e10vq
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
(Mark One)
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2010
     
o   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
1-33350
 
SOURCEFIRE, INC.
(Exact name of Registrant as Specified in its Charter)
     
Delaware
(State or Other Jurisdiction of
Incorporation or Organization)
  52-2289365
(I.R.S. Employer
Identification No.)
     
9770 Patuxent Woods Drive
Columbia, Maryland

(Address of Principal Executive Offices)
  21046
(Zip Code)
Registrant’s telephone number, including area code: (410) 290-1616
     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 þ      No o
     Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes o     No o
     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 definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large Accelerated Filer o   Accelerated Filer þ   Non-Accelerated Filer o   Smaller reporting Company o
        (Do not check if smaller reporting company)    
     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o     No þ
     As of April 30, 2010, there were 27,473,833 outstanding shares of the registrant’s Common Stock.
 
 


 

SOURCEFIRE, INC.
Form 10-Q
TABLE OF CONTENTS
         
       
 
       
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Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
SOURCEFIRE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value and share amounts)
                 
    March 31,     December 31,  
    2010     2009  
    (unaudited)          
Assets
               
Current assets:
               
Cash and cash equivalents
  $ 58,022     $ 53,071  
Short-term investments
    50,550       49,074  
Accounts receivable, net of allowances of $700 as of March 31, 2010 and $1,157 as of December 31, 2009
    25,554       32,771  
Inventory
    4,728       4,414  
Prepaid expenses and other current assets
    3,698       4,428  
 
           
Total current assets
    142,552       143,758  
Property and equipment, net
    7,800       7,447  
Investments
    25,586       21,075  
Other assets
    1,969       1,887  
 
           
Total assets
  $ 177,907     $ 174,167  
 
           
 
               
Liabilities and Stockholders’ Equity
               
Current liabilities:
               
Accounts payable
  $ 1,501     $ 2,846  
Accrued compensation and related expenses
    3,627       5,074  
Other accrued expenses
    2,932       3,025  
Current portion of deferred revenue
    30,035       29,294  
Other current liabilities
    819       464  
 
           
Total current liabilities
    38,914       40,703  
Deferred revenue, less current portion
    6,216       4,883  
Other long-term liabilities
    128       92  
 
           
Total liabilities
    45,258       45,678  
 
           
 
               
Commitments and contingencies
               
 
               
Stockholders’ equity:
               
Preferred stock, $0.001 par value; 19,700,000 shares authorized; no shares issued or outstanding as of March 31, 2010 and December 31, 2009
           
Series A junior participating preferred stock, $0.001 par value; 300,000 shares authorized; no shares issued or outstanding at March 31, 2010 or December 31, 2009
           
Common stock, $0.001 par value; 240,000,000 shares authorized; 27,447,578 and 27,117,051 shares issued and outstanding as of March 31, 2010 and December 31, 2009, respectively
    27       26  
Additional paid-in capital
    173,532       170,157  
Accumulated deficit
    (40,906 )     (41,716 )
Accumulated other comprehensive income (loss)
    (4 )     22  
 
           
Total stockholders’ equity
    132,649       128,489  
 
           
Total liabilities and stockholders’ equity
  $ 177,907     $ 174,167  
 
           
See accompanying notes to consolidated financial statements.

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SOURCEFIRE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(in thousands, except share and per share amounts)
                 
    Three Months Ended  
    March 31,  
    2010     2009  
Revenue:
               
Products
  $ 14,338     $ 9,868  
Technical support and professional services
    11,493       8,732  
 
           
Total revenue
    25,831       18,600  
Cost of revenue:
               
Products
    3,796       2,767  
Technical support and professional services
    1,405       1,382  
 
           
Total cost of revenue
    5,201       4,149  
 
           
Gross profit
    20,630       14,451  
Operating expenses:
               
Research and development
    3,795       3,320  
Sales and marketing
    10,619       7,870  
General and administrative
    4,319       3,843  
Depreciation and amortization
    814       821  
 
           
Total operating expenses
    19,547       15,854  
 
           
Income (loss) from operations
    1,083       (1,403 )
Other income, net:
               
Interest and investment income
    118       384  
Interest expense
    (9 )     (10 )
Other expense
    (109 )     (13 )
 
           
Total other income, net
          361  
 
           
Income (loss) before income taxes
    1,083       (1,042 )
Provision for income taxes
    273       75  
 
           
Net income (loss)
  $ 810     $ (1,117 )
 
           
Net income (loss) per share:
               
Basic
  $ 0.03     $ (0.04 )
 
           
Diluted
  $ 0.03     $ (0.04 )
 
           
 
               
Weighted average shares outstanding used in computing per share amounts:
               
Basic
    27,220,667       25,934,259  
 
           
Diluted
    29,060,559       25,934,259  
 
           
See accompanying notes to consolidated financial statements.

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SOURCEFIRE, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)
(in thousands, except share amounts)
                                                 
                                    Accumulated        
                    Additional             Other        
    Common Stock     Paid-in     Accumulated     Comprehensive        
    Shares     Amount     Capital     Deficit     Income (Loss)     Total  
Balance as of January 1, 2010
    27,117,051     $ 26     $ 170,157     $ (41,716 )   $ 22     $ 128,489  
Exercise of common stock options
    256,654       1       1,236                   1,237  
Issuance of restricted common stock
    76,246                                
Cancellation of restricted common stock
    (2,373 )                              
Stock-based compensation expense
                1,926                   1,926  
Excess tax benefits relating to share-based payments
                213                   213  
Comprehensive income:
                                               
Net income for the three months ended March 31, 2010
                      810             810  
Change in unrealized loss on investments, net of tax
                            (26 )     (26 )
 
                                             
Total comprehensive income:
                                            784  
 
                                   
Balance as of March 31, 2010
    27,447,578     $ 27     $ 173,532     $ (40,906 )   $ (4 )   $ 132,649  
 
                                   
See accompanying notes to consolidated financial statements.

