SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549


Form
10-K







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




For
the year ended December 31, 2008





or




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




For
the transition period from     
to    .





Commission
File Number 000-27723







SonicWALL,
Inc.


(Exact
name of registrant as specified in its charter)


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





1143
Borregas Avenue


Sunnyvale,
CA 94089


(Address
of Principal Executive Offices, including zip code)





(408)
745-9600


(Registrant’s
Telephone Number, including area code)





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





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





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


None




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




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





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




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




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





Large
accelerated filer  ̈                                                                               Accelerated
filer x




Non-accelerated
filer   ̈                                                                              Smaller
reporting company  ̈


(Do not
check if a smaller reporting company)





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




As of
June 30, 2008, the aggregate market value of Common Stock held by
non-affiliates of the registrant (based upon the closing sale price on the
NASDAQ Global Market on that date) was approximately
$334,105,784.  Shares held by each executive officer, director and by
each person who owns 10% or more of the outstanding Common Stock have been
excluded in that such persons may be deemed to be affiliates.  This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.




As of
February 28, 2009, there were 53,771,515 shares of the Registrant’s Common Stock
outstanding.  This is the only outstanding class of common stock of
the Registrant.




DOCUMENTS
INCORPORATED BY REFERENCE




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













TABLE OF CONTENTSPagePART
      I
                    3ITEM
      1. Business
                    3ITEM
      1A. Risk Factors
                    14ITEM
      1B. Unresolved Staff Comments
                    25ITEM
      2. Properties
                    26ITEM
      3. Legal Proceedings
                    26ITEM
      4. Submission of Matters to a Vote of Security Holders
                    27PART
      II
                    28ITEM
      5. Market for Registrant's Common Equity and Related Stockholder
      Matters
                    28ITEM
      6. Selected Consolidated Financial Data
                    30ITEM
      7. Management's Discussion and Analysis of Financial Condition and Results
      of Operations
                    31ITEM
      7A. Quantitative and Qualitative Disclosures About Market
    Risk
                    56ITEM
      8. Financial Statements and Supplementary Data
                    58ITEM
      9. Changes in and Disagreements with Accountants on Accounting and
      Financial Disclosure
                    93ITEM
      9A. Controls and Procedures
                    93ITEM
      9B. Other Information
                    94PART
      III
                    95ITEM
      10. Directors, Executive Officers and Corporate Governance
                    95ITEM
      11. Executive Compensation
                    95ITEM
      12. Security Ownership of Certain Beneficial Owners and Management and
      Related Stockholder Matters
                    95ITEM
      13. Certain Relationships and Related Transactions, and Director
      Independence
                    95ITEM
      14. Principal Accounting Fees and Services
                    95PART
      IV
                    96ITEM
      15. Exhibits and Financial Statement Schedules
                    96SIGNATURES
                    101Exhibit
      Index
                    103EXHIBIT
      10.44EXHIBIT
      10.45EXHIBIT
      21.1EXHIBIT
      23.1EXHIBIT
      31.1EXHIBIT
      31.2EXHIBIT
      32.1


2
 Table of Contents




CAUTIONARY
NOTE ON FORWARD-LOOKING STATEMENTS





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





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





PART I





ITEM 1.  Business





Overview





SonicWALL
designs, develops, manufactures, and sells network security, content security,
and business continuity solutions for businesses of all sizes.  Our
products are designed to provide secure Internet access to both wired and
wireless broadband customers, enable secure Internet-based connectivity for
distributed organizations, inspect  the content entering and leaving
our customers networks, protect organizations against inbound and outbound email
threats, and provide business continuity in the case of data or connectivity
loss.  We believe our security appliances and software provide
high-performance, robust, reliable, easy-to-use, and affordable security
solutions for our customers.  Additionally, our Internet security
products are designed to make our customers more productive and more mobile,
while still maintaining a high level of security.  As of December 31,
2008, we have sold more than 1.3 million of our Internet security appliance
platforms worldwide.  We also sell value-added services for our
security appliances, including content filtering, anti-spam protection, client
anti-virus protection, integrated gateway anti-virus, anti-spyware, email
protection, offsite data backup, and intrusion prevention on a subscription
basis and license software packages such as our Global Management System
(“GMS”), our Global VPN Client, and our email security licenses.  Our
GMS solutions enable distributed enterprises and service providers to manage and
monitor a large number of SonicWALL Internet security appliances and deploy our
security software and services from a central location thereby reducing staffing
requirements, increasing the speed of deployment and lowering
costs.  Our Global VPN Client provides mobile users with a simple,
easy-to-use solution for securely accessing the network.





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





SonicWALL,
Inc. was incorporated in California in 1991 as Sonic Systems.  The
company name was changed to SonicWALL, Inc. in August
1999.  References in this report to “we,” “our,” “us,” and “the
Company” refer to SonicWALL, Inc.  Our principal executive offices are
located at 1143 Borregas Avenue, Sunnyvale, California 94089, and our telephone
number is (408) 745-9600.





Industry
Background





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


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  Increasing
Use of Broadband Access Technologies





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





Importance
of Data Security





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





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





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





We
believe that many enterprises are aware of the need to increase their
information technology budget to address these concerns, thereby reducing the
risk to their business and to their customers.





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





Integrated
Solutions for Internet Security





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





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


The
Advent of Secure Virtual Private Networks (VPNs)


4
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Large and small
enterprises utilize VPNs in the place of more costly private, dedicated networks
or leased lines.  VPNs allow for two or more individual networks to be
linked creating one large private network.  The private network is
“virtual” because it leverages the public Internet as the network
infrastructure.  Enterprises use VPNs to achieve a variety of
objectives.  Telecommuters and traveling workers can access a
corporate network to work from their out-of-office locations using remote access
VPN.  Satellite and branch offices can connect to the home office
network using site-to-site VPNs.  An enterprise can connect with its
business partners, suppliers, and customers utilizing an Extranet
VPN.  These VPN connections must be secure from unauthorized
access and safe from unauthorized alteration.  To secure a VPN,
information traveling between the locations is encrypted and
authenticated.  To help deliver the desired quality and security
levels, businesses, and enterprises can monitor and prioritize network traffic
for business-critical applications and allocate bandwidth for specific traffic,
typically using customer premises equipment encryption and authentication
products.




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





Changing
Mobile Computing Environment and Demand for SSL-VPN





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





SSL-VPN
allows any user in any location where internet connectivity is available to
connect to any network resource reliably and conveniently, with enhanced levels
of security.  SSL-VPN does not establish a network-layer connection
between users and the VPN gateway.  Rather, connections are
established at the transport layer.  The Web browser on the user’s
device provides the means for establishing an encrypted tunnel between the
user’s device and the SSL-VPN gateway.  Through a Web browser, users
can access applications and resources behind the gateway.  SSL-VPN
solutions were originally designed for large enterprises with a feature set and
price that exceeded SMB needs and means.  This situation is changing
with a new generation of SSL-VPN product offerings specifically designed to meet
the remote access needs of SMBs at affordable prices.





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





The
Computer Security Institute Computer Crime and Security Survey published in 2004
reported the two most common forms of attack or abuse were virus outbreaks and
insider abuse of network access.  In addition to lost productivity,
companies, their partners, and customers are vulnerable to severe financial
losses.  This reality has been underscored by the rapid infection of
many users through widespread and highly publicized virus outbreaks affecting
business networks around the globe.  At the same time, we believe that
issues such as loss of employee productivity, liability concerns, and network
bandwidth constraints continue to fuel the growth of content
filtering.  Enterprises are deploying anti-virus protection, content
filtering, and intrusion prevention solutions across the enterprise and
expending technical resources to keep these defenses updated against the latest
virus threats and objectionable or inappropriate content.





Rising
Value of Data and Demand for Business Continuity





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


5
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Increases
in Unsolicited E-Mail





Email is
one of the most popular and often one of the most critical business applications
making use of the Internet.  Recent years have seen a dramatic rise in
the amount of unsolicited email (“spam”) directed to both consumers and business
Internet users.  This unsolicited email can be a nuisance at best,
consuming employee productivity as each employee must read and delete each
unwanted message.  In more extreme cases, spam can cause email servers
to slow down or even stop working, causing delays or interruptions in business
operations.  Aside from the employee and network productivity
degradations, some forms of unsolicited mail may also contain other types of
threats, including attempts to cause recipient computers to execute malicious
code, or attempts to mislead recipients in disclosing confidential information
for the purposes of fraud or theft.





Strategy





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





Key
elements of our strategy include:





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





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





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





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





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





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





The
SonicWALL Solutions





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


6
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  SonicWALL products are
designed to provide comprehensive Internet security solutions for (1) networks
ranging in size from one to more than 15,000 users; (2) enterprises having
branch offices, telecommuting employees or POS locations; and (3) e-commerce
applications that handle millions of secure transactions daily.  Our
security appliances span a wide range of requirements, from single-user
appliances to rack-mounted enterprise-class units capable of supporting
thousands of users.  Our products offer substantial flexibility in the
number of supported users, the number of ports, and a variety of software
options such as gateway anti-virus, anti-spyware, intrusion prevention and
content filtering, protection against spam, phishing, virus, and other attacks,
as well as management and reporting tools that enable our customers to easily
manage SonicWALL appliances installed throughout their
networks.




Security
Appliances





SonicWALL
Internet security appliances vary with respect to the number of supported users,
the number of ports, product features, processor speed, and
scalability.  During 2008, we introduced the next generation solutions
for all of our PRO products, certain TZ appliances, all of our CDP offerings and
certain SSL products.  These next generation security appliances
provide new and existing customers with new security and productivity features
and capabilities.  SonicWALL maintains an ongoing development effort
to continuously improve and advance our platforms.





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





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





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





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





SonicWALL Content filtering
appliances.Our Content Security Management appliance-based
solutions integrate into virtually any network environment.  The
SonicWALL Content Security Manager delivers appliance-based Internet filtering
that is designed to enhance security and employee productivity, optimize network
utilization, and manage access to objectionable Web content.





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





Security
Application and Services





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


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


7
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  SonicWALL Content Filtering
Service.Our content filtering service enables businesses,
families, schools and libraries to control access to objectionable or
inappropriate web sites by uniform resource locator (“URL”), keyword or
application type.  We offer a content filtering subscription service
that provides a list of objectionable web sites that is automatically updated on
an hourly basis.




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





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





SonicWALL Anti-Virus, Email
Security.SonicWALL Anti-Spam / Email Security provides effective,
high-performance and easy-to-use inbound and outbound email threat protection.
This self-running, self-updating solution, delivers powerful protection against
spam, virus and phishing attacks in addition to preventing leaks of confidential
information. Combining anti-spam, anti-phishing, content filtering, policy
management and content compliance capabilities in a single seamlessly integrated
solution, SonicWALL Anti-Spam / Email Security solutions provide powerful
protection without complexity.





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





Global
Security Management Applications





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





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





Value
Proposition





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





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




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


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


8
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  -
                Our
      client anti-virus services provide comprehensive virus protection with
      automatic updates and minimal
administration.


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




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




-
            Our
      Secure Content Management solutions provide an end-to-end comprehensive
      protection against spam, virus, Spyware, intrusion and other
      vulnerabilities.




-
            Our
      products can serve customer sites ranging from a network of sub-10 user
      segments to large enterprise with tens of thousands of
      users.  Each of our solutions, (e.g., Email Security, Content
      Security Manager, Client Anti-Virus & Anti-Spyware) work as a
      standalone solution, but also together to provide layered protection
      against a rapidly changing threat
environment.





•
            Ease of Installation and
      Use.  The SonicWALL product line of Internet security
      solutions delivers “plug-and-play” appliances designed for easy
      installation and use.  SonicWALL products are configured and
      managed through a web browser-based interface or through our GMS with no
      required reconfiguration of personal computer
  applications.




•
            Low Total Cost of
      Ownership.  The SonicWALL product design minimizes the
      purchase, installation, and maintenance costs of Internet
      security.  The suggested retail prices of our security solutions
      start below $400 and scale up to over
$35,000.





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





Technology





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





Appliance
Platforms





SonicWALL’s
TZ Series appliances are based on a highly integrated system-on-a-chip
architecture which SonicWALL purchases from a third
party.  SonicWALL’s PRO Series appliances are based on an industry
standard processor architecture coupled to an auxiliary processor purchased from
a third party. SonicWALL’s NSA and NSA E-class products are based on a new,
highly efficient multi-core processor technology, allowing us to offer a level
of performance beyond any of our previous designs.  This multi-core
technology scales up to 16 cores in the current product line and is capable of
expanding further to create an entire scalable product line based on this one
design.





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





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


•
              IP Address
      Management.  Our appliances manage the complexity of IP
      addressing through Network Address Translation (“NAT”) tools which allow
      networks to share a small number of valid public IP addresses with an
      equal or larger number of client computers on the
  LAN.
 
 The
SonicWALL security solutions offer the following options for device
management:


9
 Table of Contents


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





•
            SonicWALL Global Management
      System.  Our global management system, SonicWALL GMS, is
      an enterprise software application that is designed to enable service
      providers and distributed enterprises to manage all of their SonicWALL
      appliances from a central location.  SonicWALL GMS is available
      to use in Windows NT, Windows 2000, and Sun Solaris operating
      environments.  SonicWALL GMS is also compatible with leading
      relational database management systems such as Oracle and Microsoft SQL
      Server.





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





The
SonicWALL SSL solutions provide the following core features:





•
            The
      SonicWALL Aventail E-Class Secure Remote Access offerings are clientless
      SSL VPN solutions that deliver secure, easy-to-manage remote access for
      mobile enterprise organizations, supporting up to 2,000 concurrent users
      from a single appliance.





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





The
SonicWALL content security solutions provide the following core
features:





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





•
            SonicWALL
      Content Security Manager products are appliance-based gateway security and
      content filtering solutions that integrate real-time gateway anti-virus,
      anti-spyware, and intrusion prevention to deliver network protection from
      Internet threats.





The
SonicWALL CDP solutions provide the following core features:





•
            SonicWALL
      CDP is a proprietary software / hardware appliance that continuously
      search servers, mobile laptops, and connected desktops for file
      changes.  Our unique Adaptive Replication Engine (ARE)
      coordinates protection of multiple networked client PCs and servers,
      updates client servers with latest versions, and coordinates updates with
      the SonicWALL web infrastructure.





Applications
and Services





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


•
              Content
      Filtering.  Our Internet content filter blocks
      objectionable content using a list of prohibited URLs and keywords as well
      as cookies, Java and ActiveX
scripts.
 
 •
              Gateway
      Anti-Virus.  Our gateway anti-virus service is intended
      to provide anti-virus protection throughout a business and across a
      distributed network and delivers protection for high threat viruses and
      malaria by conducting inspections over the most common protocols used in
      today's networked environments.  Automatic anti-virus updates
      are available for all network nodes to protect them from new virus
      outbreaks.


10
 Table of Contents


•
              Anti-Spyware.Our
      gateway anti-spyware service is intended to provide anti-spyware
      protection throughout a business and across a distributed network and
      delivers protection for intrusive and unwanted applications, from being
      loaded onto user’s computers without their knowledge.  Automatic
      anti-spyware updates are available for all network nodes to protect them
      from new virus outbreaks.
  •
              Intrusion Prevention.Our
      intrusion prevention service utilizes a configurable, ultra-high
      performance deep packet inspection engine to deliver network protection
      while preventing known buffer overflow vulnerabilities in
      software.  This service also defends against various worms,
      Trojans, and backdoor exploits.  The service not only protects
      networks from attacks originating outside the network (WAN), but also from
      internal attacks targeting network segments (LANs), and provides a robust
      database of attack and vulnerability signatures that is dynamically
      updated as new exploits and vulnerabilities are
      discovered.  •
                Anti-spam
      Protection.Our anti-spam
      protection service offers end-to-end attack monitoring through a response
      network consisting of over one million nodes worldwide. Feedback from this
      service provides SonicWALL with daily information on the latest spam
      attacks, new spam domains and other e-mail threats, which in turn is used
      to deliver the most current, updated anti-spam engine on the
      market.
  •
                Offsite Data
      Backup.Our
      offsite data backup service uses SSL encryption, advanced compression, and
      backup of only binary differences. Data can be sent to a secure
      datacenter, via SonicWALL CDP Offsite Service, or to another CDP
      Appliance, via SonicWALL CDP Site-to-Site Backup. This offsite feature
      protects data against the risks of fire, theft, misplacement and other
      issues relating to tape or CD-based
  backup.
 Competition
 
 The
market for Internet security solutions is global and highly
competitive.  Competition in our market has increased over the past
year, and we expect competition to further intensify in the
future.  There are few substantial barriers to
entry.  Additional competition from existing competitors and new
market entrants will likely occur in the future.
 
 Our
competitors may be able to respond more quickly than we can to new or emerging
technologies and changes in customer requirements.  In addition, our
current and future competitors may integrate security solutions into the
infrastructure of their existing product lines, including operating systems,
routers, and browsers, in a manner that may discourage users from purchasing the
products and services we offer.  Many of our current and potential
competitors have greater name recognition, larger customer bases to leverage,
and greater access to proprietary technology, and could therefore gain market
share to our detriment.  In addition, our current and potential
competitors may consolidate through mergers or acquisitions or establish
cooperative relationships among themselves or with third
parties.  These actions may further enhance their financial,
technical, and other resources.  We expect additional competition as
other established and emerging companies enter the Internet security market and
new products and technologies are introduced.
 
 Principal
competitors in our markets include, but are not limited to the following, all of
which sell worldwide or have a presence in most of the major markets for such
products:
 
 •
              Enterprise
      firewall software vendors such as Check Point, Microsoft, and
      Symantec;
 
 •
              Network
      equipment manufacturers such as Cisco Systems, Lucent Technologies, and
      Checkpoint;
 
 •
              Security
      appliance suppliers such as WatchGuard Technologies, Fortinet, and Juniper
      Networks;
 
 •
              Content
      security suppliers such as Barracuda Networks and
  McAfee.
 
 The
market for data loss protection solutions changes rapidly due primarily to the
price drop in disk capacity.  Our primary competitors are tape drive
manufacturers, software providers whose software points to tape devices, and
offsite backup providers.  Competitive tape manufacturers include
Sony, Hewlett-Packard, and Quantum, while software competitors include Symantec,
Computer Associates, Seagate, and Iron Mountain.
 11
 Table of Contents
  Customer
Service and Technical Support
 
 We offer
our customers a complete range of support programs that include electronic
support, product maintenance, and personalized technical support services on a
worldwide basis.  We offer direct support to customers in North
America, Europe, Japan, and selected countries in Asia
Pacific.  Support services in other locations are provided through
SonicWALL distributors.  We now have customer support centers located
in California, Arizona, Washington, The Netherlands, Japan, and
India.  A small portion of our technical support function is
outsourced to third party service providers under agreements that may be
cancelled upon advance written notice of either 90 or 180 days.  The
benefits of having our technical support in-house include the increased quality
and dedication of our personnel and enhancing our ability to take advantage of
additional selling opportunities.
 
 Our
standard service offerings include support which is available during normal
business hours, as well as an enhanced offering providing access to support
services 24 hours a day, seven days a week.  These support offerings
provide problem identification, problem resolution, replacement for failing
hardware, telephone or web-based technical support, and firmware
updates.  For certain large customers, SonicWALL offers custom support
agreements that may include additional features including dedicated technical
account management, accelerated escalation, and logistical support.
 
 Customers
 
 We sell
our products primarily through distributors who then sell them to authorized
resellers who in turn market and sell our products to end-user
customers.  Our top worldwide distributors based on revenues in the
year ended December 31, 2008 were Alternative Technology, Ingram Micro, and Tech
Data.
 
 Sales
and Marketing
 
 Our sales
and marketing efforts focus on successfully penetrating the small to medium size
networks used in enterprises, e-commerce, education, healthcare, and
retail/point-of-sale markets.  Our marketing programs promote
SonicWALL brand awareness and reputation as a provider of reliable,
high-performance, easy-to-use, and affordable Internet security solutions
including a suite of value added support, service, and software
offerings.  We try to strengthen our brand through a variety of
marketing programs including on-going public relations, our web site,
advertising, direct mail, industry and regional trade shows, and
seminars.  We intend to continue expanding and strengthening our
indirect channel relationships through additional marketing programs and
increased promotional activities.
 
 We
believe that SonicWALL solutions are ideally suited for the indirect channel
business model.  We market and sell our solutions in this indirect
channel through a two-tiered distribution structure consisting of distributors
and authorized resellers in the United States and over 50 other
countries.  Distributors and authorized resellers accounted for
approximately 99% of our total revenue for the year ended December 31,
2008.  Authorized resellers, including systems integrators, ISPs,
dealers, and mail order online catalogs, generally purchase our products from
our distributors and then sell our products to end-users in our target
markets.
 
 We divide
our sales organization regionally into the following territories: the Americas;
Asia Pacific (APAC); and Europe, the Middle East and Africa
(EMEA).  Regional sales representatives manage our relationships with
our network of distributors, value-added resellers, and customers, help our
value-added reseller network sell and support key customer accounts, and act as
a liaison between our value-added reseller network and our marketing
organization.  The regional sales representative’s primary
responsibility is to help the indirect channel succeed and grow within the
territory.  We also have an internal sales staff that supports the
indirect channel.
 
 Domestic
Channel.In the Americas, the primary distributors of our
products to resellers are Alternative Technology, Inc., Tech Data Product
Management, Inc., and Ingram Micro, Inc.  Alternative Technology
accounted for 16%, 18%, and 18% of total revenue in 2008, 2007, and 2006,
respectively.  Tech Data accounted for approximately 17%, 17%, and 18%
of total revenue in 2008, 2007, and 2006, respectively.  Ingram Micro
accounted for approximately 16%, 16% and 17% of total revenue in 2008, 2007, and
2006, respectively.
 12
 Table of Contents
  Domestic
resellers receive various benefits and product discounts, generally depending on
the level of purchase commitment and achievement.  Our standard
reseller program offers access to sales and marketing
materials.  Certain of our resellers qualify for our Medallion
program, which extends those benefits by adding access to an expanded set of
partnership benefits including sales and marketing tools, priority technical
support and other benefits.
 
 International
Channel.We believe there is a strong international market for
our products.  International sales represented approximately 34%, 32%,
and 31%, of our total revenue in 2008, 2007, and 2006.  We direct
substantially all of our international resellers to an appropriate distributor
in each territory.  We support our international distributors by
offering customizable marketing materials, sales tools, leads, co-operative
marketing funds, joint advertising, discounted demonstration units, and
training.  We also participate in regional press tours, trade shows,
and seminars.
 
 Original Equipment Manufacturer
Channel.From time to time we may enter intoselect original
equipment manufacturer relationships in order to take advantage of opportunities
to rapidly penetrate certain target markets.  We believe these
opportunities expand our overall market while having a minor impact on our own
indirect channel sales.
 
 Research
and Development
 
 We
believe that our future success will depend in large part on our ability to
develop new and enhanced Internet security solutions and our ability to meet the
rapidly changing needs of our target customers who have broadband access to the
Internet.  We focus our research and development on evolving Internet
security needs.  We have made substantial investments in hardware,
firmware, and software, which are critical to drive product cost reductions and
higher performance solutions.  Our research and development activities
are primarily conducted at our headquarter facilities in Sunnyvale,
California.
 
 Intellectual
Property
 
 We
currently rely on a combination of patent, trademark, copyright, and trade
secret laws, confidentiality provisions and other contractual provisions to
protect our intellectual property.  Our intellectual property program
consists of an on-going patent disclosure and application process, the purchase
of intellectual property assets and the licensing of intellectual property from
others.  We plan to continue our aggressive plan to build our
intellectual property portfolio.  We believe that the duration of the
patents we have been granted is adequate relative to the expected market lives
of our products.  Despite our efforts to protect our intellectual
property, unauthorized parties may misappropriate or infringe our intellectual
property.  We plan to aggressively pursue any such misappropriation or
infringement of our intellectual property.  Our patent applications
may not result in the issuance of any patents.  Even if we obtain the
patents we are seeking, that will not guarantee that our patent rights will be
valuable, create a competitive barrier, or will be free from
infringement.  Furthermore, if any patent is issued, it might be
invalidated or circumvented or otherwise fail to provide us any meaningful
protection.  We face additional risk of adequately protecting our
intellectual property when conducting business in countries that have poorly
developed or inadequately enforced intellectual property laws.  In
addition, competitors may independently develop similar or superior technologies
or duplicate the technologies we have developed, which could substantially limit
the value of our intellectual property.
 
 U.S.
Government Export Regulation Compliance
 
 Our
products are subject to federal export restrictions on encryption
strength.  Federal legal requirements allow the export of any-strength
encryption to designated business sectors overseas, including U.S. subsidiaries,
banks, financial institutions, insurance companies, and health and medical end
users.  We have federal export authorization that allows us to export
encryption technology to commercial entities in approved
countries.  In certain instances, we require individual export
licenses.  With appropriate approvals, we are able to export strong
encryption to a wide range of foreign end-users, subject to limitations and
record-keeping requirements.  We require that our distributors
understand these export requirements and comply with them in the sale and
distribution of our products.
 13
 Table of Contents
  Manufacturing
 
 We currently outsource our hardware
manufacturing and assembly to contract manufacturers in the U.S. and
Taiwan.  Typically, the agreements with our contract manufacturers
specify an initial term of one (1) year with automatic yearly renewal terms
unless terminated by either party upon 90 days prior written
notice.  Outsourcing our manufacturing and
assembly enables us to reduce fixed overhead and personnel costs and to provide
flexibility in meeting market demand.
 
 We design
and develop the key components for the majority of our products.  In
addition, we generally determine the components that are incorporated in our
products and select the appropriate suppliers of these
components.  Product testing and burn-in are performed by our contract
manufacturer using tests that we typically specify.
 
 As part
of our design and development activity, we constantly review environmental and
safety regulations in the jurisdictions in which we do
business.  Working with our contract manufacturers, we review the
applicability of these regulations to our products and the established
timetables for implementation of the regulations to position us to meet various
environmental and safety restrictions on product content.
 
 Information
about Segments and Geographic Areas
 
 Financial
information relating to our segments and information on revenues generated in
different geographic areas are set forth in Note 10, entitled “Segment
Reporting,” of the Notes to Consolidated Financial Statements in Part II, Item 8
of this report.  In addition, information regarding risks attendant to
our foreign operations is set forth under the heading “RISK FACTORS” included
later in this report.
 
 Employees
 
 As of
December 31, 2008, we had 820 employees.  Of these, 231 were employed
in sales and marketing, 60 in finance and administration, 293 in research and
development and 236 in support and operations.  We are not party to
any collective bargaining agreements with our employees and we have not
experienced any work stoppages.  We believe we have excellent
relations with our employees.
 
 Where
You Can Find More Information
 
 We make
our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports
on Form 8-K, and all amendments to such reports filed pursuant to Section 13(a)
or 15(d) of the Exchange Act, available free of charge on or through our
Internet website located at www.sonicwall.com, as soon as
reasonably practicable after they are filed with or furnished to the
SEC.
 
 We also
make available on our Internet website our Corporate Governance Principles and
other corporate governance related documents including the charters of the Audit
Committee, Compensation Committee, and Nominations and Corporate Governance
Committee of our Board of Directors, the Code of Conduct for all employees and
directors, and our Code of Ethics for Principal Executive and Senior Financial
Officers.  Such information is also available in print to shareholders
upon request.
 
 
 ITEM 1A.  Risk Factors
  You
should carefully review the following risks associated with owning our common
stock.  Our business, operating results or financial condition could
be materially adversely affected in the event any of the following risks were to
be realized.  You should also refer to the other information set forth
in this report and incorporated by reference herein, including our financial
statements and the related notes.  Given these risks and
uncertainties, readers are cautioned not to place undue reliance on such
forward-looking statements.
 
 Rapid
changes in technology, regulatory requirements and industry standards could
render our products, software and services unmarketable or obsolete, and we may
be unable to successfully introduce new products and services.
 14
 Table of Contents
 To
succeed, we must continually introduce new products, software and services and
change and improve our solutions in response to new competitive product
introductions, rapid technological developments, changes in regulatory
requirements, and changes in operating systems, Internet access, application and
networking software, computer and communications hardware, programming tools,
computer language technology and other security threats.  Product and
service development for security, productivity, mobility, and data protection
solutions requires substantial engineering time and testing.  The
disparities between the laws and administrative measures adopted by various
jurisdictions in which we do business create uncertainty over the applicability,
scope, and form of the regulations affecting our products and services and the
timing for compliance with applicable regulations.  Releasing new
products, software and services prematurely may result in quality problems, and
delays may result in loss of customer confidence and market share.  In
the past, we have on occasion experienced delays in the scheduled introduction
of new and enhanced products, software and services, and we may experience
delays in the future.  We may be unable to develop new products,
software, and services or achieve and maintain market acceptance of them once
they have come to market.  Furthermore, when we do introduce new or
enhanced products, software and services, we may be unable to manage the
transition from previous generations of products or previous versions of
software and services to minimize disruption in customer ordering patterns,
avoid excessive inventories of older products, and deliver enough new products,
software, and services to meet customer demand.  If any of the
foregoing were to occur, our business could be adversely affected.
 
 Sales
to three major distributors account for a significant amount of our revenue, and
if they or others cancel or delay purchase orders or fail to pay us in a timely
fashion, and we are unable to offset these factors our revenue may decline and
the price of our stock may fall.
 
 Sales
through Alternative Technologies, Tech Data, and Ingram Micro account for a
significant portion of our revenue.  For the fiscal years ended
December 31, 2008, 2007, and 2006, substantially all of our sales were to
distributors and authorized resellers as shown in the following table, expressed
as a percentage of total revenue:
 2008
                      
                      
                      2007
                      
                      
                      2006Distributors/Resellers
                      
                      
                      99%
                      
                      
                      
                      98%
                      
                      
                      
                      98%
  Sales
through Alternative Technologies, Tech Data, and Ingram Micro for the fiscal
years ended December 31, 2008, 2007, and 2006 represented the following
percentages of total revenue:
  2008
                        
                        
                        2007
                        
                        
                        2006Alternative
      Technology
                        
                        
                        16%
                        
                        
                        
                        18%
                        
                        
                        
                        18%Tech
      Data
                        
                        
                        17%
                        
                        
                        
                        17%
                        
                        
                        
                        18%Ingram
      Micro
                        
                        
                        16%
                        
                        
                        
                        16%
                        
                        
                        
                        17%
 For the
fiscal year ended December 31, 2008, our top 10 distributors and resellers
accounted for 67% of our total revenue.  In 2007 and 2006, our top 10
distributors and resellers accounted for 67% and 69%, respectively of total
revenue.
 
 We
anticipate that sales of our solutions to relatively few distributors will
continue to account for a significant portion of our
revenue.  Although we have renewable one-year agreements with
Alternative Technologies, Tech Data, and Ingram Micro and certain other large
distributors, these contracts are subject to termination at any
time.  We cannot assure you that any of these distributors will
continue to place orders with us, that orders will continue at the levels of
previous periods, or that we will be able to obtain large orders from new
distributors or resellers.  We also anticipate that sales of our
solutions to certain enterprise customers will account for an increasing portion
of our revenue.  We cannot assure you that sales to enterprise
customers will materialize at anticipated levels.  The current
financial turmoil impacting the banking system and financial markets has
resulted in a tightening in the credit markets.  This lowering of the
level of liquidity in the credit markets may impact the ability of our
distributors to obtain credit to finance purchases of our products and services.
If any of the foregoing should occur, our rate of revenue growth will suffer,
our revenue may decline and our business will be adversely
affected.
 
 In
addition, Alternative Technology, Tech Data, and Ingram Micro represented the
following dollar amount and percentages of our accounts receivable balance (in
millions, except for percentages):
 15
 Table of Contents
 December 31,2008
                      
                      
                      2007
                      
                      
                      2006Alternative
      Technology
                      
                      
                      $2.8M
                      
                      
                      
                      13%
                      
                      
                      
                      $1.1M
                      
                      
                      
                      4%
                      
                      
                      
                      $5.3M
                      
                      
                      
                      23%Tech
      Data
                      
                      
                      $2.0M
                      
                      
                      
                      10%
                      
                      
                      
                      $3.1M
                      
                      
                      
                      12%
                      
                      
                      
                      $1.9M
                      
                      
                      
                      8%Ingram
      Micro
                      
                      
                      $2.5M
                      
                      
                      
                      12%
                      
                      
                      
                      $3.6M
                      
                      
                      
                      14%
                      
                      
                      
                      $4.0M
                      
                      
                      
                      17%
  In the
event the liquidity of our distributors or enterprise customers is adversely
impacted by the current uncertainties in the financial markets, they may be
unable to pay us in a timely manner. The failure to receive timely payment from
our distributors or enterprise customers could adversely affect our balance
sheet, our results of operations and our creditworthiness.
 
 If
we are unable to compete successfully in the highly competitive market for
Internet security products, software, and services, our business could be
adversely affected.
 
 The
market for Internet security products, software, and services is global and
highly competitive.  Competition in our market continues to increase,
and we expect competition to further intensify in the future.  There
are few substantial barriers to entry and additional competition from existing
competitors and new market entrants will likely occur in the
future.  Current and potential competitors in our markets include, but
are not limited to, Check Point, Microsoft, Symantec, Cisco Systems, Lucent
Technologies, Nokia, Fortinet, WatchGuard Technologies, Barracuda Networks, and
Juniper Networks, all of which sell worldwide or have a presence in most of the
major markets for such products.
 
 Competitors
to date have generally targeted the security needs of enterprises of every size
with firewall and VPN products that range in price starting from below $400 to
more than $35,000.  We may experience increased competitive pressure
for some of our products, software, and services.  This increased
competitive pressure may result in both lower prices and gross
profits.  Many of our current or potential competitors have longer
operating histories, greater name recognition, larger customer bases, and
significantly greater financial, technical, marketing, and other resources than
we do.  Some of our competitors focus all of their attention on a
single market area rather than offering a comprehensive suite of security
solutions and services.  In addition, our competitors may bundle
products, software and services that are competitive to ours with other
products, software and services that they may sell to our current or potential
customers.  These customers may accept these bundled offerings rather
than separately purchasing our offerings.  If any of the foregoing
were to occur, our business could be adversely affected.
 
 The
current financial crises in the United States and the global capital and credit
markets can adversely affect our revenue, results of operations and overall
financial strength.
 Recent
turmoil in the world financial markets, the present economic slowdown and the
uncertainty over its breadth, depth and duration may continue to put pressure on
the global economy and have a negative effect on our business. The shortage of
liquidity and credit combined with recent substantial losses in worldwide equity
markets could lead to an extended economic recession in the United States and
worldwide.  Financial markets in the United States, Europe and Asia
have been experiencing extreme disruption in recent months, including, among
other things, extreme volatility in security prices, severely diminished
liquidity and credit availability, rating downgrades of certain investments and
declining valuations of others.  Governments have taken unprecedented
actions intended to address extreme market conditions, such as severely
restricted credit, declines in real estate values and
unemployment.  There can be no assurance that the deterioration in
financial markets will not impair our operating results.  If
conditions in the global economy, United States economy or other key vertical or
geographic markets remain uncertain or weaken further, we could experience
material adverse impacts on our business, overall financial condition, results
of operations, cash flow, capital resources and liquidity.
 
 Difficulty
predicting our future operating results or profitability due to volatility in
general economic conditions and in the security, productivity, mobility, and
data protection markets may
result in a misallocation in spending, and a shortfall in revenue which would
harm our operating results.
 
 Changes
in general economic conditions and the volatility in the demand for network
security, content security, and business continuity solutions are two of the
many factors underlying our inability to predict our revenue for a given
period.  Our operating results may be affected by uncertain or
changing economic conditions impacting particular customer and geographic
segments
 16
 Table of Contents
  of our
business.  If global economic conditions remain uncertain, persist or
deteriorate further, we may experience material impact on our operating results
and overall financial condition. A large proportion of our expenses for product
development, sales and marketing are fixed for a particular quarter or year, and
therefore, we may be unable to implement an immediate decrease in our spending
in time to compensate for any unexpected quarterly or annual shortfall in
revenue.  As a result, any shortfall in revenue would likely adversely
affect our operating results.  For the year ended December 31, 2008,
we reported a net income of $4.9 million.  For the year ended December
31, 2007, we reported a net income of $28.6 million.  For the year
ended December 31, 2006, we reported a net loss of $10.8 million.  Our
accumulated deficit as of December 31, 2008 is $121.2 million.  We do
not know if we will be able to sustain profitability in the
future.
 
 The
selling prices of our solution offerings may decrease, which may reduce our
gross profits.
 
 The
average selling prices for our solution offerings may decline as a result of
competitive pricing pressures, an overall reduction in demand for our products
and services, a change in our mix of products, software, and services,
anticipation of introduction of new functionality in our products or software,
promotional programs and customers who negotiate price reductions in exchange
for longer-term purchase commitments.  In addition, competition
continues to increase in the market segments in which we participate and we
expect competition to further increase in the future, thereby leading to
increased pricing pressures.  Furthermore, we anticipate that the
average selling prices and gross profits for our products will decrease over
product life cycles.  We cannot assure you that we will be successful
in developing and introducing new offerings with enhanced functionality on a
timely basis, or that our product, software and service offerings, if
introduced, will enable us to maintain our prices and gross profits at current
levels.  If the price of individual products, software, or services
decline or if the price of our solution offerings decline, our overall revenue
may decline and our operating results may be adversely affected.
 
 We
offer retroactive price protection to our major distributors and if we fail to
balance their inventory with end- user demand for our products, our allowance
for price protection may be inadequate.  This could adversely affect
our results of operations.
 
 We
provide our major distributors with price protection rights for inventories of
our products held by them.  If we reduce the list price of our
products, our major distributors receive refunds or credits from us that reduce
the price of such products held in their inventory based upon the new list
price.  As of December 31, 2008, we estimated that approximately $22.4
million of our products in our distributors’ inventory were subject to price
protection.  We have issued credits of approximately $1,040,000,
$494,000, and $481,000 under our price protection policies in 2008, 2007, and
2006, respectively.  Future credits for price protection will depend
on the percentage of our price reductions for the products in inventory and our
ability to manage the level of our major distributors’ inventory.  If
future price protection adjustments are higher than expected, our future results
of operations could be materially adversely affected.
 
 We
are dependent on international sales for a substantial amount of our
revenue.  We face the risk of international business and associated
currency fluctuations, which might adversely affect our operating
results.
 
 International
revenue represented 34%, 32%, and 31% of total revenue in 2008, 2007, and 2006,
respectively.  We expect that international revenue will continue to
represent a substantial portion of our total revenue in the foreseeable
future.  Our performance depends significantly on worldwide economic
conditions.  Our risks of doing business abroad include the impact of
global economic conditions on the demand for our products and services, the
ability of our international channel partners to pay us in a timely fashion, the
ability of our international channel partners to obtain credit to finance
purchases of our products and services, and our ability to structure our
distribution relationships in a manner consistent with marketplace requirements
and on favorable terms.  Our sales are denominated in U.S. dollars. As
a result, the strengthening of the U.S. dollar against a local foreign currency,
a general and significant trend recently, will increase the price of our
products, software, and services in such country and may reduce our sales by
making our products, software, and services more expensive in the local
currency.  A weakened dollar could increase the cost of local
operating expenses and procurement of raw materials.  We are subject
to other risks of operating a global business, including potential foreign
government regulation of our technology, geopolitical risks associated with
political and economic instability, changes in diplomatic and trade
relationships, and changes in foreign countries’ laws affecting such areas as
employment relationships, environmental and safety regulation, intellectual
property protection and the Internet generally.
 
 Delays
in deliveries from our suppliers could cause our revenue to decline and
adversely affect our results of operations.
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  Our
products incorporate certain components, component subassemblies, or
technologies, including our highly integrated system-on-a-chip architecture,
that are available from single or limited sources of
supply.  Specifically, our products rely upon components from
companies such as Flextronics, Intel, Cavium, and Marvell.  We do not
have long-term supply arrangements with any vendor, and any disruption in the
supply of these products or technologies may adversely affect our ability to
obtain necessary components or technology for our products.  If this
were to happen, our product shipments may be delayed and business lost,
resulting in a decline in sales.  In addition, our products utilize
components that have in the past been subject to market shortages and price
fluctuations.  If we experience price increases in our product
components, we will experience declines in our gross profit.
 
 We
license intellectual property, including certain databases and software, and if
our licensors experience delays in product updates or provide us with products
of substandard quality, the revenue we receive from our products and services
that use this intellectual property would be at risk.
 
 We have
agreements to license intellectual property, including databases and software,
which we incorporate as part of certain of our products and
services.  Licensors of such databases and software may fail to
provide us with updated products or may experience delays in providing us with
updated products.  In addition, our licensors may provide us with
products of substandard quality.  If either of these events happens,
we may be unable to provide our customers with the appropriate level of
functionality in our solution offerings.  In that event, our customers
may purchase similar offerings from one of our competitors, or sales to our
customers may be delayed.  In either case, our revenue would be
adversely affected.
 
 We
rely primarily on contract manufacturers for our product manufacturing and
assembly, and if these operations are disrupted for any reason, we may not be
able to ship our products.
 
 We
currently outsource our hardware manufacturing and assembly to contract
manufacturers in the U.S. and Taiwan.  Typically, the agreement with
our contract manufacturers specify an initial term of one (1) year with
automatic yearly renewal terms unless terminated by either party upon 90 days
prior written notice.  Our operations could be disrupted if we have to
switch to a replacement vendor or if our hardware supply is interrupted for any
reason.  In addition, we provide forecasts of our demand to our
contract manufacturers nine months prior to scheduled delivery of products to
our customers.  If we overestimate our requirements, our contract
manufacturers may have excess inventory, which would increase our
costs.  If we underestimate our requirements, our contract
manufacturers may have an inadequate component inventory, which could interrupt
manufacturing of our products and result in delays in shipments and
revenue.  In addition, lead times for materials and components that we
order vary significantly and depend on factors such as the specific supplier,
contract terms and demand for each component at a given
time.  Liquidity or other financial problems of our contract
manufacturers or reservation of manufacturing capacity by other companies,
inside or outside of our industry, could either limit supply or increase
costs.  We may also experience shortages of components from time to
time, which also could delay the manufacturing of our products.  If
any of the foregoing occurs we could lose customer orders and revenue could
decline.
 
 Sales of our
solutions may be adversely affected by various factors which would adversely
affect our revenue.
 
 Sales of
our solutions may be adversely affected in the future by changes in the
geopolitical environment and global economic conditions, including the financial
stability of our customers and supply chain; sales and implementation cycles;
changes in our product mix; structural variations in sales channels; ability of
our channel to absorb new product, software and service introductions; ability
of our sales organization to sell into enterprise level accounts; acceptance of
our solutions in the market place; and changes in our supply chain model. These
changes may result in corresponding variations in order backlog.  A
variation in backlog levels could result in less predictability in our
quarter-to-quarter net sales and operating results.  Sales may also be
adversely affected by fluctuations in demand, price and product competition in
the markets we service, introduction and market acceptance of new technologies
and new product, software or service offerings, and financial difficulties
experienced by our distributors, resellers or end-users. We may, from time to
time, experience manufacturing issues that create a delay in our suppliers’
ability to provide specific components resulting in delayed
shipments.  To the extent that manufacturing issues and any related
component shortages result in delayed shipments in the future, and particularly
in periods when we and our suppliers are operating at higher levels of capacity,
it is possible that revenue could be adversely affected for a quarter or
longer.
 
 The
failure to successfully conduct offshore activities could adversely affect
results of operations.
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 Table of Contents
  To better
align our costs with market conditions, increase its presence in growing
markets, and enhance productivity and operational efficiency, we conduct
engineering, development and certain technical support activities in India and
China.  We have undertaken a transition of certain technical support
activities to facilities located in India.  In addition, we conduct
certain engineering and development activities in Shanghai, China.  As
part of these offshore activities we have established a corporate presence in
both India and China, entered into a long-term lease for facilities to support
these offshore efforts, and are hiring employees.  If we are unable to
effectively develop and implement our offshore strategies, including the ability
to recruit or retain qualified technical personnel, or are unable to build the
necessary corporate infrastructure in a timely and efficient manner, or are
unable to effectively integrate certain technical support and engineering
functions, the costs associated with the these offshore activities may be
greater than anticipated and we may not realize anticipated productivity
improvements and may experience other operational difficulties, and or all of
which could materially and adversely affect our business, financial condition
and results of operations.
 
 Environmental
and safety regulations enacted in various jurisdictions in which we do business
may increase the component costs of our products and if we experience delays in
shipment of compliant products our revenue would decline and our operating
results would be adversely affected.
 
