Letter to our Stockholders

Dear Blue Coat Systems Stockholders:

Fiscal 2005 was a good year for Blue Coat Systems and the proxy appliance business. This year an increasing number of enterprises realized that the Web can be a cesspool that creates significant businessrisks. These organizations look to Blue Coat’s proxy appliances to protect, control, and accelerate their web infrastructure. Our success in the last year was due to a combination of increased awareness of proxysolutions to web problems and our improved product capabilities versus our major competitors in the proxy appliance space. We continued to make strategic investments in our business throughout the year to strengthen our market position, and we are very excited about our growth opportunities as we move intofiscal year 2006.

With the Web browser quickly becoming the universal client for enterprise applications, organizations learned there are many “bad” things that “good” employees can do on the Web. Bandwidth hoggingapplications, such as peer-to-peer (P2P) file downloads and streaming audio/video consume valuable network bandwidth. Web-based viruses circumvent existing anti-virus protection, and inappropriate Web surfing exposes organizations to legal liabilities. Organizations now understand that they must gain visibility and control of their employees’ Web communications to minimize risks to their business, and that a proxy appliance is the best way to do that while maintaining the “real-time” performance demanded by Web communications. As a result, more and more organizations – including influential organizations such as Wal-Mart, Ericsson, Federal Deposit and Insurance Corporation (FDIC), Hong Kong Broadband andConocoPhillips are turning to Blue Coat and our proxy appliances to provide a safe and productive Web environment.

From a financial perspective, we are pleased with our growth and achievement of profitability on an annualbasis for the first time in our company’s history. We had net revenue of $96.2 million -- an increase of 45.6% compared to fiscal year 2004. Our GAAP net income for the year was $5.4 million, or $0.41 per share,compared to a GAAP net loss of $0.3 million, or $0.03 per share, for fiscal year 2004. We increased our cash, cash equivalents and restricted investments to $49.1 million, up from $41.5 million at the end of fiscal2004. Our gross profit was 67.4% in fiscal 2005.

Looking to fiscal year 2006, we are excited about our growth opportunity. Organizations understand the value of deploying proxy appliances at the core of the network, and are now starting to add more proxy appliancesthroughout their distributed organizations. Just as routers and firewalls moved from the core of networks out to the regional and branch locations, we are starting to see the same trend occur with proxy appliances.

In conclusion, fiscal 2005 was a year of growth and profitability for Blue Coat. We enter fiscal 2006 with solid momentum and, going forward, will continue to make the appropriate investments in our business tomaintain that momentum. Finally, I would like to thank our customers, stockholders, partners and employees for their continued support and trust. The opportunity before us is significant, and I look forward to continuing our business success in fiscal 2006.

Sincerely,

Brian M. NeSmithPresident & Chief Executive Officer

Forward Looking Statements

The statements contained in this letter to stockholders that are not purely historical are forward-looking statements, including statements regarding BlueCoat Systems’ growth and future operating performance, expectations, beliefs, intentions or strategies regarding the future. All forward-looking statementsincluded in this letter to stockholders are based upon information available to Blue Coat Systems as of the date hereof, and Blue Coat Systems assumes no obligation to update any such forward-looking statements. Forward-looking statements involve risks and uncertainties, which could cause actual resultsto differ materially from those projected. These and other risks relating to Blue Coat Systems’ business are set forth in Blue Coat Systems’ most recentlyfiled Form 10-K for the year ended April 30, 2005, and other reports filed from time to time with the Securities and Exchange Commission.

The adoption of the Web browser as the medium forapplication access and Internet communication hascompletely permeated the computing environment.More than ever, companies are implementingbrowser-based applications as solutions for nearlyevery aspect of their business operations. With thesame intensity, employees have adopted the use ofthe browser as the means to obtain and communicate information over the Internet.

While the Web browser has become the universalclient for mission-critical business communications and information, it has also led to growing risks for the enterprise. Organizations are now facing

increased help desk calls due to spyware-infectedPCs, legal liabilities associated with inappropriate Web surfing and content, and opened backdoors forviruses with instant messaging (IM) and personal Web based email. When every user on the networkhas Internet access, every user also has the means to negatively affect the business, intentionally or not.

Blue Coat® helps organizations make the Web safe and productive for business. Blue Coat proxyappliances provide visibility and control of Webcommunications to protect organizations from therisks of spyware, Web viruses, inappropriate Websurfing, instant messaging (IM), video streaming and peer-to-peer (P2P) file sharing - while actuallyimproving Web performance.

While security devices such as firewalls block internal networks from external access, it's proxyappliances that provide visibility and control of alluser-initiated Web communications. As a result, more and more organizations—including 70% of

the Dow Jones Industrialcompanies—rely on Blue Coat's high performance proxyappliances to control how theiremployees use the Internet.

The Blue Coat ProxySG™ familyof proxy appliances providestotal visibility and control of Web communications, whileactually improving Webperformance. Based on BlueCoat SGOS™, a custom,

object-based operating system with integratedcaching, these proxy appliances leverage existingauthentication systems to enable flexible policyenforcement down to the individual user. ProxySGprovides comprehensive proxy support of all Webprotocols with integrated content filtering, spywareprevention, Web virus scanning, instant messaging

Making the Web Good for Business.

“The ProxySG and ProxyAV appliances from Blue Coat serve as a central platform

for enabling spyware prevention, Web virus scanning and Web filtering across our

statewide network. We are very pleased with the effectiveness of Blue Coat's

products in preventing viruses from attacking our network and actually making

our network perform faster”

--Thomas Jarrett, CIOState of Delaware Department of Technology and Information

control, peer-to-peer (P2P) control, streaming control, and pop-up ad blocking.

Along with the ProxySG solution, Blue Coat offers theProxyAV family of appliances that provide scalable,high-performance, real-time scanning of Web content for viruses, worms and trojans. Pairing theProxyAV with the ProxySG provides significantadvantages for high-speed Web virus scanning thatstandalone systems cannot match. Both the ProxyAV

400 and the ProxyAV 2000 provide comprehensivefeatures with easy deployment - and a choice of virus scanning engines from Sophos, McAfee,Kaspersky, and Panda.

Blue Coat's end-to-end product portfolio includespowerful reporting, policy and configurationmanagement software - delivering a scalable proxysystem architecture for centralized or distributedenterprise environments.

Blue Coat provides proxy appliances to protect, control, and accelerate Web communications.

UNITED STATESSECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K(MARK ONE)È ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934FOR THE FISCAL YEAR ENDED APRIL 30, 2005

OR

‘ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 000-28139

BLUE COAT SYSTEMS, INC.(Exact Name of Registrant as Specified In Its Charter)

DELAWARE 91-1715963(State or Other Jurisdiction ofIncorporation or Organization)

(IRS EmployerIdentification)

650 ALMANOR AVENUESUNNYVALE, CALIFORNIA 94085

(Address of Principal Executive Offices) (Zip Code)

Registrant’s Telephone Number, Including Area Code: (408) 220-2200

Securities Registered Pursuant to Section 12(b) of the Act:Title of Each Class Name of Exchange on Which Registered

None NoneSecurities Registered Pursuant to Section 12(g) of the Act:

Common Stock, $.0001 Par Value(Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to such filing requirements for the past90 days. Yes È No ‘

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

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

The aggregate market value of the Common Stock held by non-affiliates of the Registrant (based on theclosing price for the Common Stock on the Nasdaq National Market on October 29, 2004) was approximately$178,790,428.

As of June 30, 2005, there were 12,394,350 shares of the Registrant’s Common Stock outstanding.DOCUMENTS INCORPORATED BY REFERENCE

Documents Incorporated by Reference: Part III of this Annual Report on Form 10-K incorporatesinformation by reference from the Registrant’s Proxy Statement for its 2005 Annual Meeting of Stockholders.Except as expressly incorporated by reference, the Registrant’s Proxy Statement shall not be deemed to be a partof this Annual Report on Form 10-K.

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BLUE COAT SYSTEMS, INC.

ANNUAL REPORT ON FORM 10-KTABLE OF CONTENTS

PAGE

PART I.

Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

PART II.

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters . . . . . . . . . . . . . . . . 28Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations . . . 31Item 7A. Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . 45Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure . . . 78Item 9A. Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78Item 9B. Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79

PART III.

Item 10. Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder

Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80Item 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80Item 14. Principal Accountant Fees and Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80

PART IV.

Item 15. Exhibits, Financial Statement Schedules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85Exhibit Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86Schedule II . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89

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PART I.

Item 1. Business

The discussion in this Annual Report on Form 10-K contains forward-looking statements that involve risksand uncertainties. The statements contained in this Report that are not purely historical are forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended, including statements on revenue expectations, future productacceptance, future product and sales development, future operating results, and future cash usage, as well asstatements regarding our expectations, beliefs, intentions or strategies regarding the future. All forward-lookingstatements included in this document are based on information available to us on the date hereof. We assume noobligation to update any such forward-looking statements. Our actual results could differ materially from thoseindicated in such forward-looking statements. Factors that could cause or contribute to such differences include,but are not limited to, our limited ability to forecast quarterly operating results and meet analyst or investorexpectations, inability to create additional sales through our sales channel partners, variability in net revenueand earnings resulting from deferred revenue, manufacturing delays and price increases from our third-partymanufacturers, supply shortage, inability to maintain a competitive position in the proxy appliance market,increased competition and inability to compete with our competitors, costs and effort in responding toinvestigations from the Securities and Exchange Commission (“SEC”), inability to sustain profitability,unpredictable increase in demand for our products, product concentration, technological changes, gross marginfluctuations, reliance on third-party software licenses, inability to generate increased international sales,unpredictable macroeconomic conditions, unpredictable sales cycles, legislation surrounding corporategovernance and internal controls, undetected product errors, foreign currency exchange rate movements andeconomic conditions in foreign markets, inability to attract and retain key employees, costs and effort indefending a Class Action Lawsuit, inability to defend our intellectual property rights, inability to raise additionalcapital, gross margin erosion from large sales deals, increased litigation, new accounting standards, futureacquisitions, product liability claims, occurrence of a natural disaster, volatility in our stock price and otherrisks discussed in this item under the heading “Factors Affecting Future Operating Results” and the risksdiscussed in our other recent SEC filings.

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

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

Overview

As organizations grow increasingly dependent on the Internet to communicate with customers, partners andemployees, the Web browser is fast becoming the universal window into mission-critical communications andinformation. This has many advantages for the enterprise: Web-based applications and protocols are fast,inexpensive and easy to deploy and manage. But these benefits can lead to increased risks for the enterprise, suchas increased help-desk calls due to spyware, legal liabilities associated with inappropriate Web surfing andcontent, open back doors for Web viruses to enter via instant messaging (“IM”) or personal Web email, networkbandwidth and storage abuse due to peer-to-peer (“P2P”) file sharing and video streaming, and productivitylosses from non-business related Web surfing and IM chatting. When every user on the network has a Web

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browser, every user also has the means to negatively affect the network infrastructure, whether intentionally ornot. A solution is to use a proxy appliance that is designed to provide Web visibility and control while alsoimproving network performance.

Blue Coat proxy appliances help organizations make the Web safe and productive for business, providingvisibility and control of Web communications to protect against risks from spyware, Web viruses, inappropriateWeb surfing, IM, video streaming and P2P file sharing - while actually improving Web performance. Positionedin the network between the users and the Internet, proxy appliances do not replace existing perimeter securitydevices; rather, they complement network firewalls by providing granular policy-based controls over Web trafficin ways that firewalls and other externally focused devices cannot.

Blue Coat Solutions

The Blue Coat ProxySG™ family of proxy appliances provides enhanced visibility and control of Webcommunications while actually improving Web performance. Based on Blue Coat SGOS™, a custom, object-based operating system with integrated caching, these proxy appliances leverage existing authentication systemsto enable flexible policy enforcement down to the individual user. ProxySG provides comprehensive proxysupport of all Web protocols with integrated content filtering, spyware prevention, web virus scanning, instantmessaging control, peer-to-peer control, streaming control and pop-up ad blocking.

The ProxyAV™ family of appliances integrates with the ProxySG to provide scalability and performance inreal-time scanning of Web-based file downloads for viruses, worms and Trojans. Pairing the ProxyAV with theProxySG provides significant advantages for high-speed Web virus scanning that standalone systems cannotmatch. Both the ProxyAV 400 and ProxyAV 2000 series appliances provide the same comprehensive featureswith easy deployment and a choice of virus scanning engines from Sophos, McAfee and Panda.

Blue Coat’s end-to-end product portfolio includes powerful reporting, policy and configuration managementsoftware - delivering a scalable proxy system architecture for centralized or distributed enterprise environments.Each of these features is described in more detail below.

Web Proxy

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

Configured as a proxy server deployed between corporate users and the Internet, Blue Coat proxyappliances intelligently manage user requests for content. When a user selects a Universal Resource Locator(“URL”), the request first goes to the Blue Coat proxy appliance for authentication and authorization. If theobjects from the requested page are already “cached” or stored on the Blue Coat appliance, they are immediatelyserved to the user. If the objects are not stored locally, the Blue Coat appliance acts as a proxy for the user bycommunicating to the origin server via the Internet. When the objects are returned from the origin server, a copyis delivered to the user and also stored in the system’s cache to serve all subsequent requests. The entiretransaction is monitored and logged for reporting and analyses purposes.

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

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Web Filtering

URL filtering, or the ability to control access to Web sites, is critical to minimizing an organization’sbusiness risk. Inappropriate Web surfing can lead to decreased worker productivity and the introduction ofviruses. Both situations can result in considerable financial costs for any company. Other security breaches occurthrough inappropriate Web use such as the loss of intellectual property and other proprietary information.Unsanctioned Web-based applications can also consume large amounts of network bandwidth and the viewing ofadult content sites by employees can lead to costly lawsuits.

Blue Coat proxy appliances provide policy controls in performance-based hardware and a custom operatingsystem to give enterprises visibility and control over their employee’s Web communications. Combined withcomprehensive enterprise policy controls, the Blue Coat ProxySG appliances provide the necessary componentsfor effective content filtering.

Effectively controlling spyware, P2P, or IM requires deep content inspection and a high level of systemperformance. Controlling spyware, for example, not only requires URL filtering but also the ability to recognizeand block “drive-by” installers, scan for known spyware signatures and detects spyware communication attempts.A URL filtering list alone cannot provide this level of content inspection to all instances of spyware activity. TheBlue Coat solution combines custom hardware with a high-performance operating system, unique policyarchitecture with deep content inspection and an integrated proxy cache that stores commonly accessed content.The Blue Coat solution extends the reach of URL filtering with the performance that organizations require.

URL filtering deployed on a ProxySG (On-Proxy) integrates the scalability, performance, and protection ofthe proxy appliance with a comprehensive URL database. Blue Coat offers customers the option of integratingtheir choice of URL filtering database on-proxy, including Blue Coat Web Filter, Secure Computing’sSmartFilter, SurfControl Web Filter, Websense Enterprise, ISS Proventia Web Filter, ALSI InterSafe, andCyberGuard Webwasher.

The Blue Coat ProxySG also supports custom category creation, exceptions and overrides. Combined with acustomer’s preferred URL filtering list, custom categories can be defined for special circumstances enabling anorganization to advise, coach, and enforce corporate Internet policies and apply additional content securitycontrols. These lists can act as both “black lists” (undesirable content) and “white lists” (allowed content).

Automatic URL updates ensure that the vendor’s list stays current on the ProxySG appliance while log filessecurely transferred to the favorite reporting solution produce reports for providing visibility of webcommunications.

Web Anti-Virus

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

Blue Coat now enables organizations to deploy Web anti-virus with scalable, high-performance optionsdesigned to meet the “real-time” requirements of Web traffic. Blue Coat has developed the ProxyAV appliance, ahigh-performance Web anti-virus appliance that delivers up to 249 Mbps throughput and 4 millisecond averagelatency for “real-time” Web traffic virus scanning. The ProxyAV appliance works in concert with Blue Coat’sProxySG platform, which quickly and intelligently processes Web objects to determine which objects should bescanned for viruses. Suspect Web objects are then sent to the ProxyAV appliance where they are quickly scanned

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for viruses using the Sophos, McAfee or Panda virus scanning engine. If deemed clean by the scanning engine, asignal is sent back to the ProxySG indicating that delivery of the object may proceed to the end-user. Cleanobjects are also cached on the ProxySG for an additional performance benefit.

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

Spyware Prevention

Spyware and adware pose security, privacy and productivity risks for the enterprise. Users, oftenunknowingly, download spyware and Web content providers are financially incented to disperse spyware agents.This results in backdoors, key loggers, information collection, privacy breaches, and network abuse as spywarequietly “calls home.” It also crashes browsers, slows networks and overwhelms IT help desks.

Spyware leverages multiple vectors to be successful, making silver bullet defenses using coarse-grainedcontrols useless and unproductive, impeding critical Web-based business communications. No single techniquecan filter out spyware and adware to defend against the threat.

Blue Coat provides a preventive spyware defense that combines multiple techniques in a high-performancesolution acceptable for Web-based business communications. Latency is minimal and the protection layers arecomprehensive to stop, block and scan spyware without impeding business processes.

Blue Coat’s proxy-based gateway anti-spyware solution utilizes advanced policy controls to stop “drive-by”spyware installations, which secretly install on desktop computers without user knowledge. The comprehensivesolution also blocks access to known spyware Web sites and scans Web content for known spyware signatures.In addition, Blue Coat’s solution identifies and reports infected computers to IT administrators, while end-usersare also notified that a spyware clean-up is required.

Instant Messaging Control

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

Peer-to-Peer (P2P) Control

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

• Decreased bandwidth for mission critical applications;

• Law suits stemming from music and motion picture copyright infringement;

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• Introduction of adware, spyware, viruses and worms to the enterprise;

• Decreased user productivity when searching for files and listening/viewing content;

• Possible customer service delays due to network congestion; or

• Possible loss of revenue through poor response times.

P2P file sharing services allow an employee to circumvent corporate security measures. The very nature ofthe P2P client design is to evade firewalls and general network security. Blocking P2P at the firewall has provento be extremely difficult because the application is capable of port-hopping, or finding open ports on the firewall.Because of the agile nature of P2P applications, P2P file sharing can be very difficult for administrators to detect,much less control. P2P packets cannot be classified simply by looking at packet headers such as IP address andport number.

Controlling the use of P2P in the enterprise requires a solution that is as dynamic as the problem itself. Thismeans that an administrator must be able to evaluate the P2P problem from their own network perspective andapply controls that relate to their company’s policy needs. Blue Coat provides the architecture for immediate anddynamic P2P control. Blue Coat’s ProxySG allows an administrator to log and control P2P traffic to the degreerequired. Additionally, as P2P clients change, the ProxySG policy can be adjusted to capture new clients,blocking P2P communications to and from the Internet.

Bandwidth Management

Left unchecked, streaming media and recreational Web surfing can clog corporate networks withunnecessary traffic and limit mission-critical applications of the bandwidth needed to run effectively.Additionally, both service providers and corporations need to be able to protect themselves from flash-trafficsituations and to manage their external bandwidth access costs. To protect bandwidth and scale a networkrequires infrastructure that employs policy-based controls to manage content, users and protocols.

Blue Coat ProxySG appliances provide a proven, flexible way to control and apply content-based protectionpolicies for network bandwidth. With Blue Coat solutions, companies can control their network by applying:

• Policy-based Bandwidth Limits: Create policies to constrain who can use certain media types, and howmuch. For example, companies can allow their executives to view high-bandwidth streaming media, butonly allow the accounting group to view streams up to 56k on corporate sites.

• Deny by content type: Flexible policy architecture limits certain users or network segments access tolarge amounts of data that potentially clog corporate networks. For example, block MP3 files from beingdownloaded. Or, block MP3 files for everyone except the Webmaster who may require audio files tocomplete a corporate project.

• Access control based on user, group, network address and time of day: Prevent all access to the Internetexcept for a group of users that need access to do their jobs, effectively freeing bandwidth for mission-critical needs.

• Content positioning: Provides pre-positioning of content commonly accessed by users. Tools areavailable that let administrators pre-position large data types like multimedia and streaming content,effectively optimizing the use of expensive WAN links through intelligent content positioning policies.

• Caching: Integrated into every Blue Coat appliance is patent-pending, intelligent caching softwareenabling Web and multimedia content to be stored locally - closer to users. With up to 60 percent ofend-user requests for content being redundant, caching provides a foundation for bandwidthmanagement.

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Products

The Blue Coat ProxySG family of appliances includes the ProxySG 200 Series, 400 Series, 800 Series and8000 Series. The four ProxySG appliance models are very similar in terms of functionality, but differ mainly interms of their performance characteristics and scalability. The Blue Coat ProxyAV Web anti-virus appliancesinclude the ProxyAV 400 Series and same as ProxyAV 2000 Series. These two models are also similar infunctionality but differ primarily in terms of performance and scalability. The Blue Coat Spyware Interceptoranti-spyware appliance comes in one model and is designed for networks with 1,000 users or less. We currentlylicense to our customers custom operating systems, which are used in conjunction with our ProxySG andProxyAV appliances, which include third party URL filtering software, third party anti-virus software and BlueCoat Reporter. We also manufacture an appliance called Director, which is used primarily to manage largenumbers of ProxySG appliances in a customer’s environment.

ProxySG

The ProxySG family of proxy appliances includes the 200 Series, 400 Series, 800 Series and 8000 Series.Based on Blue Coat SGOS™, a custom, object-based operating system with integrated caching, these proxyappliances leverage existing authentication systems to enable granular policy enforcement down to the individualuser. Blue Coat’s end-to-end product portfolio includes powerful reporting, policy and configurationmanagement software - delivering a scalable proxy system architecture for centralized or distributed enterpriseenvironments. Delivered as a rack mountable appliance for simple installation and management, these ICSA-certified solutions easily integrate with existing security and network infrastructure.

The ProxySG 200 and 400 Series appliances enable corporations to extend Web traffic protection andcontrol to the branch and remote locations, while significantly reducing the administration and management costsfor securing a distributed enterprise. Both the ProxySG 800 and the ProxySG 8000 Series appliances weredesigned to meet enterprise requirements for capacity, performance, availability and centralized management.While all four provide the same broad application support and features, the 8000 Series provides an expandable,modular platform for customizing disk size, RAM and network interface cards. Our ProxySG appliances arecomprised of a specialized hardware platform and our custom operating system (SGOS).

ProxySG 200 Series

The ProxySG 200 Series appliances are rack mount proxy appliances that extend Web visibility andcontrol to the branch office. The 200 Series appliances include secure remote administration capabilities,and provide flexible control and high-end performance with up to 512 megabytes (“MB”) of memory, 40gigabytes (“GB”) of disk capacity and a built-in pass-through card. Utilizing a custom, object-basedoperating system with integrated caching for performance, organizations can advise, coach and enforcegranular policies down to individual users.

ProxySG 400 Series

The Blue Coat ProxySG 400 Series are designed to increase control over branch and regional officeWeb communications while reducing the costs associated with distributed deployments. Available as a rackmountable or desktop device, the ProxySG 400 platform easily “drops in” to branch and regionalenvironments. The ProxySG 400 is available in two fixed configurations, one with a single 40GB disk driveand 256MB of random access memory (RAM), and the other with two 40GB disk drives and 512 MB ofRAM.

ProxySG 800 Series

The ProxySG 800 Series appliances are easy to manage and install in minutes with little ongoingmaintenance, optimized for regional and corporate office installations. The systems include removable, hot-

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swappable disk drives. Specific configurations range from systems with a single 36 GB disk drive and 512MB of RAM, to systems with four 73 GB disk drives and 2 GB of RAM.

ProxySG 8000 Series

Blue Coat ProxySG 8000 Series appliances represent the next generation in high-end applianceplatforms. These purpose-built proxy appliances provide enhanced visibility and control of Webcommunications with wire-speed performance. Specific configurations range from systems with two 73 GBdisk drives and 1 GB of RAM to systems with eight 73 GB disk drives and 4 GB of RAM.

ProxyAV

The ProxyAV family of Web anti-virus appliances includes the 400 Series and 2000 Series. The Blue CoatProxyAV enables organizations to scan for viruses, worms and trojans entering through Web-based backdoorsthat include personal Web email accounts where a majority of viruses and worms propagate, Web spam or emailspam which unknowingly activates trojan downloads, and browser-based file downloads that bypass existingvirus scanning defenses. The ProxyAV combined with the ProxySG provides scalability for virus scanning, pluscomprehensive visibility and control of enterprise Web communications. The ProxyAV leverages virus scanningengines from Sophos, McAfee and Panda. Our ProxyAV appliances are comprised of a specialized hardwareplatform.

ProxyAV 400 Series

The ProxyAV 400 Series represents the next generation in appliance platforms for enterprise Web anti-virus scanning. The ProxyAV 400 Series is a purpose-built Web anti-virus appliance designed for quickintegration with the ProxySG 800 Series appliance for deployment in medium enterprise or distributedenvironments. The ProxyAV is delivered in two fixed configurations, one with a single 850 megahertz(MHz) processor and 512 megabytes (MB) of random access memory (RAM), and the other with a single1.26 gigahertz (GHz) processor and 512 MB of RAM.

ProxyAV 2000 Series

The ProxyAV 2000 Series is an appliance designed for scalable performance and simple integrationwith the Blue Coat ProxySG appliance. The ProxyAV 2000 Series is available in four differentconfigurations ranging from systems with a single 2.0 gigahertz (GHz) Intel P4 Xeon processor with 768megabytes (MB) of random access memory (RAM), to dual 2.4 gigahertz (GHz) Intel P4 Xeon processorswith 3.0 gigabytes of RAM.

Spyware Interceptor

Blue Coat Spyware Interceptor is an effective anti-spyware appliance for networks with 1,000 users or less.Spyware Interceptor is built on Blue Coat’s proxy technology, and comes in an easy-to-deploy and affordableappliance form-factor. The appliance utilizes SCOPE™ (Spyware Catching Object Protection Engine) technologyto prevent both known and unknown forms of spyware at the gateway, which uniquely allows access tolegitimate Web applications and the ability to safely view spyware-laden Web sites without becoming infected.The spyware prevention capabilities in Spyware Interceptor are derived from Blue Coat’s enterprise focusedProxySG™ solution. Spyware Interceptor allows IT administrators to minimize futile cycles using ineffectivespyware cleaners.

Spyware Interceptor requires an annual license subscription based on the number of computers beingsupported. The subscription includes SCOPE engine updates, continuous spyware profile updates and BlueCoat’s policy optimization service backed by Blue Coat Labs.

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Blue Coat Reporter

The Blue Coat Reporter is a log processing and reporting product that generates out-of-the-box reportstailored for the Blue Coat proxy appliances. Reporter provides identity-based user and network reporting thathelps evaluate Web security policies and resource management. Because it is Web-based and cross-platform, itgives companies the flexibility to view Web usage reports from anywhere administrators or managers haveaccess to a network connection and a Web browser.

Blue Coat Director

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

• Reduce management costs by centrally managing all ProxySG appliances;

• Eliminate the need to configure remote devices manually;

• Rapidly deploy and upgrade ProxySG appliances;

• Distribute user security policy across the network; and

• Recover from system problems with configuration snapshots and recovery.

WinProxy Software

The Blue Coat WinProxy® SecureSuite is an Internet security and sharing software package. The softwareallows small organizations and users to share an Internet connection without having Internet sharing expertise.

Our Key Strategies

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

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

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

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

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Sales and Marketing

We utilize a combination of our territory-based sales teams, resellers and distributors as appropriate for eachof our target markets. We support our distribution channels with systems engineers and customer supportpersonnel that provide technical service and support to our customers. We have entered into agreements withresellers and distributors such as Westcon, Allasso, Nissho Electronics, Alternative Technologies and others.

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

Research and Development

We believe that strong product development capabilities are essential to our continued success and growth.Our research and development efforts are focused on developing new products as well as improvements andenhancements to our existing products. Research and development expenses were $16.5 million, $12.0 millionand $11.9 million for the fiscal years ended April 30, 2005, 2004 and 2003, respectively.

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

The market for proxy appliances is evolving rapidly. In order to stay competitive, we must make significantinvestments in research and development based on what we perceive to be the direction of the market. Wecurrently spend a significant amount of our resources on research and development projects and plan to continueto do so for the foreseeable future. Current research and development projects will enhance our position in themarketplace only if the proxy appliance market matures as we anticipate. Failure on our part to anticipate thedirection of the market and develop products that meet those emerging needs will seriously impair our business,financial condition, and results of operations.

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

Manufacturing

We currently outsource, to third parties, the manufacturing of our ProxySG products, except that we performfinal assembly and testing ourselves for our ProxySG 800. This approach allows us to reduce our investment inmanufacturing capital and to take advantage of the expertise of our vendors. Our internal manufacturingoperations consist primarily of prototype development, materials planning and procurement, and some finalassembly, testing and quality control. Our standard parts and components are generally available from more thanone vendor, while our custom parts are usually single sourced. We typically obtain these components throughpurchase orders and currently do not have contractual relationships or guaranteed supply arrangements with thesesuppliers. If one of these vendors ceased to provide us with necessary parts and components, we would likelyencounter delays in product production as we make the transition to another vendor, which could seriously harmour business. Furthermore, if actual orders do not match our forecasts (as we have experienced in the past), we

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may have excess or insufficient inventory of some materials and components or we could incur cancellationcharges or penalties, which would increase our costs or prevent or delay product shipments and could seriouslyharm our business.

Backlog

We typically ship products shortly after receipt of an order. Our backlog is comprised of deferred revenueand accepted product orders which have not shipped. Deferred revenue is derived from products which haveshipped to distributors but have not yet shipped to end customers, product shipments which do not yet qualify asrevenue in accordance with our revenue recognition policy, and service contracts. Aggregate backlog at April 30,2005 and April 30, 2004 was approximately $25.4 million and $15.4 million, respectively. We do not believe thatbacklog as of any particular date is indicative of future results.

Competition

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

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

Intellectual Property and Other Proprietary Rights

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

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We presently have several issued patents and pending U.S. patent applications. We cannot assure you thatwe will be able to detect any infringement or, if infringement is detected, that patents issued will be enforceableor that any damages awarded to us will be sufficient to adequately compensate us.

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

There has been a substantial amount of litigation in the technology industry regarding intellectual propertyrights and we recently settled a lawsuit, which alleged infringement of certain United States patents by us (SeeItem 8, Note 11 “Litigation” of the consolidated financial statements included in this Annual Report on Form10-K). Third parties may claim that we, or our current or potential future products, infringe their intellectualproperty. We expect that companies in the Internet and networking industries will increasingly be subject toinfringement claims as the number of products and competitors in our industry segment grows and thefunctionality of products in different industry segments overlaps. Any claims, with or without merit, could betime-consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty orlicensing agreements. Royalty or licensing agreements, if required, may not be available on terms acceptable tous or at all, which could seriously harm our business.

Acquisitions

On November 16, 2004, we completed our acquisition of Cerberian, Inc. (“Cerberian”). The purchase priceof approximately $19.3 million consisted of approximately 0.8 million shares of Blue Coat common stock valuedat $17.4 million, $0.4 million in direct transaction costs, Cerberian options assumed by Blue Coat valued atapproximately $0.5 million and the fair value of promissory notes from Cerberian to Blue Coat of $1.0 million.

On November 14, 2003, we completed the acquisition of Ositis Software, Inc. (“Ositis”). The purchase priceof $8.7 million consisted of 0.4 million shares of Blue Coat common stock valued at $6.7 million, $1.1 million incash, $0.9 million in direct transaction costs, and Ositis warrants assumed by the Company valued at $43,000.

Employees

As of April 30, 2005, we had a total of 336 employees, comprised of 116 in research and development, 115in sales, 11 in marketing, 39 in customer support, 15 in manufacturing and 40 in general and administrative. Ofthese employees, 234 were located in North America and 102 located internationally. None of our employees arerepresented by collective bargaining agreements, nor have we experienced any work stoppages. We consider ourrelations with our employees to be good.

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

Available Information

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

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FACTORS AFFECTING FUTURE OPERATING RESULTS

This Annual Report on Form 10-K contains forward-looking statements that involve risks and uncertainties,including statements about our future plans, objectives, intentions and expectations. Many factors, includingthose described below, could cause actual results to differ materially from those discussed in these forward-looking statements.

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

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

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

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

• Fluctuations in demand for our products and services;

• The market in which we compete is relatively new and rapidly evolving;

• Our sales cycle varies substantially from customer to customer;

• Variations in the mix of products sold;

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

• Our sales cycle may lengthen as the complexity of proxy appliance solutions continues to increase;

• The level of competition in our target product markets;

• Market acceptance of new products and product enhancements;

• Announcements, introductions and transitions of new products or product enhancements by us or ourcompetitors;

• Deferrals of customer orders in anticipation of new products or product enhancements introduced by usor our competitors;

• Technological changes in our target product markets;

• The percentage of our sales related to subscription-based products;

• Future accounting pronouncements and changes in accounting policies; and

• Our inability to predict future macro-economic conditions.

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

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

A significant amount of our revenue is generated through sales by our sales channel partners, which includedistributors, resellers and system integrators. During fiscal 2005, approximately 93.0% of our revenues weregenerated through our indirect sales channels. We increasingly depend upon these partners to generate salesopportunities and to independently manage the entire sales process. In order to continue to increase our revenue,we will need to maintain our existing sales channel partners and add new sales channel partners. If we cannot doso, our business will not grow and our operating results will be adversely affected.

We provide our sales channel partners with specific programs to assist them in selling our products, butthere can be no assurance that these programs will be effective. In addition, our sales channel partners may beunsuccessful in marketing, selling and supporting our products and services, may also market, sell and supportproducts and services that are competitive with ours, may devote more resources to the marketing, sales andsupport of products competitive to ours, or may cease selling our products and services altogether. We cannotassure you that we will retain these indirect channel partners or that we will be able to secure additional orreplacement partners. The loss of one or more of our key indirect channel partners or the failure to obtain andship a number of large orders each quarter through them could harm our operating results. Any new sales channelpartner will require extensive training and typically take several months to achieve productivity. Many of oursales channel partners do not have minimum purchase or resale requirements and carry products that arecompetitive with our products. If we fail to manage existing sales channels, our business will be seriouslyharmed.

In addition, a limited number of sales channel partners have accounted for a large part of our revenue todate. For example, one of our distributors accounted for 15.9%, 24.1% and 19.0% of our net sales during thefiscal year ended April 30, 2005, 2004 and 2003, respectively. If this distributor, or any of our other largedistributors, individually or in the aggregate, do not create additional sales, or fail to maintain their current levelsof marketing, sales and support of our products and services, our operating results could be adversely affected.Since our expense levels are based on our expectations as to future revenue and to a large extent are fixed in theshort term, any significant reduction or delay in sales of our products to any significant indirect channel partnersor unexpected returns from these indirect channel partners could harm our business.

If we are unable to establish fair value for any undelivered portion of a customer order, revenue relating tothe entire order will be deferred until the revenue recognition criteria for all portions of the customer orderare met. This could lower our net revenue in one period and increase it in future periods resulting in greatervariability in net revenue and earnings period to period.