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SOURCEFIRE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
                 
    Three Months Ended  
    March 31,  
    2010     2009  
Operating activities
               
Net income (loss)
  $ 810     $ (1,117 )
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
               
Depreciation and amortization
    866       834  
Stock-based compensation
    1,926       1,202  
Excess tax benefits related to share-based payments
    (213 )      
Amortization of premium (discount) on investments
    285       (105 )
Loss on disposal of assets
    22        
Changes in operating assets and liabilities:
               
Accounts receivable, net
    7,217       5,920  
Inventory
    (325 )     167  
Prepaid expenses and other assets
    657       (528 )
Accounts payable
    (1,345 )     (2,863 )
Accrued expenses
    (1,327 )     (1,468 )
Deferred revenue
    2,074       2,360  
Other liabilities
    340       (133 )
 
           
Net cash provided by operating activities
    10,987       4,269  
 
           
Investing activities
               
Purchase of property and equipment
    (1,185 )     (639 )
Purchase of investments
    (30,499 )     (15,335 )
Proceeds from maturities of investments
    24,200       22,650  
 
           
Net cash (used in) provided by investing activities
    (7,484 )     6,676  
 
           
Financing activities
               
Repayments of capital lease obligations
    (2 )     (32 )
Proceeds from exercise of stock options
    1,237       128  
Excess tax benefits relating to share-based payments
    213        
 
           
Net cash provided by financing activities
    1,448       96  
 
           
Net increase in cash and cash equivalents
    4,951       11,041  
Cash and cash equivalents at beginning of period
    53,071       39,768  
 
           
Cash and cash equivalents at end of period
  $ 58,022     $ 50,809  
 
           
See accompanying notes to consolidated financial statements.

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SOURCEFIRE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Description of Business
     We are a leading provider of intelligent cybersecurity solutions for information technology, or IT, environments of commercial enterprises, including healthcare, financial services, manufacturing, energy, education, retail and telecommunications companies, and federal, state and local government organizations worldwide. Our solutions are comprised of multiple hardware and software product and service offerings, enabling a comprehensive, intelligent approach to network security. Our security solutions provide our customers with an efficient and effective network security defense of assets and applications before, during and after an attack.
     We are also the creator of Snort® and the owner of ClamAV®. Snort is an open source intrusion prevention technology that is incorporated into the IPS software component of our comprehensive Intrusion Detection and Prevention System. ClamAV is an open source anti-virus and anti-malware project.
     In addition to our commercial and open source network security products, we offer a variety of services to help our customers install and support our solutions. Available services include Customer Support, Education, Professional Services and Vulnerability Research Team, or VRT, and Snort rule subscriptions.
2. Summary of Significant Accounting Policies
  Basis of Presentation
     The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial reporting and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles in the United States have been condensed or omitted pursuant to those rules or regulations. The interim financial statements are unaudited, but reflect all adjustments which are, in the opinion of management, considered necessary for a fair presentation. These financial statements should be read in conjunction with the audited consolidated financial statements and the notes included in our Annual Report on Form 10-K for the year ended December 31, 2009 filed with the Securities and Exchange Commission on March 12, 2010. The results of operations for the interim periods are not necessarily indicative of results to be expected in future periods.
   Use of Estimates
     The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates.
     On an ongoing basis, we evaluate our estimates, including those related to the accounts receivable allowance, sales return allowance, warranty reserve, reserve for excess and obsolete inventory, useful lives of long-lived assets (including intangible assets), income taxes, and our assumptions used for the purpose of determining stock-based compensation, among other things. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which can affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements, as well as the reported amounts of revenue and expenses during the periods presented.
     Investments
     We determine the appropriate classification of our investments at the time of purchase and reevaluate such classification as of each balance sheet date. Our investments are comprised of money market funds, corporate debt investments, commercial paper, government-sponsored enterprise securities, government securities and certificates of deposit. These investments have been classified as available-for-sale. Available-for-sale investments are stated at fair value, with the unrealized gains and losses, net of tax, reported in accumulated other comprehensive income (loss). The amortization of premiums and accretion of

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discounts to maturity are computed using the effective interest method. Amortization is included in interest and investment income. Interest on securities classified as available-for-sale is also included in interest and investment income. See Note 3 for further discussion of the classification of our investments.
     We evaluate our investments on a regular basis to determine whether an other-than-temporary decline in fair value has occurred. If an investment is in an unrealized loss position and we have the intent to sell the investment, or it is more likely than not that we will have to sell the investment before recovery of its amortized cost basis, the decline in value is deemed to be other-than-temporary and is charged against earnings for the period. For investments that we do not intend to sell or it is more likely than not that we will not have to sell the investment, but we expect that we will not fully recover the amortized cost basis, the credit component of the other-than-temporary impairment is charged against earnings for the applicable period and the non-credit component of the other-than-temporary impairment is recognized in other comprehensive income on our consolidated statement of changes in stockholders’ equity. Unrealized losses entirely caused by non-credit related factors related to investments for which we expect to fully recover the amortized cost basis are recorded in accumulated other comprehensive income.
     Fair Value of Financial Instruments
     Our financial instruments consist primarily of cash and cash equivalents, investments, accounts receivable, cash surrender value on our split-dollar life insurance policy, accounts payable and deferred revenue. The fair value of these financial instruments approximates their carrying amounts reported in the consolidated balance sheets. The fair value of available-for-sale investments is determined using quoted market prices for those investments.
     Allowance for Doubtful Accounts and Sales Return Allowance
     We make estimates regarding the collectability of our accounts receivable. When we evaluate the adequacy of our allowance for doubtful accounts, we consider multiple factors, including historical write-off experience, the need for specific customer reserves, the aging of our receivables, customer creditworthiness and changes in customer payment cycles. Historically, our allowance for doubtful accounts has been adequate based on actual results. If any of the factors used to calculate the allowance for doubtful accounts change or if the allowance does not reflect our actual ability to collect outstanding receivables, additional provisions for doubtful accounts may be needed, and our future results of operations could be materially affected. As of March 31, 2010 and December 31, 2009, the allowance for doubtful accounts was $360,000 and $777,000, respectively.
     We also use our judgment to make estimates regarding potential future product returns related to reported product revenue in each period. We analyze factors such as our historical return experience, current product sales volumes, and changes in product warranty claims when evaluating the adequacy of the sales returns allowance. If any of the factors used to calculate the sales return allowance were to change, we may experience a material difference in the amount and timing of our product revenue for any given period. As of March 31, 2010 and December 31, 2009, the sales return allowance was $340,000 and $380,000, respectively.
     Inventories
     Inventories consist of hardware and related component parts and are stated at the lower of cost on a first-in, first-out basis, or market, except for evaluation and advance replacement units which are stated at the lower of cost, on a specific identification basis, or market. Evaluation units are used for customer testing and evaluation and are predominantly located at the customers’ premises. Advance replacement units, which include replacement units and spare parts, are used to provide replacement units under technical support arrangements if a customer’s unit is not functioning. In prior periods, advance replacement units were included in other assets and depreciated using the straight-line method. In the third quarter of 2009, we reclassified these assets to inventory to better reflect the nature of the assets. We make estimates of forecasted demand for our products, and inventory that is obsolete or in excess of our estimated demand is written down to its estimated net realizable value based on historical usage, expected demand, the timing of new product introductions and age. It is reasonably possible that our estimate of future demand for our products could change in the near term and result in additional inventory write-downs, which would negatively impact our gross margin.

