captioned “Security Ownership of Certain Beneficial Owners and Management”, and “Equity Compensation Plan Information” which will appear in the 2010 Proxy Statement we will deliver to our shareholders in connection with our Annual Meeting of Shareholders to be held on June 17, 2010. We are incorporating the information contained in that section here by reference.

ITEM 13. Certain Relationships and Related Transactions, and Director Independence

You will find this information in the sections captioned “Certain Relationships and Related Transactions,” and “Corporate Governance and Other Matters” which will appear in the 2010 Proxy Statement we will deliver to our shareholders in connection with our Annual Meeting of Shareholders to be held on June 17, 2010. We are incorporating the information contained in those sections here by reference.

ITEM 14. Principal Accounting Fees and Services

You will find this information in the sections captioned “Report of the Audit Committee” and Proposal No. 2--- Ratification of Selection of Independent Auditors” which will appear in the 2010 Proxy Statement we will deliver to our shareholders in connection with our Annual Meeting of Shareholders to be held on June 17, 2010. We are incorporating the information contained in those sections here by reference.

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PART IV

ITEM 15. Exhibits and Financial Statement Schedules

(a) The following documents are filed as part of this report:

1. Financial Statements—See Index to Consolidated Financial Statements in Part II, Item 8.

2. Financial Statement Schedules— Schedule II (Valuation and Qualifying Accounts) are included in this Annual Report on Form 10-K. All other financial statement schedules have been omitted because the information required is not applicable or is shown in the Consolidated Financial Statements or notes thereto.

3. Exhibits—

Number	Description
2.1	Agreement and Plan of Merger and Reorganization, dated as of October 16, 2000, among Registrant, Pluto Acquisition Corp., Phobos Corporation, and GMS Capital Partners, L.P. (Incorporated by reference to Registrant’s Current Report on Form 8-K (File No. 000-27723), filed on November 27, 2000).
2.2	Amendment to Agreement and Plan of Merger dated as of November 6, 2000, by and among Registrant, Pluto Acquisition Corp., Phobos Corporation, and GMS Capital Partners, L.P. (Incorporated by reference to Registrant’s Current Report on Form 8-K (File No. 000-27723), filed on November 27, 2000).
2.3	Agreement and Plan of Merger and Reorganization, dated March 1, 2001, among Registrant, ITI Acquisition Corp., Ignyte Technology, Inc., and Jeff Stark. (Incorporated by reference to Registrant’s Registration Statement on Form S-3 (File No. 333-61168), filed on May 17, 2001).
2.4	Amendment No. 1 to the Agreement and Plan of Merger and Reorganization by and among Registrant, ITI Acquisition Corp., Ignyte Technology, Inc., and Jeff Stark, dated as of March 6, 2001. (Incorporated by reference to Registrant’s Registration Statement on Form S-3 (File No. 333-61168), filed on May 17, 2001).
2.5	Agreement and Plan of Merger and Reorganization, dated November 18, 2005, by and among the Registrant, Spectrum Acquisition Corporation and Lasso Logic, Inc., et al. (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the year ended December 31, 2005, filed on March 15, 2006).
2.6	Agreement and Plan of Merger, dated February 7, 2006, by and among the Registrant, Meridian Acquisition Corporation, MailFrontier, Inc., and Anne Bonaparte and Sonja Hoel, as the Representatives. (Incorporated by reference to the Registrant’s Current Report on Form 8-K (File No. 0000950134-06-003922), filed on February 28, 2007).
2.7	Agreement and Plan of Merger, date June 12, 2007, by and among the Registrant, Avalon Acquisition Corp. and Aventail, including amendment number one thereto effective July 5, 2007. (Incorporated by reference to the Registrant’s Current Report on Form 8-K (File No. 0001093885-07-000004), filed on July 7, 2007).
3.1	Registrant’s Amended and Restated Articles of Incorporation (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
3.2	Registrant’s Bylaws, as amended December 12, 2003 (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the year ended December 31, 2005, filed on March 15, 2006).