In the course of our selling efforts, we often enter into arrangements with our customers that require us todeliver a combination of different appliances, software products or services. We refer to each individualappliance, software product or service as an “element” of the overall arrangement with our customer. In somecases, these arrangements require us to deliver particular elements in a future period. We do not recognizerevenue on any undelivered elements until we have fair value for the undelivered elements or such elements havebeen delivered to our customer. In the event we are unable to determine the fair value of any undeliveredelements, we defer the revenue from the entire arrangement rather than just the undelivered elements. As a result,a portion of the revenue we recognize in each quarter could relate to previously delivered products. As such, anincrease in the number of multiple element arrangements for which we cannot determine the fair value of anyundelivered elements would negatively impact our net revenues in the current period while increasing netrevenues in future periods. In addition, we may be unable to timely adjust our cost structure to reflect thisreduction in net revenue recognized in the current period which could reduce our earnings for the current period.In addition, if sales related to multiple element arrangements for which we cannot determine the fair value of anyundelivered elements increase significantly, sequential growth in our net revenue will decline since revenueassociated with such arrangement will be recognized in future periods.

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Because we depend on several third-party manufacturers to build our products, we are susceptible tomanufacturing delays and sudden price increases, which could prevent us from shipping customer orders ontime, if at all, and may result in the loss of sales and customers.

We currently purchase base assemblies or final assemblies for all of our current appliances. Our reliance onour third-party manufacturers reduces our control over the manufacturing process, exposing us to risks, includingreduced control over quality assurance, product costs and product supply. Any manufacturing disruption by ourthird-party manufacturers could impair our ability to fulfill orders. We also rely on several other third-partymanufacturers to build portions of our products. If we or our suppliers are unable to manage the relationshipswith these third-party manufacturers effectively, or if these third-party manufacturers experience delays,disruptions, capacity constraints or quality control problems in their manufacturing operations, or fail to meet ourfuture requirements for timely delivery, our ability to ship products to our customers could be impaired and ourbusiness would be seriously harmed.

These manufacturers fulfill our supply requirements on the basis of individual purchase orders oragreements with us. Accordingly, these third-party manufacturers are not obligated to continue to fulfill oursupply requirements, and the prices we are charged for these components could be increased on short notice. Ifthere is any interruption in the operations of any one of these third-party manufacturers, or if we are required tochange third-party manufacturers, this would adversely affect our ability to meet our scheduled productdeliveries to our customers, which could cause the loss of existing or potential customers, or could increase ourcosts, which could adversely affect our gross margins.

In addition, the products that these third-party manufacturers build for us may not be sufficient in quality orin quantity to meet our needs. Our delivery requirements could be higher than the capacity of these third-partymanufacturers, which would likely result in manufacturing delays, which could result in lost sales and the loss ofexisting and potential customers. We cannot be certain that these third-party manufacturers will be able to meetthe technological or delivery requirements of our current products or any future products that we may developand introduce. The inability of these third-party manufacturers in the future to provide us with adequate suppliesof high-quality products, or the loss of any of our third-party manufacturers in the future, would cause a delay inour ability to fulfill customer orders while we attempt to obtain a replacement manufacturer. Delays associatedwith our attempting to replace or our inability to replace one of our third-party manufacturers would seriouslyharm our business by increasing our costs and affecting our gross margins.

We have no long-term contracts or arrangements with any of our third-party manufacturers that guaranteeproduct availability, the continuation of particular payment terms or the extension of credit limits. We haveexperienced in the past, and may experience in the future, problems with our third-party manufacturers, such asinferior quality, insufficient quantities and late delivery of product. To date, these problems have not materiallyadversely affected us. We may not be able to obtain additional volume purchase or manufacturing arrangementson terms that we consider acceptable, if at all. If we enter into a high-volume or long-term supply arrangementand subsequently decide that we cannot use the products or services provided for in the agreement, our businesswill be harmed. Any of these difficulties could harm our relationships with customers and cause us to lose orders.

In the future, we may seek to use additional third-party manufacturers. We may experience difficulty inlocating and qualifying suitable manufacturing candidates capable of satisfying our product specifications orquantity requirements.

Because some of the key components in our products come from limited sources of supply, we are susceptibleto supply shortages or supply changes, which could disrupt or delay our scheduled product deliveries to ourcustomers and may result in the loss of sales and customers.

We currently purchase several key parts and components used in the manufacture of our products fromlimited sources of supply. The introduction by these suppliers of new versions of their hardware, particularly ifnot anticipated by us, could require us to expend significant resources to incorporate this new hardware into our

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products. In addition, if these suppliers were to discontinue production of a necessary part or component, wewould be required to expend significant resources in locating and integrating replacement parts or componentsfrom another vendor. In particular, we currently purchase the microprocessor for our ProxySG 200 and SypwareInterceptor appliances from a supplier who has notified us of their intent to discontinue the manufacture of thisproduct. As a result, we are redesigning these appliances to allow us to utilize microprocessors from othersources. Our inability to modify the design of both the ProxySG 200 and Spyware Interceptor appliances andobtain microprocessors from an alternate supplier before on-hand inventories, and amounts expected to bereceived from existing purchase commitments, are depleted could have an adverse impact on our financialcondition and results of operations.

In addition, our reliance on a limited number of suppliers involves several risks, including:

• a potential inability to obtain an adequate supply of required parts or components;

• supplier capacity restraints;

• financial or other difficulties faced by our suppliers;

• price increases;

• timely delivery; and

• component quality.

Qualifying additional suppliers for limited source components can be time-consuming and expensive. Anyof these events would be disruptive to us and could seriously harm our business. Any interruption or delay in thesupply of any of these parts or components, or the inability to obtain these parts or components from alternatesources at acceptable prices and within a reasonable amount of time, would seriously harm our ability to meetour scheduled product deliveries to our customers.

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

To maintain our competitive position in a market characterized by rapid rates of technological advancement,we must continue to invest significant resources in research and development. We need to develop and introducenew products and enhancements to existing products on a timely basis that keep pace with technologicaldevelopments and emerging industry standards and address the increasingly sophisticated needs of ourcustomers. The introduction of new products by others, market acceptance of products based on new oralternative technologies, or the emergence of new industry standards, could render our existing products obsoleteor make it easier for other products to compete with our products. Our future success will depend in part uponour ability to:

• develop and maintain competitive products;

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

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

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

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

We intend to extend the offerings under our product families in the future, both by introducing new productsand by introducing enhancements to our existing products. However, we may experience difficulties in doing so,and our inability to timely and cost-effectively introduce new products and product enhancements, or the failure

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of these new products or enhancements to achieve market acceptance, could seriously harm our business. Theprocess of developing new technologies is complex and uncertain, and if we fail to accurately predict our targetcustomers’ changing needs and emerging technological trends, our business could be harmed. This processrequires commitment of significant resources to develop new products before knowing whether our investmentswill result in products the market will accept. Furthermore, we may not be able to execute on new productinitiatives because of errors in product planning or timing, technical hurdles that we fail to overcome in a timelyfashion, or a lack of appropriate resources. This could result in competitors providing those solutions before wedo and loss of market share and sales.

In addition, life cycles of our products are difficult to predict because the market for our products is new andevolving and characterized by rapid technological change, frequent enhancements to existing products and newproduct introductions, changing customer needs and evolving industry standards. The emergence of new industrystandards might require us to redesign our products. If our products are not in compliance with industrystandards, our customers and potential customers will not purchase our products. There is no guarantee that wewill accurately predict the direction in which the proxy appliance market will evolve. Failure on our part toanticipate the direction of the market and develop products that meet those emerging needs will significantlyimpair our business, financial condition and results of operations.

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

The market for proxy appliances is intensely competitive, highly fragmented and characterized by changingtechnology and evolving standards. Our competitors may announce new products, services or enhancements toexisting products that better meet the needs of customers. Increased competition may cause price reductions or aloss of market share, either of which could have a material adverse effect on our business, results of operationsand financial condition. Primary competitive factors that have typically affected our market include productcharacteristics such as reliability, scalability and ease of use, as well as price and customer support. The intensityof competition is expected to increase in the future. Increased competition is likely to result in price reductions,reduced gross margins and loss of market share, any one of which could seriously harm our business. We maynot be able to compete successfully against current or future competitors and we cannot be certain thatcompetitive pressures we face will not seriously harm our business.

Some of our competitors have greater financial, technical, sales, marketing and other resources than we do.In addition, acquisitions of or other strategic transactions by our competitors could weaken our competitiveposition or reduce our revenue.

Our competitors vary in size and in the scope and breadth of the products and services they offer. Weencounter competition from a variety of companies, including Cisco Systems, Network Appliance, Microsoft,and various others. In addition, we expect additional competition from other established and emerging companiesas the market for proxy appliances continues to develop and expand. Some of our current and potentialcompetitors have longer operating histories, significantly greater financial, technical, marketing and otherresources, significantly greater name recognition and a larger installed base of customers than we do. In addition,many of our competitors have well-established relationships with our current and potential customers and haveextensive knowledge of our industry. As a result, our competitors may be able to respond more quickly to new oremerging technologies and changes in customer requirements, or to devote greater resources to the development,marketing, promotion and sale of their products than we can. The products of our competitors may have featuresand functionality that our products do not have. Current and potential competitors have established or mayestablish cooperative relationships among themselves or with third parties to increase the market acceptance oftheir products. In addition, our competitors may be able to replicate our products, make more attractive offers toexisting and potential employees and strategic partners, develop new products or enhance existing products andservices more quickly, or bundle proxy appliances in a manner that we cannot provide. Accordingly, it is possiblethat new competitors or alliances among competitors may emerge and rapidly acquire significant market share.We also expect that competition will increase as a result of industry consolidation.

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We have been informed of SEC investigations, which could result in substantial costs and divert managementattention and resources.

The SEC has informed us of its investigation into trading in certain securities, including trading in oursecurities, prior to our public announcement on May 27, 2004 of our financial results for the fourth quarter andfiscal year 2004 (the “May 27, 2004 Announcement”). The investigation is captioned In the Matter of Trading inCertain Securities, H0-9818. To date the SEC has not identified us or any of our directors or executive officers astargets of its investigation, but has served subpoenas for information from us and for testimony from certainofficers. We are cooperating with the investigation. The SEC subsequently informed us that we are the subject ofa formal order of private investigation captioned In the Matter of Blue Coat Systems, Inc., HO-10096. We believethat the SEC is investigating whether certain present or former officers, directors, employees, affiliates or othersmade intentional or non-intentional selective disclosure of material nonpublic information, traded in our stockwhile in possession of such information, or communicated such information to others who thereafter traded inour stock. We are cooperating with the SEC. An unfavorable outcome in, or resolution of, this matter may becostly, result in damage to our reputation among our customers and investors, or a drop in the price of ourcommon stock, or both.

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

Although we achieved profitability in the second half of the fiscal year ended April 30, 2004, we incurredlosses in each quarter prior to the third quarter of fiscal 2004. Since the third quarter of fiscal 2004, we have onlybeen marginally profitable in some quarters and our profitability has fallen in several quarters. We may not beable to maintain quarterly or annual profitability in the future. Our ability to sustain or increase profitability on aquarterly or annual basis will be affected by changes in our business and the demand for our products andservices. We expect our operating expenses to increase as our business grows, and we anticipate that we willmake investments in our business. As a result, our results of operations will be harmed if our sales do notincrease at a rate commensurate with the rate of increase in our expenses. If our sales growth is less thananticipated or if operating expenditures exceed our expectations or cannot be adjusted accordingly, we mayexperience losses on a quarterly and annual basis.

We experienced an increase in demand in our third quarter of fiscal 2004, which did not continue into thefollowing quarter, and this may happen again.

If we experience an increase in demand in any one quarter, investors or analysts could view this as anindication of a trend that may continue into the following quarter. If the trend does not continue, investor oranalyst perceptions of our company may be adversely affected and could cause a decline in the market price ofour stock. For example, we experienced an increase in demand in our third quarter of fiscal 2004. This increasedlevel of demand did not continue into the fiscal fourth quarter. Our stock price increased significantly followingthe release of our third quarter fiscal 2004 financial results, but declined dramatically when the trend did notcontinue into the next several quarters. Accordingly, our stock price may vary significantly as our operatingresults continue to fluctuate from quarter to quarter.

Our sales may not grow because our proxy appliances only protect Web-based applications and content, andour target customers may not wish to purchase our network security device without protection for non-Webbased applications and content. Any failure of this product to satisfy customer demands could harm ourbusiness.

Our proxy appliances are specially designed to secure only Web-based protocols, such as http, https, ftp andstreaming. While we believe that the majority of traffic traveling over the networks of our target customers isWeb-based, a significant amount of our target customers’ network traffic may not be Web-based. Our productsdo not protect non-Web protocols. If our target customers do not wish to purchase a security device that onlyhandles network traffic that is Web protocol-based, our target customers may not purchase our products and our

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growth could be limited. We may not be successful in achieving market acceptance of any new products that wedevelop if they do not contain non-Web based applications and content.

The market for proxy appliance solutions is relatively new, unknown and evolving, and subject to rapidtechnological changes. If this market does not develop as we anticipate, our sales may not grow and maydecline. We need to continue to develop market awareness of our company and our products.

Sales of our products depend on increased demand for proxy appliances. The market for proxy appliances isa new and rapidly evolving market. If the market for proxy appliances fails to grow as we anticipate, or growsmore slowly than we anticipate, our business will be seriously harmed. In addition, our business will be harmedif the market for proxy appliances continues to be negatively impacted by uncertainty surroundingmacroeconomic growth.

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

Our gross margin percentage may be below our expectations or the expectations of investors and analysts dueto a variety of factors, which would adversely affect our operating results and could result in a decline in themarket price of our common stock.

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

• fluctuations in demand for our products;

• market acceptance of our products;

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

• the mix of direct and indirect sales;

• the mix and average selling prices of products;

• new product introductions and enhancements;

• component costs;

• manufacturing costs;

• availability of sufficient inventory to meet demand;

• increased price competition and pressures;

• changes in product pricings;

• actions taken by our competitors;

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

• product configuration.

Factors that could cause demand to be different from our expectations can include changes in customerorder patterns, including order cancellations, changes in the level of inventory, and changes in business andeconomic conditions. We might achieve our revenue and operating expense objectives, but fail to meet our netincome objectives, which would cause our operating results to be below our expectations and the expectations ofinvestors and analysts, which might cause our stock price to decline.

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We rely on technology that we license from third parties, including software that is integrated with internallydeveloped software and used in our products to perform key functions.

We rely on technology that we license from third parties, including software that is used in our products toperform key functions. If we are unable to continue to license any of this software on commercially reasonableterms, we will face delays in releases of our software or we will be required to drop this functionality from oursoftware until equivalent technology can be identified, licensed or developed, and integrated into our currentproduct. In addition, the inability to obtain certain licenses or other rights might require us to engage in litigationregarding these matters, which could have a material adverse effect on our financial condition. Any of thesedelays could seriously harm our business.

We may not be able to generate a significant level of sales from the international markets in which wecurrently operate.

We expect international customers to continue to account for a significant percentage of net sales in thefuture, but we may fail to maintain or increase international market demand for our products. Also, because ourinternational sales are currently denominated in United States dollars, an increase in the value of the UnitedStates dollar relative to foreign currencies could make our products more expensive and, therefore, potentiallyless competitive in international markets, and this would decrease our international sales. Our ability to generateinternational sales depends on our ability to maintain our international operations (including efficient use ofexisting resources and effective channel management), and to recruit additional international resellers.

Our international operations are subject to certain inherent risks including:

• technical difficulties and costs associated with product localization;

• challenges associated with coordinating product development efforts among geographically dispersedareas;

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

• lack of experience in certain geographic markets;

• longer payment cycles for sales in certain foreign countries;

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

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

• potentially adverse tax consequences;

• import and export restrictions and tariffs;

• foreign laws and other government controls, such as trade and employment restrictions;

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

• political instability in the countries where we are doing business; and

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

To the extent we are unable to manage these risks effectively, our growth, if any, in international sales willbe limited and our business could be seriously harmed.

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Unpredictable macroeconomic conditions could adversely impact our existing and potential customers’ abilityand willingness to purchase our products, which would cause a decline in our sales.

Although we saw sequential revenue growth in fiscal years 2005 and 2004, there is uncertainty relating to theprospects for near-term U.S. economic growth and growth within the international markets. This uncertainty couldpossibly contribute to delays in decision-making by our existing and potential customers and a resulting decline inour sales. Continued uncertainty or a decrease in corporate spending could result in a decline to our sales and ouroperating results could be below our expectations and the expectations of public market analysts and investors.

Our variable sales cycle makes it difficult to predict the timing of a sale or whether a sale will be made, whichmakes our quarterly operating results less predictable.

Because customers have differing views on the strategic importance of implementing proxy appliances, thetime required to educate customers and sell our products can vary widely. As a result, the evaluation, testing,implementation and acceptance procedures undertaken by customers can vary, resulting in a variable sales cycle,which typically ranges from one to nine months. While our customers are evaluating our products and beforethey place an order with us, we may incur substantial sales and marketing expenses and expend significantmanagement efforts. In addition, purchases of our products are frequently subject to unplanned processing andother delays, particularly with respect to larger customers for whom our products represent a very smallpercentage of their overall purchase activity. Large customers typically require approvals at a number ofmanagement levels within their organizations, and, therefore, frequently have longer sales cycles. Since one ofour strategies is to focus on mid-to-large size enterprises, we may experience a lengthening of our sales cycle. Inaddition, as we compete for larger orders, competition is likely to increase causing customers to extend theirdecision making process. As a result of these factors, it is difficult to predict the timing of a sale or whether a salewill be made, which makes our quarterly operating results less predictable.

We are subject to evolving and expensive corporate governance regulations and requirements. our failure toadequately adhere to these requirements or the failure or circumvention of our controls and procedures couldseriously harm our business.

Because we are a publicly-traded company, we are subject to certain federal, state and other rules andregulations, including rules and regulations recently adopted in response to laws adopted by Congress, such asthe Sarbanes-Oxley Act of 2002. Compliance with these evolving regulations is costly and requires a significantdiversion of management time and attention, particularly with regard to our disclosure controls and proceduresand our internal controls over financial reporting. Although we have reviewed our disclosure controls andprocedures and our internal controls over financial reporting in order to determine whether they are effective, ourcontrols and procedures may not be able to prevent errors or fraud in the future. Faulty judgments, simple errorsor mistakes, or the failure of our personnel to adhere to established controls and procedures may make itimpossible for us to ensure that the objectives of the control system are met. A failure of our controls andprocedures to detect errors or fraud could seriously harm our business and results of operations.

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

Our products may contain undetected operating errors when first introduced or as new versions are released.Despite testing by us and by current and potential customers, errors may not be found in new products or newversions until after commencement of commercial shipments, resulting in loss of or delay in market acceptance,which could materially adversely affect our operating results. These errors may cause us to incur significantwarranty and repair costs, divert the attention of our engineering personnel from our product development effortsand cause significant customer relations problems.

In addition, all of our products operate on our internally developed operating system. As a result, any errorin the operating system will affect all of our products. We have experienced minor errors in the past in

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connection with new products. We expect that errors will be found from time to time in new or enhancedproducts after commencement of commercial shipments, which could seriously harm our business.

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

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

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

We are dependent upon key personnel and we must attract, assimilate and retain other highly qualifiedpersonnel or our ability to execute our business strategy and generate sales could be harmed.

Our business could be seriously disrupted if we do not maintain the continued service of our seniormanagement, research and development and sales personnel. We have hired several senior executives recentlyand have experienced and may continue to experience transition in our management team. We expect that it willtake time for our new management team to integrate into our company. The majority of our employees areemployed on an “at-will” basis. Our ability to conduct our business also depends on our continuing ability toattract, hire, train and retain a number of highly skilled managerial, technical, sales, marketing and customersupport personnel. New hires frequently require extensive training before they achieve desired levels ofproductivity, so a high employee turnover rate could seriously impair our ability to operate and manage ourbusiness.

We are the target of a Class Action Lawsuit, which could result in substantial costs and divert managementattention and resources.

Beginning on May 16, 2001, a series of putative securities class actions were filed against the firms thatunderwrote our initial public offering, us and some of our officers and directors in the U.S. District Court for theSouthern District of New York. These cases have been consolidated under the case captioned In re CacheFlow,Inc. Initial Public Offering Securities Litigation., Civil Action No. 1-01-CV-5143. An additional putativesecurities class action has been filed in the United States District Court for the Southern District of Florida. TheCourt in the Florida case dismissed us and individual officers and directors from the action without prejudice.The complaints in the New York and Florida cases generally allege that the underwriters obtained excessive andundisclosed commissions in connection with the allocation of shares of common stock in our initial publicoffering, and maintained artificially high market prices through tie-in arrangements which required customers tobuy shares in the after-market at pre-determined prices. The complaints allege that we and our current and formerofficers and directors violated Sections 11 and 15 of the Securities Act of 1933, and Sections 10(b) (and Rule10b-5 promulgated thereunder) and 20(a) of the Securities Exchange Act of 1934, by making material false andmisleading statements in the prospectus incorporated in the Company’s Form S-1 Registration Statement filedwith the SEC in November 1999. Plaintiffs seek an unspecified amount of damages on behalf of persons whopurchased our stock between November 19, 1999 and December 6, 2000. On April 19, 2002, plaintiffs filed anamended complaint.

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Various plaintiffs have filed similar actions asserting virtually identical allegations against over 300 otherpublic companies, their underwriters, and their officers and directors arising out of each company’s publicoffering. The lawsuits against us, along with these other related securities class actions currently pending in theSouthern District of New York, have been assigned to Judge Shira A. Scheindlin for coordinated pretrialproceedings and are collectively captioned In re Initial Public Offering Securities Litigation, Civil Action No.21-MC-92. Defendants in these cases have filed omnibus motions to dismiss. On February 19, 2003, the Courtdenied in part and granted in part the motion to dismiss filed on behalf of defendants, including us. The Court’sorder did not dismiss any claims against us. As a result, discovery may now proceed. Our officers and directorshave been dismissed without prejudice in this litigation.

In June 2004, a stipulation of settlement and release of claims against the issuer defendants, including us,was submitted to the Court for approval. The terms of the settlement, if approved would dismiss and release allclaims against participating defendants, including us. In exchange for this dismissal, D&O insurance carrierswould agree to guarantee a recovery by the plaintiffs from the underwriter defendants of at least $1.0 billion, andthe issuer defendants would agree to an assignment or surrender to the plaintiffs of certain claims the issuerdefendants may have against the underwriters. The settlement is subject to a number of conditions, includingcourt approval.

If the settlement does not occur, litigation against us would continue. We believe we have meritoriousdefenses and intends to defend the case vigorously. Securities class action litigation could result in substantialcosts and divert our management’s attention and resources, which could seriously harm our business.

Beginning on April 11, 2004, several purported securities class action lawsuits were filed in the UnitedStates District Court for the Northern District of California against us and certain of our current and formerofficers on behalf of purchasers of our stock between February 20, 2004 and May 27, 2004 (the “alleged ClassPeriod”). Plaintiffs allege that, during the alleged Class Period, defendants violated Sections 10(b), 20(a) and20A of the Securities Exchange Act of 1934, and Rule 10b-5 promulgated thereunder, by making false ormisleading statements about our prospects. The cases have been consolidated but a lead plaintiff has not yet beenselected. We and related defendants intend to defend the case vigorously.

On May 18, 2005, a purported shareholder derivative action was filed in the Superior Court of California,Santa Clara County, alleging that certain of our officers and directors violated their fiduciary duties to theCompany. The complaint is based largely on the same factual allegations as in the federal securities class action.Defendants intend to defend the case vigorously.

Although we cannot predict whether the IPO allocation cases will settle as proposed, and cannot predict theoutcome of the SEC investigations, the securities class action, or the derivative case, the costs of defending thesematters, an adverse result, or the diversion of management’s attention and resources could have a materialadverse effect on our results of operations and financial condition.

In addition, from time to time and in the ordinary course of business, we may be subject to various otherclaims and litigation. Such claims, even if not estimable, could result in the expenditure of significant financialand other resources.

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

We depend significantly on our ability to develop and maintain the proprietary aspects of our technology.To protect our proprietary technology, we rely primarily on a combination of contractual provisions,confidentiality procedures, trade secrets, copyright and trademark laws and patents. Despite our efforts to protectour proprietary rights, unauthorized parties may attempt to copy aspects of our products or obtain and useinformation that we regard as proprietary. Policing unauthorized use of our products is difficult. In addition, the

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laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of theUnited States. Our means of protecting our proprietary rights may not be adequate and our competitors mayindependently develop similar technology, duplicate our products or design around patents that may be issued tous or our other intellectual property.

We presently have several issued patents, and pending United States patent applications. We cannot assurethat any U.S. patent will be issued from these applications. Even with issued patents, we cannot assure that wewill be able to detect any infringement or, if infringement is detected, that patents issued will be enforceable orthat any damages awarded to us will be sufficient to adequately compensate us.

We currently operate in foreign locations and may increase the amount of research and development that isdone internationally. The laws of some foreign countries do not protect our proprietary rights to as great anextent as do the laws of the United States. Should we be unable to defend our existing or developed intellectualproperty, or should the existing laws protecting intellectual property and its development deteriorate, ourbusiness and our results of operations would be adversely affected.

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

There has been a substantial amount of litigation in the technology industry regarding intellectual propertyrights and we recently settled a suit that alleged infringement of certain U.S. patents by us. (See Note 11“Litigation” of the consolidated financial statements included in this Annual Report on Form 10-K) We expectthat companies in the Internet and networking industries will increasingly be subject to infringement claims asthe number of products and competitors in our industry segment grows and the functionality of products indifferent industry segments overlaps. Any claims, with or without merit, could be time-consuming, result incostly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements.Royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all, which couldseriously harm our business.

If we are unable to raise additional capital, our business could be harmed.

As of April 30, 2005, we had approximately $47.3 million in cash and cash equivalents. We believe thatthese amounts will enable us to meet our capital requirements for at least the next 12 months. However, if cash isused for unanticipated needs, we may need additional capital during that period. The development and marketingof new products will require a significant commitment of resources. In addition, if the market for proxyappliances develops at a slower pace than anticipated or if we fail to establish significant market share andachieve a meaningful level of sales, we could be required to raise substantial additional capital. We cannot becertain that additional capital will be available to us on favorable terms, or at all. If we were unable to raiseadditional capital when we require it, our business would be seriously harmed.

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

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

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

Our products operate in part by storing material available on the Internet and making this material availableto end users from our appliance. This creates the potential for claims to be made against us, either directly orthrough contractual indemnification provisions with customers, for defamation, negligence, copyright ortrademark infringement, personal injury, invasion of privacy or other legal theories based on the nature, contentor copying of these materials. As of April 30, 2005, we have not accrued any liabilities relating toindemnification provisions with our customers. It is also possible that if any information provided through any ofour products contains errors, third parties could make claims against us for losses incurred in reliance on thisinformation. Our insurance may not cover potential claims of this type or be adequate to protect us from allliability that may be imposed.

Potential new accounting pronouncements may impact our future financial position or results of operations.

Future changes in financial accounting standards, including new changes in accounting for employee stock-based awards, may cause adverse, unexpected fluctuations in the timing of the recognition of revenues orexpenses and may affect our financial position or results of operations. New pronouncements and varyinginterpretations of pronouncements have occurred and expected to continue to occur frequently, and we may makechanges in our accounting policies in the future. As a result, we intend to invest significant resources to complywith evolving standards, and this investment may result in increased general and administrative expenses.

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

We may make acquisitions in the future. Acquisitions of companies, products or technologies entailnumerous risks, including:

• an inability to successfully integrate the operations, technologies, products and personnel of the acquiredcompanies;

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

• loss of key employees of acquired companies; and

• substantial transaction costs.

Acquisitions may also cause us to:

• issue equity securities that would dilute our current stockholders’ percentage ownership;

• assume certain liabilities;

• incur additional debt;

• make large and immediate one-time write-offs and restructuring and other related expenses;

• become subject to intellectual property or other litigation; and

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

Any of these problems or factors could seriously harm our business.

We could be subject to product liability claims, which are time-consuming and costly to defend.

Our customers install our proxy appliance products directly into their network infrastructures. Any errors,defects or other performance problems with our products could negatively impact the networks of our customersor other Internet users, resulting in financial or other damages to these groups. These groups may then seek

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damages from us for their losses. If a claim were brought against us, we may not have sufficient protection fromstatutory limitations or license or contract terms with our customers, and any unfavorable judicial decisions couldseriously harm our business. A product liability claim brought against us, even if not successful, would likely betime-consuming and costly. A product liability claim could also seriously harm our business reputation.

Our operations could be significantly hindered by the occurrence of a natural disaster, terrorist attack or othercatastrophic event.

Our operations are susceptible to outages due to fire, floods, power loss, telecommunications failures,terrorist attacks and other events beyond our control. In addition, a substantial portion of our facilities, includingour headquarters, is located in Northern California, an area susceptible to earthquakes. We do not carryearthquake insurance for earthquake-related losses. Despite our implementation of network security measures,our servers are vulnerable to computer viruses, break-ins, and similar disruptions from unauthorized tamperingwith our computer systems. We may not carry sufficient business interruption insurance to compensate us forlosses that may occur as a result of any of these events. Any such event could have a material adverse effect onour business, operating results and financial condition.

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

Since our initial public offering, the market price of our common stock has fluctuated significantly. Themarket price of our common stock may fluctuate significantly in response to the following factors, among others:

• changes in macro-economic conditions;

• the introduction of new products by our competitors;

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

• our ability to keep pace with changing technological requirements;

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

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

• loss of a major customer;

• additions or departures of key personnel;

• fluctuations in stock market volumes;

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

• significant transactions; and

• variations in our quarterly operating results.Š

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Item 2. Properties

We lease approximately 53,000 square feet for our headquarters facility in Sunnyvale, California, under alease that expires on August 31, 2005. In April 2004, we entered into a lease agreement to occupy approximately29,000 square feet for general office uses located in Sunnyvale, California, which also expires on August 31,2005. In March 2001, we entered into a lease agreement to occupy 46,000 square feet for a research anddevelopment facility in Sunnyvale, California, beginning in the first quarter of our 2002 fiscal year, whichexpires on June 30, 2006. We also lease space for research and development in Draper, Utah, Waterloo, Ontario,Canada and Latvia. In addition, we lease space for sales and support in three metropolitan areas in NorthAmerica. We also lease space for sales and support in the following countries: France, Germany, Japan, People’sRepublic of China, Belgium, Taiwan, South Korea, United Arab Emirates and the United Kingdom.

In April 2005, we signed a lease agreement to occupy approximately 117,000 square feet for ourheadquarters facility in Sunnyvale, California, commencing September 2005. The lease will expire in August2010.

In February 2002 we announced a restructuring plan that included closing down our research anddevelopment facilities in Redmond, Washington and certain facilities in Sunnyvale, California, and moving theU.S. research and development organization back into our headquarters facility in Sunnyvale, California. InOctober 2004, one of our facilities in Sunnyvale, California was subleased for the remainder of the lease term ata rental price that was consistent with our initial estimates. Our facility in Redmond, Washington was subleasedin December 2002 for the remainder of the term of the original lease at a rental price consistent with our initialestimates.

We believe that our existing facilities are adequate to meet our current requirements, and that suitableadditional or substitute space will be available, if necessary.

Item 3. Legal Proceedings

See Item 8, Note 11 “Litigation” of the consolidated financial statements included in this Annual Report onForm 10-K.

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

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year endedApril 30, 2005.

PART II.

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters

Our common stock has been quoted on the NASDAQ National Market since November 19, 1999 under thesymbol “BCSI”, or “CFLO” prior to our name change on August 21, 2002. Prior to November 19, 1999, therewas no public market for the common stock. The following table sets forth, for the periods indicated, the highand low closing prices of the common stock as reported on the Nasdaq National Market.

High Low

For the year ended April 30, 2004:First Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7.22 $ 5.36Second Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $17.39 $ 5.30Third Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $25.38 $14.81Fourth Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $64.16 $21.53

For the year ended April 30, 2005:First Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $47.56 $17.56Second Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $19.67 $10.41Third Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $25.75 $16.05Fourth Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $25.56 $14.40

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Our present policy is to retain earnings, if any, to finance future growth. We have never paid cash dividendsand have no present intention to pay cash dividends. At June 30, 2005, there were approximately 378stockholders of record and the price of our common stock was $29.88. We believe that a significant number ofbeneficial owners of our common stock hold shares in street name.

Item 6. Selected Financial Data

The following table sets forth selected financial data for the fiscal years ended April 30, 2001 through April30, 2005. For additional discussion regarding the items in this table, refer to Item 7, “Management’s Discussionand Analysis of Financial Condition and Results of Operations.” Included in our operating results for the yearsended April 30, 2005 and 2004, are the operations of Cerberian, Inc. and Ositis Software, Inc., from the dates ofacquisition on November 16, 2004 and November 14, 2003, respectively.

Year Ended April 30,

2005 2004 2003 2002 2001

(in thousands, except per share data)

Consolidated Statement of Operations Data:Net revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 96,186 $ 66,068 $ 45,738 $ 55,641 $ 97,739Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64,876 44,749 28,423 26,649 43,066Research and development . . . . . . . . . . . . . . . . . . . . . . 16,549 11,992 11,911 39,910 37,963Sales and marketing . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33,882 25,104 26,236 39,541 81,698General and administrative . . . . . . . . . . . . . . . . . . . . . . 9,075 5,206 5,042 11,616 42,667Goodwill amortization (1) . . . . . . . . . . . . . . . . . . . . . . . — — — 29,489 98,987In-process technology (2) . . . . . . . . . . . . . . . . . . . . . . . — 151 — — 32,200Impairment of assets (3) . . . . . . . . . . . . . . . . . . . . . . . . — — — 138,785 272,871Amortization of intangible assets (4) . . . . . . . . . . . . . . 648 305 — — —Restructuring (reversal) (5) . . . . . . . . . . . . . . . . . . . . . . (96) 1,536 1,273 15,475 1,850Legal settlement (6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 1,100 — — —

Total operating expenses . . . . . . . . . . . . . . . . . . . . . . . . 60,058 45,394 44,462 274,816 568,236Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,375 (348) (15,928) (247,031) (519,096)Net income (loss) available to common

stockholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,375 (348) (15,928) (247,031) (519,096)

Basic net income (loss) per common share . . . . . . . . . . $ 0.46 $ (0.03) $ (1.81) $ (29.66) $ (72.20)Diluted net income (loss) per common share . . . . . . . . $ 0.41 $ (0.03) $ (1.81) $ (29.66) $ (72.20)

Shares used in computing basic net income (loss) percommon share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,628 9,956 8,777 8,329 7,190

Shares used in computing diluted net income (loss) percommon share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,977 9,956 8,777 8,329 7,190

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As of April 30,

2005 2004 2003 2002 2001

(in thousands)

Consolidated Balance Sheet Data:Cash, cash equivalents and short-term investments . . . . . . . . . . . $47,264 $39,504 $23,322 $39,946 $ 81,564Working capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35,234 26,737 16,919 29,743 77,880Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97,862 67,669 39,992 58,714 287,232Total stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66,249 36,115 16,777 30,264 256,751

(1) Goodwill amortization includes charges related to the June 2000 acquisition of SpringBank Networks, Inc.and the December 2000 acquisition of Entera, Inc.

(2) Acquired in-process technology relates to certain research and development projects assumed in the Enteraand Ositis acquisitions that had not yet reached technological feasibility and were deemed to have noalternative future use.

(3) Impairment charges were recorded during fiscal 2001 and 2002 after we performed impairment assessmentsand concluded that a substantial portion of enterprise-level goodwill related to Entera and Springbankacquisitions was not recoverable.In addition, excess property and equipment were deemed impaired and written off in fiscal 2002.

(4) Amortization of intangible assets relates to identifiable intangible assets obtained through the Ositis andCerberian acquisitions on November 14, 2003 and November 16, 2004, respectively.