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     Inventory consisted of the following (in thousands):
                 
    As of  
    March 31,     December 31,  
    2010     2009  
Finished goods
  $ 2,863     $ 2,850  
Evaluation units
    889       733  
Advance replacement units
    976       831  
 
           
Total inventory
  $ 4,728     $ 4,414  
 
           
     Inventory write-downs, mostly related to evaluation units and excess and obsolete inventory, are reflected as cost of revenues and amounted to approximately $43,000 and $211,000 for the three months ended March 31, 2010 and 2009, respectively.
   Revenue Recognition
     We derive revenue from arrangements that include hardware products with embedded software, software licenses and royalties, technical support, and professional services. Revenue from products in the accompanying consolidated statements of operations consists primarily of sales of software-based appliances, but also includes fees and royalties for the license of our technology in a software-only format and subscriptions to receive rules released by the VRT that are used to update the appliances for current exploits and vulnerabilities. Technical support, which generally has a contractual term of 12 months, includes telephone and web-based support, software updates, and rights to software upgrades on a when-and-if-available basis. Professional services include training and consulting.
     For each arrangement, we recognize revenue when: (a) persuasive evidence of an arrangement exists (e.g., a signed contract); (b) delivery of the product has occurred and there are no remaining obligations or substantive customer acceptance provisions; (c) the fee is fixed or determinable; and (d) collection of the fee is deemed probable.
     We allocate the total arrangement fee among each deliverable based on the fair value of each of the deliverables, determined based on vendor-specific objective evidence, or VSOE. If VSOE of fair value does not exist for each of the deliverables, all revenue from the arrangement is deferred until the earlier of the point at which sufficient VSOE of fair value can be determined for any undelivered elements or all elements of the arrangement have been delivered. If the only undelivered elements are elements for which we currently have VSOE of fair value, we recognize revenue for the delivered elements based on the residual method. When VSOE of fair value does not exist for undelivered elements such as maintenance and support, the entire arrangement fee is recognized ratably over the performance period.
     We have established VSOE of fair value for substantially all of our technical support based upon actual renewals of each type of technical support that is offered and for each customer class. Technical support and technical support renewals are currently priced based on a percentage of the list price of the respective product or software and historically have not varied from a narrow range of values in the substantial majority of our arrangements. Revenue related to technical support is deferred and recognized ratably over the contractual period of the technical support arrangement, which is generally 12 months. The VSOE of fair value of our other services is based on the price for these same services when they are sold separately. Revenue for professional services that are sold either on a stand-alone basis or included in multiple element arrangements is deferred and recognized as the services are performed.
     All amounts billed or received in excess of the revenue recognized are included in deferred revenue. In addition, we defer all direct costs associated with revenue that has been deferred. These amounts are included in either prepaid expenses and other current assets or inventory in the accompanying balance sheets, depending on the nature of the costs and the reason for the deferral.
     For sales through resellers and distributors, we recognize revenue upon the shipment of the product only if those resellers and distributors provide us, at the time of placing their order, with the identity of the end-user customer to whom the product has been sold. To the extent that a reseller or distributor requests an inventory or stock of products, we defer revenue on that product until we receive notification that it has been sold through to an identified end-user.
     We record taxes collected on revenue-producing activities on a net basis.

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     For the three months ended March 31, 2010, two customers, one a reseller and the other a distributor of our products to the U.S. government, accounted for 10% and 12%, respectively, of total revenue. For the three months ended March 31, 2009 we had no customers that accounted for greater than 10% of total revenue.
     As of March 31, 2010, two customers, both resellers, accounted for 15% and 11%, respectively, of our accounts receivable. As of March 31, 2009, we had no customers that accounted for greater than 10% of our accounts receivable.
  Warranty
     Under our standard warranty arrangement, we warrant that our software will perform in accordance with its documentation for a period of 90 days from the date of shipment. Similarly, we warrant that the hardware will perform in accordance with its documentation for a period of one year from date of shipment. We further agree to repair or replace software or products that do not conform to those warranties. The one year warranty on hardware coincides with the hardware warranty that we obtain from the manufacturer. We estimate the additional costs, if any, that may be incurred under our warranties outside of the warranties supplied by the manufacturer and record a liability at the time product revenue is recognized. Factors that affect our warranty liability include the number of units sold, historical and anticipated rates of warranty claims and the estimated cost per claim. We periodically assess the adequacy of our recorded warranty liability and adjust the amounts as necessary. While actual warranty costs have historically been within our cost estimations, it is possible that warranty rates could increase in the future due to new hardware introductions, general hardware component cost and availability, among other factors.
  Income Taxes
     We account for income taxes using the liability method, which requires the recognition of deferred tax assets or liabilities for the temporary differences between financial reporting and tax bases of our assets and liabilities and for tax carry-forwards at enacted statutory tax rates in effect for the years in which the differences are expected to reverse.
     We continue to assess the realizability of our deferred tax assets, which primarily consists of net operating loss, or NOL, carry-forwards, stock-based compensation expense and deferred revenue. In assessing the realizability of these deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will be realized. As of March 31, 2010 and December 31, 2009, our deferred tax assets were fully reserved except for foreign deferred tax assets of $63,000, which are expected to be available to offset foreign tax liabilities in the future. Our provision for income taxes for the three months ended March 31, 2010 consists principally of federal, state and foreign income tax expense. Our provision for income taxes for the three months ended March 31, 2009 consists principally of foreign income tax expense.
     With respect to foreign earnings, it is our policy to invest the earnings of foreign subsidiaries indefinitely outside the U.S. With respect to stock-based compensation expense, the benefit of the deferred tax asset is being recognized as the related stock options are exercised. The excess tax benefit from the exercise of stock options is recorded in additional paid-in-capital in the consolidated balance sheets to the extent that cash taxes payable are reduced.
     We have determined there are no material uncertain tax positions that would require a reserve as of March 31, 2010.
     Because tax laws are complex and subject to different interpretations, significant judgment is required. As a result, we make certain estimates and assumptions, in (i) calculating our provision for income taxes, deferred tax assets and deferred tax liabilities, (ii) determining any valuation allowance recorded against deferred tax assets and (iii) evaluating the amount of unrecognized tax benefits, as well as the interest and penalties related to such uncertain tax positions. Our estimates and assumptions may differ significantly from tax benefits ultimately realized.
   Stock-Based Compensation
     Stock-based awards granted include stock options, restricted stock awards, restricted stock units and stock purchased under our Amended and Restated 2007 Employee Stock Purchase Plan, or ESPP. Stock-based compensation expense is measured at the grant date, based on the fair value of the awards, and is recognized as expense over the requisite service period, net of estimated forfeitures.