 We are
subject to environmental and safety regulations in connection with out global
business operations, including but not limited to regulations relating to the
development, manufacture, and use of its products and, the safe use of
chemicals, and recycling and disposal of material used in its
products.  Various jurisdictions in which we do business are in the
process of implementing environmental and safety directives that impact
manufacturers doing business in those jurisdictions.  The disparities
between the regulatory frameworks adopted create uncertainty over the
applicability, scope, and form of the regulations affecting our products and the
timing for compliance with the applicable regulations.   Our
inability to comply with applicable environmental and safety regulations in a
timely fashion may subject us to fines and penalties levied by appropriate
regulatory authorities.  Certain of these regulations may necessitate
changes to the components used in our products which could result in an increase
in product cost and a decrease in our gross profit.  Further, while we
and our contract manufacturers constantly review environmental and safety
regulations in the jurisdictions in which we do business, the timetable for
implementation of these regulations may result in delays in our ability to
provide compliant products in a timely manner to those markets which would cause
our revenues to decline and our operating results to be adversely
affected.
 
 If
we fail to maintain an effective system of internal controls, we may not be able
to accurately report our financial results.  As a result, current and
potential shareholders could lose confidence in our financial reporting which
would harm our business and the trading price of our stock.
 
 Section
404 of the Sarbanes-Oxley Act of 2002 requires our management to report on, and
our independent registered public accounting firm to attest to, the
effectiveness of our internal control over financial reporting.  We
have an ongoing program to perform the system and process evaluation and testing
necessary to comply with these requirements.  We have incurred
considerable expense and have devoted additional management resources to on
going Section 404 compliance activity.  Effective internal controls
are necessary for us to provide reliable financial reports.  If we
cannot provide reliable financial reports, our business and operating results
could be harmed.
 
 Acquisitions
could be difficult to integrate, disrupt our business, dilute shareholder value
and the products and services acquired may not be accepted by the market. As
a result, our operating results would be adversely affected.
 
 We are
continually reviewing the market for possible corporate opportunities and we may
announce acquisitions or investments in other companies, products, or
technologies in the future. As part of each transaction, we will be required to
integrate operations, train, retain, and motivate the personnel of these
entities. We may be unable to maintain uniform standards, controls, information
technology systems, procedures and policies across our entire enterprise and if
the products and services released as a result of these acquisitions experience
quality problems or are otherwise not accepted by the market, we may suffer a
loss of confidence by our distributors, resellers and end users and sales of
these products and services will not meet expectations. As a consequence, these
acquisitions may cause disruptions in our operations and divert management’s
attention from day-to-day operations, which could impair our relationships with
our current employees, customers, and strategic partners.
 
 We may
have to incur debt or issue equity securities to pay for any future
acquisitions. The issuance of equity securities for any acquisition could be
substantially dilutive to our shareholders. In addition, due to acquisitions
made in the past, our profitability
 19
 Table of Contents
  has
suffered because of acquisition-related costs, amortization costs, and
impairment losses for acquired goodwill and other intangible
assets.
 
 We
cannot be certain that our internal controls over financial reporting will be
effective or sufficient when tested by increased scale of growth or the impact
of acquisitions.
 
 It may be
difficult to design and implement effective internal controls over financial
reporting for combined operations and differences in existing controls of
acquired businesses may result in weaknesses that require remediation when
internal controls over financial reporting are combined.  Our ability
to manage our operations and growth will require us to improve our operations,
financial and management controls, as well as our internal reporting systems and
controls.  We may not be able to implement improvements to our
internal reporting systems and controls in an efficient and timely manner and
may discover deficiencies and weaknesses in existing systems and controls
especially when such systems and controls are tested by increased scale of
growth or the impact of acquisitions.
 
 Our
Financial Statements could be affected by the need to restate previously issued
annual or interim financial statements.
 
 In the
event an error in our financial statements requires us to report that previously
reported financial statements should no longer be relied upon, amended financial
statements for such previously reported periods would be required.  In
such an event, we may be unable to file our current interim or annual reports
with the Securities and Exchange Commission in a timely fashion and may be
subject to delisting by the NASDAQ Global Market.  Furthermore, we may
be unable to certify the adequacy of our internal controls over financial
reporting and our independent registered public accounting firm may be unable to
attest thereto.  In such circumstances, investors could lose
confidence in our internal controls over financial reporting, our disclosure
controls, and the reliability of our financial statements, which could result in
a decrease in the value of our common stock and could cause serious harm to our
business, financial condition, and results of operations.
 
 Changes
in our effective tax rate or tax liability may have an adverse effect on our
results of operations.
 
 As a
global company, we are subject to taxation in the United States and various
other countries.  Significant judgment is required to determine and
estimate worldwide tax liabilities.  Our future effective tax rates
may be adversely affected by a number of factors including changes in the
valuation of our deferred tax assets; our ability to use net operating losses of
acquired companies to the fullest extent; increases in expenses not deductible
for tax purposes, including write-offs of acquired in-process research and
development and impairment of goodwill in connection with acquisitions; changes
in share-based compensation expense; and changes in tax laws in the countries in
which we operate or the interpretation of such tax laws and changes in generally
accepted accounting principles. Any significant change in our future effective
tax rates could adversely impact our consolidated financial position, results of
operations, and cash flows.
 
 If
our estimates or judgments relating to our critical accounting
policies  based on assumptions change or prove to be incorrect, our
operating results could fall below expectations of securities analysts and
investors, resulting in a decline in our stock price.
 
 Our
discussion and analysis of financial condition and results of operations in this
report is based on our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States.  The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes.  On an ongoing basis, we
evaluate significant estimates used in preparing our financial statements,
including those related to: the valuation and recognition of investments, the
valuation of the revenue and accounts receivable, the valuation of inventory,
the assessment of recoverability of intangible assets and their estimated useful
lives, the valuation and recognition of stock based compensation and the
recognition and measurement of current and deferred income tax assets and
liabilities.
 
 We base
our estimates on historical experience and on various other assumptions that we
believe to be reasonable under the circumstances, as provided in our discussion
and analysis of financial condition and results of operations in this annual
report, the results of which form the basis for making judgments about the
carrying values of assets and liabilities that are not readily apparent from
other sources.  The current volatility in the financial markets and
overall economic uncertainty increases the risk that actual amounts realized
from the sale or exchange of certain of our financial instruments may differ
significantly from those
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  in our
assumptions.  In any such case, our operating results could fall below
the expectations of securities analysts and investors, resulting in a decline in
our stock price.
 
 Changes
to our senior management may have an adverse effect on our ability to execute
our business strategy.
 
 Our
future success will depend largely on the efforts and abilities of our senior
management to execute our business plan.  Changes in our senior
management and any future departures of key employees may be disruptive to our
business and may adversely affect our operations.
 
 Our
ability to attract, retain, and motivate key qualified employees is vital to our
success.
 
 Our
success depends in part on our ability to attract, retain, and motivate key
engineering, operations, finance, information systems, customer support, and
sales and marketing personnel.  Our employees may leave us at any
time, and we have continuing challenges in retaining employees from acquired
companies.  The loss of services of any of our key personnel, the
inability to attract, retain, and motivate qualified personnel in the future, or
delays in hiring required personnel, particularly engineering and sales
personnel, could delay the development and introduction of, and negatively
impact our ability to sell, our products, software and services.  If
we are not successful in attracting, retaining, and motivating key employees,
our ability to capitalize on our business opportunities and our operating
results maybe materially and adversely affected.
 
 We may be unable
to adequately protect our intellectual property proprietary rights, which may
limit our ability to compete effectively.
 
 We
currently rely on a combination of patent, trademark, copyright, and trade
secret laws, confidentiality provisions and other contractual provisions to
protect our intellectual property.  Our intellectual property program
consists of an on-going patent disclosure and application process, the purchase
of intellectual property assets including intellectual property assets from
acquisition activity, and the licensing of intellectual property from
others.  We plan to continue our aggressive plan to build our
intellectual property portfolio.  Despite our efforts to protect our
intellectual property, unauthorized parties may misappropriate or infringe our
intellectual property.  We plan to aggressively pursue any such
misappropriation or infringement of our intellectual property.  Our
patent applications may not result in the issuance of any
patents.  Even if we obtain the patents we are seeking, that will not
guarantee that our patent rights will be valuable, create a competitive barrier,
or will be free from infringement.  Furthermore, if any patent is
issued, it might be invalidated or circumvented or otherwise fail to provide us
any meaningful protection.  We face additional risk of adequately
protecting our intellectual property when conducting business in countries that
have poorly developed or inadequately enforced intellectual property
laws.  In addition, competitors may independently develop similar or
superior technologies or duplicate the technologies we have developed, which
could substantially limit the value of our intellectual property.
 
 Potential
intellectual property claims and litigation could subject us to significant
liability for damages and invalidation of our proprietary rights.
 
 Litigation
over intellectual property rights is not uncommon in our industry.  We
may face infringement claims from third parties in the future, or we may have to
resort to litigation to protect our intellectual property rights.  We
expect that infringement or misappropriation claims will be more frequent as the
number of products, feature sets in software and services, and the number of
competitors grows in the market segments in which we do business.  Any
litigation, regardless of its success, would probably be costly and require
significant time and attention of our key management and technical
personnel.  An adverse result in litigation could also force us
to:
 
 ·
              stop
      or delay selling, incorporating or using products that incorporate the
      challenged intellectual property;
 
 ·
              pay
      damages;
 
 ·
              enter
      into licensing or royalty agreements, which may be unavailable on
      acceptable terms; or
 
 ·
              redesign
      products or services that incorporate infringing
    technology.
 
 If any of
the above occurs, our revenue could decline and our business could
suffer.
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 Table of Contents
  We
have been named as defendant in litigation matters that could subject us to
liability for significant damages.
 
 We are a
defendant in on-going litigation matters.  No estimate can be made of
the possible loss or possible range of loss, if any, associated with the
resolution of these litigation matters.  Failure to prevail in these
matters could have a material adverse effect on our consolidated financial
position, results of operations, and cash flows in the future.
 
 In
addition, the results of litigation are uncertain and the litigation process may
utilize a significant portion of our cash resources and divert management’s
attention from the day-to-day operations, all of which could harm our
business.
 
 Any
alleged or actual failure of our products, software or services to operate as
warranted may require us to defend product liability or breach of warranty
claims.
 
 Our
products, software, and services provide network security, business continuity
and content security.  Networks protected by our products, software
and services may be vulnerable to electronic break-ins.  Because the
techniques used by computer hackers to access or sabotage networks change
frequently and generally are not recognized until launched against a target, we
may be unable to anticipate these techniques.  If a third party were
able to successfully overcome our security measures, such a person or entity
could misappropriate customer data, third party data stored by our customers and
other information, including intellectual property.  In addition, the
operations of our end user customers may be interrupted.  If that
happens, affected end-users or others may file actions against us alleging
product liability, tort, or breach of warranty claims.  Although we
attempt to reduce the risk of losses from claims through contractual warranty
disclaimers and liability limitations, these provisions may not be
enforceable.  Some courts, for example, have found contractual
limitations of liability in standard computer and software contracts to be
unenforceable in some circumstances.  Defending a lawsuit, regardless
of its merit, could be costly and could divert management
attention.  Although we currently maintain business liability
insurance, this coverage may be inadequate or may be unavailable in the future
on acceptable terms, if at all.  In addition, the market perception of
our products, software, and services would likely be adversely affected which
could cause us to lose current and potential customers, resellers, distributors
or other business partners.  If any of the above occurs, our revenue
could decline and our business would suffer.
 
 A
security breach of our internal systems could harm our business.
 
 Because
we provide Internet security, we may be a more attractive target for attacks by
computer hackers.  We will not succeed unless the marketplace is
confident that we provide effective Internet security
protection.  Although we have not experienced significant damages from
acts of sabotage or unauthorized access by a third party of our internal
network, if an actual or perceived breach of Internet security occurs in our
internal systems it could adversely affect the market perception of our
products, software and services.  In addition, such a security breach
may impact the ability of our company to operate, including the ability to
adequately support our customers.  If this happens, our revenue could
decline and our business could suffer.
 
 If
our solutions do not interoperate with our end customers’ networks,
installations could be delayed or cancelled, which could significantly reduce
our revenue.
 
 Our
solutions are designed to interface with existing networks of our end-users,
each of which have different specifications and utilize multiple protocol
standards.  Many of the networks of our end-user’s contain multiple
generations of products that have been added over time as these networks have
grown and evolved.  Our solutions must interoperate with the products
within these networks as well as with future products that might be added to
these networks in order to meet the requirements of our end-users.  If
we find errors in the existing software used in the networks of our end-users,
we may elect to modify our software to fix or overcome these errors so that our
solutions will interoperate and scale with their existing software and
hardware.  If our solutions do not interoperate properly,
installations could be delayed or orders for our solutions could be cancelled,
which could significantly reduce our revenue.
 
 Product
errors or defects could result in loss of revenue, delayed market acceptance,
and claims against us.
 
 We offer
one and two year warranty periods on our products.  During the
warranty period end users may receive a refurbished or replacement product for
any defective unit subject to completion of certain procedural
requirements.  Our products may contain undetected errors or
defects.  If there is a product failure, we may have to replace all
affected products without being able to record revenue for the replacement
units, or we may have to refund the purchase price for such units if the defect
cannot be
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 Table of Contents
  resolved. Despite
extensive testing, some errors are discovered only after a product has been
installed and used by customers.  Any errors discovered after
commercial release could result in loss of revenue and an increase in warranty
related claims against us.  Such product defects can negatively impact
our products’ reputation and result in reduced sales.
 
 Industry
consolidation may lead to increased competition and may harm our operating
results.
 
 There has
been a trend toward industry consolidation in our market.  We expect
this trend toward industry consolidation to continue as companies attempt to
strengthen or hold their market positions in an evolving industry and as
companies are acquired or are unable to continue operations.  We
believe that industry consolidation may result in stronger competitors that are
better able to compete with us.  This could lead to more variability
in operating results and could have a material adverse effect on our business,
operating results, and financial condition.
 
 If
we are unable to meet our future capital requirements, our business will be
harmed.
 
 We expect
our cash on hand, cash equivalents and short-term investments to meet our
working capital and capital expenditure needs for at least the next twelve
months.  However, at any time, we may decide to raise additional
capital to take advantage of strategic opportunities available or attractive
financing terms.  If we issue equity securities, shareholders may
experience additional dilution or the new equity securities may have rights,
preferences, or privileges senior to those of existing holders of common
stock.  If we cannot raise funds, if needed, on acceptable terms, we
may not be able to develop or enhance our products, software or services, take
advantage of future opportunities, or respond to competitive pressures or
unanticipated requirements, which could have a material adverse effect on our
business, operating results, and financial condition.
 
 Governmental
regulations of imports or exports affecting Internet security could affect our
revenue.
 
 Any
additional governmental regulation of imports or exports or failure to obtain
required export approval of our encryption technologies could adversely affect
our international and domestic sales.  The United States and various
foreign governments have imposed controls, export license requirements, and
restrictions on the import or export of some technologies, especially encryption
technology.  In addition, from time to time, governmental agencies
have proposed additional regulation of encryption technology, such as requiring
the escrow and governmental recovery of private encryption keys.  In
response to terrorist activity, governments could enact additional regulation or
restriction on the use, import, or export of encryption
technology.  This additional regulation of encryption technology could
delay or prevent the acceptance and use of encryption products and public
networks for secure communications resulting in decreased demand for our
products and services.  In addition, some foreign competitors are
subject to less stringent controls on exporting their encryption
technologies.  As a result, they may be able to compete more
effectively than we can in the United States and the international Internet
security market.
 
 Our
stock price may be volatile.
 
 The
market price of our common stock has been highly volatile and has fluctuated
significantly in the past.  We believe that it may continue to
fluctuate significantly in the future in response to the following factors, some
of which are beyond our control:
 
 ·
              general
      economic conditions and the effect that such conditions have upon
      customers’ purchasing decisions;
 
 ·
              variations
      in quarterly operating results;
 
 ·
              changes
      in financial estimates by securities
analysts;
 
 ·
              changes
      in market valuations of technology and Internet infrastructure
      companies;
 
 ·
              announcements
      by us of significant contracts, acquisitions, strategic partnerships,
      joint ventures or capital
commitments;
 
 ·
              the
      accretive or dilutive effects of acquisitions on operating
      results;
 
 ·
              loss
      of a major client or failure to complete significant license
      transactions;
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 ·
              additions
      or departures of key personnel;
 
 ·
              our
      ability to remediate material weaknesses and/or significant deficiencies,
      if any, in internal controls over financial reporting in an effective and
      timely manner;
 
 ·
              receipt
      of an adverse or qualified opinion from our independent auditors regarding
      our internal controls over financial
reporting;
 
 ·
              sales
      of common stock in the future; and
 
 ·
              fluctuations
      in stock market price and volume, which are particularly common among
      highly volatile securities of Internet-related
  companies.
 
 The
long sales and implementation cycles for our solutions may cause revenue and
operating results to vary significantly.
 
 The
decision of an end-user to purchase our solutions often involves a significant
commitment of resources and a lengthy evaluation and qualification
process.  Throughout the sales cycle, we often spend considerable time
educating our channel partners and providing information for prospective
end-users regarding the use and benefits of our products, software, and
services.  Budget constraints, the availability of credit, and the
need for multiple approvals within enterprises, carriers, and government
entities may delay purchase decisions.  Failure to obtain the required
approval for a particular project or purchase decision may delay the purchase of
our solutions from our channel partners.  As a result, the sales cycle
for our security solutions could be longer than 90 days.
 
 Even
after making the decision to purchase our solutions end-users may not deploy
these solutions broadly within their networks.  The timing of
implementation can vary widely and depends on the skill set of the end-user, the
size of the network deployment, the complexity of the network environment, and
the degree of specialized hardware and software configuration necessary to
deploy.  End-users with large networks usually expand their networks
in large increments on a periodic basis.  Large deployments and
purchases of our security solutions also require a significant outlay of capital
by the end-user.  If the deployment of our solutions in these complex
network environments is slower than expected, sales through our distributors to
our resellers would slow, our revenue could be below our expectations, and our
operating results could be adversely affected.
 
 The
inability to obtain any third-party license required to developing new products
or software or enhancements to our products or software could require us to
obtain substitute technology of lower quality or performance standards or at
greater cost, which could seriously harm our business, financial condition, and
results of operations.
 
 We
license intellectual property from third parties to develop new products or
software or enhancements to existing products or
software.  Third-party licenses may not be available to us on
commercially reasonable terms or at all.  The inability to obtain
third-party licenses required developing new products or software or
enhancements to existing products or software could require us to obtain
substitute technology of lower quality or performance standards or at greater
cost, any of which could seriously harm our business, financial condition, and
results of operations.
 
 Seasonality
and concentration of revenue at the end of the quarter could cause our revenue
to fall below the expectations of securities analysts and investors, resulting
in a decline in our stock price.
 
 The rate
of our domestic and international sales has been and may continue to be lower in
the summer months or be adversely affected by other seasonal factors, both
domestically and internationally.  During these periods, businesses
often defer purchasing decisions.  As a result of customer buying
patterns and the efforts of our sales force to meet or exceed quarterly and
year-end quotas,  we have historically received a substantial portion
of a quarter’s sales orders and earned a substantial portion of a quarter’s
revenue during its last month of each quarter.  If expected revenue at
the end of any quarter is delayed, our revenue for that quarter could fall below
the expectations of securities analysts and investors, resulting in a decline in
our stock price.
 
 Our
business is especially subject to the risks of earthquakes, floods and other
natural catastrophic events, and to interruption by manmade problems such as
computer viruses or terrorism.
 24
 Table of Contents
  Our
corporate headquarters, including certain of our research and development
operations and some of our contract manufacturer’s facilities, are located in
the Silicon Valley area of Northern California, a region known for seismic
activity.  Additionally, certain of our facilities, which include one
of our contracted manufacturing facilities, are located near rivers that have
experienced flooding in the past.  A significant natural disaster,
such as an earthquake or a flood, could have a material adverse impact on our
business, operating results, and financial condition.  In addition,
despite our implementation of network security measures, our servers are
vulnerable to computer viruses, break-ins, and similar disruptions from
unauthorized tampering with our computer systems.  Any such event
could have a material adverse effect on our business, operating results, and
financial condition.  In addition, the effects of war or acts of
terrorism could have a material adverse effect on our business, operating
results, and financial condition.  The continued threat of terrorism
and heightened security and military action in response to this threat, or any
future acts of terrorism, may cause further disruptions to these economies and
create further uncertainties.  To the extent that such disruptions or
uncertainties result in delays, curtailment or cancellations of customer orders,
or the manufacture or shipment of our products, our revenue, gross profits and
operating profits may decline and we may not achieve our financial goals and
achieve or maintain profitability.
 
 We
face risks associated with changes in telecommunications regulation and
tariffs.
 
 Changes
in telecommunications requirements in the United States or other countries could
affect the sales of our products.  We believe it is possible that
there may be changes in U.S. telecommunications regulations in the future that
could slow the expansion of the service providers’ network infrastructures and
materially adversely affect our business, operating results, and financial
condition.  Future changes in tariffs by regulatory agencies or
application of tariff requirements to currently untariffed services could affect
the sales of our products for certain classes of
customers.  Additionally, in the United States, our products must
comply with various Federal Communications Commission requirements and
regulations.  In countries outside of the United States, our products
must meet various requirements of local telecommunications
authorities.  Changes in tariffs or failure by us to obtain timely
approval of products could have a material adverse effect on our business,
operating results, and financial condition.
 
 Due
to the global nature of our business, economic or social conditions or changes
in a particular country or region could adversely affect our sales or increase
our costs and expenses, which would have a material adverse impact on our
financial condition.
 
 We
conduct significant sales, research and development, and customer support
operations in countries outside of the United States.  Accordingly,
our future results could be materially adversely affected by a variety of
uncontrollable and changing factors including, among others, political or social
unrest or economic instability or terrorist activity in a specific country or
region; macro economic conditions adversely affecting geographies where we do
business; trade protection measures; environmental and safety directives and
other regulatory requirements which may affect our ability to import or export
our products from various countries; government spending patterns affected by
political considerations; and difficulties in staffing and managing
international operations. Any or all of these factors could have a material
adverse impact on our revenue, costs, expenses, and financial
condition.
 
 We
are exposed to various risks associated with the credit and capital
markets.
 
 Included
within our investment portfolio at December 31, 2008 were auction rate
securities that we purchased for $55.3 million, partially offset by a right
issued by one of our investment firms of $45.3 million.  Investments
in auction rate securities have failed to trade at auctions due to insufficient
bids from buyers and cannot be quickly converted into cash, and are considered
illiquid at December 31, 2008.  The Company has recognized unrealized
losses in its consolidated financial statements as of December 31, 2008. If the
credit ratings of these investments continue to deteriorate, the fair value of
these auction rate securities may decline further.  If uncertainties
in the credit and capital markets continue or if the Company experiences any
rating downgrades on any investments in its portfolio, the Company may incur
impairment charges to its investment portfolio, which would negatively affect
our financial condition, cash flow, and reported earnings.
 
 
 ITEM
1B.  Unresolved Staff
Comments
 
 None.
 25
 Table of Contents
  ITEM 2.  Properties
  The
Company leases office space in several U.S. locations including California,
Washington, and Arizona. The Company also leases significant facilities in
Bangalore, India and Shanghai, China for certain of its support and research and
development activities. Additional sales and support offices are leased
worldwide.  The expiration dates of these leases range from 2009 to
2015.
 
 The
Company’s corporate headquarters and executive offices are located in
approximately 86,000 square feet of office space in Sunnyvale, California under
a lease that expires in September 2009.  The lease provides for one
five-year renewal option. In addition, the Company leases office space of
approximately 32,000 square feet in Tempe, Arizona.  The lease term is for
7.5 years and expires in August 2015.  The base rent for this lease
escalates annually at 3%.
 
 In July
2007, the Company assumed a five-year lease for approximately 20,000 square feet
of office space located in Seattle, Washington.  This lease expires in
February 2012. In September 2008, the Company closed approximately half of its
leased facility and has recorded a liability of approximately $900,000
equivalent to the net present value of the expected future lease costs, net of
estimated future sublease. The liability is recorded as a component of “Other
accrued liabilities”.
 
 In
February 2008, the Company entered into a lease agreement to lease approximately
36,000 square feet of office space in Bangalore, India to carry out certain
research and development and technical support activities.  The lease
term is for a period of five years commencing in March 2008 and requires a lock
in period of 4 years, after which either party to the contract can terminate the
lease with notice duly given.  The base rent for this lease escalates
annually at 5%.
 
 In
November 2008, the Company expanded its existing lease agreement in Shanghai,
China to lease a total of approximately 16,000 square feet of office space to
carry out our research and development activities. The lease term is for a
period of three years and expires in November 2011. The base rent will be
increased by 15% in September 2009.
 
 We
believe that our existing facilities are suitable and adequate for our current
needs and that the capacity of such facilities is substantially being utilized
or we have plans to utilize it.
 
 
 ITEM 3.  Legal
Proceedings
 
 On
December 5, 2001, a securities class action complaint was filed in the U.S.
District Court for the Southern District of New York against the Company, three
of its officers and directors, and certain of the underwriters in the Company’s
initial public offering in November 1999 and its follow-on offering in March
2000.  Similar complaints were filed in the same court against
numerous public companies that conducted initial public offerings (“IPOs”) of
their common stock since the mid-1990s.  All of these lawsuits were
consolidated for pretrial purposes before Judge Shira Scheindlin.  On
April 19, 2002, plaintiffs filed an amended complaint.  The amended
complaint alleges claims under the Securities Act of 1933 and the Securities
Exchange Act of 1934, and seeks damages or rescission for misrepresentations or
omissions in the prospectuses relating to, among other things, the alleged
receipt of excessive and undisclosed commissions by the underwriters in
connection with the allocation of shares of common stock in the Company’s public
offerings.  On July 15, 2002, the issuers filed an omnibus motion to
dismiss for failure to comply with applicable pleading standards.  On
October 8, 2002, the Court entered an Order of Dismissal as to all of the
individual defendants in the SonicWALL IPO litigation, without
prejudice.  On February 19, 2003, the Court denied the motion to
dismiss the Company’s claims.  A tentative agreement was reached with
plaintiffs’ counsel and the insurers for the settlement and release of claims
against the issuer defendants, including SonicWALL, in exchange for a guaranteed
recovery to be paid by the issuer defendants’ insurance carriers and an
assignment of certain claims.  Papers formalizing the settlement among
the plaintiffs, issuer defendants, including SonicWALL, and insurers were
presented to the Court on September 14, 2004.  On February 15, 2005,
the Court granted preliminary approval of the settlement, subject to the parties
fulfilling certain conditions.  On August 31, 2005, the Court entered
an order confirming its preliminary approval of the settlement.  In
December 2006, the Second Circuit Court of Appeals reversed the class
certification decision of the District Court in six (6) focus
cases.  The Second Circuit Court of Appeals also denied
rehearing.  In June 2007, the District Court signed a stipulation
terminating the settlement approval process.  In December 2007,
plaintiffs filed an opposition to motions to dismiss of the focus case issuers
and underwriters.  The focus case issuers and underwriters in turn
submitted briefs in opposition to plaintiffs’ motion for class
certification.  In March 2008, plaintiffs filed a reply in support of
their motion for class certification in the focus cases. Discussions among the
various parties are ongoing.  If the litigation against the Company
continues, the Company
 26
 Table of Contents
  believes it has a
meritorious defense and intends to defend the case vigorously.  No estimate
can be made of the possible loss or possible range of loss, if any, associated
with the resolution of this contingency.  As a result, no loss has been
accrued in the Company’s financial statements as of December 31,
2008.
 On March
13, 2006, eSoft, Inc. (“eSoft”) filed a complaint captioned eSoft, Inc. v.
SonicWALL, Inc., No. 06-CV-00445, in the United States District Court for the
District of Colorado.  The Complaint alleged that the Company has
willfully infringed, actively induced the infringement of and/or knowingly
contributorily infringed U.S. Patent No. 6,961,773 (the “773 Patent”) and
sought  (1) a judgment that the Company has willfully infringed,
actively induced the infringement and/or knowingly contributorily infringed the
patent, (2) the award of an unspecified amount of trebled damages, together with
expenses, costs and attorneys’ fees and (3) permanent injunctive relief
restraining and enjoining the Company from infringing the patent. At essentially
the same time, eSoft filed complaints against five (5) other defendants alleging
infringement of the 773 Patent.  In response to a motion to re-examine
filed with the patent office by defendants in two of the other cases, the
Company filed a motion to stay proceedings pending the results of the
re-examination process.  eSoft joined in that motion and on February
12, 2007, the Court granted our motion for stay.  On September 15,
2008, the Patent and Trademark Office (the “PTO”) issued its first office action
as part of the re-examination process. Counsel for eSoft has requested an
extension to December 15, 2008 to respond to the PTO office action. On December
10, 2008, the parties filed a status report on the case. According to the status
report, the re-examination process was ongoing with no discernible end to that
process and any subsequent appeals. After receiving the report, the Court, on
December 17, 2008, administratively closed the case with leave to reopen the
case by any party showing good cause. In light of the administrative closure of
this case, no loss has been accrued in the Company’s financial statements as of
December 31, 2008.
 
 On
October 8, 2008, Northpeak Wireless, LLC filed a complaint captioned Northpeak
Wireless, LLC v. 3Com Corporation, et al, No. CV-08-J-1813-NE, in the United
States District Court for the Northern District of Alabama. The complaint names
thirty one (31) defendants, including the Company. The complaint alleges that
the Company makes, uses, sells, offers to sell, and/or imports products that
incorporate and/or utilize direct sequence spread spectrum wireless technology
that infringes U.S. Patent No. 4,977,577 (the “577 Patent”) and U.S. Patent No.
5,987,058 (the “058 Patent”) and seeks a judgment that the Company has
infringed, actively induced infringement and/or contributorily infringed the 577
Patent and the 058 Patent. The complaint seeks an award of unspecified damages,
pre-judgment and post-judgment interest together with costs, expenses and
attorneys’ fees. On January 21, 2009, the Court granted the motion made by the
defendants, including SonicWALL, to transfer the case to the Northern District
of California. The Company intends to defend the case vigorously. No estimate
can be made at this time of the possible loss or possible range of loss, if any,
associated with the resolution of this matter. As a result, no loss has been
accrued in the Company’s financial statements as of December 31,
2008.
 
 Additionally,
the Company is, from time to time, a party to routine litigation incidental to
its business.  The Company believes that none of these legal
proceedings will have a material adverse effect on the Company’s consolidated
financial statements taken as a whole or its results of operations, financial
position, and cash flows.
 
 ITEM 4.  Submission of Matters to a Vote of
Security Holders
 
 None.
 27
 Table of Contents
  PART
II


ITEM 5.Market for Registrant’s Common
Equity and Related Stockholder Matters
 
 Price
Range of Common Stock
 
 Our
common stock commenced trading on the NASDAQ Global Market on November 11, 1999
and is traded under the symbol “SNWL”.  As of December 31, 2008, there
were approximately 92 shareholders of record of the common stock.  The
high and low sale prices for the common stock as reported on the NASDAQ Global
Market were:
  High
                    
                    
                    LowFiscal
      2007First
      Quarter
                    
                    
                    $9.09
                    
                    
                    
                    $8.01Second
      Quarter
                    
                    
                    $8.78
                    
                    
                    
                    $7.77Third
      Quarter
                    
                    
                    $9.20
                    
                    
                    
                    $7.67Fourth
      Quarter
                    
                    
                    $11.03
                    
                    
                    
                    $8.92Fiscal
      2008First
      Quarter
                    
                    
                    $10.91
                    
                    
                    
                    $7.51Second
      Quarter
                    
                    
                    $8.74
                    
                    
                    
                    $6.45Third
      Quarter
                    
                    
                    $6.82
                    
                    
                    
                    $4.78Fourth
      Quarter
                    
                    
                    $5.23
                    
                    
                    
                    $2.90
 
 Dividend
Policy
 
 We have
never paid a cash dividend on our capital stock.  We currently
anticipate that we will retain all available funds, for use in our business and
we do not currently anticipate paying any cash dividends.
 
 Stock
Performance Graph
 
 Below is
a line graph comparing relative performance in the cumulative return to
shareholders of our common stock with the cumulative return on the Nasdaq
Composite Index, Russell 2000 Index and RDG Technology Composite Index over a
60-month period commencing December 31, 2003 and ending on December 31,
2008.  This graph assumes the investment of $100 on December 31,
2003 and the reinvestment of dividends, if any, through December 31,
2008.
 
 The
comparisons shown in the graph below are based upon historical
data.  We consistently caution that the stock price performance shown
in the graph below is not indicative of, nor intended to forecast, the potential
future performance of our common stock.
 28
 Table of Contents
 COMPARISON OF 5 YEAR CUMULATIVE
TOTAL RETURN*
  
 
 
 *$100 invested on
12/31/03 in stock or index-including reinvestment of
dividends.
 Fiscal
year ending December 31.
   Recent
Sales of Unregistered Securities
 
 None.
   Issuer
Purchases of Equity Securities
 
 None.
 29
 Table of Contents
  ITEM 6.  Selected Consolidated Financial
Data
 
 The
following selected consolidated financial data should be read in conjunction
with our consolidated financial statements and related notes thereto and
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations” included in this Form 10-K.
 Year Ended December 31,2008
                          
                          
                          2007
                          
                          
                          2006
                          
                          
                          2005
                          
                          
                          2004Statements
      of Operations Data:
                          
                          (In
      thousands, except per share data)Revenues:Product
                          
                          $
                          90,857
                          
                          
                          $
                          98,936
                          
                          
                          $
                          92,797
                          
                          
                          $
                          75,525
                          
                          
                          $
                          82,994License
      and service
                          
                          
                          127,787
                          
                          
                          
                          100,263
                          
                          
                          
                          82,741
                          
                          
                          
                          59,799
                          
                          
                          
                          42,655Total
      revenues
                          
                          
                          218,644
                          
                          
                          
                          199,199
                          
                          
                          
                          175,538
                          
                          
                          
                          135,324
                          
                          
                          
                          125,649Cost
      of revenues:Product
                          
                          
                          43,507
                          
                          
                          
                          40,555
                          
                          
                          
                          39,164
                          
                          
                          
                          27,699
                          
                          
                          
                          30,118License
      and service
                          
                          
                          20,102
                          
                          
                          
                          15,894
                          
                          
                          
                          12,287
                          
                          
                          
                          8,031
                          
                          
                          
                          7,002Amortization
      of purchased technology
                          
                          
                          3,017
                          
                          
                          
                          2,232
                          
                          
                          
                          5,387
                          
                          
                          
                          4,552
                          
                          
                          
                          4,543Total
      cost of revenues
                          
                          
                          66,626
                          
                          
                          
                          58,681
                          
                          
                          
                          56,838
                          
                          
                          
                          40,282
                          
                          
                          
                          41,663Gross
      profit
                          
                          
                          152,018
                          
                          
                          
                          140,518
                          
                          
                          
                          118,700
                          
                          
                          
                          95,042
                          
                          
                          
                          83,986Operating
      expenses:Research
      and development
                          
                          
                          44,176
                          
                          
                          
                          39,410
                          
                          
                          
                          33,670
                          
                          
                          
                          22,768
                          
                          
                          
                          23,412Sales
      and marketing
                          
                          
                          82,348
                          
                          
                          
                          77,741
                          
                          
                          
                          71,256
                          
                          
                          
                          53,403
                          
                          
                          
                          47,353General
      and administrative
                          
                          
                          18,613
                          
                          
                          
                          21,473
                          
                          
                          
                          20,324
                          
                          
                          
                          15,535
                          
                          
                          
                          14,365Amortization
      of purchased intangible assets
                          
                          
                          1,114
                          
                          
                          
                          715
                          
                          
                          
                          2,721
                          
                          
                          
                          2,893
                          
                          
                          
                          3,089Restructuring
      charges (reversals)
                          
                          
                          1,683
                          
                          
                          
                          -
                          
                          
                          
                          1,409
                          
                          
                          
                          -
                          
                          
                          
                          (171
                          )In-process
      research and development
                          
                          
                          -
                          
                          
                          
                          1,930
                          
                          
                          
                          1,580
                          
                          
                          
                          -
                          
                          
                          
                          -Total
      operating expenses
                          
                          
                          147,934
                          
                          
                          
                          141,269
                          
                          
                          
                          130,960
                          
                          
                          
                          94,599
                          
                          
                          
                          88,048Income
      (loss) from operations
                          
                          
                          4,084
                          
                          
                          
                          (751
                          )
                          
                          
                          (12,260
                          )
                          
                          
                          443
                          
                          
                          
                          (4,062
                          )Interest
      income and other expense, net
                          
                          
                          6,368
                          
                          
                          
                          11,771
                          
                          
                          
                          9,713
                          
                          
                          
                          6,867
                          
                          
                          
                          4,050Income
      (loss) before income taxes
                          
                          
                          10,452
                          
                          
                          
                          11,020
                          
                          
                          
                          (2,547
                          )
                          
                          
                          7,310
                          
                          
                          
                          (12
                          )Benefit
      (provision) for income taxes
                          
                          
                          (5,571
                          )
                          
                          
                          17,601
                          
                          
                          
                          (8,206
                          )
                          
                          
                          (1,034
                          )
                          
                          
                          (301
                          )Net
      income (loss)
                          
                          $
                          4,881
                          
                          
                          $
                          28,621
                          
                          
                          $
                          (10,753
                          )
                          
                          $
                          6,276
                          
                          
                          $
                          (313
                          )Net
      income (loss) per share:Basic
                          
                          $
                          0.09
                          
                          
                          $
                          0.45
                          
                          
                          $
                          (0.17
                          )
                          
                          $
                          0.10
                          
                          
                          $
                          (0.00
                          )Diluted
                          
                          $
                          0.08
                          
                          
                          $
                          0.43
                          
                          
                          $
                          (0.17
                          )
                          
                          $
                          0.09
                          
                          
                          $
                          (0.00
                          )Shares
      used in computing net income (loss) per share:Basic
                          
                          
                          56,069
                          
                          
                          
                          64,305
                          
                          
                          
                          65,117
                          
                          
                          
                          64,684
                          
                          
                          
                          70,850Diluted
                          
                          
                          57,897
                          
                          
                          
                          67,099
                          
                          
                          
                          65,117
                          
                          
                          
                          66,797
                          
                          
                          
                          70,850
 As of December 31,2008
                            
                            
                            2007
                            
                            
                            2006
                            
                            
                            2005
                            
                            
                            2004(In
      thousands, except per share data)Consolidated
      Balance Sheet Data:Cash
      and cash equivalents
                            
                            $
                            45,127
                            
                            
                            $
                            33,324
                            
                            
                            $
                            25,927
                            
                            
                            $
                            42,593
                            
                            
                            $
                            23,446Short-term
      investments
                            
                            
                            60,327
                            
                            
                            
                            195,647
                            
                            
                            
                            209,251
                            
                            
                            
                            197,849
                            
                            
                            
                            229,226Total
      assets
                            
                            
                            401,836
                            
                            
                            
                            472,635
                            
                            
                            
                            416,291
                            
                            
                            
                            387,683
                            
                            
                            
                            386,845Total
      shareholders’ equity
                            
                            
                            265,771
                            
                            
                            
                            327,704
                            
                            
                            
                            318,068
                            
                            
                            
                            320,170
                            
                            
                            
                            337,976Long-term
      liabilities
                            
                            
                            15,072
                            
                            
                            
                            17,495
                            
                            
                            
                            6,269
                            
                            
                            
                            636
                            
                            
                            
                            -
 30
 Table of Contents


ITEM 7.  Management’s Discussion and Analysis
of Financial Condition and Results of Operations
 This
Form 10-K contains forward-looking statements which relate to future events or
our future financial performance.   In many cases you can
identify forward-looking statements by terminology such as “may”, “will,”
“should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,”
“potential,” “intend” or “continue,” or the negative of such terms and other
comparable terminology.  In addition, forward-looking statements in
this document include, but are not limited to, those regarding the dedication of
resources to develop new products and services and marketing those products and
services to channel partners and customers; the introduction of more service
offerings on our platforms as a vehicle to generate additional revenue from our
installed base of products; our ability to deliver comprehensive and profitable
solutions to our channel partners; the growth opportunity associated with sales
through our indirect channel to larger distributed enterprises; weakening
economic conditions that could lead to decreases in IT spending that could
adversely impact operating results;  the level of comfort of our
channel partners in offering our solutions to their customers; the growth of the
Network Security, Secure Content Management and Business Continuity markets, the
impact of a failure to achieve greater international sale;
our  ability to maintain and enhance current product lines, develop
new products, maintain technological competitiveness and meet the expanding
range of customer requirements; the market opportunity for license and service
revenue growth;  our ability to deliver comprehensive solutions to
channel partners, the positive characteristics of our software license and
service revenue model on future revenue growth and the predictability of our
revenue stream; expected growth in license and subscription service revenue; the
impact on revenue of the combination of subscription services sold in
conjunction with new product offerings; expected competition in the Internet
security market and our ability to compete in markets in which we participate;
impact of service renewal rates on lowering selling and marketing expense; our
ability to achieve increased incremental revenue per transaction through success
of our software license and service revenue model; the impact of IT spending on
demand for our products and services;  the current and likely future
impact of share based compensation expense as required by SFAS 123R on reported
operating results, anticipated revenue contributions of new products including
continuous data protection, email security and SSL-VPN products and related
services; the impact of growth in international operations on our exposure to
foreign currency fluctuations; the possible impact of uncertainties in the
auction rate and asset backed securities markets on the Company’s financial
performance; our ability to access funds held as auction rate securities in our
investment portfolio,  pricing pressures on our solution based
offerings; anticipated higher gross margins associated with our license and
service offerings; the probability of realization of all deferred tax assets;
assessment of future effective tax rates and the continued need for a partial
tax valuation allowance; the potential for product gross margins to erode based
upon changes in product mix; downward pressure on product pricing or upward
pressure on production costs; the impact of product mix on product gross
profits; the impact of the completion of “in sourcing” certain technical support
functions on period over period comparisons of cost of license and service
revenue and gross margin; our ability to maintain investment in current and
future product development and enhancement efforts; the introduction of new
products and the broadening of existing product offerings; planned investments
and expenses in current and future product development, production costs and
sales volume comparisons between the NSA and SSL-VPN products and other hardware
appliances; the rate of change of general and administrative
expenses,  the impact of geopolitical and macro-economic conditions on
demand for our offerings; the ability of our contract manufacturers to meet our
requirements; the belief that existing cash, cash equivalents and short-term
investments will be sufficient to meet our cash requirements at least through
the next twelve months; factors potentially impacting operating cash flows in
future periods; and expected fluctuations in day sales outstanding. These
statements are only predictions, and they are subject to risks and
uncertainties.  Our actual results may differ materially from those
anticipated in these forward-looking statements as a result of a variety of
factors, including, but not limited to, those set forth herein under the heading
“Risk Factors”  and also under the heading “Risk
Factors”.  References to “we,” “our,” and “us” refer to SonicWALL,
Inc. and its subsidiaries.
  Overview
 
 SonicWALL
provides network security, content security, and business continuity solutions
for businesses of all sizes.  Our solutions are typically deployed at
the edges of networks.  These networks are often aggregated into
broader distributed deployments to support companies that do business in
multiple physical locations, interconnect their networks with trading partners,
or support a mobile or remote workforce.  Our solutions are sold in
over 50 countries worldwide.
 
 The
Company groups revenue into the following primary product categories of similar
products:
  (1)
              Unified Threat Management
      (UTM) including Network Security Appliance (NSA), PRO, and TZ
      products; subscription services such as Comprehensive Gateway Security
      Suite (CGSS), integrated Gateway Anti-Virus, and Intrusion Prevention;
      software licenses such as our enhanced “SonicOS” operating system, node
      upgrades, and other services such
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  as
      extended warranty and service contracts, training, consulting and
      engineering services.
 
 (2)
              SSL VPN Secure Remote Access
      (SSL)including SSL-VPN appliances, add-on software licenses and
      other services such as extended warranty and service contracts, training,
      consulting and engineering services.
 (3)
              Secure Content Management
      (SCM)including CSM and email security appliances, subscription
      services such as internet filtering and email protection term and
      perpetual licenses, and other services such as extended warranty and
      service contracts, training, consulting and engineering
      services.
 (4)
              Continuous Data Protection
      (CDP) including the CDP appliances, off-site data backup
      subscription services, site-to-site back-up licenses, and other services
      such as extended warranty and service contracts, training, consulting and
      engineering services.
 
 We
generate revenue within these product categories primarily from the sale of: (1)
products, (2) software licenses, (3) subscriptions for services such as content
filtering, anti-virus protection and intrusion prevention, offsite data backup,
email protection, and (4) other services such as extended warranty and service
contracts, training, consulting and engineering services.
 We
currently outsource our hardware manufacturing and assembly to third party
contract manufacturers and some of the key components in the Company’s products
come from single or limited number of suppliers.  Outsourcing our
manufacturing and assembly enables us to reduce fixed overhead and personnel
costs and to provide flexibility in meeting market demand.
  We design
and develop the key components for the majority of our products.  In
addition, we generally determine the components that are incorporated in our
products and select the appropriate suppliers of these
components.  Product testing and burn-in are performed by our contract
manufacturers using tests that we typically specify.
  We sell
our solutions primarily through distributors and value-added resellers, who in
turn sell our products to end-users.  Some of our resellers are
carriers or service providers who provide solutions to the end-user customers as
managed services.  Channel sales accounted for approximately 99%, 98%,
and 98% of total revenue in 2008, 2007, and 2006,
respectively.  Alternative Technology, Tech Data, and Ingram Micro,
all of whom are technology product distributors, collectively accounted for
approximately 49%, 50%, and 53% of our revenue during 2008, 2007, and 2006,
respectively.
 