(5) Restructuring (reversal) expense includes costs associated with severance, abandoned lease space, and othercharges; reversal of restructuring accrual in fiscal 2005 resulted from reductions in the estimated costs forreal estate taxes and contract termination fees.

(6) Legal settlement expense relates to the settlement with Network Caching Technology L.L.C. in November2003. Refer to Note 11 in the Notes to the Consolidated Financial Statements for additional information.

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

The discussion in this Annual Report on Form 10-K contains forward-looking statements that involve risksand uncertainties. The statements contained in this Report that are not purely historical are forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended, including statements on revenue expectations, future productacceptance, future product and sales development, future operating results, and future cash usage, as well asstatements regarding our expectations, beliefs, intentions or strategies regarding the future. All forward-lookingstatements included in this document are based on information available to us on the date hereof. We assume noobligation to update any such forward-looking statements. Our actual results could differ materially from thoseindicated in such forward-looking statements. Factors that could cause or contribute to such differences include,but are not limited to, our limited ability to forecast quarterly operating results and meet analyst or investorexpectations, inability to create additional sales through our sales channel partners, variability in net revenueand earnings resulting from deferred revenue, manufacturing delays and price increases from our third-partymanufacturers, supply shortage, inability to maintain a competitive position in the proxy appliance market,increased competition and inability to compete with our competitors, costs and effort in responding toinvestigations from the Securities and Exchange Commission (“SEC”), inability to sustain profitability,unpredictable increase in demand for our products, product concentration, technological changes, gross marginfluctuations, reliance on third-party software licenses, inability to generate increased international sales,unpredictable macroeconomic conditions, unpredictable sales cycles, legislation surrounding corporategovernance and internal controls, undetected product errors, foreign currency exchange rate movements andeconomic conditions in foreign markets, inability to attract and retain key employees, costs and effort indefending a Class Action Lawsuit, inability to defend our intellectual property rights, inability to raise additionalcapital, gross margin erosion from large sales deals, increased litigation, new accounting standards, futureacquisitions, product liability claims, occurrence of a natural disaster, volatility in our stock price and otherrisks discussed in this item under the heading “Factors Affecting Future Operating Results” and the risksdiscussed in our other recent SEC filings.

Overview

Blue Coat® Systems, Inc., also referred to in this report as “we”, “us” or the “Company”, was incorporatedin Delaware on March 16, 1996 and our current focus is on the proxy appliance market. Blue Coat proxyappliances help organizations make the Web safe and productive for business, providing visibility and control ofWeb communications to protect against risks from spyware, Web viruses, inappropriate Web surfing, instantmessaging, video streaming and peer-to-peer file sharing - while actually improving Web performance.Positioned in the network between the users and the Internet, proxy appliances do not replace existing perimetersecurity devices; rather, proxy appliances complement network firewalls by providing granular policy-basedcontrols over Web traffic in ways that firewalls and other externally focused devices cannot.

Our initial products, introduced in May of 1998, utilized caching technology to improve user response timefor accessing Internet content. These systems were used by service providers and enterprises throughout theworld and we achieved a market leadership position. By 1999, the caching market began evolving into twodistinct markets – enterprises looking for proxy caches to securely connect employees to the Internet, and serviceproviders looking for increased bandwidth savings and response time for their subscribers. During thistimeframe, service provider customers represented the majority of our revenues. However, we enhanced ourcompetitive position in both of the aforementioned markets through internal development and acquisitions. Byearly 2001, the demand for our enterprise proxy caches was growing, while the service provider marketdecreased significantly. In response to this trend, we accelerated our development and marketing efforts aroundour enterprise business, resulting in the launch of our ProxySG products in February 2002.

The Blue Coat family of proxy appliances is designed to address today’s new business risks, which caninclude the risk of being sued by employees who witness inappropriate Web surfing by their coworkers, viruses

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brought in via back door channels such as instant messaging and Web-based email, and network resource abusedue to peer-to-peer (P2P) file sharing and video streaming. The Blue Coat ProxySG appliances, and newProxyAV appliances for high-performance Web anti-virus, are designed to enable organizations to minimizesecurity risks and reduce the management costs and complexity of their Web infrastructure.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in theUnited States of America requires that we make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On anongoing basis, we evaluate our estimates, including those related to inventories, valuation of goodwill, valuationof long-lived and identifiable intangible assets, restructuring liabilities, revenue recognition and relatedreceivable allowances, warranty obligations, income taxes and contingencies. We base our estimates on historicalexperience and various other assumptions that are believed to be reasonable under the current circumstances, theresults of which form the basis for making judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. Actual results may differ from these estimates under differentassumptions or conditions, and such differences could be material. We believe the following critical accountingpolicies affect the more significant judgments and estimates used in the preparation of our consolidated financialstatements.

We have discussed the development and selection of critical accounting policies and estimates with ouraudit committee. We believe the accounting policies described below, among others, are the ones that mostfrequently require us to make estimates and judgments, and therefore are critical to the understanding of ourfinancial condition and results of operations:

• Inventories;

• Valuation of goodwill;

• Valuation of long-lived and identifiable intangible assets;

• Restructuring liabilities;

• Revenue recognition and related receivable allowances;

• Warranty obligations;

• Income taxes; and

• Contingencies.

Inventories. Inventories consist of raw materials, work-in-process and finished goods. Inventories arerecorded at the lower of cost or market using the first-in, first-out method, after appropriate consideration hasbeen given to obsolescence and inventory in excess of anticipated future demand. In assessing the ultimaterecoverability of inventories, we are required to make estimates regarding future customer demand and marketconditions. If actual market conditions are less favorable than those projected, additional write-offs and othercharges against earnings may be required.

Valuation of Goodwill. We perform goodwill impairment tests annually in our fourth quarter or wheneverindicators of impairment are present. The process of evaluating the potential impairment of goodwill is highlysubjective and requires significant judgment. For the purposes of our fiscal 2005 annual impairment test, weconsidered our market capitalization on the date of our impairment test and determined that no impairmentexisted.

Valuation of long-lived and identifiable intangible assets. We evaluate our long-lived and identifiableintangible assets in accordance with Financial Accounting Standards Board (“FASB”) Statement of Financial

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Accounting Standards (“SFAS”) No. 144, Accounting for Impairment or Disposal of Long-Lived Assets (“SFASNo. 144”). We review our long-lived assets, including property and equipment and identifiable intangible assets,for impairment whenever events or changes in circumstances indicate that the carrying value of such assets maynot be recoverable. Events or changes in circumstances that could result in an impairment review include, but arenot limited to, significant underperformance relative to expected historical or projected future operating results,significant changes in the manner of use of acquired assets or the strategy for our business and significantnegative industry or economic trends. Impairment is recognized when the carrying amount of an asset exceeds itsfair value as calculated on a discounted cash flow basis.

Restructuring Liabilities. We have accrued various restructuring liabilities, through charges to“Restructuring Expense”, related to employee severance costs, facilities closure and lease abandonment costs,and contract termination costs in our consolidated financial statements. Our restructuring liabilities for facilitiesclosure and lease abandonment costs include various assumptions, such as the time period over which abandonedfacilities will be vacant, expected sublease terms, and expected sublease rates.

Revenue Recognition and Related Receivable Allowances. We recognize appliance and WinProxy revenueupon delivery of the product, assuming that evidence of an arrangement between the customer and us exists, thefee to the customer is fixed or determinable, and collectability is reasonably assured. In the event we have futureperformance obligations or must obtain customer acceptance, revenue is deferred until the obligations are met oracceptance is obtained. During the fiscal year ended April 30, 2005, we deferred certain revenue and related costsof revenue based on future obligations.

Revenue and related cost of revenue resulting from shipments to our distributors who have certain stockrotation rights are deferred until a point of sale report is received from the distributor confirming that ourproducts have been sold to a reseller or an end user. For sales to resellers, revenue and related cost of revenuesare recognized upon shipment based on our understanding that an end user has been identified at the time ofshipment.

Maintenance and subscription contract revenue is initially deferred and recognized ratably over the life ofthe contract with the related service cost expensed as incurred. Maintenance and subscription contracts usuallyhave a 12-month duration but can extend to 36 months. Unearned maintenance and subscription contract revenueis included in deferred revenue.

Delivery is considered to have occurred for our appliances when the customer takes title to the product andassumes the risks and rewards of ownership. WinProxy software delivery is considered to have occurred whenthe software key is made available to the customer electronically.

When a sale involves multiple elements, we determine if these elements can be separated into multiple unitsof accounting. The entire fee from the arrangement is allocated to each respective element based on its relativefair value or using the residual method, if appropriate. Revenue for each element is then recognized whenrevenue recognition criteria for that element is met. If we cannot establish fair value for any undelivered element,we would be required to recognize revenue for the whole arrangement at the time revenue recognition criteria forthe undelivered element is met. Relative fair value for maintenance elements are determined based on substantiverenewal rates.

We record the shipping costs in both revenue and cost of revenue when we bill our customers for shipping.If we do not charge our customers for shipping, the costs incurred for shipping are reflected in cost of revenuebut not recorded in revenue.

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

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We perform ongoing credit evaluations of our customers’ financial condition and maintain an allowance fordoubtful accounts. We analyze accounts receivable and historical bad debts, customer concentrations, customersolvency, current economic and geographic trends, and changes in customer payment terms and practices whenevaluating the adequacy of such allowance, and any changes are charged to general and administrative expense.

Warranty Obligations. We accrue for warranty expenses as part of our cost of revenue at the time revenue isrecognized and maintain an accrual for estimated future warranty obligations based upon the relationshipbetween historical and anticipated warranty costs and revenue volumes. If actual warranty expenses are greaterthan those projected, additional obligations and other charges against earnings may be required. If actualwarranty expenses are less than projected, prior obligations could be reduced providing a positive impact on ourreported results. We generally provide a one-year warranty on hardware products and a 90-day warranty onsoftware products.

Income Taxes. We use the liability method to account for income taxes as required by the FASB SFAS No.109, Accounting for Income Taxes (“SFAS No. 109”). As part of the process of preparing our consolidatedfinancial statements, we are required to estimate our income taxes in each of the jurisdictions in which weoperate. This process involves determining our income tax expense (benefit) together with calculating thedeferred income tax expense (benefit) related to temporary differences resulting from the differing treatment ofitems for tax and accounting purposes, such as deferred revenue or deductibility of certain intangible assets.These differences result in deferred tax assets and liabilities, which are included within the consolidated balancesheets. We must then assess the likelihood that the deferred tax assets will be recovered through the generation offuture taxable income and record a valuation allowance to reduce deferred tax assets to an amount we believemore likely than not will be realized. We have recorded a full valuation allowance against deferred tax assets.

Contingencies. From time to time we are involved in various claims and legal proceedings. If managementbelieves that a loss arising from these matters is probable and can reasonably be estimated, we record the amountof the loss, or the minimum estimated liability when the loss is estimated using a range and no point within therange is more probable than any other. As additional information becomes available, any potential liabilityrelated to these matters is assessed and the estimates are revised, if necessary. Litigation is subject to inherentuncertainties, and unfavorable rulings could occur.

Results of Operations

Net Revenue

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

Year Ended April 30,

2005 2004 2003

Total net revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $96,186 $66,068 $45,738Change from prior year ($) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $30,118 $20,330 $ (9,903)Change from prior year (%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45.6% 44.4% (17.8)%

Demand for our products and related services continued to increase in fiscal 2005, which resulted in anincrease in net revenue of $30.1 million, or 45.6%, from the prior year. The increase in demand is primarilyattributable to continued market acceptance of our products resulting from investments in our sales andmarketing organizations, as well as our focus on larger enterprise customers.

Net revenue in fiscal 2004 increased $20.3 million, or 44.4%, from fiscal 2003. This increase was primarilydriven by our success in establishing a broader market presence and expanding our distribution channels. Althoughnet revenue increased slightly in the first half of fiscal 2004, net revenue increased significantly in the second half ofthe fiscal 2004 due to the release of our second generation of ProxySG products in September of 2003, as well as anoverall increase in Information Technology spending during the fourth calendar quarter of 2003.

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One of our distributors accounted for 15.9%, 24.1% and 19.0% of our net revenue during the years endedApril 30, 2005, 2004 and 2003, respectively. The same distributor accounted for 11.3%, 12.7% and 20.4% of ourgross accounts receivable at April 30, 2005, 2004 and 2003, respectively. Net revenue from this distributor hasdecreased as we have increasingly relied on sales to larger resellers who purchase directly from us. No othercustomer accounted for more than 10.0% of our net revenue or gross accounts receivable at April 30, 2005, 2004and 2003, respectively.

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

Year Ended April 30,

2005 2004 2003

North America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $48,951 $36,955 $23,774EMEA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,148 19,608 12,839Asia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,087 9,505 9,125

Total net revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $96,186 $66,068 $45,738

In fiscal 2005, we experienced strong growth in all geographic markets. Net revenue in North Americaincreased $12.0 million, up 32.5% from prior year, on strong demand, especially for our ProxySG appliances. Infiscal 2004, net revenue in the North America increased $13.2 million, up 55.4% from fiscal 2003, again basedon strong demand. Net revenue in North America comprises a significant portion of the total net revenue in partbecause we focused a substantial portion of our sales and marketing activities in North America.

Net revenue in Europe, Middle East, and Africa (“EMEA”) increased $10.5 million in fiscal 2005, up 53.8%from the prior year. From fiscal 2003 to fiscal 2004, net revenue for EMEA increased $6.8 million, or 52.7%.The year-over-year increases in net revenue in EMEA for both fiscal 2005 and fiscal 2004 are primarily relatedto investments in our sales and marketing organizations in the region, coupled with broader market acceptance ofour products.

Net revenue in Asia increased 79.8% to $17.1 million in fiscal 2005 from the prior year as a result ofincreased demand for our products and related services as well as increased investment in our sales andmarketing organization in the Asia region. Growth in net revenue from fiscal 2003 to fiscal 2004 was 4.2% as wetransitioned our selling efforts from caching appliances to proxy appliances.

Gross Profit

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

Year Ended April 30,

2005 2004 2003

Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $64,876 $44,749 $28,423Gross profit as a percentage of net revenue . . . . . . . . . . . . . . . . . . . . 67.4% 67.7% 62.1%

Gross profit for fiscal 2005 increased $20.1 million, representing a 45.0% increase year-over-year which isconsistent with the increase in net revenue. As a percentage of net revenue, gross profit in fiscal 2005 decreasedslightly to 67.4% from 67.7% as the gross profit improvement associated with the increased volume was offsetby investments in our service infrastructure, approximately $0.5 million of which related to the Cerberianacquisition.

Fiscal 2004 gross profit increased $16.3 million, or 57.4%, compared to fiscal 2003 due to higher netrevenue coupled with increased absorption of manufacturing and support costs. Gross profit as a percent of netrevenue increased 5.6% from fiscal 2003 to 67.7% in fiscal 2004 as a result of increased absorption ofmanufacturing and support costs in addition to lower component costs.

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Research and Development (R&D)

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

Year Ended April 30,

2005 2004 2003

Research and development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $16,549 $11,992 $11,911Research and development as a percentage of net revenue . . . . . . . . 17.2% 18.2% 26.0%

R&D expense in fiscal 2005 increased $4.6 million over the prior year, although R&D expense as apercentage of net revenue decreased slightly. R&D expense increased over the prior year primarily due to anincrease in headcount of 34 people hired to facilitate the continued development of our product portfolio, 7 ofwhich resulted from the Cerberian acquisition. Included in R&D expense for fiscal 2005 is approximately $0.6million related to the Cerberian acquisition.

R&D expense in fiscal 2004 was relatively flat in absolute dollars as compared to fiscal 2003. However, dueto the sharp increase in net revenue in fiscal 2004 as compared to 2003, R&D expense as a percentage of netrevenue decreased significantly. The R&D organization increased by 20 people in the second half of fiscal 2004primarily due to the acquisition of Ositis and headcount additions required to effect the enhancement of ourproduct portfolio.

R&D expense consists primarily of salaries and benefits, prototype, and testing equipment costs. R&Dheadcount was 116 at April 30, 2005, 82 at April 30, 2004 and 62 at April 30, 2003. We believe that continuedinvestment in product enhancement and new product development is critical to achieving our strategic objectives.As a result, as our net revenue allow, we expect R&D expense to continue to increase in absolute dollars.

Sales and Marketing

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

Year Ended April 30,

2005 2004 2003

Sales and marketing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $33,882 $25,104 $26,236Sales and marketing as a percentage of net revenue . . . . . . . . . . . . . 35.2% 38.0% 57.4%

Sales and marketing expense increased $8.8 million in fiscal 2005 from the prior year as we continued toexecute our strategy of expanding our market presence through investment in our sales and marketingorganizations. Included in sales and marketing expense for fiscal 2005 is approximately $0.5 million related tothe Cerberian acquisition. Sales and marketing expense decreased $1.1 million in fiscal 2004 compared to fiscal2003 due to a substantial decrease in marketing expenditures offset by an increase in headcount. Sales andmarketing headcount was 126 at April 30, 2005, 93 at April 30, 2004 and 81 at April 30, 2003. Sales andmarketing expense consists primarily of salaries and benefits, commissions, travel, advertising and promotionalexpenses.

Should increased demand for our products continue, we expect sales and marketing expense will increase inabsolute dollars in an effort to expand domestic and international markets, establish and expand new distributionchannels, and introduce new products.

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General and Administrative

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

Year Ended April 30,

2005 2004 2003

General and administrative expense . . . . . . . . . . . . . . . . . . . . . . . . . . $ 9,075 $ 5,206 $ 5,042General and administrative as a percentage of net revenue . . . . . . . . 9.4% 7.9% 11.0%

General and administrative expense in fiscal 2005 increased $3.9 million from the prior year to $9.1 million.In addition to an increase in G&A headcount, contributing to the year-over-year increase were professional feesrelated to compliance with the Sarbanes-Oxley Act as well as legal fees associated with various legal mattersmore fully described in Note 11 to the consolidated financial statements. We also recorded approximately $0.3million in stock-based compensation expense related to the modification of the vesting terms for certain stockoption grants included as part of a severance agreement with our former CFO. G&A expense increased in fiscal2004 compared to fiscal 2003 due to an increase in headcount.

We have been notified by our insurance carrier that we will be reimbursed for legal fees in excess of$350,000 incurred subsequent to April 16, 2005 related to the legal matters discussed under the caption “SECInvestigations” in Note 11 of our consolidated financial statements. As a result, we do not expect legal feesassociated with such matters to be significant to our results of operations for our fiscal year ending April 30,2006.

Should increased demand for our products continue, we expect that general and administrative expense willincrease in absolute dollars as we increase headcount to manage expanding operations and to appropriatelyrespond to the requirements of section 404 of the Sarbanes Oxley Act.

Legal Settlement Fees

On August 1, 2001, Network Caching Technology L.L.C. (“NCT”) filed suit against us and others in theUnited States District Court for the Northern District of California, alleging infringement of certain patentsowned by NCT. The lawsuit was titled Network Caching Technology LLC vs. Novell, Inc. et al., Case No.CV-01-2079. On October 29, 2003, Blue Coat and NCT entered into a settlement agreement by which Blue Coatreceived a fully paid up license under the NCT patents for all Blue Coat products and services and a full andcomplete release from any and all claims of liability for any actual or alleged past and present infringement of theNCT patents. As consideration for the license rights and release, we paid $1.1 million to NCT and this expensewas classified as a “Legal Settlement” on our statement of operations. The Order of Dismissal regarding allcauses of action between NCT and Blue Coat was entered on November 14, 2003.

Acquired In-Process Technology

We recorded a non-cash charge of approximately $0.2 million in fiscal 2004 for the value of in-processtechnology acquired in the Ositis acquisition, which relates to research and development projects that had not yetreached technological feasibility and had no future use in our development activities. No such charges wererecorded in fiscal years 2005 or 2003.

To establish the value of the in-process technology acquired from Ositis, we used an income approach,which values an asset based on the earnings capacity of such asset considering the future cash flows that couldpotentially be generated by the asset over its estimated remaining life. These cash flows were discounted to theirpresent value using a discount rate of 25.0%, theoretically equal to a rate that would provide sufficient return to apotential investor at an appropriate level of risk. The present value of the cash flows over the life of the asset issummed to equal the estimated value of the asset.

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Restructuring Charges

The following summarizes restructuring (reversal) expense and changes in restructuring expense by fiscalyear (in thousands):

Year Ended April 30,

2005 2004 2003

Restructuring (reversal) expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (96) $1,536 $ 1,273Change in restructuring expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(1,632) $ 263 $(14,202)% Change in restructuring expense . . . . . . . . . . . . . . . . . . . . . . . . . . . (106.3)% 20.7% (91.8)%

As discussed further under “Restructuring Plans” below, and in Note 5 “Restructuring Accrual” of theconsolidated financial statements included in this Annual Report on Form 10-K, we recorded $1.5 million and$1.3 million in fiscal 2004 and fiscal 2003, respectively, primarily related to facilities abandonment costs. Werevised certain of our estimates related to lease termination costs and reversed $0.1 million of restructuringcharges in fiscal 2005.

Interest and Other Income (Expense)

The following summarizes interest and other income (expense) and changes in interest and other income(expense) by fiscal year (in thousands):

Year Ended April 30,

2005 2004 2003

Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 700 $ 295 $ 437Other income (expense) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (26) $ 126 $ (65)% Change in interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137.3% (32.5)% (79.2)%% Change in other income (expense) . . . . . . . . . . . . . . . . . . . . . . . . . . . (120.6)% (293.8)% (87.0)%

Interest income increased for the year ended April 30, 2005 due to higher average cash and investmentbalances throughout the year as well as higher interest rates compared to the prior year. Interest incomedecreased in fiscal 2004 compared to fiscal 2003 due to lower average cash and investment balances as well aslower interest rates.

Other income consists primarily of realized gains and losses on investments, foreign exchange gains orlosses, banking fees, and non-recurring gains or losses realized outside our normal course of business and, assuch, is subject to variability. Other income for fiscal 2004 primarily reflected our recovery of a previouslyreserved employee note that was collected during the fourth quarter of fiscal 2004.

Provision for Income Taxes

The following summarizes the provision for income taxes and changes in the provision for income taxes byfiscal year (in thousands):

Year Ended April 30,

2005 2004 2003

Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $117 $ 124 $ 261Change in provision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (7) $ (137) $ (200)% Change in provision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5.6)% (52.5)% (43.4)%

The provision for income taxes, which is composed entirely of foreign corporate income taxes, were $0.1million, $0.1 million and $0.3 million for the years ended April 30, 2005, 2004 and 2003, respectively. The

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foreign corporate income taxes result from our international expansion and the establishment of branches andsubsidiaries in various jurisdictions.

We have incurred losses from our inception through the second quarter in fiscal 2004. Management believesthat, based on the history of such losses and other factors, the weight of available evidence indicates that it ismore likely than not that we will not be able to realize our deferred tax assets. Therefore, a full valuationallowance has been recorded against deferred tax assets at April 30, 2005, 2004 and 2003. The valuationallowance increased (decreased) by $1.2 million, $1.9 million and ($10.4) million during fiscal years 2005, 2004and 2003, respectively.

As of April 30, 2005, we had net operating loss carryforwards for federal income tax purposes ofapproximately $204.5 million which will expire in fiscal years ending in 2011 through 2025 if not utilized. Wealso had net operating loss carryforwards for state income tax purposes of approximately $110.5 million whichwill expire in fiscal years ending in 2006 through 2015 if not utilized. We also had federal and Californiaresearch and other tax credit carryforwards of approximately $7.4 million which will expire in fiscal years 2012through 2025 if not utilized.

Utilization of our net operating loss and tax credit carryforwards may be subject to substantial annuallimitations due to the ownership change limitations provided by the Internal Revenue Code and similar stateprovisions. Such annual limitations could result in the expiration of the net operating loss and tax creditcarryforwards before utilization. The events that may cause ownership changes in our net operating loss include,but are not limited to, a cumulative stock ownership change of greater than 50.0% over a three year period.

Our deferred tax assets, which have been offset by the valuation allowance, include deferred tax benefitsassociated with employee stock options and acquired net operating loss carryforwards. Deferred tax benefitsassociated with employee stock options of approximately $21.5 million will be credited to additional paid-in-capitalwhen realized. Deferred tax benefits associated with acquired net operating loss carryforwards of approximately$3.6 million, when realized, will first reduce goodwill and then non-current identifiable intangible assets.

Acquisitions

Cerberian, Inc. On November 16, 2004, we completed the acquisition of Cerberian, Inc. (“Cerberian”). Thepurchase price of approximately $19.3 million consisted of approximately 0.8 million shares of Blue Coatcommon stock valued at $17.4 million, $0.4 million in direct transaction costs, Cerberian options assumed byBlue Coat valued at approximately $0.5 million and the fair value of promissory notes from Cerberian to BlueCoat of $1.0 million. Cerberian was founded in 2000 as a Utah corporation and later incorporated as a Delawarecorporation on January 9, 2001. Cerberian is a provider of URL filtering software. Cerberian’s operations wereassumed as of the date of the acquisition and are included in our results of operations beginning on November 16,2004 and, as a result, are not reflected in our results of operations for the years ended April 30, 2004 and 2003.

Ositis Software, Inc. On November 14, 2003, we completed the acquisition of Ositis Software, Inc. (“Ositis”).The purchase price of $8.7 million consisted of 0.4 million shares of Blue Coat common stock valued at $6.7million, $1.1 million in cash and $0.9 million in direct transaction costs. Ositis, a California corporation, developedWeb security and Internet access technologies. Ositis offered software and appliance solutions that providecustomers with a system to safeguard and connect networked devices. Acquired products include “WinProxy”, asecure Internet sharing solution, “eShield”, an appliance that includes anti-spam, antivirus and Web filtering on oneplatform, and Access Now VBN for visitor-based network connectivity. Ositis’ operations were assumed as of thedate of the acquisition and are included in our results of operations beginning on November 14, 2003 and, as aresult, are not reflected in the results of operations for the fiscal year ended April 30, 2003.

Both acquisitions were accounted for as purchases in accordance with SFAS No. 141, Accounting forBusiness Combinations (“SFAS No. 141”); accordingly, we allocated the purchase price to the fair value of net

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tangible and intangible assets acquired, with the excess purchase price allocated to goodwill. See Note 3“Acquisitions” of the consolidated financial statements included in this Annual Report on Form 10-K for furtherdiscussion on Cerberian and Ositis acquisitions.

Stock Compensation

The following summarizes stock compensation expense included in the below cost classifications in theconsolidated statement of operations for the years ended April 30, 2005, 2004 and 2003, respectively (inthousands):

Year Ended April 30,

2005 2004 2003

Stock-based compensation:

Classified in cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 8 $ 81 $ 325

Classified in operating expense:Research and development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 370 485 513Sales and marketing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 322 568 1,009General and administrative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 291 79 223

Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 983 1,132 1,745

$991 $1,213 $2,070

We recorded stock compensation expense totaling $1.0 million, $1.2 million and $2.1 million for the yearsended April 30, 2005, 2004 and 2003, respectively, which were included in various cost classifications in theconsolidated statement of operations. Stock compensation expense reflects the amortization of deferred stockcompensation, charges associated with stock options and warrants granted to non-employees for services, andmodifications to stock-based awards for certain departed employees. As a result of the acquisition of Ositis onNovember 14, 2003, total deferred stock compensation of $1.4 million was recorded in stockholders’ equity, ofwhich approximately $0.7 million was recognized in each of the fiscal years ending April 30, 2005 and 2004. Infiscal 2005, we also recorded approximately $0.3 million in expense related to the modification of the vestingterms for certain stock option grants included as part of a severance agreement with our former Chief FinancialOfficer. Total stock compensation expense in fiscal 2005 decreased $0.2 million from the prior year.

Stock compensation expense decreased in fiscal 2004 compared to fiscal 2003 as a result of the reduction indeferred stock compensation associated with a reduction in headcount, partially offset in fiscal 2004 by anincrease in expense due to stock awards committed to be issued to Ositis Software personnel employed by usafter the acquisition.

Deferred stock compensation from the Cerberian acquisition was insignificant in fiscal 2005. We recordeddeferred stock compensation of approximately $1.4 million associated with the Ositis acquisition. We did not recordany deferred stock compensation in fiscal 2003. Our deferred stock compensation expense results from a variety ofstock-based transactions. Increases to our deferred stock compensation balance represent the difference between theexercise price and the market price of the underlying stock on the date of the stock option grant. However, we havealso completed other stock-based transactions that impact deferred stock compensation, such as acquisitions inwhich the outstanding options of the acquired entity are assumed, instances where modifications are made to theterms and conditions of outstanding stock option grants, and acquisitions where we have committed to issuing stockoption awards to employees from the acquired entity, who have joined Blue Coat.

Deferred stock compensation is amortized to stock compensation expense over the option vesting periodrecognized immediately if there is no vesting period, or recognized over the term that the award is earned. Inaddition to amortization of deferred stock compensation, stock compensation expense includes chargesassociated with stock options and warrants granted to non-employees for services, and modifications to stock-

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based awards for certain departed employees. Our policy is to amortize Ositis related deferred stockcompensation using a straight line method. Deferred stock compensation recorded in connection with ourNovember 1999 initial public offering, certain below-market option grants in fiscal 2001 and unvested optionsassumed in our December 2000 acquisition of Entera are amortized using a graded method. Graded amortizationmethods result in greater amortization in earlier years, including fiscal 2003.

Although deferred stock compensation relating to shares issued to former Ositis employees was fullyamortized in fiscal 2005, we may record additional deferred stock compensation and/or stock compensationexpense in the future if management decides to grant stock options with exercise prices lower than fair marketvalue of the stock, assume outstanding options in future acquisitions, issue stock awards in future acquisitions,modify outstanding stock awards subsequent to their date of grant, or enter into other transactions that mayrequire the recognition of additional compensation.

Restructuring Plans

As of April 30, 2005, substantially all actions under the February 2002, August 2001, and February 2001restructuring plans had been completed, except for payment of future rent obligations of $3.6 million, which areto be paid in cash through fiscal year 2008.

The following table summarizes activity related to restructuring activity during the three years ended April30, 2005 (in thousands):

AbandonedLease Space

Accrual

SeveranceRelatedAccrual

ContractTermination andFacilities Closure

Accrual Total

Balances at April 30, 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 9,503 $ 406 $ 969 $10,878Cash payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3,067) (406) (641) (4,114)Additions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,553 — — 1,553Reversals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — (280) (280)

Balances at April 30, 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,989 — 48 8,037Cash payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,947) — (22) (2,969)Additions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,536 — — 1,536

Balances at April 30, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,578 — 26 6,604Cash payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,863) — (2) (2,865)Reversals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (72) — (24) (96)

Balances as of April 30, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . 3,643 — — 3,643Less: current portion included in “Current liabilities” . . . . . . . 2,729 — — 2,729

Long-term restructuring accrual . . . . . . . . . . . . . . . . . . . . . . . . $ 914 $ — $ — $ 914

In fiscal 2005, we reduced our restructuring accrual by $72,000 related to a revised estimate of real estatetaxes on one of the leased facilities and by $24,000 due to contract termination costs which were lower thanoriginally estimated.

During fiscal 2004, we increased our restructuring accruals for abandoned lease space by $1.5 million toreflect additional revisions of market trend information provided by a commercial real estate broker.

During fiscal 2003, we increased the restructuring accruals by $1.6 million for abandoned lease space,mainly due to the loss of our tenant in a leased building in Sunnyvale, California. We also reduced our estimatesfor contract termination costs by $0.3 million during fiscal 2003, as we were able to negotiate lower settlementamounts than originally estimated.

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Liquidity and Capital Resources

We believe the existing cash, cash equivalents, and cash generated from operations, if any, will be sufficientto meet our operating requirements for at least the next 12 months, including working capital requirements andcapital expenditures. We may choose at any time to raise additional capital to strengthen our financial position,facilitate expansion, and pursue strategic investments or to take advantage of business opportunities as they arise.

April 30,

(In thousands) 2005 2004 2003

Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 47,264 $ 39,504 $ 23,322Restricted investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,855 1,991 1,991

$ 49,119 $ 41,495 $ 25,313

Percentage of total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50.2% 61.3% 63.3%

Year Ended April 30,

(In thousands) 2005 2004 2003

Cash provided by (used in) operating activities . . . . . . . . . . . . . . . $ 11,025 $ 3,951 $(16,266)Cash provided by (used in) investing activities . . . . . . . . . . . . . . . (5,068) 5,427 16,285Cash provided by financing activities . . . . . . . . . . . . . . . . . . . . . . 1,803 17,262 365

Net increase in cash and cash equivalents . . . . . . . . . . . . . . . . . . . $ 7,760 $ 26,640 $ 384

Since our inception, we have financed our operations and capital expenditures through private sales ofpreferred and common stock, bank loans, equipment leases, and an initial public offering of our common stock.During fiscal 2005 and 2004 we also financed our operations and capital expenditures through cash provided byoperating activities.

During the year ended April 30, 2005, we generated $11.0 million in cash from operating activitiescompared to $4.0 million in the prior year. The sharp increase in cash provided by operating activities is a resultof higher net income driven by the growth in net revenue. Working capital sources of cash included a decrease inaccounts payable of $0.6 million and an increase in deferred revenue of $4.3 million. Accounts payable increasedduring the year ended April 30, 2005 as a result of a higher volume of business. Deferred revenue increased as aresult of increased sales of service and support. Working capital uses of cash included increases in accountsreceivable balance of $0.5 million, prepaid expenses and other current assets of $1.6 million, and a decrease inaccrued liabilities of $2.1 million. Accounts receivable increased as a result of significantly higher net revenueduring fiscal 2005 as reflected in an increase in our day sales outstanding from 43.2 at April 30, 2004 to 44.5 atApril 30, 2005, partially offset by increased collection efforts. Accrued liabilities decreased over the prior yearprimarily as a result of cash payments made against the restructuring accrual recorded in prior years.

Net cash used in investing activities was $5.1 million for the year ended April 30, 2005 compared with $5.4million net cash provided by investing activities for the year ended April 30, 2004. Net cash used in investingactivities for the year ended April 30, 2005 included $1.4 million for the acquisition of Cerberian and $0.7million for the remaining payments from the Ositis acquisition, as well as purchase of property and equipment of$2.5 million. Net cash provided by investing activities in fiscal 2004 was $5.4 million, primarily due to sales ofshort-term investments of $10.4 million partially offset by purchases of property and equipment of $1.4 millionand $3.6 million used to acquire Ositis. In the future, we expect that any cash in excess of current requirementswill continue to be invested in short-term investment grade, interest-bearing securities.

Net cash provided by financing activities was $1.8 million and $17.3 million for the years ended April 30,2005 and 2004. The net cash provided by financing activities for the year ended April 30, 2005 was from theissuance of common stock through employee stock compensation plans. The net cash provided by our financing

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activities for fiscal 2004 was primarily due to a private equity financing and the issuance of common stockthrough employee stock compensation plans. On September 18, 2003, we raised $12.9 million from the sale of1,311,807 shares of our common stock to investment funds and an individual affiliated with Sprout Group, aventure capital affiliate of Credit Suisse First Boston.

Our long-term strategy is to maintain a minimum amount of cash and cash equivalents for operationalpurposes and to invest the remaining amount of our cash in interest bearing and highly liquid cash equivalentsand marketable debt securities. As of April 30, 2005, we had a total of $47.3 million in cash equivalents andshort-term investments, as well as $1.9 million in restricted investments, providing us with a total cash positionof $49.1 million.