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     We use the Black-Scholes option pricing model for estimating the fair value of stock options granted and for employee stock purchases under the ESPP. For a prior option award that contained a market condition relating to our stock price achieving specified levels, we used a Lattice option pricing model. The use of option valuation models requires the input of highly subjective assumptions, including the expected term and the expected stock price volatility. Additionally, the recognition of expense requires the estimation of the number of options that will ultimately vest and the number of options that will ultimately be forfeited. See Note 4 for additional discussion of stock-based compensation.
  Net Income (Loss) Per Share
     Basic net income (loss) per share is computed on the basis of the weighted-average number of shares of common stock outstanding during the period. Diluted net income (loss) per share is computed on the basis of the weighted-average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and restricted stock units. See Note 5 for additional discussion of our net income (loss) per share.
  Recent Accounting Pronouncements
     In October 2009, the FASB clarified the accounting guidance for sales of tangible products containing both software and hardware elements and issued new guidance that amends the criteria for evaluating the individual items in a multiple deliverable revenue arrangement and how to allocate the consideration received to the individual items. The guidance is effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. We believe this literature is applicable to our revenue arrangements. We are currently evaluating the impact this guidance will have on our consolidated financial statements.
     In January 2010, the FASB issued revised guidance intended to improve disclosures related to fair value measurements. This guidance requires new disclosures as well as clarifies certain existing disclosure requirements. New disclosures under this guidance require separate information about significant transfers in and out of Level 1 and Level 2 and the reason for such transfers, and also require purchases, sales, issuances, and settlements information for Level 3 measurement to be included in the rollforward of activity on a gross basis. The guidance also clarifies the requirement to determine the level of disaggregation for fair value measurement disclosures and the requirement to disclose valuation techniques and inputs used for both recurring and nonrecurring fair value measurements in either Level 2 or Level 3. This accounting guidance is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the rollforward of activity in Level 3 fair value measurements, which is effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of this guidance did not have an affect on our consolidated financial statements.
  Reclassifications
     Certain reclassifications have been made to the prior year consolidated financial statements to conform with the current year presentation.

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3. Investments
     The following is a summary of available-for-sale investments as of March 31, 2010 (in thousands):
                                 
            Gross     Gross        
    Amortized     Unrealized     Unrealized     Estimated  
    Cost     Gains     Losses     Fair Value  
Money market funds
  $ 12,965     $     $     $ 12,965  
Corporate debt investments
    18,958       22       (15 )     18,965  
Commercial paper
    5,296                   5,296  
Government-sponsored enterprises
    46,189       19       (43 )     46,165  
Government securities
    1,996       13             2,009  
Certificate of deposit
    3,702                   3,702  
 
                       
Total investments
    89,106       54       (58 )     89,102  
Amounts classified as cash equivalents *
    (12,966 )                 (12,966 )
 
                       
Total available-for-sale investments
  $ 76,140     $ 54     $ (58 )   $ 76,136  
 
                       
 
Due in one year or less
  $ 50,532                     $ 50,550  
Due after one year through five years
    25,608                       25,586  
 
                           
Total
  $ 76,140                     $ 76,136  
 
                           
 
*   Does not include cash held in our bank accounts
     The following is a summary of available-for-sale investments as of December 31, 2009 (in thousands):
                                 
            Gross     Gross        
    Amortized     Unrealized     Unrealized     Estimated  
    Cost     Gains     Losses     Fair Value  
Money market funds
  $ 17,617     $     $     $ 17,617  
Corporate debt investments
    17,715       15       (17 )     17,713  
Commercial paper
    7,543       2             7,545  
Government-sponsored enterprises
    39,218       41       (27 )     39,232  
Government securities
    1,995       8             2,003  
Certificate of deposit
    4,905                   4,905  
 
                       
Total investments
    88,993       66       (44 )     89,015  
Amounts classified as cash equivalents *
    (18,866 )                 (18,866 )
 
                       
Total available-for-sale investments
  $ 70,127     $ 66     $ (44 )   $ 70,149  
 
                       
 
*   Does not include cash held in our bank accounts
     The following tables show the gross unrealized losses and fair value of our investments as of March 31, 2010 with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position (in thousands):
                                                 
    Less Than 12 Months     12 Months or More     Total  
            Gross             Gross             Gross  
    Fair     Unrealized     Fair     Unrealized     Fair     Unrealized  
    Value     Losses     Value     Losses     Value     Losses  
Corporate debt investments
  $ 10,423     $ 15     $     $     $ 10,423     $ 15  
Government-sponsored enterprises
    24,429       43                   24,429       43  
 
                                   
 
  $ 34,852     $ 58     $     $     $ 34,852     $ 58  
 
                                   
     As of March 31, 2010, the net unrealized holding loss on available-for-sale securities included in accumulated other comprehensive loss totaled $4,000. We have evaluated our investments and have determined there were no other-than-temporary impairments as of March 31, 2010. There are eleven corporate debt investments and fourteen government-sponsored