 We seek
to provide our channel partners and customers with differentiated solutions that
are innovative, easy to use, reliable, and provide good value.  To
support this commitment, we dedicate significant resources to develop new
products and market our products to our channel partners and
customers.
 
 Key
Success Factors of our Business
 
 We
believe that there are several key success factors of our business, and that we
create value in our business by focusing on our execution in these
areas.
 
 Channel
 
 Our
distributors and authorized resellers provide a valuable service in assisting
end-users in the design, implementation, and service of our network security,
content security, and business continuity solutions.  We support our
distribution and channel partners with sales, marketing, and technical support
to help them create and fulfill demand for our offerings.  We also
focus on helping our channel partners succeed with our solutions by
concentrating on comprehensive reseller training and certification, and support
for our channel’s sales activities.
 
 Product
and Service Platform
 
 Our
products serve as a platform for revenue generation for both us and our channel
partners.  Most product sales can result in additional revenue through
the simultaneous or subsequent acquisition of software licenses, such as our
Global Management System, or through the sale of additional value-added
subscription services, such as Content Filtering; client Anti-Virus and
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  integrated
Gateway Anti-Virus; Anti-Spyware and Intrusion Prevention Services; email
protection and off-site data backup.
  Distributed
Architecture
 
 Our
security solutions are based on a distributed architecture, which we believe
allows our offerings to be deployed and managed at the most efficient location
in the network.  We are providing our customers and their service
providers with mechanisms to enforce the networking and security policies they
have defined for their business.  We also use the flexibility of a
distributed architecture to allow us to enable new functionality in
already-deployed platforms through the provisioning of an electronic key, which
may be distributed through the Internet.
 
 Market
Acceptance
 
 We began
offering integrated security appliances in 1997, and since that time we have
shipped over 1.3 million revenue units.  When measured by units
shipped, we are typically among the top three suppliers in the markets in which
we compete.  Our experience in serving a broad market and our
installed base of customers provides us with opportunities to sell our new
network security, content security, and business continuity solutions as they
become available.  The market acceptance of our current solutions
provides our current and prospective channel partners with an increased level of
comfort when deciding to offer our new solutions to their
customers.
 
 Integrated
Design
 
 Our
platforms utilize a highly integrated design in order to improve ease-of-use,
lower acquisition and operational costs for our customers, and enhance
performance.  Various models also integrate functionality to support
different internet connection alternatives.  Every appliance also
ships with pre-loaded firmware to provide for rapid set up and easy
installation.  Each of these tasks can be managed through a simple
web-browser session.
 
 Our
Opportunities, Challenges, and Risks
 
 We serve
substantial markets for network security, content security, and business
continuity.  Our goal is to deliver comprehensive and profitable
solutions to our channel partners which address their customers'
needs.  We pursue the creation of these solutions through a blend of
organic and inorganic growth strategies including internal development efforts,
licensing and OEM opportunities, and acquisition of other
companies.  To the extent that these efforts result in solutions which
fit well with our channel and end-users, we would expect to generate increasing
sales.  To the extent that these efforts are not successful, we would
expect to see loss of sales and/or increased expenses without commensurate
return.
 
 International
Growth
 
 We expect
that international revenue will continue to represent a substantial portion of
our total revenue in the foreseeable future.  Our percentage of sales
from international territories does not represent the same degree of penetration
of those markets as we have achieved domestically.  We believe that a
significant opportunity exists to grow our revenue by increasing our
international penetration rate to match our penetration rate in the domestic
market.
  If we
fail to structure our distribution relationships in a manner consistent with
marketplace requirements and on favorable terms, the percentage of sales from
international territories will decline and the revenue from our international
operations may decrease.
  Growth in Enterprises
  We
believe that sales through our indirect channel to larger end-customers
represent a growth opportunity for the Company.  Our percentage of
revenues from such customers does not represent the same degree of penetration
of that segment as we have achieved with small to medium sized
businesses.  We believe that a significant opportunity exists to grow
our revenue by increasing our penetration rate with this segment by leveraging
the company’s technological and channel strengths.
  If we
fail to establish competitive products and services for this segment, or fail to
develop the correct channel partners and resources, the percentage of our
revenue derived from larger end-customers will not increase, and may, in fact,
decrease.
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 License
and Services
RevenueWe
believe that the software license and services component of our revenue has
several characteristics that are positive for our business as a whole: our
license and services revenue is associated with a higher gross profit than our
product revenue; the subscription services component of license and services
revenue is recognized ratably over the services period, and thus provides, in
the aggregate, a more predictable revenue stream than product or license
revenue, which are generally recognized at the time of the sale; and to the
extent that we are able to achieve good renewal rates, we have the opportunity
to lower our selling and marketing expenses attributable to that segment. We
have been successfully increasing the rate at which we have been able to sell
our services to both our installed base and in conjunction with our new solution
sales.  As a result, we have been able to generate incremental revenue
out of each product transaction.  We expect the percentage of our
total revenue from software licenses and services to continue to
grow.  However, should we not achieve reasonable rates of selling our
products and services to our installed base or as part of new solution sales, or
realize lower subscription service renewal rates, we risk having our revenue
concentrated in more unpredictable product and license
sales.
 
 Macro-Economic
Factors Affecting IT Spending
 
 We believe that our products and
services are subject to the macro-economic factors that affect much of the
information technology (“IT”) market.  Growing IT budgets and an
increased funding for projects to provide security, mobility, data protection,
and productivity could drive product upgrade cycles and/or create demand for new
applications of our solutions.  Contractions in IT spending can affect
our revenue by causing projects incorporating our products and services to be
delayed and/or canceled.  We believe that demand for our solutions
correlate with increases or decreases in global IT spending and we believe that
current economic uncertainties, including fluctuating energy prices,
difficulties in the financial sector, the availability of credit, softness in
the housing market, underlying market liquidity, and geopolitical uncertainties
may continue to have an adverse impact on IT spending in the markets in which we
do business.
 
 Critical
Accounting Policies and Critical Accounting Estimates
  The
preparation of our financial statements and related disclosures in conformity
with accounting principles generally accepted in the United States requires us
to make judgments, assumptions, and estimates that affect the amounts reported
in our consolidated financial statements and accompanying notes.  We
believe that the judgments, assumptions and estimates upon which we rely are
reasonable based upon information available to us at the time that these
judgments, assumptions and estimates are made.  However, any
differences between these judgments, assumptions and estimates and actual
results could have a material impact on our statement of operations and
financial condition.  The current volatility in the financial markets
and associated general economic uncertainty increase the risk that such
differences may be realized.  The accounting policies that reflect our
most significant judgments, assumptions and estimates and which we believe are
critical in understanding and evaluating our reported financial results include:
(1) revenue recognition; (2) sales returns and other allowances, allowance for
doubtful accounts and warranty reserve; (3) valuation of inventory; (4)
accounting for income taxes; (5) valuation of long-lived and intangible assets
and goodwill, (6) share-based compensation, and (7) fair value of
investments.
 
 Revenue
Recognition
 
 The
Company derives its revenue primarily from the sale of: (1) products, (2)
software licenses, (3) subscriptions for services; and (4) other services such
as extended warranty and service contracts, training, consulting and engineering
services.  As described below, significant management judgments and
estimates must be made and used in connection with the revenue recognized in any
accounting period.  The Company may experience material differences in
the amount and timing of its revenue for any period if management makes
different judgments or utilizes different estimates.
 
 The
Company recognizes product and service revenues in accordance with SEC Staff
Accounting Bulletin No. 104, Revenue Recognition,and all
related amendments and interpretations.  The Company applies
provisions of Statement of Position 97-2, Software Revenue Recognition
(SOP No. 97-2), and all related amendments and interpretations, to all
transactions involving the sale of hardware products that include software
solutions.
 
 The
Company recognizes revenue for products when persuasive evidence of an
arrangement exists, the product has been delivered, title and risk of loss have
been transferred to the customer, the fee is fixed or determinable, and
collection of the resulting receivable is reasonably assured.  While
the Company’s sales agreements contain standard terms and conditions, there are
agreements that contain non-standard terms and conditions.  In these
cases, interpretation of non-standard provisions is required to determine the
appropriate accounting for the transaction.
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 Retroactive
price protection rights resulting from price reductions on products previously
sold to customers are contractually offered to the Company’s channel
partners.  The Company evaluates the revenue impact of these rights
carefully based on stock on hand in the channels and records a provision for
estimated future price protection credit. Revenue from Ingram Micro and Tech
Data is not recognized until these distributors sell the product to their
customers.  As a consequence, there is no provision required for sales
to these distributors.  In general, retroactive price adjustments are
not significant.  At December 31, 2008, 2007, and 2006, the Company
recorded a provision for price protection on sales to the Company’s channel
partners in the amounts of $200,000, $985,000, and $42,000,
respectively.
 
 Delivery
to customers is generally deemed to occur when we deliver the product to a
common carrier.  Certain distributor agreements provide customers with
rights of return for stock rotation.  These stock rotation rights are
generally limited to 15% to 25% of the distributor's purchases for the
immediately prior 3 to 6 months period or contain other measurable restrictions,
and we estimate reserves for these return rights as discussed
below.  Two of our largest distributors, Ingram Micro and Tech Data,
have rights of return under certain circumstances that are not limited,
therefore, we do not deem delivery to have occurred for any sales to Ingram
Micro and Tech Data until they sell the product to their customers.
 
 Evidence
of an arrangement is manifested by a master distribution or OEM (Original
Equipment Manufacturer) agreement, an individual binding purchase order, or a
signed license agreement.  In most cases, sales through our
distributors and OEM partners are governed by a master agreement against which
individual binding purchase orders are placed on a transaction-by-transaction
basis.
 
 At the
time of the transaction, the Company assesses whether the fee associated with
the transaction is fixed or determinable, and whether or not collection is
reasonably assured.  The Company assesses whether the fee is fixed or
determinable based upon the terms of the binding purchase order, including the
payment terms associated with the transaction.  If a significant
portion of a fee is due beyond the Company’s normal payment terms, typically 30
to 90 days from invoice date, the Company accounts for the fee as not being
fixed or determinable and recognizes revenue as the fees become
due.
  The
Company assesses probability of collection based on a number of factors,
including past transaction history with and the credit-worthiness of the
customer.  The Company does not request collateral from its
customers.  If the Company determines that collection of a fee is not
reasonably assured, it defers the fee and recognizes revenue at the time
collection becomes reasonably assured, which is generally upon receipt of
cash.
  For
arrangements with multiple obligations (for example, the sale of an appliance
which includes a year of maintenance or a subscription based product), the
Company allocates revenue first to undelivered components of the arrangement
based on the vendor specific objective evidence of fair value of the undelivered
elements, which is generally the average selling price of each element when sold
separately.  This allocation process means that the Company defers
revenue from the arrangement equal to the fair value of the undelivered elements
and recognizes such amounts as revenue when the elements are
delivered.
 
 The
Company’s arrangements do not generally include acceptance
clauses.  However, if an arrangement includes an acceptance provision,
recognition of revenue occurs upon the earlier of receipt of a written customer
acceptance or expiration of the acceptance period.
 
 The
Company recognizes revenue for subscriptions and services such as content
filtering, anti-virus protection and intrusion prevention, and extended warranty
and service contracts, ratably over the contract term.  The Company’s
training, consulting and engineering services are generally billed and
recognized as revenue as these services are performed.
 
 The
Company collects and remits sales taxes on products and services that it
purchases and sells under its contracts withcustomers, and reports
such amounts under the net method in its consolidated statements of
operations.  Accordingly, there are no salestaxes included in
revenue.
  Sales
Returns and Other Allowances, Allowance for Doubtful Accounts, and Warranty
Reserve
 
 The
preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires us to make estimates
and assumptions that affect the reported amount of assets and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reported
period.  Specifically, we must make estimates of potential future
product returns and price changes related to current
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 period
product revenue.  We analyze historical returns, current economic
trends, and changes in customer demand and acceptance of our products when
evaluating the adequacy of the sales returns and other
allowances.  Significant management judgments and estimates must be
made and used in connection with establishing the sales returns and other
allowances in any accounting period.  We may experience material
differences in the amount and timing of our revenue for any period if management
makes different judgments or utilizes different estimates.
  In
addition, we must make estimates based upon a combination of factors to ensure
that our accounts receivable balances are not overstated due to
uncollectibility.  We specifically analyze accounts receivable and
historical bad debts, the length of time receivables are past due, macroeconomic
conditions including liquidity and the availability of credit facilities,
deterioration in customer’s operating results or financial position, customer
concentrations, and customer credit-worthiness, when evaluating the adequacy of
the allowance for doubtful accounts.
  Our
appliance products are generally covered by a warranty period of one or two
years.  We accrue a warranty reserve for estimated costs to provide
warranty services, including the cost of technical support, product repairs, and
product replacement for units that cannot be repaired.  Our estimate
of costs to fulfill our warranty obligations is based on historical experience
and expectation of future conditions.  To the extent we experience
increased warranty claim activity or increased costs associated with servicing
those claims, our warranty accrual will increase, resulting in decreased gross
profit.
  Valuation
of Inventory
 
 We
continually assess the valuation of our inventory and periodically write-down
the value for estimated excess and obsolete inventory based upon assumptions
about future demand and market conditions.  Such estimates are
difficult to make since they are based, in part, on estimates of current and
future economic conditions.  Reviews for excess inventory are done on
a quarterly basis and required reserve levels are calculated with reference to
our projected ultimate usage of that inventory.  In order to determine
the ultimate usage, we take into account forecasted demand, rapid technological
changes, product life cycles, projected obsolescence, current inventory levels,
and purchase commitments.  The excess balance determined by this
analysis becomes the basis for our excess inventory charge.  If actual
demand is lower than our forecasted demand, and we fail to reduce manufacturing
output accordingly, we could be required to record additional inventory
write-downs, which would have a negative effect on our gross profit and
earnings.
 
 Accounting
for Income Taxes
 
 As part
of the process of preparing our consolidated financial statements we are
required to estimate our taxes in each of the jurisdictions in which we
operate.  We must make certain estimates and judgments in determining
income tax expense for financial statement purposes.  These estimates
and judgments occur in the calculation of tax credits, benefits, and deductions,
and in the calculation of certain tax assets and liabilities, which arise from
differences in the timing of recognition of revenue and expense for tax and
financial statement purposes, as well as the interest and penalties related to
these uncertain tax positions. Significant changes to these estimates may result
in an increase or decrease to our tax provision in a subsequent
period.
 
 We must
assess the likelihood that we will be able to recover our deferred tax assets.
If recovery is not likely, we must increase our provision for taxes by recording
a valuation allowance against the deferred tax assets that we estimate will not
ultimately be recoverable.  We believe that we will ultimately recover
a substantial majority of the deferred tax assets recorded on our consolidated
balance sheets.  However, should there be a change in our ability to
recover our deferred tax assets, our tax provision would increase in the period
in which we determined that the recovery was not likely.
  The
calculation of our tax liabilities involves dealing with uncertainties in the
application of complex tax regulations. We recognize liabilities for uncertain
tax positions based on the two-step process.  The first step is to
evaluate the tax position for recognition by determining if the weight of
available evidence indicates that it is more likely than not that the position
will be sustained on audit, including resolution of related appeals or
litigation processes, if any.  The second step requires us to estimate
and measure the tax benefit as the largest amount that is more than 50% likely
to be realized upon ultimate settlement.  It is inherently difficult
and subjective to estimate such amounts, as we have to determine the probability
of various possible outcomes.  We reevaluate these uncertain tax
positions on a quarterly basis.  This evaluation is based on factors
including, but not limited to, changes in facts or circumstances, changes in tax
law, effectively settled issues under audit, and new audit
activity.  Such a change in recognition or measurement would result in
the recognition of a tax benefit or an additional charge to the tax
provision.
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  Valuation
of Long-Lived Assets, Intangible Assets and Goodwill
 
 Purchased
intangibles consist of purchased technology, customer installed
base/relationships, customer backlog and other
intangibles.  Intangible assets are amortized on a straight-line basis
over their estimated useful lives which range from 3 months to eight
years.  We periodically evaluate our intangible assets for indications
of impairment.  If this evaluation indicates that the value of the
intangible asset may be impaired, we make an assessment of the recoverability of
the net carrying value of the asset over its remaining useful
life.  If this assessment indicates that the intangible asset is not
recoverable, based on the estimated undiscounted future cash flows of the
technology over the remaining amortization period, we reduce the net carrying
value of the related intangible asset to fair value and may adjust the remaining
amortization period.
 
 Goodwill
represents the excess of the aggregate purchase price over the fair market value
of the net tangible and intangible assets acquired by the
Company.  Goodwill is tested for impairment in the fourth quarter of
each fiscal year or more often if an event or circumstances indicate that an
impairment loss has been incurred.  An impairment charge is recognized
if a reporting unit’s goodwill carrying amount exceeds its implied fair
value.  Goodwill impairment is determined using a two-step approach in
accordance with SFAS 142, Goodwill and Other Intangible Assetsusing one or more of the following fair value measures including: present
value techniques of estimated future cash flows; or valuation techniques based
on multiples of earnings or revenue, or a similar performance
measure.  Any such impairment charge could be significant and could
have a material adverse effect on our reported financial
statements.  Based on the impairment tests performed, there was no
impairment of goodwill in 2008, 2007, and 2006.  The goodwill recorded
as a result of the business combinations in the years presented is not
deductible for tax purposes.
 
 We
continually monitor events and changes in circumstances that could indicate
carrying amounts of long-lived assets, including intangible assets, may not be
recoverable.  When such events or changes in circumstances occur, we
assess the recoverability of long-lived assets by determining whether the
carrying value of such assets will be recovered through undiscounted expected
future cash flows.  If the total of the future cash flows is less than
the carrying amount of those assets, we record an impairment charge based on the
excess of the carrying amount over the fair value of the assets.
 
 Share-Based
Compensation
 
 On
January 1, 2006, the Company adopted SFAS 123R, which requires the
measurement and recognition of compensation expense for all share-based payment
awards made to employees and directors including employee stock options and
employee stock purchases related to the Employee Stock Purchase Plan (“employee
stock purchases”) based on estimated fair values. The Company adopted SFAS 123R
using the modified prospective transition method, which requires the application
of the accounting standard as of January 1, 2006, the first day of the
Company’s fiscal year 2006.  The Company’s Consolidated Financial
Statements as of and for the years ended December 31, 2008, 2007, and 2006
reflect the impact of SFAS 123R.
 
 SFAS 123R
requires companies to estimate the fair value of share-based payment awards on
the date of grant using an option-pricing model.  The value of the
portion of the award that is ultimately expected to vest is recognized as
expense over the requisite service periods in the Company’s Consolidated
Statements of Operations.
  Share-based
compensation expense recognized in the Consolidated Statements of Operations for
the years ended December 31, 2008, 2007, and 2006 are based on awards ultimately
expected to vest and has been reduced for estimated
forfeitures.  Share-based compensation expense recognized in the
Company’s Consolidated Statements of Operations for the years ended December 31,
2008, 2007, and 2006 included compensation expense for share-based payment
awards granted prior to, but not yet vested as of December 31, 2005 based
on the grant date fair value estimated in accordance with the pro forma
provisions of SFAS 123 and compensation expense for the share-based payment
awards granted subsequent to December 31, 2005 based on the grant date fair
value estimated in accordance with the provisions of SFAS 123R. In conjunction
with the adoption of SFAS 123R, the Company continued to use the straight-line
single option method.  SFAS 123R requires forfeitures to be estimated
at the time of grant and revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates.
 
 Fair
Value of Investments
 
 Fair
Value
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  Our
investments consist of U.S. Treasury and U.S. government agency securities,
auction rate securities (ARS), asset backed securities (ABS), corporate notes
and bonds, commercial paper, and money market funds. In the current market
environment, the assessment of the fair value of the debt securities can be
difficult and subjective. The volume of trading activity of certain
debt instruments has declined, and the rapid changes occurring in today’s
financial markets can lead to changes in the fair value of financial instruments
in the relatively short periods of time. Financial Accounting Standards
Board (FASB) Statement No. 157, “Fair Value Measurements”
(SFAS 157) establishes three levels of inputs that may be used to measure
fair value (see “Note 3: Investments and Fair Value Measurements” in the Notes
to the Consolidated Financial Statements of this Form 10-K). Each level of
input has different levels of subjectivity and difficulty involved in
determining fair value.
 
 Level 1
instruments generally represent quoted prices in active markets. Therefore,
determining fair value for Level 1 instruments generally does not require
significant management judgment, and the estimation is not
difficult.
 
 Level 2
instruments include inputs other than Level 1 that are observable, either
directly or indirectly, such as quoted prices for similar assets or
liabilities; quoted prices for identical instruments in markets that are
not active; or other inputs that are observable or can be corroborated by
observable market data for substantially the full term of the assets or
liabilities.
 
 Level 3
instruments include unobservable inputs that are supported by little or no
market activity and that are significant to the fair value of the assets
or liabilities. The determination of fair value for Level 3 instruments
requires the most management judgment and subjectivity.
 All of
the securities classified as Level 3 instruments are ARS and ABS.  In
February 2008, auctions began to fail for the auction rate securities (ARS).
Since auctions for ARS continue to fail, the investments are not currently
liquid. All ARS are currently rated AAA, the highest rating by a rating agency,
and the underlying collateral of the ARS consists of student loan obligations,
which are primarily supported by the federal government as part of the Federal
Family Education Loan Program (“FFELP”). The Company does not expect the need to
access these funds in the short-term; however, in the event the Company needed
to access these funds, they are not expected to be accessible until one of the
following occurs: a successful auction occurs, the issuer redeems the issue,
a buyer is found outside of the auction process or the underlying
securities mature. Based on these factors, along with the underlying
maturities of the securities, a portion of which is greater than 20 years, the
Company has classified auction rate securities as long-term assets on its
Consolidated Balance Sheet as of December 31, 2008. The ARS were classified
as short-term investments as of December 31, 2007. The failures of these
auctions do not affect the value of the collateral underlying the ARS, and the
Company continues to earn and receive interest on its ARS based on a
pre-determined formula.
 
 Notwithstanding
the foregoing, in November 2008, the Company accepted an offer (the “Right”)
from UBS, one of its investment providers, entitling the Company to sell to UBS
at par value ARS originally purchased from UBS (approximately $45.3 million, par
value) at anytime during the period commencing June 30, 2010 through
July 2, 2012.  In accepting the Right, the Company also granted UBS
the authority to sell or auction the ARS at par at any time after accepting the
offer until the expiration date of the offer provided that the Company receive
par value of their ARS.  As part of the offer, the Company released
UBS from any claims relating to the marketing and sale of ARS. Although the
Company expects to sell its ARS under the Right, if the Right is not exercised
before July 2, 2012, the Right will expire and UBS will have no further
right or obligation to buy the Company’s ARS.
 
 UBS’s
obligations under the Right are not secured by its assets and do not require UBS
to obtain any financing to support its performance obligations under the Rights.
UBS has disclaimed any assurance that it will have sufficient financial
resources to satisfy its obligations under the Rights.
 
 The Right
represents a firm agreement in accordance with FASB Statement No. 133,
“Accounting
for Derivative Instruments and Hedging Activities ”, (SFAS 133), which
defines a firm agreement with an unrelated party, binding on both parties and
usually legally enforceable, with the following characteristics: a) the
agreement specifies all significant terms, including the quantity to be
exchanged, the fixed price, and the timing of the transaction, and b) the
agreement includes a disincentive for nonperformance that is sufficiently large
to make performance probable.  The enforceability of the Right results in a
put option and should be recognized as a separate freestanding asset and is
accounted for separately from the ARS investment. As of December 31, 2008,
the Company recorded $7.6 million as the fair value of the put option asset,
classified as long-term investment on the Balance Sheet as of December 31,
2008, with a corresponding credit to Interest and other income, net, in the
Consolidated Statement of Income for the year ended December 31, 2008. The
put option does not meet the definition of a
 38
 Table of Contents
 derivative
instrument under SFAS 133. Therefore, the Company elected to measure the put
option at fair value under SFAS 159, which permits an entity to elect the fair
value option for recognized financial assets, in order to match the changes in
the fair value of the ARS.  On date available as of December 31, 2008,
the Company valued the Right using a discounted cash flow approach including
estimates of interest rates, timing and amount of cash flow, adjusted for
any bearer risk associated with UBS’s financial ability to repurchase the ARS
beginning June 30, 2010. These assumptions are volatile and subject to
change if the underlying sources of these assumptions and market conditions
change.
 
 Prior to
accepting the UBS offer, the Company recorded its ARS as available-for-sale
investments. In connection with the acceptance of the UBS offer in November
2008, resulting in a right to require UBS to purchase the ARS at par value
beginning on June 30, 2010, the Company has reclassified the related
portion of its ARS subject to the Right and held by UBS from available-for-sale
to trading in accordance with FASB Statement No. 115, “Accounting for Certain Investments
in Debt and Equity Securities” (SFAS 115). The transfer to trading
securities reflects management’s intent to exercise its put option during the
period June 30, 2010 to July 3, 2012.  Prior to its agreement
with UBS, management’s intent was to hold the ARS until the earlier of
anticipated recovery in market value or maturity.  Upon the
reclassification of the related ARS to trading securities, the Company
immediately recognized a loss of $7.8 million, included in Interest and other
income, net, for the amount of the unrealized loss not previously recognized in
earnings.  The Company holds additional ARS with another investment advisor
who has not made an offer similar to UBS.  These ARS will continue to be
held as available-for-sale.  The Company intends to retain its investment
in the ARS until the earlier of anticipated recovery in market value or maturity
and as a result has not recorded an other-than-temporary loss on these
ARS.
 As of
December 31, 2008, the underlying assets of the asset backed securities (ABS)
are all prime mortgages.  None of the underlying assets of these ABS
are subprime mortgages or have a collateralized debt obligation
exposure.  The Company has $25.1 million in ABS backed by the U.S.
Government.  These securities could be generally liquidated within a
timeframe of three to nine months and were included in short-term investments on
the consolidated balance sheet.  For the remaining $15.3 million in
non-government backed ABS, the market continues to be illiquid.  As a
result, the Company has classified these as long-term.  The Company
has both the intent and the ability to hold these investments until a recovery
of the fair value occurs, which may be at maturity, evidenced by its cash and
short-term investment position and the ability to generate positive cash flows
from its operation.
 Historically,
the fair value of the ARS and the ABS investments approximated par value
due to the frequent resets through the auction process.  While the Company
continues to earn interest on its ARS and ABS investments at the contractual
rate, these investments are not currently trading and therefore do not have a
readily determinable market value.  Accordingly, the estimated fair value
of the ARS no longer approximates par value.  At December 31, 2008,
the Company’s investment advisors provided a valuation based on Level 3 inputs
for the ARS and the ABS investments.  The investment advisors utilized a
discounted cash flow approach to arrive at this valuation, which for the ARS
securities was corroborated by a separate and comparable discounted cash flow
analysis prepared by the Company.  The assumptions used in preparing the
discounted cash flow model include estimates of, based on data available as of
December 31, 2008, interest rates, timing and amount of cash flows, credit
and liquidity premiums, and expected holding periods of the ARS.  The
Company valued the Right as a put option asset using a discounted cash flow
approach including estimates of, based on Level 3 data available as of
December 31, 2008, interest rates, timing and amount of cash flow, adjusted
for any bearer risk associated with UBS’s financial ability to repurchase the
ARS beginning June 30, 2010.  In addition, the Company engaged an
independent valuation firm to evaluate the values received from the
broker/dealer statement for the ABS securities.  The independent valuation
firm used a market approach methodology utilizing information such as trade
data, two-sided markets, institutional bids, comparable trades, dealer quotes,
and data from news media.  The Company reviewed the methodology used and
the resulting valuation confirms the quotes received from the investment
advisor.  The assumptions used in valuing the ARS, the ABS, and the
put option are volatile and subject to change as the underlying sources of these
assumptions and market conditions change.
 
 Other-Than-Temporary
Impairment. All of the Company’s available-for-sale investments are
subject to a periodic impairment review.  The Company recognizes an
impairment charge when a decline in the fair value of its investments below the
cost basis is judged to be other-than-temporary.  The Company considers
various factors in determining whether to recognize an impairment charge,
including the length of time and extent to which the fair value has been less
than the Company’s cost basis, the financial condition and near-term prospects
of the investee, and the Company’s intent and ability to hold the investment for
a period of time sufficient to allow for any anticipated recovery in the market
value.  During the years ended December 31, 2008, 2007 and 2006 the
Company did not record any other-than-temporary impairment charges on its
available-for-sale securities.
 39
 Table of Contents
 Significant
Transactions
  Acquisitions
 
 On July
10, 2007, the Company completed the acquisition of 100% of the outstanding
shares of Aventail Corporation (“Aventail”) for approximately $25.6 million
in purchase consideration, consisting of cash of approximately $23.6 million,
$2.0 million in direct transaction costs incurred in connection with the
acquisition, and stock options assumed.  In accordance with Statement
of Financial Accounting Standards (SFAS) No. 141,Business
Combinations(SFAS 141), this transaction was accounted for as
a purchase business combination.  The Company acquired Aventail to
complement and extend its current SSL-VPN product offering.  Of the
total purchase price of $25.6 million, approximately $1.9 million was allocated
to in-process research and development, approximately $6.9 million was allocated
to purchased technology that will be amortized over its estimated useful life of
six years, approximately $7.9 million was allocated to customer relationship
that will be amortized over eight years, approximately $2.6 million was used to
pay off an assumed loan, and approximately $4.0 million was recorded for net
liabilities assumed.  The remaining $15.4 million was allocated to
goodwill. In addition, pursuant to the terms of the Merger Agreement, 744,043
stock options held by employees of Aventail were assumed by
SonicWALL.  The fair value as of the acquisition date of these stock
options assumed, using the Black-Scholes valuation method, was $2.2
million.  There were no options vested as of the acquisition date thus
the purchase price component related to the assumption was zero.  The
total fair value of $2.2 million is being recognized as compensation cost over
the requisite service period.
 
 On
February 22, 2006, the Company completed the acquisition of MailFrontier, Inc.
(“MailFrontier”) for approximately $29.8 million in purchase consideration,
consisting of cash of approximately $29.3 million, assumed stock options with a
fair value of $109,000 and direct transaction costs incurred in connection with
the acquisition of approximately $450,000.  The Company acquired
MailFrontier to expand its offering in secure content management, especially in
the email security market.  MailFrontier’s email security solutions
protect organizations against inbound and outbound threats such as “spam”,
“phishing”, “viruses”, directory harvest attacks and policy violations, provide
control for content compliance, and enable consolidation of email
infrastructure.  In addition, certain employees of MailFrontier became
employees of the Company.  Of the total purchase price of $29.8
million, $1.6 million was allocated to in-process research and development, $2.7
million was allocated to purchased technology that is being amortized over its
estimated useful life of four years, approximately $600,000 was allocated to
customer relationship that is being amortized over six years, approximately
$300,000 was allocated to technology licenses and non-compete covenants that is
being amortized over a period of 4 to 24 months, and $3.6 million was recorded
for net liabilities assumed.  The remaining $28.2 million was
allocated to goodwill.
 
 The
Consolidated Financial Statements include the operating results of each business
from the date of acquisition.  In accordance with SFAS 141, Business Combinations, the
above transactions were accounted for as a purchase business
combination.  The Company allocated the purchase price based upon the
fair value of the assets acquired and liabilities assumed.  The excess
of the purchase price over the fair value of the assets acquired and liabilities
assumed has been allocated to the identified intangible assets in accordance
with the requirements of SFAS 141 and SFAS 142, Goodwill and Other Intangible
Assets.
  Commercialization
of acquired technologies carries a significant risk due to the remaining efforts
to achieve technical viability, rapidly changing customer markets, uncertain
standards for new products, and significant competitive threats.  The
nature of the efforts to develop these technologies into commercially viable
products consists primarily of planning, designing, experimenting, and testing
activities necessary to determine that the technologies can meet market
expectations, including functionality and technical
requirements.  Failure to bring products to market in a timely manner
could result in a loss of market share or a lost opportunity to capitalize on
emerging markets and could have a material adverse impact on our business and
operating results.
  Restructuring
  During
the first quarter of fiscal year 2008, the Company commenced the implementation
of a 2008 restructuring plan associated primarily with the relocation of support
activities, the closure of facilities in Pune, India and Sunnyvale, California,
and other employee reductions for the purpose of better integration and
alignment of Company functions.
 
 During
the first quarter of fiscal 2006, the Company commenced the implementation of a
2006 restructuring plan associated primarily with the integration of companies
acquired during the fourth quarter of 2005 and the first quarter of 2006 as well
as other employee reductions for the purpose of better integration and alignment
of Company functions.  40
 Table of Contents
  The
information contained in Note 7 to the Consolidated Financial Statements is
hereby incorporated by reference into this Part II, Item 7.


Results
of Operations





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




Year
      Ended December 31,2008
                
                
                2007
                
                
                2006Revenues:Product
                
                
                41.6%
                
                
                
                49.7%
                
                
                
                52.9%License
      and service
                
                
                58.4%
                
                
                
                50.3%
                
                
                
                47.1%Total
      revenues
                
                
                100.0%
                
                
                
                100.0%
                
                
                
                100.0%Cost
      of revenues:Product
                
                
                19.9%
                
                
                
                20.4%
                
                
                
                22.3%License
      and service
                
                
                9.2%
                
                
                
                8.0%
                
                
                
                7.0%Amortization
      of purchased technology
                
                
                1.4%
                
                
                
                1.1%
                
                
                
                3.1%Total
      cost of revenues
                
                
                30.5%
                
                
                
                29.5%
                
                
                
                32.4%Gross
      profit
                
                
                69.5%
                
                
                
                70.5%
                
                
                
                67.6%Operating
      expenses:Research
      and development
                
                
                20.2%
                
                
                
                19.8%
                
                
                
                19.2%Sales
      and marketing
                
                
                37.7%
                
                
                
                39.0%
                
                
                
                40.5%General
      and administrative
                
                
                8.5%
                
                
                
                10.8%
                
                
                
                11.6%Amortization
      of purchased intangible assets
                
                
                0.5%
                
                
                
                0.4%
                
                
                
                1.6%Restructuring
      charges
                
                
                0.8%
                
                
                
                0.0%
                
                
                
                0.8%In-process
      research and development
                
                
                0.0%
                
                
                
                1.0%
                
                
                
                0.9%Total
      operating expenses
                
                
                67.7%
                
                
                
                71.0%
                
                
                
                74.6%Income
      (loss) from operations
                
                
                1.8%
                
                
                
                (0.5%)
                
                
                
                (7.0%)Interest
      income and other expense, net
                
                
                2.9%
                
                
                
                5.9%
                
                
                
                5.5%Income
      (loss) before income taxes
                
                
                4.7%
                
                
                
                5.4%
                
                
                
                (1.5%)Benefit
      (provision) for income taxes
                
                
                (2.5%)
                
                
                
                8.8%
                
                
                
                (4.6%)Net
      income (loss)
                
                
                2.2%
                
                
                
                14.2%
                
                
                
                (6.1%)





The
following table shows SFAS 123R share-based compensation cost before taxes as a
percent of total revenue for the periods indicated:


Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Cost
      of sales
                  
                  
                  0.2%
                  
                  
                  
                  0.3%
                  
                  
                  
                  0.3%Research
      and development
                  
                  
                  1.5%
                  
                  
                  
                  2.3%
                  
                  
                  
                  2.5%Sales
      and marketing
                  
                  
                  1.7%
                  
                  
                  
                  2.4%
                  
                  
                  
                  2.9%General
      and administrative
                  
                  
                  1.4%
                  
                  
                  
                  2.0%
                  
                  
                  
                  2.5%Total
      Share-based compensation expenses
                  
                  
                  4.8%
                  
                  
                  
                  7.0%
                  
                  
                  
                  8.2%
  Total
Revenue
 
 Total
Revenue by Product Category (in thousands, except for percentage
data)
 41
 Table of Contents


Year Ended December 31,
                                
                                
                                Dollar Change
                                
                                
                                Percent Change2008
                                
                                
                                2007
                                
                                
                                2006
                                
                                
                                2008 vs. 2007
                                
                                
                                2007 vs. 2006
                                
                                
                                2008 vs. 2007
                                
                                
                                2007 vs. 2006UTM
                                
                                $
                                164,788
                                
                                
                                $
                                147,696
                                
                                
                                $
                                142,246
                                
                                
                                $
                                17,092
                                
                                
                                $
                                5,450
                                
                                
                                
                                12%
                                
                                
                                
                                4%%
      of total revenue
                                
                                
                                75%
                                
                                
                                
                                74%
                                
                                
                                
                                81%SSL
                                
                                
                                20,668
                                
                                
                                
                                15,706
                                
                                
                                
                                5,913
                                
                                
                                
                                4,962
                                
                                
                                
                                9,793
                                
                                
                                
                                32%
                                
                                
                                
                                166%%
      of total revenue
                                
                                
                                9%
                                
                                
                                
                                8%
                                
                                
                                
                                3%SCM
                                
                                
                                22,988
                                
                                
                                
                                23,604
                                
                                
                                
                                20,034
                                
                                
                                
                                (616
                                )
                                
                                
                                3,570
                                
                                
                                
                                (3%)
                                
                                
                                
                                18%%
      of total revenue
                                
                                
                                11%
                                
                                
                                
                                12%
                                
                                
                                
                                12%CDP
                                
                                
                                10,200
                                
                                
                                
                                12,193
                                
                                
                                
                                7,345
                                
                                
                                
                                (1,993
                                )
                                
                                
                                4,848
                                
                                
                                
                                (16%)
                                
                                
                                
                                66%%
      of total revenue
                                
                                
                                5%
                                
                                
                                
                                6%
                                
                                
                                
                                4%Total
      revenue
                                
                                $
                                218,644
                                
                                
                                $
                                199,199
                                
                                
                                $
                                175,538
                                
                                
                                $
                                19,445
                                
                                
                                $
                                23,661
                                
                                
                                
                                10%
                                
                                
                                
                                13%
 The
growth in revenue in the UTM product category in 2008 compared to 2007 was
primarily due to increased sales of our subscription services, offset by a
decrease in product revenue.  The growth in subscription services
revenue was largely attributed to increased revenue from our CGSS subscriptions
services.  Product revenue declined primarily due to a decrease in net
revenue per unit and unit sales in the TZ product offerings, offset by an
increase in net revenue per unit associated with the NSA/PRO products combined
with a slight increase in units sold.  The growth in revenue in the
SSL product category in 2008 compared to 2007 was primarily due to increased
sales of extended service contracts and software licenses, associated with
products that were available for all of 2008 but limited to the second half of
2007.  The decline in revenue in the SCM product category in 2008
compared to 2007 was primarily due to reduced product and software license
revenue, offset by increased sales of extended service
contracts.  This decline in product revenue was caused by a decrease
in unit sales and in net revenue per unit.  The decline in revenue in
the CDP product category in 2008 compared to 2007 was primarily due to decreased
unit sales of CDP appliances, offset by increased sales of extended service
contracts.
 
 The
growth in revenue in the UTM product category in 2007 compared to 2006 was
primarily due to increased sales of our subscription services, offset by
decreased software license sales, appliance sales, and revenue from extended
service contracts.  The growth in subscription services was primarily
due to increased revenue from our CGSS subscriptions services.  The
decline in software license sales was a result of reduced revenue from enhanced
operating system upgrades.  Product revenue declined primarily due to
lower unit sales in the TZ product offerings, offset by increased unit sales of
the PRO and Access Point products.  The growth in revenue in the SSL
product category in 2007 compared to 2006 was primarily due to increased sales
of products, extended service contracts and software licenses.  The
growth in all SSL categories was a direct result of the Aventail acquisition at
the beginning of the third quarter of 2007.  The growth in revenue in
the SCM product category in 2007 compared to 2006 was primarily due to increased
revenue from email subscription services and increased email security appliance
sales.  The growth in product revenue was primarily due to increased
unit sales, offset by a reduction in net revenue per unit.  The growth
in revenue in the CDP product category in 2007 compared to 2006 was primarily
due to increased appliance sales and increased sales of extended service
contracts. The growth in product revenue was primarily driven by an increase in
net revenue per unit.
  Total
Revenue by Geographic Area (in thousands, except for percentage
data)
  Year Ended December 31,
                                
                                
                                Dollar Change
                                
                                
                                Percent Change2008
                                
                                
                                2007
                                
                                
                                2006
                                
                                
                                2008 vs. 2007
                                
                                
                                2007 vs. 2006
                                
                                
                                2008 vs. 2007
                                
                                
                                2007 vs. 2006Americas
                                
                                $
                                149,986
                                
                                
                                $
                                138,678
                                
                                
                                $
                                124,806
                                
                                
                                $
                                11,308
                                
                                
                                $
                                13,872
                                
                                
                                
                                8%
                                
                                
                                
                                11%%
      of total revenue
                                
                                
                                69%
                                
                                
                                
                                70%
                                
                                
                                
                                71%EMEA
                                
                                
                                46,144
                                
                                
                                
                                40,420
                                
                                
                                
                                32,865
                                
                                
                                
                                5,724
                                
                                
                                
                                7,555
                                
                                
                                
                                14%
                                
                                
                                
                                23%%
      of total revenue
                                
                                
                                21%
                                
                                
                                
                                20%
                                
                                
                                
                                19%APAC
                                
                                
                                22,514
                                
                                
                                
                                20,101
                                
                                
                                
                                17,867
                                
                                
                                
                                2,413
                                
                                
                                
                                2,234
                                
                                
                                
                                12%
                                
                                
                                
                                13%% of
      total revenue
                                
                                
                                10%
                                
                                
                                
                                10%
                                
                                
                                
                                10%Total
      revenue
                                
                                $
                                218,644
                                
                                
                                $
                                199,199
                                
                                
                                $
                                175,538
                                
                                
                                $
                                19,445
                                
                                
                                $
                                23,661
                                
                                
                                
                                10%
                                
                                
                                
                                13%
 42
 Table of Contents
 The
growth in revenue in the Americas in 2008 compared to 2007 was primarily due to
increased sales of (1) UTM solutions driven by increased sales of CGSS
subscription services; and (2) SSL solutions attributable to the sales of
products and support agreements that were only available in the second half of
2007 compared to all of 2008.  These increases were offset by
decreased sales of CDP solutions due to a decrease in the number of appliances
sold.  Revenue in the Americas included sales from regions outside the
United States of $40.0 million, $34.4 million, and $30.9 million for the years
ended December 31, 2008, 2007, and 2006, respectively.  The growth in
revenue in EMEA in 2008 compared to 2007 was primarily due to increased sales of
(1) UTM solutions; (2) SSL solutions attributable to the sale of products and
support agreements that were only available in the second half of 2007 compared
to all of 2008; (3) SCM solutions; and (4) CDP hardware and extended service
contracts.  The increase in revenue in APAC in 2008 compared to 2007
was primarily due to increased revenue from (1) our UTM solutions; and (2) SSL
solutions attributable to the sale of products and support agreements that were
only available in the second half of 2007 compared to four quarters in
2008.
 
 The
growth in revenue in the Americas in 2007 compared to 2006 was primarily due to
increased sales of (1) SSL solutions driven by the sales of Aventail products
and support agreements that were only available in the second half of 2007 and
not in 2006; (2) CDP solutions, (3) SCM solutions; and (4) UTM
offerings.  The growth in revenue in EMEA in 2007 compared to 2006 was
primarily due to increased sales of (1) SSL solutions driven by the sales of
Aventail products and support agreements that were only available in the second
half of 2007 and not in 2006; (2) UTM offerings; (3) SCM solutions; and (4) CDP
solutions.  The growth in revenue in APAC in 2007 compared to 2006 was
primarily due to increased sales of (1) SSL solutions driven by the sales of
Aventail products and support agreements that were only available in the second
half of 2007 and not available in 2006, and (2) UTM
offerings.
  Product
and License and Service Revenue (in thousands, except for percentage
data)
 Year ended December 31,
                                      
                                      
                                      Dollar Change
                                      
                                      
                                      Percent Change2008
                                      
                                      
                                      2007
                                      
                                      
                                      2006
                                      
                                      
                                      2008 vs. 2007
                                      
                                      
                                      2007 vs. 2006
                                      
                                      
                                      2008 vs. 2007
                                      
                                      
                                      2007 vs. 2006Product
                                      
                                      $
                                      90,857
                                      
                                      
                                      $
                                      98,936
                                      
                                      
                                      $
                                      92,797
                                      
                                      
                                      $
                                      (8,079
                                      )
                                      
                                      $
                                      6,139
                                      
                                      
                                      
                                      (8%)
                                      
                                      
                                      
                                      7%%
      of total revenue
                                      
                                      
                                      42%
                                      
                                      
                                      
                                      50%
                                      
                                      
                                      
                                      53%License
      and service
                                      
                                      
                                      127,787
                                      
                                      
                                      
                                      100,263
                                      
                                      
                                      
                                      82,741
                                      
                                      
                                      
                                      27,524
                                      
                                      
                                      
                                      17,522
                                      
                                      
                                      
                                      27%
                                      
                                      
                                      
                                      21%%
      of total revenue
                                      
                                      
                                      58%
                                      
                                      
                                      
                                      50%
                                      
                                      
                                      
                                      47%Total
      revenue
                                      
                                      $
                                      218,644
                                      
                                      
                                      $
                                      199,199
                                      
                                      
                                      $
                                      175,538
                                      
                                      
                                      $
                                      19,445
                                      
                                      
                                      $
                                      23,661
                                      
                                      
                                      
                                      10%
                                      
                                      
                                      
                                      13%
  Product
Revenue
 
 We
shipped approximately 182,000, 196,000, and 193,000 total units, respectively,
during fiscal 2008, 2007, and 2006.
 