We believe that our cash, cash equivalent and short-term investment balances as of April 30, 2005 and cashgenerated from operations, if any, will provide sufficient capital to meet our requirements for at least the nexttwelve months. However, should prevailing economic conditions and/or financial, business and other factorsbeyond our control adversely affect our estimates of our future cash requirements, or if cash is used forunanticipated purposes, we may need additional capital sooner than expected. Although we cannot guarantee thatplanned results will be obtained in fiscal 2006 or that sufficient debt or equity capital will be available to usunder acceptable terms, if at all, we believe that our planned cash flow assumptions can be realized. However, ifwe are not successful in generating sufficient cash flow from operations or in raising additional capital whenrequired in sufficient amounts and on terms acceptable to us, we could be unable to continue our operations. Ifwe raise additional funds through the issuance of equity or convertible debt securities, the percentage ownershipof our existing stockholders will be reduced.

Contractual Obligations

Below is a summary of fixed payments related to certain contractual obligations (in thousands):

Payments due by period

TotalLess than

1 year 1-3 years 3-5 yearsMore than

5 years

Operating leases:Abandoned space . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,299 $3,023 $1,276 $ — $ —In use . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,798 1,621 3,934 4,525 718

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,097 4,644 5,210 4,525 718

Purchase and other commitments (1) . . . . . . . . . . . . . 2,973 2,973 — — —

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $18,070 $7,617 $5,210 $4,525 $ 718

(1) Purchase and other commitments represent agreements to purchase component inventory, manufacturingmaterial and equipment.

We lease certain equipment and office facilities under non-cancelable operating leases that expire at variousdates through 2010. The facility leases generally require us to pay operating costs, including property taxes,insurance and maintenance, and contain scheduled rent increases and certain other rent escalation clauses. Rentexpense is reflected in our consolidated financial statements on a straight-line basis over the terms of therespective leases.

In April 2005, we executed a five-year operating lease for a 117,000-square foot facility which will serve asour headquarters in Sunnyvale, California. The lease commencement occurs in September 2005 and will extendfor a term of five years from the commencement date. Lease payments escalate annually and the total futureminimum lease payments amount to $8.4 million over the lease term, excluding lease payments totaling $0.6million for the first six months to be excused if the Company is not in default during the first 12 months of the

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lease term. A lessee improvement allowance of $1.2 million is provided to us to be used by June 30, 2006 andany unused portion of the allowance shall be waived and forfeited. As part of this agreement, we are required tomaintain a $0.4 million irrevocable standby letter of credit with a major financial institution as a form of security.This letter of credit provides for automatic annual extensions, without amendment, through the end of the leaseterm. Both irrevocable standby letters of credit referred to above are classified as “Restricted investments” in theaccompanying consolidated balance sheets as of April 30, 2005. In addition to the standby letter of creditdiscussed above, we maintain a $1.5 million irrevocable standby letter of credit for a five-year operating leaserelated to a 46,000-square foot research and development facility in Sunnyvale, California. This letter of creditalso extends automatically to each succeeding calendar year through June 30, 2006, unless otherwise terminatedin writing.

We have firm purchase and other commitments with various suppliers and contract manufacturers topurchase component inventory, manufacturing material and equipment. These agreements are enforceable andlegally binding against us in the short-term and all amounts under these arrangements are due in fiscal 2006. Ourminimum obligation at April 30, 2005 under these arrangements was $3.0 million.

Off-Balance Sheet Arrangements

As of April 30, 2005, we did not have any relationships with unconsolidated entities or financialpartnerships, such as entities often referred to as structured finance or special purpose entities, which would havebeen established for the purpose of facilitating off-balance sheet arrangements or for other contractually narrowor limited purposes. Further, we have not guaranteed any obligations of unconsolidated entities, nor do we haveany commitment or intent to provide additional funding to any such entities. As such, we are not materiallyexposed to any market, credit, liquidity or financing risk that could arise if we had engaged in such relationships.

We do not maintain any off-balance sheet transactions, arrangements, or obligations that are reasonablylikely to have a material current or future effect on our financial condition, results of operations, liquidity, orcapital resources.

Recent Accounting Pronouncements

In June 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (“SFAS No.154”), a replacement of APB Opinion No. 20, Accounting Changes (“APB 20”), and FASB SFAS No. 3,Reporting Accounting Changes in Interim Financial Statements (“SFAS No. 3”). SFAS No. 154 applies to allvoluntary changes in accounting principle, and changes the requirements for accounting for and reporting of achange in accounting principle. SFAS No. 154 requires retrospective application to prior periods’ financialstatements of a voluntary change in accounting principle unless it is impracticable. SFAS No. 154 also requiresthat a change in method of depreciation, amortization, or depletion for long-lived, non-financial assets beaccounted for as a change in accounting estimate that is affected by a change in accounting principle. SFAS No.154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December15, 2005. Earlier application is permitted for accounting changes and corrections of errors made occurring infiscal years beginning after June 1, 2005. SFAS No. 154 does not change the transition provisions of any existingaccounting pronouncements, including those that are in a transition phase as of the effective date of thisStatement. We do not believe the adoption of SFAS No. 154 will have a material impact on our financialstatements.

On December 16, 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS No.123(R)”), which is a revision of FASB SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No.123”). SFAS No. 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, andamends FASB SFAS No. 95, Statement of Cash Flows (“SFAS No. 95”). SFAS No. 123(R) would require allshare-based payments to employees, including grants of employee stock options, to be measured using a fairvalue method and record such expense in the consolidated financial statements. In addition, the adoption of

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SFAS No. 123(R) will require additional accounting related to the income tax effects and additional disclosureregarding the cash flow effects resulting from share-based payment arrangements. Based on the phase-inimplementation announced by the SEC on April 14, 2005, SFAS No. 123(R) is effective at the beginning of thefirst fiscal year beginning after June 15, 2005. The Company will be required to apply SFAS No. 123(R)beginning May 1, 2006. The adoption of SFAS No. 123(R) will result in recording material charges related toemployee stock-based compensation in future periods, impacting our consolidated financial position and resultsof operations.

In November 2004, the FASB issued SFAS No. 151, Inventory Costs (“SFAS No. 151”), which clarifies theaccounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material. SFAS No.151 will be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. We do notbelieve the adoption of SFAS No. 151 will have a material impact on our financial statements.

In September 2004, the FASB staff issued FASB Staff Position (“FSP”) Emerging Issues Task Force(“EITF”) 03-1-1, or FSP EITF 03-01-1. Effective upon issuance, FSP EITF 03-1-1 delayed, indefinitely, certainmeasurement and recognition guidance contained in EITF No. 03-1, The Meaning of Other-Than-TemporaryImpairment and Its Application to Certain Investments. Issued in March 2004, EITF No. 03-1 includes guidancefor determining and recording impairment for both debt and equity securities. EITF No. 03-1 also requiresadditional disclosure for investments that are deemed to be temporarily impaired under the standard. We do notbelieve that the adoption of FSP EITF 03-01-1 will have a material impact on our financial position, results ofoperations or liquidity.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

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

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. As ofApril 30, 2005, we had approximately $43.7 million invested primarily in certificates of deposit and fixed-rate,short-term corporate and U.S. government debt securities which are included in cash and cash equivalents in ourconsolidated balance sheets. We maintain a strict investment policy, which is intended to ensure the safety andpreservation of our invested funds by limiting default risk, market risk and reinvestment risk. The fair value ofour investment portfolio would not be significantly impacted by either a 100 basis point increase or decrease ininterest rates due mainly to the short-term nature of the major portion of our investment portfolio.

Foreign Currency Exchange Rate Risk

We develop products in the United States and sell them throughout the world. As a result, our financialresults could be affected by factors such as changes in foreign currency exchange rates or weak economicconditions in foreign markets. Since all of our sales are currently made in United States dollars, a strengtheningof the dollar could make our products less competitive in foreign markets. If any of the events described abovewere to occur, our net revenue could be seriously impacted, since a significant portion of our net revenue arederived from international operations. For the fiscal years 2005, 2004 and 2003, approximately 49.1%, 44.1%and 48.0%, respectively, of our total net revenue were derived from customers outside of North America. Incontrast, substantially all of the expenses of operating our foreign subsidiaries are incurred in foreign currencies.As a result, our U.S. dollar earnings and net cash flows from international operations may be adversely affectedby changes in foreign currency exchange rates. However, we do not consider the market risk associated with ourinternational operations to be material. We do not currently use derivative financial instruments for hedging orspeculative purposes.

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Item 8. Financial Statements and Supplementary Data

Index to Consolidated Financial Statements

Page

Consolidated Balance Sheets as of April 30, 2005 and 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

Consolidated Statements of Operations for each of the three years in the period ended April 30, 2005 . . . . . 48

Consolidated Statements of Stockholders’ Equity for each of the three years in the period ended April 30,2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49

Consolidated Statements of Cash Flows for each of the three years in the period ended April 30, 2005 . . . . 50

Notes to the Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51

Reports of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76

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BLUE COAT SYSTEMS, INC.

CONSOLIDATED BALANCE SHEETS(In thousands)

April 30,2005

April 30,2004

ASSETSCurrent assets:

Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 47,264 $ 39,504Accounts receivable, net of allowance for doubtful accounts of $235 and $540 at

April 30, 2005 and 2004, respectively . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,541 10,441Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 350 1,228Prepaid expenses and other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,460 1,829

Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62,615 53,002

Property and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,763 2,490Restricted investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,855 1,991Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24,753 7,456Identifiable intangible assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,993 1,849Purchased software . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 411 —Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 472 881

Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 97,862 $ 67,669

LIABILITIES AND STOCKHOLDERS’ EQUITYCurrent liabilities:

Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,743 $ 2,890Accrued payroll and related benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,468 2,564Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,592 10,147Accrued acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 4,991Accrued restructuring . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,729 3,100Other accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,830 2,573

Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27,381 26,265

Accrued restructuring, less current portion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 914 3,504Deferred revenue, less current portion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,318 1,785

Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31,613 31,554

Commitments and contingencies

Stockholders’ equity:Preferred stock: $0.0001 par value, issuable in series, 10,000,000 shares

authorized; none issued . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Common stock: $0.0001 par value, 200,000,000 shares authorized; 12,436,482 and

11,128,164 shares issued and outstanding at April 30, 2005 and 2004,respectively . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1

Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 927,184 903,141Treasury stock, at cost; 140,217 and 132,214 shares held at April 30, 2005 and

2004, respectively . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (903) (903)Deferred stock compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (10) (727)Accumulated deficit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (860,024) (865,399)Accumulated other comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2

Total stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66,249 36,115

Total liabilities and stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 97,862 $ 67,669

The accompanying notes are an integral part of these Consolidated Financial Statements.

ŠF

orm

10-K

47

BLUE COAT SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except per share data)

Year Ended April 30,

2005 2004 2003

Net revenue:Product . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $78,495 $52,251 $ 35,827Service . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,691 13,817 9,911

Total net revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96,186 66,068 45,738Cost of revenue:

Product . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25,589 17,141 12,733Service . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,721 4,178 4,582

Total cost of revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31,310 21,319 17,315

Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64,876 44,749 28,423

Operating expenses:Research and development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,549 11,992 11,911Sales and marketing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33,882 25,104 26,236General and administrative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,075 5,206 5,042Amortization of intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 648 305 —Restructuring (reversal) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (96) 1,536 1,273Legal settlement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 1,100 —In-process technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 151 —

Total operating expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,058 45,394 44,462

Operating income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,818 (645) (16,039)Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 700 295 437Other income (expense) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (26) 126 (65)

Income (loss) before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,492 (224) (15,667)Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (117) (124) (261)

Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,375 $ (348) (15,928)

Net income (loss) per common share:Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.46 $ (0.03) $ (1.81)

Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.41 $ (0.03) $ (1.81)

Weighted average shares used in computing net income (loss) per commonshare:

Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,628 9,956 8,777

Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,977 9,956 8,777

The accompanying notes are an integral part of these Consolidated Financial Statements.

48

BLUE COAT SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY(In thousands)

Common Stock AdditionalPaid-InCapital

TreasuryStock

NotesReceivable

FromStockholders

DeferredStock

CompensationAccumulated

Deficit

AccumulatedOther

ComprehensiveIncome (Loss) TotalShares Amount Shares Amount

Balances at April 30, 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,913 $ 1 $883,967 (136) $(895) $ (57) $(3,622) $(849,123) $ (7) $ 30,264

Components of comprehensive loss:Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — — — (15,928) — (15,928)Net unrealized gain on available for sale securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — — — — 20 20

Total comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (15,908)

Issuance of common stock under employee stock option and employee stock purchase plans . . . . . . . . . . . . . . . . . . . . . . . . . 139 — 339 29 5 — — — — 344Interest on notes receivable from stockholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — (14) — — — (14)Stock-based compensation expense related to modified employee stock options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — 162 — — — (114) — — 48Amortization of deferred stock-based compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — (882) — — — 2,904 — — 2,022Reversal of deferred stock-based compensation due to cancellations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — (225) — — — 225 — — —Repayment of notes receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — 27 — — — 27Repurchase of stock and related notes receivable settlement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (4) — (9) (25) (13) 16 — — — (6)

Balances at April 30, 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,048 1 883,352 (132) (903) (28) (607) (865,051) 13 16,777

Components of comprehensive loss:Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — — — (348) — (348)Net unrealized (loss) on available for sale securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — — — — (11) (11)

Total comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (359)

Issuance of common stock under employee stock option and employee stock purchase plans . . . . . . . . . . . . . . . . . . . . . . . . . 619 — 4,318 — — — — — — 4,318Interest on notes receivable from stockholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — (11) — — — (11)Repayment of notes receivable from stockholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — 39 — — — 39Sale of common stock, net of issuance costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,312 — 12,944 — — — — — — 12,944Stock-based compensation expense related to modified employee stock options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — 20 — — — — — — 20Common stock issued in Ositis acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127 — 2,164 — — — — — — 2,164Fair Value of warrants assumed in connection with Ositis acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — 43 — — — — — — 43Deferred stock-based compensation related to Ositis acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — — (1,389) — — (1,389)Common stock issued to certain Blue Coat employees as part of Ositis acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 — 376 — — — — — — 376Amortization of deferred stock-based compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — — 1,222 — — 1,222Reversal of deferred stock-based compensation due to cancellations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — (47) — — — 47 — — —Reversal of previously amortized deferred stock-based compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — (29) — — — — — — (29)

Balances at April 30, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,128 1 903,141 (132) (903) — (727) (865,399) 2 36,115

Components of comprehensive income:Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — — — 5,375 — 5,375Net unrealized (loss) on available for sale securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — — — — (1) (1)

Total comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,374

Issuance of common stock under employee stock option and employee stock purchase plans . . . . . . . . . . . . . . . . . . . . . . . . . 253 — 1,810 — — — — — — 1,810Common stock issued to certain Blue Coat employees as part of Ositis acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 249 — 4,122 (8) — — — — — 4,122Common stock issued in Cerberian acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 806 — 17,854 — — — — — — 17,854Deferred Stock-based compensation related to modified employee stock options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — 262 — — — — — — 262Deferred stock-based compensation related to Cerberian acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — — (17) — — (17)Reversal of deferred stock-based compensation due to cancellations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — (5) — — — 5 — — —Amortization of deferred stock-based compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — — 729 — — 729

Balances at April 30, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,436 $ 1 $927,184 (140) $(903) $ — $ (10) $(860,024) $ 1 $ 66,249

The accompanying notes are an integral part of these Consolidated Financial Statements.

Š Form 10-K

49

BLUE COAT SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)

Year Ended April 30,

2005 2004 2003

Operating ActivitiesNet income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,375 $ (348) $(15,928)Adjustments to reconcile net income (loss) to net cash provided by (used in)

operating activities:Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,679 2,068 2,930Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,012 305 —Stock-based compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 991 1,213 2,070Non-cash charge (reversal) for acquired in-process technology and

restructuring charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (96) 1,687 —Loss (gain) on disposition of equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 (29) 53Interest payments (accrued) on notes receivable from stockholders . . . . . . . — 28 (14)Changes in operating assets and liabilities:

Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (513) (2,361) (1,980)Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 878 (105) 133Prepaid expenses and other current assets . . . . . . . . . . . . . . . . . . . . . . . (1,558) (673) 654Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 430 184 7Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 619 2,279 (1,942)Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,122) (2,715) (4,767)Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,316 2,418 2,518

Net cash provided by (used in) operating activities . . . . . . . . . . . . . . . . . . . . . . . . 11,025 3,951 (16,266)

Investing ActivitiesPurchases of property and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,548) (1,431) (743)Sales of investment securities, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135 10,447 17,028Purchase of capitalized software . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (537) — —Acquisition of Ositis, net of cash acquired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (669) (3,628) —Acquisition of Cerberian, net of cash acquired . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,449) — —Proceeds from sales of equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 39 —

Net cash provided by (used in) investing activities . . . . . . . . . . . . . . . . . . . . . . . . (5,068) 5,427 16,285

Financing ActivitiesNet proceeds from issuance of common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,803 4,318 344Net proceeds from equity financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 12,944 —Repayment of notes receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — 27Repurchase of common stock from employees . . . . . . . . . . . . . . . . . . . . . . . . . . . — — (6)

Net cash provided by financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,803 17,262 365

Net increase in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,760 26,640 384Cash and cash equivalents at beginning of period . . . . . . . . . . . . . . . . . . . . . . . . . 39,504 12,864 12,480

Cash and cash equivalents at end of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $47,264 $39,504 $ 12,864

Supplemental schedule of noncash investing and financing activitiesIssuance of common stock for acquisition of businesses . . . . . . . . . . . . . . . . . . . . $21,971 $ 2,540 $ —Cash paid for income taxes, net of refunds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 98 $ 277 $ 313

The accompanying notes are an integral part of these Consolidated Financial Statements.

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Note 1. Business

Blue Coat® Systems, Inc., also referred to in this report as “it”, “its” or “the Company,” was incorporated inDelaware on March 16, 1996 as CacheFlow, Inc. On August 21, 2002 the Company changed its name fromCacheFlow,® Inc. to Blue Coat Systems, Inc. and this filing and all future Securities Exchange Commission(“SEC”) filings will be under the name Blue Coat Systems, Inc. The ticker symbol for the Company’s commonstock was also changed from CFLO to BCSI.

As organizations grow increasingly dependent on the Internet to communicate with customers, partners andemployees, the Web browser is fast becoming the universal window into mission-critical communications andinformation. This has many advantages for the enterprise: Web-based applications and protocols are fast,inexpensive and easy to deploy and manage. But these benefits can lead to increased risks for the enterprise, suchas increased help-desk calls due to spyware, legal liabilities associated with inappropriate Web surfing andcontent, open back doors for Web viruses to enter via instant messaging (IM) or personal Web email, networkbandwidth and storage abuse due to peer-to-peer (P2P) file sharing and video streaming, and productivity lossesfrom non-business related Web surfing and IM chatting. When every user on the network has a Web browser,every user also has the means to negatively affect the network infrastructure, whether intentionally or not. Asolution is to use a proxy appliance that is designed to provide Web visibility and control while also improvingnetwork performance.

Blue Coat proxy appliances help organizations make the Web safe and productive for business, providingvisibility and control of Web communications to protect against risks from spyware, Web viruses, inappropriateWeb surfing, instant messaging, video streaming and peer-to-peer file sharing – while actually improving Webperformance. Sitting in the network between the users and the Internet, proxy appliances do not replace existingperimeter security devices; rather, proxy appliances complement network firewalls by providing granular policy-based controls over Web traffic in ways that firewalls and other externally focused devices cannot.

Note 2. Summary of Significant Accounting Policies

Basis of Presentation

The consolidated financial statements include Blue Coat Systems, Inc.’s accounts and those of itssubsidiaries, all of which are wholly owned. All intercompany balances and transactions have been eliminated.

The consolidated financial statements for the fiscal year ended April 30, 2005 and 2004 include the accountsand operating results of Cerberian, Inc. and Ositis Software, Inc., beginning November 16, 2004 and November14, 2003, respectively (see Note 3).

Use of Estimates

The preparation of consolidated financial statements and related disclosures in conformity with accountingprinciples generally accepted in the United States requires management to make estimates and judgments thataffect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, at the datesof the consolidated financial statements and the reported amounts of revenues and expenses during the reportingperiods. Actual results may differ from these estimates, and such differences could be material to the Company’sconsolidated financial position and results of operations. The Company’s critical accounting estimates include (i)inventories, (ii) valuation of goodwill, (iii) valuation of long-lived and identifiable intangible assets, (iv)restructuring liabilities, (v) revenue recognition and related receivable allowances, (vi) warranty obligations, (vii)income taxes, and (viii) commitments and contingencies.

Reclassifications

Certain balances in the Company’s 2004 and 2003 consolidated financial statements have been reclassifiedto conform to the current year presentation.

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Cash Equivalents and Short-Term Investments

The Company considers all highly liquid investments with insignificant interest rate risk and originalmaturities of three months or less to be cash equivalents.

Short-term investments consist primarily of debt securities with original maturities between three monthsand one year. Management determines the appropriate classification of the Company’s investments at the time ofpurchase and evaluates such designation as of each balance sheet date based on its intent and ability to use suchfunds for current operations. To date, all of the Company’s investments have been classified as available-for-saleand are carried at fair value with unrealized gains and losses, if any, included in accumulated othercomprehensive income (loss) in stockholders’ equity. The fair value of these securities is based on quoted marketprices. Realized gains and losses and declines in value of securities judged to be other than temporary areincluded in other income (expenses) and have not been significant to date. Interest and dividends on all securitiesare included in interest income.

Inventories

Inventories consist of raw materials, work-in-process and finished goods. Inventories are recorded at thelower of cost or market using the first-in, first-out method, after appropriate consideration has been given toobsolescence and inventory in excess of anticipated future demand. In assessing the ultimate recoverability ofinventories, the Company is required to make estimates regarding future customer demand and marketconditions.

Property and Equipment

Property and equipment are stated at cost, subject to adjustments for impairment, less accumulateddepreciation and amortization. Depreciation and amortization are provided on a straight-line basis over thefollowing estimated useful lives:

Software 3 yearsFurniture and fixtures 3 yearsComputer and office equipment 3-5 yearsLeasehold improvements Shorter of useful life or remaining lease term

Valuation of Goodwill

The Company performs goodwill impairment tests in accordance with Financial Accounting StandardsBoard (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and OtherIntangible Assets, (“SFAS No. 142”) on an annual basis during its fourth fiscal quarter, or whenever events orchanges in circumstances indicate that the carrying amount of goodwill may not be recoverable. The first step ofthe test identifies if potential impairment may have occurred, while the second step of the test measures theamount of the impairment, if any. Impairment is recognized when the carrying amount of goodwill exceeds itsfair value. The process of evaluating the potential impairment of goodwill is highly subjective and requiressignificant judgment. For the purposes of the Company’s fiscal 2005 annual impairment test of its goodwill, theCompany considered its market capitalization on the date of its impairment test and determined that no goodwillimpairment existed.

Valuation of Long-Lived and Identifiable Intangible Assets

The Company periodically evaluates potential impairments of its long-lived assets, including identifiableintangible assets, in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-LivedAssets (“SFAS No. 144”). The Company evaluates long-lived assets, including identifiable intangible assets, for

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impairment on an annual basis during its fourth quarter, or whenever events or changes in circumstances indicatethat the carrying amount of the assets may not be recoverable. Events or changes in circumstances that couldresult in an impairment review include, but are not limited to, significant underperformance relative to historicalor projected future operating results, significant changes in the manner of use of the acquired assets or thestrategy for the Company’s overall business and significant negative industry or economic trends. Impairment isrecognized when the carrying amount of an asset exceeds its fair value. In connection with the annual impairmentanalysis of goodwill, the Company assessed the recoverability of the intangible assets subject to amortization inaccordance with SFAS No. 144. For the year ended April 30, 2005, no impairment expense was recognized.

Restructuring Liabilities

Restructuring activities were initiated prior to December 31, 2002 and were recorded in accordance withEmerging Issues Task Force (“EITF”) Issue No. 94-3, Liability Recognition for Certain Employee TerminationBenefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring). The Companyhas accrued various restructuring liabilities, through charges to “Restructuring Expense”, related to employeeseverance costs, facilities closure and lease abandonment costs, and contract termination costs in the consolidatedfinancial statements. The Company’s restructuring liabilities for facilities closure and lease abandonment costsinclude various assumptions, such as the time period over which abandoned facilities will be vacant, expectedsublease terms, and expected sublease rates.

Revenue Recognition and Related Receivable Allowances

The Company recognizes appliance and WinProxy revenue upon delivery of the product, assuming thatevidence of an arrangement between the customer and the Company exists, the fee to the customer is fixed ordeterminable and collectability is reasonably assured. In the event the Company has future performanceobligations or must obtain customer acceptance, revenue is deferred until the obligations are met or acceptance isobtained. During the fiscal year ended April 30, 2005, the Company deferred certain revenue and related costs ofrevenue based on future obligations.

Revenue and related cost of revenue resulting from shipments to the Company’s distributors who havecertain stock rotation rights are deferred until a point of sale report is received from the distributor confirmingthat the Company’s products have been sold to a reseller or an end user. For sales to resellers, revenue andrelated cost of revenues are recognized upon shipment based on the Company’s understanding that an end userhas been identified at the time of shipment.

Maintenance contract and subscription revenue is initially deferred and recognized ratably over the life ofthe contract with the related service cost expensed as incurred. Maintenance and subscription contracts usuallyhave a 12-month duration but can extend to 36 months. Unearned maintenance and subscription contract revenueis included in deferred revenue.

Delivery is considered to have occurred for the Company’s appliances when the customer takes title to theproduct and assumes the risks and rewards of ownership. WinProxy software delivery is considered to haveoccurred when the software key is made available to the customer electronically.

When a sale involves multiple elements, the Company determines if these elements can be separated intomultiple units of accounting. The entire fee from the arrangement is allocated to each respective element basedon its relative fair value or using the residual method, if appropriate. Revenue for each element is then recognizedwhen revenue recognition criteria for that element is met. If the Company cannot establish fair value for anyundelivered element, the Company would be required to recognize revenue for the whole arrangement at the timerevenue recognition criteria for the undelivered element is met. Relative fair value for maintenance elements arebased on substantive renewal rates.

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The Company records shipping costs in both revenue and cost of revenue when it bills its customers forshipping. If the Company does not charge its customers for shipping, the costs incurred for shipping are reflectedin cost of revenue but not recorded in revenue.

Probability of collection is assessed on a customer-by-customer basis. The Company’s customers aresubjected to a credit review process that evaluates the customers’ financial condition and ability to pay for theCompany’s products and services. If it is determined from the outset of an arrangement that collection is notprobable based upon the review process, revenue is not recognized until cash receipt.

The Company performs ongoing credit evaluations of its customers’ financial condition and maintains anallowance for doubtful accounts. The Company analyzes accounts receivable and historical bad debts, customerconcentrations, customer solvency, current economic and geographic trends, and changes in customer paymentterms and practices when evaluating the adequacy of such allowance, and any changes are expensed to generaland administrative expense.

Research and Development

Research and development costs are expensed as incurred.

Guarantees and Warranty Obligations

The Company’s customer agreements generally include certain provisions for indemnifying such customersagainst liabilities if the Company’s products infringe a third party’s intellectual property rights. To date, theCompany has not incurred any material costs as a result of such indemnifications and has not accrued anyliabilities related to such obligations in the accompanying consolidated financial statements.

The Company accrues for warranty expenses as part of its cost of revenue at the time revenue is recognizedand maintains an accrual for estimated future warranty obligations based upon the relationship between historicaland anticipated warranty costs and revenue volumes. If actual warranty expenses are greater than those projected,additional obligations and other charges against earnings may be required. If actual warranty expenses are lessthan projected, prior obligations could be reduced, providing a positive impact on our reported results. TheCompany generally provides a one-year warranty on hardware products and a 90-day warranty on softwareproducts.

Advertising Costs

Advertising costs are charged to sales and marketing expense as incurred. Advertising costs were $0.2million, $0.1 million and $0.1 million, for the years ended April 30, 2005, 2004 and 2003, respectively.

Income Taxes

The Company uses the liability method to account for income taxes as required by SFAS No. 109,Accounting for Income Taxes, (“SFAS No. 109”). As part of the process of preparing the Company’sconsolidated financial statements, the Company is required to estimate its income taxes in each of thejurisdictions in which it operates. This process involves determining the Company’s income tax expense (benefit)together with calculating the deferred income tax expense (benefit) related to temporary differences resultingfrom the differing treatment of items for tax and accounting purposes, such as deferred revenue or deductibilityof certain intangible assets. These differences result in deferred tax assets and liabilities, which are includedwithin the consolidated balance sheets. The Company must then assess the likelihood that the deferred tax assetswill be recovered through the generation of future taxable income. As of April 30, 2005, the Company has a fullvaluation allowance against its net deferred tax assets because the Company determined that it is more likely thannot that its deferred tax assets will not be realized in the foreseeable future.

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Comprehensive Income (Loss)

The Company reports comprehensive income (loss) in accordance with Statement of Financial AccountingStandard No. 130, Reporting Comprehensive Income, (“SFAS No. 130”). Included in other comprehensiveincome (loss) are adjustments to record unrealized gains and losses on available-for-sale securities. Theseadjustments are accumulated in “Accumulated other comprehensive income (loss)” in the stockholders’ equitysection of the balance sheets.

Significant components of the Company’s comprehensive income (loss) are as follows (in thousands):

Year Ended April 30,

2005 2004 2003

Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,375 $(348) $(15,928)Unrealized gains (losses) on available-for-sale securities . . . . . . . . . . . . . . . . . . . . . . (1) (11) 20

Comprehensive income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,374 $(359) $(15,908)

Stock-Based Compensation

The Company accounts for stock-based awards granted to employees and officers using the intrinsic valuemethod and to non-employees using the fair value method.

Under the intrinsic value method, when the exercise price of employee stock options equals the market priceof the underlying stock on the date of grant, no compensation expense is recognized as prescribed by AccountingPrinciples Board Opinion 25, “Accounting for Stock Issued to Employees” and related interpretations. Inaccordance with SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), as amended bySFAS No. 148, Accounting for Stock-Based Compensation (“SFAS No. 148”), under the fair value method, costsare measured on the earlier of either a performance commitment or the completion of performance by the non-employee provider of goods or services, and are determined based on estimated fair value of the considerationreceived or the estimated fair value of the equity instruments issued, whichever is more reliably measurable.During fiscal 2005, a stock-based compensation charge of $0.3 million was recorded due to a stock optionmodification in a severance agreement with the Company’s departing Chief Financial Officer where the vestingof certain options was accelerated.

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The following table illustrates the pro forma effect on net loss and net loss per share for the years endedApril 30, 2005, 2004 and 2003 had the Company applied the fair value method to account for stock-based awardsto employees (in thousands):

Year Ended April 30,

2005 2004 2003

Net income (loss), as reported . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,375 $ (348) $(15,928)Stock-based employee compensation expense included in the determination of net

income (loss), as reported . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 991 1,213 2,070Stock-based compensation for stock awards issued related to Ositis acquisition . . . (676) (714) —Stock-based employee compensation expense that would have been included in

the determination of net loss if the fair value method had been applied to allawards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (8,388) (11,870) (16,736)

Pro forma net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(2,698) $(11,719) $(30,594)

Basic net income (loss) per common share:As reported . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.46 $ (0.03) $ (1.81)

Pro forma . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (0.23) $ (1.18) $ (3.49)

Diluted net income (loss) per common share:As reported . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.41 $ (0.03) $ (1.81)

Pro forma . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (0.23) $ (1.18) $ (3.49)

For purposes of pro forma disclosures, the estimated fair value of stock-based awards to employees isamortized to pro forma expense over the vesting period for stock options and over the applicable purchaseperiods for stock purchases under the Employee Stock Purchase Plan (“ESPP”). The weighted average grant datefair value of stock options granted to employees was $13.82, $8.40 and $1.98 per share during the years endedApril 30, 2005, 2004 and 2003, respectively. The weighted average fair value of employee stock purchase rightsgranted under the ESPP was $8.40, $2.40 and $1.95 per share during the years ended April 30, 2005, 2004 and2003, respectively. Such weighted average grant date fair values were estimated using the Black-Scholes optionvaluation model and the assumptions included below.

Pro forma information regarding the results of operations and net loss per share is determined as if theCompany had accounted for employee stock options using the fair value method. Under this method, the fairvalue of each option granted is estimated on the date of grant using the Black-Scholes option valuation model.

For the years ended April 30, 2005, 2004 and 2003, the fair value of the Company’s stock-based awards toemployees was estimated using the following weighted average assumptions:

Year Ended April 30,

Options ESPP

2005 2004 2003 2005 2004 2003

Risk-free interest rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.30% 3.49% 3.26% 2.43% 1.37% 1.38%Dividend yield . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0% 0% 0% 0% 0% 0%Expected life (years) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.97 4.00 4.00 1.25 0.50 0.50Expected volatility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.23 0.82 1.22 1.02 0.77 1.01

Per Share Amounts

Basic net income (loss) per common share and diluted net income (loss) per common share are presented inconformity with SFAS No. 128, Earnings Per Share (“SFAS No. 128”), for all periods presented. Basic net

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income (loss) per share is computed by dividing net income (loss) by the weighted-average number of commonshares outstanding during the period. Basic per share amounts are computed by using the weighted averagenumber of shares of the Company’s common stock, less the weighted average number of common shares subjectto repurchase, outstanding during the period. Diluted net income (loss) per share is computed using the weighted-average number of shares of common stock outstanding, including dilutive common shares subject to repurchaseand potential shares assuming the (i) exercise of dilutive stock options and warrants using the treasury stockmethod and (ii) issuance of committed but un-issued stock awards. Basic and diluted net income (loss) per sharefor the years ended April 30, 2005 were presented separately. For periods for which there is a net loss, thenumbers of shares used in the computation of diluted net income (loss) per share are the same as those used forthe computation of basic net income (loss) per share as the inclusion of dilutive securities would be anti-dilutive.The total number of shares excluded from the calculation of diluted net loss per common share wasapproximately 1,619,000 and 320,000 for the years ended April 30, 2004 and 2003, respectively.

The following table presents the calculation of weighted average common shares used in the computationsof basic and diluted per share amounts presented in the accompanying consolidated statements of operations (inthousands):

Year Ended April 30,

2005 2004 2003

Net income (loss) available to common stockholders . . . . . . . . . . . . . . . . . . . . . . . $ 5,375 $ (348) $(15,928)

Basic:Weighted-average shares of common stock outstanding . . . . . . . . . . . . . . . . . 11,628 9,958 8,830Less: Weighted average shares of common stock subject to repurchase . . . . . — (2) (53)

Weighted average common shares used in computing basic net income (loss)per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,628 9,956 8,777

Basic net income (loss) per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.46 $ (0.03) $ (1.81)

Diluted:Weighted-average common shares used in computing basic net income (loss)

per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,628 9,956 8,777Add: Weighted average employee stock options and warrants . . . . . . . . . . . . 1,271 — —Add: Other weighted-average dilutive potential common stock . . . . . . . . . . . 78 — —

Weighted average common shares used in computing diluted net income(loss) per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,977 9,956 8,777

Diluted net income (loss) per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.41 $ (0.03) $ (1.81)

Foreign Currency Adjustments

The functional currency of the Company’s domestic and foreign operations is the U.S. dollar. Accordingly,the effects of foreign currency transactions, and of remeasuring the financial position and results of operationsfrom local currencies into the functional currency, are included in “other income (expense)” in the accompanyingconsolidated statements of operations. These amounts were not material during any of the three years in theperiod ended April 30, 2005.