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Number	Description
3.3	Bylaws of SonicWALL, Inc., as Amended July 24, 2007. (Incorporated by reference to the Registrant’s Current Report on Form 8-K (File No. 0001093885-07-000008), filed on July 30, 2007).
4.1	Registrant’s specimen common stock certificate (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
10.1	Registrant’s 1994 Stock Option Plan, as amended to date (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
10.2	Form of Stock Option Agreement for Registrant’s 1994 Stock Option Plan (Incorporated by reference to the Registrant’s Filing on Schedule TO (File No. 005-58485), filed on January 9, 2003).
10.3	Registrant’s 1998 Stock Option Plan, as amended to date (Incorporated by reference to the Registrant’s 2000 Definitive Proxy Statement (File No. 000-27723), filed on November 7, 2001).
10.4	Form of Stock Option Agreement for Registrant’s 1998 Stock Option Plan (Incorporated by reference to the Registrant’s Filing on Schedule TO (File No. 005-58485), filed on January 9, 2003).
10.5	Registrant’s 1999 Employee Stock Purchase Plan (Incorporated by reference to the Registrant’s 2003 Definitive Proxy Statement (File No. 000-27723), filed on November 5, 2003).
10.6	Form of Stock Option Agreement under Phobos Corporation 1998 Stock Plan (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 (File No. 333-54976), filed on February 5, 2001).
10.7	Form of Stock Option Agreement under Phobos Corporation 1999 Stock Plan (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 (File No. 333-54976), filed on February 5, 2001).
10.8	RedCreek Communications, Inc. 2001 Stock Option Plan (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 (File No. 333-81492), filed on January 28, 2002).
10.9	Employment agreement dated June 21, 2003 between Registrant and Kathleen Fisher (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended June 30, 2003, filed on August 14, 2003).
10.10	Registrant’s Form of Individual Compensation Arrangements (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 (File No. 333-81492), filed on January 28, 2002).
10.11	Form of Indemnification Agreement entered into by Registrant with each of its officers and directors (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended September 30, 2001, filed on November 14, 2001).
10.12	Loan and Security Agreement dated May 26, 1995 between Registrant and Comerica Bank (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).

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Number	Description
10.13++	Distribution Agreement dated February 9, 1999 between Registrant and Tech Data Product Management, Inc. (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
10.14++	Distribution Agreement dated July 5, 1998 between Registrant and Sumitomo Metal Systems Development Co., Ltd. (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
10.15++	Distribution Agreement dated November 11, 1992 between Registrant and Ingram Micro, Inc. (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
10.16	Agreement of Sublease dated as of October 26, 1998 between Registrant and AMP Incorporated (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
10.17	Purchase Agreement dated September 28, 1999 between Registrant and Flash Electronics Inc. (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
10.18	Lease dated September 27, 1999 between Registrant, as Tenant, and AMB Property, L.P., as Landlord (Incorporated by reference to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-85997), which became effective on November 9, 1999).
10.19		First Amendment to Lease dated May 2, 2001 between Registrant, as Tenant, and AMB Property, L.P., as Landlord (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the fiscal year ended December 31, 2001, filed on April 1, 2002).
10.20		Second Amendment to Lease dated September 26, 2001 between Registrant, as Tenant, and AMB Property, L.P., as Landlord (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the fiscal year ended December 31, 2001, filed on April 1, 2002).
10.21++		OEM Hardware (with Software) License and Purchase Agreement effective as of May 29, 2001 between Registrant and Cisco Systems, Inc. (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the fiscal year ended December 31, 2001, filed on April 1, 2002).
10.22++		Amendment Number One to OEM Hardware (with Software) License and Purchase Agreement dated June 25, 2002 between Registrant and Cisco Systems, Inc. (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended June 30, 2002, filed on August 14, 2002).
10.23		Employment agreement dated March 14, 2003 between Registrant and Matthew Medeiros (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the fiscal year ended December 31, 2002, filed on March 31, 2003).
10.24		Employment agreement dated August 11, 2003 between Registrant and Michael Stewart (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended September 30, 2003, filed on November 14, 2003).