 The
decrease in product revenue in 2008 compared to 2007 was primarily due to lower
unit sales and lower revenue per unit in the UTM, SSL, CSM, and CDP product
categories.
 The
increase in product revenue in 2007 compared to 2006 was primarily due to higher
revenue per unit in the SSL and CDP product categories combined with higher unit
sales of SCM and SSL products, offset by lower revenue per unit in the SCM
product category and a decrease in the unit sales of UTM
products.
  License
and Service Revenue
  The
increases in license and service revenue in 2008 compared to 2007 and 2007
compared to 2006 were primarily due to increases in all four product
categories.
  We have
experienced significant year over year growth in license and services revenue
and expect the market opportunity for our license and subscription service
offerings to grow as our product sales increase and customer awareness around
the dynamic requirements of unified network threat prevention and management
becomes more pervasive.  In addition, there is an opportunity to sell
subscription service offerings in conjunction with our product offerings in
continuous data protection, SSL and email security and to our installed base of
customers in the form of renewals of existing contracts along with additional
services.
 
 Cost
of Revenue and Gross Profit
 43
 Table of Contents
  The
following table shows the cost of revenue for product and the cost of revenue
for license and service (in thousands, except for percentage
data):
 Year
      Ended December 31,
                            
                            
                            Percent
      Variance2008
                            
                            
                            2007
                            
                            
                            2006
                            
                            
                            2008
      vs. 2007
                            
                            
                            2007
      vs. 2006Product
                            
                            $
                            43,507
                            
                            
                            $
                            40,555
                            
                            
                            $
                            39,164
                            
                            
                            
                            7%
                            
                            
                            
                            4%License
      and service
                            
                            $
                            20,102
                            
                            
                            $
                            15,894
                            
                            
                            $
                            12,287
                            
                            
                            
                            26%
                            
                            
                            
                            29%Amortization
      of purchased technology
                            
                            $
                            3,017
                            
                            
                            $
                            2,232
                            
                            
                            $
                            5,387
                            
                            
                            
                            35%
                            
                            
                            
                            (59%)Total
      cost of revenue
                            
                            $
                            66,626
                            
                            
                            $
                            58,681
                            
                            
                            $
                            56,838
                            
                            
                            
                            14%
                            
                            
                            
                            3%
 Note
      –
                  Effect
      of amortization of purchased technology has been excluded from product and
      license and service gross profit discussions
  below.
  The
following table shows the gross profit for product and the gross profit for
license and service (in thousands, except for percentage data):
  Gross Profit Amount
                                  
                                  
                                  Gross MarginYear Ended December 31,
                                  
                                  
                                  Year Ended December 31,2008
                                  
                                  
                                  2007
                                  
                                  
                                  2006
                                  
                                  
                                  2008
                                  
                                  
                                  2007
                                  
                                  
                                  2006Product
                                  
                                  $
                                  47,350
                                  
                                  
                                  $
                                  58,381
                                  
                                  
                                  $
                                  53,633
                                  
                                  
                                  
                                  52%
                                  
                                  
                                  
                                  59%
                                  
                                  
                                  
                                  58%License
      and service
                                  
                                  
                                  107,685
                                  
                                  
                                  
                                  84,369
                                  
                                  
                                  
                                  70,454
                                  
                                  
                                  
                                  84%
                                  
                                  
                                  
                                  84%
                                  
                                  
                                  
                                  85%Amortization
      of purchased technology
                                  
                                  
                                  (3,017
                                  )
                                  
                                  
                                  (2,232
                                  )
                                  
                                  
                                  (5,387
                                  )Total
      gross profit
                                  
                                  $
                                  152,018
                                  
                                  
                                  $
                                  140,518
                                  
                                  
                                  $
                                  118,700
                                  
                                  
                                  
                                  70%
                                  
                                  
                                  
                                  71%
                                  
                                  
                                  
                                  68%
  Cost
of Product Revenue and Gross Profit/Margin
  Cost of
product revenue includes costs associated with the production of our products,
including cost of materials, manufacturing and assembly costs paid to contract
manufacturers, freight, related fulfillment cost, and overhead costs associated
with our manufacturing operations.  Additionally, warranty costs and
inventory provisions or write-downs are included in cost of product
revenue.
 
 In 2008
compared to 2007, cost of product revenue increased by approximately 16%, on a
per unit basis, and the number of units shipped decreased by approximately 7%.
In 2007 compared to 2006, cost of product revenue increased by approximately 2%,
on a per unit basis, and the number of units shipped increased by approximately
2%.
 In 2008
compared to 2007, the cost of revenue increased in the UTM product category, but
decreased in the SCM, SSL, and CDP product categories.  In the UTM
product category, the cost of revenue and the average cost per unit increased
because of higher production costs related to NSA products (including our
“E-Class” products), partially offset by decreased cost of revenue for the TZ
products due to lower shipments.  The E-Class NSA products have
significantly higher production costs compared to our other products while the
volume on these products is generally lower compared to our other hardware
appliance products.  In the SCM product category, the cost of revenue
decreased and the cost per unit increased as a result of fewer units sold and
the mix within the product family.  In the SSL product category, the
cost of revenue decreased as a result of a decrease in cost per unit for the
Aventail products.  In the CDP product category, the cost of revenue
decreased as a result of fewer units sold, offset by an increase in production
cost per unit.
 
 In 2007
compared to 2006, the cost of revenue increased in the SSL, SCM, and CDP product
categories, but decreased in the UTM product category.  In the SSL
product category, the cost of revenue and the cost per unit increased as a
result of the timing of the Aventail acquisition and the significant cost
differences between the acquired Aventail products and the products available
from the Company in the prior period.  In the SCM product category,
the cost of revenue increased and the cost per unit decreased as a result of the
mix within the product family.  In the CDP product category, the cost
of revenue and the cost per unit increased as a result of an increase in units
sold and the mix within the product family.  In the UTM product
category, the cost of revenue decreased as a result of significantly lower TZ
unit sales.
 44
 Table of Contents
 Gross
profit and gross profit percentage from product sales in 2008 compared to 2007
decreased in the UTM, SCM, and CDP product categories and increased in the SSL
product category.  In the UTM category, the decrease was due to the
combination of higher production costs per unit, and a decrease in unit volume,
offset by higher net revenue per unit.  In the SCM category, the
decrease was due to the combination of a decrease in unit volume, higher
production costs per unit, and lower net revenue per unit.  In the CDP
category, the decrease was due to the combination of a decrease in unit volume,
lower net revenue per unit, and higher production costs per unit.  In
the SSL category, the increase was due to higher net revenue per unit, offset by
a decrease in unit volume.
  Gross
profit and gross profit percentage from product sales in 2007 compared to 2006
decreased in the UTM, and SCM product categories and increased in the SSL, and
CDP product categories.  In the UTM category, the decrease was due to
the combination of a decrease in unit volume, higher production costs per unit,
offset by higher net revenue per unit.  In the SCM category, the
decrease was due to lower net revenue per unit, offset by lower production costs
per unit and an increase in unit volume.  In the SSL category, the
increase was due to the combination of an increase in unit volume, higher net
revenue per unit, offset by higher production costs per unit.  In the
CDP category, the increase was due to higher net revenue per unit, offset by the
combination of higher production cost per unit, and a decrease in the unit
volume.
  We expect
future product gross profit to erode to the extent that we experience downward
pressure on product pricing or upward pressure on production costs.  A
change in the mix of product sold could also change product gross profit and
gross profit percentage.
 
 Cost
of License and Service Revenue and Gross Profit
  Cost of
license and service revenue includes costs associated with the production and
delivery of our license and service offerings, including technical support costs
related to our service contracts, royalty costs related to certain subscription
offerings, personnel costs related to the delivery of training, consulting, and
professional services; and cost of packaging materials and related costs paid to
contract manufacturers.
 
 Cost of
license and service revenue increased by 26% in 2008 as compared to
2007.  This increase was primarily due to the technical support costs
associated with a larger base of license and subscription services
customers.  In addition, in 2007, we started a process to “in-source”
the substantial portion of our technical support delivery to centers located in
the United States and in India.  The planning and other ramp up costs
associated with these centers, without a corresponding decrease in costs
associated with existing third party service providers, resulted in
duplicate/redundant technical support expenses for a period of time, causing a
decrease in the license and services gross profit percentage.  That
process is now completed and we anticipate that period to period comparisons of
the costs of license and service revenue as well as gross profit will become
more relevant.
 Cost of license and
service revenue increased by 29% in 2007 as compared to 2006.  This
increase was due primarily to the technical support costs associated with a
larger base of license and subscription services customers.  To
deliver services under these
contracts, we outsourced a significant portion of technical support delivery to
third party service providers.  In 2007, we started a process to
“in-source” the substantial portion of our technical support delivery to
centers located in the United States and in India.  The planning and
other initial ramp up costs associated with these centers, without a
corresponding decrease in costs associated with existing third party service
providers, resulted in duplicate/redundant technical support expenses for a
period of time, causing a decrease of the license and services gross profit
percentage.
 Amortization
of Purchased Technology
 Year Ended December
      31,2008
                          
                          
                          2007
                          
                          
                          2006(in
      thousands)Expenses
                          
                          $
                          3,017
                          
                          
                          $
                          2,232
                          
                          
                          $
                          5,387Percentage
      of total revenue
                          
                          
                          1%
                          
                          
                          
                          1%
                          
                          
                          
                          3%Year
      over year change in dollars
                          
                          
                          785
                          
                          
                          
                          (3,155
                          )Year
      over year change in percent
                          
                          
                          35%
                          
                          
                          
                          (59%)
 45
 Table of Contents
 Amortization
of purchased technology represents the amortization of existing technology
acquired in our business combinations accounted for using the purchase
method.  Purchased technology is being amortized over the estimated
useful lives of four to eight years.  The increase in amortization for
the year ended December 31, 2008 as compared to the same period last year is
primarily due to the timing difference of the amortization of the purchased
technology from Aventail.
 
 The
amounts for the year ended December 31, 2008 and 2007 represent amortization of
purchased intangibles associated with our acquisitions of enKoo, Lasso Logic,
MailFrontier, and Aventail.
 
 Future
amortization to be included in cost of revenue based on the current balance of
purchased technology absent any additional investment is as follows (in
thousands):
  Fiscal
    Year
                
                Amortization Amount to Cost of
      Revenue2009
                
                $
                3,0172010
                
                
                2,3742011
                
                
                1,3822012
                
                
                1,3822013
                
                
                803Thereafter
                
                
                431Total
                
                $
                9,389
  Our gross
profit has been and will continue to be affected by a variety of factors,
including competition; the mix of products and services; new product
introductions and enhancements; fluctuations in manufacturing volumes; and the
cost of components and manufacturing labor.
 
 Operating
Expenses
 
 Research
and Development
  Year Ended December
      31,2008
                        
                        
                        2007
                        
                        
                        2006(in
      thousands)Expenses
                        
                        $
                        44,176
                        
                        
                        $
                        39,410
                        
                        
                        $
                        33,670Percentage
      of total revenue
                        
                        
                        20%
                        
                        
                        
                        20%
                        
                        
                        
                        19%Year
      over year change in dollars
                        
                        
                        4,766
                        
                        
                        
                        5,740Year
      over year change in percent
                        
                        
                        12%
                        
                        
                        
                        17%
  Research
and development expenses primarily consist of personnel costs, contract
consultants, outside testing services and equipment and supplies associated with
enhancing existing products and developing new products.
  During
2008, the increase in research and development costs in comparison to the same
period last year was primarily due to the following: (1) increased salaries and
benefits of $3.3 million resulting primarily from increased headcount related to
the Aventail acquisition; (2) higher costs associated with the development of
new products and technologies of $130,000; and (3) increased information service
and facilities costs allocated to product development of $2.7 million. These
increases in research and development expenses were partially offset by a
decrease in share-based compensation expense under SFAS 123R related to employee
stock options and rights granted under the Employee Stock Purchase Plan (ESPP)
of approximately $1.4 million.
  During 2007, the increase
in research and development costs in comparison to the same period last year was
primarily due to the following: (1) increased salaries and benefits of $2.8
million resulting primarily from increased headcount related to Aventail
acquisition; (2) higher prototyping costs associated with the development of new
products and technologies of $449,000; (3) an increase of $528,000 in contract
labor and professional service expenses primarily due to the localization of
certain products for international markets; (4) increased information service
and facilities costs allocated to product development
of $1.0
 46
 Table of Contents
 million;
and (5) $273,000 of increased share-based compensation expense under SFAS 123R
related to employee stock options and rights granted under the
ESPP.
  We
believe that our future performance will depend in large part on our ability to
maintain and enhance our current product line, develop new products that achieve
market acceptance, maintain technological competitiveness, and meet an expanding
range of customer requirements.  We plan to maintain our investments
in current and future product development and enhancement efforts, and incur
expenses associated with these initiatives, such as prototyping expense and
non-recurring engineering charges associated with the development of new
products and technologies.
 
 Sales
and Marketing
 Year Ended December
      31,2008
                        
                        
                        2007
                        
                        
                        2006(in
      thousands)Expenses
                        
                        $
                        82,348
                        
                        
                        $
                        77,741
                        
                        
                        $
                        71,256Percentage
      of total revenue
                        
                        
                        38%
                        
                        
                        
                        39%
                        
                        
                        
                        41%Year
      over year change in dollars
                        
                        
                        4,607
                        
                        
                        
                        6,485Year
      over year change in percent
                        
                        
                        6%
                        
                        
                        
                        9%
 Sales and
marketing expenses primarily consist of personnel costs, including commissions,
costs associated with the development of our business and corporate
identification, costs related to customer support, travel, tradeshows,
promotional and advertising costs, and related facilities costs.
 
 During
2008, the increase in sales and marketing expenses compared to the same period
in 2007 is primarily due to (1) increased personnel costs, including
commissions, contract labor, and other related employee benefits, of
approximately $3.7 million resulting from the acquisition of Aventail and the
“in-sourcing” of our technical support services; (2) an increase of
approximately $3.9 million in expenses associated with our sales and marketing
facilities including rent, maintenance costs, telephone, and internet
connectivity primarily due to the “in-sourcing” of our technical support
services; and (3) an increase of approximately $269,000 in travel related
expenses. These increases in sales and marketing expenses were partially offset
by a decrease in the cost of channel marketing and promotional activities of
approximately $2.2 million due to lower advertising costs, the impact of certain
cost control measures and the timing of various marketing programs; and a
decrease in the cost of share-based compensation expense under SFAS 123R of
approximately $1.0 million related to employee stock options and rights granted
under the ESPP.
  During 2007, the increase
in sales and marketing expenses compared to the same period in 2006 was
primarily due to (1) increased personnel costs, including commissions, contract
labor, and other related employee benefits, of approximately $3.2 million
resulting from the acquisition of Aventail, higher commissionable sales, and the
execution of the restructuring plan in the first quarter of 2006; (2) an
increase of approximately $1.5 million in expenses associated with our sales and
marketing facilities
including rent, maintenance costs, telephone, and internet connectivity; (3) an
increase of approximately $758,000 in expenses associated with outsourced
third-party activity in connection with subscription renewal services; (4) an
increase of approximately $587,000 in travel related expenses; and (5) an
increase of approximately $442,000 in the cost of channel marketing and
promotional activities. These increases in sales and marketing expenses were
partially offset by a decrease in the cost of share-based compensation expense
under SFAS 123R of approximately $134,000 related to employee stock options and
rights granted under the ESPP. 
 We expect
to direct our sales and marketing expenses toward the expansion of domestic and
international markets, introduction of new products and establishment and
expansion of new distribution channels.
 47
 Table of Contents
 General
and Administrative
 Year Ended December
      31,2008
                        
                        
                        2007
                        
                        
                        2006(in
      thousands)Expenses
                        
                        $
                        18,613
                        
                        
                        $
                        21,473
                        
                        
                        $
                        20,324Percentage
      of total revenue
                        
                        
                        9%
                        
                        
                        
                        11%
                        
                        
                        
                        12%Year
      over year change in dollars
                        
                        
                        (2,860
                        )
                        
                        
                        1,149Year
      over year change in percent
                        
                        
                        (13%)
                        
                        
                        
                        6%
  General
and administrative expenses consist primarily of personnel costs, business
insurance, corporate governance costs, professional fees, travel expense, and
related facilities costs.
 
 During
2008, the decrease in G&A expenses was primarily related to (1) lower
compensation expense of approximately $1.2 million primarily due to decreased
performance based bonus expenses; (2) a decrease in share-based compensation
expense of $995,000; (3) a decrease of approximately $384,000 in allocated
expenses for facilities including rent, maintenance costs, depreciation,
telephone, and internet connectivity; (4) a decrease in litigation related
expenses of $271,000; and (5) a decrease of approximately $109,000 in travel
related expenses.
 
 During
2007, the increase in G&A expenses was primarily related to (1) higher
compensation expense of approximately $2.0 million primarily due to higher
salaries related to the acquisition of Aventail and increased bonus expense
resulting from achievement of performance targets; (2) an increase in
professional fees and expenses of approximately $675,000 that were associated
primarily with accounting activities; (3) an increase of approximately $307,000
in allocated expenses for facilities including rent, maintenance costs,
depreciation,  telephone, and internet connectivity; and (4) an
increase of approximately $160,000 in travel related expenses.  These
increases in general and administrative expenses were partially offset by a
decrease in litigation related expenses of $1.3 million and a decrease in the
share-based compensation expense of $488,000.
 
 We
believe that general and administrative expenses will increase in absolute
dollars and remain relatively stable as a percentage of total revenue as we
incur costs related to corporate governance matters and the pursuit of various
corporate opportunities.
 
 Amortization
of Purchased Intangible Assets Included in Operating Expenses
 Year Ended December
      31,2008
                        
                        
                        2007
                        
                        
                        2006(in
      thousands)Expenses
                        
                        $
                        1,114
                        
                        
                        $
                        715
                        
                        
                        $
                        2,721Percentage
      of total revenue
                        
                        
                        0.5%
                        
                        
                        
                        0.4%
                        
                        
                        
                        1.6%Year
      over year change in dollars
                        
                        
                        399
                        
                        
                        
                        (2,006
                        )Year
      over year change in percent
                        
                        
                        56%
                        
                        
                        
                        (74%)
 Amortization
of purchased intangibles included in operating expenses represents the
amortization of assets arising from contractual or other legal rights acquired
in business combinations and excludes for amortization of acquired developed
technology which is included in cost of revenue.  Purchased intangible
assets are being amortized over their estimated useful lives of three to eight
years.
 The
increase in amortization expense included in operating expense in 2008 compared
to 2007 was the result of an increase in the amortization of intangibles
associated with the acquisition of Aventail. This increase was partially offset
by a decrease in the amortization of intangibles associated with the acquisition
of MailFrontier.
 
 The
reduction in amortization expense included in operating expense in 2007 compared
to 2006 was the result of the completion of amortization of certain intangibles
associated with the acquisition of Phobos, RedCreek, Lasso Logic, enKoo, and
MailFrontier.  Amortization for 2007 is primarily related to the
Aventail and MailFrontier acquisitions.
 
 Future
amortization to be included in operating expenses based on current balance of
purchased intangibles absent any additional investment is as follows (in
thousands):
 48
 Table of Contents
 Fiscal
    Year
                            
                            Amortization Amount to Operating
      Expenses2009
                            
                            $
                            1,0952010
                            
                            
                            1,0952011
                            
                            
                            1,0952012
                            
                            
                            1,0082013
                            
                            
                            990Thereafter
                            
                            
                            1,485Total
                            
                            $
                            6,768
 Restructuring
Charges
 Year Ended December
      31,2008
                        
                        
                        2007
                        
                        
                        2006(in
      thousands)Expenses
                        
                        $
                        1,683
                        
                        
                        $
                        -
                        
                        
                        $
                        1,409Percentage
      of total revenue
                        
                        
                        0.8%
                        
                        
                        
                        0.0%
                        
                        
                        
                        0.8%Year
      over year change in dollars
                        
                        
                        1,683
                        
                        
                        
                        (1,409
                        )Year
      over year change in percent
                        
                        
                        100%
                        
                        
                        
                        (100%)
  During
the first quarter of fiscal year 2008, the Company commenced the 2008
restructuring plan associated primarily with the relocation of support
activities, the closure of facilities in Pune, India and Sunnyvale, California,
and other employee reductions for the purpose of better integration and
alignment of Company functions.  The restructuring activities were
recorded in accordance with Statement of Financial Accounting Standards
No. 146 Accounting for
Costs Associated with Exit or Disposal Activities (SFAS 146).
Accordingly, the Company recorded $1.0 million in restructuring expenses related
to costs associated with the termination of 21 employees across multiple
geographic regions and functions, primarily related to severance, benefits and
related costs.  Furthermore, the Company recorded additional
restructuring costs of $0.8 million in connection with facilities and property
and equipment that was disposed of or removed from service.  At
December 31, 2008, the Company’s restructuring accrual was $72,000 and included
as a component of “Other accrued liabilities” in the Company’s Condensed
Consolidated Balance Sheets.
 
 During
the first quarter of fiscal 2006, the Company commenced the 2006 restructuring
plan associated primarily with the integration of companies acquired during the
fourth quarter of 2005 and the first quarter of 2006 as well as other employee
reductions for the purpose of better integration and alignment of Company
functions.  The restructuring activities were recorded in accordance
with Statement of Financial Accounting Standards No. 146 Accounting
for Costs Associated with Exit or Disposal Activities (SFAS 146) and
Statement of Financial Accounting Standards No. 112, Employees’
Accounting for Postemployment Benefits (SFAS
112).  Accordingly, the Company recorded $1.4 million in restructuring
expenses related to costs associated with workforce reduction across multiple
geographic regions and functions.  Furthermore, the Company recorded
additional restructuring costs of $835,000 in connection with the integration of
acquired businesses.  The additional restructuring costs were charged
to goodwill and consisted primarily of severance costs of $553,000 and excess
facility costs of $282,000 related to a lease commitment for space no longer
needed.  As of December 31, 2007 and 2006, respectively, the Company
has no remaining liability relating to the restructuring
activities. 
 In-Process
Research and Development
  Year Ended December
      31,2008
                          
                          
                          2007
                          
                          
                          2006(in
      thousands)Expenses
                          
                          $
                          -
                          
                          
                          $
                          1,930
                          
                          
                          $
                          1,580Percentage
      of total revenue
                          
                          
                          0%
                          
                          
                          
                          1%
                          
                          
                          
                          1%Year
      over year change in dollars
                          
                          
                          (1,930
                          )
                          
                          
                          350Year
      over year change in percent
                          
                          
                          (100%)
                          
                          
                          
                          22%
 49
 Table of Contents
 Our
methodology for allocating the purchase price for purchase acquisitions to
in-process research and development (“IPR&D”) is determined through
established valuation techniques and analysis, as applied in the high-technology
internet security industry.
  The
IPR&D expense in 2007, which is related to the acquisition of Aventail, was
primarily for the development of Aventail’s next generation
product.  This IPR&D was expensed upon the acquisition of Aventail
because technological feasibility had not been established and no future
alternative uses existed.  Total IPR&D expense of $1.9 million was
charged to product development expenses on the date the assets were
acquired.
  The
IPR&D expense in 2006, which was related to the MailFrontier acquisition,
was primarily for the development of MailFrontier’s version 5.0.  This
IPR&D was expensed upon acquisition because technological feasibility had
not been established and no future alternative uses existed.  Total
IPR&D expense of $1.6 million was charged to product development expenses on
the date the assets were acquired.
  The fair
value of the existing purchased technology, as well as the technology under
development, is determined using the income approach, which discounts expected
future cash flows to present value.  The discount rate used in the
present value calculation was derived from a weighted average cost of capital
analysis.  We consider this pricing model for acquired products and
technology to be standard within the high-technology internet security
industry.  We do not expect to achieve a material amount of expense
reductions as a result of integrating the acquired in-process
technology.  Therefore, the valuation assumptions do not include
significant anticipated cost savings.
  The key
assumptions underlying the valuation of our 2007 Aventail purchase acquisition
for which in-process research and development was recorded were as
follows:  1) estimated cost to complete technology at time of
acquisition was approximately $1.3 million; and 2) risk adjusted discount rate
of 22%.  Other key assumptions include an expected completion date of
approximately one year and revenue and expense projections, assuming that the
product has entered the market.
  The key
assumptions underlying the valuation of our 2006 MailFrontier purchase
acquisition for which in-process research and development was recorded were as
follows:  1) estimated cost to complete technology at time of
acquisition of less than $500,000; and 2) risk adjusted discount rate of
23%.  Other key assumptions include an expected completion date of
less than one year and revenue and expense projections, assuming that the
product has entered the market.
  Interest
Income and Other Expense, Net
 
 Interest
income and other expense (net) were $6.4 million, $11.8 million, and $9.7
million in the years ended December 31, 2008, 2007 and 2006, respectively, and
primarily consists of interest income on our cash, cash equivalents, and investments.  The
fluctuations in the short-term interest rates directly influence the interest
income we recognize.  The decrease in 2008 as compared to 2007 was
caused by a combination of a significantly lower overall balance in our
investment portfolio due to our share repurchase program and lower investment
yields. The increase in 2007 as compared to 2006 was primarily due to higher
effective interest rates earned in our investment portfolio. 
 Benefit
(Provision) for Income Taxes
 Year Ended December
      31,2008
                          
                          
                          2007
                          
                          
                          2006(in
      thousands)Benefit
      (provision) for income taxes
                          
                          $
                          (5,571
                          )
                          
                          $
                          17,601
                          
                          
                          $
                          (8,206
                          )Percentage
      of income (loss) before taxes
                          
                          
                          (53%)
                          
                          
                          
                          160%
                          
                          
                          
                          322%Percentage
      of total revenue
                          
                          
                          (3%)
                          
                          
                          
                          9%
                          
                          
                          
                          (5%)Year
      over year change in dollars
                          
                          
                          (23,172
                          )
                          
                          
                          25,807Year
      over year change in percent
                          
                          
                          (132%)
                          
                          
                          
                          (314%)
  The
effective tax rate was 53%, (160%), and 322% in fiscal years 2008, 2007 and
2006, respectively.
 50
 Table of Contents
 Our
effective tax rate differs from the statutory federal and state tax rates for
the fiscal year ended December 31, 2008 primarily due to non-deductible
share-based compensation expense and state income taxes which were offset
by state research and development tax credits.
 
 Our
effective tax rate differs from the statutory federal and state tax rates for
the fiscal year ended December 31, 2007 primarily due to the tax benefit from
the partial release of the valuation allowance, the effect of share-based
compensation related to incentive stock options, goodwill and intangible assets,
which are permanent, non-deductible book/tax differences, and the utilization of
the deferred tax assets derived from previously acquired
companies.  The cumulative effect of the acquired company deferred tax
assets resulted in a reduction in goodwill.
 
 In 2007,
we released a substantial portion of our valuation allowance considering all
available evidence.  The available positive evidence at December 31,
2007, included three years of cumulative historical operating profits, a
projection of future income sufficient to realize most of the remaining deferred
tax assets, and other evidence.  The Company recorded a partial
valuation allowance release of $23.5 million in fiscal year 2007, because as of
December 31, 2007, it was considered more likely than not that the Company’s
deferred tax assets would be realized with the exception of certain acquired net
operating losses due to the annual “change in ownership” limitation by the
Internal Revenue Code of 1986, as amended.
 Quarterly
Results of Operations
 
 The
following table sets forth our unaudited quarterly results of operations, in
dollars for the eight quarters ended December 31, 2008.  You should
read the following table in conjunction with the financial statements and
related notes contained elsewhere in this Form 10-K.  We have prepared
this unaudited information on the same basis as our audited financial
statements.  This table includes all adjustments, consisting only of
normal recurring adjustments, that we consider necessary for a fair presentation
of our financial position and operating results for the quarters
presented.  You should not draw any conclusions about our future
results from the results of operations for any quarter.
 51
 Table of Contents
 Year Ended December 31,
2008
                                
                                
                                Year Ended December 31,
2007Q4
                                
                                
                                
                                Q3
                                
                                
                                
                                Q2
                                
                                
                                
                                Q1
                                
                                
                                
                                Q4
                                
                                
                                
                                Q3
                                
                                
                                
                                Q2
                                
                                
                                
                                Q1(in
      thousands, except per share data)Revenues:Product
                                
                                $
                                21,867
                                
                                
                                $
                                21,439
                                
                                
                                $
                                23,810
                                
                                
                                $
                                23,741
                                
                                
                                $
                                27,295
                                
                                
                                $
                                25,389
                                
                                
                                $
                                23,575
                                
                                
                                $
                                22,677License
      and service
                                
                                
                                32,389
                                
                                
                                
                                31,839
                                
                                
                                
                                31,989
                                
                                
                                
                                31,570
                                
                                
                                
                                28,719
                                
                                
                                
                                25,597
                                
                                
                                
                                23,489
                                
                                
                                
                                22,458Total
      revenues
                                
                                
                                54,256
                                
                                
                                
                                53,278
                                
                                
                                
                                55,799
                                
                                
                                
                                55,311
                                
                                
                                
                                56,014
                                
                                
                                
                                50,986
                                
                                
                                
                                47,064
                                
                                
                                
                                45,135Cost
      of revenues:Product
                                
                                
                                11,028
                                
                                
                                
                                10,627
                                
                                
                                
                                10,811
                                
                                
                                
                                11,041
                                
                                
                                
                                11,842
                                
                                
                                
                                10,148
                                
                                
                                
                                9,353
                                
                                
                                
                                9,212License
      and service
                                
                                
                                4,689
                                
                                
                                
                                5,150
                                
                                
                                
                                5,441
                                
                                
                                
                                4,822
                                
                                
                                
                                4,742
                                
                                
                                
                                4,167
                                
                                
                                
                                3,790
                                
                                
                                
                                3,195Amortization
      of purchased technology
                                
                                
                                755
                                
                                
                                
                                754
                                
                                
                                
                                754
                                
                                
                                
                                754
                                
                                
                                
                                716
                                
                                
                                
                                698
                                
                                
                                
                                409
                                
                                
                                
                                409Total
      cost of revenues
                                
                                
                                16,472
                                
                                
                                
                                16,531
                                
                                
                                
                                17,006
                                
                                
                                
                                16,617
                                
                                
                                
                                17,300
                                
                                
                                
                                15,013
                                
                                
                                
                                13,552
                                
                                
                                
                                12,816Gross
      profit
                                
                                
                                37,784
                                
                                
                                
                                36,747
                                
                                
                                
                                38,793
                                
                                
                                
                                38,694
                                
                                
                                
                                38,714
                                
                                
                                
                                35,973
                                
                                
                                
                                33,512
                                
                                
                                
                                32,319Operating
      expenses:Research
      and development
                                
                                
                                9,807
                                
                                
                                
                                11,411
                                
                                
                                
                                11,414
                                
                                
                                
                                11,544
                                
                                
                                
                                10,479
                                
                                
                                
                                10,838
                                
                                
                                
                                9,077
                                
                                
                                
                                9,016Sales
      and marketing
                                
                                
                                18,395
                                
                                
                                
                                19,472
                                
                                
                                
                                21,756
                                
                                
                                
                                22,725
                                
                                
                                
                                23,194
                                
                                
                                
                                20,023
                                
                                
                                
                                17,205
                                
                                
                                
                                17,319General
      and administrative
                                
                                
                                4,479
                                
                                
                                
                                3,957
                                
                                
                                
                                5,032
                                
                                
                                
                                5,145
                                
                                
                                
                                5,632
                                
                                
                                
                                5,808
                                
                                
                                
                                4,750
                                
                                
                                
                                5,283Amortization
      of purchased intangible assets
                                
                                
                                273
                                
                                
                                
                                274
                                
                                
                                
                                274
                                
                                
                                
                                293
                                
                                
                                
                                303
                                
                                
                                
                                302
                                
                                
                                
                                55
                                
                                
                                
                                55Restructuring
      charges
                                
                                
                                -
                                
                                
                                
                                (87
                                )
                                
                                
                                (35
                                )
                                
                                
                                1,805
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -In-process
      research and development
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                1,930
                                
                                
                                
                                -
                                
                                
                                
                                -Total
      operating expenses
                                
                                
                                32,954
                                
                                
                                
                                35,027
                                
                                
                                
                                38,441
                                
                                
                                
                                41,512
                                
                                
                                
                                39,608
                                
                                
                                
                                38,901
                                
                                
                                
                                31,087
                                
                                
                                
                                31,673Income
      (loss) from operations
                                
                                
                                4,830
                                
                                
                                
                                1,720
                                
                                
                                
                                352
                                
                                
                                
                                (2,818
                                )
                                
                                
                                (894
                                )
                                
                                
                                (2,928
                                )
                                
                                
                                2,425
                                
                                
                                
                                646Interest
      income and other expense, net
                                
                                
                                1,041
                                
                                
                                
                                1,122
                                
                                
                                
                                1,585
                                
                                
                                
                                2,620
                                
                                
                                
                                2,926
                                
                                
                                
                                2,974
                                
                                
                                
                                3,053
                                
                                
                                
                                2,818Income
      (loss) before income taxes
                                
                                
                                5,871
                                
                                
                                
                                2,842
                                
                                
                                
                                1,937
                                
                                
                                
                                (198
                                )
                                
                                
                                2,032
                                
                                
                                
                                46
                                
                                
                                
                                5,478
                                
                                
                                
                                3,464Benefit
      (provision) for income taxes
                                
                                
                                (2,418
                                )
                                
                                
                                (2,273
                                )
                                
                                
                                (1,012
                                )
                                
                                
                                132
                                
                                
                                
                                20,974
                                
                                
                                
                                (342
                                )
                                
                                
                                (1,864
                                )
                                
                                
                                (1,167
                                )Net
      income (loss)
                                
                                $
                                3,453
                                
                                
                                $
                                569
                                
                                
                                $
                                925
                                
                                
                                $
                                (66
                                )
                                
                                $
                                23,006
                                
                                
                                $
                                (296
                                )
                                
                                $
                                3,614
                                
                                
                                $
                                2,297Net
      income (loss) per share:Basic
                                
                                $
                                0.06
                                
                                
                                $
                                0.01
                                
                                
                                $
                                0.02
                                
                                
                                $
                                (0.00
                                )
                                
                                $
                                0.37
                                
                                
                                $
                                (0.00
                                )
                                
                                $
                                0.06
                                
                                
                                $
                                0.04Diluted
                                
                                $
                                0.06
                                
                                
                                $
                                0.01
                                
                                
                                $
                                0.02
                                
                                
                                $
                                (0.00
                                )
                                
                                $
                                0.35
                                
                                
                                $
                                (0.00
                                )
                                
                                $
                                0.05
                                
                                
                                $
                                0.03Shares
      used in computing net income (loss) per share:Basic
                                
                                
                                53,575
                                
                                
                                
                                53,412
                                
                                
                                
                                56,356
                                
                                
                                
                                60,988
                                
                                
                                
                                62,678
                                
                                
                                
                                64,458
                                
                                
                                
                                64,777
                                
                                
                                
                                65,336Diluted
                                
                                
                                54,459
                                
                                
                                
                                54,928
                                
                                
                                
                                58,605
                                
                                
                                
                                60,988
                                
                                
                                
                                66,141
                                
                                
                                
                                64,458
                                
                                
                                
                                67,258
                                
                                
                                
                                67,815
 Liquidity
and Capital Resources
 
 We ended
December 31, 2008 with $105.5 million in cash, cash equivalents, and short-term
investments, consisting principally of corporate bonds, U.S. government
securities and money market funds, a decrease of $123.5 million as compared to
prior year ending balance.  Our primary source of cash is receipts
from sales of our products, license and services, and issuance of common stock
under employee stock option and purchase plans.  The primary uses of
cash during 2008 are related to payments for the production of our products,
payroll (salaries and related benefits), acquisition related activity, general
operating expenses (marketing, travel, office rent), and the repurchase of
shares of our common stock under our share repurchase program.
 
 Operating
Activities
 
 Cash
provided by operating activities for fiscal 2008 totaled $19.2 million, a $42.9
million decrease in comparison to the prior year.  Cash provided by
operating activities was primarily the result of the net income of $4.9 million
adjusted by non-cash items such as SFAS 123R related share-based compensation
expense of $10.6 million, depreciation and amortization expense of $8.9
 52
 Table of Contents
  million, unrealized loss
on auction rate securities of $7.9 million, unrealized gain on auction rate
security right of $7.6 million, income tax benefit from the exercise of employee
stock options of $3.6 million, deferred income taxes of $349,000,
adjustment to goodwill of $283,000, and changes in our operating assets and
liabilities of $1.7  million.  The main drivers of the
changes in operating assets and liabilities are as follows:
 §
                  Accounts
      receivable decreased due to the timing of collections.  Our DSO
      in accounts receivable was 34 days at December 31, 2008 compared to 42
      days at December 31, 2007.  The decrease in DSO at December 31,
      2008 as compared to December 31, 2007 was primarily due to the timing of
      shipments and billings, combined with certain customers taking advantage
      of early payment discounts.  Collection of accounts receivable
      and related DSO will continue to fluctuate in future periods due to the
      timing and amount of our future shipments and billings, the payment terms
      that we extend to our customers, and the effectiveness of our collection
      efforts.
 §
                The
      decrease in prepaid expenses and other current assets was primarily due to
      (1) a decrease in our Deferred Compensation asset primarily driven by
      participant activities; and (2) a decrease in the amount of deferred cost
      of goods sold associated with products shipped on deferred revenue
      arrangements.
  §
                The
      increase in other assets was primarily due to increase in our deposits for
      our leased business offices in India and
  Shanghai.
  §
                The
      decrease in accounts payable is primarily due to a decrease in the
      payables related to cost of goods sold and partially offset by an increase
      in the payables from our operating
expenses.
  §
                The
      decrease in accrued payroll and related benefits was primarily attributed
      to (1) a decrease in the accrual related to our Deferred Compensation
      plan; (2) a decrease in amount accrued under payroll, commissions, and
      payroll taxes payable; (3) a decrease in our ESPP withholding; and (4) a
      decrease in our vacation accrual.
  §
                Deferred
      revenue increased due to increased sales of subscription services as well
      as an increase related to shipments to distributors whereby revenue is
      recognized on a sell-through basis.
  §
                The
      decrease in other accrued liabilities was primarily due to one final
      settlement of the restricted cash in escrow in connection with the
      acquisition of MailFrontier.
 
 Cash
provided by operating activities for fiscal 2007 totaled $63.7 million, a $30.1
million increase in comparison to the prior year.  Cash provided by
operating activities was primarily the result of the net income of $28.6 million
adjusted by non-cash items such as deferred income taxes of ($27.5) million,
SFAS 123R related share-based compensation expense of $13.5 million, adjustment
to goodwill of $7.1 million, depreciation and amortization expense of $6.0
million, in-process research and development expense of $1.9 million, income tax
benefit from the exercise of employee stock options of $1.5 million, and changes
in our operating assets and liabilities of $34.2 million.  The main
drivers of the changes in operating assets and liabilities are as
follows:
  §
                Accounts
      receivable decreased due to the timing of collections.  Our DSO
      in accounts receivable was 42 days at December 31, 2007 compared to 45
      days at December 31, 2006.  The decrease in DSO at December 31,
      2007 as compared to December 31, 2006 was primarily due to the timing of
      shipments and billings, combined with an increase in
      revenue.  Collection of accounts receivable and related DSO will
      continue to fluctuate in future periods due to the timing and amount of
      our future shipments and billings, the payment terms that we extend to our
      customers, and the effectiveness of our collection
  efforts.
  §
                The
      increase in prepaid expenses and other current assets was primarily due to
      (1) an increase in our Deferred Compensation asset primarily from
      participant contributions; and (2) an increase in the amount of deferred
      cost of goods sold associated with products shipped on deferred revenue
      arrangements.
  §
                The
      increase in accounts payable is primarily due to an increase in the level
      of cost of goods sold and operating expenses and the timing of payments to
      our vendors.
  §
                The
      increase in accrued payroll and related benefits was primarily attributed
      to (1) an increase in the accrual related to our Deferred Compensation
      plan; (2) an increase in amount accrued under payroll, commissions, and
      payroll taxes payable;
 53
 Table of Contents
  and
      (3) an increase in our vacation
accrual.
 §
                    Deferred
      revenue increased due to increased sales of subscription services as well
      as an increase related to shipments to distributors whereby revenue is
      recognized on a sell-through basis.  In addition, as of December
      31, 2007 there was approximately $3.7 million remaining in deferred
      revenue derived through the acquisition of
  Aventail.
  §
                    The
      decrease in other accrued liabilities was primarily due to final
      settlement of the restricted cash in escrow in connection with the
      acquisition of MailFrontier.
 
 Cash
provided by operating activities for fiscal 2006 totaled $33.6 million, a $1.1
million increase from 2005.  During 2006, cash provided by operating
activities was primarily the result of the net loss of $10.8 million adjusted by
non-cash items such as depreciation and amortization expense of $10.2 million,
SFAS 123R related share-based compensation expense of 13.2 million, adjustment
of goodwill of approximately $6.8 million, in-process research and development
expense of $1.6 million and changes in our operating assets and liabilities of
$12.4 million.  The main drivers of the 2006 changes in operating
assets and liabilities are as follows:
 
 §
                    Accounts
      receivable increased due to higher sales and the normalization of our
      collection cycle.  Our DSO in accounts receivable was 45 days at
      December 31, 2006 compared to 32 days at December 31, 2005.  The
      increase in DSO at December 31, 2006 as compared to December 31, 2005 was
      primarily due to the timing of shipments and billings combined with the
      increase in revenue.  Collection of accounts receivable and
      related DSO will fluctuate in future periods due to the timing and amount
      of our future shipments and billings, the payment terms that we extend to
      our customers and the effectiveness of our collection
    efforts.
  §
                    Deferred
      revenue increased due to increased sales of subscription services as well
      as an increase related to shipments to distributors whereby revenue is
      recognized on a sell-through basis.  In addition, there was
      approximately $2.2 million in deferred revenue derived through the
      acquisition of MailFrontier.
  §
                    The
      increase in prepaid expenses and other current assets was primarily due to
      (1) an increase in our restricted cash in escrow in connection with the
      acquisition; (2) an increase in our Deferred Compensation asset primarily
      from participant contributions; and (3) an increase in the amount of
      deferred cost of goods sold associated with products shipped on deferred
      revenue arrangements.
  §
                    The
      increase in accrued payroll and related benefits was primarily attributed
      to (1) an increase in the accrual of bonuses; (2) an increase in the
      accrual related to our Deferred Compensation plan; (3) an increase in the
      amount withheld and accrued under our employee stock purchase plan
      (“ESPP”); and (4) an increase in our vacation
  accrual.
  §
                    The
      decrease in accrued restructuring was caused by the payment of employee
      severance benefits and facility costs for space no longer needed in
      connection with the 2006 Restructuring
Plan.
  §
                    The
      increase in other accrued liabilities was primarily due to (1) an increase
      in the accrual related to the restricted cash in escrow in connection with
      the acquisition of MailFrontier; (2) an increase in the accrual related to
      royalty contracts; and (3) an increase in the accrual related to travel
      expenses.
 
 In
addition, our operating cash flows may be impacted in the future  as a
result of a number of factors, including fluctuations in our operating results,
accounts receivable collections, inventory management, expensing stock options,
and the timing and amount of income tax and the timing of payments to our
vendors for accounts payable.  For additional discussion, see the
section entitled “Risk Factors” in this Form 10-K.
 
 Investing
Activities
 
 Net cash
provided by investing activities in 2008 was $63.1 million, principally as a
result of (1) the net sale and maturity of $66.7 million in investments; (2) a
net decrease in restricted cash in escrow of $1.4 million primarily due to the
final settlement of the MailFrontier escrow, and (3) the purchase of $5.0
million in property and equipment.
  Net
cash used in investing activities in 2007 was $23.4 million, principally as a
result of (1) the acquisition of Aventail Corporation for $25.3 million, net of
cash acquired; (2) the net sale and maturity of $12.5 million in short-term
investments; (3)
 54
 Table of Contents
  the
purchase of $7.5 million in property and equipment and $1.8 million in
intangible assets related to a license agreement for certain intellectual
property; and (4) a net increase in restricted cash in escrow of $1.4 million
primarily due to the final settlement of the MailFrontier escrow, partially
offset by the creation of a new escrow related to the Aventail
acquisition.
 Net cash used in investing
activities in 2006 was $45.4 million, principally as a result of (1) $11.2
million net purchase of short-term investments; (2) $29.5 million acquisition of
MailFrontier, net of cash acquired; (3) $3.4 million purchase of property and
equipment; and (4) $1.3 million net increase in restricted cash in
escrow.
 