Fair Value of Financial Instruments

The carrying amounts of the Company’s financial instruments, which include cash, cash equivalents, short-term investments and restricted investments, approximate their respective fair values based on quoted marketprices.

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Concentration and Other Risks

Financial instruments that potentially subject the Company to credit risk consist of demand depositaccounts, money market accounts, commercial paper, corporate debt securities and trade receivables. TheCompany maintains its demand deposit and money market accounts primarily with one financial institution withhigh credit standing. The Company invests only in high-quality, investment grade securities and limitsinvestment exposure in any one issue. Investments are classified as cash equivalents on the Company’sconsolidated balance sheets for the years ended April 30, 2005 and 2004. Management believes the financialrisks associated with these financial instruments are minimal. The Company has not experienced material lossesfrom its investments in these securities.

Generally, the Company does not require collateral for sales to customers. However, the Company performson-going credit valuations of its customers’ financial condition and maintains an allowance for doubtfulaccounts. One of the Company’s distributors accounted for 15.9%, 24.1% and 19.0% of its net revenue duringthe years ended April 30, 2005, 2004 and 2003, respectively. The same distributor accounted for 11.3%, 12.7%and 20.4% of the Company’s gross accounts receivable balances for the years ended April 30, 2005, 2004 and2003, respectively. No other customer accounted for more than 10.0% of the Company’s gross accountsreceivable balances for the same time periods.

The Company currently purchases several key parts and components used in the manufacture of its productsfrom a limited number of suppliers. Generally the Company has been able to obtain an adequate supply of suchparts and components. However, an extended interruption in the supply of parts and components currentlyobtained from the Company’s suppliers could adversely affect its business and consolidated financial statements.

Contingencies

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

Recent Accounting Pronouncements

In June 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (“SFAS No.154”), a replacement of APB Opinion No. 20, Accounting Changes (“APB 20”), and FASB SFAS No. 3,Reporting Accounting Changes in Interim Financial Statements (“SFAS No. 3”). SFAS No. 154 applies to allvoluntary changes in accounting principle, and changes the requirements for accounting for and reporting of achange in accounting principle. SFAS No. 154 requires retrospective application to prior periods’ financialstatements of a voluntary change in accounting principle unless it is impracticable. SFAS No. 154 also requiresthat a change in method of depreciation, amortization, or depletion for long-lived, non-financial assets beaccounted for as a change in accounting estimate that is affected by a change in accounting principle. SFAS No.154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December15, 2005. Earlier application is permitted for accounting changes and corrections of errors made occurring infiscal years beginning after June 1, 2005. SFAS No. 154 does not change the transition provisions of any existingaccounting pronouncements, including those that are in a transition phase as of the effective date of thisStatement. The Company does not believe the adoption of SFAS No. 154 will have a material impact on itsfinancial statements.

On December 16, 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS No.123(R)”), which is a revision of FASB SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No.

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123”). SFAS No. 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, andamends FASB SFAS No. 95, Statement of Cash Flows (“SFAS No. 95”). SFAS No. 123(R) would require allshare-based payments to employees, including grants of employee stock options, to be measured using a fairvalue method and record such expense in the consolidated financial statements. In addition, the adoption ofSFAS No. 123(R) will require additional accounting related to the income tax effects and additional disclosureregarding the cash flow effects resulting from share-based payment arrangements. Based on the phase-inimplementation announced by the SEC on April 14, 2005, SFAS No. 123(R) is effective at the beginning of thefirst fiscal year beginning after June 15, 2005. The Company will be required to apply SFAS No. 123(R)beginning May 1, 2006. The adoption of SFAS No. 123(R) will result in recording material charges related toemployee stock-based compensation in future periods, impacting the Company’s consolidated financial positionand results of operations.

In November 2004, the FASB issued SFAS No. 151, Inventory Costs (“SFAS No. 151”), which clarifies theaccounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material. SFAS No.151 will be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. TheCompany does not believe the adoption of SFAS No. 151 will have a material impact on its financial statements.

In September 2004, the FASB staff issued FASB Staff Position (“FSP”) EITF 03-01-1, or FSP EITF 03-01-1.Effective upon issuance, FSP EITF 03-1-1 delayed, indefinitely, certain measurement and recognition guidancecontained in EITF No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to CertainInvestments. Issued in March 2004, EITF No. 03-1 included guidance for determining and recording impairment forboth debt and equity securities. EITF No. 03-1 also requires additional disclosure for investments that are deemed tobe temporarily impaired under the standard. We do not believe that the adoption of FSP EITF 03-01-1 will have amaterial impact on our financial position, results of operations or liquidity.

Note 3. Acquisitions

Cerberian, Inc.

On November 16, 2004, the Company completed its acquisition of Cerberian, Inc. (“Cerberian”). Thepurchase price of approximately $19.3 million consisted of approximately 0.8 million shares of Blue Coatcommon stock valued at $17.4 million, $0.4 million in direct transaction costs, Cerberian options assumed byBlue Coat valued at approximately $0.5 million and the elimination of promissory notes from Cerberian to BlueCoat of $1.0 million. The acquisition was accounted for as a purchase in accordance with SFAS No. 141,Accounting for Business Combinations (“SFAS No. 141”). This purchase price has been allocated to the tangibleand intangible assets acquired with the excess purchase price being allocated to goodwill.

Cerberian was founded in 2000 as a Utah corporation and later incorporated as a Delaware corporation onJanuary 9, 2001. Cerberian was a provider of URL filtering software. Cerberian’s operations were assumed as ofthe date of the acquisition and are included in the results of operations of the Company beginning on November16, 2004 and, as a result, are not reflected in the results of operations for the years ended April 30, 2004 and2003.

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The updated allocation of the purchase price, based on the fair value of each component, consisted of thefollowing at April 30, 2005 (in thousands):

Consideration and direct transaction costs:Fair value of Blue Coat common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $17,357Direct transaction costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 437Fair value of assumed Cerberian options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 497Promissory notes from Cerberian to Blue Coat . . . . . . . . . . . . . . . . . . . . . . . . 1,034

Total purchase price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $19,325

Allocation of purchase price:Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 588Other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66Fixed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 184Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21Liabilities assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,033)Deferred stock compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17Identifiable intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,030Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,450

Total purchase price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $19,325

Upon closing the acquisition of Cerberian, the Company eliminated the promissory notes from Cerberian toBlue Coat totaling $1.0 million and paid off other notes payable to third parties totaling $0.5 million and paid offvarious capital leases of $0.1 million. The Company also incurred $0.4 million in severance costs during the yearended April 30, 2005, related to the consolidation of various activities in an effort to eliminate redundancies andincrease organizational efficiencies within the newly combined company.

The Company’s primary purpose for acquiring Cerberian was to expand its employee internet managementproducts, as well as gain access to Cerberian’s customer base. The Company believes that the intangible assets ofCerberian strengthen its product offerings and allow it to market a more competitive solution to its customers.

To establish the value of the intangible assets, the Company, with the assistance of an independent valuationspecialist, used an income approach. The Company utilized a five-step process to value the intangible assets: (i)revenue associated with the intangible assets was projected; (ii) cost of revenue was then estimated for eachperiod in which revenue was projected; (iii) the resulting net cash flow was tax effected and reduced further bycharges for the use of fixed assets, working capital and other assets necessary to generate these cash flows; (iv)the resulting net cash flows were discounted at a rate commensurate with their risk; and (v) the Companysummed the discounted cash flows to estimate their fair market values. The Company then estimated the taxbenefits associated with the intangible asset and this benefit was included in the value of the intangible assets.

As part of the valuation analysis, an understanding of the technology acquired and its future use after theacquisition was necessary. Accordingly, several factors were considered: (i) whether or not the acquiredtechnology had achieved technological feasibility; (ii) the time, costs and risks to complete the development ofthe technology; (iii) the roadmap for the technology post acquisition; (iv) the existence of any alternative use forthe technology; (v) the additional use of any core technology; and (vi) the results of any enhancements orembellishments to the technology.

Using the above guidelines at the time of the acquisition, the Company’s management identified intangibleassets that were valued separately from goodwill. The intangible assets identified were core technology andcustomer base. The intangible assets were valued using an income approach as described above. The cash flows

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were discounted to their present value using a discount rate of 24.0%. Intangible assets acquired through theCerberian acquisition and their estimated useful lives are as follows (in thousands):

Identifiable intangible assetsAmortization

periodGross

Amount

Core technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 years $2,590Customer base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 years 440

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,030

The potential value of the combined companies’ products and technologies contributed to a purchase pricethat resulted in goodwill. Goodwill represents the excess of the purchase price of an acquired business over thefair value of the underlying net tangible and intangible assets. Goodwill is not deductible for tax purposes and isnot subject to amortization; however, it is to be tested for impairment at least annually in accordance with SFASNo. 142. Approximately $17.6 million of the total purchase price was allocated to goodwill upon the closing ofCerberian acquisition on November 16, 2004. In the fourth quarter of fiscal 2005, the Company recorded anadjustment of $0.2 million related to a decrease in legal and accounting transaction fees, resulting in acorresponding decrease to goodwill.

Ositis Software, Inc.

On November 14, 2003, the Company completed its acquisition of Ositis Software, Inc. (“Ositis”). Thepurchase price of $8.7 million consisted of 0.4 million shares of Blue Coat common stock valued at $6.7 million,$1.1 million in cash, $0.9 million in direct transaction costs, and Ositis warrants assumed by the Company valuedat $43,000 which have all been exercised.

Ositis’ operations have been included in the results of operations of Blue Coat beginning on November 14,2003. The acquisition was accounted for as a purchase in accordance with SFAS No. 141, Accounting forBusiness Combinations (“SFAS No. 141”); accordingly, the Company allocated the purchase price to the fairvalue of assets acquired and liabilities assumed.

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The final allocation of the purchase price, based on the fair value of each component, consisted of thefollowing (in thousands):

Consideration and direct transaction costs:Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,051Fair value of Blue Coat common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,662Estimated direct transaction costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 911Fair value of assumed Ositis warrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

Total purchase price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 8,667

Allocation of purchase price:Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 350Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 441Other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124Debt assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,100)Moving, lease termination, and transition costs . . . . . . . . . . . . . . . . . . . . . . . . (491)Legal and investment banking fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (479)Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (174)Accounts payable and accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,250)Deferred employee compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,596Identifiable amortizable intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,153In-process technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,303

Total purchase price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 8,667

Upon closing the acquisition of Ositis, the Company recorded approximately $1.6 million of deferredemployee compensation. Of the $1.6 million, $0.2 million was recorded as a prepaid expense related tocommitted cash consideration and $1.4 million related to committed stock awards to be issued over 12 months,which was recorded as deferred stock compensation in the equity section of the Company’s balance sheet. Theseamounts were amortized over a 12-month period beginning in November 2003. The Company incurredcompensation expense of $0.8 million during each of the years ended April 30, 2005 and 2004, related toamortization of prepaid employee compensation and deferred employee stock compensation. The final allocationof purchase price also included the return of approximately 8,000 escrow shares to treasury stock in the thirdquarter of fiscal 2005.

To establish the value of the intangible assets, the Company used an income approach, which values an assetbased on the future cash flows that could potentially be generated by the asset over its estimated remaining life.These cash flows were discounted to their present value using a discount rate of 15.0% for the developedtechnology and 20.0% for the core technology that would provide sufficient return to a potential investor and anappropriate level of risk. The present value of the cash flows over the life of the asset is summed to equal theestimated value of the asset. Intangible assets acquired through the Ositis acquisition and their estimated usefullives consisted of the following (in thousands):

Identifiable intangible assetsAmortization

periodGross

Amount

Developed technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 years $1,331Core technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 years 339Customer base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 years 483

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,153

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The potential value of the combined companies’ products and technologies contributed to a purchase pricethat resulted in goodwill. Goodwill represents the excess of the purchase price of an acquired business over thefair value of the underlying net tangible and intangible assets. Goodwill is not deductible for tax purposes and isnot subject to amortization, however, it is to be tested for impairment at least annually in accordance with SFASNo. 142. Approximately $7.7 million of the total purchase price was allocated to goodwill upon closing of theOsitis acquisition on November 14, 2003. For the year ended April 30, 2005, the Company recorded anadjustment of $0.2 million related to a decrease in the fair value of assumed liabilities, resulting in acorresponding decrease to goodwill.

Pro-forma financial results

Unaudited pro forma results from operations for the years ended April 30, 2005 and 2004, assuming theacquisitions of Cerberian and Ositis were completed on May 1, 2004 and 2003, respectively, would be as follows(in thousands, except per share amounts):

Year Ended April 30,

2005 2004

Net revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $98,174 $69,700Operating income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,087 $ (5,687)Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,240 $ (5,990)Basic income (loss) per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.35 $ (0.55)Diluted income (loss) per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.32 $ (0.55)

The unaudited pro forma financial information is presented for informational purposes only, and is notnecessarily indicative of what the Company’s operating results would have been, had the acquisition beencompleted on the date for which the pro forma results give effect (May 1, 2004 and 2003). Included in the resultsfor the years ended April 30, 2005, and 2004 were expenses related to the acquisition of Ositis and Cerberian,such as the amortization of intangible assets, stock compensation, and integration costs.

Note 4. Consolidated Balance Sheet Data

Inventories

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

April 30,

2005 2004

Raw materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 255 $ 450Work-in-process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 186Finished goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 592

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 350 $ 1,228

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Property and Equipment

Property and equipment, net consist of the following (in thousands):

April 30,

2005 2004

Computer and office equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,527 $ 6,376Software . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,727 3,564Furniture and fixtures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,292 1,168Leasehold improvements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,049 869Construction in progress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232 272

14,827 12,249Less accumulated depreciation and amortization . . . . . . . . . . . . . . . . (11,064) (9,759)

$ 3,763 $ 2,490

Depreciation expense was $1.7 million, $2.1 million and $2.9 million for the years ended April 30, 2005,2004 and 2003, respectively.

Intangible Assets

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

April 30, 2005Amortization

periodGross

AmountAccumulatedAmortization

Net CarryingValue

Developed technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 years $1,331 $ (665) $ 666Core technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 years 2,929 (340) 2,589Customer base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 years 923 (185) 738

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,183 $(1,190) $3,993

April 30, 2004Amortization

periodGross

AmountAccumulatedAmortization

Net CarryingValue

Developed technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 years $1,331 $ (222) $1,109Core technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 years 339 (34) 305Customer base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 years 483 (48) 435

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,153 $ (304) $1,849

Total amortization expense for the identifiable intangible assets was approximately $0.9 million and $0.3million for the years ended April 30, 2005 and 2004, respectively. No amortization expense was recognized forthe year ended April 30, 2003. As of April 30, 2005, the Company had no identifiable intangible assets withindefinite lives. The weighted average life of identifiable intangible assets was 4.4 and 3.5 years as of April 30,2005 and 2004, respectively. There were no identifiable intangible assets as of April 30, 2003.

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

Year Ended April 30, Amortization

2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,2142007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9922008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7712009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6882010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 328

$3,993

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Goodwill

Changes in goodwill are as follows (in thousands):

Year Ended April 30,

2005 2004

Balance, beginning of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,456 $ —Ositis acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 7,712Ositis adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (153) (256)Cerberian acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,565 —Cerberian adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (115) —

Balance, end of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $24,753 $7,456

Current Other Accrued Liabilities

Current other accrued liabilities consisted of the following (in thousands):

April 30,

2005 2004

Professional and consulting fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 959 $ 462Accrued royalty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 703 432Warranty reserve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262 295Sales and marketing costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 226 308Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,680 1,076

Total other accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,830 $2,573

Warranty Obligations

Changes in the Company’s warranty obligations, which are included in Other Current Liabilities, for theyears ended April 30, 2005 and 2004 were as follows (in thousands):

Year Ended April 30,

2005 2004

Beginning balances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 295 $ 350Warranties issued during the period . . . . . . . . . . . . . . . . . . . . . . . . . . . 952 386Settlements made during the period . . . . . . . . . . . . . . . . . . . . . . . . . . . (985) (441)

Ending balances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 262 $ 295

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Note 5. Restructuring Accrual

As of April 30, 2005, substantially all actions under the February 2002, August 2001, and February 2001restructuring plans had been completed, except for payment of future rent obligations of $3.6 million, which areto be paid in cash through fiscal year 2008.

The following table summarizes restructuring activity during the three years ended April 30, 2005:

AbandonedLease Space

Accrual

SeveranceRelatedAccrual

ContractTermination andFacilities Closure

Accrual Total

Balances at April 30, 2002 . . . . . . . $ 9,503 $ 406 $ 969 $10,878Cash payments . . . . . . . . . . . . . . . . (3,067) (406) (641) (4,114)Additions . . . . . . . . . . . . . . . . . . . . 1,553 — — 1,553Reversals . . . . . . . . . . . . . . . . . . . . — — (280) (280)

Balances at April 30, 2003 . . . . . . . 7,989 — 48 8,037Cash payments . . . . . . . . . . . . . . . . (2,947) — (22) (2,969)Additions . . . . . . . . . . . . . . . . . . . . 1,536 — — 1,536

Balances at April 30, 2004 . . . . . . . 6,578 — 26 6,604Cash payments . . . . . . . . . . . . . . . . (2,863) — (2) (2,865)Reversals . . . . . . . . . . . . . . . . . . . . (72) — (24) (96)

Balances as of April 30, 2005 . . . . 3,643 — — 3,643Less: current portion included in

“Current liabilities” . . . . . . . . . . 2,729 — — 2,729

Long-term restructuring accrual . . $ 914 $ — $ — $ 914

In fiscal 2005, the Company reduced its restructuring accrual by $72,000 related to a revised estimate of realestate taxes on one of the leased facilities and by $24,000 due to lower contract termination costs than originallyestimated.

During fiscal 2004, the Company increased its restructuring accruals, for abandoned lease space by $1.5million to reflect a deterioration in market trend information provided by a commercial real estate broker.

During fiscal 2003, the Company increased the restructuring accruals by $1.6 million for abandoned leasespace, mainly due to the loss of its tenant in a leased building in Sunnyvale, California. The Company alsoreduced its estimates for contract termination costs by $0.3 million during fiscal 2003, as it was able to negotiatelower settlement amounts than originally estimated.

Note 6. Stockholders’ Equity

Preferred Stock

The Company’s Certificate of Incorporation authorizes 10,000,000 shares of preferred stock. The preferredstock is undesignated and the Board of Directors has the authority to issue new series of preferred stock anddetermine the rights, preferences and privileges of such preferred stock.

Common Stock

The Company has either assumed or entered into Stock Purchase Agreements in connection with the sale ofcommon stock to employees, consultants and directors. The Company has the right to repurchase, at the originalissue price, a declining percentage of certain of the shares of common stock issued based on the respective

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service periods. As of April 30, 2005, 2004 and 2003, 70, 2,387 and 4,322, shares, respectively, of common stockissued under these agreements were subject to repurchase.

Equity Financing

On September 18, 2003, the Company sold 1,311,807 shares of common stock, $.0001 par value per share,to investment funds and an individual affiliated with Sprout Group, a venture capital affiliate of Credit SuisseFirst Boston, at a price of $9.91 per share. The share price was determined using the average closing price pershare of Blue Coat’s common stock on the Nasdaq National Market over the five trading days ending on thetrading date prior to the date of closing. The offering resulted in net proceeds of approximately $12.9 million,which were used for general corporate purposes. The shares of common stock issued in the transaction have notbeen registered under the Securities Act of 1933, and may not be offered or sold in the absence of a registrationstatement in effect with respect to the securities under the Securities Act of 1933 or an applicable exemptionfrom registration requirements. The shares of common stock issued in such transaction are eligible for re-salepursuant to Rule 144 under the Securities Act of 1933, subject to the volume limitations and other conditionsspecified in such rule.

Warrants

In connection with the acquisition of Ositis, the Company assumed warrants outstanding to purchase Ositiscommon stock using an exchange ratio contained in the Ositis merger agreement. Based on this exchange ratio,the total number of the Company’s shares that may be purchased by warrant holders of Ositis common stock is2,804. Using the Black Scholes valuation model, the Company valued these shares at $43,000, which wasincluded as part of the total purchase consideration for Ositis. As of April 30, 2005, 2,727 of these warrants wereissued.

The following table illustrates total outstanding warrants as of April 30, 2005:

April 30, 2005

Shares Exercise Price Expiration Date

1,982 $ 0.63 Jan. 2006 - Dec. 2009119 47.32 March, 2006626 $91.48 July, 2008

2,727

Note 7. Employee and Director Stock Plans

1996 Stock Incentive Plan

In 1996, the Company established the 1996 Stock Option Plan (the “1996 Plan”) under which stock optionswere granted to employees, directors and consultants. After September 24, 1999 no options could be grantedunder the 1996 plan.

Options that expire and shares issued under the 1996 Plan that are repurchased become available forissuance under the Company’s 1999 Stock Incentive Plan, which is discussed further below.

1999 Stock Incentive Plan

In September 1999, the Company’s Board of Directors adopted the 1999 Stock Incentive Plan (the“Incentive Plan”), which became effective upon the effective date of the Company’s initial public offering. Thenumber of shares reserved under the Incentive Plan automatically increase on January 1 each year beginning2002 by 400,000 shares, and will increase on an annual basis by the lesser of 5% of the total amount of common

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stock outstanding or 400,000 shares. Furthermore, any options granted under the 1996 Plan that are cancelled orexercised and subsequently repurchased by the Company become available for future issuance under theIncentive Plan. As of April 30, 2005, 3,590,084 shares of common stock have been authorized for issuance underthe plan. The exercise price for incentive stock options and non-qualified stock options granted under theIncentive Plan may not be less than 100.0% and 85.0%, respectively, of the fair market value of common stockon the option grant date and the stock options are generally subject to a four-year vesting term.

1999 Director Option Plan

In September 1999, the Company’s Board of Directors adopted the 1999 Director Option Plan (the“Directors Plan”). Under the Directors Plan, each non-employee director joining the Board of Directorsfollowing the effective date of the Company’s initial public offering automatically receives options to purchase5,000 shares of common stock. In addition, each non-employee director automatically receives options topurchase 1,000 shares of common stock at each annual meeting of the Board of Directors held in the year 2000and thereafter. Options granted under the Directors Plan will have an exercise price equal to the fair market valueof the common stock on the option grant date. The number of shares reserved under the Directors Planautomatically increases by 20,000 shares annually beginning January 1, 2000. As of April 30, 2005, 176,500shares of common stock have been authorized for issuance under the plan. The Company’s Board of Directors, atits discretion, may reduce the automatic annual increase in reserved shares.

2000 Supplemental Stock Option Plan

In February 2000, the Company’s Board of Directors adopted the 2000 Supplemental Stock Option Plan(the “2000 Plan”), under which 600,000 shares of common stock were reserved for issuance. Non-executiveemployees and consultants are eligible to participate in the 2000 Plan. The 2000 Plan provides for the grant ofnon-statutory stock options to purchase shares of the Company’s common stock and/or grants of restricted sharesof common stock. The exercise price for stock options issued under the 2000 Plan may not be less than 25.0% ofthe fair market value of common stock on the option grant date. As of April 30, 2005, the number of commonstock shares authorized for issuance under the plan for future issuance equaled 358,536.

Stock option activity under all stock option plans is as follows:

Outstanding Options

Number ofShares

Weighted-AverageExercise Price

Per Share

Balance at April 30, 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,916,726 $60.60Options granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,092,587 $ 2.43Options exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (57,390) $ 2.65Options canceled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (856,322) $49.14

Balance at April 30, 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,095,601 $37.05Options granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,419,500 $13.60Options exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (533,199) $ 7.63Options canceled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (197,017) $76.43

Balance at April 30, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,784,885 $27.95Options granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 631,413 $17.61Options exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (147,939) $ 6.10Options canceled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (124,461) $33.59

Balance at April 30, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,143,898 $26.44

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The following table provides segregated ranges of stock options outstanding at April 30, 2005:

Options Outstanding Options Exerciseable

Range ofExercisePrices

Number of OptionsOutstanding atApril 30, 2005

Weighted AverageContractual Life

(Years)

Weighted AverageExercise

Price

Number of OptionsExercisable atApril 30, 2005

Weighted AverageExercise

Price

$0.05-$0.05 50 5.53 $ 0.05 50 $ 0.05$2.25-$2.25 422,194 7.19 $ 2.25 280,618 $ 2.25$2.50-$5.44 299,047 7.68 $ 4.75 166,692 $ 4.58$5.60-$5.60 329,483 8.13 $ 5.60 139,077 $ 5.60

$7.86-$11.95 375,778 8.85 $ 10.14 66,908 $ 8.52$12.50-$16.05 329,083 8.13 $ 14.96 139,891 $ 14.98$16.24-$18.04 353,306 7.27 $ 16.94 242,196 $ 16.78$19.09-$21.53 463,147 8.27 $ 21.12 160,789 $ 20.89$21.60-$60.00 323,850 7.88 $ 31.99 109,325 $ 37.33

$85.31-$525.00 247,960 5.13 $177.58 245,960 $177.80

$0.05-$525.00 3,143,898 7.71 $ 26.44 1,551,506 $ 38.72

At April 30, 2005, 1,247,809 options were available for grant and 4,391,707 shares of common stock wereauthorized for future issuance under the aforementioned option plans.

Employee Stock Purchase Plan (“ESPP”)

In September 1999, the Company’s Board of Directors adopted the ESPP, which became effective upon theeffective date of the Company’s initial public offering. Under the plan, eligible employees may purchasecommon stock through payroll deductions, which in any event may not exceed 15% of an employee’scompensation, at a price equal to the lower of 85% of the closing fair market value of the common stock on theday prior to the beginning of the offering or the last day of the applicable six-month purchase period. The numberof shares reserved under the ESPP is automatically increased by 100,000 shares annually, beginning January 31,2000. As of April 30, 2005, a total of 638,273 shares of common stock have been authorized for future issuanceunder the ESPP. The Company’s Board of Directors, at its discretion, may reduce the automatic annual increasein reserved shares.

Note 8. Income Taxes

The provision for income taxes of $0.1 million, $0.1 million and $0.3 million for the years ended April 30,2005, 2004 and 2003, respectively, is composed entirely of foreign corporate income taxes.

A reconciliation of the income tax provision to the amount computed by applying the statutory federalincome tax rate to net income (loss) before income taxes is summarized as follows (in thousands):

Year Ended April 30,

2005 2004 2003

Provision at statutory rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,922 $ (78) $(5,484)Acquired in-process technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 53 —Future benefits not currently recognized . . . . . . . . . . . . . . . . . . . . . . . . . (2,067) (54) 4,707Stock compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 28 724Foreign taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117 124 261Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141 51 53

Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 117 $124 $ 261

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Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts ofassets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significantcomponents of the Company’s deferred tax assets are as follows (in thousands):

April 30,

2005 2004

Deferred tax assets:Net operating loss carryforwards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 75,627 $ 94,816Stock compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,011 8,206Inventory reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 1,677Restructuring reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,408 2,203Other accruals/reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,848 2,241Fixed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,720 806Tax credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,051 4,091Capitalized research and development . . . . . . . . . . . . . . . . . . . . . . . . . . 23,062 2,791

Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 118,823 $ 116,831

Valuation allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (117,279) (116,077)

Total deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,544 $ 754

Deferred tax liabilities:Intangibles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,544) (754)

Total deferred tax liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,544) (754)

Net deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ — $ —

The Company has incurred losses from its inception through April 30, 2004. Management believes that,based on the history of such losses and other factors, the weight of available evidence indicates that it is morelikely than not that it will not be able to realize its deferred tax assets. Therefore, a full valuation allowance hasbeen recorded at April 30, 2005 and 2004. The valuation allowance increased (decreased) by $1.2 million, $1.9million, and ($10.4) million during fiscal years 2005, 2004 and 2003, respectively.

As of April 30, 2005, the Company had net operating loss carryforwards for federal income tax purposes ofapproximately $204.5 million, which will expire in fiscal years ending in 2011 through 2025, if not utilized. TheCompany also had net operating loss carryforwards for state income tax purposes of approximately $110.5million, which will expire in fiscal years ending in 2006 through 2015, if not utilized. The Company also hadfederal and California research and other tax credit carryforwards of approximately $7.4 million, which willexpire in fiscal years 2012 through 2025, if not utilized.

Utilization of the Company’s net operating loss and tax credit carryforwards may be subject to substantialannual limitations due to the ownership change limitations provided by the Internal Revenue Code and similarstate provisions. Such annual limitations could result in the expiration of the net operating loss and tax creditcarryforward before utilization. The events that may cause ownership changes in the Company’s net operatingloss include, but are not limited to, a cumulative stock ownership change of greater than 50.0% over a three yearperiod.

The Company’s deferred tax assets, which have been offset by the valuation allowance, include deferred taxbenefits associated with employee stock options and acquired net operating loss carryforwards. Deferred taxbenefits associated with employee stock options of approximately $21.5 million will be credited to additionalpaid-in-capital when realized. Deferred tax benefits associated with acquired net operating loss carryforwards ofapproximately $3.6 million, when realized, will first reduce goodwill and then non-current identifiable intangibleassets.

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Federal and state income taxes have not been provided on accumulated but undistributed earnings of certainforeign subsidiaries aggregating approximately $0.8 million at April 30, 2005, as such earnings have beenreinvested in the business. If such earnings were not permanently reinvested, a deferred tax liability of $35,000would have been required.

Note 9. Defined Contribution Benefit Plan

The Company has a defined contribution benefit plan under Section 401(k) of the Internal Revenue Code,which covers substantially all United States employees. Eligible employees may contribute pre-tax amounts tothe plan via payroll withholdings, subject to certain limitations. The Company does not match contributions byplan participants.

Note 10. Commitments and Contingencies

Guarantees and Product Warranties

The Company applies the disclosure provisions of FASB interpretation No. 45, Guarantor’s Accounting andDisclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others (“FIN 45”) toits agreements that contain guarantee or indemnification clauses. These disclosure provisions expand thoserequired by SFAS No. 5, Accounting for Contingencies, (“SFAS No. 5”) by requiring that guarantors disclosecertain types of guarantees, even if the likelihood of requiring the guarantor’s performance is remote. As of April30, 2005, to the best of the Company’s estimates, it has no liabilities under indemnification arrangements andguarantees, as applicable.

Lease Commitments

The Company leases certain facilities and equipment under non-cancelable operating leases. Certain of theCompany’s facility leases provide for periodic rent increases based on the general rate of inflation and containprovisions which permit renewal at the end of the respective lease terms.

Future minimum lease payments under non-cancelable operating leases with initial or remaining terms inexcess of one year are as follows (in thousands):

Year ending April 30, Abandoned In Use Total

2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,023 $ 1,621 $ 4,6442007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,018 1,659 2,6772008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 258 2,275 2,5332009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 2,289 2,2892010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 2,236 2,236Thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 718 718

Total minimum lease payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . $4,299 $10,798 $15,097

Rent expense was $2.9 million, $2.6 million and $3.0 million for the years ended April 30, 2005, 2004 and2003, respectively. Of the $4.3 million in total operating lease commitments for abandoned facilities, assummarized above, a reserve for $3.6 million has been provided and is included in the captions “Accruedrestructuring reserve” and “Accrued restructuring reserve, less current portion” in the accompanyingconsolidated balance sheet at April 30, 2005 and 2004. The remaining $0.7 million represents estimated subleaseincome.

In April 2005, the Company executed a five-year operating lease for a 117,000-square foot facility whichwill serve as the Company’s headquarters in Sunnyvale, California. The lease commencement occurs inSeptember 2005 and will extend for a term of five years from the commencement date. Lease payments escalate

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annually and the total future minimum lease payments amount to $8.4 million over the lease term, excludinglease payment of $0.6 million for the first six months to be excused if the Company is not in default during thefirst 12 months of the lease term. A lessee improvement allowance of $1.2 million is provided to us to be used byJune 30, 2006 and any unused portion of the allowance shall be waived and forfeited. As part of this agreement,the Company is required to maintain a $0.4 million irrevocable standby letter of credit with a major financialinstitution as a form of security. This letter of credit provides for automatic annual extensions, withoutamendment, through the end of the lease term. Both irrevocable standby letters of credit referred to above areclassified as “Restricted investments” in the accompanying consolidated balance sheets as of April 30, 2005. Inaddition to the standby letter of credit discussed above, the Company maintains a $1.5 million irrevocablestandby letter of credit for a five-year operating lease related to a 46,000-square foot research and developmentfacility in Sunnyvale, California. This letter of credit also extends automatically to each succeeding calendar yearthrough June 30, 2006, unless otherwise terminated in writing.

Purchase and Other Commitments

The Company has firm purchase and other commitments with various suppliers and contract manufacturersto purchase component inventory, manufacturing material and equipment. These agreements are enforceable andlegally binding against the Company in the short-term and all amounts under these arrangements are due in fiscal2006. The minimum obligation under these commitments at April 30, 2005 was $3.0 million.

Note 11. Litigation

IPO Allocation Litigation. Beginning on May 16, 2001, a series of putative securities class actions werefiled against the firms that underwrote the Company’s initial public offering, the Company, and some of itsofficers and directors in the U.S. District Court for the Southern District of New York. These cases have beenconsolidated under the case captioned In re CacheFlow, Inc. Initial Public Offering Securities Litigation., CivilAction No. 1-01-CV-5143. An additional putative securities class action has been filed in the United StatesDistrict Court for the Southern District of Florida. The Court in the Florida case dismissed the Company andindividual officers and directors from the action without prejudice. The complaints in the New York and Floridacases generally allege that the underwriters obtained excessive and undisclosed commissions in connection withthe allocation of shares of common stock in the Company’s initial public offering, and maintained artificiallyhigh market prices through tie-in arrangements which required customers to buy shares in the after-market at pre-determined prices. The complaints allege that the Company and its current and former officers and directorsviolated Sections 11 and 15 of the Securities Act of 1933, and Sections 10(b) (and Rule 10b-5 promulgatedthereunder) and 20(a) of the Securities Exchange Act of 1934, by making material false and misleadingstatements in the prospectus incorporated in the Company’s Form S-1 Registration Statement filed with theSecurities and Exchange Commission in November 1999. Plaintiffs seek an unspecified amount of damages onbehalf of persons who purchased the Company’s stock between November 19, 1999 and December 6, 2000. OnApril 19, 2002, plaintiffs filed an amended complaint. Various plaintiffs have filed similar actions assertingvirtually identical allegations against over 300 other public companies, their underwriters, and their officers anddirectors arising out of each company’s public offering. The lawsuits against the Company, along with theseother related securities class actions currently pending in the Southern District of New York, have been assignedto Judge Shira A. Scheindlin for coordinated pretrial proceedings and are collectively captioned In re InitialPublic Offering Securities Litigation, Civil Action No. 21-MC-92. Defendants in these cases have filed omnibusmotions to dismiss. On February 19, 2003, the Court denied in part and granted in part the motion to dismissfiled on behalf of defendants, including the Company. The Court’s order did not dismiss any claims against theCompany. As a result, discovery may now proceed. The Company’s officers and directors have been dismissedwithout prejudice in this litigation. In June 2004, a stipulation of settlement and release of claims against theissuer defendants, including the Company, was submitted to the Court for approval. The terms of the settlement,if approved would dismiss and release all claims against participating defendants, including the Company. Inexchange for this dismissal, D&O insurance carriers would agree to guarantee a recovery by the plaintiffs fromthe underwriter defendants of at least $1.0 billion, and the issuer defendants would agree to an assignment or

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surrender to the plaintiffs of certain claims the issuer defendants may have against the underwriters. Thesettlement is subject to a number of conditions, including court approval. If the settlement does not occur,litigation against the Company would continue. The Company believes it has meritorious defenses and intends todefend the case vigorously.