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enterprise investments with unrealized losses that have existed for less than one year. The unrealized losses related to these investments are entirely caused by non-credit related factors. We do not have the intent to sell these securities and we expect to fully recover the amortized cost basis of these investments. For the three months ended March 31, 2010, the deferred tax benefit recorded in other comprehensive loss was fully offset by the increase of the valuation allowance we recorded for related deferred tax assets.
4. Stock-Based Compensation
     In March 2007, our Board of Directors and stockholders approved the Sourcefire, Inc. 2007 Stock Incentive Plan, or 2007 Plan, which provides for the granting of equity-based awards, including stock options, restricted or unrestricted stock awards, and stock appreciation rights to employees, officers, directors, and other individuals as determined by the Board of Directors. As of December 31, 2009, we had reserved an aggregate of 5,164,850 shares of common stock for issuance under the 2007 Plan. On January 1, 2010, under the terms of the 2007 Plan, the aggregate number of shares reserved for issuance under the 2007 Plan was increased by an amount equal to 4% of our outstanding common stock as of December 31, 2009, or 1,084,682 shares. Therefore, as of March 31, 2010, we have reserved an aggregate of 6,249,532 shares of common stock for issuance under the 2007 Plan. Prior to adoption of the 2007 Plan, we granted stock options and restricted stock awards under the Sourcefire, Inc. 2002 Stock Incentive Plan, or 2002 Plan.
     The 2002 Plan and the 2007 Plan are administered by the Compensation Committee of our Board of Directors. The vesting period for awards under the plans is generally between three and five years. Options granted prior to March 2010 have a maximum term of ten years, and options granted beginning March 2010 have a maximum term of seven years. The exercise price of stock option awards is equal to at least the fair value of the common stock on the date of grant. The fair value of our common stock is determined by reference to the closing trading price of the common stock on the Nasdaq Global Market on the date of grant.
     Valuation of Stock-Based Compensation
     We use the Black-Scholes option pricing model for estimating the fair value of stock options granted and for employee stock purchases under the ESPP. For a prior option award that contained a market condition relating to our stock price achieving specified levels, we used a Lattice option pricing model. The use of option valuation models requires the input of highly subjective assumptions, including the expected term and the expected stock price volatility. Additionally, the recognition of expense requires the estimation of the number of options that will ultimately vest and the number of options that will ultimately be forfeited. The fair value of stock-based awards is recognized as expense over the requisite service period, net of estimated forfeitures. We rely on historical experience of employee turnover to estimate our expected forfeitures.
The following are the weighted-average assumptions and fair values used in the Black-Scholes option valuation of stock options granted under the 2002 Plan and the 2007 Plan and ESPP grants.
                 
    Three Months Ended
    March 31,
    2010   2009
Stock options:
               
Average risk-free interest rate
    2.7 %     2.2 %
Expected dividend yield
    %     %
Expected life (years)
    6.06       6.25  
Expected volatility
    61.4 %     64.7 %
Weighted-average fair value at grant date
  $ 14.22     $ 4.00  
 
               
Employee stock purchase plan:
               
Average risk-free interest rate
    %     %
Expected dividend yield
           
Expected life (years)
           
Expected volatility
    %     %
Weighted-average fair value at grant date
  $     $  
     Average risk-free interest rate — This is the average U.S. Treasury rate, with a term that most closely resembles the expected life of the option, as of the grant date.

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     Expected dividend yield — We use an expected dividend yield of zero, as we have never declared or paid dividends on our common stock and do not anticipate paying dividends in the foreseeable future.
     Expected life — This is the period of time that the stock options granted under our equity incentive plans and ESPP grants are expected to remain outstanding.
     We have elected to use the simplified method of determining the expected term of stock options. This estimate is derived from the average midpoint between the weighted-average vesting period and the contractual term. In future periods, we expect to begin to incorporate our own data in estimating the expected life as we develop appropriate historical experience of employee exercise and post-vesting termination behavior considered in relation to the contractual life of the option.
     For ESPP grants, the expected life is the plan period.
     Expected volatility — Volatility is a measure of the amount by which a financial variable such as a share price has fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period.
     For stock options granted, since we only have historical stock data from our IPO in March 2007, which is less than the expected life of the stock options, we have used a blended volatility to estimate expected volatility. The blended volatility includes a weighting of our historical volatility from the date of our IPO to the respective grant date and an average of our peer group historical volatility consistent with the expected life of the option. Our peer group historical volatility includes the historical volatility of companies that are similar in revenue size, in the same industry or are competitors. We expect to continue to use a larger proportion of our historical volatility in future periods as we develop additional historical experience of our own stock price fluctuations considered in relation to the expected life of the option.
     For ESPP grants, we use our historical volatility since we have historical data available since our IPO, which is consistent with the expected life.
     If we had made different assumptions about the stock price volatility rates, expected life, expected forfeitures and other assumptions, the related stock-based compensation expense and net income could have been significantly different.
     The following table summarizes stock-based compensation expense included in the accompanying consolidated statements of operations (in thousands):
                 
    Three Months Ended  
    March 31,  
    2010     2009  
Product cost of revenue
  $ 31     $ 11  
Services cost of revenue
    71       33  
 
           
Stock-based compensation expense included in cost of revenue
    102       44  
 
           
Research and development
    318       205  
Sales and marketing
    666       383  
General and administrative
    840       570  
 
           
Stock-based compensation expense included in operating expenses
    1,824       1,158  
 
           
Total stock-based compensation expense
  $ 1,926     $ 1,202  
 
           

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Stock Options
     The following table summarizes stock option activity under the plans for the three months ended March 31, 2010 (in thousands, except share and per share data):
                                         
                            Weighted        
                    Weighted-     Average
Remaining
    Aggregate  
    Number of     Range of     Average     Contractual     Intrinsic  
    Shares     Exercise Prices     Exercise Price     Term     Value  
Outstanding at December 31, 2009
    2,542,038     $ 0.24 to 15.49     $ 7.75             $ 5,878  
Granted
    221,400       22.27 to 27.09       24.30                  
Exercised
    (256,654 )     0.24 to 13.10       4.82                  
Forfeited
    (33,154 )     5.26 to 27.09       15.46                  
 
                                     
Outstanding at March 31, 2010
    2,473,630     $ 0.24 to 27.09     $ 9.43       7.48     $ 33,816  
 
                               
 
                                       
Vested and exercisable at March 31, 2010
    1,202,011     $ 0.24 to 15.49     $ 5.33       6.26     $ 21,182  
 
                               
 
                                       
Vested and expected to vest at March 31, 2010
    2,122,628             $ 8.94       7.31     $ 30,023  
 
                                 
     The following table summarizes information about stock options outstanding as of March 31, 2010:
                                         