 Financing
Activities
  Net cash
used in financing activities in 2008 was $70.5 million, of which $79.4 million
was used to repurchase common stock under the Company’s stock repurchase
program, partially offset by (1) $5.3 million provided by common stock issuances
through employee stock option exercises or purchase of shares under the employee
stock purchase plan; and (2) $3.6 million provided by income tax benefit from
the exercise of employee stock options.
  Net cash
used in financing activities in 2007 was $32.9 million, of which $49.9 million
was used to repurchase common stock under the Company’s stock repurchase
program, partially offset by (1) $17.0 million provided by common stock
issuances through employee stock option exercises or purchase of shares under
the employee stock purchase plan; and (2) $1.5 million provided by income tax
benefit from the exercise of employee stock options.
 
 Net cash
used in financing activities in 2006 was $4.8 million, of which cash of $16.3
million was provided by common stock issuances through employee stock option
exercises or purchase of shares under the employee stock purchase plan, offset
by $21.1 million used to buyback common stock under the Company’s stock
repurchase program.
 
 Liquidity
and Capital Resource Requirements
  We
believe our existing cash, cash equivalents, and short-term investments will be
sufficient to meet our cash requirements at least through the next twelve
months.  However, we could elect to seek additional funding prior to
that time.  Our future capital requirements will depend on many
factors, including our rate of revenue growth, the timing and extent of spending
to support product development efforts and expansion of sales, marketing, and
support operations, the timing of introductions of new products and enhancements
to existing products, market acceptance of our products, and pursuit of
corporate opportunities.  We cannot assure you that additional equity
or debt financing will be available on acceptable terms or at
all.  Our sources of liquidity beyond twelve months, in management’s
opinion, will be our then current cash balances, funds from operations and
whatever long-term credit facilities we can arrange.  We have no
agreements or arrangements with third parties to provide us with sources of
liquidity and capital resources beyond twelve months.  We believe that
future liquidity and capital resources will not be materially affected in the
event we are not able to prevail in litigation for which we have been named a
defendant as described in Note 11 of the consolidated financial
statements.
 
 Off-Balance
Sheet Arrangements
 
 As of
December 31, 2008, we did not have any significant off-balance sheet
arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation
S-K.
 
 Contractual
Obligations
 
 We do not
have any debt, long-term obligations, or long-term capital
commitments.  The following summarizes our principal contractual
commitments as of December 31, 2008 (in thousands):
 Payments
      Due by PeriodLess
      Than
                        
                        
                        1
      to 3
                        
                        
                        3
      to 5Contractual Obligations
                        
                        Total
                        
                        
                        One Year
                        
                        
                        Years
                        
                        
                        Years
                        
                        
                        ThereafterOperating
      lease obligations
                        
                        $
                        10,722
                        
                        
                        $
                        2,506
                        
                        
                        $
                        4,851
                        
                        
                        $
                        2,366
                        
                        
                        $
                        999Non-cancelable
      purchase obligations
                        
                        $
                        4,893
                        
                        
                        $
                        4,893
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
  We outsource our
manufacturing function to third party contract manufacturers, and at December
31, 2008 we have purchase obligations
totaling $8.0 million.  Of this amount, $3.4 million cannot be
cancelled and is payable within one year.  We
are
 55
 Table of Contents
  contingently
liable for any inventory owned by a contract manufacturer that becomes excess
and obsolete.  As of December 31, 2008, $370,000 had been accrued for
excess and obsolete inventory held by our contract manufacturers.  In
addition, as of December 31, 2008 in the normal course of business, we had $1.5
million in non-cancelable purchase commitments.
 
 Stock
Repurchase Program
  In
November 2004, the Company’s Board of Directors authorized a stock repurchase
program to reacquire up to $50 million of common stock.  The term of
the stock repurchase plan was set at twelve (12) months from the date of
authorization.  In February 2005, the Company’s Board of Directors
increased the amount authorized for repurchase from $50 million to $75 million,
extended the term of the program from twelve (12) to twenty-four (24) months
following the date of original authorization and increased certain predetermined
pricing formulas.  In April 2005, the Company’s Board of Directors
authorized a modification to the stock repurchase program to delete certain
elements that provided for systematic repurchases.
  In
February 2006, the Company’s Board of Directors approved an increase in the
amount authorized for repurchase under the Company’s share repurchase program
from $75.0 million to $100.0 million and extended the term of the program from
twenty-four (24) months to thirty-six (36) months following the date of original
authorization.
  On July
24, 2007, the Company’s Board of Directors approved a follow-on program for the
repurchase of the Company’s common stock.  The authorization under the
follow-on share repurchase program is $100 million plus approximately $19.6
million remaining under the share repurchase program originally authorized by
the Company’s Board of Directors in November 2004.  The term of the
follow-on program was one year from the date of approval.  As of
December 31, 2008, the Company’s Stock Repurchase Program has been
completed.
  Recent
Accounting Pronouncements
 
 The
information contained in Note 2 to the Consolidated Financial Statements under
the heading recent accounting pronouncements is hereby incorporated by reference
into this Part II, Item 7.
   ITEM 7A.  Quantitative and Qualitative
Disclosures about Market Risk
 
 Interest
Rate Risk
 
 Our
exposure to market risk for changes in interest rates relates primarily to our
cash, cash equivalents, and investment portfolio.  In accordance with
Statement of Financial Accounting Standards No. 115 (“SFAS No. 115”),
“Accounting for Certain Investments in Debt and Equity Securities,” we
classified our investments as available-for-sale except the auction rate
securities in one of our investment firms.  Refer to Note 6 to the
Consolidated Financial Statements for further detailed discussion. The
available-for-sale investments are recorded on the balance sheet at the fair
value with unrealized gains and losses reported as a separate component of
accumulated other comprehensive income (loss), net of tax.  As of
December 31, 2008, our cash, cash equivalents and investment portfolio included
money-markets securities, corporate bonds, municipal bonds, auction rate
securities, asset backed securities, and commercial papers which are generally
subject to no interest rate risk when held to maturity, but may increase or
decrease in value if interest rates change prior to maturity. A hypothetical 100
basis point change in the floating interest rates applicable to the December 31,
2008 balance would result in a change in annual interest income of approximately
$1.7 million.
 
 Fixed-rate
securities may have their fair market value adversely impacted due to a rise in
interest rates, while floating-rate securities may produce less income than
expected if interest rates fall.  Due in part to these factors, our
future investment income may fall short of expectations due to changes in
interest rates or we may suffer losses in principal if we are forced to sell
securities which have declined in market value due to changes in interest
rates.
  As stated
in our investment policy, we are adverse to principal loss and further the goal
of preservation of our invested funds by limiting default and market
risk.  We mitigate default risk by investing in only investment-grade
instruments.  As of December 31, 2008, we do not have any derivative
financial instruments in our investment portfolio.
  Principal
amounts by expected year of maturity in U.S. dollars as of December 31, 2008 are
as follows (in thousands, except percentages):
 56
 Table of Contents
 Maturing
      in2009
                              
                              
                              2010
                              
                              
                              2011
                              
                              
                              2012
                              
                              
                              2013
                              
                              
                              Thereafter
                              
                              
                              Total
                              
                              
                              Fair
      ValueCorporate
      debt securities
                              
                              $
                              12,172
                              
                              
                              $
                              612
                              
                              
                              $
                              -
                              
                              
                              $
                              -
                              
                              
                              $
                              -
                              
                              
                              $
                              -
                              
                              
                              $
                              12,784
                              
                              
                              $
                              12,815Weighted
      average interest rate
                              
                              
                              2.1%
                              
                              
                              
                              4.1%
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              2.2%U.S.
      government securities
                              
                              
                              17,064
                              
                              
                              
                              5,263
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              22,327
                              
                              
                              
                              22,337Weighted
      average interest rate
                              
                              
                              1.7%
                              
                              
                              
                              4.1%
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              2.3%Asset
      backed securities
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              243
                              
                              
                              
                              -
                              
                              
                              
                              353
                              
                              
                              
                              39,865
                              
                              
                              
                              40,461
                              
                              
                              
                              34,905Weighted
      average interest rate
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              5.8%
                              
                              
                              
                              -
                              
                              
                              
                              6.2%
                              
                              
                              
                              5.7%
                              
                              
                              
                              5.7%Auction
      rate securities
                              
                              
                              -
                              
                              
                              
                              45,325
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              10,000
                              
                              
                              
                              55,325
                              
                              
                              
                              51,719Weighted
      average interest rate
                              
                              
                              -
                              
                              
                              
                              2.0%
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              3.4%
                              
                              
                              
                              2.2%Total
      marketable securities
                              
                              $
                              29,236
                              
                              
                              $
                              51,200
                              
                              
                              $
                              243
                              
                              
                              $
                              -
                              
                              
                              $
                              353
                              
                              
                              $
                              49,865
                              
                              
                              $
                              130,897
                              
                              
                              $
                              121,776
  At
December 31, 2008, included within our investment portfolio are $55.3 million of
investments in auction rate securities and $40.0 million of assets backed
securities.  Refer to Note 6, “Financial Instruments”, in Part II Item
8 for additional information.
 
 Foreign
Currency Risk
 
 We
consider our exposure to foreign currency exchange rate fluctuations in general
to be moderate.  We invoice substantially all of our foreign customers
from the United States in U.S. dollars and substantially all revenue is
collected in U.S. dollars.  For the year ended December 31, 2008, we
earned approximately 34% of our revenue from international
markets.  We may, in the future, denominate these transactions in
various local currencies.  Because our sales are currently denominated
in U.S. dollars, the weakness of a foreign country’s currency against the dollar
could increase the price of our products in such country and reduce our product
unit sales by making our products more expensive in the local
currency.  A weakened dollar could increase the cost of local
operating expenses and procurement of raw materials to the extent we must
purchase components in foreign currencies.  As our base of
international operations expands, a greater percentage of our employee base will
be paid in local currency. This expansion increases our exposure to emerging
market currencies, which can have extreme currency volatility.  As a
result, our operating results may become subject to significant fluctuations
based upon changes in the exchange rates of some currencies in relation to the
U.S. dollar and diverging economic conditions in foreign markets in which we do
business.  We have minimal cash balances denominated in foreign
currencies.  We do not enter into forward exchange contracts to hedge
exposures denominated in foreign currencies and do not use derivative financial
instruments for trading or speculative purposes.
 
 As our
business model changes to include greater international participation, our
exposure to foreign currency risk increases. We will continue to monitor our
exposure to currency transactions.  We cannot, however, assure you
that exchange rate fluctuations will not adversely affect our financial results
in the future.
 
 Financial
Market Risk
 
 Included
within our investment portfolio at December 31, 2008 were ARS that we purchased
for $55.3 million whose underlying assets are primarily student loans which are
substantially backed by the federal government and ABS that were purchased for
$40.0 million whose underlying assets are all prime mortgages of which
approximately 65% are backed by the federal government.  The ARS are
currently rated AAA, the highest rating, by a rating
agency.  Beginning in February 2008, auctions for certain of these
securities failed due to insufficient bids from buyers.  In 2008, we
accepted an offer from one of our investment banks under which the bank would
purchase over 80% of these securities at par anytime during a two-year period
beginning June 30, 2010. In the event the liquidity of our investment bank is
adversely impacted by the current uncertainties in the financial market, they
may be unable to pay us when their payment option comes due.  The
market for the non-government backed ABS securities has been illiquid in 2008.
We may not be able to access these funds until our investment bank is able to
pay us the offered amount, future auctions for the auction rate securities in
our portfolio are successful or until we sell the securities in a secondary
market which currently is very volatile and has experienced discount rates of up
to 25% for similar investments.  Although there have been instances of
redemptions at par by municipalities through refinance of new debt along with
speculation that the federal government will provide incentive plans to spur the
refinancing activities, the ARS and non-government backed ABS investments
currently lack short term liquidity and were therefore reclassified as
non-current on our December 31, 2008 balance sheet.  We will continue
to evaluate any changes in the market for ARS and ABS.  Depending upon
future market conditions, we may be required to record an other-than-temporary
decline in market value.  In such an event, the Company’s financial
condition, cash flow and reported earnings could be negatively
affected.


57
 Table of Contents




ITEM
8.  Financial
Statements and Supplementary Data





INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT
SCHEDULE




PageReport
      of Independent Registered Public Accounting Firm
                59Consolidated
      Balance Sheets
                60Consolidated
      Statements of Operations
                61Consolidated
      Statements of Shareholders’ Equity
                62Consolidated
      Statements of Cash Flows
                63Notes
      to Consolidated Financial Statements
                64Financial
      Statement Schedule – Valuation and Qualifying Accounts
                102


58
 Table of Contents
  REPORT
OF ARMANINO McKENNA LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM
  The Board of Directors and Shareholders, SonicWALL,
Inc.
 
 We have
audited the accompanying consolidated balance sheets of SonicWALL, Inc. and
subsidiaries (“the Company”) as of December 31, 2008 and 2007, and the related
consolidated statements of operations, shareholders’ equity and cash flows for
each of the years in the three-year period ended December 31, 2008. We have also
audited the Company’s internal control over financial reporting as of December
31, 2008, based on criteria established in Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Our audits also included the financial statement
schedule listed in the Index at Part IV, Item 15. The Company's management is
responsible these financial statements and schedule, for maintaining effective
internal control over financial reporting, and for its assessment of the
effectiveness of internal control over financial reporting, included in the
accompanying Management Report on Internal Control Over Financial Reporting,
appearing under Item 9A. Our responsibility is to express an opinion on these
financial statements and schedule and an opinion on the Company's internal
control over financial reporting based on our audits.
 
 We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. Our audits of the financial statements included examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
Our audit of internal control over financial reporting included obtaining an
understanding of internal control over financial reporting, assessing the risk
that a material weakness exists, and testing and evaluating the design and
operating effectiveness of internal control based on the assessed risk. Our
audits also included performing such other procedures as we considered necessary
in the circumstances. We believe that our audits provide a reasonable basis for
our opinions.
 
 A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
  Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
  In our
opinion, the consolidated financial statements and schedule referred to above
present fairly, in all material respects, the financial position of the Company
as of December 31, 2008 and 2007, and the results of its operations and its cash
flows for each of the years in the three-year period ended December 31, 2008 in
conformity with accounting principles generally accepted in the United States of
America. Also in our opinion, the Company maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2008,
based on criteria established in Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).
 
 
 
 /s/
ARMANINO McKENNA LLP
 San
Ramon, California
 March 6,
2009
 
 59
 Table of
Contents


SONICWALL,
INC.


CONSOLIDATED BALANCE SHEETS


(In
thousands, except share data)


December
      31,2008
                          
                          
                          2007ASSETSCurrent
      Assets:Cash
      and cash equivalents
                          
                          $
                          45,127
                          
                          
                          $
                          33,324Short-term
      investments
                          
                          
                          60,327
                          
                          
                          
                          195,647Accounts
      receivable, net of allowance for doubtful accounts of$113
      and $177 in 2008 and 2007, respectively
                          
                          
                          20,945
                          
                          
                          
                          26,255Inventories
                          
                          
                          8,956
                          
                          
                          
                          6,057Deferred
      tax assets
                          
                          
                          9,423
                          
                          
                          
                          11,107Prepaid
      expenses and other current assets
                          
                          
                          11,861
                          
                          
                          
                          9,447Total
      current assets
                          
                          
                          156,639
                          
                          
                          
                          281,837Property
      and equipment, net
                          
                          
                          9,543
                          
                          
                          
                          9,357Goodwill
                          
                          
                          138,470
                          
                          
                          
                          138,753Long-term
      investments
                          
                          
                          61,450
                          
                          
                          
                          -Deferred
      tax assets, non-current
                          
                          
                          18,406
                          
                          
                          
                          16,367Purchased
      intangibles and other assets, net
                          
                          
                          17,328
                          
                          
                          
                          26,321Total
      assets
                          
                          $
                          401,836
                          
                          
                          $
                          472,635LIABILITIES
      AND SHAREHOLDERS' EQUITYCurrent
      Liabilities:Accounts
      payable
                          
                          $
                          10,717
                          
                          
                          $
                          10,875Accrued
      payroll and related benefits
                          
                          
                          11,554
                          
                          
                          
                          20,388Other
      accrued liabilities
                          
                          
                          10,307
                          
                          
                          
                          7,355Deferred
      revenue
                          
                          
                          88,415
                          
                          
                          
                          88,818Total
      current liabilities
                          
                          
                          120,993
                          
                          
                          
                          127,436Deferred
      revenue, non-current
                          
                          
                          15,072
                          
                          
                          
                          12,419Other
      accrued liabilities, non-current
                          
                          
                          -
                          
                          
                          
                          5,076Total
      liabilities
                          
                          
                          136,065
                          
                          
                          
                          144,931Commitments
      and contingencies (Note 11)Shareholders'
      Equity:Common
      stock, no par value; 200,000,000 shares authorized; 53,575,371
      and62,477,590
      shares issued and outstanding in 2008 and 2007,
    respectively
                          
                          
                          396,223
                          
                          
                          
                          446,431Accumulated
      other comprehensive loss, net
                          
                          
                          (9,209
                          )
                          
                          
                          (2,284
                          )Accumulated
      deficit
                          
                          
                          (121,243
                          )
                          
                          
                          (116,443
                          )Total  shareholders'
      equity
                          
                          
                          265,771
                          
                          
                          
                          327,704Total
      liabilities and shareholders' equity
                          
                          $
                          401,836
                          
                          
                          $
                          472,635


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


60
 Table of Contents


SONICWALL,
INC.


CONSOLIDATED STATEMENTS OF OPERATIONS


(In
thousands, except per share data)




Year
      Ended December 31,2008
                              
                              
                              2007
                              
                              
                              2006Revenues:Product
                              
                              $
                              90,857
                              
                              
                              $
                              98,936
                              
                              
                              $
                              92,797License
      and service
                              
                              
                              127,787
                              
                              
                              
                              100,263
                              
                              
                              
                              82,741Total
      revenues
                              
                              
                              218,644
                              
                              
                              
                              199,199
                              
                              
                              
                              175,538Cost
      of revenues:Product
                              
                              
                              43,507
                              
                              
                              
                              40,555
                              
                              
                              
                              39,164License
      and service
                              
                              
                              20,102
                              
                              
                              
                              15,894
                              
                              
                              
                              12,287Amortization
      of purchased technology
                              
                              
                              3,017
                              
                              
                              
                              2,232
                              
                              
                              
                              5,387Total
      cost of revenues
                              
                              
                              66,626
                              
                              
                              
                              58,681
                              
                              
                              
                              56,838Gross
      profit
                              
                              
                              152,018
                              
                              
                              
                              140,518
                              
                              
                              
                              118,700Operating
      expenses:Research
      and development
                              
                              
                              44,176
                              
                              
                              
                              39,410
                              
                              
                              
                              33,670Sales
      and marketing
                              
                              
                              82,348
                              
                              
                              
                              77,741
                              
                              
                              
                              71,256General
      and administrative
                              
                              
                              18,613
                              
                              
                              
                              21,473
                              
                              
                              
                              20,324Amortization
      of purchased intangible assets
                              
                              
                              1,114
                              
                              
                              
                              715
                              
                              
                              
                              2,721Restructuring
      charges
                              
                              
                              1,683
                              
                              
                              
                              -
                              
                              
                              
                              1,409In-process
      research and development
                              
                              
                              -
                              
                              
                              
                              1,930
                              
                              
                              
                              1,580Total
      operating expenses
                              
                              
                              147,934
                              
                              
                              
                              141,269
                              
                              
                              
                              130,960Income
      (loss) from operations
                              
                              
                              4,084
                              
                              
                              
                              (751
                              )
                              
                              
                              (12,260
                              )Interest
      income and other expense, net
                              
                              
                              6,368
                              
                              
                              
                              11,771
                              
                              
                              
                              9,713Income
      (loss) before income taxes
                              
                              
                              10,452
                              
                              
                              
                              11,020
                              
                              
                              
                              (2,547
                              )Benefit
      (provision) for income taxes
                              
                              
                              (5,571
                              )
                              
                              
                              17,601
                              
                              
                              
                              (8,206
                              )Net
      income (loss)
                              
                              $
                              4,881
                              
                              
                              $
                              28,621
                              
                              
                              $
                              (10,753
                              )Net
      income (loss) per share:Basic
                              
                              $
                              0.09
                              
                              
                              $
                              0.45
                              
                              
                              $
                              (0.17
                              )Diluted
                              
                              $
                              0.08
                              
                              
                              $
                              0.43
                              
                              
                              $
                              (0.17
                              )Shares
      used in computing net income (loss) per share:Basic
                              
                              
                              56,069
                              
                              
                              
                              64,305
                              
                              
                              
                              65,117Diluted
                              
                              
                              57,897
                              
                              
                              
                              67,099
                              
                              
                              
                              65,117


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


61
 Table of Contents


SONICWALL,
INC.


CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY


(In thousands, except for share
data)




AccumulatedOther
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      TotalCommon Stock
                                                      
                                                      
                                                      Comprehensive
                                                      
                                                      
                                                      Accumulated
                                                      
                                                      
                                                      Shareholders'Shares
                                                      
                                                      
                                                      Amount
                                                      
                                                      
                                                      Loss
                                                      
                                                      
                                                      Deficit
                                                      
                                                      
                                                      EquityBALANCE
      AT DECEMBER 31, 2005
                                                      
                                                      
                                                      65,026,138
                                                      
                                                      
                                                      $
                                                      440,172
                                                      
                                                      
                                                      $
                                                      (1,367
                                                      )
                                                      
                                                      $
                                                      (118,635
                                                      )
                                                      
                                                      $
                                                      320,170Issuance
      of common stock upon exercise ofstock options
                                                      
                                                      
                                                      2,362,576
                                                      
                                                      
                                                      
                                                      14,123
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      14,123Issuance
      of common stock in connection withthe Employee Stock Purchase Plan (ESPP)
                                                      
                                                      
                                                      414,156
                                                      
                                                      
                                                      
                                                      2,146
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      2,146Stock
      options assumed in connection with acquisition
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      109
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      109Share-based
      compensation
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      13,202
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      13,202Repurchase
      of common stock
                                                      
                                                      
                                                      (2,417,241
                                                      )
                                                      
                                                      
                                                      (16,343
                                                      )
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      (4,756
                                                      )
                                                      
                                                      
                                                      (21,099
                                                      )Comprehensive
      loss:Change
      in unrealized gain on investmentsecurities
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      170
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      170Net
      loss
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      (10,753
                                                      )
                                                      
                                                      
                                                      (10,753
                                                      )Total
      comprehensive loss
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      (10,583
                                                      )BALANCE
      AT DECEMBER 31, 2006
                                                      
                                                      
                                                      65,385,629
                                                      
                                                      
                                                      
                                                      453,409
                                                      
                                                      
                                                      
                                                      (1,197
                                                      )
                                                      
                                                      
                                                      (134,144
                                                      )
                                                      
                                                      
                                                      318,068Cumulative
      effect of adoption of FIN 48
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      (89
                                                      )
                                                      
                                                      
                                                      (89
                                                      )ADJUSTED
      BALANCE AT DECEMBER 31, 2006
                                                      
                                                      
                                                      65,385,629
                                                      
                                                      
                                                      
                                                      453,409
                                                      
                                                      
                                                      
                                                      (1,197
                                                      )
                                                      
                                                      
                                                      (134,233
                                                      )
                                                      
                                                      
                                                      317,979Issuance
      of common stock upon exercise ofstock options
                                                      
                                                      
                                                      2,269,940
                                                      
                                                      
                                                      
                                                      14,305
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      14,305Issuance
      of common stock in connection with ESPP
                                                      
                                                      
                                                      378,908
                                                      
                                                      
                                                      
                                                      2,730
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      2,730Share-based
      compensation
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      13,542
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      13,542Repurchase
      of common stock
                                                      
                                                      
                                                      (5,556,887
                                                      )
                                                      
                                                      
                                                      (39,085
                                                      )
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      (10,831
                                                      )
                                                      
                                                      
                                                      (49,916
                                                      )Income
      tax benefits from stock option exercises
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      1,530
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      1,530Comprehensive
      income:Change
      in unrealized loss on investmentsecurities
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      (1,087
                                                      )
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      (1,087
                                                      )Net
      income
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      28,621
                                                      
                                                      
                                                      
                                                      28,621Total
      comprehensive income
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      27,534BALANCE
      AT DECEMBER 31, 2007
                                                      
                                                      
                                                      62,477,590
                                                      
                                                      
                                                      
                                                      446,431
                                                      
                                                      
                                                      
                                                      (2,284
                                                      )
                                                      
                                                      
                                                      (116,443
                                                      )
                                                      
                                                      
                                                      327,704Issuance
      of common stock upon exercise ofstock options
                                                      
                                                      
                                                      446,923
                                                      
                                                      
                                                      
                                                      2,878
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      2,878Issuance
      of common stock in connection with ESPP
                                                      
                                                      
                                                      376,728
                                                      
                                                      
                                                      
                                                      2,428
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      2,428Share-based
      compensation
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      10,617
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      10,617Repurchase
      of common stock
                                                      
                                                      
                                                      (9,725,870
                                                      )
                                                      
                                                      
                                                      (69,727
                                                      )
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      (9,681
                                                      )
                                                      
                                                      
                                                      (79,408
                                                      )Excess
      tax benefit from share-based compensation
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      3,596
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      3,596Comprehensive
      loss:Change
      in unrealized loss on investmentsecurities
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      (6,925
                                                      )
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      (6,925
                                                      )Net
      income
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      4,881
                                                      
                                                      
                                                      
                                                      4,881Total
      comprehensive loss
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      (2,044
                                                      )BALANCE
      AT DECEMBER 31, 2008
                                                      
                                                      
                                                      53,575,371
                                                      
                                                      
                                                      $
                                                      396,223
                                                      
                                                      
                                                      $
                                                      (9,209
                                                      )
                                                      
                                                      $
                                                      (121,243
                                                      )
                                                      
                                                      $
                                                      265,771


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


62
 Table of Contents


SONICWALL,
INC.


CONSOLIDATED STATEMENTS OF CASH FLOWS


(In
thousands)


Year
      Ended December 31,2008
                          
                          
                          2007
                          
                          
                          2006CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income (loss)
                          
                          $
                          4,881
                          
                          
                          $
                          28,621
                          
                          
                          $
                          (10,753
                          )Adjustments
      to reconcile net income (loss) to net cash provided byoperating
      activities:Depreciation
      and amortization
                          
                          
                          8,939
                          
                          
                          
                          5,961
                          
                          
                          
                          10,246Adjustment
      of goodwill
                          
                          
                          283
                          
                          
                          
                          7,100
                          
                          
                          
                          6,826In-process
      research and development
                          
                          
                          -
                          
                          
                          
                          1,930
                          
                          
                          
                          1,580Share-based
      compensation expense related to employee stock options and
      ESPP
                          
                          
                          10,617
                          
                          
                          
                          13,542
                          
                          
                          
                          13,202Excess
      tax benefits from share-based compensation
                          
                          
                          (3,596
                          )
                          
                          
                          (1,530
                          )
                          
                          
                          -Auction
      rate securities impairment, net
                          
                          
                          210
                          
                          
                          
                          -
                          
                          
                          
                          -Change
      in allowance for doubtful accounts and others
                          
                          
                          (24
                          )
                          
                          
                          (169
                          )
                          
                          
                          61Deferred
      income taxes
                          
                          
                          (355
                          )
                          
                          
                          (27,474
                          )
                          
                          
                          -Changes
      in operating assets and liabilities, net of effects of businesses
      acquired:Accounts
      receivable
                          
                          
                          5,374
                          
                          
                          
                          902
                          
                          
                          
                          (8,899
                          )Inventories
                          
                          
                          (2,899
                          )
                          
                          
                          (606
                          )
                          
                          
                          (1,543
                          )Prepaid
      expenses and other current assets
                          
                          
                          1,283
                          
                          
                          
                          (1,596
                          )
                          
                          
                          (2,039
                          )Other
      assets
                          
                          
                          (215
                          )
                          
                          
                          28
                          
                          
                          
                          (346
                          )Accounts
      payable
                          
                          
                          (158
                          )
                          
                          
                          3,781
                          
                          
                          
                          (2,331
                          )Accrued
      payroll and related benefits
                          
                          
                          (8,833
                          )
                          
                          
                          3,366
                          
                          
                          
                          4,071Other
      accrued liabilities
                          
                          
                          1,477
                          
                          
                          
                          103
                          
                          
                          
                          2,643Deferred
      revenue
                          
                          
                          2,249
                          
                          
                          
                          28,201
                          
                          
                          
                          20,854Net
      cash provided by operating activities
                          
                          
                          19,233
                          
                          
                          
                          62,160
                          
                          
                          
                          33,572CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of property and equipment
                          
                          
                          (5,035
                          )
                          
                          
                          (7,481
                          )
                          
                          
                          (3,378
                          )Purchase
      of intangible asset
                          
                          
                          -
                          
                          
                          
                          (1,800
                          )
                          
                          
                          -Cash
      paid for acquisitions, net of cash acquired
                          
                          
                          -
                          
                          
                          
                          (25,269
                          )
                          
                          
                          (29,501
                          )Change
      in restricted cash in escrow
                          
                          
                          1,375
                          
                          
                          
                          (1,379
                          )
                          
                          
                          (1,296
                          )Maturity
      and sale of investments
                          
                          
                          183,224
                          
                          
                          
                          325,747
                          
                          
                          
                          229,888Purchase
      of investments
                          
                          
                          (116,488
                          )
                          
                          
                          (313,230
                          )
                          
                          
                          (241,121
                          )Net
      cash provided by (used in) investing activities
                          
                          
                          63,076
                          
                          
                          
                          (23,412
                          )
                          
                          
                          (45,408
                          )CASH
      FLOWS FROM FINANCING ACTIVITIES:Issuance
      of common stock under employee stock options and purchase
      plans
                          
                          
                          5,306
                          
                          
                          
                          17,035
                          
                          
                          
                          16,269Repurchase
      of common stock
                          
                          
                          (79,408
                          )
                          
                          
                          (49,916
                          )
                          
                          
                          (21,099
                          )Excess
      tax benefits from share-based compensation
                          
                          
                          3,596
                          
                          
                          
                          1,530
                          
                          
                          
                          -Net
      cash used in financing activities
                          
                          
                          (70,506
                          )
                          
                          
                          (31,351
                          )
                          
                          
                          (4,830
                          )NET
      INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
                          
                          
                          11,803
                          
                          
                          
                          7,397
                          
                          
                          
                          (16,666
                          )CASH
      AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
                          
                          
                          33,324
                          
                          
                          
                          25,927
                          
                          
                          
                          42,593CASH
      AND CASH EQUIVALENTS AT END OF PERIOD
                          
                          $
                          45,127
                          
                          
                          $
                          33,324
                          
                          
                          $
                          25,927SUPPLEMENTAL
      CASH FLOW INFORMATION:Cash
      paid for income taxes, net of refunds received
                          
                          $
                          1,339
                          
                          
                          $
                          1,700
                          
                          
                          $
                          1,220


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


63
 Table of Contents
 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


Note 1—Description of Business
 
 SonicWALL,
Inc. (the “Company”) was incorporated in California in February 1991 as Sonic
Systems, Inc.  The name of the Company was changed to SonicWALL, Inc.
in August, 1999.  SonicWALL, Inc. designs, develops, and manufactures
comprehensive network security, secure remote access, Web and e-mail security,
backup and recovery, and policy and management solutions, which enable
organizations to maximize network security without compromising network
performance.
 
 Note
2—Summary of Significant Accounting Policies
 
 Principles
of Consolidation
 
 The
consolidated financial statements have been prepared in accordance with
Generally Accepted Accounting Principles in the United States of America (U.S.
GAAP) and include the accounts of the Company and its wholly owned
subsidiaries.  All intercompany accounts and transactions have been
eliminated.
 
 Use
of Estimates
 
 The
preparation of financial statements in conformity with U.S. GAAP requires
management to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes.  The
accounting estimates that require management’s most significant, difficult and
subjective judgments include the valuation of investments, the valuation and
recognition of revenue and accounts receivable, the valuation of inventory, the
assessment of recoverability of intangible assets and their estimated useful
lives, the valuation and recognition of stock based compensation and the
recognition and measurement of current and deferred income tax assets and
liabilities.  Actual results could differ materially from these
estimates.
 
 Foreign
Currencies
 
 The
functional currency for all of the Company’s foreign subsidiaries is the U.S.
dollar, and accordingly, the foreign subsidiaries’ assets and liabilities are
remeasured into U.S. dollars using exchange rates at the period end or
historical exchange rate, as appropriate.  The results of operations
are remeasured at the average exchange rate during each reporting
period.  Currency remeasurement gains (losses) for the years ended
December 31, 2008, 2007, and 2006 amounted to $(361,000), $14,000, and
($277,000), respectively, and are included in interest income and other expense,
net.
 
 Cash
and Cash Equivalents
 
 The
Company considers all highly liquid investments purchased with an original
maturity or remaining maturity at the date of purchase of three months or less
to be cash equivalents.
 
 Investments
 
 Available-For-Sale and Trading
Investments. The Company’s investments consist of U.S. Treasury and U.S.
government agency securities, auction rate securities (ARS), asset backed
securities (ABS), corporate notes and bonds, commercial paper, and money market
funds. The Company designated all investments, except for ARS held by UBS, as
available-for-sale and therefore these investments are reported at fair value,
with unrealized gains and losses recorded in accumulated other comprehensive
income.  During the fourth quarter of fiscal 2008, the Company reclassified
ARS held by UBS from available-for-sale to trading securities.  Investments
that the Company designates as trading assets are reported at fair value, with
gains or losses resulting from changes in fair value recognized in earnings. See
Note 6 of the Company’s consolidated financial statements for further detailed
discussion.  For securities sold prior to maturity, the cost of securities
sold is based on the specific identification method.  Realized gains and
losses on the sale of investments are recorded in interest income and other
expense, net.  Investments that are readily convertible to cash are
classified as short-term investments. Investments that are not readily
convertible to cash are classified as long-term investments.  At December
31, 2008, all ARS and the non-government backed ABS are classified as
long-term investments.


64
 Table of Contents
 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)
  Other-Than-Temporary
Impairment. All of the Company’s available-for-sale investments are
subject to a periodic impairment review.  The Company recognizes an
impairment charge when a decline in the fair value of its investments below the
cost basis is judged to be other-than-temporary.  The Company considers
various factors in determining whether to recognize an impairment charge,
including the length of time and extent to which the fair value has been less
than the Company’s cost basis, the financial condition and near-term prospects
of the investee, and the Company’s intent and ability to hold the investment for
a period of time sufficient to allow for any anticipated recovery in the market
value. During the years ended December 31, 2008, 2007 and 2006 the Company
did not record any other-than-temporary impairment charges on its
available-for-sale securities.
 
 Fair
Value of Financial Instruments
 
 The
carrying value of the Company’s financial instruments, including cash and cash
equivalents, short-term investments, accounts receivable, and accounts payable,
approximates their fair values due to their relatively short maturities. The
Company does not hold or issue financial instruments for trading purposes other
than the UBS auction rate securities.
 
 Allowance
for Doubtful Accounts
 
 Trade
accounts receivable is recorded at the invoiced amount and do not bear interest.
The allowance for doubtful accounts is based on the Company’s assessment of the
collectability of customer accounts. The Company reviews the allowance monthly
by considering factors such as historical experience, type of receivables,
credit quality, the age of the accounts receivable balances, and the current
economic conditions that may affect a customer’s ability to pay. Account
balances are charged off against the allowance when it is probable the
receivable will not be recovered.
 
 Concentration
of Credit Risk, Foreign Operations, and Significant Customers
 
 Financial
instruments that potentially subject the Company to concentrations of credit
risk consist principally of cash and cash equivalents, investments and accounts
receivable.  The Company maintains its cash, cash equivalents, and
investments with high quality financial institutions and limits its investment
in individual securities based on the type and credit quality of each such
security.  Cash balances held with banks periodically exceed the amount of
insurance provided on such balances.
 
 The
Company’s customer base consists of international businesses, and the Company
performs ongoing credit evaluations of its customers’ financial condition and
requires no collateral from its customers.  Sales to foreign customers for
the years ended December 31, 2008, 2007, and 2006, all of which were denominated
in U.S. dollars, accounted for 34%, 32%, and 31% of total revenue,
respectively.
 
 Sales
through our three largest distributors, Alternative Technology, Tech Data, and
Ingram Micro represented the following percentages of total
revenue:


2008
                  
                  
                  2007
                  
                  
                  2006Alternative
      Technology
                  
                  
                  16%
                  
                  
                  
                  18%
                  
                  
                  
                  18%Tech
      Data
                  
                  
                  17%
                  
                  
                  
                  17%
                  
                  
                  
                  18%Ingram
      Micro
                  
                  
                  16%
                  
                  
                  
                  16%
                  
                  
                  
                  17%


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




December
      31,2008
                  
                  
                  2007
                  
                  
                  2006Alternative
      Technology
                  
                  
                  13%
                  
                  
                  
                  4%
                  
                  
                  
                  23%Tech
      Data
                  
                  
                  10%
                  
                  
                  
                  12%
                  
                  
                  
                  8%Ingram
      Micro
                  
                  
                  12%
                  
                  
                  
                  14%
                  
                  
                  
                  17%
 65
 Table of Contents
 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)
  While a
reduction in sales by any of these distributors could be offset by an increase
in sales to either of the other two distributors or by the addition of other
distributors, a material reduction in sales to any of these distributors, would
likely result in a temporary decline in overall sales.  The current
financial turmoil impacting the banking system and financial markets has
resulted in a tightening in the credit markets.  This lowering of the
level of liquidity in the credit markets may impact the ability of our
distributors to obtain credit to finance purchases of our products and
services.  If the liquidity of our distributors is adversely impacted
by the current uncertainties in the financial markets, they may be unable to pay
us in a timely manner.  If any of the foregoing should occur, our rate
of revenue growth will suffer, our revenue may decline and our business will be
adversely affected.
 
 The
Company outsources its manufacturing to third party contract manufacturers and
some of the key components in the Company’s products come from single or limited
number of suppliers.  The inability of any supplier or manufacturer to
fulfill supply requirements of the Company could materially impact future
operating results.
 
 Inventories
 
 Inventories
are stated at the lower of standard cost (which approximates cost determined on
a first-in, first-out basis) or market.  The Company writes down the
value of inventories for estimated excess and obsolete inventories based upon
assumptions about future demand and market conditions.  Inventories
consist primarily of finished goods.  Inventory reserves, once
established, are only reversed upon sale or disposition of related
inventories.
 
 Property
and Equipment
 
 Property
and equipment are stated at cost less accumulated depreciation and
amortization.  Depreciation is computed using the straight-line method
over the estimated useful lives of the related assets, which range from three to
five years.  Leasehold improvements are amortized over the lesser of
the related lease term or the estimated useful life of the improvement, which
ranges from one to five years.  Depreciation and amortization expenses
for the years ended December 31, 2008, 2007 and 2006 were $4.8 million, $3.0
million, and $2.1 million, respectively. Gains or losses on disposals are
included in the results of operations at amounts equal to the difference between
the net book value of the disposed assets and the proceeds received upon
disposal.  Costs for replacements and betterments are capitalized, while
the costs of repairs and maintenance are charged against earnings as
incurred.
 
 Purchased
Intangibles and Other Long-Lived Assets
 
 Purchased
intangibles consist of purchased technology, customer installed
base/relationships, customer backlog and other
intangibles.  Intangible assets are amortized on a straight-line basis
over their estimated useful lives which range from 3 months to eight
years.  Amortization of intangible assets was $4.1 million, $2.9
million, and $8.1 million in fiscal 2008, 2007, and 2006,
respectively.  The Company periodically evaluates its intangible and
other long-lived assets for indications of impairment.  If this
evaluation indicates that the value of the asset may be impaired, the Company
makes an assessment of the recoverability of the net carrying value of the asset
over its remaining useful life.  If this assessment indicates that the
intangible or other long-lived asset is not recoverable, based on the estimated
undiscounted future cash flows of the technology over the remaining amortization
period, the Company reduces the net carrying value of the related asset to fair
value and may adjust the remaining amortization period.
 
 Goodwill
and Impairment of Goodwill
 
 Goodwill
represents the excess of the aggregate purchase price over the fair market value
of the net tangible and intangible assets acquired by the
Company.  Goodwill is tested for impairment in the fourth quarter of
each fiscal year or more often if an event or circumstances indicate that an
impairment loss has been incurred.  An impairment charge is recognized
if a reporting unit’s goodwill carrying amount exceeds its implied fair
value.  Goodwill impairment is determined using a two-step approach in
accordance with SFAS 142 using one or more of the following fair value measures
including: present value techniques of estimated future cash flows; or valuation
techniques based on multiples of earnings or revenue; or a similar performance
measure.  Any such impairment charge could be significant and could
have a material adverse effect on the Company’s reported financial
statements.  The goodwill recorded as a result of the business
combinations in the years presented is not deductible for tax
purposes.


66
 Table of Contents
 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)
 The
Company’s stock price has experienced a significant decline in fiscal 2008. The
Company performed its annual impairment test in the fourth quarter of fiscal
2008 and considered factors such as current and forecasted earnings, current and
forecasted cash flow trends and expectations, market capitalization, control
premium, industry trends, legal factors, change in key personnel, and other
factors. These qualitative and quantitative considerations indicated that the
goodwill was not impaired at December 31, 2008. The Company also performed the
annual assessment in the fourth quarter of 2007, and 2006 and no indication of
impairment was noted. Goodwill as of December 31, 2008 was $138
million. There can be no assurances that future goodwill impairments will
not occur.
 
 Interest
Income and Other Expense, Net
 
 Interest
income and other expense, net consist primarily of interest income in the amount
of $7.0 million, $11.9 million, and $10.0 million for the years ended December
31, 2008, 2007 and 2006, respectively.
 
 Share-Based
Compensation
 
 On
January 1, 2006, the Company adopted SFAS 123R, which requires the
measurement and recognition of compensation expense for all share-based payment
awards made to employees and directors including employee stock options and
employee stock purchases related to the Employee Stock Purchase Plan (“employee
stock purchases”) based on estimated fair values. The Company adopted SFAS 123R
using the modified prospective transition method, which requires the application
of the accounting standard as of January 1, 2006, the first day of the
Company’s fiscal year 2006.  The Company’s Consolidated Financial
Statements as of and for the years ended December 31, 2008, 2007, and 2006
reflect the impact of SFAS 123R.
 
 SFAS 123R
requires companies to estimate the fair value of share-based payment awards on
the date of grant using an option-pricing model.  The value of the
portion of the award that is ultimately expected to vest is recognized as
expense over the requisite service periods in the Company’s Consolidated
Statements of Operations.
  Share-based
compensation expense recognized in the Consolidated Statements of Operations for
the years ended December 31, 2008, 2007, and 2006 are based on awards ultimately
expected to vest and has been reduced for estimated
forfeitures.  Share-based compensation expense recognized in the
Company’s Consolidated Statements of Operations for the years ended December 31,
2008, 2007, and 2006 included compensation expense for share-based payment
awards granted prior to, but not yet vested as of December 31, 2005 based
on the grant date fair value estimated in accordance with the pro forma
provisions of SFAS 123 and compensation expense for the share-based payment
awards granted subsequent to December 31, 2005 based on the grant date fair
value estimated in accordance with the provisions of SFAS 123R. In conjunction
with the adoption of SFAS 123R, the Company continued to use the straight-line
single option method.  SFAS 123R requires forfeitures to be estimated
at the time of grant and revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates.
 
 See Note
12 for additional information on share-based compensation.
 
 Revenue
Recognition
 
 The
Company derives its revenue primarily from the sale of: (1) products, (2)
software licenses, (3) subscriptions for services; and (4) other services such
as extended warranty and service contracts, training, consulting and engineering
services.  As described below, significant management judgments and
estimates must be made and used in connection with the revenue recognized in any
accounting period.  The Company may experience material differences in
the amount and timing of its revenue for any period if management makes
different judgments or utilizes different estimates.
 
 The
Company recognizes product and service revenues in accordance with SEC Staff
Accounting Bulletin No. 104, Revenue Recognition,and all
related amendments and interpretations.  The Company applies
provisions of Statement of Position 97-2, Software Revenue Recognition
(SOP No. 97-2), and all related amendments and interpretations, to all
transactions involving the sale of hardware products that include software
solutions.


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 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)
  The
Company recognizes revenue for products when persuasive evidence of an
arrangement exists, the product has been delivered, title and risk of loss have
been transferred to the customer, the fee is fixed or determinable, and
collection of the resulting receivable is reasonably assured.  While
the Company’s sales agreements contain standard terms and conditions, some
agreements include non-standard terms and conditions.  In these cases,
interpretation of non-standard provisions is required to determine the
appropriate accounting for the transaction.
 