SEC Investigations. The SEC has informed the Company of its investigation into trading in certainsecurities, including trading in the Company’s securities, prior to the Company’s public announcement on May27, 2004 of its financial results for the fourth quarter and fiscal year 2004 (the “May 27, 2004 Announcement”).The investigation is captioned In the Matter of Trading in Certain Securities, H0-9818. To date the SEC has notidentified the Company or any of its directors or executive officers as targets of its investigation, but has servedsubpoenas for information from the Company and for testimony from certain officers. The Company iscooperating with the investigation. The SEC subsequently informed the Company that it is the subject of a formalorder of private investigation captioned In the Matter of Blue Coat Systems, Inc., HO-10096. The Companybelieves that the Commission is investigating whether certain present or former officers, directors, employees,affiliates or others made intentional or non-intentional selective disclosure of material nonpublic information,traded in the Company’s stock while in possession of such information, or communicated such information toothers who thereafter traded in the Company’s stock. The Company is cooperating with the SEC.

Class Action Litigation. Beginning on April 11, 2004, several purported securities class action lawsuits werefiled in the United States District Court for the Northern District of California against the Company and certainof its current and former officers on behalf of purchasers of the Company’s stock between February 20, 2004 andMay 27, 2004 (the “alleged Class Period”). Plaintiffs allege that, during the alleged Class Period, defendantsviolated Sections 10(b), 20(a) and 20A of the Securities Exchange Act of 1934, and Rule 10b-5 promulgatedthereunder, by making false or misleading statements about the Company’s prospects. The cases have beenconsolidated but a lead plaintiff has not yet been selected. The Company and related defendants intend to defendthe case vigorously.

Derivative Litigation. On May 18, 2005, a purported shareholder derivative action was filed in the SuperiorCourt of California, Santa Clara County, alleging that certain of the Company’s officers and directors violatedtheir fiduciary duties to the Company. The complaint is based largely on the same factual allegations as in thefederal securities class action. Defendants intend to defend the case vigorously.

Although the Company cannot predict whether the IPO allocation cases will settle as proposed, and cannotpredict the outcome of the SEC investigations, the securities class action, or the derivative case, the costs ofdefending these matters, an adverse result, or the diversion of management’s attention and resources could have amaterial adverse effect on the Company’s results of operations and financial position.

Infringement Litigation. On August 1, 2001, Network Caching Technology L.L.C. (“NCT”) filed suitagainst the Company and others in the United States District Court for the Northern District of California,alleging infringement of certain patents owned by NCT. The lawsuit was styled Network Caching TechnologyLLC vs. Novell, Inc. et al., Case No. CV-01-2079. On October 29, 2003, the Company and NCT entered into asettlement agreement by which the Company received a fully paid up license under the NCT patents for allCompany products and services and a full and complete release from any and all claims of liability for any actualor alleged past and present infringement of the NCT patents. As consideration for the license rights and release,the Company paid a total of $1.1 million, expensed as a separate line item on the Company’s statement ofoperations named “Legal settlement.” The Order of Dismissal regarding all causes of action between NCT andthe Company was entered November 14, 2003.

Periodically, the Company reviews the status of each significant matter and assesses potential financialexposure. Because of the uncertainties related to the (i) determination of the probability of an unfavorableoutcome and (ii) amount and range of loss in the event of an unfavorable outcome, management is unable tomake a reasonable estimate of the liability that could result from any pending litigation described above and no

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accrual was recorded in the Company’s balance sheet as of April 30, 2005. As additional information becomesavailable, the Company will reassess the probability and potential liability related to pending litigation, whichcould materially impact the Company’s results of operations and financial position.

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

Note 12. Geographic and Product Category Information Reporting

The Company operates in one segment to design, develop, market and support proxy appliances. The chiefoperating decision maker, the Company’s chief executive officer, allocates resources and makes operatingdecisions based on financial data consistent with the presentation in the accompanying consolidated financialstatements. The Company’s revenue consists of two product categories: product and service. Total internationalrevenue consists of sales from the Company’s U.S. operations to non-affiliated customers in other geographicregions. During fiscal 2005, 2004 and 2003, there were no intra-company sales, and no material long-lived assetswere located in the Company’s foreign subsidiaries.

Operating decisions regarding the costs of the Company’s products and services are made with informationthat is consistent with the presentation in the accompanying consolidated statements of operations. Therefore, theCompany currently believes it is impractical to separately present such costs.

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

Year Ended April 30,

2005 2004 2003

$ % $ % $ %

North America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $48,951 50.9% $36,955 55.9% $23,774 52.0%EMEA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,148 31.3 19,608 29.7 12,839 28.0Asia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,087 17.8 9,505 14.4 9,125 20.0

Total net revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $96,186 100.0% $66,068 100.0% $45,738 100.0%

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

Year Ended April 30,

2005 2004 2003

$ % $ % $ %

Product . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $78,495 81.6% $52,251 79.1% $35,827 78.3%Service . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,691 18.4 13,817 20.9 9,911 21.7

Total net revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $96,186 100.0% $66,068 100.0% $45,738 100.0%

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Note 13. Selected Quarterly Financial Data (Unaudited)

A summary of the Company’s quarterly consolidated financial results is as follows (in thousands, except pershare data):

Three Months Ended

July 31,2004 (1)

October 31,2004 (1)

January 31,2005 (2)

April 30,2005 (3)

Net revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $21,124 $21,928 $24,749 $28,385Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,205 14,434 16,789 19,456Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,680 607 267 2,821Basic net income per common share . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.15 $ 0.05 $ 0.02 $ 0.23Diluted net income per common share . . . . . . . . . . . . . . . . . . . . . . . $ 0.13 $ 0.05 $ 0.02 $ 0.21

Three Months Ended

July 31,2003

October 31,2003 (4)

January 31,2004 (5)

April 30,2004 (6)

Net revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $12,410 $13,418 $19,114 $21,126Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,268 8,865 13,537 14,160Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,056) (2,644) 1,962 1,390Basic net income (loss) per common share . . . . . . . . . . . . . . . . . . . . $ (0.12) $ (0.27) $ 0.19 $ 0.13Diluted net income (loss) per common share . . . . . . . . . . . . . . . . . . $ (0.12) $ (0.27) $ 0.16 $ 0.11

(1) The first and second quarters of fiscal 2005 results include a $0.3 million stock compensation expense eachquarter related to the amortization of deferred stock compensation and intangible asset amortization of $0.2million each quarter, both related to the Ositis acquistion.

(2) The third quarter of fiscal 2005 results include a $1.0 million stock compensation expense related to themodification of stock option grants associated with a severance agreement with the former CFO andintangible asset amortization of $0.2 million in connection with the Cerberian acquisition.

(3) The fourth quarter of fiscal 2005 results include a $0.7 million stock compensation reversal related topreviously recorded expense as a result of revising the severance agreement with the former CFO.Amortization of Cerberian intangible assets for $0.2 million was also recorded.

(4) The second quarter of fiscal 2004 results include a $1.1 million legal settlement with Network CachingTechnology L.L.C. and restructuring expense of $0.9 million for abandoned lease space.

(5) The third quarter of fiscal 2004 results include a $0.2 million write-off of acquired in-process technology,intangible asset amortization of $0.2 million and deferred stock compensation of $0.3 million in connectionwith the Ositis acquisition.

(6) The fourth quarter of fiscal 2004 results include a $0.6 million restructuring expense as a result of increasingthe accrual for abandoned lease space, intangible asset amortization of $0.2 million and amortization ofdeferred stock compensation of $0.3 million in connection with the Ositis acquisition.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of Blue Coat Systems, Inc.

We have audited the accompanying consolidated balance sheets of Blue Coat Systems, Inc. as of April 30,2005 and 2004, and the related consolidated statements of operations, stockholders’ equity, and cash flows foreach of the three years in the period ended April 30, 2005. Our audits also included the financial statementschedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of theCompany’s management. Our responsibility is to express an opinion on these financial statements based on ouraudits.

We conducted our audits in accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform the audit to obtain reasonable assuranceabout whether the financial statements are free of material misstatement. An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made by management, as well as evaluatingthe overall financial statement presentation. We believe that our audits provide a reasonable basis for ouropinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, theconsolidated financial position of Blue Coat Systems, Inc. at April 30, 2005 and 2004, and the consolidatedresults of their operations and their cash flows for each of the three years in the period ended April 30, 2005, inconformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financialstatement schedule when considered in relation to the basic financial statements taken as a whole, present fairly,in all material respects, the information set forth herein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of Blue Coat Systems, Inc. internal control over financial reporting as of April30, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission and our report dated July 11, 2005 expressed anunqualified opinion thereon.

/s/ ERNST & YOUNG LLP

San Jose, CaliforniaJuly 11, 2005

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of Blue Coat Systems, Inc.

We have audited management’s assessment, included in the accompanying Management Report on InternalControl Over Financial Reporting, that Blue Coat Systems, Inc. maintained effective internal control overfinancial reporting as of April 30, 2005, based on criteria established in Internal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). BlueCoat Systems Inc.’s management is responsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is toexpress an opinion on management’s assessment and an opinion on the effectiveness of the company’s internalcontrol over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform the audit to obtain reasonable assuranceabout whether effective internal control over financial reporting was maintained in all material respects. Ouraudit included obtaining an understanding of internal control over financial reporting, evaluating management’sassessment, testing and evaluating the design and operating effectiveness of internal control, and performing suchother procedures as we considered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assuranceregarding the reliability of financial reporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles. A company’s internal control over financial reportingincludes 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 reasonableassurance that transactions are recorded as necessary to permit preparation of financial statements in accordancewith generally accepted accounting principles, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of the company; and (3) provide reasonableassurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of thecompany’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 detectmisstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk thatcontrols may become inadequate because of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

In our opinion, management’s assessment that Blue Coat Systems, Inc. maintained effective internal controlover financial reporting as of April 30, 2005, is fairly stated, in all material respects, based on the COSO criteria.Also, in our opinion, Blue Coat Systems Inc. maintained, in all material respects, effective internal control overfinancial reporting as of April 30, 2005, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board(United States), the fiscal 2005 consolidated financial statements and our report dated July 11, 2005 expressed anunqualified opinion thereon.

/s/ ERNST & YOUNG LLP

San Jose, CaliforniaJuly 11, 2005

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

None.

Item 9A. Controls and Procedures

Attached as exhibits to this Annual Report on Form 10-K are certifications of our Chief Executive Officer(“CEO”) and Chief Financial Officer (“CFO”), which are required pursuant to Rule 13a-14 of the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”). The “Controls and Procedures” section of this AnnualReport on Form 10-K includes information concerning the controls and controls evaluation referenced in thecertifications. The report of Ernst & Young LLP, our independent registered public accounting firm, is set forthat the end of Part II, Item 8 of this Annual Report on Form 10-K. This report addresses Ernst & Young LLP’saudit of our internal control over financial reporting and of management’s assessment of internal control overfinancial reporting set forth below. This section of the Annual Report on Form 10-K should be read inconjunction with the certifications and the report of Ernst & Young LLP for a more complete understanding ofthe matters presented.

Evaluation of Disclosure Controls

We evaluated the effectiveness of the design and operation of our disclosure controls and procedures as ofthe end of the period covered by this Annual Report on Form 10-K. This controls evaluation was performedunder the supervision and with the participation of management, including our CEO and CFO. Disclosurecontrols are procedures that are designed to ensure that information required to be disclosed in our reports filedunder the Exchange Act, such as this Annual Report on Form 10-K, is recorded, processed, summarized andreported within the time periods specified by the SEC. Disclosure controls are also designed to ensure that suchinformation is accumulated and communicated to our management, including the CEO and CFO, as appropriateto allow timely decisions regarding required disclosure. Our quarterly evaluation of disclosure controls includesan evaluation of some components of our internal control over financial reporting. We also perform a separateannual evaluation of internal control over financial reporting for the purpose of providing the management reportbelow.

The evaluation of our disclosure controls included a review of their objectives and design, ourimplementation of the controls and the effect of the controls on the information generated for use in this AnnualReport on Form 10-K. In the course of the controls evaluation, we reviewed identified data errors or controlproblems and sought to confirm that appropriate corrective actions, including process improvements, were beingundertaken. This type of evaluation is performed on a quarterly basis so that the conclusions of management,including the CEO and CFO, concerning the effectiveness of the disclosure controls can be reported in ourperiodic reports on Form 10-Q and Form 10-K. Many of the components of our disclosure controls are alsoevaluated on an ongoing basis by our internal finance organization. The overall goals of these various evaluationactivities are to monitor our disclosure controls and to modify them as necessary. We intend to maintain thedisclosure controls as dynamic systems that we adjust as circumstances merit.

Based on the controls evaluation, our CEO and CFO have concluded that, subject to the limitations noted inthis Part II, Item 9A, as of the end of the period covered by this Form 10-K, our disclosure controls wereeffective to provide reasonable assurance that information required to be disclosed in our Exchange Act reports isrecorded, processed, summarized and reported within the time periods specified by the SEC, and that materialinformation relating to the Company is made known to management, including the CEO and the CFO,particularly during the time when our periodic reports are being prepared.

Management Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financialreporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and

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with the participation of our management, including our CEO and CFO, we conducted an evaluation of theeffectiveness of our internal control over financial reporting as of April 30, 2005 based on the guidelinesestablished in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations ofthe Treadway Commission (COSO). Based on the results of our evaluation, our management concluded that ourinternal control over financial reporting was effective as of April 30, 2005 to provide reasonable assuranceregarding the reliability of financial reporting and the preparation of financial statements for external reportingpurposes in accordance with generally accepted accounting principles.

Management’s assessment of the effectiveness of our internal control over financial reporting as of April 30,2005 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated intheir report which is included at the end of Part II, Item 8 of this Annual Report on Form 10-K.

Limitations on Effectiveness of Controls

Our management, including the CEO and the CFO, do not expect that our disclosure controls or our internalcontrols over financial reporting will prevent all errors and fraud. A control system, no matter how wellconceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the controlsystem are met. Further, the design of a control system must reflect the fact that there are resource constraints,and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in allcontrol systems, no evaluation of controls can provide absolute assurance that all control issues and instances offraud, if any, within our company have been detected. These inherent limitations include the realities thatjudgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake.Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or morepeople, or by management override of the controls. The design of any system of controls also is based in partupon certain assumptions about the likelihood of future events, and there can be no assurance that any design willsucceed in achieving its stated goals under all potential future conditions; over time, controls may becomeinadequate because of changes in conditions, or the degree of compliance with the policies or procedures maydeteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to errors orfraud may occur and not be detected.

Item 9B. Other Information

None

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PART III.

Item 10. Directors and Executive Officers of the Registrant.

Executives of the Registrant

See the information set forth in the section entitled “Proposal No. 1 – Election of Directors,” “OtherInformation – Executive Officers” and “Compliance with Section 16(a) of the Exchange Act” in the 2005 ProxyStatement, which is incorporated herein by reference.

Item 11. Executive Compensation.

See the information set forth in the sections entitled “Equity Compensation Plan Information” and“Executive Compensation and Related Information” in the 2005 Proxy Statement, which are incorporated hereinby reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related StockholderMatters.

See the information set forth in the section entitled “Security Ownership of Certain Beneficial Owners andManagement” in the 2005 Proxy Statement, which is incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions.

See the information set forth in the section entitled “Certain Relationships and Related Transactions” in the2005 Proxy Statement, which is incorporated herein by reference.

Item 14. Principal Accountant Fees and Services.

See the information set forth in the section entitled “Principal Accountant Fees and Services” in the 2005Proxy Statement, which is incorporated herein by reference.

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PART IV.

Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

(a) Financial Statements and Financial Statement Schedules

1. Financial Statements

See Item 8 of this Annual Report on Form 10-K

2. Financial Statement Schedules

The following financial statement schedule of Blue Coat Systems, Inc. is filed as part of thisReport and should be read in conjunction with the Financial Statements of Blue Coat Systems,Inc.

Schedule II Valuation and Qualifying Accounts

Schedules not listed above have been omitted because the information required to be set forththerein is not applicable or is shown in the financial statements or notes thereto.

3. Exhibits

Number Description

2.1 Agreement and Plan of Merger and Reorganization, dated as of October 28, 2003, by andamong Blue Coat Systems, Inc., Riga Corp., Ositis Software, Inc., Vilis Ositis and LianaAbele (which is incorporated herein by reference to Exhibit 2.1 of Form 8-K filed by theRegistrant with the Commission on November 28, 2003)

2.2 Agreement and Plan of Merger and Reorganization, dated as of July 16, 2004, by and amongBlue Coat Systems, Inc., Utah Merger Corporation, Cerberian, Inc., and Scott Petty (whichis incorporated herein by reference to Exhibit 2.1 of Form 8-K filed by the Registrant withthe Commission on November 23, 2004)

2.3 Amendment Number 1 to Agreement and Plan of Merger and Reorganization, dated as ofOctober 5, 2004, by and among Blue Coat Systems, Inc., Utah Merger Corporation,Cerberian, Inc., and Scott Petty (which is incorporated herein by reference to Exhibit 2.2 ofForm 8-K filed by the Registrant with the Commission on November 23, 2004

3.1 Amended and Restated Certificate of Incorporation of the Registrant (which is incorporatedherein by reference to Exhibit 3.2 to the Registrant’s Registration Statement on Form S-1No. 333-87997)

3.2 Amended and Restated Bylaws of the Registrant (which is incorporated herein by reference toExhibit 3.4 to the Registrant’s Registration Statement on Form S-1 No. 333-87997)

3.3 Certificate of Ownership and Merger of Blue Coat Systems, Inc. with and into Cacheflow Inc.(which is incorporated herein by reference to Exhibit 3.3 of Form 10-Q filed by theRegistrant with the Commission on December 16, 2002)

3.4 Certificate of Amendment to Amended and Restated Certificate of Incorporation of Blue CoatSystems, Inc. dated September 12, 2002 (which is incorporated herein by reference toExhibit 3.4 of Form 10-Q filed by the Registrant with the Commission on December 16,2002)

3.5 Certificate of Amendment to Certificate of Incorporation of Cacheflow International Inc.,changing its name from Cacheflow International Inc. to Blue Coat Systems InternationalInc. (which is incorporated herein by reference to Exhibit 3.5 of Form 10-Q filed by theRegistrant with the Commission on December 16, 2002)

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Number Description

4.1 Reference is made to Exhibits 3.1, 3.2, 3.3, 3.4 and 3.5

4.2 Specimen Certificate of the Registrant’s Common Stock (which is incorporated herein byreference to Exhibit 4.3 of Form 10-K filed by the Registrant with the Commission on July29, 2003)

10.1 Form of Indemnification Agreement (which is incorporated herein by reference to Exhibit10.1 to the Registrant’s Registration Statement on Form S-1 No. 333-87997)

10.2 1996 Stock Option Plan (which is incorporated herein by reference to Exhibit 10.2 to theRegistrant’s Registration Statement on Form S-1 No. 333-87997)

10.3 1999 Stock Incentive Plan (which is incorporated herein by reference to Exhibit 10.3 to theRegistrant’s Registration Statement on Form S-1 No. 333-87997)

10.4 1999 Director Option Plan (which is incorporated herein by reference to Exhibit 10.4 to theRegistrant’s Registration Statement on Form S-1 No. 333-87997)

10.5 1999 Employee Stock Purchase Plan (which is incorporated herein by reference to Exhibit10.5 to the Registrant’s Registration Statement on Form S-1 No. 333-87997)

10.6 Commercial lease agreement between Registrant, the Arrillaga Foundation and the PerryFoundation, dated July 14, 1998 (which is incorporated herein by reference to Exhibit 10.6to the Registrant’s Registration Statement on Form S-1 No. 333-87997)

10.7 Commercial lease agreement between Registrant and Zetron Properties, Inc., dated April 20,2000 (which is incorporated herein by reference to Exhibit 10.7 of Form 10-K filed by theRegistrant with the Commission on July 16, 2001)

10.8 Commercial lease agreement between Blue Coat Systems Canada and Wiebe PropertyCorporation Ltd., dated May 1, 1999 (which is incorporated herein by reference to Exhibit10.8 to the Registrant’s Registration Statement on Form S-1 No. 333-87997)

10.9 Offer Letter with Brian NeSmith (which is incorporated herein by reference to Exhibit 10.9 tothe Registrant’s Registration Statement on Form S-1 No. 333-87997)

10.10 Offer Letter with Alan Robin (which is incorporated herein by reference to Exhibit 10.10 tothe Registrant’s Registration Statement on Form S-1 No. 333-87997)

10.11 Offer Letter with John Scharber (which is incorporated herein by reference to Exhibit 10.13of Form 10-K filed by the Registrant with the Commission on July 16, 2001)

10.12 Offer Letter with Robert Verheecke (which is incorporated herein by reference to Exhibit10.14 of Form 10-K filed by the Registrant with the Commission on July 16, 2001)

10.13 Consulting Agreement with Marc Andreessen (which is incorporated herein by reference toExhibit 10.16 to the Registrant’s Registration Statement on Form S-1 No. 333-87997)

10.14 2000 Supplemental Stock Option Plan (which is incorporated herein by reference to Exhibit99.1 of Form S-8 filed by the Registrant with the Commission on April 11, 2000)

10.15 Michael Malcolm Resignation Agreement (which is incorporated herein by reference toExhibit 10.18 of Form 10-Q filed by the Registrant with the Commission on December 15,2000)

10.16 SpringBank Networks, Inc. 2000 Stock Incentive Plan (which is incorporated herein byreference to Exhibit 99.2 of Form S-8 filed by the Registrant with the Commission onSeptember 8, 2000)

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Number Description

10.17 Entera, Inc. 1999 Equity Incentive Plan (which is incorporated herein by reference to Exhibit99.1 of Form S-8 filed by the Registrant with the Commission on December 18, 2000)

10.18 Entera, Inc. 2000 Equity Incentive Plan (which is incorporated herein by reference to Exhibit99.2 of Form S-8 filed by the Registrant with the Commission on December 18, 2000)

10.19 Commercial lease agreement between Registrant and Sunnyvale VIII Trust, dated March 30,2001 (which is incorporated herein by reference to Exhibit 10.22 of Form 10-K filed by theRegistrant with the Commission on July 16, 2001)

10.20 Commercial sublease agreement between Registrant and Kuokoa Networks, Inc., dated July10, 2002 and First Amendment to Sublease between Registrant and Kuokoa Networks,Inc., dated July 16, 2002 (which is incorporated herein by reference to Exhibit 10.22 ofForm 10-Q filed by the Registrant with the Commission on December 16, 2002)

10.21 Commercial sublease agreement between Registrant and Merit Financial, Inc., dated October25, 2002 (which is incorporated herein by reference to Exhibit 10.23 of Form 10-Q filed bythe Registrant with the Commission on December 16, 2002)

10.22 Offer Letter with David de Simone (which is incorporated herein by reference to Exhibit10.24 of Form 10-Q filed by the Registrant with the Commission on December 12, 2003)

10.23 Common Stock Purchase Agreement dated September 18, 2003 (which is incorporated hereinby reference to Exhibit 10.1 of Form 8-K filed by the Registrant with the Commission onSeptember 22, 2003)

10.24 Registration Rights Agreement dated September 18, 2003 (which is incorporated herein byreference to Exhibit 10.2 of Form 8-K filed by the Registrant with the Commission onSeptember 22, 2003)

10.25 Technology License And Settlement Agreement dated October 29, 2003 by and betweenNetwork Caching Technology L.L.C and Blue Coat Systems, Inc. (which is incorporatedherein by reference to Exhibit 10.27 of Form 10-Q filed by the Registrant with theCommission on December 12, 2003.)

10.26 Commercial lease agreement between Registrant and 525 Almanor LLC, dated March 9,2004 (which is incorporated herein by reference to Exhibit 10.28 of Form 10-K filed by theRegistrant with the Commission on July 14, 2004)

10.27 Source Code License & Services Agreement, effective August 12, 2004, by and between BlueCoat Systems, Inc. and Flowerfire, Inc. (which is incorporated herein by reference toExhibit 10.1 of Form 10-Q filed by the Registrant with the Commission on September 9,2004)

10.28 Commercial sublease agreement between Registrant and Infoblox Inc., dated October 7, 2004(which is incorporated herein by reference to Exhibit 10.4 of Form 10-Q filed by theRegistrant with the Commission on December 9, 2004)

10.29 Employment Agreement between Blue Coat Systems, Inc. and Robert Verheecke dated as ofNovember 4, 2004 (which is incorporated herein by reference to Exhibit 10.1 of Form 10-Q filed by the Registrant with the Commission on December 9, 2004)

10.30 Form of Notice of Grant of Stock Option and Stock Option Agreement used to evidenceoptions granted under the Blue Coat Systems, Inc. 1999 Stock Incentive Plan (which isincorporated herein by reference to Exhibit 10.2 of Form 10-Q filed by the Registrant withthe Commission on December 9, 2004)

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Number Description

10.31 Triple Net Space Lease between Mary Avenue Office LLC as Lessor and Blue Coat Systems,Inc., a Delaware corporation, as Lessee, dated April 21, 2005 (which is incorporated hereinby reference to Exhibit 10.1 of Form 8-K filed by the Registrant with the Commission onApril 26, 2005)

10.32 Employment Agreement between Blue Coat Systems, Inc. and Kevin Royal dated as ofMarch 31, 2005

10.33 Separation Agreement between Blue Coat Systems, Inc. and Robert Verheecke dated as ofApril 29, 2005

14.1 Code of Business Conduct, adopted by the Board of Directors of Blue Coat Systems, Inc. onNovember 16, 2004 (which is incorporated herein by reference to Exhibit 14.1 of Form8-K filed by the Registrant with the Commission on November 23, 2004)

21.1 Subsidiaries

23.1 Consent of Independent Registered Public Accounting Firm

31.1 Certification of Brian NeSmith

31.2 Certification of Kevin Royal

32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of theSarbanes-Oxley Act of 2002

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registranthas duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

BLUE COAT SYSTEMS, INC.(Registrant)

July 12, 2005 By: /s/ BRIAN M. NESMITH

Brian M. NeSmithPresident, Chief Executive Officer and Director

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears belowconstitutes and appoints Brian M. NeSmith and Kevin Royal, or either of them, each with the power ofsubstitution, his attorney-in-fact, to sign any amendments to this Form 10-K, and to file the same, with exhibitsthereto and other documents in connection therewith, with the Securities and Exchange Commission, herebyratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause tobe done by virtue hereof.

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

Signature Title Date

/s/ BRIAN M. NESMITH

Brian M. NeSmithPresident, Chief Executive Officer and Director

(Principal Executive Officer)July 12, 2005

/s/ KEVIN ROYAL

Kevin Royal

Senior Vice President, Chief Financial Officer(Principal Financial and Accounting Officer)

July 12, 2005

/s/ MARC ANDREESSEN

Marc AndreessenDirector July 12, 2005

/s/ JAY SHIVELEY

Jay ShiveleyDirector July 12, 2005

/s/ DAVE HANNA

Dave HannaDirector July 12, 2005

/s/ ANDREW S. RACHLEFF

Andrew S. RachleffDirector July 12, 2005

/s/ JAMES A. BARTH

James A. BarthDirector July 12, 2005

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EXHIBIT INDEX

Number Description

2.1 Agreement and Plan of Merger and Reorganization, dated as of October 28, 2003, by and among BlueCoat Systems, Inc., Riga Corp., Ositis Software, Inc., Vilis Ositis and Liana Abele (which isincorporated herein by reference to Exhibit 2.1 of Form 8-K filed by the Registrant with theCommission on November 28, 2003)

2.2 Agreement and Plan of Merger and Reorganization, dated as of July 16, 2004, by and among Blue CoatSystems, Inc., Utah Merger Corporation, Cerberian, Inc., and Scott Petty (which is incorporatedherein by reference to Exhibit 2.1 of Form 8-K filed by the Registrant with the Commission onNovember 23, 2004)

2.3 Amendment Number 1 to Agreement and Plan of Merger and Reorganization, dated as of October 5,2004, by and among Blue Coat Systems, Inc., Utah Merger Corporation, Cerberian, Inc., and ScottPetty (which is incorporated herein by reference to Exhibit 2.2 of Form 8-K filed by the Registrantwith the Commission on November 23, 2004

3.1 Amended and Restated Certificate of Incorporation of the Registrant (which is incorporated herein byreference to Exhibit 3.2 to the Registrant’s Registration Statement on Form S-1 No. 333-87997)

3.2 Amended and Restated Bylaws of the Registrant (which is incorporated herein by reference to Exhibit3.4 to the Registrant’s Registration Statement on Form S-1 No. 333-87997)

3.3 Certificate of Ownership and Merger of Blue Coat Systems, Inc. with and into Cacheflow Inc. (which isincorporated herein by reference to Exhibit 3.3 of Form 10-Q filed by the Registrant with theCommission on December 16, 2002)

3.4 Certificate of Amendment to Amended and Restated Certificate of Incorporation of Blue Coat Systems,Inc. dated September 12, 2002 (which is incorporated herein by reference to Exhibit 3.4 of Form10-Q filed by the Registrant with the Commission on December 16, 2002)

3.5 Certificate of Amendment to Certificate of Incorporation of Cacheflow International Inc., changing itsname from Cacheflow International Inc. to Blue Coat Systems International Inc. (which isincorporated herein by reference to Exhibit 3.5 of Form 10-Q filed by the Registrant with theCommission on December 16, 2002)

4.1 Reference is made to Exhibits 3.1, 3.2, 3.3, 3.4 and 3.5

4.2 Specimen Certificate of the Registrant’s Common Stock (which is incorporated herein by reference toExhibit 4.3 of Form 10-K filed by the Registrant with the Commission on July 29, 2003)

10.1 Form of Indemnification Agreement (which is incorporated herein by reference to Exhibit 10.1 to theRegistrant’s Registration Statement on Form S-1 No. 333-87997)

10.2 1996 Stock Option Plan (which is incorporated herein by reference to Exhibit 10.2 to the Registrant’sRegistration Statement on Form S-1 No. 333-87997)

10.3 1999 Stock Incentive Plan (which is incorporated herein by reference to Exhibit 10.3 to the Registrant’sRegistration Statement on Form S-1 No. 333-87997)

10.4 1999 Director Option Plan (which is incorporated herein by reference to Exhibit 10.4 to the Registrant’sRegistration Statement on Form S-1 No. 333-87997)

10.5 1999 Employee Stock Purchase Plan (which is incorporated herein by reference to Exhibit 10.5 to theRegistrant’s Registration Statement on Form S-1 No. 333-87997)

10.6 Commercial lease agreement between Registrant, the Arrillaga Foundation and the Perry Foundation,dated July 14, 1998 (which is incorporated herein by reference to Exhibit 10.6 to the Registrant’sRegistration Statement on Form S-1 No. 333-87997)

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Number Description

10.7 Commercial lease agreement between Registrant and Zetron Properties, Inc., dated April 20, 2000(which is incorporated herein by reference to Exhibit 10.7 of Form 10-K filed by the Registrant withthe Commission on July 16, 2001)

10.8 Commercial lease agreement between Blue Coat Systems Canada and Wiebe Property CorporationLtd., dated May 1, 1999 (which is incorporated herein by reference to Exhibit 10.8 to the Registrant’sRegistration Statement on Form S-1 No. 333-87997)

10.9 Offer Letter with Brian NeSmith (which is incorporated herein by reference to Exhibit 10.9 to theRegistrant’s Registration Statement on Form S-1 No. 333-87997)

10.10 Offer Letter with Alan Robin (which is incorporated herein by reference to Exhibit 10.10 to theRegistrant’s Registration Statement on Form S-1 No. 333-87997)

10.11 Offer Letter with John Scharber (which is incorporated herein by reference to Exhibit 10.13 of Form10-K filed by the Registrant with the Commission on July 16, 2001)

10.12 Offer Letter with Robert Verheecke (which is incorporated herein by reference to Exhibit 10.14 ofForm 10-K filed by the Registrant with the Commission on July 16, 2001)

10.13 Consulting Agreement with Marc Andreessen (which is incorporated herein by reference to Exhibit10.16 to the Registrant’s Registration Statement on Form S-1 No. 333-87997)

10.14 2000 Supplemental Stock Option Plan (which is incorporated herein by reference to Exhibit 99.1 ofForm S-8 filed by the Registrant with the Commission on April 11, 2000)

10.15 Michael Malcolm Resignation Agreement (which is incorporated herein by reference to Exhibit 10.18of Form 10-Q filed by the Registrant with the Commission on December 15, 2000)

10.16 SpringBank Networks, Inc. 2000 Stock Incentive Plan (which is incorporated herein by reference toExhibit 99.2 of Form S-8 filed by the Registrant with the Commission on September 8, 2000)

10.17 Entera, Inc. 1999 Equity Incentive Plan (which is incorporated herein by reference to Exhibit 99.1 ofForm S-8 filed by the Registrant with the Commission on December 18, 2000)

10.18 Entera, Inc. 2000 Equity Incentive Plan (which is incorporated herein by reference to Exhibit 99.2 ofForm S-8 filed by the Registrant with the Commission on December 18, 2000)

10.19 Commercial lease agreement between Registrant and Sunnyvale VIII Trust, dated March 30, 2001(which is incorporated herein by reference to Exhibit 10.22 of Form 10-K filed by the Registrant withthe Commission on July 16, 2001)

10.20 Commercial sublease agreement between Registrant and Kuokoa Networks, Inc., dated July 10, 2002and First Amendment to Sublease between Registrant and Kuokoa Networks, Inc., dated July 16,2002 (which is incorporated herein by reference to Exhibit 10.22 of Form 10-Q filed by theRegistrant with the Commission on December 16, 2002)

10.21 Commercial sublease agreement between Registrant and Merit Financial, Inc., dated October 25, 2002(which is incorporated herein by reference to Exhibit 10.23 of Form 10-Q filed by the Registrant withthe Commission on December 16, 2002)

10.22 Offer Letter with David de Simone (which is incorporated herein by reference to Exhibit 10.24 of Form10-Q filed by the Registrant with the Commission on December 12, 2003)

10.23 Common Stock Purchase Agreement dated September 18, 2003 (which is incorporated herein byreference to Exhibit 10.1 of Form 8-K filed by the Registrant with the Commission on September 22,2003)

10.24 Registration Rights Agreement dated September 18, 2003 (which is incorporated herein by reference toExhibit 10.2 of Form 8-K filed by the Registrant with the Commission on September 22, 2003)

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Number Description

10.25 Technology License And Settlement Agreement dated October 29, 2003 by and between NetworkCaching Technology L.L.C and Blue Coat Systems, Inc. (which is incorporated herein by referenceto Exhibit 10.27 of Form 10-Q filed by the Registrant with the Commission on December 12, 2003)

10.26 Commercial lease agreement between Registrant and 525 Almanor LLC, dated March 9, 2004 (which isincorporated herein by reference to Exhibit 10.28 of Form 10-K filed by the Registrant with theCommission on July 14, 2004)

10.27 Source Code License & Services Agreement, effective August 12, 2004, by and between Blue CoatSystems, Inc. and Flowerfire, Inc. (which is incorporated herein by reference to Exhibit 10.1 of Form10-Q filed by the Registrant with the Commission on September 9, 2004)

10.28 Commercial sublease agreement between Registrant and Infoblox Inc., dated October 7, 2004 (which isincorporated herein by reference to Exhibit 10.4 of Form 10-Q filed by the Registrant with theCommission on December 9, 2004)

10.29 Employment Agreement between Blue Coat Systems, Inc. and Robert Verheecke dated as of November4, 2004 (which is incorporated herein by reference to Exhibit 10.1 of Form 10-Q filed by theRegistrant with the Commission on December 9, 2004)

10.30 Form of Notice of Grant of Stock Option and Stock Option Agreement used to evidence optionsgranted under the Blue Coat Systems, Inc. 1999 Stock Incentive Plan (which is incorporated hereinby reference to Exhibit 10.2 of Form 10-Q filed by the Registrant with the Commission on December9, 2004)

10.31 Triple Net Space Lease between Mary Avenue Office LLC as Lessor and Blue Coat Systems, Inc., aDelaware corporation, as Lessee, dated April 21, 2005 (which is incorporated herein by reference toExhibit 10.1 of Form 8-K filed by the Registrant with the Commission on April 26, 2005)

10.32 Employment Agreement between Blue Coat Systems, Inc. and Kevin Royal dated as of March 31, 2005

10.33 Separation Agreement between Blue Coat Systems, Inc. and Robert Verheecke dated as of April 29,2005

14.1 Code of Business Conduct, adopted by the Board of Directors of Blue Coat Systems, Inc. on November16, 2004 (which is incorporated herein by reference to Exhibit 14.1 of Form 8-K filed by theRegistrant with the Commission on November 23, 2004

21.1 Subsidiaries

23.1 Consent of Independent Registered Public Accounting Firm

31.1 Certification of Brian NeSmith

31.2 Certification of Kevin Royal

32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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Schedule II

BLUE COAT SYSTEMS, INC.