    Options Outstanding     Options Exercisable  
                    Weighted-                
            Weighted-     Average             Weighted-  
          Range of   Number of     Average     Contractual     Number of     Average  
     Exercise Prices   Shares     Exercise Prices     Life (Years)     Shares     Exercise Prices  
$  0.24 to   6.32
    624,072     $ 2.33       5.08       546,967     $ 1.84  
$  6.41 to   6.77
    800,209       6.71       8.27       367,119       6.72  
$  7.10 to 18.25
    622,749       10.63       7.59       287,925       10.17  
$19.11 to 27.09
    426,600       23.19       9.36              
 
                             
 
    2,473,630     $ 9.43       7.48       1,202,011     $ 5.33  
 
                             
     The aggregate intrinsic value of all options exercised during the three months ended March 31, 2010 and 2009 was $5.3 million and $378,000, respectively.
     Outstanding stock option awards are generally subject to service-based vesting; however, in some instances, awards contain provisions for acceleration of vesting upon performance measures, change in control and in certain other circumstances. On a quarterly basis, we evaluate the probability of achieving performance measures and adjust compensation expense accordingly. Based on the estimated grant date fair value of employee stock options granted, we recognized compensation expense of $892,000 and $641,000 for the three months ended March 31, 2010 and 2009, respectively. The grant date aggregate fair value of options, net of estimated forfeitures, not yet recognized as expense as of March 31, 2010 was $7.7 million, which is expected to be recognized over a weighted average period of 2.76 years.
Restricted Stock Awards
     The following table summarizes the unvested restricted stock award activity during the three months ended March 31, 2010:
                 
            Weighted-Average  
    Number of     Grant Date  
    Shares     Fair Value  
Unvested at December 31, 2009
    435,222     $ 7.85  
Granted
           
Vested
    (84,865 )     7.88  
Forfeited
    (2,373 )     8.47  
 
           
Unvested at March 31, 2010
    347,984     $ 7.84  
 
           

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     Restricted stock awards are generally subject to service-based vesting; however, in some instances, awards contain provisions for acceleration of vesting upon performance measures, change in control and in certain other circumstances. Holders of restricted stock awards have the right to vote such shares and receive dividends. The restricted stock awards are considered issued and outstanding at the date the award is granted. On a quarterly basis, we evaluate the probability of achieving performance measures and adjust compensation expense accordingly. The compensation expense is recognized ratably over the estimated vesting period. The vesting restrictions for outstanding restricted stock awards generally lapse over a period of 36 to 60 months.
     The vest date fair value of restricted stock awards that vested during the three months ended March 31, 2010 and 2009 was $2.1 million and $529,000, respectively.
     The fair value of the unvested restricted stock awards is measured using the closing price of our stock on the date of grant. The total compensation expense related to restricted stock awards for the three months ended March 31, 2010 and 2009 was $448,000 and $506,000, respectively.
     As of March 31, 2010, there was $1.3 million of unrecognized compensation expense, net of estimated forfeitures, related to unvested restricted stock awards. This amount is expected to be recognized over a weighted-average period of 1.85 years.
Restricted Stock Units
     The following table summarizes the unvested restricted stock unit activity during the three months ended March 31, 2010:
                 
            Weighted-Average  
    Number of     Grant Date  
    Shares     Fair Value  
Unvested at December 31, 2009
    604,400     $ 10.91  
Granted
    173,500       23.80  
Vested
    (76,246 )     25.33  
Forfeited
           
 
           
Unvested at March 31, 2010
    701,654     $ 14.44  
 
           
     Restricted stock units are generally subject to service-based vesting; however, in some instances, restricted stock units contain provisions for acceleration of vesting upon performance measures, change in control and in certain other circumstances. On a quarterly basis, we evaluate the probability of achieving performance measures and adjust compensation expense accordingly. The compensation expense is recognized ratably over the estimated vesting period. The vesting restrictions for outstanding restricted stock units generally lapse over a period of 36 to 60 months.
     The fair value of the unvested restricted stock units is measured using the closing price of our stock on the date of grant. The total compensation expense related to restricted stock units for the three months ended March 31, 2010 was $485,000 and $18,000, respectively.
     As of March 31, 2010, there was $5.9 million of unrecognized compensation expense, net of estimated forfeitures, related to unvested restricted stock units. This amount is expected to be recognized over a weighted-average period of 3.68 years.
     Employee Stock Purchase Plan
     The ESPP allows eligible employees to purchase our common stock at 85% of the lower of the stock price at the beginning or end of the offering period, which generally is a six-month period. An aggregate of 1,000,000 shares of our common stock have been reserved for issuance under the ESPP. For the three months ended March 31, 2010 and 2009, no shares were purchased under the ESPP. The total compensation expense related to the ESPP for the three months ended March 31, 2010 and 2009 was $102,000 and $37,000, respectively.

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5. Net Income (Loss) Per Share
     The calculation of basic and diluted net income (loss) per share for the three months ended March 31, 2010 and 2009 is summarized as follows (in thousands, except share and per share data):
                 
    Three Months Ended  
    March 31,  
    2010     2009  
Numerator:
               
Net income (loss)
  $ 810     $ (1,117 )
 
           
 
               
Denominator:
               
Weighted average shares outstanding — basic
    27,220,667       25,934,259  
Dilutive effect of employee stock plans
    1,839,892        
 
           
Weighted average shares outstanding — diluted
    29,060,559       25,934,259  
 
           
 
               
Net income (loss) per share:
               
Basic
  $ 0.03     $ (0.04 )
Diluted
  $ 0.03     $ (0.04 )
 
           
     The following potential weighted-average common shares were excluded from the computation of diluted earnings per share, as their effect would have been anti-dilutive:
                 
    Three Months Ended  
    March 31,  
    2010     2009  
Options to purchase common stock
    381,979       1,868,387  
Restricted stock units
          51,104  
 
           
 
    381,979       1,919,491  
 
           
6. Comprehensive Income (Loss)
     The components of comprehensive income (loss), net of tax, are as follows (in thousands):
                 
    Three Months Ended  
    March 31,  
    2010     2009  
Net income (loss)
  $ 810     $ (1,117 )
Comprehensive income (loss):
               
Change in net unrealized gains (losses) on investments
    (26 )     (96 )
 
           
Total comprehensive income (loss)
  $ 784     $ (1,213 )
 
           
7. Fair Value Measurement
     We measure the fair value of assets and liabilities using a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires us to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:
    Level 1 — Unadjusted quoted prices in active markets that are accessible at the measurement date for identical unrestricted assets or liabilities.
 