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Number	Description
10.25	Employment agreement dated October 29, 2003 between Registrant and Robert Knauff (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the fiscal year ended December 31, 2003, filed on March 15, 2004).
10.26	Manufacturing and Purchase Agreement dated June 4, 2004 by and between Flash Electronics, Inc. and SonicWALL, Inc. (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended June 30, 2004, filed on August 9, 2004).
10.27	Third Amendment to Lease executed on April 28, 2004 by and between AMB Property, L.P., as Landlord, and SonicWALL, Inc. as Tenant. (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended June 30, 2004, filed on August 9, 2004).
10.28	Retention and Severance Agreement for Executive Officers dated April 20, 2004. (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended June 30, 2004, filed on August 9, 2004).
10.29	Registrant’s Stock Option Agreement dated July 29, 2004 (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended September 30, 2004, filed on November 9, 2004).
10.30	Employment Agreement as amended and restated July 29, 2004 between Registrant and Matthew Medeiros (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended September 30, 2004, filed on November 9, 2004).
10.31	Stock Option Agreement dated July 29, 2004 between Registrant and Outside Directors (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended September 30, 2004, filed on November 9, 2004).
10.32	Issuer Repurchase Plan Agreement dated November 29, 2004 between Registrant and RBC Dain Rauscher Inc. (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the year ended December 31, 2004, filed on March 21, 2005).
10.33	Issuer Repurchase Plan Agreement amended and restated, dated February 15, 2005 between Registrant and RBC Dain Rauscher Inc. (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the year ended December 31, 2004, filed on March 21, 2005).
10.34	Lease dated December 19, 2006 between Registrant, as Tenant, and Kolte Patil Developers Limited, as Landlord (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 0000950134-07-005644) for the year ended December 31, 2006, filed on March 14, 2007).
10.35	Issuer Repurchase Plan Agreement amended and restated, dated November 3, 2006 between Registrant and RBC Dain Rauscher Inc. (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 0000950134-07-005644) for the year ended December 31, 2006, filed on March 14, 2007).
10.36	Registrant’s Employee Stock Purchase Plan, dated August 24, 1999, as amended August 1, 2006 (Incorporated by reference to the Registrant’s Annual Report on Form 10-K (File No. 0000950134-07-005644) for the year ended December 31, 2006, filed on March 14, 2007).

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Number	Description
10.37	Lease dated September 25, 2007 between Registrant, as Tenant, and TMC-3011 S 52nd ST, LLC, as Landlord. (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 0001093885-07-000021) for the quarter ended September 30, 2007, filed on November 7, 2007).
10.38	Lease dated February 1, 2008 between Aventail Info Tech Private Limited, a subsidiary of the Registrant, as Tenant, and Salarpuria Softzone, as Landlord, and SPPL Property Management Private Limited, as Maintenance Service Provider. (Incorporated by reference to the Registrant’s Annual Report on Form 10K (File No. 0000950134-08-004440) for the year ended December 31, 2007, filed on March 10, 2008).
10.39	Limited Licensed Materials License Agreement dated December 14, 2007 between Registrant, as Licensee, and Linkbit, Inc. (Incorporated by reference to the Registrant’s Annual Report on Form 10K (File No. 0000950134-08-004440) for the year ended December 31, 2007, filed on March 10, 2008).
10.40	Registrant’s 2008 Equity Incentive Plan (Incorporated by reference to the Registrant’s Current Report on Form 8-K (File No. 0001093885-08-000017), filed on June 16, 2008).
10.41	Registrant’s 2008 Inducement Equity Incentive Plan (Incorporated by reference to the Registrant’s Current Report on Form 8-K (File No. 0001093885-08-000017), filed on June 16, 2008).
10.42	Registrant’s 2008 Inducement Equity Incentive Plan as amended (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 0001093885-08-000027) for the quarter ended September 30, 2008, filed on October 31, 2008).
10.43	Registrant’s Deferred Compensation Plan as amended and restated August 8, 2008 (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 0001093885-08-000027) for the quarter ended September 30, 2008, filed on October 31, 2008).
10.44	Employment Agreement as amended and restated, dated October 20, 2008 between Registrant and Matthew Medeiros (Incorporated by reference to the Registrant’s Annual Report on Form 10K (File No. 0001093885-09-000007) for the year ended December 31, 2008, filed on March 6, 2009).
10.45	Retention and Severance Agreement as amended and restated, dated October 20, 2008 among Registrant and Executive Officers (Incorporated by reference to the Registrant’s Annual Report on Form 10K (File No. 0001093885-09-000007) for the year ended December 31, 2008, filed on March 6, 2009).
10.46++	Lease dated June 19, 2009 between Registrant, as Tenant, and Xilinx, as Landlord. (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 0001093885-09-000025) for the quarter ended June 30, 2009, filed on August 7, 2009).
10.47	Registrant’s 2008 Equity Incentive Plan Restricted Stock Unit Agreement (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 0001093885-09-000025) for the quarter ended June 30, 2009, filed on August 7, 2009).
10.48	Second Amendment to Lease dated August 12, 2009 between the Registrant, as Tenant, and Xilinx, as Landlord. (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 0001093885-09-000036) for the quarter ended September 30, 2009, filed on November 6, 2009).