VALUATION AND QUALIFYING ACCOUNTS

Allowance for Doubtful Accounts and Sales Returns

Year Ended April 30,

Balance atBeginning of

Period

Additions -(Reductions) to

Costs andExpenses Deductions

Balance atEnd ofPeriod

2003 . . . . . . . . . . . . . . . . . . . . . . $2,250,000 $ (52,000) $(1,523,000) $675,0002004 . . . . . . . . . . . . . . . . . . . . . . 675,000 (147,000) 12,000 540,0002005 . . . . . . . . . . . . . . . . . . . . . . 540,000 (330,000) 25,000 235,000

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BLUE COAT SYSTEMS, INC.650 Almanor AvenueSunnyvale, CA 94085

August 17, 2005

TO THE STOCKHOLDERS OF BLUE COAT SYSTEMS, INC.:

You are cordially invited to attend the Annual Meeting of Stockholders of Blue Coat Systems, Inc.(formerly known as CacheFlow Inc.) (the “Company”), which will be held at the Company’s headquarterslocated at 650 Almanor Avenue, Sunnyvale, California 94085, on Tuesday, September 20, 2005, at 10:00 a.m.,local time.

Details of the business to be conducted at the Annual Meeting are given in the attached Proxy Statement andNotice of Annual Meeting of Stockholders.

It is important that your shares be represented and voted at the meeting. WHETHER OR NOT YOUPLAN TO ATTEND THE ANNUAL MEETING, PLEASE COMPLETE, SIGN, DATE, ANDPROMPTLY RETURN THE ACCOMPANYING PROXY IN THE ENCLOSED POSTAGE-PAIDENVELOPE. Returning the proxy does NOT deprive you of your right to attend the Annual Meeting. If youdecide to attend the Annual Meeting and wish to change your proxy vote, you may do so automatically by votingin person at the meeting.

On behalf of the Board of Directors, I would like to express our appreciation for your continued interest inthe affairs of the Company. We look forward to seeing you at the Annual Meeting.

Sincerely,

Brian M. NeSmithPresident andChief Executive Officer

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BLUE COAT SYSTEMS, INC.650 Almanor Avenue

Sunnyvale, California 94085

NOTICE OF ANNUAL MEETING OF STOCKHOLDERSTO BE HELD ON SEPTEMBER 20, 2005

The Annual Meeting of Stockholders (the “Annual Meeting”) of Blue Coat Systems, Inc. (formerly knownas CacheFlow Inc.) (the “Company”) will be held at the Company’s headquarters located at 650 AlmanorAvenue, Sunnyvale, California 94085, on Tuesday, September 20, 2005, at 10:00 a.m. local time for thefollowing purposes:

1. To elect four directors of the Board of Directors to serve until the next Annual Meeting or until theirsuccessors have been duly elected and qualified;

2. To ratify the appointment of Ernst & Young LLP as the Company’s independent registered publicaccountants for the fiscal year ending April 30, 2006; and

3. To transact such other business as may properly come before the meeting or any adjournments orpostponements thereof.

The foregoing items of business are more fully described in the attached Proxy Statement accompanyingthis notice.

Only stockholders of record at the close of business on August 8, 2005 are entitled to notice of, and to voteat, the Annual Meeting and at any adjournments or postponements thereof. A list of such stockholders will beavailable for inspection at the Company’s headquarters located at 650 Almanor Avenue, Sunnyvale, California,during ordinary business hours for ten days prior to the Annual Meeting.

BY ORDER OF THE BOARD OF DIRECTORS,

Cameron S. LaughlinSecretary

Sunnyvale, CaliforniaAugust 17, 2005

IMPORTANT

WHETHER OR NOT YOU PLAN TO ATTEND THE ANNUAL MEETING, PLEASE COMPLETE,SIGN, DATE, AND PROMPTLY RETURN THE ACCOMPANYING PROXY IN THE ENCLOSEDPOSTAGE-PAID ENVELOPE. YOU MAY REVOKE YOUR PROXY AT ANY TIME PRIOR TOTHE ANNUAL MEETING. IF YOU DECIDE TO ATTEND THE ANNUAL MEETING AND WISHTO CHANGE YOUR PROXY VOTE, YOU MAY DO SO AUTOMATICALLY BY VOTING INPERSON AT THE MEETING.

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BLUE COAT SYSTEMS, INC.650 Almanor Avenue

Sunnyvale, California 94085

PROXY STATEMENTFOR THE ANNUAL MEETING OF STOCKHOLDERS

TO BE HELD ON SEPTEMBER 20, 2005

GENERAL INFORMATION

These proxy materials are furnished in connection with the solicitation of proxies by the Board of Directorsof Blue Coat Systems, Inc., a Delaware corporation (formerly known as CacheFlow Inc.) (the “Company”), forthe Annual Meeting of Stockholders (the “Annual Meeting”) to be held at the Company’s headquarters located at650 Almanor Avenue, Sunnyvale, California 94085, on Tuesday, September 20, 2005, at 10:00 a.m. local time,and at any adjournments or postponements of the Annual Meeting. These proxy materials were first mailed tostockholders on or about August 17, 2005. Share numbers and prices for dates preceding September 16, 2002have been adjusted to reflect the 1-for-5 reverse stock split effected on such date.

PURPOSE OF MEETING

The specific proposals to be considered and acted upon at the Annual Meeting are summarized in theaccompanying Notice of Annual Meeting of Stockholders. Each proposal is described in more detail in this ProxyStatement.

VOTING RIGHTS AND SOLICITATION OF PROXIES

The Company’s Common Stock is the only type of security entitled to vote at the Annual Meeting. OnAugust 8, 2005, the record date for determination of stockholders entitled to vote at the Annual Meeting, therewere 12,401,773 shares of Common Stock outstanding. Each stockholder of record on August 8, 2005 is entitledto one vote for each share of Common Stock held by such stockholder on August 8, 2005. All votes will betabulated by the inspector of elections appointed for the meeting who will separately tabulate affirmative andnegative votes, abstentions and broker non-votes.

Quorum Required

The Company’s bylaws provide that the holders of a majority of the Company’s Common Stock issued andoutstanding, and entitled to vote at the Annual Meeting, present in person or represented by proxy, shallconstitute a quorum for the transaction of business at the Annual Meeting. Abstentions and broker non-votes willbe counted as present for the purpose of determining the presence of a quorum.

Votes Required

Proposal 1. Directors are elected by a plurality of the affirmative votes cast by those shares present inperson, or represented by proxy, and entitled to vote at the Annual Meeting. The four nominees for directorreceiving the highest number of affirmative votes will be elected. Abstentions and broker non-votes will not becounted as having been voted in favor of a nominee. Stockholders may not cumulate votes in the election ofdirectors.

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Proposal 2. Ratification of the appointment of Ernst & Young LLP as the Company’s independentregistered public accounting firm for the fiscal year ending April 30, 2006 requires the affirmative vote of amajority of those shares present in person, or represented by proxy, and cast either affirmatively or negatively atthe Annual Meeting. Abstentions and broker non-votes will not be counted as having been voted on the proposal.

Proxies

Whether or not you are able to attend the Company’s Annual Meeting, you are urged to complete and return theenclosed proxy, which is solicited by the Company’s Board of Directors (the “Board of Directors”) and whichwill be voted as you direct on your proxy when properly completed. In the event no directions are specified, suchproxies will be voted FOR the Nominees of the Board of Directors (as set forth in Proposal No. 1), FOR ProposalNo. 2, and in the discretion of the proxy holders as to other matters that may properly come before the AnnualMeeting. You may also revoke or change your proxy at any time before the Annual Meeting. To do this, send awritten notice of revocation or another signed proxy with a later date to the Secretary of the Company at theCompany’s principal executive office before the beginning of the Annual Meeting. You may also automaticallyrevoke your proxy by attending the Annual Meeting and voting in person. All shares represented by a valid proxyreceived prior to the Annual Meeting will be voted.

Solicitation of Proxies

The Company will bear the entire cost of solicitation, including the preparation, assembly, printing, andmailing of this Proxy Statement, the proxy, and any additional solicitation materials furnished to stockholders.Copies of solicitation materials will be furnished to brokerage houses, fiduciaries, and custodians holding sharesin their names that are beneficially owned by others so that they may forward these solicitation materials to suchbeneficial owners. In addition, the Company may reimburse such persons for their costs of forwarding thesolicitation materials to such beneficial owners. The original solicitation of proxies by mail may be supplementedby solicitation by telephone, telegram, or other means by directors, officers, employees or agents of theCompany. No additional compensation will be paid to these individuals for such services.

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PROPOSAL NO. 1

ELECTION OF DIRECTORS

The directors who are being nominated for reelection to the Board of Directors (the “Nominees”), their agesas of July 31, 2005, their positions and offices held with the Company and certain biographical information areset forth below. The proxy holders intend to vote all proxies received by them in the accompanying form FORthe Nominees listed below unless otherwise instructed. In the event any Nominee is unable or declines to serve asa director at the time of the Annual Meeting, the proxies will be voted for any nominee who may be designatedby the present Board of Directors to fill the vacancy. As of the date of this Proxy Statement, the Board ofDirectors is not aware of any Nominee who is unable or will decline to serve as a director. The four (4) nomineesreceiving the highest number of affirmative votes of the shares entitled to vote at the Annual Meeting will beelected directors of the Company to serve until the next Annual Meeting or until their successors have been dulyelected and qualified.

Nominees Age Position(s) and Office(s) Held with the Company

James A. Barth (1)(2)(3) . . . . . . . . . . . . . . . . . . . . . . . 62 DirectorDavid W. Hanna (1)(2)(3) . . . . . . . . . . . . . . . . . . . . . . 66 Chairman of the Board and DirectorBrian M. NeSmith . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 President, Chief Executive Officer and DirectorJay W. Shiveley III (1)(3) . . . . . . . . . . . . . . . . . . . . . . 48 Director

(1) Member of Audit Committee(2) Member of Compensation Committee(3) Member of the Nominating/Corporate Governance Committee

James A. Barth has served as a director of the Company since January 2005. Since September 2004,Mr. Barth has been Chief Executive Officer and a Director of Proximex Corporation, a developer of intelligentsurveillance management software. From March 1999 to September 2004, Mr. Barth was Chief Financial Officerof NetIQ Corporation, a systems and security management software company. He was also vice president andthen senior vice president of finance and administration during this period. From November 1997 until it wassold to Sterling Software in March 1999, Mr. Barth served as Vice President and Chief Financial Officer ofInterlink Computer Sciences, Inc., a developer of enterprise networking software designed for the IBMmainframe platform. From 1980 to November 1997, Mr. Barth served as Chief Financial Officer at several otherhigh technology companies, including eleven years at Rational Software Corporation. Mr. Barth holds a B.S. inbusiness administration from the University of California at Los Angeles and is a certified public accountant.

David W. Hanna has served as a director of the Company since October 1996 and as its Chairman of theBoard of Directors since February 2001. From December 1998 to March 1999, Mr. Hanna also served as theCompany’s Interim President and Chief Executive Officer. Mr. Hanna has served as Chairman of the Board ofTropos Networks, Inc. since January 2002 and also served as that company’s Chief Executive Officer fromJanuary 2002 to January 2004. From March 1998 to March 2000, Mr. Hanna served as President and ChiefExecutive Officer of Sage Software, Inc., a financial software company. Mr. Hanna served as President and ChiefExecutive Officer of State of the Art, Inc., a financial software developer, from November 1993 until March1998. Mr. Hanna serves on the Board of Handmark, Inc. In addition, Mr. Hanna has served as Chairman, CEOand/or President of The Hanna Group since 1984; Hanna Capital Management since 1998; and Hanna Venturessince 1999. Mr. Hanna holds a B.S. in business administration from the University of Arizona.

Brian M. NeSmith has served as President, Chief Executive Officer and a director of the Company sinceMarch 1999. From December 1997 to March 1999, Mr. NeSmith served as Vice President of Nokia IP, Inc., asecurity router company, which acquired Ipsilon Networks, Inc., an IP switching company, where Mr. NeSmithserved as Chief Executive Officer from May 1995 to December 1997. From October 1987 to April 1995,Mr. NeSmith held several positions at Newbridge Networks Corporation, a networking equipment manufacturer,including vice president and general manager of the VIVID group. Mr. NeSmith holds a B.S. in electricalengineering from the Massachusetts Institute of Technology.

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Jay W. Shiveley III has served as a director of the Company since May 2004. Since January 2004, he hasserved as a Managing Director at VantagePoint Venture Partners. Prior to that, he was a Venture Partner andManaging Director of the Sprout Group from May 2003 to December 2003 and a General Partner of AtlasVentures from June 2001 to December 2002. From June 1997 to February 2001, Mr. Shiveley was Senior VicePresident of Worldwide Operations at Vitria Technology, a software company. Prior to that, he served in variouspositions, including Senior Vice President of North American Operations for Forte Software, Group Director forU.S. Operations for all Federal contractors and systems integrators worldwide for Oracle Corporation, andPrincipal and head of worldwide sales for Lawson Software. Mr. Shiveley is a director of several privately heldcompanies. Mr. Shiveley holds a B.S. in finance and accounting from the Mankato State University.

Board of Directors Meetings and Committees

During the fiscal year ended April 30, 2005, the Board of Directors held nine (9) meetings and acted bywritten consent in lieu of a meeting on three (3) occasions. The Board of Directors currently consists of six(6) directors. Mr. Rachleff, a director of the Company since 1997, has notified the Board of Directors that hedoes not intend to stand for re-election at the 2005 Annual Meeting of Stockholders. His term will expire at the2005 Annual Meeting of Stockholders. Mr. Andreessen, a director of the Company since 1999, has notified theBoard of Directors that he does not intend to stand for re-election at the 2005 Annual Meeting of Stockholders.His term will expire at the 2005 Annual Meeting of Stockholders. For the fiscal year, each of the directors duringthe term of his tenure attended or participated in at least 75% of the aggregate of (i) the total number of meetingsor actions by written consent of the Board of Directors and (ii) the total number of meetings or actions by writtenconsent of a committee of the Board of Directors on which each such director served, except for Mr. Shiveley,who attended 60% of the meetings of the Board of Directors and committees of which he is a member. TheBoard of Directors has three (3) standing committees: the Audit Committee, the Compensation Committee andthe Nominating/Corporate Governance Committee.

Audit Committee. During the fiscal year ended April 30, 2005, the Audit Committee of the Board ofDirectors (the “Audit Committee”) held eight (8) meetings and acted by written consent in lieu of a meeting onthree (3) occasions. The Audit Committee serves as the representative of the Board of Directors for generaloversight of the Company’s financial accounting and reporting process, system of internal control, audit process,and process for monitoring compliance with laws and regulations and the Company’s Standards of BusinessConduct. The Audit Committee annually appoints an independent registered public accounting firm to audit thefinancial statements of the Company. In addition, the Audit Committee approves the scope of the annual auditsand fees to be paid to the Company’s auditors. Three directors currently comprise the Audit committee:Mr. Barth, who was elected to the committee in January 2005, Mr. Hanna and Mr. Rachleff. Mr. Hanna wasChairman of the Audit Committee until January 2005, when Mr. Barth was elected Chairman of the AuditCommittee. Mr. Andreessen served on the Audit Committee until January 2005, when he resigned from the AuditCommittee. Mr. Rachleff, a member of the Audit Committee, has notified the Board of Directors that he does notintend to stand for re-election at the 2005 Annual Meeting of Stockholders. As of the date of the 2005 AnnualMeeting of Stockholders, Mr. Shiveley will replace Mr. Rachleff as a member of the Audit Committee. Allcurrent members of the Audit Committee are, and all members of the Audit Committee as of the Annual Meetingof Stockholders are, independent under applicable SEC and Nasdaq rules. In addition, the Board has determinedthat Mr. Hanna and Mr. Barth each qualify as an “audit committee financial expert” as defined by Item 401(h) ofregulation S-K of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

Compensation Committee. During the fiscal year ended April 30, 2005, the Compensation Committee ofthe Board of Directors (the “Compensation Committee”) held no meetings and acted by written consent in lieu ofa meeting on eighteen (18) occasions. The Compensation Committee reviews the performance of the executiveofficers of the Company, establishes compensation programs for the officers and reviews the compensationprograms for other key employees, including salary and cash bonus levels, and administers the Company’s 1999Stock Incentive Plan, the 2000 Supplemental Stock Option Plan and the Employee Stock Purchase Plan. Thecurrent members of the Compensation Committee are Messrs. Hanna and Rachleff. Mr. Rachleff, a member of

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the Compensation Committee, has notified the Board of Directors that he does not intend to stand for re-electionat the 2005 Annual Meeting of Stockholders. As of the date of the 2005 Annual Meeting of Stockholders,Mr. Barth will replace Mr. Rachleff as a member of the Compensation Committee.

Nominating/Corporate Governance Committee. During the fiscal year ended April 30, 2005, theNominating/Corporate Governance Committee of the Board of Directors (the “Nominating Committee”) heldone meeting and acted by written consent in lieu of a meeting on one occasion. The Nominating Committeeoversees the nomination of directors for service on the Board of Directors and its committees and other relatedmatters, reviews and considers developments in corporate governance practices, and recommends to the Board ofDirectors corporate governance policies and procedures applicable to the Company. The current members of theNominating Committee are Messrs. Hanna, Rachleff and Shiveley, each of whom are independent underapplicable Nasdaq rules. Mr. Rachleff, a current member of the Nominating Committee, has notified the Board ofDirectors that he does not intend to stand for re-election when his term expires at the 2005 Annual Meeting ofStockholders. As of the date of the 2005 Annual Meeting of Stockholders, Mr. Barth will replace Mr. Rachleff asa member of the Nominating Committee.

When reviewing a potential candidate for nomination as director, including an incumbent whose term isexpiring, the Nominating Committee will consider the perceived needs of the Board of Directors, the candidate’srelevant background, experience, skills and expected contributions, and the qualification standards establishedfrom time to time by the Nominating Committee. With respect to such standards, it is the NominatingCommittee’s goal to assemble a Board that has a diversity of experience at policy-making levels in business,government, education and technology, and in areas that are relevant to our global activities. In addition, theNominating Committee believes that members of the Board of Directors should possess the highest personal andprofessional ethics, integrity and values, and be committed to representing the long-term interests of ourstockholders. They must have an inquisitive and objective perspective and mature judgment. They must also haveexperience in positions with a high degree of responsibility and be leaders in the companies or institutions withwhich they are affiliated. In addition to the benefits of diverse viewpoints, the Nominating Committee may alsotake into account the benefits of a constructive working relationship among directors. Members of the Board ofDirectors will be expected to rigorously prepare for, attend, and participate in all Board and applicable committeemeetings. Other than the foregoing, there are no stated minimum criteria for director nominees, although theNominating Committee may also consider such other factors as it may deem, from time to time, are in the bestinterests of Blue Coat and our stockholders.

The Nominating Committee will consider candidates for directors proposed by directors or management,and will evaluate any such candidates against the criteria and pursuant to the policies and procedures set forthabove. If the Nominating Committee believes that the Board of Directors requires additional candidates fornomination, it may engage, as appropriate, a third party search firm to assist in identifying qualified candidates.As part of the nominating process, all incumbent directors and non-incumbent nominees will be required tosubmit a completed form of directors’ and officers’ questionnaire and all incumbent directors may be required toparticipate in a peer-assessment process. The nomination process may also include interviews and additionalbackground and reference checks for non-incumbent nominees, at the discretion of the Nominating Committee.

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In addition, stockholders may recommend or nominate directors for election at an annual meeting, providedthe advance notice requirements set forth in our Bylaws have been met. Candidates recommended bystockholders will be evaluated against the same criteria and pursuant to the same policies and proceduresapplicable to the evaluation of candidates proposed by directors or management.

Code of Business Conduct and Ethics. The Board of Directors has adopted a Code of Business Conductand Ethics (the “Code”), which outlines the principles of legal and ethical business conduct under which we dobusiness. The Code is applicable to all of our directors, officers and employees. The Code is available athttp://www.bluecoat.com/aboutus/investor_relations/. The Company will also provide a copy of the Code, free ofcharge, upon request to the Company’s Secretary. Any substantive amendment of the Code, and any waiver ofthe Code for executive officers or directors, will be made only after approval by a committee comprised of amajority of our independent directors and will be disclosed on our website. In addition, disclosure of any suchwaiver will be made within four days by the filing of a Form 8-K with the SEC.

The Board has also adopted a written charter for each of the Audit Committee, Compensation Committeeand Nominating/ Corporate Governance Committee. Each charter is available on the Company’s website athttp://www.bluecoat.com/aboutus/investor_relations/.

Independence of Directors

The Board of Directors is comprised of a majority of directors who qualify as independent directors underapplicable SEC and Nasdaq rules. The Board of Directors has determined Messrs. Andreessen, Barth, Hanna,Rachleff and Shiveley to be independent under NASDAQ Rule 4200. Mr. Rachleff and Mr. Andreessen, bothdirectors, have notified the Board of Directors that they each do not intend to stand for re-election at the 2005Annual Meeting of Stockholders. As of the date of the 2005 Annual Meeting of Stockholders, the Board ofDirectors will continue to be comprised of a majority of directors who qualify as independent directors pursuantto the rules adopted by the SEC and Nasdaq.

Communication with the Board of Directors

Interested parties may contact the Board of Directors or any committee of the Board of Directors by sendingcorrespondence to the attention of the Company’s Secretary, c/o Blue Coat Systems, Inc., 650 Almanor Avenue,Sunnyvale, California 94085. Any mail received by the Secretary with the exception of improper commercialsolicitations will then be forwarded to the members of the Board of Directors or the appropriate committee fortheir further action, if necessary. The Company does not have a policy requiring attendance by members of theBoard of Directors at the Company’s annual meeting. At the Company’s 2004 Annual Meeting, Brian M.NeSmith, a member of the Board of Directors and the Company’s Chief Executive Officer was in attendance andavailable for questions.

Director Compensation

Except for grants of stock options, directors of the Company generally do not receive compensation forservices provided as a director. The Company also does not pay compensation for committee participation orspecial assignments of the Board of Directors, except that Mr. Barth is paid a director fee in the amount of$45,000 per annum for serving as Chairman of the Audit Committee.

Non-employee directors are eligible for periodic automatic option grants under our 1999 Stock IncentivePlan (the “Incentive Plan”) and our 1999 Director Plan (the “Director Plan”). Under the current provisions of theIncentive Plan and Director Plan, each individual who first becomes a non-employee director after November 16,2004 will be granted options to purchase 10,000 shares on the date such individual joins the Board of Directorsand each individual who first becomes Chairman of the Audit Committee after November 16, 2004 will begranted options to purchase 7,500 shares on the date such individual becomes Chairman of the Audit Committee,

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provided in each case such individual has not been previously employed by the Company. Each non-employeedirector will be granted an additional option to purchase 4,000 shares annually on the date of each AnnualMeeting of Stockholders. In addition, beginning on November 16, 2004 and thereafter, at each Annual Meetingof Stockholders, each individual who will continue serving as a member of the Audit Committee thereafter willreceive annual option grants to purchase 2,500 shares of Common Stock. At each Annual Meeting ofStockholders after November 16, 2004, each individual who will continue serving as the chairman of the AuditCommittee thereafter will receive additional option grants to purchase 5,000 shares of Common Stock. Theoption price for each automatic option grant will be equal to the fair market value per share of Common Stock onthe automatic grant date. Each initial automatic grant shall become exercisable for 25% of the shares upon theoptionee’s completion of 12 months of service from the date of grant and the balance of the shares in annualinstallments over the three-year period thereafter; each annual automatic grant shall become exercisable in full onthe first anniversary of the grant date. In addition, initial and annual automatic grants become exercisable in fullin the event of a change in control of the Company. Directors are eligible to receive additional options and beissued shares of Common Stock directly under the Incentive Plan, and directors who are also employees of theCompany are also eligible to participate in the Company’s Employee Stock Purchase Plan.

On May 14, 2004, Mr. Shiveley was granted an option to purchase 5,000 shares of Common Stock at anexercise price of $36.09 in connection with joining the Board of Directors. On October 5, 2004, each of Messrs.Andreessen, Hanna and Rachleff received an option to purchase 2,500 shares at an exercise price of $16.70 pershare in connection with their continuing service on the Board of Directors. On October 5, 2004, each of Messrs.Andreessen, Hanna, and Rachleff received an option to purchase 1,250 shares at an exercise price of $16.70 pershare in connection with their services on the Audit Committee. In addition, Mr. Hanna received an option topurchase 2,500 shares of Common Stock on October 5, 2004 at an exercise price of $16.70 per share inconnection with his service as Chairman of the Audit Committee. On January 14, 2005, Mr. Barth was grantedoptions to purchase 10,000 shares of Common Stock in connection with joining the Board of Directors and anoption to purchase 7,500 shares of Common Stock, in connection with joining the Audit Committee as Chair,each at an exercise price of $19.09 per share.

On the date of this Annual Meeting, each of Messrs. Barth, Hanna and Shiveley will receive options topurchase 4,000 shares of Common Stock in connection with their continuing service on the Board of Directors.In addition, each of Messrs. Barth and Hanna will receive an additional option to purchase 2,500 shares ofCommon Stock for continuing to serve as a member of the Audit Committee. Mr. Barth will receive an additionaloption to purchase 5,000 shares of Common Stock for continuing to serve as the Chairman of the AuditCommittee.

Recommendation of the Board of Directors

THE BOARD OF DIRECTORS RECOMMENDS A VOTE “FOR” THE NOMINEES LISTED HEREIN.

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PROPOSAL NO. 2

RATIFICATION OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Company is asking the stockholders to ratify the appointment of Ernst & Young LLP as the Company’sindependent registered public accounting firm for the fiscal year ending April 30, 2006. The affirmative vote ofthe holders of a majority of shares present or represented by proxy and voting at the Annual Meeting will berequired to ratify the appointment of Ernst & Young LLP.

In the event the stockholders fail to ratify the appointment, the Board of Directors will reconsider itsselection. Even if the appointment is ratified, the Board of Directors, in its discretion, may direct the appointmentof a different independent registered accounting firm at any time during the year if the Board of Directors feelsthat such a change would be in the Company’s and its stockholders’ best interests.

Ernst & Young LLP has audited the Company’s financial statements since 1999. Its representatives areexpected to be present at the Annual Meeting, will have the opportunity to make a statement if they desire to doso, and will be available to respond to appropriate questions.

Recommendation of the Board of Directors

THE BOARD OF DIRECTORS RECOMMENDS A VOTE “FOR” THE RATIFICATION OF THESELECTION OF ERNST & YOUNG LLP TO SERVE AS THE COMPANY’S INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM FOR THE FISCAL YEAR ENDING APRIL 30, 2006.

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MANAGEMENT

The following chart sets forth certain information regarding the executive officers of Blue Coat as ofAugust 1, 2005:

Nominees Age Position(s) and Office(s) Held with the Company

Brian M. NeSmith . . . . . . . . . . . . . . . . . . . . . . 43 President, Chief Executive Officer and DirectorKevin S. Royal . . . . . . . . . . . . . . . . . . . . . . . . 41 Senior Vice President and Chief Financial OfficerThomas B. Ayers . . . . . . . . . . . . . . . . . . . . . . . 49 Senior Vice President of Worldwide Field OperationsDavid A. de Simone . . . . . . . . . . . . . . . . . . . . 50 Senior Vice President of EngineeringDavid L. Cox . . . . . . . . . . . . . . . . . . . . . . . . . . 42 Vice President of OperationsStephen P. Mullaney . . . . . . . . . . . . . . . . . . . . 41 Vice President of Worldwide MarketingCameron S. Laughlin . . . . . . . . . . . . . . . . . . . . 36 Vice President, General Counsel and Secretary

Brian M. NeSmith has served as President and Chief Executive Officer and a director of the Company sinceMarch 1999. From December 1997 to March 1999, Mr. NeSmith served as Vice President of Nokia IP, Inc., asecurity router company, which acquired Ipsilon Networks, Inc., an IP switching company, where Mr. NeSmithserved as Chief Executive Officer from May 1995 to December 1997. From October 1987 to April 1995,Mr. NeSmith held several positions at Newbridge Networks Corporation, a networking equipment manufacturer,including vice president and general manager of the VIVID group. Mr. NeSmith holds a B.S. in electricalengineering from the Massachusetts Institute of Technology.

Kevin S. Royal has served as Senior Vice President and Chief Financial Officer of Blue Coat since May2005. From January 2002 to April 2005, Mr. Royal served as Chief Financial Officer at Novellus Systems, Inc.Mr. Royal joined Novellus in 1996 and held various senior finance positions including Vice President Financeand Corporate Controller. Prior to Novellus, Mr. Royal worked for Ernst & Young LLP in their NorthernCalifornia high technology practice for over 10 years. Mr. Royal received his Bachelor of BusinessAdministration from Harding University and is a Certified Public Accountant in the State of California.

Thomas B. Ayers has served as Senior Vice President, Worldwide Field Operations at Blue Coat sinceNovember 2004, after serving as Senior Vice President of Sales since joining Blue Coat in October 2002. FromFebruary 1999 to October 2002, Mr. Ayers served as Vice President of Sales, for the McAfee division ofNetwork Associates, for both enterprise accounts and the SMB sales organizations. Mr. Ayers served as aregional sales director at Sequent Computers from 1997 until the company’s acquisition by IBM in 1999. He alsoheld several sales management positions at Amdahl Corporation from 1991 to 1997, most recently serving asVice President of Sales for operational services from 1995 to 1997. Additionally, Mr. Ayers has more than 13years of systems engineering, sales, and sales management experience from IBM, where he worked from 1977until 1991. Mr. Ayers holds a B.B.A. degree in marketing from the University of Texas at Austin.

David A. de Simone has served as Senior Vice President of Engineering at Blue Coat since September 2003.From December 2002 to September 2003, Mr. de Simone worked as an independent consultant providingtechnical assistance and executive coaching to several clients. From May 2000 to December 2002, Mr. deSimone served as Vice President of Platform Development for Brocade Communications Systems a leadingprovider of storage area networking products. From February 1989 to May 2000, Mr. de Simone held a numberof positions with Tandem Computers, which was acquired by Compaq Computer Systems. During the lastseveral years of his tenure with Compaq and Tandem, Mr. de Simone was Vice President of ClusteringTechnology, and earlier in his tenure with Tandem he was a Director of Engineering. Mr. de Simone has anadditional 11 years of experience in a variety of Engineering and Operations roles. Mr. de Simone holds aB.S.E.E. from the University of California, Davis.

David L. Cox has served as Vice President of Operations, responsible for Manufacturing and Facilities, atBlue Coat since July 2003. From February 2001 to July 2003, Mr. Cox served as Vice President of Operations

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and/or an operations consultant to several internet infrastructure start-ups, including Pluris, RouteScienceTechnologies, and Hammerhead Systems. From January 1996 to February 2001, Mr. Cox served in multiplemanufacturing management roles at Cisco Systems; his last role was that of Business Operations Director.Mr. Cox holds an M.B.A. from Santa Clara University and a B.A. in International Relations from the Universityof California, Davis.

Stephen P. Mullaney has served as Vice President of Worldwide Marketing at Blue Coat Systems since July2003. From October 2000 to March 2003, Mr. Mullaney was Vice President of Marketing at Force10 Networks,a networking company. From February 2000 to October 2000, Mr. Mullaney was Vice President of Marketing atGrowth Networks, a developer of terabit switching fabric ICs, which was acquired by Cisco Systems. Prior tojoining Growth Networks, Mr. Mullaney spent ten years at SynOptics and Bay Networks in various marketing,product management, and engineering roles. Mr. Mullaney holds a B.S. in Electrical Engineering fromUniversity of Rhode Island.

Cameron S. Laughlin has served as Vice President and General Counsel of the Company since May 2004and was appointed Secretary of Blue Coat in August 2004. From August 2003 to February 2004, Ms. Laughlinserved as Vice President of Business Affairs, General Counsel and Secretary of CommerceNet, Inc., a non-profitcompany focused on a wide variety of internet applications. From October 1999 to May 2003, Ms. Laughlinserved as Vice President Business Affairs, General Counsel and Secretary for Perfect Commerce, Inc., anenterprise software company focused on strategic sourcing. Prior to joining Perfect Commerce, Ms. Laughlin wasan associate at Gunderson Dettmer, a law firm in Menlo Park, from September 1995 to September 1999.Ms. Laughlin holds a B.S. in biochemistry from University of California at Santa Barbara and a J.D. from theUniversity of San Francisco. Ms. Laughlin is a member of the State Bar of California and the American BarAssociation.

10

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth, as of May 31, 2005, certain information with respect to shares beneficiallyowned by (i) each person who is known by the Company to be the beneficial owner of more than five percent ofthe Company’s outstanding shares of Common Stock, (ii) each of the Company’s directors as of that date,(iii) each of the executive officers named in the Summary Compensation Table below and (iv) all currentdirectors and executive officers as a group. Beneficial ownership has been determined in accordance withRule 13d-3 under the Securities Exchange Act of 1934. Under this rule, certain shares may be deemed to bebeneficially owned by more than one person (if, for example, persons share the power to vote or the power todispose of the shares). In addition, shares are deemed to be beneficially owned by a person if the person has theright to acquire shares (for example, upon exercise of an option or warrant) within sixty (60) days of the date asof which the information is provided. Shares issuable pursuant to stock options and warrants exercisable withinsixty (60) days of May 31, 2005 are deemed outstanding for computing the percentage of the person holding theoptions and warrants, but are not outstanding for purposes of computing the percentage of any other person. As aresult, the percentage ownership of outstanding shares of any person as shown in the following table does notnecessarily reflect the person’s actual voting power at any particular date.