 Retroactive
price protection rights resulting from price reductions on products previously
sold to customers are contractually offered to the Company’s channel
partners.  The Company evaluates the revenue impact of these rights
carefully based on stock on hand in the channels and records a provision for
estimated future price protection credit. Revenue from Ingram Micro and Tech
Data is not recognized until these distributors sell the product to their
customers.  As a consequence, there is no provision required for sales
to these distributors.  In general, retroactive price adjustments are
not significant.  At December 31, 2008, 2007, and 2006, the Company
recorded a provision for price protection on sales to the Company’s channel
partners in the amounts of $200,000, $985,000, and $42,000,
respectively.
 
 Delivery
to customers is generally deemed to occur when we deliver the product to a
common carrier.  Certain distributor agreements provide customers with
rights of return for stock rotation.  These stock rotation rights are
generally limited to 15% to 25% of the distributor's purchases for the
immediately prior 3 to 6 months period or contain other measurable restrictions,
and we estimate reserves for these return rights as discussed
below.  Two of our largest distributors, Ingram Micro and Tech Data,
have rights of return under certain circumstances that are not limited,
therefore, we do not deem delivery to have occurred for any sales to Ingram
Micro and Tech Data until they sell the product to their customers.
 
 Evidence
of an arrangement is manifested by a master distribution or OEM (Original
Equipment Manufacturer) agreement, an individual binding purchase order, or a
signed license agreement.  In most cases, sales through our
distributors and OEM partners are governed by a master agreement against which
individual binding purchase orders are placed on a transaction-by-transaction
basis.
 
 At the
time of the transaction, the Company assesses whether the fee associated with
the transaction is fixed or determinable, and whether or not collection is
reasonably assured.  The Company assesses whether the fee is fixed or
determinable based upon the terms of the binding purchase order, including the
payment terms associated with the transaction.  If a significant
portion of a fee is due beyond the Company’s normal payment terms, typically 30
to 90 days from invoice date, the Company accounts for the fee as not being
fixed or determinable and recognizes revenue as the fees become
due.
  The
Company assesses probability of collection based on a number of factors,
including past transaction history with and the credit-worthiness of the
customer.  The Company does not request collateral from its
customers.  If the Company determines that collection of a fee is not
reasonably assured, it defers the fee and recognizes revenue at the time
collection becomes reasonably assured, which is generally upon receipt of
cash.
  For
arrangements with multiple obligations (for example, the sale of an appliance
which includes a year of maintenance or a subscription based product), the
Company allocates revenue first to undelivered components of the arrangement
based on the vendor specific objective evidence of fair value of the undelivered
elements, which is generally the average selling price of each element when sold
separately.  This allocation process means that the Company defers
revenue from the arrangement equal to the fair value of the undelivered elements
and recognizes such amounts as revenue when the elements are
delivered.
 
 The
Company’s arrangements do not generally include acceptance
clauses.  However, if an arrangement includes an acceptance provision,
recognition of revenue occurs upon the earlier of receipt of a written customer
acceptance or expiration of the acceptance period.
 
 The
Company recognizes revenue for subscriptions and services such as content
filtering, anti-virus protection and intrusion prevention, and extended warranty
and service contracts, ratably over the contract term.  The Company’s
training, consulting and engineering services are generally billed and
recognized as revenue as these services are performed.
 
 The
Company collects and remits sales taxes on products and services that it
purchases and sells under its contracts withcustomers, and reports
such amounts under the net method in its consolidated statements of
operations.  Accordingly, there are no salestaxes included in
revenue.


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INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)


Sales
Returns, Other Allowances, and Warranty Reserve
 
 The
preparation of financial statements in accordance with U.S. GAAP requires the
Company to make estimates and assumptions that affect the reported amount of
assets and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenue and expenses during the
reported period.  Specifically, the Company must make estimates of
potential future product returns and price changes related to current period
product revenue.  The Company analyzes historical returns, current
economic trends, and changes in customer demand and acceptance of its products
when evaluating the adequacy of the sales returns and other
allowances.  Significant management judgments and estimates must be
made and used in connection with establishing the sales returns and other
allowances in any accounting period.  The Company may experience
material differences in the amount and timing of its revenue for any period if
management makes different judgments or utilizes different
estimates.
 
 The
Company’s appliance products are generally covered by a warranty for a one year
period.  The Company accrues a warranty reserve for estimated costs to
provide warranty services, including the cost of technical support, product
repairs, and product replacement for units that cannot be
repaired.  The estimate of costs to fulfill the Company’s warranty
obligations is based on historical experience and expectation of future
conditions.  To the extent the Company experiences increased warranty
claim activity or increased costs associated with servicing those claims, its
warranty accrual will increase, resulting in decreased gross
profit.
 
 Shipping
and Handling Costs
 
 The
Company records costs related to shipping and handling of products in cost of
revenue for all periods presented.
 
 Income
Taxes
 
 The
Company accounts for income taxes under the liability method, which requires,
among other things, that deferred income taxes be provided for temporary
differences between the tax bases of the Company’s assets and liabilities and
their financial statement reported amounts.  In addition, deferred tax
assets are recorded for the future benefit of utilizing net operating losses,
research and development credit carry forwards and temporary
differences.  A valuation allowance is provided to reduce deferred tax
assets to an amount for which realization is more likely than not.
 
 Research
and Development and Capitalized Software Development Costs
 
 Software
development costs incurred prior to the establishment of technological
feasibility are charged to research and development expense as
incurred.  Technological feasibility is established upon completion of
a working model, which is typically demonstrated by initial beta
shipment.  Software development costs incurred subsequent to the time
a product’s technological feasibility has been established, through the time the
product is available for general release to customers, are capitalized if
material.  To date, software development costs incurred subsequent to
the establishment of technological feasibility have been immaterial and
accordingly have not been capitalized.
 
 Reclassifications
 
 Certain
reclassifications have been made to prior year balances in order to present the
financial statements on a consistent basis with current year
presentation.  Such reclassifications have not changed previously
reported net income (loss) or shareholders’ equity.
 
 Advertising
Costs
 
 The
Company expenses advertising costs as incurred.  Advertising expense
totaled $4.4 million, $5.8 million, and $6.9 million for the years ended
December 31, 2008, 2007 and 2006, respectively.
 
 The
Company has agreements with certain of its distributors to provide marketing
development funds.  The Company accounts for such fees in accordance
with Emerging Issues Task Force (“EITF”) Issue No. 01-09, Accounting for Consideration Given
by a Vendor to a Customer, as a reduction in revenue, unless there is an
identifiable benefit and the fair value of the charges can


69
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INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)
  be
reasonably estimated in which case the Company records these transactions as
marketing expense.  In the years ended December 31, 2008, 2007, and
2006, the Company incurred operating expense for marketing development funds of
$2.9 million, $4.1 million, and $5.0 million, respectively.
 Computation
of Net Income (Loss) Per Share
 
 Basic net
income (loss) per share is computed by dividing the net income (loss) for the
period by the weighted average number of common shares outstanding during the
period.  Weighted average shares exclude shares subject to repurchase
(“restricted shares”).  Diluted net income (loss) per share is
computed by dividing the net income (loss) for the period by the weighted
average number of common and potential dilutive securities outstanding during
the period.  Potential dilutive securities are composed of incremental
common shares issuable upon the exercise of stock options.
 
 The
following table sets forth the computation of basic and diluted net income
(loss) per share for the periods indicated (in thousands, except per share
amounts):
 Year
      Ended December 31,2008
                        
                        
                        2007
                        
                        
                        2006Numerator:Net
      income (loss)
                        
                        $
                        4,881
                        
                        
                        $
                        28,621
                        
                        
                        $
                        (10,753
                        )Denominator:Weighted
      average shares used to compute basic EPS
                        
                        
                        56,069
                        
                        
                        
                        64,305
                        
                        
                        
                        65,117Effect
      of dilutive securities:Dilutive
      common stock equivalents
                        
                        
                        1,828
                        
                        
                        
                        2,794
                        
                        
                        
                        -Weighted
      average shares used to compute diluted EPS
                        
                        
                        57,897
                        
                        
                        
                        67,099
                        
                        
                        
                        65,117Net
      income (loss) per share:Basic
                        
                        $
                        0.09
                        
                        
                        $
                        0.45
                        
                        
                        $
                        (0.17
                        )Diluted
                        
                        $
                        0.08
                        
                        
                        $
                        0.43
                        
                        
                        $
                        (0.17
                        )
  Because
the Company reported a net loss during 2006, the impact of stock options was
excluded from the computation of dilutive earnings per share for this period, as
their effect would be anti-dilutive.  For the years ended December 31,
2008, 2007, and 2006, 13,697,705, 838,437, and 645,254 stock options with a
weighted average exercise price of $8.59, $16.22, and $18.02 respectively, were
not included in the computation of diluted earnings per share because the
options’ exercise prices were greater than the average market price of the
common shares for the period and therefore, the effect would be
anti-dilutive.
 
 Recent
Accounting Pronouncements
 
 In
September 2006, the FASB, issued SFAS No. 157,Fair Value Measurements
(SFAS 157).  SFAS 157 defines fair value, establishes a framework for
measuring fair value under generally accepted accounting principles, and expands
disclosures about fair value measurements.  The Company has adopted
SFAS 157 to account for its financial assets and liabilities for the fiscal year
beginning January 1, 2008. In February 2008, the FASB issued Staff Position
157-2, which delays the effective date of SFAS 157 for nonfinancial assets and
liabilities until January 1, 2009. The Company is in the process of evaluating
this standard and has not yet determined the impact that the adoption of SFAS
157 related to nonfinancial assets and liabilities will have on its consolidated
financial position, results of operations and cash flows. In October 2008, the
FASB issued Staff Position 157-3 (“FSP 157-3”), “Determining the Fair Value of a
Financial Asset When
the Market for That Asset Is Not Active.”  FSP 157-3
clarifies the application of SFAS No. 157 in a market that is not active and
addresses application issues such as the use of internal assumptions when
relevant observable data does not exist, the use of observable market
information when the market is not active and the use of market quotes when
assessing the relevance of observable and unobservable data. FSP 157-3 is
effective for all periods presented in accordance with SFAS 157. The guidance in
FSP 157-3 is effective immediately and did not have a material impact on the
Company’s consolidated financial statements.
 
 In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities—Including an amendment of FASB Statement No.
115 (SFAS 159).  SFAS 159 is expected to expand the use of fair
value accounting but does not affect existing standards which require
certain assets or liabilities to be carried at fair value.  The
objective of SFAS 159 is to improve financial reporting by providing companies
with the opportunity to mitigate volatility in
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 Table of Contents
 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)
  reported
earnings caused by measuring related assets and liabilities differently without
having to apply complex hedge accounting provisions.  Under SFAS
159, a company may choose, at specified election dates, to measure eligible
items at fair value and report unrealized gains and losses on items for
which the fair value option has been elected in earnings at each subsequent
reporting date.  SFAS 159 is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years.  The Company only elected
to adopt the fair value option under this Statement for the initial recognition
of the UBS Right as discussed in Note 6.
  In
December 2007, the FASB issued SFAS No. 141 (R), Business
Combinations.SFAS No. 141 (R) requires an acquirer to measure the
identifiable assets acquired, the liabilities assumed and any noncontrolling
interest in theacquired
entity at their fair values on the acquisition date, with goodwill being the
excess value over the net identifiable assets acquired. SFAS No. 141 (R) is
effective for financial statements issued for fiscalyears
beginning after December 15, 2008. Early adoption is prohibited.


Note
3—Balance Sheet Components:




December
      31,2008
                            
                            
                            2007(in
      thousands)Prepaid
      expenses and other current assets:Cash
      in escrow
                            
                            $
                            5,104
                            
                            
                            $
                            1,402Deferred
      compensation asset
                            
                            
                            3,430
                            
                            
                            
                            4,030Other
      prepaid expenses
                            
                            
                            3,327
                            
                            
                            
                            4,015$
                            11,861
                            
                            
                            $
                            9,447Property
      and equipment, net:Equipment
                            
                            $
                            19,787
                            
                            
                            $
                            17,426Office
      equipment and furniture
                            
                            
                            5,371
                            
                            
                            
                            3,801Leasehold
      improvements
                            
                            
                            2,364
                            
                            
                            
                            2,024Software
                            
                            
                            10,824
                            
                            
                            
                            10,40538,346
                            
                            
                            
                            33,656Less:
      accumulated depreciation
                            
                            
                            (28,803
                            )
                            
                            
                            (24,299
                            )$
                            9,543
                            
                            
                            $
                            9,357Purchased
      intangibles and other assets, net:Purchased
      intangible assets
                            
                            $
                            77,650
                            
                            
                            $
                            77,650Cash
      in escrow- non-current
                            
                            
                            -
                            
                            
                            
                            5,076Other
      assets
                            
                            
                            1,172
                            
                            
                            
                            95778,822
                            
                            
                            
                            83,683Less:
      accumulated amortization
                            
                            
                            (61,494
                            )
                            
                            
                            (57,362
                            )$
                            17,328
                            
                            
                            $
                            26,321Other
      accrued liabilities:Accrued
      acquisition costs
                            
                            $
                            5,104
                            
                            
                            $
                            1,414Warranty
      reserves
                            
                            
                            575
                            
                            
                            
                            741Income
      taxes (receivable) payable
                            
                            
                            97
                            
                            
                            
                            (22
                            )Other
      accrued liabilities
                            
                            
                            4,531
                            
                            
                            
                            5,222$
                            10,307
                            
                            
                            $
                            7,355


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INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)




Note
4—Goodwill and Purchased Intangibles:




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


December
      31,2008
                    
                    
                    2007Balance
      as of beginning of the year
                    
                    $
                    138,753
                    
                    
                    $
                    130,399Aventail
      Acquisition
                    
                    
                    -
                    
                    
                    
                    15,454Tax
      adjustment related to acquisitions (see Note 9)
                    
                    
                    (283
                    )
                    
                    
                    (7,100
                    )Balance
      at the end of the year
                    
                    $
                    138,470
                    
                    
                    $
                    138,753


Intangible
assets for the year ended December 31, 2008 and 2007 consist of the following
(in thousands):




December
      31, 2008
                      
                      
                      December
      31, 2007Weighted
      Average Amortization Period
                      
                      Gross
      Carrying Amount
                      
                      
                      Accumulated
      Amortization
                      
                      
                      Net
                      
                      
                      Gross
      Carrying Amount
                      
                      
                      Accumulated
      Amortization
                      
                      
                      NetPurchased
      technology
                      70
      month
                      
                      $
                      43,211
                      
                      
                      $
                      (33,822
                      )
                      
                      $
                      9,389
                      
                      
                      $
                      43,211
                      
                      
                      $
                      (30,805
                      )
                      
                      $
                      12,406Non-compete
      agreements
                      36
      month
                      
                      
                      7,249
                      
                      
                      
                      (7,249
                      )
                      
                      
                      -
                      
                      
                      
                      7,249
                      
                      
                      
                      (7,230
                      )
                      
                      
                      19Customer
      base
                      77
      month
                      
                      
                      26,690
                      
                      
                      
                      (19,922
                      )
                      
                      
                      6,768
                      
                      
                      
                      26,690
                      
                      
                      
                      (18,827
                      )
                      
                      
                      7,863Other
                      16
      month
                      
                      
                      500
                      
                      
                      
                      (500
                      )
                      
                      
                      -
                      
                      
                      
                      500
                      
                      
                      
                      (500
                      )
                      
                      
                      -Total
      intangibles
                      69
      month
                      
                      $
                      77,650
                      
                      
                      $
                      (61,493
                      )
                      
                      $
                      16,157
                      
                      
                      $
                      77,650
                      
                      
                      $
                      (57,362
                      )
                      
                      $
                      20,288
  On
December 14, 2007, the Company entered into a perpetual license agreement with
Linkbit, Inc. for certain intellectual property for $1.8 million, which will be
amortized over the estimated useful life of the technology of eight
years.





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




Fiscal
    Year
                    
                    Amortization Amount to Cost of
      Revenue
                    
                    
                    Amortization Amount to Operating
      Expenses2009
                    
                    $
                    3,017
                    
                    
                    $
                    1,0952010
                    
                    
                    2,374
                    
                    
                    
                    1,0952011
                    
                    
                    1,382
                    
                    
                    
                    1,0952012
                    
                    
                    1,382
                    
                    
                    
                    1,0082013
                    
                    
                    803
                    
                    
                    
                    990Thereafter
                    
                    
                    431
                    
                    
                    
                    1,485Total
                    
                    $
                    9,389
                    
                    
                    $
                    6,768


Note
5—Acquisitions:


On July
10, 2007, the Company completed the acquisition of 100% of the outstanding
shares of Aventail Corporation (“Aventail”) for approximately $25.6 million
in purchase consideration, consisting of cash of approximately $23.6 million,
and $2.0 million in direct transaction costs incurred
in connection with the acquisition.  In accordance with Statement of
Financial Accounting Standards (SFAS) No. 141,Business Combinations(SFAS 141), this transaction was
accounted for as a purchase business combination.  The Company
acquired Aventail to complement and extend its current SSL-VPN product
offering.
  The
Company allocated the purchase price based upon the fair value of the assets
acquired and liabilities assumed.  The excess of the purchase price
over the fair value of the assets acquired and liabilities assumed has been
allocated to the identified intangible


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INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)




assets
in accordance with the requirements of SFAS 141 and SFAS 142, Goodwill and Other
Intangible Assets.  The following is the final allocation of the
purchase consideration (in thousands):




Fair
      Market ValuesCash
      and cash equivalents
                      
                      $
                      352Accounts
      receivable, net
                      
                      
                      3,764Inventories
                      
                      
                      241Prepaid
      expenses and other current assets
                      
                      
                      661Property
      and equipment, net
                      
                      
                      825In-process
      research and development
                      
                      
                      1,930Goodwill
                      
                      
                      15,454Intangible
      assets:Existing
      technology
                      
                      
                      6,940Customer
      relationships
                      
                      
                      7,920Other
      Assets
                      
                      
                      235Total
      assets acquired
                      
                      
                      38,322Accounts
      payable and other current liabilities
                      
                      
                      1,253Accrued
      compensation
                      
                      
                      3,695Deferred
      revenue
                      
                      
                      5,146Loan
      payable
                      
                      
                      2,607Total
      liabilities assumed
                      
                      
                      12,701Net
      assets acquired
                      
                      $
                      25,621




Pursuant to the terms of
the Merger Agreement, options held by employees of Aventail to acquire 744,043
shares of common stock were assumed by SonicWALL.  The fair value as
of the acquisition date of these stock options assumed, using the Black-Scholes
valuation method, was $2.2 million.  There were no options vested as
of the acquisition date, therefore the purchase price component related to the
assumption was zero.  The total fair value of $2.2 million is being
recognized as compensation cost over the requisite service period. The
acquired purchased technology and customer relationships are
being amortized over their estimated useful life of six and eight years,
respectively.
  The
Company's methodology for allocating a portion of the purchase price for
purchase acquisitions to in-process research and development (“IPR&D”) is
determined through established valuation techniques in the high-technology
internet security industry.  IPR&D is expensed upon acquisition
because technological feasibility had not been established and no future
alternative use exists.  Total IPR&D expense of $1.9 million
was charged to product development expenses on the date the assets were
acquired.
 
 The
results of operations of Aventail have been included in the Company’s
consolidated financial statements subsequent to the date of
acquisition.  The financial information in the table below summarizes
the combined results of operations of SonicWALL and Aventail, on a pro forma
basis, as though the companies had been combined as of the beginning of each of
the periods presented (in thousands, except per share amounts):


Year
      Ended December 31,(unaudited)
                    
                    2007
                    
                    
                    2006Total
      revenue
                    
                    $
                    209,458
                    
                    
                    $
                    193,976Pro
      forma net income (loss)
                    
                    $
                    24,649
                    
                    
                    $
                    (19,556
                    )Pro
      forma net income (loss) per share - basic
                    
                    $
                    0.38
                    
                    
                    $
                    (0.30
                    )Pro
      forma net income (loss) per share - diluted
                    
                    $
                    0.37
                    
                    
                    $
                    (0.30
                    )Reported
      net income (loss)
                    
                    $
                    28,621
                    
                    
                    $
                    (10,753
                    )Reported
      net income (loss) per share - basic
                    
                    $
                    0.45
                    
                    
                    $
                    (0.17
                    )Reported
      net income (loss) per share - diluted
                    
                    $
                    0.43
                    
                    
                    $
                    (0.17
                    )


73
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 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)
  The pro
forma financial information is presented for informational purposes only and is
not indicative of the results of operations that would have been achieved if the
merger had taken place at the beginning of each of the periods
presented.  The pro forma financial information for the year ended
December 31, 2007 excludes a charge of $1.9 million for
IPR&D.  The pro forma financial information for year ended
December 31, 2006 also includes amortization charges from acquired intangible
assets.
 On
February 22, 2006, the Company completed the acquisition of MailFrontier, Inc.
(“MailFrontier”) for approximately $29.8 million in purchase consideration,
consisting of cash of approximately $29.3 million, assumed stock options with a
fair value of $109,000 and direct transaction costs incurred in connection with
the acquisition of approximately $450,000.  In accordance with SFAS
141, Business
Combinations, this transaction was accounted for as a purchase business
combination.  The fair value of the stock options assumed was
determined using the Black-Scholes option-pricing model.  The use of
the Black-Scholes model and method of determining the assumptions is consistent
with the Company’s valuation of stock options in accordance with
SFAS123R.  MailFrontier’s results of operations are included in the
Company’s consolidated statements of operations from the date of
acquisition.
  The
Company acquired MailFrontier to expand its offering in secure content
management, especially in the email security market.  MailFrontier’s
email security solutions protect organizations against inbound and outbound
threats such as “spam”, “phishing”, “viruses”, directory harvest attacks and
policy violations, provide control for content compliance, and enable
consolidation of email infrastructure.
  The
Company allocated the purchase price based upon the fair value of the assets
acquired and liabilities assumed.  The excess of the purchase price
over the fair value of the assets acquired and liabilities assumed has been
allocated to the identified intangible assets in accordance with the
requirements of SFAS 141 and SFAS 142, Goodwill and Other Intangible
Assets.  The following is the final allocation of the purchase
consideration (in thousands):
 Fair
      Market ValuesCash
      and cash equivalents
                              
                              $
                              97Accounts
      receivable, net
                              
                              
                              1,203Prepaid
      expenses and other current assets
                              
                              
                              181Property
      and equipment, net
                              
                              
                              303In-process
      research and development
                              
                              
                              1,580Goodwill
                              
                              
                              28,220Intangible
      assets:Existing
      technology
                              
                              
                              2,700Customer
      relationships
                              
                              
                              630Technology
      license
                              
                              
                              30Non-compete
      covenants
                              
                              
                              230Other
      Assets
                              
                              
                              8Total
      assets acquired
                              
                              
                              35,182Accounts
      payable and other current liabilities
                              
                              
                              1,450Accrued
      compensation
                              
                              
                              749Deferred
      revenue
                              
                              
                              2,395Accrued
      restructuring
                              
                              
                              792Total
      liabilities assumed
                              
                              
                              5,386Net
      assets acquired
                              
                              $
                              29,796
 The
acquired intangible assets are being amortized as follows: (1) Purchased
technology over its estimated useful life of four years; (2) Customer base value
over six years; and (3) Technology licenses and non-compete covenants over a
period of 4 to 24 months.
  The
Company’s methodology for allocating a portion of the purchase price for
acquisitions to in-process research and development (“IPR&D”) was determined
through established valuation techniques and analysis, as applied in the
high-technology


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 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)




internet security
industry.  IPR&D was expensed upon acquisition because
technological feasibility had not been established and no future alternative
uses existed.  Total IPR&D of $1.6 million was charged to
operations on the date of acquisition.




The
results of operations of MailFrontier have been included in the Company’s
consolidated financial statements subsequent to the date of
acquisition.  The financial information in the table below summarizes
the combined results of operations of SonicWALL and MailFrontier, on a pro forma
basis, as though the companies had been combined as of the beginning of each of
the periods presented (in thousands, except per share amounts):


(unaudited)
                        
                        Year
      Ended December 31, 2006Total
      revenue
                        
                        $
                        176,970Pro
      forma net loss
                        
                        $
                        (11,291
                        )Pro
      forma net loss per share - basic and diluted
                        
                        $
                        (0.17
                        )Reported
      net loss
                        
                        $
                        (10,753
                        )Reported
      net loss per share - basic
                        
                        $
                        (0.17
                        )Reported
      net loss per share - diluted
                        
                        $
                        (0.17
                        )
  The pro
forma financial information is presented for informational purposes only and is
not indicative of the results of operations that would have been achieved if the
merger had taken place at the beginning of each of the periods
presented.  The pro forma financial information for the year ended
December 31, 2006 excludes merger related expenses of $526,500 recorded by
MailFrontier and a charge of $1.6 million for IPR&D.  The pro
forma financial information for year ended December 31, 2006 and 2005 includes
amortization charges from acquired intangible assets.
 
 Note
6—Financial Instruments:
 
 Investments
 
 Our
investment portfolio consists of the following securities, excluding the rights
offering from UBS AG (“UBS”) described below (in thousands):


December
      31, 2008Marketable
      securities
                      
                      Fair Value
                      
                      
                      Gross Unrealized Gains
                      
                      
                      Gross Unrealized (Losses)
                      
                      
                      Book ValueCorporate
      debt securitiesAuction
      rate securities (ARS)
                      
                      $
                      51,929
                      
                      
                      $
                      -
                      
                      
                      $
                      (3,444
                      )
                      
                      $
                      55,373Asset
      backed securities (ABS)
                      
                      
                      34,905
                      
                      
                      
                      60
                      
                      
                      
                      (5,809
                      )
                      
                      
                      40,654Corporate
      bonds
                      
                      
                      12,816
                      
                      
                      
                      26
                      
                      
                      
                      (5
                      )
                      
                      
                      12,795Total
      corporate debt securities
                      
                      
                      99,650
                      
                      
                      
                      86
                      
                      
                      
                      (9,258
                      )
                      
                      
                      108,822U.S.
      government securities
                      
                      
                      22,337
                      
                      
                      
                      36
                      
                      
                      
                      (72
                      )
                      
                      
                      22,373Total
      marketable securities
                      
                      $
                      121,987
                      
                      
                      $
                      122
                      
                      
                      $
                      (9,330
                      )
                      
                      $
                      131,195Included
      in short-term investments
                      
                      $
                      60,327
                      
                      
                      $
                      116
                      
                      
                      $
                      (248
                      )
                      
                      $
                      60,459Included
      in long-term investments
                      
                      
                      61,660
                      
                      
                      
                      6
                      
                      
                      
                      (9,082
                      )
                      
                      
                      70,736Total
      marketable securities
                      
                      $
                      121,987
                      
                      
                      $
                      122
                      
                      
                      $
                      (9,330
                      )
                      
                      $
                      131,195




The following tables
provide the breakdown of the investments with unrealized losses at December 31,
2008 and 2007 (in thousands):


75
 Table of Contents
 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)
  December
      31, 2008
                        
                        Unrealized Losses Less Than 12
      Months
                        
                        
                        Unrealized Losses 12 Months or
      Greater
                        
                        
                        TotalMarketable
      securities
                        
                        Fair Value
                        
                        
                        Gross Unrealized Losses
                        
                        
                        Fair Value
                        
                        
                        Gross Unrealized Losses
                        
                        
                        Fair Value
                        
                        
                        Gross Unrealized LossesCorporate
      debt securitiesAuction
      rate securities
                        
                        $
                        44,079
                        
                        
                        $
                        (3,444
                        )
                        
                        $
                        -
                        
                        
                        $
                        -
                        
                        
                        $
                        44,079
                        
                        
                        $
                        (3,444
                        )Asset
      backed securities
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        22,230
                        
                        
                        
                        (5,809
                        )
                        
                        
                        22,230
                        
                        
                        
                        (5,809
                        )Corporate
      bonds
                        
                        
                        618
                        
                        
                        
                        (5
                        )
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        618
                        
                        
                        
                        (5
                        )Total
      corporate debt securities
                        
                        
                        44,697
                        
                        
                        
                        (3,449
                        )
                        
                        
                        22,230
                        
                        
                        
                        (5,809
                        )
                        
                        
                        66,927
                        
                        
                        
                        (9,258
                        )U.S.
      government securities
                        
                        
                        8,232
                        
                        
                        
                        (72
                        )
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        8,232
                        
                        
                        
                        (72
                        )Total
      marketable securities
                        
                        $
                        52,929
                        
                        
                        $
                        (3,521
                        )
                        
                        $
                        22,230
                        
                        
                        $
                        (5,809
                        )
                        
                        $
                        75,159
                        
                        
                        $
                        (9,330
                        )
 
 December
      31, 2007
                        
                        Unrealized Losses Less Than 12
      Months
                        
                        
                        Unrealized Losses 12 Months or
      Greater
                        
                        
                        TotalMarketable
      securities
                        
                        Fair Value
                        
                        
                        Gross Unrealized Losses
                        
                        
                        Fair Value
                        
                        
                        Gross Unrealized Losses
                        
                        
                        Fair Value
                        
                        
                        Gross Unrealized LossesCorporate
      debt securitiesAsset
      backed securities
                        
                        $
                        42,338
                        
                        
                        $
                        (1,024
                        )
                        
                        $
                        16,102
                        
                        
                        $
                        (1,303
                        )
                        
                        $
                        58,440
                        
                        
                        $
                        (2,327
                        )Corporate
      bonds
                        
                        
                        4,252
                        
                        
                        
                        (14
                        )
                        
                        
                        10,385
                        
                        
                        
                        (12
                        )
                        
                        
                        14,637
                        
                        
                        
                        (26
                        )Total
      corporate debt securities
                        
                        
                        46,590
                        
                        
                        
                        (1,038
                        )
                        
                        
                        26,487
                        
                        
                        
                        (1,315
                        )
                        
                        
                        73,077
                        
                        
                        
                        (2,353
                        )Total
      marketable securities
                        
                        $
                        46,590
                        
                        
                        $
                        (1,038
                        )
                        
                        $
                        26,487
                        
                        
                        $
                        (1,315
                        )
                        
                        $
                        73,077
                        
                        
                        $
                        (2,353
                        )
 
 The
estimated fair value of investments classified by date of maturity as of
December 31, 2008 is as follows (in thousands):
  2008Due
      within one year
                            
                            $
                            29,320Due
      between one and five years (1)
                            
                            
                            51,603Due
      between five and ten years
                            
                            
                            1,698Due
      after 10 years
                            
                            
                            39,156Total
      investments
                            
                            $
                            121,777
 _______________
 Note:
 (1)  Includes
auction rate securities of $45.3 million from UBS.
 As of
December 31, 2008, the Company had approximately 34 investments that were in an
unrealized loss position. The unrealized losses on U.S. corporate debt and U.S.
government agency securities were the result of overall market risk aversion,
lack of demand for securities that are not government guaranteed, and the
relative widening of credit spreads relative to the U.S. treasuries. The Company
believes that it will be able to collect all principal and interest amounts due
at maturity given the high credit quality of these investments. Since the
decline in the market value is attributable to changes in market conditions and
not credit quality, and since the Company has the ability and intent to hold
those investments until a recovery of par value, which may be maturity, the
Company does not consider these investments to be other-than temporarily
impaired as of December 31, 2008.
 
 In
February 2008, auctions began to fail for the auction rate securities (ARS).
Approximately 42% of the Company’s investments portfolio is comprised of these
ARS, whose underlying assets are student loans which are substantially backed by
the federal government. After the initial issuance of the securities, the
interest rate on the securities is reset periodically, at intervals established
at the time of issuance (primarily every twenty-eight days), based on market
demand for a reset period. ARS had been bought and sold in the marketplace
through a competitive bidding process often referred to as a “Dutch auction.” If
there is insufficient interest in the securities at the time of an auction, the
auction may not be completed and the rates may be reset to predetermined
“penalty” or “maximum” rates based on mathematical formulas in accordance with
each security’s prospectus.
 76
 Table of Contents
 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)
  Since
auctions for ARS continue to fail, the investments are not currently liquid. All
ARS are currently rated AAA, the highest rating by a rating agency, and the
underlying collateral of the ARS consists of student loan obligations, which are
primarily supported by the federal government as part of the Federal Family
Education Loan Program (“FFELP”). The Company does not expect the need to access
these funds in the short-term; however, in the event the Company needed to
access these funds, they are not expected to be accessible until one of the
following occurs: a successful auction occurs, the issuer redeems the issue,
a buyer is found outside of the auction process or the underlying
securities mature. Based on these factors, along with the underlying
maturities of the securities, a portion of which is greater than 20 years, the
Company has classified auction rate securities as long-term assets on its
Consolidated Balance Sheet as of December 31, 2008. The ARS were classified
as short-term investments as of December 31, 2007. The failures of these
auctions do not affect the value of the collateral underlying the ARS, and the
Company continues to earn and receive interest on its ARS based on a
pre-determined formula.
 
 Notwithstanding
the foregoing, in November 2008, the Company accepted an offer (the “Right”)
from UBS, one of its investment providers, entitling the Company to sell to UBS
at par value ARS originally purchased from UBS (approximately $45.3 million, par
value) at anytime during the period June 30, 2010 through July 2,
2012.  In accepting the Right, the Company also granted UBS the authority
to sell or auction the ARS at par at any time after accepting the offer until
the expiration date of the offer provided that the Company receive par value of
their ARS.  As part of the offer, the Company released UBS from any
claims relating to the marketing and sale of ARS. Although the Company expects
to sell its ARS under the Right, if the Right is not exercised before
July 2, 2012, the Right will expire and UBS will have no further right or
obligation to buy the Company’s ARS.
 
 UBS’s
obligations under the Right are not secured by its assets and do not require UBS
to obtain any financing to support its performance obligations under the Rights.
UBS has disclaimed any assurance that it will have sufficient financial
resources to satisfy its obligations under the Rights.
 
 The Right
represents a firm agreement in accordance with FASB Statement No. 133,
“Accounting for Derivative
Instruments and Hedging Activities ”, (SFAS 133), which defines a firm
agreement with an unrelated party, binding on both parties and usually legally
enforceable, with the following characteristics: a) the agreement specifies all
significant terms, including the quantity to be exchanged, the fixed price, and
the timing of the transaction, and b) the agreement includes a disincentive for
nonperformance that is sufficiently large to make performance probable. 
The enforceability of the Right results in a put option and should be recognized
as a separate freestanding asset and is accounted for separately from the ARS
investment. As of December 31, 2008, the Company recorded $7.6 million as
the fair value of the put option asset, classified as long-term investment on
the Balance Sheet as of December 31, 2008, with a corresponding credit to
Interest and other income, net, in the Consolidated Statement of Income for the
year ended December 31, 2008. The put option does not meet the definition
of a derivative instrument under SFAS 133. Therefore, the Company elected to
measure the put option at fair value under SFAS 159, which permits an entity to
elect the fair value option for recognized financial assets, in order to match
the changes in the fair value of the ARS.  On date available as of
December 31, 2008, the Company valued the Right using a discounted cash flow
approach including estimates of interest rates, timing and amount of cash
flow, adjusted for any bearer risk associated with UBS’s financial ability to
repurchase the ARS beginning June 30, 2010. These assumptions are volatile
and subject to change if the underlying sources of these assumptions and market
conditions change.
 
 Prior to
accepting the UBS offer, the Company recorded its ARS as available-for-sale
investments. In connection with the acceptance of the UBS offer in November
2008, resulting in a right to require UBS to purchase the ARS at par value
beginning on June 30, 2010, the Company has reclassified the related
portion of its ARS subject to the Right and held by UBS from available-for-sale
to trading in accordance with FASB Statement No. 115, “Accounting for Certain Investments
in Debt and Equity Securities” (SFAS 115). The transfer to trading
securities reflects management’s intent to exercise its put option during the
period June 30, 2010 to July 3, 2012.  Prior to its agreement
with UBS, management’s intent was to hold the ARS until the earlier of
anticipated recovery in market value or maturity.  Upon the
reclassification of the related ARS to trading securities, the Company
immediately recognized a loss of $7.8 million, included in Interest and other
income, net, for the amount of the unrealized loss not previously recognized in
earnings.  The Company holds additional ARS with another investment advisor
who has not made an offer similar to UBS.  These ARS will continue to be
held as available-for-sale.  The Company intends to retain its investment
in the ARS until the earlier of anticipated recovery in market value or maturity
and as a result has not recorded an other-than-temporary loss on these
ARS.
 77
 Table of Contents
 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)
 As of
December 31, 2008, the underlying assets of the asset backed securities (ABS)
are all prime mortgages.  None of the underlying assets of these ABS
are subprime mortgages or have a collateralized debt obligation
exposure.  The Company has $25.1 million in ABS backed by the U.S.
Government.  These securities could be generally liquidated within a
timeframe of three to nine months and were included in short-term investments on
the consolidated balance sheet.  For the remaining $15.3 million in
non-government backed ABS, the market continues to be illiquid.  As a
result, the Company has classified these as long-term.  The Company
has both the intent and the ability to hold these investments until a recovery
of the fair value occurs, which may be at maturity, evidenced by its cash and
short-term investment position and the ability to generate positive cash flows
from its operation.
  Fair
Value of Financial Instruments
 
 SFAS 157
defines fair value, establishes a framework for measuring fair value under
generally accepted accounting principles and enhances disclosures about fair
value measurements. Fair value is defined under SFAS 157 as the exchange price
that would be received for an asset or paid to transfer a liability (an exit
price) in the principal or most advantageous market for the asset or liability
in an orderly transaction between market participants on the measurement
date.  Valuation techniques used to measure fair value under SFAS 157 must
maximize the use of observable inputs and minimize the use of unobservable
inputs.  The standard describes a fair value hierarchy based on three
levels of inputs, of which the first two are considered observable and the last
unobservable, that may be used to measure fair value which are the
following:
 
 Level
      1—Quoted prices in active markets for identical assets or
      liabilities.
 Level
      2—Inputs other than Level 1 that are observable, either directly or
      indirectly, such as quoted prices for similar assets or liabilities;
      quoted prices in markets that are not active; or other inputs that are
      observable or can be corroborated by observable market data for
      substantially the full term of the assets or liabilities.
 Level
      3—Unobservable inputs that are supported by little or no market activity
      and that are significant to the fair value of the assets or
      liabilities.
 
 In
accordance with SFAS 157, the following table represents the Company’s fair
value hierarchy for its financial assets (cash equivalents and investments)
measured at fair value on a recurring basis as of December 31, 2008 (in
thousands):
  Fair
      Value Measurements at Reporting Date UsingQuoted
      Prices in Active Markets for Identical Assets
                          
                          
                          Significant
      Other Observable Inputs
                          
                          
                          Significant
      Unobservable InputsTotal
                          
                          
                          (Level
      1)
                          
                          
                          (Level
      2)
                          
                          
                          (Level
      3)Money
      Market Funds (1)
                          
                          $
                          25,211
                          
                          
                          $
                          25,211
                          
                          
                          $
                          -
                          
                          
                          $
                          -Asset
      Backed Securities (2)
                          
                          
                          34,905
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          34,905Auction
      Rate Securities (3)
                          
                          
                          44,079
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          44,079Auction
      Rate Securities Right (4)
                          
                          
                          7,640
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          7,640Other
      available-for-sale Securities (5)
                          
                          
                          35,152
                          
                          
                          
                          35,152
                          
                          
                          
                          -
                          
                          
                          
                          -Total
                          
                          $
                          146,987
                          
                          
                          $
                          60,363
                          
                          
                          $
                          -
                          
                          
                          $
                          86,624 _______________ Note:
 (1)
                              Classified
      as cash and cash equivalents in the consolidated balance
      sheet.
 (2)
                              Consisting
      of $25.1 million classified as short-term investments and $9.8 million as
      long-term investments in the consolidated balance
  sheet.
 (3)
                              Classified
      as long-term investments in the consolidated balance
  sheet.
 (4)
                              Classified
      as long-term investments in the consolidated balance
  sheet.
 (5)
                              Classified
      short-term investments in the consolidated balance
  sheet.


78
 Table of Contents
 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)


Historically,
the fair value of the ARS and the ABS investments approximated par value
due to the frequent resets through the auction process.  While the Company
continues to earn interest on its ARS and ABS investments at the contractual
rate, these investments are not currently trading and therefore do not have a
readily determinable market value.  Accordingly, the estimated fair value
of the ARS no longer approximates par value.  At December 31, 2008,
the Company’s investment advisors provided a valuation based on Level 3 inputs
for the ARS and the ABS investments.  The investment advisors utilized a
discounted cash flow approach to arrive at this valuation, which for the ARS
securities was corroborated by a separate and comparable discounted cash flow
analysis prepared by the Company.  The assumptions used in preparing the
discounted cash flow model include estimates of, based on data available as of
December 31, 2008, interest rates, timing and amount of cash flows, credit
and liquidity premiums, and expected holding periods of the ARS.  The
Company valued the Right as a put option asset using a discounted cash flow
approach including estimates of, based on Level 3 data available as of
December 31, 2008, interest rates, timing and amount of cash flow, adjusted
for any bearer risk associated with UBS’s financial ability to repurchase the
ARS beginning June 30, 2010.  In addition, the Company engaged an
independent valuation firm to evaluate the values received from the broker/
dealer statement for the ABS securities. The independent valuation firm used a
market approach methodology utilizing information such as trade data, two-sided
markets, institutional bids, comparable trades, dealer quotes, and data from
news media. The Company reviewed the methodology used and the resulting
valuation confirms the quotes received from the investment advisor. The
assumptions used in valuing the ARS, the ABS, and the put option are
volatile and subject to change as the underlying sources of these assumptions
and market conditions change.
  The
following table presents the Company’s activity for assets measured at fair
value on a recurring basis using significant unobservable inputs (Level 3) as
defined in SFAS 157 for the year ended December 31, 2008 (in
thousands):
 Asset
      Backed Securities
                        
                        
                        Auction
      Rate Securities
                        
                        
                        Auction
      Rate Securities Right
                        
                        
                        Total
      (1)Balance
      at December 31, 2007
                        
                        $
                        -
                        
                        
                        $
                        -
                        
                        
                        $
                        -
                        
                        
                        $
                        -Transfers
      to Level 3
                        
                        
                        40,655
                        
                        
                        
                        79,100
                        
                        
                        
                        -
                        
                        
                        
                        119,755Purchases,
      sales, issuances and settlements, net
                        
                        
                        -
                        
                        
                        
                        (23,727
                        )
                        
                        
                        -
                        
                        
                        
                        (23,727
                        )Total
      realized or unrealized gains or (losses)Included
      in other comprehensive income
                        
                        
                        (5,750
                        )
                        
                        
                        (3,444
                        )
                        
                        
                        -
                        
                        
                        
                        (9,194
                        )Included
      in earnings
                        
                        
                        -
                        
                        
                        
                        (7,850
                        )
                        
                        
                        7,640
                        
                        
                        
                        (210
                        )Balance
      at December 31, 2008
                        
                        $
                        34,905
                        
                        
                        $
                        44,079
                        
                        
                        $
                        7,640
                        
                        
                        $
                        86,624The
      amount of total gains or (losses) for the periodincluded
      in earnings attributable to the changein
      unrealized gains or losses relating to assetsstill
      held at December 31, 2008
                        
                        $
                        -
                        
                        
                        $
                        (7,850
                        )
                        
                        $
                        7,640
                        
                        
                        $
                        (210
                        )
 
 Note:
 (1)
                Included
      in long-term investments on our consolidated balance
  sheet.
  Note
7—Restructuring Charges:
  2008
Restructuring Plan
 
 During
the first quarter of fiscal year 2008, the Company commenced the implementation
of a 2008 restructuring plan associated primarily with the relocation of support
activities, the closure of facilities in Pune, India and Sunnyvale, California,
and other employee reductions for the purpose of better integration and
alignment of Company functions.  The restructuring activities were
recorded in accordance with Statement of Financial Accounting Standards
No. 146 Accounting for
Costs Associated with Exit or Disposal Activities (SFAS
146).  Accordingly, the Company recorded $1,042,000 in restructuring
expenses related to costs associated with the termination of 21 employees across
multiple geographic regions and functions,


79
 Table of Contents
 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)


primarily
related to severance, benefits and related costs.  Furthermore, the
Company recorded additional restructuring costs of $762,000 in connection with
facilities and property and equipment that was disposed of or removed from
service.  At December 31, 2008, the Company’s restructuring accrual
was $72,000 and included as a component of “Other accrued liabilities” in the
Company’s Condensed Consolidated Balance Sheets.
 The
following tables set forth an analysis of the components of the 2008
restructuring plan and the payments made in 2008 (in thousands):
 Employee Severance Benefits
                          
                          
                          Facility Costs
                          
                          
                          TotalAccrual
      balance at December 31, 2007
                          
                          $
                          -
                          
                          
                          $
                          -
                          
                          
                          $
                          -Restructuring charges incurred
                          
                          
                          1,042
                          
                          
                          
                          762
                          
                          
                          
                          1,804Impairment charges recorded
                          
                          
                          -
                          
                          
                          
                          (56
                          )
                          
                          
                          (56
                          )Adjustment
                          
                          
                          (125
                          )
                          
                          
                          -
                          
                          
                          
                          (125
                          )Cash paid
                          
                          
                          (917
                          )
                          
                          
                          (634
                          )
                          
                          
                          (1,551
                          )Accrual
      balance at December 31, 2008
                          
                          $
                          -
                          
                          
                          $
                          72
                          
                          
                          $
                          72
  2006
Restructuring Plan
 
 During
the first quarter of fiscal 2006, the Company commenced the implementation of a
2006 restructuring plan associated primarily with the integration of companies
acquired during the fourth quarter of 2005 and the first quarter of 2006 as well
as other employee reductions for the purpose of better integration and alignment
of Company functions.  The restructuring activities were recorded in
accordance with Statement of Financial Accounting Standards No. 146 Accounting for Costs Associated with
Exit or Disposal Activities (SFAS 146) and Statement of Financial
Accounting Standards No. 112, Employees’ Accounting for
Postemployment Benefits (SFAS 112).  Accordingly, the Company
recorded $1.4 million in restructuring expenses related to costs associated with
workforce reduction across multiple geographic regions and
functions.  Furthermore, the Company recorded additional restructuring
costs of $835,000 in connection with the integration of acquired
businesses.  The additional restructuring costs were charged to
goodwill and consisted primarily of severance costs of $553,000 and excess
facility costs of $282,000 related to a lease commitment for space no longer
needed.  As of December 31, 2007 and 2006, respectively, the Company
has no remaining liability relating to the restructuring
activities.
 