    Level 2 — Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly.
 
    Level 3 — Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

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     The fair value measurement of an asset or liability is based on the lowest level of any input that is significant to the fair value assessment. Our investments that are measured at fair value on a recurring basis are generally classified within Level 1 or Level 2 of the fair value hierarchy. The fair value of investments classified as Level 2 utilized the market approach. There were no transfers between Level 1 and Level 2 for the three months ended March 31, 2010.
     The following table presents our financial assets and liabilities that were accounted for at fair value as of March 31, 2010 by level within the fair value hierarchy (in thousands):
                                 
            Fair Value Measurement Using  
    Fair Value     Level 1     Level 2     Level 3  
Cash and cash equivalents:
                               
Money market funds
  $ 12,965     $ 12,965     $     $  
Investments:
                               
Corporate debt investments
    18,965             18,965        
Commercial paper
    5,296             5,296        
Government-sponsored enterprises
    46,165             46,165        
Government securities
    2,009       2,009              
Certificate of deposit
    3,702             3,702        
 
                       
Total
  $ 89,102     $ 14,974     $ 74,128     $  
 
                       
8. Business and Geographic Segment Information
     We manage our operations on a consolidated basis for purposes of assessing performance and making operating decisions. Accordingly, we do not have reportable segments. Revenues by geographic area for the three months ended March 30, 2010 and 2009 were as follows (in thousands):
                 
    Three Months Ended  
    March 31,  
    2010     2009  
United States
  $ 18,306     $ 12,195  
All foreign countries.
    7,525       6,405  
 
           
Consolidated total
  $ 25,831     $ 18,600  
 
           
9. Commitments and Contingencies
     We purchase components for our products from a variety of suppliers and use several contract manufacturers to provide manufacturing services for our products. During the normal course of business, in order to manage manufacturing lead times and help ensure adequate component supply, we enter into agreements with contract manufacturers and suppliers that allow them to procure inventory based upon information we provide. In certain instances, these agreements allow us the option to cancel, reschedule, and adjust our requirements based on our business needs prior to firm orders being placed. A portion of our reported purchase commitments arising from these agreements are firm, non-cancelable, and unconditional commitments. As of March 31, 2010, we had total purchase commitments for inventory of approximately $7.3 million due within the next 12 months.
     We maintain office space in the United Kingdom for which the lease agreement requires that we return the office space to its original condition upon vacating the premises. The present value of the costs associated with this retirement obligation is approximately $140,000, payable upon termination of the lease. This cost is being accreted based on estimated discounted cash flows over the lease term.

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Item 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
     Certain statements contained in this Quarterly Report on Form 10-Q may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The words or phrases “would be,” “will allow,” “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” or similar expressions, or the negative of such words or phrases, are intended to identify “forward-looking statements.” We have based these forward-looking statements on our current expectations and projections about future events. Because such statements include risks and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements. Factors that could cause or contribute to these differences include those below and elsewhere in this Quarterly Report on Form 10-Q, particularly in “Risk Factors,” and our other filings with the Securities and Exchange Commission. Statements made herein are as of the date of the filing of this Form 10-Q with the Securities and Exchange Commission and should not be relied upon as of any subsequent date. Unless otherwise required by applicable law, we do not undertake, and we specifically disclaim, any obligation to update any forward-looking statements to reflect occurrences, developments, unanticipated events or circumstances after the date of such statement.
     The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes that appear elsewhere in this Quarterly Report on Form 10-Q and with our Annual Report on Form 10-K for the fiscal year ended December 31, 2009.
     Introduction
     Management’s discussion and analysis of financial condition, changes in financial condition and results of operations is provided as a supplement to the accompanying consolidated financial statements and notes to help provide an understanding of Sourcefire, Inc.’s financial condition and results of operations. This item of our Quarterly Report on Form 10-Q is organized as follows:
    Overview. This section provides a general description of our business, the key financial metrics that we use in assessing our performance, and anticipated trends that we expect to affect our financial condition and results of operations.
 
    Results of Operations. This section provides an analysis of our results of operations for the three months ended March 31, 2010 and 2009.
 
    Non-GAAP Financial Measures. This section discusses non-GAAP financial results that we use in evaluating the operating performance of our business. These measures should be considered in addition to results prepared in accordance with United States generally accepted accounting principles, or GAAP, but should not be considered a substitute for, or superior to, GAAP results. The non-GAAP measures discussed have been reconciled to the nearest GAAP measure in a table included in this section.
 
    Liquidity and Capital Resources. This section provides an analysis of our cash flows for the three months ended March 31, 2010 and a discussion of our capital requirements and the resources available to us to meet those requirements.
 
    Critical Accounting Policies and Estimates. This section discusses accounting policies that are considered important to our financial condition and results of operations, require significant judgment or require estimates on our part in applying them. Our significant accounting policies, including those considered to be critical accounting policies, are summarized in Note 2 to the accompanying consolidated financial statements.
Overview
     We are a leading provider of intelligent cybersecurity solutions for information technology, or IT, environments of commercial enterprises, including healthcare, financial services, manufacturing, energy, education, retail and telecommunications companies, and federal, state and local government organizations worldwide. Our solutions are comprised of multiple hardware and software product and service offerings, enabling a comprehensive, intelligent approach to network security. Our security solutions provide customers with an efficient and effective network security defense of assets and applications before, during and after an attack.