Shares Beneficially OwnedAs of April 30, 2005(1)

Beneficial Owner Number of Shares Percentage of Class

Credit Suisse First Boston (2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,311,490 10.6%Massachusetts Financial Services Company (3) . . . . . . . . . . . . . . . . . . . . . . 1,085,750 8.8Brian M. NeSmith (4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 526,521 4.2Robert P. Verheecke (5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174,400 1.4Thomas B. Ayers (6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62,714 *David A. de Simone (7) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68,965 *Stephen P. Mullaney (8) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,322 *Marc L. Andreessen (9) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 188,368 1.5James A. Barth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 *David W. Hanna (10) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 253,095 2.0Andrew S. Rachleff (11) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 399,271 3.2Jay W. Shiveley III (12) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,452 *All current directors and executive officers as a group (12 persons) (13) . . 1,786,344 13.9%

* Less than 1% of the outstanding shares of Common Stock.(1) Except as indicated in the footnotes to this table and pursuant to applicable community property laws, each

of the persons named in the table has, to the Company’s knowledge, sole voting and investment powerwith respect to all shares of Common Stock shown as beneficially owned by such person. Unless otherwiseindicated, the address of each individual listed in the table is c/o Blue Coat Systems, Inc., 650 AlmanorAvenue, Sunnyvale, CA 94085. The percentage of beneficial ownership is based on 12,318,101 shares ofCommon Stock outstanding as of May 31, 2005.

(2) Based on a Schedule 13D filed with the SEC on September 29, 2003. Address is 11 Madison Avenue, NewYork, NY 10010. These securities are owned by Sprout Capital IX, L.P., Sprout Entrepreneurs Fund, L.P.and DLJ Capital Corporation, each of which are investment funds affiliated with the Sprout Group, aventure capital affiliate of Credit Suisse First Boston.

(3) Based on a Schedule 13G filed with the SEC on February 14, 2005. Address is 500 Boylston Street,Boston, Massachusetts 02116.

(4) Includes 141,121 shares subject to options that are exercisable within 60 days of May 31, 2005 and385,000 shares held by the Brian M. and Nancy J. NeSmith Family Trust.

(5) Includes 170,000 shares subject to options that are exercisable within 60 days of May 31, 2005 and 2,400shares held by Mr. Verheecke’s spouse and children.

(6) Includes 58,914 shares subject to options that are exercisable within 60 days of May 31, 2005.

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(7) Includes 68,165 shares subject to options that are exercisable within 60 days of May 31, 2005.(8) Includes 44,622 shares subject to options that are exercisable within 60 days of May 31, 2005, 5,000 shares

of which Mr. Mullaney exercised on June 27, 2005.(9) Includes 8,250 shares subject to options that are exercisable within 60 days of May 31, 2005. Also includes

899 shares held by the Andreessen 1996 Charitable Remainder Trust and 179,219 shares held by theAndreessen 1996 Living Trust. Mr. Andreessen, a director of the Company, has notified the Board ofDirectors that he does not intend to stand for re-election at the 2005 Annual Meeting of Stockholders.

(10) Includes 31,500 shares subject to options that are exercisable within 60 days of May 31, 2005. Alsoincludes 205,642 shares held by the David W. Hanna Trust, 3,052 shares held by the Hanna Group ProfitSharing Plan and 12,901 shares held by Mr. Hanna’s spouse. Mr. Hanna disclaims beneficial ownership ofthe shares held by these entities, except to the extent of his economic interest in the funds.

(11) Includes 14,500 shares subject to options that are exercisable within 60 days of May 31, 2005. Alsoincludes 211,476 shares held by Benchmark Capital Partners, L.P. Mr. Rachleff, one of our directors, is amanaging member of Benchmark Capital Management Co., L.L.C., which is the general partner of each ofBenchmark Capital Partners, L.P. Mr. Rachleff disclaims beneficial ownership of the shares held byBenchmark Capital Partners, L.P. and Benchmark Founders’ Fund, L.P. except to the extent of hiseconomic interest in the funds. The persons having voting or investment power with respect to thesecurities held by entities affiliated with Benchmark Capital include David M. Beirne, Bruce W. Dunlevie,Kevin R. Harvey, Robert C. Kagle, Andrew S. Rachleff, and Steven M. Spurlock. Mr. Rachleff, a directorof the Company, has notified the Board of Directors that he does not intend to stand for re-election at the2005 Annual Meeting of Stockholders.

(12) Includes 1,250 shares subject to options that are exercisable within 60 days of May 31, 2005 and 20,202shares held by the Shiveley Family Trust.

(13) Includes 567,012 shares subject to options that are exercisable within 60 days of May 31, 2005.

COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT

The members of the Board of Directors, the executive officers of the Company and persons who hold morethan ten percent of the Company’s outstanding Common Stock are subject to the reporting requirements ofSection 16(a) of the Securities Exchange Act of 1934, as amended, which require them to file reports withrespect to their ownership of the Company’s Common Stock and their transactions in such Common Stock.Based upon (i) the copies of Section 16(a) reports that the Company received from such persons for transactionsin the Common Stock and their Common Stock holdings for the year ended April 30, 2005 and (ii) the writtenrepresentations received from one or more of such persons that no annual Form 5 reports were required to befiled by them for the year ended April 30, 2005, the Company believes that all reporting requirements underSection 16(a) for such fiscal year were met in a timely manner by its executive officers, Board members andgreater than ten-percent stockholders, except that Cameron S. Laughlin, the Vice President, General Counsel andSecretary filed her Form 3 late by approximately eight months and filed her Form 4 approximately three weekslate.

12

EQUITY COMPENSATION PLAN INFORMATION

The following table provides information as of April 30, 2005 with respect to the shares of the Company’sCommon Stock that may be issued under the Company’s existing equity compensation plans. The table does notinclude information with respect to shares subject to outstanding options granted under equity compensationplans assumed by the Company in connection with acquisitions of the companies which originally granted thoseoptions. Footnote (5) to the table sets forth the total number of shares of the Company’s Common Stock issuableupon the exercise of those assumed options as of April 30, 2005, and the weighted average exercise price of thoseoptions. No additional options may be granted under those assumed plans.

Number of Securitiesto Be Issued

upon Exercise ofOutstanding Options,Warrants and Rights

Weighted-AverageExercise Price of

Outstanding Options,Warrants and Rights

Number of Securities RemainingAvailable for Future Issuanceunder Equity CompensationPlans (Excluding Securities

Reflected in Column (a))

Plan Category (a) (b) (c)

Equity compensation plans approved bysecurity holders (1) . . . . . . . . . . . . . . . 3,042,919(3) $25.02(3) 919,344(4)

Equity compensation plans not approvedby security holders (2) . . . . . . . . . . . . . 80,071 $71.15 278,465

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,122,980 $26.20 1,917,809

(1) Consists of options outstanding under the 1996 Stock Plan and options granted and shares available underthe following plans: 1999 Stock Incentive Plan, 1999 Director Option Plan and Employee Stock PurchasePlan (“Stock Plans”). Each year, commencing with the year 2000, the aggregate number of sharesauthorized under the 1999 Stock Incentive Plan automatically increases by a number equal to the lesser of5% of the total number of shares of Common Stock outstanding on January 1 of such year, or 400,000shares. Accordingly, 400,000 shares were added to the 1999 Stock Incentive Plan on January 1, 2005. Eachyear, commencing with the year 2000, the aggregate number of shares authorized under the 1999 DirectorOption Plan automatically increases by 20,000 shares or such lesser number of shares as the Company’sBoard of Directors may determine. Accordingly, 20,000 shares were added to the 1999 Director Option Planon January 1, 2005. Each year, commencing with the year 2000, the number of shares under the EmployeeStock Purchase Plan automatically increases by 100,000 shares or such lesser number of shares as theCompany’s Board of Directors may determine. Accordingly, 100,000 shares were added to the EmployeeStock Purchase Plan on January 31, 2005. The Board of Directors may authorize a lesser number of sharesto be added to the reserve for Stock Plans, as was done in 2003.

(2) Consists of shares issuable under the 2000 Supplemental Stock Option Plan (the “Supplemental Plan”),which was implemented by the Board of Directors on February 15, 2000. The Supplemental Plan is anon-shareholder approved plan. Non-statutory options and restricted stock awards may be granted under theSupplemental Plan to employees or consultants of the Company who are neither executive officers noroutside directors at the time of grant. The Board has authorized 600,000 shares of Common Stock forissuance under the Supplemental Plan. All option grants will have an exercise price per share of no less than25% of the fair market value per share of Common Stock on the grant date. Each option will vest ininstallments over the optionee’s period of service with the Company. The options will vest on an acceleratedbasis in the event the Company is acquired and (i) the options are not assumed or replaced by the acquiringentity or (ii) the optionee is subject to an involuntary termination. Additional features of the SupplementalPlan are outlined in Note 8 to the Consolidated Financial Statements.

(3) Excludes purchase rights accrued under the Employee Stock Purchase Plan.(4) Includes shares available for future issuance under the Employee Stock Purchase Plan. As of April 30, 2005,

there were 638,273 shares of Common Stock available for future issuance.(5) Table excludes information for equity compensation plans assumed by the Company in business combinations

under which no additional options may be granted. As of April 30, 2005, a total of 17,012 shares of theCompany’s Common Stock were issuable upon exercise of outstanding options under the assumed plans. Therelated weighted average exercise price of those outstanding options was $66.87 per share.

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EXECUTIVE COMPENSATION AND RELATED INFORMATION

The following Summary Compensation Table sets forth the compensation earned for the three most recentfiscal years by the Company’s Chief Executive Officer plus the four other executive officers who were serving assuch at the end of the fiscal year ended April 30, 2005, each of whose salary and bonus for the fiscal year endedApril 30, 2005 exceeded $100,000 for services rendered in all capacities to the Company and its subsidiaries forthat fiscal year. The Company’s Chief Executive Officer and the other executive officers are referred tocollectively as the “Named Officers.” No executive officers who would have otherwise been included in suchtable have been excluded by reason of his or her termination of employment or change in executive status duringthe year.

Summary Compensation Table

FiscalYear

Annual Compensation

Long-TermCompensation

Name and Principal Position

Number ofSecurities

UnderlyingOptionsSalary Bonus

Brian M. NeSmith (1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .President, Chief Executive Officer,and Director

200520042003

$250,000$135,000$ 20,000

———

050,000

100,000

Robert P. Verheecke (2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Senior Vice President, Chief Financial Officer,and Secretary

200520042003

$250,000$250,000$250,000

$ 18,125$ 20,625$ 18,750

040,00050,000

Thomas B. Ayers (3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Senior Vice President, Worldwide Sales

200520042003

$187,500$175,000$ 90,192

$162,784(4)$150,857$ 41,732

035,00066,000

David A. de Simone (5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Senior Vice President, Engineering

200520042003

$250,000$164,904

—

$137,500$ 13,545

—

0180,000

0

Stephen P. Mullaney (6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Vice President, Worldwide Marketing

200520042003

$205,000$145,747

—

$ 14,876$ 10,638

—

088,000

0

(1) Mr. NeSmith voluntarily reduced his salary effective May 1, 2002 and the Board of Directors restored hissalary to its former level effective November 1, 2003.

(2) Mr. Verheecke resigned as Senior Vice President, Chief Financial Officer and Secretary of the Company inMay 2005.

(3) Mr. Ayers commenced employment in October 2002.(4) Represents amounts paid as commissions.(5) Mr. de Simone commenced employment in September 2003.(6) Mr. Mullaney commenced employment in July 2003.

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Option Grants in Last Fiscal Year

No option grants or stock appreciation rights were granted to any Named Officers during the last fiscal year.

The following table sets forth information concerning option holdings as of the end of the fiscal year endedApril 30, 2005 with respect to each of the Named Officers. No options were exercised by any Named Officerduring the fiscal year ended April 30, 2005. No stock appreciation rights were outstanding at the end of that year.

Aggregate Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values

Number of SecuritiesUnderlying UnexercisedOptions at FY-End(1)

Value of UnexercisedIn-the-Money Options

at FY-End(2)

Name Exercisable Unexercisable Exercisable Unexercisable

Brian M. NeSmith . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72,916 27,084 $885,929 $329,071Robert P. Verheecke . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48,958 21,042 $527,840 $188,660Thomas B. Ayers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46,250 29,750 $473,413 $301,648David A. de Simone . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56,249 108,751 $357,744 $691,656Stephen P. Mullaney . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38,499 49,501 $344,951 $443,529

(1) Options vest and become exercisable in the following manner: 25% of the shares vest and are exercisableupon completion of twelve months of service measured from the date of grant and the remainder of theshares vest in thirty-six equal monthly installments upon completion of each additional month of servicethereafter. See “Employment Agreements and Termination of Employment and Change in ControlArrangements” for a description of the applicable acceleration features.

(2) Based on a market value of $14.40 per share, the closing selling price of the Common Stock as reported bythe Nasdaq National Market on April 29, 2005, less the exercise price payable for those shares. These valueshave not been, and may never be, realized.

EMPLOYMENT CONTRACTS, SEVERANCE AND CHANGE IN CONTROL ARRANGEMENTS

The compensation committee of the board of directors, as plan administrator of the 1999 Stock IncentivePlan and 2000 Supplemental Stock Option Plan, has the authority to provide for accelerated vesting of the sharesof Common Stock subject to outstanding options held by the officers named in the Summary CompensationTable and any other person in connection with certain changes in control of the Company. Under the 1999 StockIncentive Plan and 2000 Supplemental Stock Option Plan, upon a change in control of the Company, eachoutstanding option and all shares of restricted stock will generally become fully vested unless the survivingcorporation assumes the option or award or replaces it with a comparable award. In addition, an option or awardwill become fully exercisable and fully vested if the holder’s employment or service is involuntarily terminatedwithin 18 months following the change in control.

The employment of the officers named in the Summary Compensation Table may be terminated at any time.The Company entered into an agreement with Mr. NeSmith, dated February 24, 1999, which provides foracceleration of vesting of option shares as if Mr. NeSmith remained employed for one additional year in theevent of a change in control of the Company.

On April 29, 2005, the Company entered into a letter agreement with Robert P. Verheecke, then theCompany’s Senior Vice President, Chief Financial Officer, providing for his continued employment throughJanuary 31, 2006 (the “April Agreement”). The April Agreement replaces an agreement entered into between theCompany and Mr. Verheecke dated November 4, 2004. Under the April Agreement, the Company has agreedthat it will not terminate Mr. Verheecke’s employment prior to January 31, 2006 except for cause. Mr. Verheecke

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may resign his employment at any time. Mr. Verheecke will be responsible for projects as directed by theCompany’s Chief Executive Officer, which include business development and financial systems implementation.Until the earlier of January 31, 2006, Mr. Verheecke’s voluntary resignation or termination by the Company forcause, Mr. Verheecke will continue to receive his annual salary and benefits in accordance with the Company’sexisting policies. The April Agreement provides that Mr. Verheecke will vest in an additional 20,000 sharesunder an option granted in June 2003. The April Agreement also contains certain restrictive covenants, releasesand other customary terms and conditions. Pursuant to the April Agreement, Mr. Verheecke ceased to be SeniorVice President, Chief Financial Officer as of May 2, 2005.

On August 29, 2003, the Company extended an offer of employment to Mr. de Simone to be the Company’sSenior Vice President of Engineering. Pursuant to the offer letter, if Mr. de Simone’s employment isinvoluntarily terminated without cause or as a result of a change in control of the Company during his first24 months of employment, he will vest in his options as if he completed an additional six months of employmentand the Company will extend the time he has to exercise his options following termination of employment to oneyear. In lieu of the foregoing acceleration benefit, Mr. de Simone will receive the benefit available under the1999 Stock Incentive Plan if it would provide a greater benefit upon a change in control of the Company, whichprovides that an option will become fully exercisable and fully vested if the optionee’s employment or service isinvoluntarily terminated within 18 months following the change in control.

COMPENSATION COMMITTEE REPORT

The Compensation Committee of the Board of Directors (the “Committee”) has the exclusive authority toestablish the level of base salary payable to the Chief Executive Officer (“CEO”) and certain other executiveofficers of the Company and has the authority to administer the Company’s 1999 Stock Incentive Plan, 2000Supplemental Stock Option Plan, and Employee Stock Purchase Plan. In addition, the Committee has theresponsibility for approving the individual bonus programs to be in effect for the CEO and executive officerseach fiscal year.

The Committee relies upon judgment and not upon rigid guidelines or formulas in determining the amountand mix of compensation elements for each executive officer. Key factors affecting the Committee’s judgmentsinclude the nature and scope of the executive officer’s responsibilities and the officer’s effectiveness in leadinginitiatives to achieve corporate goals. For the fiscal year ended April 30, 2005, among the factors considered bythe Committee were the recommendations of the CEO with respect to the compensation of the Company’sexecutive officers.

General Compensation Policy. The Committee’s fundamental policy is to offer the Company’s executiveofficers competitive compensation opportunities based upon overall Company performance, their individualcontribution to the financial success of the Company and their personal performance. Each executive officer’scompensation package generally consists of: (i) base salary, (ii) cash bonus awards and (iii) long-term stock-based incentive awards.

Base Salary. The base salary for each executive officer is generally set at the time the officer commencesemployment based on a review of published surveys, with particular emphasis on general market levels forcompanies of similar revenue. Periodic merit raises have been awarded to executive officers on a limited basiswhere the survey data indicated that the officer’s base salary was substantially below that of individuals holdingcomparable positions.

In preparing the performance graph for this Proxy Statement, the Company has selected the NasdaqComputer Manufacturer Stocks Index. The companies included in the Company’s salary survey are notnecessarily those included in the foregoing index, because compensation information was not available.

16

Cash Bonuses. In fiscal 2005, a quarterly cash bonus was paid to each of the executive officers, other thanMr. NeSmith. Mr. NeSmith declined participation in the bonus plan. Mr. Ayers’ bonus is dependent solely on theachievement of specific quarterly revenue objectives. In awarding bonuses to the executive officers, theCommittee took into account the Company’s achievement of specific revenue and expense control targets as wellas each officer’s achievement of specific personal objectives established at the beginning of each fiscal quarter.One-half of the bonus was based on the Company meeting its specific revenue and expense control targets, andone-half of the bonus was based on each person achieving his specific personal objectives. Actual bonuses paidreflect an individual’s accomplishment of his or her specific objectives as well as the Company’s achievement ofthe revenue and expense control targets. In addition, Mr. de Simone received a sign-on bonus after completingone year of employment in accordance with the terms of his offer letter.

Long-Term Incentive Compensation. Generally, a significant option grant is made in the year that anofficer commences employment. Thereafter, option grants may be made at varying times and in varying amountsat the discretion of the Committee. Generally, the size of each grant is set at a level that the Committee deemsappropriate to create a meaningful opportunity for stock ownership based upon the individual’s position with theCompany, the individual’s potential for future responsibility and promotion, the individual’s performance in therecent period and the number of unvested options held by the individual at the time of the new grant. The relativeweight given to each of these factors will vary from individual to individual at the Committee’s discretion.

The only option grants that were made to executive officers in fiscal 2005 were grants to an executiveofficer hired in fiscal 2005 in connection with her commencement of employment.

CEO Compensation. For the 2005 fiscal year, Mr. NeSmith’s base salary was unchanged from the prioryear. Mr. NeSmith declined participation in the officer bonus plan discussed above. Mr. NeSmith was notawarded an option grant in fiscal 2005.

Tax Limitation. Under the Federal tax laws, a publicly-held company such as Blue Coat will not beallowed a federal income tax deduction for compensation paid to certain executive officers to the extent thatcompensation exceeds $1 million per officer in any year. To qualify for an exemption from the $1 milliondeduction limitation, the stockholders approved a limitation under the Company’s 1999 Stock Incentive Plan onthe maximum number of shares of Common Stock for which any one participant may be granted stock optionsper calendar year. Because this limitation was adopted, any compensation deemed paid to an executive officerwhen he exercises an outstanding option under the 1999 Stock Incentive Plan with an exercise price equal to thefair market value of the option shares on the grant date will qualify as performance-based compensation that willnot be subject to the $1 million limitation. Since it is not expected that the cash compensation to be paid to theCompany’s executive officers for the fiscal year ended April 30, 2006 will exceed the $1 million limit perofficer, the Committee will defer any decision on whether to limit the dollar amount of all other compensationpayable to the Company’s executive officers to the $1 million cap.

Compensation CommitteeDavid W. HannaAndrew S. Rachleff

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COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

The Compensation Committee of the Company’s Board of Directors was formed in September 1999, andthe members of the Compensation Committee during the fiscal year ended April 30, 2005 were Messrs. Hannaand Rachleff. Mr. Rachleff was not at any time an officer or employee of the Company; Mr. Hanna served as theCompany’s interim President and Chief Executive Officer from December 11, 1998 to March 2, 1999. Noexecutive officer of the Company serves as a member of the board of directors or compensation committee ofany entity that has one or more executive officers serving as a member of the Company’s Board of Directors orCompensation Committee.

REPORT OF THE AUDIT COMMITTEE OF THE BOARD OF DIRECTORS

The Audit Committee serves as the representative of the Board of Directors for general oversight of theCompany’s financial accounting and reporting process, system of internal control, audit process, and process formonitoring compliance with laws and regulations and the Company’s Standards of Business Conduct. The AuditCommittee annually appoints an independent registered public accounting firm to audit the financial statementsof the Company. In addition, the Audit Committee approves the plan and scope of the annual audits and fees tobe paid to the Company’s auditors and meets with them on a regular basis without management present. A moredetailed description of the functions of the Audit Committee can be found in the Company’s Audit CommitteeCharter, attached to this proxy statement as Exhibit A.

The Audit Committee currently consists of Mr. Barth, who was elected to the committee in January 2005,Mr. Hanna and Mr. Rachleff. Mr. Barth is Chairman of the Audit Committee. Mr. Andreessen served on theAudit Committee until January 2005, when he resigned from the Audit Committee. The Audit Committee heldeight (8) meetings and acted by written consent in lieu of a meeting on three occasions during the last fiscal year.Mr. Rachleff, a director of the Company since 1997, has notified the Board of Directors that he does not intend tostand for re-election at the 2005 Annual Meeting of Stockholders. As of the date of the 2005 Annual Meeting ofStockholders, Mr. Shiveley will replace Mr. Rachleff as a member of the Audit Committee.

The Company’s management has primary responsibility for preparing the Company’s financial statementsand managing its financial reporting process. The Company’s independent registered public accounting firm,Ernst & Young LLP (“Ernst & Young”), is responsible for expressing an opinion on the conformity of theCompany’s audited financial statements to generally accepted accounting principles. The Audit Committeeserves a board-level oversight role in which it provides advice, counsel and direction to management on the basisof the information it receives, discussions with management and the auditors, and the experience of the AuditCommittee’s members in business, financial and accounting matters.

In this context, the Audit Committee hereby reports as follows:

• The Audit Committee reviewed and discussed the audited financial statements with the Company’smanagement and the independent auditors.

• The Audit Committee discussed with the independent registered public accounting firm the mattersrequired to be discussed by Statement on Auditing Standards No. 61 (Codification of Statements onauditing Standard, AU 380), SAS 99 (Consideration of Fraud in a Financial Statement Audit) and othertopics as required by the SEC and PCAOB.

• The Audit Committee has received the written disclosures from its directors and executive officers andthe letter from the independent registered public accounting firm required by Independence StandardsBoard Standard No. 1 (Independence Standards Board Standards No. 1, Independence Discussions withAudit Committees) and has discussed with the independent auditors their independence.

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Aggregate fees for professional services rendered for the Company by Ernst & Young for the years endedApril 30, 2005 and 2004, were:

April 30,

2005 2004

Audit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,064,531 $345,000Audit Related . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 332,000Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54,373 18,000All Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34,771 1,000

TOTAL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,153,675 $696,000

The audit fees for the years ended April 30, 2005 and 2004 were for professional services rendered for theannual audit of the consolidated financial statements of the Company, reviews of the Company’s quarterlyreports on Form 10-Q, consents, and assistance with review of documents filed with the SEC. Increased auditfees in 2005 compared to 2004 are due to amounts for Ernst & Young’s audit of the Company’s internal controlover financial reporting and Ernst & Young’s own audit of our internal control over financial reporting inaccordance with Section 404 of the Sarbanes-Oxley Act of 2002.

The audit related fees for the year ended April 30, 2004 were principally for accounting consultations andaudits in connection with the Company’s acquisition of Ositis Software, Inc.

The tax fees for the years ended April 30, 2005 and 2004 were for services related to tax compliance,including tax advice and tax planning.

The Company’s Audit Committee adopted pre-approval policies and procedures for audit and non-auditservices during fiscal year 2004. All audit, audit related, tax and permissible non-audit services are approved inadvance by the Company’s Audit Committee to assure they do not impair the independence of the Company’sindependent registered public accountants. At the beginning of the fiscal year, management prepares an estimateof all such fees for the duration of the fiscal year and submits the estimate to the Audit Committee for its reviewand pre-approval. Any modifications to the estimates will be submitted to the Audit Committee for pre-approvalat the next regularly scheduled Audit Committee meeting, or if action is required sooner, to the Chairman of theAudit Committee. All fees paid to the Company’s independent registered public accounting firm during fiscalyear 2005 were in accordance with this pre-approval policy.

Based on the Audit Committee’s discussion with management and the independent registered publicaccounting firm, and the Audit Committee’s review of the representations of management and the report of theindependent registered public accounting firm to the Audit Committee, the Audit Committee recommended, andthe Board of Directors subsequently approved, the inclusion of the audited financial statements in the Company’sAnnual Report on Form 10-K for the fiscal year ended April 30, 2005, for filing with the Securities andExchange Commission. The Audit Committee also recommended, and the Board of directors subsequentlyapproved, subject to stockholder ratification, the selection of Ernst & Young LLP, as the Company’s independentregistered public accounting firm for the fiscal year ended April 30, 2006.

Each of the members of the Audit Committee is independent, and Mr. Barth and Mr. Hanna each qualify asa financial expert, as such terms are defined under the rules of the Securities and Exchange Commission and thelisting standards of the Nasdaq National Market.

Submitted by the following members of the Audit Committee:

James A. BarthDavid W. HannaAndrew S. Rachleff

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STOCK PERFORMANCE GRAPH

Set forth below is a graph illustrating the cumulative total stockholder return on the Company’s CommonStock. The graph compares the Company’s Common Stock between May 1, 2000 and April 30, 2005, with thecumulative total return of the Total Return Index for the Nasdaq Stock Market (US Companies) and the NasdaqComputer Manufacturer Stocks Index.

The comparisons shown in the graph below are based upon historical data. The Company cautions that thestock price performance shown in the graph below is not indicative of, nor intended to forecast, the potentialfuture performance of the Company’s Common Stock.

COMPARISON OF 5 YEAR TOTAL RETURN*AMONG BLUE COAT SYSTEMS, INC., THE NASDAQ STOCK MARKET (U.S.) INDEX AND

THE NASDAQ COMPUTER MANUFACTURERS INDEX

04/28/00 04/30/01 04/30/02 04/30/03 04/30/04 04/30/05

BLUE COAT SYSTEMS, INC. . . . . . . . . . . . . . . . . . . . 100.00 7.38 0.82 1.86 12.01 3.88NASDAQ STOCK MARKET US . . . . . . . . . . . . . . . . . 100.00 61.85 42.75 27.18 42.87 40.17NASDAQ COMPUTER MANUFACTURER . . . . . . . . 100.00 43.26 32.68 28.10 35.50 40.13

Notwithstanding anything to the contrary set forth in any of the Company’s previous or future filings underthe Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, that mightincorporate this Proxy Statement or future filings made by the Company under those statutes, the CompensationCommittee Report, the Audit Committee Report and Stock Performance Graph shall not be deemed filed with theSecurities and Exchange Commission and shall not be deemed incorporated by reference into any of those priorfilings or into any future filings made by the Company under those statutes.

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CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The Company’s Certificate of Incorporation limits the liability of its directors for monetary damages arisingfrom a breach of their fiduciary duty as directors, except to the extent otherwise required by the DelawareGeneral Corporation Law. Such limitation of liability does not affect the availability of equitable remedies suchas injunctive relief or rescission.

The Company’s Bylaws provide that the Company shall indemnify its directors and officers to the fullestextent permitted by Delaware law, including in circumstances in which indemnification is otherwisediscretionary under Delaware law. The Company has also entered into indemnification agreements with itsofficers and directors containing provisions that may require the Company, among other things, to indemnifysuch officers and directors against certain liabilities that may arise by reason of their status or service as directorsor officers and to advance their expenses incurred as a result of any proceeding against them as to which theycould be indemnified.

FORM 10-K

THE COMPANY WILL MAIL WITHOUT CHARGE, UPON WRITTEN REQUEST, A COPY OF THECOMPANY’S FORM 10-K REPORT FOR THE FISCAL YEAR ENDED APRIL 30, 2005, INCLUDING THEFINANCIAL STATEMENTS, SCHEDULES AND LIST OF EXHIBITS. REQUESTS SHOULD BE SENT TOBLUE COAT SYSTEMS, INC., 650 ALMANOR AVENUE, SUNNYVALE, CALIFORNIA 94085,ATTN: INVESTOR RELATIONS.

Delivery of Documents to Stockholders Sharing an Address

A number of brokers with account holders who are stockholders of the Company will be “householding” ourproxy materials. A single proxy statement will be delivered to multiple stockholders sharing an address unlesscontrary instructions have been received from the affected stockholders. Once you have received notice fromyour broker that they will be “householding” communications to your address, “householding” will continue untilyou are notified otherwise or until you revoke your consent. If, at any time, you no longer wish to participate in“householding” and would prefer to receive a separate proxy statement and annual report, please notify yourbroker, direct your written request to Blue Coat Systems, Inc., 650 Almanor Avenue, Sunnyvale, California94085, Attn: Secretary, or contact the Company’s secretary by telephone at (408) 220-2200. Stockholders whocurrently receive multiple copies of the proxy statement at their address and would like to request“householding” of their communications should contact their broker.

Information in this electronic message relating to the tax treatment of a taxpayer and/or the taxconsequences of one or more transactions (collectively, the “Tax Information”), if any, is not intended to be, andcannot be, used by any direct or indirect recipient of this electronic message to avoid any penalties that may beimposed on such direct or indirect recipient. Additionally, such Tax Information, if any, may have been writtento support the promotion or marketing of the transactions addressed in this electronic message. The taxconsequences of entering into such transaction(s) will vary depending on the taxpayer’s specific circumstances;accordingly, the direct and indirect recipients of this electronic message should consult their own independent taxadvisor with respect to the tax consequences of entering into the transactions discussed herein.

Stockholder Proposals For 2006 Annual Meeting

Stockholder proposals that are intended to be presented at the 2006 Annual Meeting that are eligible forinclusion in the Company’s proxy statement and related proxy materials for that meeting under the applicablerules of the Securities and Exchange Commission must be received by the Company no later than April 18, 2006and satisfy the conditions established by the Securities and Exchange Commission for stockholder proposals to

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be included in the Company’s proxy statement for that meeting. Stockholders who intend to present a proposal atthe 2006 Annual Meeting without inclusion of such proposal in the Company’s proxy materials pursuant to Rule14a-8 under the Securities Exchange Act of 1934, as amended, are required to provide advance notice of suchproposal to the Company by July 3, 2006. Such stockholder proposals should be addressed to Blue Coat Systems,Inc., 650 Almanor Avenue, Sunnyvale, California 94085, Attn: Kevin S. Royal, Senior Vice President and ChiefFinancial Officer. Stockholders are advised to review the Company’s Bylaws, which contain additionalrequirements about advance notice of stockholder proposals and director nominations.

OTHER MATTERS

The Board knows of no other matters to be presented for stockholder action at the Annual Meeting.However, if other matters do properly come before the Annual Meeting or any adjournments or postponementsthereof, the Board of Directors intends that the persons named in the proxies will vote upon such matters inaccordance with their best judgment.

BY ORDER OF THE BOARD OF DIRECTORS,

Cameron S. LaughlinSecretary

Sunnyvale, CaliforniaAugust 17, 2005

WHETHER OR NOT YOU PLAN TO ATTEND THE ANNUAL MEETING, PLEASE COMPLETE,SIGN, DATE, AND PROMPTLY RETURN THE ACCOMPANYING PROXY IN THE ENCLOSEDPOSTAGE-PAID ENVELOPE. YOU MAY REVOKE YOUR PROXY AT ANY TIME PRIOR TO THEANNUAL MEETING. IF YOU DECIDE TO ATTEND THE ANNUAL MEETING AND WISH TOCHANGE YOUR PROXY VOTE, YOU MAY DO SO AUTOMATICALLY BY VOTING IN PERSONAT THE MEETING.

THANK YOU FOR YOUR ATTENTION TO THIS MATTER. YOUR PROMPT RESPONSE WILLGREATLY FACILITATE ARRANGEMENTS FOR THE ANNUAL MEETING.

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For Your Information

Brian NeSmithPresident and CEO,Blue Coat Systems

Andrew RachleffPartner,Benchmark Capital

James A. BarthCEO,Proximex Corporation

David HannaChairman of the Board,Blue Coat Systems

Marc AndreessenChairman of the Board,Opsware

Jay ShiveleyManaging Director,Vantage Point Venture Partners

This Annual Report contains forward looking statements within the meaning of the federal securities laws. These forward

looking statements include, but are not limited to, statements related to our ability to continue to innovate, the future

expansion of our products and services, further development and the success of our recently announced products and

products that are currently in various stages of development and testing, our potential future growth and development,

and our ability to maintain a culture that attracts talented individuals and fosters innovation.

These forward-looking statements are based upon information available to Blue Coat Systems as of the date hereof, and

Blue Coat Systems assumes no obligation to update any such forward-looking statements. Forward-looking statements

involve risks and uncertainties, which could cause actual results to differ materially from those projected. These and other

risks relating to Blue Coat Systems' business are set forth in Blue Coat Systems' most recently filed Form 10-K for the year

ending April 30, 2005, and other reports filed from time to time with the Securities and Exchange Commission.

Blue Coat Systems, Inc.Copies of Blue Coat Systems Form 10-K for 2005 as filed with the SEC, as well as other financial reports and news from Blue Coat Systemsmay be read and downloaded atwww.bluecoat.com

AuditorsErnst & Young, LLPSan Jose, CA

Stock Transfer AgentEquiserve, L.P.Shareholders ServicesP.O. Box 8040Boston, MA 02266-8040Phone: 800.730.6001URL: http://www.equiserve.com

Stock ListingBlue Coat Systems stock is traded onthe NASDAQ National Market underthe symbol BCSI

Investor Relations Contact InformationInvestor Inquiries: Kevin RoyalMedia Inquiries: Steve MullaneyPhone: 408.220.2200Email: investor.relations@bluecoat.com

Brian NeSmithPresident and CEO

Tom AyersSVP, Worldwide Sales

John CarosellaVP, Business Development

Dave CoxVP, Operations

Rich HolsteinSVP, Worldwide Technical Operations

Cameron LaughlinVP, General Counsel

Steve MullaneyVP, Worldwide Marketing

Kevin S. RoyalCFO

Dave de SimoneSVP, Engineering

Executive Management

Board Members

420 N Mary Ave

Sunnyvale, CA 94085

1.866.30.BCOAT

408.220.2200 Direct

408.220.2250 Fax

www.bluecoat.com

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