 The
following table sets forth an analysis of the components of all restructuring
plans and the payments made for the plans from December 31, 2005 to December 31,
2006 (in thousands):
  Employee Severance Benefits
                          
                          
                          Facility Costs
                          
                          
                          TotalAccrual
      balance at December 31, 2005
                          
                          $
                          -
                          
                          
                          $
                          (7
                          )
                          
                          $
                          (7
                          )Restructuring charges incurred
                          
                          
                          1,409
                          
                          
                          
                          -
                          
                          
                          
                          1,409Amount charged to goodwill
                          
                          
                          553
                          
                          
                          
                          282
                          
                          
                          
                          835Cash paid
                          
                          
                          (1,962
                          )
                          
                          
                          (275
                          )
                          
                          
                          (2,237
                          )Accrual
      balance at December 31, 2006
                          
                          $
                          -
                          
                          
                          $
                          -
                          
                          
                          $
                          -
 Note
8—Shareholders’ Equity:
 
 Stock
Repurchase Program
  In
November 2004, the Company’s Board of Directors authorized a stock repurchase
program to acquire up to $50 million of common stock.  The term of the
stock repurchase plan was set at twelve (12) months from the date of
authorization.  In February 2005, the Company’s Board of Directors
increased the amount authorized for repurchase from $50 million to $75 million,
extended the term of the program from twelve (12) to twenty-four (24) months
following the date of original authorization and increased certain predetermined
pricing formulas.  In April 2005, the Company’s Board of Directors
authorized a modification to the stock repurchase program to delete certain
elements that provided for systematic repurchases.
 80
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 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)
  In
February 2006, the Company’s Board of Directors approved an increase in the
amount authorized for repurchase under the Company’s share repurchase program
from $75.0 million to $100.0 million and extended the term of the program from
twenty-four (24) months to thirty-six (36) months following the date of original
authorization.
  On July
24, 2007, the Company’s Board of Directors approved a follow-on program for the
repurchase of the Company’s common stock.  The authorization under the
follow-on share repurchase program was $100 million plus approximately $19.6
million remaining under the share repurchase program originally authorized by
the Company’s Board of Directors in November 2004.  The term of the
follow-on program was one year from the date of approval.
  During
fiscal year 2008, the Company repurchased 9.7 million shares of SonicWALL common
stock at an average price of $8.16 for an aggregate purchase price of $79.4
million.  During fiscal year 2007, the Company repurchased 5.6 million
shares of SonicWALL common stock at an average price of $8.98 for an aggregate
purchase price of $49.9 million.  During fiscal year 2006, the Company
repurchased 2.4 million shares of SonicWALL common stock at an average price of
$8.73 for an aggregate purchase price of $21.1 million.  The Company’s
Stock Repurchase Program was completed as of September 30, 2008.
  The
purchase price for the shares of the Company’s common stock repurchased was
reflected as a reduction to shareholders’ equity.  In accordance with
Accounting Principles Board Opinion No. 6, “Status of Accounting Research
Bulletins,” the Company allocated the purchase price of the repurchased shares
as a reduction to retained earnings and common stock and additional paid-in
capital.
  Note
9—Income Taxes:
 
 The
benefit (provision) for income taxes consists of the following (in
thousands):
  Year Ended December 31,2008
                              
                              
                              2007
                              
                              
                              2006Current
      tax expense:Federal
                              
                              $
                              (4,541
                              )
                              
                              $
                              (1,710
                              )
                              
                              $
                              (762
                              )State
                              
                              
                              (805
                              )
                              
                              
                              (583
                              )
                              
                              
                              (445
                              )Foreign
                              
                              
                              (484
                              )
                              
                              
                              (399
                              )
                              
                              
                              (79
                              )(5,830
                              )
                              
                              
                              (2,692
                              )
                              
                              
                              (1,286
                              )Deferred
      tax benefit (expense):Federal
                              
                              
                              (269
                              )
                              
                              
                              11,920
                              
                              
                              
                              (6,920
                              )State
                              
                              
                              528
                              
                              
                              
                              8,373
                              
                              
                              
                              -259
                              
                              
                              
                              20,293
                              
                              
                              
                              (6,920
                              )Total
                              
                              $
                              (5,571
                              )
                              
                              $
                              17,601
                              
                              
                              $
                              (8,206
                              )
 As part
of the process of preparing the Company’s consolidated financial statements, the
Company is required to estimate its income taxes in each of the jurisdictions in
which it operates.  This process involves determining the Company’s
income tax benefit (expense) together with calculating the deferred income tax
benefit (expense) related to temporary differences resulting from differing
treatment of items, such as deferred revenue or deductibility of certain
intangible assets, for tax and accounting purposes.  These differences
result in deferred tax assets and liabilities, which are included within the
consolidated balance sheet.  The Company must then assess the
likelihood that the deferred tax assets will be recovered through the generation
of future taxable income.
  The
Company considers all available evidence, both positive and negative, including
historical levels of income, expectations and risks associated with estimates of
future taxable income and ongoing prudent and feasible tax planning strategies
in assessing the need for a valuation allowance.  If it is not more
likely than not that SonicWALL will recover its deferred tax assets, the Company
will increase its provision for taxes by recording a valuation allowance against
the deferred tax assets that the Company estimates will not ultimately be
recoverable.
  The
available positive evidence at December 31, 2007, included three years of
cumulative historical operating profits, a projection of future income
sufficient to realize most of the remaining deferred tax assets, and other
evidence.  The Company recorded a partial valuation allowance release
of $23.5 million in fiscal year 2007, because as of December 31, 2007, it
was


81
 Table of Contents
 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)
  considered more likely
than not that the Company’s deferred tax assets would be realized with
the exception of certain acquired net operating losses due to the annual “change
in ownership” limitation by the Internal Revenue Code of 1986, as amended. The
Company does not forecast future income beyond a 5-year time horizon to
determine if these deferred tax assets can be realized.  At December
31, 2008, the Company continues to believe that a valuation allowance is not
necessary with the exception of certain acquired net operating
losses.  The change in valuation allowance in fiscal 2008 was
primarily related to a change in estimates of these acquired net operating
losses.  The remaining valuation allowance of approximately $10.2
million as of December 31, 2008, would result in a credit to income tax expense
if and when the Company concludes it is more likely than not that the related
deferred tax assets will be realized.
 As of
December 31, 2008, the Company believed that the amount of deferred tax assets
recorded on our balance sheet would ultimately be recovered.  However,
should there be a change in the Company’s ability to recover the deferred tax
assets, the tax provision would increase in the period in which SonicWALL
determines that it is more likely than not that the Company cannot recover the
deferred tax assets.  If the Company has to re-establish a full
valuation allowance against the deferred tax assets, it would result in an
increase of $27.8 million to income tax expense.
 
 Significant
components of the deferred tax assets and liabilities are as follows (in
thousands):
  December 31,2008
                                  
                                  
                                  2007
                                  
                                  
                                  2006Deferred
      tax assets:Net
      operating loss carryforwards
                                  
                                  $
                                  17,190
                                  
                                  
                                  $
                                  19,591
                                  
                                  
                                  $
                                  16,714Inventory
      reserves
                                  
                                  
                                  1,137
                                  
                                  
                                  
                                  623
                                  
                                  
                                  
                                  520Deferred
      revenue
                                  
                                  
                                  2,434
                                  
                                  
                                  
                                  1,893
                                  
                                  
                                  
                                  3,591Tax
      credits
                                  
                                  
                                  5,951
                                  
                                  
                                  
                                  6,996
                                  
                                  
                                  
                                  8,260Share-based
      compensation
                                  
                                  
                                  5,469
                                  
                                  
                                  
                                  3,781
                                  
                                  
                                  
                                  2,101Other
      reserves and accruals
                                  
                                  
                                  12,322
                                  
                                  
                                  
                                  13,373
                                  
                                  
                                  
                                  8,07944,503
                                  
                                  
                                  
                                  46,257
                                  
                                  
                                  
                                  39,265Deferred
      tax liabilities:Intangible
      assets
                                  
                                  
                                  (6,490
                                  )
                                  
                                  
                                  (8,089
                                  )
                                  
                                  
                                  (2,920
                                  )Net
      deferred tax assets before valuation allowance
                                  
                                  
                                  38,013
                                  
                                  
                                  
                                  38,168
                                  
                                  
                                  
                                  36,345Valuation
      allowance
                                  
                                  
                                  (10,184
                                  )
                                  
                                  
                                  (10,694
                                  )
                                  
                                  
                                  (36,345
                                  )Net
      deferred tax assets:
                                  
                                  $
                                  27,829
                                  
                                  
                                  $
                                  27,474
                                  
                                  
                                  $
                                  -
 As of
December 31, 2008, the Company had cumulative net operating loss
carry-forwards for federal and state income tax reporting purposes of
approximately $64.2 million and $58.1 million, respectively.  The
federal net operating loss carry-forwards expire through the year 2027 and the
state net operating loss carry-forwards expire at various dates through the year
2019.  Such net operating losses consist of excess tax benefits from
employee stock option exercises and have not been recorded in the Company’s
deferred tax assets in accordance with FAS 123(R).  The Company will
record $20.8 million as a credit to additional paid in capital as and when such
excess tax benefits are ultimately realized.
 
 As of
December 31, 2008, the Company had cumulative carry-forwards for research
and development credits for federal and state income tax purposes of
approximately $7.3 million and $6.9 million, respectively.  These
federal research and development tax credits expire through the year
2028.  The state research and development credits can be carried
forward indefinitely.  Furthermore, the Company has federal
alternative minimum tax credits of approximately $0.5 million that can be
carried forward indefinitely.  Certain tax credit carryovers are
attributable to excess tax benefits from employee stock option exercises
and have not been recorded in the Company’s deferred tax assets in accordance
with FAS 123(R).  The Company will record $5.6 million as a credit to
additional paid in capital as and when such excess tax benefits are ultimately
realized.
 The
utilization of certain acquired net operating losses and tax credits are subject
to substantial annual limitation due to the “change in ownership” provisions of
the Internal Revenue Code of 1986, as amended, and similar state
provisions.  As a result, the annual limitation may result in the
expiration of net operating losses and tax credits before
utilization.
 
 Additionally,
the Company determined that certain gross deferred tax assets related to the
acquired companies as of December
 82
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 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)
  31, 2008,
required a valuation allowance.  At December 31, 2008, a partial
valuation allowance of $10.2 million has been recorded for a portion of the
acquired deferred tax assets as a result of the uncertainties regarding
realization of the assets based upon the limitation on the use of the net
operating losses in the future.  If and when such deferred tax assets
become realizable, the benefit will be credited to income tax
expense.  In fiscal year 2008, the Company utilized $283,000 of the
deferred tax assets related to the acquired companies resulting in a reduction
in goodwill.  The Company’s overall change in valuation allowance was
$(0.5) million, $(25.7) million, and $1.9 million for the years ended December
31, 2008, 2007 and 2006, respectively.
 
 The
Company’s effective tax rate on income (loss) differs from the U.S. Federal
statutory regular tax rate (benefit) as follows:
  Year Ended December 31,2008
                                      
                                      
                                      2007
                                      
                                      
                                      2006Federal
      statutory rate (benefit)
                                      
                                      
                                      35%
                                      
                                      
                                      
                                      35%
                                      
                                      
                                      
                                      (35%)State
      taxes, net of federal benefit
                                      
                                      
                                      8
                                      
                                      
                                      
                                      5
                                      
                                      
                                      
                                      (4)IPR&D
                                      
                                      
                                      -
                                      
                                      
                                      
                                      7
                                      
                                      
                                      
                                      25Share-based
      compensation
                                      
                                      
                                      23
                                      
                                      
                                      
                                      22
                                      
                                      
                                      
                                      100Tax
      credits
                                      
                                      
                                      (22)
                                      
                                      
                                      
                                      (21)
                                      
                                      
                                      
                                      (59)Change
      in valuation allowance
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (213)
                                      
                                      
                                      
                                      283Other
                                      
                                      
                                      9
                                      
                                      
                                      
                                      5
                                      
                                      
                                      
                                      1253%
                                      
                                      
                                      
                                      (160%)
                                      
                                      
                                      
                                      322%
 Undistributed
earnings of the Company’s foreign subsidiaries of approximately $4.0
million at December 31, 2008, are considered to be indefinitely reinvested and,
accordingly, no provisions for federal and state income taxes have been provided
thereon.  Upon distribution of those earnings in the form of dividends
or otherwise, the Company would be subject to both U.S. income taxes
(subject to an adjustment for foreign tax credits) and withholding taxes payable
to various foreign countries.
  The
Company’s income (loss) before income taxes was earned in the following
jurisdictions (in thousands):
 Year Ended December 31,2008
                                  
                                  
                                  2007
                                  
                                  
                                  2006Domestic
                                  
                                  $
                                  8,497
                                  
                                  
                                  $
                                  9,529
                                  
                                  
                                  $
                                  (2,191
                                  )Foreign
                                  
                                  
                                  1,955
                                  
                                  
                                  
                                  1,491
                                  
                                  
                                  
                                  (356
                                  )Total
                                  
                                  $
                                  10,452
                                  
                                  
                                  $
                                  11,020
                                  
                                  
                                  $
                                  (2,547
                                  )
 In June
2006, the Financial Accounting Standards Board (FASB) issued Interpretation
No. 48, “Accounting for
Uncertainty in Income Taxes” (FIN 48).  FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprise’s
financial statements in accordance with Statement of Financial Accounting
Standards No. 109, “Accounting for Income Taxes”
(FAS 109).  This interpretation prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of
a tax position taken or expected to be taken in a tax return.  FIN 48
also provides guidance on derecognition of tax benefits, classification on the
balance sheet, interest and penalties, accounting in interim periods,
disclosure, and transition.  The Company adopted FIN 48 effective
January 1, 2007.  In accordance with FIN 48, paragraph 19, the
Company recognizes interest and penalties related to unrecognized tax benefits
within the income tax expense line in the accompanying consolidated statement of
operations.    As a result of the implementation of FIN 48,
the Company recognized an $89,000 increase in liability for unrecognized tax
benefits, which was accounted for as a reduction to the January 1, 2007
balance of retained earnings.
  A
reconciliation of the beginning and ending balances of the total amounts of
gross unrecognized tax benefits is as follows (in thousands):
 83
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 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)




2008
                    
                    
                    2007Gross
      unrecognized tax benefits at January 1
                    
                    $
                    1,657
                    
                    
                    $
                    3,124Increases
      in tax positions for prior years
                    
                    
                    86
                    
                    
                    
                    726Decreases
      in tax positions for prior years
                    
                    
                    (406
                    )
                    
                    
                    (2,443
                    )Increases
      in tax positions for current years
                    
                    
                    359
                    
                    
                    
                    250Settlements
                    
                    
                    -
                    
                    
                    
                    -Lapse
      in statute of limitations
                    
                    
                    -
                    
                    
                    
                    -Gross
      unrecognized tax benefits at December 31
                    
                    $
                    1,696
                    
                    
                    $
                    1,657


Included
in the balance of unrecognized tax benefits at December 31, 2008 and 2007
respectively, are $1.7 million and $0.7 million of tax benefits that, if
recognized, would affect the effective tax rate. Accrued interest and penalties
are immaterial at the date of adoption and as of December 31,
2008.  Such amounts are included in the unrecognized tax
benefits.


The
Company’s unrecognized tax benefits include state exposures from not filing
state tax returns.  The Company does not expect any material changes
in unrecognized tax benefits within the next 12 months.
 
 The
Company is subject to taxation in the US and various states and foreign
jurisdictions.  As of December 31, 2008, the Company’s tax years for
2004 through 2008 are subject to examination by the tax
authorities.  With few exceptions, as of December 31, 2008, the
Company is no longer subject to U.S. federal, state, local or foreign
examinations by tax authorities for years before 2004.
 
 Note
10—Segment Reporting:
 
 The
Company reports segments in accordance with Statement of Financial Accounting
Standard No. 131, Disclosures
About Segments of an Enterprise and Related Information (SFAS
131).  SFAS 131 requires publicly held companies to report financial
and other information about key revenue segments of the entity for which such
information is available and is utilized by the chief operating decision
maker.  The Company conducts its business within one business
segment.  The Company has determined that the Chief Operating Decision
Maker (CODM) is the Chief Executive Officer (CEO).  The CODM allocates
resources and assesses the performance of the Company as a whole by functional
area.
 
 Revenue
by product category is as follows (in thousands):
 Year Ended December 31,2008
                          
                          
                          2007
                          
                          
                          2006UTM
                          
                          $
                          164,788
                          
                          
                          $
                          147,696
                          
                          
                          $
                          142,246SSL
                          
                          
                          20,668
                          
                          
                          
                          15,706
                          
                          
                          
                          5,913SCM
                          
                          
                          22,988
                          
                          
                          
                          23,604
                          
                          
                          
                          20,034CDP
                          
                          
                          10,200
                          
                          
                          
                          12,193
                          
                          
                          
                          7,345Total
                          
                          $
                          218,644
                          
                          
                          $
                          199,199
                          
                          
                          $
                          175,538
 
 Revenue
by geographic region, based on ship-to address, is as follows (in
thousands):
 Year Ended December 31,2008
                          
                          
                          2007
                          
                          
                          2006United
      States
                          
                          $
                          143,913
                          
                          
                          $
                          135,000
                          
                          
                          $
                          120,405All
      other countries
                          
                          
                          74,731
                          
                          
                          
                          64,199
                          
                          
                          
                          55,133Total
                          
                          $
                          218,644
                          
                          
                          $
                          199,199
                          
                          
                          $
                          175,538
  Long-lived
assets, which consist primarily of property and equipment, by geographic region
based on the location of the asset are presented as follows (in
thousands):
 Year
      Ended December 31,2008
                          
                          
                          2007
                          
                          
                          2006United
      States
                          
                          $
                          8,301
                          
                          
                          $
                          8,558
                          
                          
                          $
                          3,997All
      other countries
                          
                          
                          2,414
                          
                          
                          
                          1,756
                          
                          
                          
                          838Total
                          
                          $
                          10,715
                          
                          
                          $
                          10,314
                          
                          
                          $
                          4,835
 84
 Table of Contents
 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)
  The
following three customers accounted for 10% or more of the Company’s
revenue:
 2008
                          
                          
                          2007
                          
                          
                          2006Alternative
      Technology
                          
                          
                          16%
                          
                          
                          
                          18%
                          
                          
                          
                          18%Tech
      Data
                          
                          
                          17%
                          
                          
                          
                          17%
                          
                          
                          
                          18%Ingram
      Micro
                          
                          
                          16%
                          
                          
                          
                          16%
                          
                          
                          
                          17%
 Revenue derived from
Alternative Technology, Tech Data, and Ingram Micro is solely in the
Americas.  No other customer represented more than 10% of our sales in
those years.
 Note
11—Commitments and Contingencies:
 
 Lease
Commitments
 
 The
Company leases office space in several U.S. locations including California,
Washington, and Arizona. Additional sales and support offices as well as
research and development facilities are leased worldwide under leases that
expire at various dates ranging from 2009 to 2015, including larger facilities
in Bangalore, India and Shanghai, China.
 
 The
Company’s corporate headquarters and executive offices are located in
approximately 86,000 square feet of office space in Sunnyvale, California under
a lease that expires in September 2009.  The lease provides for one
five-year renewal option. In addition, the Company leases office space of
approximately 32,000 square feet in Tempe, Arizona.  The lease term is for
7.5 years and expires in August 2015.  The base rent for this lease
escalates annually at 3%.
 
 In July
2007, the Company assumed a five-year lease for approximately 20,000 square feet
of office space located in Seattle, Washington.  This lease expires in
February 2012. In September 2008, the Company closed approximately half of its
leased facility and recorded a liability of approximately $0.9 million
equivalent to the net present value of the expected future lease costs, net of
estimated future sublease. The liability is recorded as a component of “Other
accrued liabilities”.
 
 In
February 2008, the Company entered into a lease agreement to lease approximately
36,000 square feet of office space in Bangalore, India to carry out certain
research and development and technical support activities.  The lease
term is for a period of five years commencing in March 2008 and requires a lock
in period of 4 years, after which either party to the contract can terminate the
lease with notice duly given.  The base rent for this lease escalates
annually at 5%.
 
 In
November 2008, the Company expanded its existing facility in Shanghai, China to
a total of approximately 16,000 square feet of office space to carry out our
research and development activities. The lease term is for a period of three
years and expires in November 2011. The base rent will be increased by 15% in
September 2009.
 
 Rent
expense for the Company was approximately $4.1 million, $ 2.1 million, and $1.2
million for the years ended December 31, 2008, 2007 and 2006,
respectively.
 
 Future
annual minimum lease payments under all non-cancelable operating leases with an
initial term in excess of one year as of December 31, 2008 were as follows (in
thousands):
 Year Ending December 31,2009
                          
                          $
                          2,5062010
                          
                          
                          2,4652011
                          
                          
                          2,3862012
                          
                          
                          1,5672013
                          
                          
                          799Thereafter
                          
                          
                          999Total
                          
                          $
                          10,722
 85
 Table of Contents
 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)
  Purchase Commitments
(Unaudited) 
 The
Company outsources its manufacturing function to third party contract
manufacturers, and at December 31, 2008 it has purchase obligations totaling
$8.0 million.  Of this amount, $3.4 million cannot be cancelled and is
payable within one year.  The Company is contingently liable for any
inventory owned by a contract manufacturer that becomes excess and
obsolete.  As of December 31, 2008, $370,000 had been accrued for
excess and obsolete inventory held by our contract manufacturers.  In
addition, as of December 31, 2008, in the normal course of business, the Company
had $1.5 million in non-cancelable purchase commitments.
 Product
Warranties
  The
Company's standard warranty period for its products is one year and includes
repair or replacement obligations for units with product defects.  The
Company's software products carry a 90-day warranty and include technical
assistance, insignificant bug fixes and feature updates.  The Company
estimates the accrual for future warranty costs based upon its historical cost
experience and its current and anticipated product failure rates.  If
actual product failure rates or replacement costs differ from its estimates,
revisions to the estimated warranty obligations would be
required.  However, the Company concluded that no adjustment to pre-
existing warranty accruals were necessary for the years ended December 31, 2008,
2007 or 2006, respectively.  A reconciliation of the changes to the
Company's warranty accrual for the years ended December 31, 2008, 2007, and 2006
is as follows (in thousands):
  Year Ended December 31,2008
                          
                          
                          2007
                          
                          
                          2006Beginning
      balance
                          
                          $
                          741
                          
                          
                          $
                          811
                          
                          
                          $
                          790Accruals
      for warranties issued
                          
                          
                          919
                          
                          
                          
                          854
                          
                          
                          
                          599Settlements
      made during the period
                          
                          
                          (1,085
                          )
                          
                          
                          (924
                          )
                          
                          
                          (578
                          )Ending
      balance
                          
                          $
                          575
                          
                          
                          $
                          741
                          
                          
                          $
                          811
 
 Guarantees
and Indemnification Agreements
 
 The
Company enters into standard indemnification agreements in its ordinary course
of business.  As part of its standard distribution agreements, the
Company indemnifies, holds harmless, and agrees to reimburse the indemnified
parties for losses suffered or incurred by the indemnified party, in connection
with any U.S. patent or any copyright or other intellectual property
infringement claim by any third party with respect to the Company's products,
software, or services.  The indemnification agreements commence upon
execution of the agreement and do not have specific terms.  The
maximum potential amount of future payments the Company could be required to
make under these agreements is not limited.  The Company has never
incurred costs to defend lawsuits or settle claims related to these
indemnification agreements.  As a result, the Company believes the
estimated fair value of these agreements is minimal.
 
 The
Company's articles of incorporation limit the liability of directors to the full
extent permitted by California law.  In addition, the Company's bylaws
provide that the Company will indemnify its directors and officers to the
fullest extent permitted by California law, including circumstances in which
indemnification is otherwise discretionary under California law.  The
Company has entered into indemnification agreements with its directors and
officers that may require the Company: to indemnify its directors and officers
against liabilities that may arise by reason of their status or service as
directors or officers, other than liabilities arising from willful misconduct of
a culpable nature; to advance their expenses incurred as a result of any
proceeding against them as to which they could be indemnified; and to obtain
directors' and officers' insurance if available on reasonable terms. The Company
currently has directors and officers insurance in place.  The Company
has not incurred costs related to these indemnification agreements.
 
 The
Company has entered into agreements with certain executives where the Company
may be required to pay severance benefits up to 24 months of salary, bonuses and
accelerate vesting of stock options in the event of termination of employment
under certain circumstances, including a change of control. In October 2008, the
Compensation Committee of the Board of Directors authorized modifications to
these agreements designed to comply with Section 409A of the Internal Revenue
Code of 1986, as amended.


86
 Table of Contents
 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)


In 2007,
the Company paid severance benefits to certain of its former executives in the
amount of $41,000.
  In
January 2008, Mr. John DiLullo, Vice President of Worldwide Sales and a named
executive officer, ceased to be employed by the Company.  Under the
terms of Mr. DiLullo’s retention and severance agreement entered into at the
time of his employment in January 2006, the Company paid severance benefits and
bonuses, in compliance with Internal Revenue Code Section 409A, in the amount of
approximately $258,000.
 Legal
Proceedings


On
December 5, 2001, a securities class action complaint was filed in the U.S.
District Court for the Southern District of NewYork against the Company,
three of its officers and directors, and certain of the underwriters in the
Company’s initial public offering in November 1999 and its follow-on offering in
March 2000.  Similar complaints were filed in the same court against
numerous public companies that conducted initial public offerings (“IPOs”) of
their common stock since the mid-1990s.  All of these lawsuits were
consolidated for pretrial purposes before Judge Shira Scheindlin.  On
April 19, 2002, plaintiffs filed an amended complaint.  The amended
complaint alleges claims under the Securities Act of 1933 and the Securities
Exchange Act of 1934, and seeks damages or rescission for misrepresentations or
omissions in the prospectuses relating to, among other things, the alleged
receipt of excessive and undisclosed commissions by the underwriters in
connection with the allocation of shares of common stock in the Company’s public
offerings.  On July 15, 2002, the issuers filed an omnibus motion to
dismiss for failure to comply with applicable pleading standards.  On
October 8, 2002, the Court entered an Order of Dismissal as to all of the
individual defendants in the SonicWALL IPO litigation, without
prejudice.  On February 19, 2003, the Court denied the motion to
dismiss the Company’s claims.  A tentative agreement was reached with
plaintiffs’ counsel and the insurers for the settlement and release of claims
against the issuer defendants, including SonicWALL, in exchange for a guaranteed
recovery to be paid by the issuer defendants’ insurance carriers and an
assignment of certain claims.  Papers formalizing the settlement among
the plaintiffs, issuer defendants, including SonicWALL, and insurers were
presented to the Court on September 14, 2004.  On February 15, 2005,
the Court granted preliminary approval of the settlement, subject to the parties
fulfilling certain conditions.  On August 31, 2005, the Court entered
an order confirming its preliminary approval of the settlement.  In
December 2006, the Second Circuit Court of Appeals reversed the class
certification decision of the District Court in six (6) focus
cases.  The Second Circuit Court of Appeals also denied
rehearing.  In June 2007, the District Court signed a stipulation
terminating the settlement approval process.  In December 2007,
plaintiffs filed an opposition to motions to dismiss of the focus case issuers
and underwriters.  The focus case issuers and underwriters in turn
submitted briefs in opposition to plaintiffs’ motion for class
certification.  In March 2008, plaintiffs filed a reply in support of
their motion for class certification in the focus cases. Discussions among the
various parties are ongoing. If the litigation against the Company continues,
the Company believes it has a meritorious defense and intends to defend the case
vigorously.  No estimate can be made of the possible loss or possible range
of loss, if any, associated with the resolution of this contingency.  As a
result, no loss has been accrued in the Company’s financial statements as of
December 31, 2008.


On March
13, 2006, eSoft, Inc. (“eSoft”) filed a complaint captioned eSoft, Inc. v.
SonicWALL, Inc., No. 06-CV-00445, in the United States District Court for the
District of Colorado.  The Complaint alleged that the Company has
willfully infringed, actively induced the infringement of and/or knowingly
contributorily infringed U.S. Patent No. 6,961,773 (the “773 Patent”) and
sought  (1) a judgment that the Company has willfully infringed,
actively induced the infringement and/or knowingly contributorily infringed the
patent, (2) the award of an unspecified amount of trebled damages, together with
expenses, costs and attorneys’ fees and (3) permanent injunctive relief
restraining and enjoining the Company from infringing the patent. At essentially
the same time, eSoft filed complaints against five (5) other defendants alleging
infringement of the 773 Patent.  In response to a motion to re-examine
filed with the patent office by defendants in two of the other cases, the
Company filed a motion to stay proceedings pending the results of the
re-examination process.  eSoft joined in that motion and on February
12, 2007, the Court granted our motion for stay.  On September 15,
2008, the Patent and Trademark Office (the “PTO”) issued its first office action
as part of the re-examination process. Counsel for eSoft requested an extension
to December 15, 2008 to respond to the PTO office action. On December 10, 2008,
the parties filed a status report on the case. According to the status report,
the re-examination process was ongoing with no discernible end to that process
and any subsequent appeals. After receiving the report, the Court, on December
17, 2008, administratively closed the case with leave to reopen the case by any
party showing good cause. In consideration of the administrative closure of this
case, no loss has been accrued in the Company’s financial statements as of
December 31, 2008.
 87
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 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)
  On
October 8, 2008, Northpeak Wireless, LLC filed a complaint captioned Northpeak
Wireless, LLC v. 3Com Corporation, et al, No. CV-08-J-1813-NE, in the United
States District Court for the Northern District of Alabama. The complaint names
thirty one (31) defendants, including the Company. The complaint alleges that
the Company makes, uses, sells, offers to sell, and/or imports products that
incorporate and/or utilize direct sequence spread spectrum wireless technology
that infringes U.S. Patent No. 4,977,577 (the “577 Patent”) and U.S. Patent No.
5,987,058 (the “058 Patent”) and seeks a judgment that the Company has
infringed, actively induced infringement and/or contributorily infringed the 577
Patent and the 058 Patent. The complaint seeks an award of unspecified damages,
pre-judgment and post-judgment interest together with costs, expenses and
attorneys’ fees. On January 21, 2009, the Court granted the motion made by the
defendants, including SonicWALL, to transfer the case to theNorthern
District of California. The Company intends to defend the case vigorously. No
estimate can be made at this time of the possible loss or possible range of
loss, if any, associated with the resolution of this matter. As a result, no
loss has been accrued in the Company’s financial statements as of December 31,
2008.
 Additionally, the Company
is, from time to time, a party to routine litigation incidental to its
business.  The Company believes that none of these legal proceedings
will have a material adverse effect on the Company’s consolidated financial
statements taken as a whole or its results of operations, financial position,
and cash flows.
 Note
12—Employee Benefits:
  1999
Employee Stock Purchase Plan
  The 1999
Employee Stock Purchase Plan (ESPP) is designed to enable eligible employees to
purchase shares of the Company’s common stock at a discount.  Each
offering period is for one year and consists of two six-month purchase
periods.  The purchase price for shares of common stock under the ESPP
is 85% of the lesser of the fair market value of the Company’s common stock on
the first day of the applicable offering period or the last day of each purchase
period.
  At their
annual meeting on June 14, 2007, the Company’s shareholders voted to increase
the number of shares authorized for issuance under the ESPP by 1,500,000 shares
and extend the term of the ESPP to July 31, 2017.  The cumulative
total shares authorized for issuance under the ESPP is 4,025,000
shares.
  For the
years ended December 31, 2008, 2007, and 2006, the Company issued approximately
377,000, 379,000, and 414,000 shares, respectively, under the
ESPP.  At December 31, 2008, 1,311,550 shares were available for
future issuance under the ESPP.  The weighted average purchase price
of the shares issued under the ESPP in 2008, 2007, and 2006 was $6.45, $7.21,
and $5.18 per share, respectively.  The weighted average fair value of
shares issued under the ESPP was $2.03, $2.34, and $1.78 per share,
respectively, for 2008, 2007, and 2006.
  Stock
Option Plans
  Stock
Option Plan Descriptions
  As of
December 31, 2008, the Company had two stock incentive plans (together the
“Stock Option Plans”): the shareholder approved 2008 Equity Incentive Plan (the
“2008 Plan”) and the Board approved 2008 Inducement Equity Incentive Plan (the
“2008 Inducement Plan”). The 2008 Plan, which was approved by the Company’s
shareholders on June 10, 2008, replaced the 1998 Stock Option Plan (the “1998
Plan”) which was expiring. No further awards were made under the 1998 Plan. In
connection with the acquisitions of various companies, the Company assumed the
share-based awards granted under stock incentive plans of the acquired
companies. Share-based awards are designed to reward employees for their
long-term contributions to the Company and provide incentives for them to remain
with the Company. The number and frequency of share-based awards are based on
competitive practices, operating results of the Company, government regulations
and the other factors disclosed by the Company in its filings under the
Securities Exchange Act of 1934, as amended. The Company’s primary stock
incentive plans are summarized as follows:
  2008
Plan
  The 2008
Plan permits the granting of stock options, restricted stock, restricted stock
units, stock appreciation rights, and
 88
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 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)
 performance shares to
employees, consultants of the Company and its subsidiaries and affiliates, and
non-employee directors of the Company. As approved by the shareholders on June
10, 2008, the maximum number of shares issuable over the term of the 2008 Plan
is 800,000 shares. Stock options granted under the 2008 Plan have an exercise
price of at least 100% of the fair market value of the underlying stock on the
grant date and expire no later than seven years from the grant date. Stock
options granted under the 2008 Plan will generally become exercisable for 25% of
the option shares one year from the date of grant and then ratably over the
following 36 months. Subject to the annual per-person limit, shares granted
under the 2008 Plan, including applicable vesting schedules, shall be granted as
determined by the Board of Directors, or any of its committees administering the
2008 Plan, in its sole discretion. Shares subject to stock options or similar
awards granted under the 1998 Plan that expire or otherwise terminate without
having been exercised in full and shares issued pursuant to awards granted under
the 1998 Plan that are forfeited to, or repurchased by the Company, up to a
maximum of 5,000,000 shares may be added to the 2008 Plan.
  2008
Inducement Plan
  The 2008 Inducement Plan
permits the granting of nonstatutory stock options, restricted stock, restricted
stock units, performance shares, and stock appreciation rights to new
employees of the Company, its subsidiaries and affiliates, as material
inducements to accept an offer of employment. As adopted by the Board on June
10, 2008, the maximum number of shares issuable over the term of the 2008
Inducement Plan is 500,000 shares. Nonqualified stock options granted under the
2008 Inducement Plan have an exercise price of at least 100% of the fair market
value of the underlying stock on the grant date and expire no later than seven
years from the grant date.  The stock options awarded under the 2008
Inducement Plan will generally become exercisable as to 25% of the option
shares, one year after the date of grant and then ratably over the following 36
months. The Board of Directors or other committees administering the plan, have
the discretion to use a different vesting schedule.
 1998
Plan
  The 1998
Plan expired on June 10, 2008 upon shareholder approval of the 2008 Plan, and
the Company can no longer make equity awards under the 1998 Plan. As amended on
August 24, 1999 and October 12, 2000, the maximum number of shares issuable over
the term of the 1998 Plan was 38.9 million shares. Incentive stock options
granted under the 1998 Plan have an exercise price of at least 100% of the fair
market value of the underlying stock on the grant date and expire no later than
ten years from the grant date. Nonqualified stock options are granted at a price
that is not to be less than 85% of the fair market value of the common stock on
the date of grant, as determined by the Board of Directors or other committees
administering the plan, and expire no later than ten years from the date of
grant.  The stock options generally become exercisable for 25% of the
option shares one year from the date of grant, and then ratably over the
following 36 months. The Board of Directors or other committees administering
the plan had the discretion to use a different vesting schedule and did so from
time to time.
  The
following table summarizes option activity under the stock option
plans:
 89
 Table of Contents
 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)
 Options
      OutstandingOptions
      Available for Grant
                              
                              
                              Number
      of Shares Outstanding
                              
                              
                              Weighted
      Average Exercise Price per ShareBalance
      at December 31, 2005
                              
                              
                              347,565
                              
                              
                              
                              16,823,438
                              
                              
                              $
                              6.33Authorized
                              
                              
                              2,601,046
                              
                              
                              
                              -
                              
                              
                              
                              -Options
      assumed related to acquisition
                              
                              
                              -
                              
                              
                              
                              76,848
                              
                              
                              $
                              1.46Granted
                              
                              
                              (3,726,000
                              )
                              
                              
                              3,726,000
                              
                              
                              $
                              8.63Exercised
                              
                              
                              -
                              
                              
                              
                              (2,362,576
                              )
                              
                              $
                              5.98Canceled
                              
                              
                              1,568,952
                              
                              
                              
                              (1,606,190
                              )
                              
                              $
                              6.62Balance
      at December 31, 2006
                              
                              
                              791,563
                              
                              
                              
                              16,657,520
                              
                              
                              $
                              6.85Authorized
                              
                              
                              2,615,425
                              
                              
                              
                              -
                              
                              
                              
                              -Options
      assumed related to acquisition
                              
                              
                              -
                              
                              
                              
                              744,043
                              
                              
                              $
                              8.44Granted
                              
                              
                              (3,295,880
                              )
                              
                              
                              3,295,880
                              
                              
                              $
                              8.82Exercised
                              
                              
                              -
                              
                              
                              
                              (2,269,940
                              )
                              
                              $
                              6.30Canceled
                              
                              
                              1,186,970
                              
                              
                              
                              (1,234,350
                              )
                              
                              $
                              7.74Balance
      at December 31, 2007
                              
                              
                              1,298,078
                              
                              
                              
                              17,193,153
                              
                              
                              $
                              7.30Authorized
                              
                              
                              3,799,104
                              
                              
                              
                              -
                              
                              
                              
                              -Granted
                              
                              
                              (4,752,037
                              )
                              
                              
                              4,752,037
                              
                              
                              $
                              7.94Exercised
                              
                              
                              -
                              
                              
                              
                              (446,923
                              )
                              
                              $
                              6.44Canceled
                              
                              
                              1,529,422
                              
                              
                              
                              (1,939,787
                              )
                              
                              $
                              8.36Retired
                              
                              
                              (89
                              )
                              
                              
                              -
                              
                              
                              
                              -Balance
      at December 31, 2008
                              
                              
                              1,874,478
                              
                              
                              
                              19,558,480
                              
                              
                              $
                              7.30
 The
following table summarizes significant ranges of outstanding and exercisable
options as of December 31, 2008:
  Options
      Outstanding
                          
                          
                          Options
      ExercisableRange
      of Exercise Prices
                          
                          
                          Number
      of Shares Outstanding
                          
                          
                          Weighted
      Average Remaining Contractual Life (in Years)
                          
                          
                          Weighted
      Average Exercise Price per Share
                          
                          
                          Aggregate
      Intrinsic Value
                          
                          
                          Number
      of Shares Exercisable
                          
                          
                          Weighted
      Average Exercise Price per Share
                          
                          
                          Aggregate
      Intrinsic Value$0.30
      – $ 0.45
                          
                          
                          
                          394
                          
                          
                          
                          6.6
                          
                          
                          $
                          0.30
                          
                          
                          $
                          1,450
                          
                          
                          
                          244
                          
                          
                          $
                          0.30
                          
                          
                          $
                          898$0.94
      – $ 1.41
                          
                          
                          
                          14,711
                          
                          
                          
                          1.3
                          
                          
                          
                          1.40
                          
                          
                          
                          37,883
                          
                          
                          
                          12,346
                          
                          
                          
                          1.40
                          
                          
                          
                          31,805$1.42
      – $ 2.13
                          
                          
                          
                          3,094
                          
                          
                          
                          0.8
                          
                          
                          
                          1.42
                          
                          
                          
                          7,921
                          
                          
                          
                          3,094
                          
                          
                          
                          1.42
                          
                          
                          
                          7,921$2.87
      – $ 4.41
                          
                          
                          
                          2,934,670
                          
                          
                          
                          4.2
                          
                          
                          
                          3.44
                          
                          
                          
                          1,640,988
                          
                          
                          
                          2,912,170
                          
                          
                          
                          3.44
                          
                          
                          
                          1,638,608$4.93
      – $ 7.40
                          
                          
                          
                          3,531,849
                          
                          
                          
                          5.5
                          
                          
                          
                          5.90
                          
                          
                          
                          -
                          
                          
                          
                          3,286,532
                          
                          
                          
                          5.87
                          
                          
                          
                          -$7.47
      – $11.21
                          
                          
                          
                          12,807,152
                          
                          
                          
                          8.0
                          
                          
                          
                          8.25
                          
                          
                          
                          -
                          
                          
                          
                          5,618,227
                          
                          
                          
                          8.26
                          
                          
                          
                          -$11.26
      – $16.89
                          
                          
                          
                          43,610
                          
                          
                          
                          1.9
                          
                          
                          
                          13.77
                          
                          
                          
                          -
                          
                          
                          
                          43,610
                          
                          
                          
                          13.77
                          
                          
                          
                          -$17.03
      – $25.55
                          
                          
                          
                          103,000
                          
                          
                          
                          2.6
                          
                          
                          
                          17.94
                          
                          
                          
                          -
                          
                          
                          
                          103,000
                          
                          
                          
                          17.94
                          
                          
                          
                          -$29.75
      – $44.63
                          
                          
                          
                          20,000
                          
                          
                          
                          1.4
                          
                          
                          
                          29.75
                          
                          
                          
                          -
                          
                          
                          
                          20,000
                          
                          
                          
                          29.75
                          
                          
                          
                          -$45.56
      – $68.34
                          
                          
                          
                          100,000
                          
                          
                          
                          1.5
                          
                          
                          
                          45.56
                          
                          
                          
                          -
                          
                          
                          
                          100,000
                          
                          
                          
                          45.56
                          
                          
                          
                          -Total
                          
                          
                          
                          19,558,480
                          
                          
                          
                          6.9
                          
                          
                          $
                          7.37
                          
                          
                          $
                          1,688,242
                          
                          
                          
                          12,099,223
                          
                          
                          $
                          6.88
                          
                          
                          $
                          1,679,232
  The
aggregate intrinsic value in the preceding table represents the total pretax
intrinsic value, based on options with an exercise price less than the Company’s
closing stock price of $3.98 as of December 31, 2008, which would have been
received by the option holders had all option holders exercised their options as
of that date.  The total number of in-the-money options exercisable as
of December 31, 2008 was 2.7 million.


90
 Table of Contents
 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)
 Fair
Value Disclosure
  The
share-based compensation expenses recognized under SFAS 123R for the years ended
December 31, 2008, 2007, and 2006 were as follows (in thousands):
 
 2008
                          
                          
                          2007
                          
                          
                          2006Employee
      Stock Options
                          
                          $
                          9,918
                          
                          
                          $
                          13,039
                          
                          
                          $
                          13,702Employee
      Stock Purchase
                          
                          
                          699
                          
                          
                          
                          938
                          
                          
                          
                          713Total
                          
                          $
                          10,617
                          
                          
                          $
                          13,977
                          
                          
                          $
                          14,415
  The
weighted average grant-date fair value of options granted for the year ended
December 31, 2008, 2007, and 2006 was $2.68, $2.92, and $3.07 per share,
respectively.  The total fair value of shares vested during the
year-ended December 31, 2008 was $9.8 million.  The total intrinsic
value of options exercised during the year-ended December 31, 2008 was $0.6
million.  The total cash received from employees as a result of
employee stock option exercises and employee stock purchase plan during the year
ended December 31, 2008 was $2.9 million.  In connection with these
exercises, there was a tax benefit of $127,000 realized by the Company due to
the Company’s current tax position.  The weighted average remaining
contractual term for options exercisable at December 31, 2008 was 5.8
years.  The Company issues new shares of common stock upon exercise of
stock options.  The total compensation cost (gross) related to
non-vested awards not yet recognized at December 31, 2008 was $19.0 million and
the weighted-average period over which this amount is expected to be recognized
is 2.82 years.
 