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Number	Description
10.49	Distribution Agreement dated April 18, 2002 between Registrant and Alternative Technology, Inc. (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 0001093885-09-000036) for the quarter ended September 30, 2009, filed on November 6, 2009).
10.50	Amendment to Distribution Agreement dated October 6, 2006 between Registrant and Alternative Technology, Inc. (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (File No. 0001093885-09-000036) for the quarter ended September 30, 2009, filed on November 6, 2009).
21.1*	List of Subsidiaries.
23.1*	Consent of Independent Registered Public Accounting Firm
31.1*	Certification of Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-15(e) and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*	Certification of Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-15(e) and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*	Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

*	Filed herewith.

++	Confidential treatment has been obtained or requested for portions of this exhibit. The omitted material has been separately filed with the Securities and Exchange Commission.

(b) Exhibits

See Item 15(a) (3) above.

See Item 15(a) (2) above.

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SIGNATURES

Pursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of San Jose, State of California.

Date: March 5, 2010

	SonicWALL, Inc.
By:	/s/ Matthew Medeiros
	Matthew Medeiros Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.

Signature	Title	Date


/s/ Matthew Medeiros	President, Chief Executive Officer and
Matthew Medeiros	Director (Principal Executives Officer)	March 5, 2010

/s/ Robert Selvi	Chief Financial Officer
Robert Selvi	(Principal Financial Officer)	March 5, 2010

/s/ Robert Knauff	Chief Accounting Officer
Robert Knauff	(Principal Accounting Officer)	March 5, 2010

/s/ John C. Shoemaker
John C. Shoemaker	Chairman of the Board of Directors	March 5, 2010

/s/ Charles Berger
Charles Berger	Director	March 5, 2010

/s/ David W. Garrison
David W. Garrison	Director	March 5, 2010

/s/ Charles Kissner
Charles Kissner	Director	March 5, 2010

/s/ Edward F. Thompson
Edward F. Thompson	Director	March 5, 2010

/s/ Cary Thompson
Cary Thompson	Director	March 5, 2010

/s/ Clark Masters
Clark Masters	Director	March 5, 2010

/s/ Carl A. Thomsen
Carl A. Thomsen	Director	March 5, 2010

Page 102 of 103

Table of Content

Schedule II

VALUATION AND QUALIFYING ACCOUNTS

	Balance at Beginning of Year		Other			Charged to Cost and Expenses		Deductions/ Write-off of Accounts			Balance at End of Year
	(in thousands)
Year ended December 31, 2007
Allowance for doubtful accounts		152		213			87		(275	)		177
Year ended December 31, 2008
Allowance for doubtful accounts		177		(171	)		233		(126	)		113
Year ended December 31, 2009
Allowance for doubtful accounts		113		-			-		(27	)		86

Page 103 of 103

SONICWALL INC - FORM 10-K - March 5, 2010

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