 The
Company has assumed certain option plans in connection with business
combinations.  Generally, the options granted under these plans have
terms similar to the Company’s own options.  The exercise prices of
such options have been adjusted to reflect the relative exchange
ratios.
 The
Company estimates the fair value of stock options using a Black-Scholes
option-pricing model to determine the fair value of share-based awards under
SFAS 123R, and consistent with that used for pro forma disclosures under SFAS
123 prior to the adoption of SFAS 123R.  The Black-Scholes
option-pricing model incorporates various and highly subjective assumptions
including expected volatility, expected term and interest rates. Although the
fair value of employee stock options is determined in accordance with SFAS 123R
and SAB 107 using an option-pricing model, that value may not be indicative of
the fair value observed in a willing buyer/willing seller market
transaction.
 Expected
Volatility:  The Company used a combination of historical and
implied volatility (“blended volatility”) in deriving its expected volatility
assumption as allowed under SFAS 123R and SAB 107.  Implied volatility
was derived based on traded options on the Company’s common stock with a minimum
term of six months.  The selection of the blended volatility approach
was based upon the availability of traded options on the Company’s stock and the
Company’s assessment that blended volatility is more representative of future
stock price trends than historical volatility alone.  In calculating
blended volatility, historical and implied volatility were weighted
equally.
  Risk-Free Interest
Rate:  The risk-free interest rate is based on the market yield
currently available on U.S. Treasury securities with an equivalent remaining
term.
  Expected Term:  The
Company’s expected term represents the period that the Company’s share-based
awards are expected to be outstanding and was determined based on historical
experience of similar awards, giving consideration to the contractual terms of
the share-based awards, vesting schedules and expectations of future employee
behavior as influenced by changes to the terms of its share-based
awards.
  Expected
Dividend: The Black-Scholes valuation model calls for a
single expected dividend yield as an input.  The Company has not paid
and does not anticipate paying any dividends in the near future.
 91
 Table of Contents
 SONICWALL,
INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS –
(Continued)
 The
assumptions used to estimate the fair value of stock options granted under the
Company’s Stock Option Plans using the Black-Scholes option pricing model for
the year ended December 31, 2008, 2007 and 2006 are as follows:
 2008
                          
                          
                          2007
                          
                          
                          2006Expected
      volatility
                          
                          40.6%
      to 46.6%
                          
                          
                          39.4%
      to 43.9%
                          
                          
                          42.4%
      to 48.4%Risk-free
      interest rate
                          
                          1.2%
      to 3.0%
                          
                          
                          3.2%
      to 5.1%
                          
                          
                          4.4%
      to 5.2%Expected
      life
                          
                          3.5 to
      3.7 years
                          
                          
                          2.9 to
      3.5 years
                          
                          
                          2.9 to
      3.1 yearsDividend
      yield
                          
                          
                          0%
                          
                          
                          
                          0%
                          
                          
                          
                          0%
  The fair
value of purchase rights issued under the Employee Stock Purchase Plan was
estimated using the following assumptions for the year ended December 31, 2008,
2007 and 2006:
  2008
                          
                          
                          2007
                          
                          
                          2006Expected
      volatility
                          
                          42.8%
      to 43.3%
                          
                          
                          30.3%
      to 34.3%
                          
                          
                          32.1%
      to 44.7%Risk-free
      interest rate
                          
                          2.0%
      to 2.8%
                          
                          
                          4.1%
      to 5.2%
                          
                          
                          3.7%
      to 5.3%Expected
      life
                          
                          0.5
      year to 1 year
                          
                          
                          0.5
      year to 1 year
                          
                          
                          0.5
      year to 1 yearDividend
      yield
                          
                          
                          0%
                          
                          
                          
                          0%
                          
                          
                          
                          0%
 
 Pension
Plan
 
 The
Company has a defined contribution retirement plan covering substantially all of
its eligible United States employees.  The Company’s contribution to
this plan is discretionary.  The Company provides for a discretionary
matching contribution amount which is currently 50% of the employee contribution
up to a maximum of $2,000 annually for each participant.  All such
employer contributions vest immediately. The Company has expensed approximately
$758,000, $678,000, and $615,000 of employer contributions for the years ended
December 31, 2008, 2007 and 2006, respectively.
 Deferred
Compensation Plan
 
 SonicWALL
has a deferred compensation plan (DCP) to provide specified benefits to, and
help retain, a select group of management and highly compensated employees and
directors (Participants) who contribute materially to the Company’s continued
growth, development, and future business success.  Under the DCP,
Participants may defer up to 80% of their salary and up to 100% of their annual
bonus and commission.  Each Participant’s deferral account is credited
with an amount equal to the net investment return of one or more equity or bond
funds selected by the Participant.  Amounts in a Participant’s
deferral account represent an unsecured claim against the Company’s assets and
are paid, pursuant to the Participant’s election, in a lump sum or in quarterly
installments at a specified date during the participant’s employment or upon the
Participant’s termination of employment with the Company.  The Company
pays for the insurance coverage provided under this plan, but does not make any
contributions to this plan.  In October 2008, the Compensation
Committee of the Board of Directors adopted modifications to the DCP designed to
comply with Section 409A of the Internal Revenue Code of 1986, as amended. At
December 31, 2008, the trust assets and the corresponding deferred compensation
liabilities were $3,430,000 and $3,678,000, respectively, and are included in
other current assets and other current liabilities,
respectively.
 92
 Table of Contents
 ITEM 9.  Changes in and Disagreements with
Accountants on Accounting and Financial
Disclosure
 None.
 
 ITEM 9A.  Controls and
Procedures
 Evaluation
of Disclosure Controls and Procedures
 
 The
Company, with the participation of our Chief Executive Officer (CEO), Chief
Financial Officer (CFO), and Chief Accounting Officer (CAO), has evaluated the
effectiveness of the design and operation of its disclosure controls and
procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended (the “Exchange Act”), as of December 31,
2008.  Based on the evaluation, the CEO, CFO and CAO have concluded
that the Company’s disclosure controls and procedures were effective as of
December 31, 2008 for the information required to be disclosed in the reports we
file or submit under the Exchange Act to be recorded, processed, summarized and
reported within the time period specified in the SEC’s rules and forms and such
information is accumulated and communicated to management as appropriate to
allow timely decisions regarding required disclosure.
 
 Management
Report on Internal Control over Financial Reporting
 
 Management
of the Company is responsible for establishing and maintaining adequate internal
control over financial reporting, as defined in Exchange Act Rule
13a-15(f).  The management, under the supervision and with the
participation of its CEO, CFO, and CAO, assessed the effectiveness of our
internal controls over financial reporting based on the criteria established in
“Internal Control – Integrated
Framework” issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).  Management’s assessment included
evaluation of such elements as the design and operating effectiveness of key
financial reporting controls, process documentation, accounting policies and our
overall control environment.  This assessment is supported by testing
and monitoring performed by our internal finance organization and our retained
internal audit organization.  Based upon the assessment performed,
management believes that, as of December 31, 2008, the Company’s internal
control over financial reporting is effective to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements in accordance with generally accepted accounting
principles.  We review with the Audit Committee of the Board of
Directors on a regular basis our assessment of our internal controls over
financial reporting including the evaluation of any changes in our internal
control over financial reporting environment to determine if material changes
have occurred.
 
 Armanino
McKenna LLP, the independent registered public accounting firm that audited our
financial statements included in this Annual Report on Form 10-K, has also
assessed the effectiveness of internal control over financial reporting as of
December 31, 2008.  Armanino McKenna LLP has issued an attestation
report with an unqualified opinion.  This attestation report is
included herein under Part II, Item 8.
  Changes
in Internal Control over Financial Reporting
 
 During
the fourth quarter ended December 31, 2008, there have not been any changes in
the Company’s internal control over financial reporting (as defined in Rules
13a-15(f) and 15d – 15(f) under the Exchange Act) that have materially affected,
or are reasonably likely to materially affect, the Company’s internal control
over financial reporting.
 Inherent
Limitations on Effectiveness of Controls
 
 The
Company’s management, including the Chief Executive Officer and the Chief
Financial Officer, does not expect that our disclosure controls or our internal
control over financial reporting will prevent or detect all error and all
fraud.  A control system, no matter how well designed and operated,
can provide only reasonable, not absolute, assurance that the control system’s
objectives will be met.  Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
misstatements due to error or fraud will not occur or that all control issues
and instances of fraud, if any, within the Company have been
detected.  These inherent limitations include the realities that
judgments in decision-making can be faulty and that breakdowns can occur because
of simple error or mistake.  Controls can also be circumvented by the
individual acts of some persons, by collusion of two or more people, or by
management override of the controls.  The design of any
system
 93
 Table of Contents
  of
controls is based in part on certain assumptions about the likelihood of future
events, and there can be no assurance that any design will succeed in achieving
its stated goals under all potential future conditions.  Over time,
controls may become inadequate because of changes in conditions or deterioration
in the degree of compliance with policies or
procedures.
 ITEM
9B.  Other
Information
  None.
 94
 Table of Contents




PART III




ITEM
10.  Directors,
Executive Officers and Corporate
Governance




You will
find information regarding our Directors and Executive Officers appearing under
the headings “Proposal No. 1 --- Election of Directors”, “Section 16(a)
Beneficial Ownership Reporting Compliance” and “Corporate Governance and
Other Matters”   in the Proxy Statement which we will deliver to
our shareholders in connection with our Annual Meeting of Shareholders to be
held on June 11, 2009.  We are incorporating the information contained
in those sections of our Proxy Statement here by reference.
  The
Company maintains a set of Corporate Governance Principles, a Code of Ethics for
Principle Executive Officers and Senior Financial Officers, and a Code of
Conduct.  Our Code of Conduct is applicable to all employees,
including all officers and our independent directors.  The full
text of our Corporate Governance Principles, our Code of Ethics for Principle
Executive Officers and Senior Financial Officers and our Code of Conduct are
published on our corporate website www.sonicwall.com
under the tab Corporate Governance.






ITEM 11.  Executive
Compensation You will
find this information in the sections captioned “Compensation Discussion and
Analysis,” “Report of the Compensation Committee”, “Executive Compensation”, and
“Director Compensation”  which will appear in the 2009 Proxy Statement
we will deliver to our shareholders in connection with our Annual Meeting of
Shareholders to be held on June 11, 2009.  We are incorporating the
information contained in those sections here by reference.






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




You will
find this information in the section captioned “Security Ownership of Certain
Beneficial Owners and Management”, and “Equity Compensation Plan Information”
which will appear in the 2009 Proxy Statement we will deliver to our
shareholders in connection with our Annual Meeting of Shareholders to be held on
June 11, 2009.  We are incorporating the information contained in that
section here by reference.


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




You will
find this information in the sections captioned “Certain Relationships and
Related Transactions,” and “Corporate Governance and Other Matters” which will
appear in the 2009 Proxy Statement we will deliver to our shareholders in
connection with our Annual Meeting of Shareholders to be held on June 11,
2009.  We are incorporating the information contained in those
sections here by reference.




ITEM
14.  Principal
Accounting Fees and Services




You will
find this information in the sections captioned “Report of the Audit Committee”
and Proposal No. 2 --- Ratification of Selection of Independent
Auditors”  which will appear in the 2009 Proxy Statement we will
deliver to our shareholders in connection with our Annual Meeting of
Shareholders to be held on June 11, 2009.  We are incorporating the
information contained in those sections here by reference.


95
 Table of Contents




PART IV




ITEM 15.  Exhibits and Financial Statement
Schedules





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




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




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




3. Exhibits—




Number
              Description2.1
              Agreement
      and Plan of Merger and Reorganization, dated as of October 16, 2000, among
      Registrant, Pluto Acquisition Corp., Phobos Corporation, and GMS Capital
      Partners, L.P. (Incorporated by reference to Registrant’s Current Report
      on Form 8-K (File No. 000-27723), filed on November 27,
2000).2.2
              Amendment
      to Agreement and Plan of Merger dated as of November 6, 2000, by and among
      Registrant, Pluto Acquisition Corp., Phobos Corporation, and GMS Capital
      Partners, L.P. (Incorporated by reference to Registrant’s Current Report
      on Form 8-K (File No. 000-27723), filed on November 27,
2000).2.3
              Agreement
      and Plan of Merger and Reorganization, dated March 1, 2001, among
      Registrant, ITI Acquisition Corp., Ignyte Technology, Inc., and Jeff
      Stark.  (Incorporated by reference to Registrant’s Registration
      Statement on Form S-3 (File No. 333-61168), filed on May 17,
      2001).2.4
              Amendment
      No. 1 to the Agreement and Plan of Merger and Reorganization by and among
      Registrant, ITI Acquisition Corp., Ignyte Technology, Inc., and Jeff
      Stark, dated as of March 6, 2001.  (Incorporated by reference to
      Registrant’s Registration Statement on Form S-3 (File No. 333-61168),
      filed on May 17, 2001).2.5
              Agreement
      and Plan of Merger and Reorganization, dated November 18, 2005, by and
      among the Registrant, Spectrum Acquisition Corporation and Lasso Logic,
      Inc., et al. (Incorporated by reference to the Registrant’s Annual Report
      on Form 10-K (File No. 000-27723) for the year ended December 31, 2005,
      filed on March 15, 2006).2.6
              Agreement
      and Plan of Merger, dated February 7, 2006, by and among the Registrant,
      Meridian Acquisition Corporation, MailFrontier, Inc., and Anne Bonaparte
      and Sonja Hoel, as the Representatives.  (Incorporated by
      reference to the Registrant’s Current Report on Form 8-K (File No.
      0000950134-06-003922), filed on February 28, 2007).2.7
              Agreement
      and Plan of Merger, date June 12, 2007, by and among the Registrant,
      Avalon Acquisition Corp. and Aventail, including amendment number one
      thereto effective July 5, 2007.  (Incorporated by reference to
      the Registrant’s Current Report on Form 8-K (File No.
      0001093885-07-000004), filed on July 7, 2007).3.1
              Registrant’s
      Amended and Restated Articles of Incorporation (Incorporated by reference
      to the Registrant’s Registration Statement on Form S-1, as amended (File
      No. 333-85997), which became effective on November 9, 1999).3.2
              Registrant’s
      Bylaws, as amended December 12, 2003 (Incorporated by reference to the
      Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the year
      ended December 31, 2005, filed on March 15, 2006).3.3
              Bylaws
      of SonicWALL, Inc., as Amended July 24, 2007.  (Incorporated by
      reference to the Registrant’s Current Report on Form 8-K (File No.
      0001093885-07-000008), filed on July 30, 2007).


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 Number
                Description4.1
                Registrant’s
      specimen common stock certificate (Incorporated by reference to the
      Registrant’s Registration Statement on Form S-1, as amended (File No.
      333-85997), which became effective on November 9, 1999).10.1
                Registrant’s
      1994 Stock Option Plan, as amended to date (Incorporated by reference to
      the Registrant’s Registration Statement on Form S-1, as amended (File No.
      333-85997), which became effective on November 9, 1999).10.2
                Form
      of Stock Option Agreement for Registrant’s 1994 Stock Option Plan
      (Incorporated by reference to the Registrant’s Filing on Schedule TO (File
      No. 005-58485), filed on January 9, 2003).10.3
                Registrant’s
      1998 Stock Option Plan, as amended to date (Incorporated by reference to
      the Registrant’s 2000 Definitive Proxy Statement (File No. 000-27723),
      filed on November 7, 2001).10.4
                Form
      of Stock Option Agreement for Registrant’s 1998 Stock Option Plan
      (Incorporated by reference to the Registrant’s Filing on Schedule TO (File
      No. 005-58485), filed on January 9, 2003).10.5
                Registrant’s
      1999 Employee Stock Purchase Plan (Incorporated by reference to the
      Registrant’s 2003 Definitive Proxy Statement (File No. 000-27723), filed
      on November 5, 2003).10.6
                Form
      of Stock Option Agreement under Phobos Corporation 1998 Stock Plan
      (Incorporated by reference to the Registrant’s Registration Statement on
      Form S-8 (File No. 333-54976), filed on February 5, 2001).10.7
                Form
      of Stock Option Agreement under Phobos Corporation 1999 Stock Plan
      (Incorporated by reference to the Registrant’s Registration Statement on
      Form S-8 (File No. 333-54976), filed on February 5, 2001).10.8
                RedCreek
      Communications, Inc. 2001 Stock Option Plan (Incorporated by reference to
      the Registrant’s Registration Statement on Form S-8 (File No. 333-81492),
      filed on January 28, 2002).10.9
                Employment
      agreement dated June 21, 2003 between Registrant and Kathleen Fisher
      (Incorporated by reference to the Registrant’s Quarterly Report on Form
      10-Q (File No. 000-27723) for the quarter ended June 30, 2003, filed on
      August 14, 2003).10.10
                Registrant’s
      Form of Individual Compensation Arrangements (Incorporated by reference to
      the Registrant’s Registration Statement on Form S-8 (File No. 333-81492),
      filed on January 28, 2002).10.11
                Form
      of Indemnification Agreement entered into by Registrant with each of its
      officers and directors (Incorporated by reference to the Registrant’s
      Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended
      September 30, 2001, filed on November 14, 2001).10.12
                Loan
      and Security Agreement dated May 26, 1995 between Registrant and Comerica
      Bank (Incorporated by reference to the Registrant’s Registration Statement
      on Form S-1, as amended (File No. 333-85997), which became effective on
      November 9, 1999).10.13++
                Distribution
      Agreement dated February 9, 1999 between Registrant and Tech Data Product
      Management, Inc. (Incorporated by reference to the Registrant’s
      Registration Statement on Form S-1, as amended (File No. 333-85997), which
      became effective on November 9, 1999).10.14++
                Distribution
      Agreement dated July 5, 1998 between Registrant and Sumitomo Metal Systems
      Development Co., Ltd. (Incorporated by reference to the Registrant’s
      Registration Statement on Form S-1, as amended (File No. 333-85997), which
      became effective on November 9, 1999).
 97
 Table of Contents
  Number
                Description10.15++
                Distribution
      Agreement dated November 11, 1992 between Registrant and Ingram Micro,
      Inc. (Incorporated by reference to the Registrant’s Registration Statement
      on Form S-1, as amended (File No. 333-85997), which became effective on
      November 9, 1999).10.16
                Agreement
      of Sublease dated as of October 26, 1998 between Registrant and AMP
      Incorporated (Incorporated by reference to the Registrant’s Registration
      Statement on Form S-1, as amended (File No. 333-85997), which became
      effective on November 9, 1999).10.17
                Purchase
      Agreement dated September 28, 1999 between Registrant and Flash
      Electronics Inc. (Incorporated by reference to the Registrant’s
      Registration Statement on Form S-1, as amended (File No. 333-85997), which
      became effective on November 9, 1999).10.18
                Lease
      dated September 27, 1999 between Registrant, as Tenant, and AMB Property,
      L.P., as Landlord (Incorporated by reference to the Registrant’s
      Registration Statement on Form S-1, as amended (File No. 333-85997), which
      became effective on November 9, 1999).10.19
                First
      Amendment to Lease dated May 2, 2001 between Registrant, as Tenant, and
      AMB Property, L.P., as Landlord (Incorporated by reference to the
      Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the
      fiscal year ended December 31, 2001, filed on April 1, 2002).10.20
                Second
      Amendment to Lease dated September 26, 2001 between Registrant, as Tenant,
      and AMB Property, L.P., as Landlord (Incorporated by reference to the
      Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the
      fiscal year ended December 31, 2001, filed on April 1, 2002).10.21++
                OEM
      Hardware (with Software) License and Purchase Agreement effective as of
      May 29, 2001 between Registrant and Cisco Systems, Inc. (Incorporated by
      reference to the Registrant’s Annual Report on Form 10-K (File No.
      000-27723) for the fiscal year ended December 31, 2001, filed on April 1,
      2002).10.22++
                Amendment
      Number One to OEM Hardware (with Software) License and Purchase Agreement
      dated June 25, 2002 between Registrant and Cisco Systems, Inc.
      (Incorporated by reference to the Registrant’s Quarterly Report on Form
      10-Q (File No. 000-27723) for the quarter ended June 30, 2002, filed on
      August 14, 2002).10.23
                Employment
      agreement dated March 14, 2003 between Registrant and Matthew Medeiros
      (Incorporated by reference to the Registrant’s Annual Report on Form 10-K
      (File No. 000-27723) for the fiscal year ended December 31, 2002, filed on
      March 31, 2003).10.24
                Employment
      agreement dated August 11, 2003 between Registrant and Michael Stewart
      (Incorporated by reference to the Registrant’s Quarterly Report on Form
      10-Q (File No. 000-27723) for the quarter ended September 30, 2003, filed
      on November 14, 2003).10.25
                Employment
      agreement dated October 29, 2003 between Registrant and Robert Knauff
      (Incorporated by reference to the Registrant’s Annual Report on Form 10-K
      (File No. 000-27723) for the fiscal year ended December 31, 2003, filed on
      March 15, 2004).10.26
                Manufacturing
      and Purchase Agreement dated June 4, 2004 by and between Flash
      Electronics, Inc. and SonicWALL, Inc. (Incorporated by reference to the
      Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the
      quarter ended June 30, 2004, filed on August 9, 2004).10.27
                Third
      Amendment to Lease executed on April 28, 2004 by and between AMB Property,
      L.P., as Landlord, and SonicWALL, Inc. as Tenant.  (Incorporated
      by reference to the Registrant’s Quarterly Report on Form 10-Q (File No.
      000-27723) for the quarter ended June 30, 2004, filed on August 9,
      2004).
 98
 Table of Contents
 Number
                Description
 10.28
                Retention
      and Severance Agreement for Executive Officers dated April 20,
      2004.  (Incorporated by reference to the Registrant’s Quarterly
      Report on Form 10-Q (File No. 000-27723) for the quarter ended June 30,
      2004, filed on August 9, 2004).10.29
                Registrant’s
      Stock Option Agreement dated July 29, 2004 (Incorporated by reference to
      the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for
      the quarter ended September 30, 2004, filed on November 9,
      2004).10.30
                Employment
      Agreement as amended and restated July 29, 2004 between Registrant and
      Matthew Medeiros (Incorporated by reference to the Registrant’s Quarterly
      Report on Form 10-Q (File No. 000-27723) for the quarter ended September
      30, 2004, filed on November 9, 2004).10.31
                Stock
      Option Agreement dated July 29, 2004 between Registrant and Outside
      Directors (Incorporated by reference to the Registrant’s Quarterly Report
      on Form 10-Q (File No. 000-27723) for the quarter ended September 30,
      2004, filed on November 9, 2004).10.32
                Issuer
      Repurchase Plan Agreement dated November 29, 2004 between Registrant and
      RBC Dain Rauscher Inc. (Incorporated by reference to the Registrant’s
      Annual Report on Form 10-K (File No. 000-27723) for the year ended
      December 31, 2004, filed on March 21, 2005).10.33
                Issuer
      Repurchase Plan Agreement amended and restated, dated February 15, 2005
      between Registrant and RBC Dain Rauscher Inc. (Incorporated by reference
      to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for
      the year ended December 31, 2004, filed on March 21, 2005).10.34
                Lease
      dated December 19, 2006 between Registrant, as Tenant, and Kolte Patil
      Developers Limited, as Landlord (Incorporated by reference to the
      Registrant’s Annual Report on Form 10-K (File No. 0000950134-07-005644)
      for the year ended December 31, 2006, filed on March 14,
      2007).10.35
                Issuer
      Repurchase Plan Agreement amended and restated, dated November 3, 2006
      between Registrant and RBC Dain Rauscher Inc. (Incorporated by reference
      to the Registrant’s Annual Report on Form 10-K (File No.
      0000950134-07-005644) for the year ended December 31, 2006, filed on March
      14, 2007).10.36
                Registrant’s
      Employee Stock Purchase Plan, dated August 24, 1999, as amended August 1,
      2006 (Incorporated by reference to the Registrant’s Annual Report on Form
      10-K (File No. 0000950134-07-005644) for the year ended December 31, 2006,
      filed on March 14, 2007).10.37
                Lease
      dated September 25, 2007 between Registrant, as Tenant, and TMC-3011 S
      52nd
      ST, LLC, as Landlord.  (Incorporated by reference to the
      Registrant’s Quarterly Report on Form 10-Q (File No. 0001093885-07-000021)
      for the quarter ended September 30, 2007, filed on November 7,
      2007).10.38
                Lease
      dated February 1, 2008 between Aventail Info Tech Private Limited, a
      subsidiary of the Registrant, as Tenant, and Salarpuria Softzone, as
      Landlord, and SPPL Property Management Private Limited, as Maintenance
      Service Provider. (Incorporated by reference to the Registrant’s Annual
      Report on Form 10K (File No. 0000950134-08-004440) for the year ended
      December 31, 2007, filed on March 10, 2008).10.39
                Limited
      Licensed Materials License Agreement dated December 14, 2007 between
      Registrant, as Licensee, and Linkbit, Inc. (Incorporated by reference to
      the Registrant’s Annual Report on Form 10K (File No. 0000950134-08-004440)
      for the year ended December 31, 2007, filed on March 10,
      2008).10.40
                Registrant’s
      2008 Equity Incentive Plan (Incorporated by reference to the Registrant’s
      Current Report on Form 8-K (File No. 0001093885-08-000017), filed on June
      16, 2008).
  99
 Table of Contents
  Number
                Description
 10.41
                Registrant’s
      2008 Inducement Equity Incentive Plan (Incorporated by reference to the
      Registrant’s Current Report on Form 8-K (File No. 0001093885-08-000017),
      filed on June 16, 2008).10.42
                Registrant’s
      2008 Inducement Equity Incentive Plan as amended (Incorporated by
      reference to the Registrant’s Quarterly Report on Form 10-Q (File No.
      0001093885-08-000027) for the quarter ended September 30, 2008, filed on
      October 31, 2008).10.43
                Registrant’s
      Deferred Compensation Plan as amended and restated August 8, 2008
      (Incorporated by reference to the Registrant’s Quarterly Report on Form
      10-Q (File No. 0001093885-08-000027) for the quarter ended September 30,
      2008, filed on October 31, 2008).10.44*
                Employment
      Agreement as amended and restated, dated October 20, 2008 between
      Registrant and Matthew Medeiros10.45*
                Retention
      and Severance Agreement as amended and restated, dated October 20, 2008
      among Registrant and Executive Officers21.1*
                List
      of Subsidiaries.23.1*
                Consent
      of Independent Registered Public Accounting Firm31.1*
                Certification
      of Chief Executive Officer pursuant to Securities Exchange Act Rules
      13a-15(e) and 15d-15(e), as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2*
                Certification
      of Chief Financial Officer pursuant to Securities Exchange Act Rules
      13a-15(e) and 15d-15(e), as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1*
                Certification
      of Chief Executive Officer and Chief Financial Officer pursuant to 18
      U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.


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


(b) Exhibits




See Item
15(a) (3) above.




(c) Financial Statement
Schedules




See Item
15(a) (2) above.







100
 Table of Contents




SIGNATURES





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





Date:
March 6, 2009




SonicWALL,
      Inc.By:
                  /s/
      Matthew MedeirosMatthew
      MedeirosChief
      Executive Officer


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





Signature
              Title
              Date/s/ Matthew Medeiros
              President,
      Chief Executive Officer andMatthew
      Medeiros
              Director
      (Principal Executives Officer)
              March
      6, 2009/s/ Robert Selvi
              Chief
      Financial OfficerRobert
      Selvi
              (Principal
      Financial Officer)
              March
      6, 2009/s/ Robert Knauff
              Chief
      Accounting OfficerRobert
      Knauff
              (Principal
      Accounting Officer)
              March
      6, 2009/s/ John C. ShoemakerJohn
      C. Shoemaker
              Chairman
      of the Board of Directors
              March
      6, 2009/s/ Charles BergerCharles
      Berger
              Director
              March
      6, 2009/s/ David W. GarrisonDavid
      W. Garrison
              Director
              March
      6, 2009/s/ Charles KissnerCharles
      Kissner
              Director
              March
      6, 2009/s/ Edward F. ThompsonEdward
      F. Thompson
              Director
              March
      6, 2009/s/ Cary ThompsonCary
      Thompson
              Director
              March
      6, 2009/s/ Clark MastersClark
      Masters
              Director
              March
      6, 2009


101
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  Schedule II
 
 VALUATION
AND QUALIFYING ACCOUNTS


Balance
      at Beginning of Year
                      
                      
                      Other
                      
                      
                      Charged
      to Cost and Expenses
                      
                      
                      Deductions/
      Write-off of Accounts
                      
                      
                      Balance
      at End of Year(in
      thousands)Year
      ended December 31, 2006Allowance
      for doubtful accounts
                      
                      
                      123
                      
                      
                      
                      -
                      
                      
                      
                      53
                      
                      
                      
                      (24
                      )
                      
                      
                      152Year
      ended December 31, 2007Allowance
      for doubtful accounts
                      
                      
                      152
                      
                      
                      
                      213
                      
                      
                      
                      87
                      
                      
                      
                      (275
                      )
                      
                      
                      177Year
      ended December 31, 2008Allowance
      for doubtful accounts
                      
                      
                      177
                      
                      
                      
                      (171
                      )
                      
                      
                      233
                      
                      
                      
                      (126
                      )
                      
                      
                      113








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Exhibit Index


Number
            Description


2.1
              Agreement
      and Plan of Merger and Reorganization, dated as of October 16, 2000, among
      Registrant, Pluto Acquisition Corp., Phobos Corporation, and GMS Capital
      Partners, L.P. (Incorporated by reference to Registrant’s Current Report
      on Form 8-K (File No. 000-27723), filed on November 27,
2000).2.2
              Amendment
      to Agreement and Plan of Merger dated as of November 6, 2000, by and among
      Registrant, Pluto Acquisition Corp., Phobos Corporation, and GMS Capital
      Partners, L.P. (Incorporated by reference to Registrant’s Current Report
      on Form 8-K (File No. 000-27723), filed on November 27,
2000).2.3
              Agreement
      and Plan of Merger and Reorganization, dated March 1, 2001, among
      Registrant, ITI Acquisition Corp., Ignyte Technology, Inc., and Jeff
      Stark.  (Incorporated by reference to Registrant’s Registration
      Statement on Form S-3 (File No. 333-61168), filed on May 17,
      2001).2.4
              Amendment
      No. 1 to the Agreement and Plan of Merger and Reorganization by and among
      Registrant, ITI Acquisition Corp., Ignyte Technology, Inc., and Jeff
      Stark, dated as of March 6, 2001.  (Incorporated by reference to
      Registrant’s Registration Statement on Form S-3 (File No. 333-61168),
      filed on May 17, 2001).2.5
              Agreement
      and Plan of Merger and Reorganization, dated November 18, 2005, by and
      among the Registrant, Spectrum Acquisition Corporation and Lasso Logic,
      Inc., et al. (Incorporated by reference to the Registrant’s Annual Report
      on Form 10-K (File No. 000-27723) for the year ended December 31, 2005,
      filed on March 15, 2006).2.6
              Agreement
      and Plan of Merger, dated February 7, 2006, by and among the Registrant,
      Meridian Acquisition Corporation, MailFrontier, Inc., and Anne Bonaparte
      and Sonja Hoel, as the Representatives.  (Incorporated by
      reference to the Registrant’s Current Report on Form 8-K (File No.
      0000950134-06-003922), filed on February 28, 2007).2.7
              Agreement
      and Plan of Merger, date June 12, 2007, by and among the Registrant,
      Avalon Acquisition Corp. and Aventail, including amendment number one
      thereto effective July 5, 2007.  (Incorporated by reference to
      the Registrant’s Current Report on Form 8-K (File No.
      0001093885-07-000004), filed on July 7, 2007).3.1
              Registrant’s
      Amended and Restated Articles of Incorporation (Incorporated by reference
      to the Registrant’s Registration Statement on Form S-1, as amended (File
      No. 333-85997), which became effective on November 9, 1999).3.2
              Registrant’s
      Bylaws, as amended December 12, 2003 (Incorporated by reference to the
      Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the year
      ended December 31, 2005, filed on March 15, 2006).3.3
              Bylaws
      of SonicWALL, Inc., as Amended July 24, 2007.  (Incorporated by
      reference to the Registrant’s Current Report on Form 8-K (File No.
      0001093885-07-000008), filed on July 30, 2007).4.1
              Registrant’s
      specimen common stock certificate (Incorporated by reference to the
      Registrant’s Registration Statement on Form S-1, as amended (File No.
      333-85997), which became effective on November 9, 1999).10.1
              Registrant’s
      1994 Stock Option Plan, as amended to date (Incorporated by reference to
      the Registrant’s Registration Statement on Form S-1, as amended (File No.
      333-85997), which became effective on November 9, 1999).10.2
              Form
      of Stock Option Agreement for Registrant’s 1994 Stock Option Plan
      (Incorporated by reference to the Registrant’s Filing on Schedule TO (File
      No. 005-58485), filed on January 9, 2003).10.3
              Registrant’s
      1998 Stock Option Plan, as amended to date (Incorporated by reference to
      the Registrant’s 2000 Definitive Proxy Statement (File No. 000-27723),
      filed on November 7, 2001).


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Number
            Description 10.4
                Form
      of Stock Option Agreement for Registrant’s 1998 Stock Option Plan
      (Incorporated by reference to the Registrant’s Filing on Schedule TO (File
      No. 005-58485), filed on January 9, 2003).10.5
                Registrant’s
      1999 Employee Stock Purchase Plan (Incorporated by reference to the
      Registrant’s 2003 Definitive Proxy Statement (File No. 000-27723), filed
      on November 5, 2003).10.6
                Form
      of Stock Option Agreement under Phobos Corporation 1998 Stock Plan
      (Incorporated by reference to the Registrant’s Registration Statement on
      Form S-8 (File No. 333-54976), filed on February 5, 2001).10.7
                Form
      of Stock Option Agreement under Phobos Corporation 1999 Stock Plan
      (Incorporated by reference to the Registrant’s Registration Statement on
      Form S-8 (File No. 333-54976), filed on February 5, 2001).10.8
                RedCreek
      Communications, Inc. 2001 Stock Option Plan (Incorporated by reference to
      the Registrant’s Registration Statement on Form S-8 (File No. 333-81492),
      filed on January 28, 2002).10.9
                Employment
      agreement dated June 21, 2003 between Registrant and Kathleen Fisher
      (Incorporated by reference to the Registrant’s Quarterly Report on Form
      10-Q (File No. 000-27723) for the quarter ended June 30, 2003, filed on
      August 14, 2003).10.10
                Registrant’s
      Form of Individual Compensation Arrangements (Incorporated by reference to
      the Registrant’s Registration Statement on Form S-8 (File No. 333-81492),
      filed on January 28, 2002).10.11
                Form
      of Indemnification Agreement entered into by Registrant with each of its
      officers and directors (Incorporated by reference to the Registrant’s
      Quarterly Report on Form 10-Q (File No. 000-27723) for the quarter ended
      September 30, 2001, filed on November 14, 2001).10.12
                Loan
      and Security Agreement dated May 26, 1995 between Registrant and Comerica
      Bank (Incorporated by reference to the Registrant’s Registration Statement
      on Form S-1, as amended (File No. 333-85997), which became effective on
      November 9, 1999).10.13++
                Distribution
      Agreement dated February 9, 1999 between Registrant and Tech Data Product
      Management, Inc. (Incorporated by reference to the Registrant’s
      Registration Statement on Form S-1, as amended (File No. 333-85997), which
      became effective on November 9, 1999).10.14++
                Distribution
      Agreement dated July 5, 1998 between Registrant and Sumitomo Metal Systems
      Development Co., Ltd. (Incorporated by reference to the Registrant’s
      Registration Statement on Form S-1, as amended (File No. 333-85997), which
      became effective on November 9, 1999).10.15++
                Distribution
      Agreement dated November 11, 1992 between Registrant and Ingram Micro,
      Inc. (Incorporated by reference to the Registrant’s Registration Statement
      on Form S-1, as amended (File No. 333-85997), which became effective on
      November 9, 1999).10.16
                Agreement
      of Sublease dated as of October 26, 1998 between Registrant and AMP
      Incorporated (Incorporated by reference to the Registrant’s Registration
      Statement on Form S-1, as amended (File No. 333-85997), which became
      effective on November 9, 1999).10.17
                Purchase
      Agreement dated September 28, 1999 between Registrant and Flash
      Electronics Inc. (Incorporated by reference to the Registrant’s
      Registration Statement on Form S-1, as amended (File No. 333-85997), which
      became effective on November 9, 1999).10.18
                Lease
      dated September 27, 1999 between Registrant, as Tenant, and AMB Property,
      L.P., as Landlord (Incorporated by reference to the Registrant’s
      Registration Statement on Form S-1, as amended (File No. 333-85997), which
      became effective on November 9, 1999).


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Number
            Description 10.19
                First
      Amendment to Lease dated May 2, 2001 between Registrant, as Tenant, and
      AMB Property, L.P., as Landlord (Incorporated by reference to the
      Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the
      fiscal year ended December 31, 2001, filed on April 1, 2002).10.20
                Second
      Amendment to Lease dated September 26, 2001 between Registrant, as Tenant,
      and AMB Property, L.P., as Landlord (Incorporated by reference to the
      Registrant’s Annual Report on Form 10-K (File No. 000-27723) for the
      fiscal year ended December 31, 2001, filed on April 1, 2002).10.21++
                OEM
      Hardware (with Software) License and Purchase Agreement effective as of
      May 29, 2001 between Registrant and Cisco Systems, Inc. (Incorporated by
      reference to the Registrant’s Annual Report on Form 10-K (File No.
      000-27723) for the fiscal year ended December 31, 2001, filed on April 1,
      2002).10.22++
                Amendment
      Number One to OEM Hardware (with Software) License and Purchase Agreement
      dated June 25, 2002 between Registrant and Cisco Systems, Inc.
      (Incorporated by reference to the Registrant’s Quarterly Report on Form
      10-Q (File No. 000-27723) for the quarter ended June 30, 2002, filed on
      August 14, 2002).10.23
                Employment
      agreement dated March 14, 2003 between Registrant and Matthew Medeiros
      (Incorporated by reference to the Registrant’s Annual Report on Form 10-K
      (File No. 000-27723) for the fiscal year ended December 31, 2002, filed on
      March 31, 2003).10.24
                Employment
      agreement dated August 11, 2003 between Registrant and Michael Stewart
      (Incorporated by reference to the Registrant’s Quarterly Report on Form
      10-Q (File No. 000-27723) for the quarter ended September 30, 2003, filed
      on November 14, 2003).10.25
                Employment
      agreement dated October 29, 2003 between Registrant and Robert Knauff
      (Incorporated by reference to the Registrant’s Annual Report on Form 10-K
      (File No. 000-27723) for the fiscal year ended December 31, 2003, filed on
      March 15, 2004).10.26
                Manufacturing
      and Purchase Agreement dated June 4, 2004 by and between Flash
      Electronics, Inc. and SonicWALL, Inc. (Incorporated by reference to the
      Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for the
      quarter ended June 30, 2004, filed on August 9, 2004).10.27
                Third
      Amendment to Lease executed on April 28, 2004 by and between AMB Property,
      L.P., as Landlord, and SonicWALL, Inc. as Tenant.  (Incorporated
      by reference to the Registrant’s Quarterly Report on Form 10-Q (File No.
      000-27723) for the quarter ended June 30, 2004, filed on August 9,
      2004).10.28
                Retention
      and Severance Agreement for Executive Officers dated April 20,
      2004.  (Incorporated by reference to the Registrant’s Quarterly
      Report on Form 10-Q (File No. 000-27723) for the quarter ended June 30,
      2004, filed on August 9, 2004).10.29
                Registrant’s
      Stock Option Agreement dated July 29, 2004 (Incorporated by reference to
      the Registrant’s Quarterly Report on Form 10-Q (File No. 000-27723) for
      the quarter ended September 30, 2004, filed on November 9,
      2004).10.30
                Employment
      Agreement as amended and restated July 29, 2004 between Registrant and
      Matthew Medeiros (Incorporated by reference to the Registrant’s Quarterly
      Report on Form 10-Q (File No. 000-27723) for the quarter ended September
      30, 2004, filed on November 9, 2004).10.31
                Stock
      Option Agreement dated July 29, 2004 between Registrant and Outside
      Directors (Incorporated by reference to the Registrant’s Quarterly Report
      on Form 10-Q (File No. 000-27723) for the quarter ended September 30,
      2004, filed on November 9, 2004).


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Number
            Description 10.32
                Issuer
      Repurchase Plan Agreement dated November 29, 2004 between Registrant and
      RBC Dain Rauscher Inc. (Incorporated by reference to the Registrant’s
      Annual Report on Form 10-K (File No. 000-27723) for the year ended
      December 31, 2004, filed on March 21, 2005).10.33
                Issuer
      Repurchase Plan Agreement amended and restated, dated February 15, 2005
      between Registrant and RBC Dain Rauscher Inc. (Incorporated by reference
      to the Registrant’s Annual Report on Form 10-K (File No. 000-27723) for
      the year ended December 31, 2004, filed on March 21, 2005).10.34
                Lease
      dated December 19, 2006 between Registrant, as Tenant, and Kolte Patil
      Developers Limited, as Landlord (Incorporated by reference to the
      Registrant’s Annual Report on Form 10-K (File No. 0000950134-07-005644)
      for the year ended December 31, 2006, filed on March 14,
      2007).10.35
                Issuer
      Repurchase Plan Agreement amended and restated, dated November 3, 2006
      between Registrant and RBC Dain Rauscher Inc. (Incorporated by reference
      to the Registrant’s Annual Report on Form 10-K (File No.
      0000950134-07-005644) for the year ended December 31, 2006, filed on March
      14, 2007).10.36
                Registrant’s
      Employee Stock Purchase Plan, dated August 24, 1999, as amended August 1,
      2006 (Incorporated by reference to the Registrant’s Annual Report on Form
      10-K (File No. 0000950134-07-005644) for the year ended December 31, 2006,
      filed on March 14, 2007).10.37
                Lease
      dated September 25, 2007 between Registrant, as Tenant, and TMC-3011 S
      52nd
      ST, LLC, as Landlord.  (Incorporated by reference to the
      Registrant’s Quarterly Report on Form 10-Q (File No. 0001093885-07-000021)
      for the quarter ended September 30, 2007, filed on November 7,
      2007).10.38
                Lease
      dated February 1, 2008 between Aventail Info Tech Private Limited, a
      subsidiary of the Registrant, as Tenant, and Salarpuria Softzone, as
      Landlord, and SPPL Property Management Private Limited, as Maintenance
      Service Provider. (Incorporated by reference to the Registrant’s Annual
      Report on Form 10K (File No. 0000950134-08-004440) for the year ended
      December 31, 2007, filed on March 10, 2008).10.39
                Limited
      Licensed Materials License Agreement dated December 14, 2007 between
      Registrant, as Licensee, and Linkbit, Inc. (Incorporated by reference to
      the Registrant’s Annual Report on Form 10K (File No. 0000950134-08-004440)
      for the year ended December 31, 2007, filed on March 10,
      2008).10.40
                Registrant’s
      2008 Equity Incentive Plan (Incorporated by reference to the Registrant’s
      Current Report on Form 8-K (File No. 0001093885-08-000017), filed on June
      16, 2008).10.41
                Registrant’s
      2008 Inducement Equity Incentive Plan (Incorporated by reference to the
      Registrant’s Current Report on Form 8-K (File No. 0001093885-08-000017),
      filed on June 16, 2008).10.42
                Registrant’s
      2008 Inducement Equity Incentive Plan as amended (Incorporated by
      reference to the Registrant’s Quarterly Report on Form 10-Q (File No.
      0001093885-08-000027) for the quarter ended September 30, 2008, filed on
      October 31, 2008).10.43
                Registrant’s
      Deferred Compensation Plan as amended and restated August 8, 2008
      (Incorporated by reference to the Registrant’s Quarterly Report on Form
      10-Q (File No. 0001093885-08-000027) for the quarter ended September 30,
      2008, filed on October 31, 2008).10.44*
                Employment
      Agreement as amended and restated, dated October 20, 2008 between
      Registrant and Matthew Medeiros10.45*
                Retention
      and Severance Agreement as amended and restated, dated October 20, 2008
      among Registrant and Executive Officers21.1*
                List
      of Subsidiaries.


106
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Number
            Description23.1*
            Consent
      of Independent Registered Public Accounting Firm31.1*
            Certification
      of Chief Executive Officer pursuant to Securities Exchange Act Rules
      13a-15(e) and 15d-15(e), as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2*
            Certification
      of Chief Financial Officer pursuant to Securities Exchange Act Rules
      13a-15(e) and 15d-15(e), as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1*
            Certification
      of Chief Executive Officer and Chief Financial Officer pursuant to 18
      U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.








*
            Filed
      herewith.


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








107