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     We sell our network security solutions to a diverse customer base that includes Global 2000 companies, global enterprises, U.S. and international government agencies and small and mid-size businesses. We also manage two of the security industry’s leading open source initiatives, Snort® and ClamAV®.
   Key Financial Metrics and Trends
     Our financial results are affected by a number of factors, including general economic conditions in the United States and globally, the amount and type of technology spending of our customers, and the financial condition of our customers and other entities in the industries and geographic areas that we serve. Beginning in the second half of 2008, the industries and geographic areas that we serve experienced weakness as macroeconomic conditions, credit market conditions and levels of business confidence and activity deteriorated. We are continuing to monitor economic conditions and their potential effect on our customers and on us. An additional economic downturn could adversely affect our customers’ financial condition and the levels of business activity. This could reduce demand and depress pricing for our products and services, which could have a material adverse effect on our results of operations or financial condition.
     During the first quarter of 2010, a significant portion of our revenue growth resulted from sales of our products and services to U.S. federal and state government agencies. Contracts with the U.S. federal and state government agencies collectively accounted for 24% and 14% of our total revenue for the three months ended March 31, 2010 and 2009, respectively. We expect sales to U.S. federal and state government agencies to continue to account for a significant portion of our total revenue in 2010. A reduction in the amount of U.S. government purchases of our products could have a material adverse effect on our results of operations or financial condition.
     We evaluate our performance on the basis of several key financial metrics, including revenue, cost of revenue, gross profit, and operating expenses. We compare these key performance indicators, on a quarterly basis, to both target amounts established by management and to our performance for prior periods. We also evaluate performance on the basis of adjusted income (loss) from operations, adjusted net income and adjusted net income per share, which are non-GAAP financial measures. Information regarding our non-GAAP financial measures and a reconciliation to the nearest GAAP measure is provided under “Non-GAAP Financial Measures” below.
     Revenue
     We currently derive revenue from product sales and services. Product revenue is principally derived from the sale of our network security solutions. Our network security solutions include a perpetual software license bundled with a third-party hardware platform. Services revenue is principally derived from technical support and professional services. We typically sell technical support to complement our network security product solutions. Technical support entitles a customer to product updates and new rule releases on a when and if available basis and both telephone and web-based assistance for using our products. Our professional services revenue includes optional installation, configuration and tuning, which we refer to collectively as network security deployment services. These services typically occur on-site after delivery has occurred.
     Product sales are typically recognized as revenue upon shipment of the product to the customer. For sales through resellers and distributors, we recognize revenue upon the shipment of the product only if those resellers and distributors provide us, at the time of placing their order, with the identity of the end-user customer to whom the product has been sold. We recognize revenue from services when the services are performed. For technical support services, we recognize revenue ratably over the term of the support arrangement, which is generally 12 months. Our support agreements generally provide for payment in advance.
     We sell our network security solutions globally. However, 71% and 66% of our revenue for the three months ended March 31, 2010 and 2009, respectively, was generated by sales to U.S.-based customers. We expect that our revenue from customers based outside of the United States will increase in absolute dollars and as a percentage of revenue as we strengthen our international presence. We also expect that our revenue from sales through our indirect sales channel, comprised of resellers, distributors, managed security service providers, or MSSPs, government integrators and other partners, will increase in amount and as a percentage of total revenue as we expand our current relationships and establish new relationships with these third parties.
     We continue to generate a majority of our product revenue through sales to existing customers, both for new locations and for additional technology to protect existing networks and locations. Product sales to existing customers accounted for 68% and

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78% of total product revenue for the three months ended March 31, 2010 and 2009, respectively. We expect product sales to existing customers to continue to account for a significant portion of our product revenue in 2010.
     Historically, our product revenue has been seasonal, with a significant portion of our total product revenue in recent fiscal years generated in the third and fourth quarters. Revenue from our government customers has been influenced by the September 30th fiscal year-end of the U.S. federal government, which has historically resulted in our revenue from government customers being highest in the second half of the year. While we expect these historical trends to continue, they could be affected by a number of factors, including another decline in general economic conditions, changes in the timing or amounts of U.S. government spending and our planned international expansion. Notwithstanding these general seasonal patterns, our revenue within a particular quarter is often affected significantly by the unpredictable procurement patterns of our customers. Our prospective customers usually spend a long time evaluating and making purchase decisions for network security solutions. Historically, many of our customers have not finalized their purchasing decisions until the final weeks or days of a quarter. We expect these purchasing patterns to continue in the future. Therefore, a delay in even one large order beyond the end of the quarter could materially reduce our anticipated revenue for a quarter. In addition, because we typically recognize revenue upon shipment, the timing of our quarter-end and year-end shipments could materially affect our reported product revenue for a given quarter or year. Because many of our expenses are incurred before we recognize revenue, delayed orders could negatively impact our results of operations and cash flows for a particular period and could therefore cause us to fail to meet the financial performance expectations of financial and industry research analysts or investors.
     Cost of Revenue
     Cost of product revenue includes the cost of the hardware platform, royalties for third-party software, materials and labor, logistics, warranty, shipping and handling costs, expense for inventory excess and obsolescence and depreciation in the instances where we lease our network security solutions to our customers. We allocate overhead costs, including facilities, supplies, communication and information systems and employee benefits, to the cost of product revenue. Overhead costs are reflected in each cost of revenue and operating expense category. As our product volume increases, we anticipate incurring an increased amount of both direct and overhead expenses to supply and manage the increased volume. Hardware unit costs, our most significant cost item, have generally remained constant on a per unit basis; however, hardware unit costs or other costs of manufacturing could increase in the future.
     Cost of services revenue includes the direct labor costs of our employees and outside consultants engaged to furnish those services, as well as their travel and associated direct material costs. Additionally, we include in cost of services revenue an allocation of overhead costs, as well as the cost of time and materials to service or repair the hardware component of our products covered under a renewed support arrangement beyond the manufacturer’s warranty and the expense for advance replacement unit inventory excess and obsolescence. As our customer base continues to grow, we anticipate incurring an increasing amount of these service and repair costs, as well as costs for additional personnel to provide support and service to our customers.
     Gross Profit
     Our gross profit is affected by a variety of factors, including competition, the mix and average selling prices of our products, our pricing policy, technical support and professional services, new product introductions, the cost of hardware platforms, expense for inventory excess and obsolescence, warranty expense, the cost of labor and materials and the mix of distribution channels through which our products are sold. Our gross profit would be adversely affected by price declines or pricing discounts if we are unable to reduce costs on existing products and fail to introduce new products with higher margins. Currently, product sales typically have a lower gross profit as a percentage of revenue than our services due to the cost of the hardware platform. Our gross profit for any particular quarter could be adversely affected if we do not complete a sufficient level of sales of higher-margin products by the end of the quarter. As discussed above, many of our customers do not finalize purchasing decisions until the final weeks or days of a quarter, so a delay in even one large order of a high-margin product could reduce our total gross profit percentage for that quarter.
     Operating Expenses
     Research and Development. Research and development expenses consist primarily of salaries, incentive compensation and allocated overhead costs for our engineers; costs for professional services to design, test and certify our products; and costs associated with data used by us in our product development.

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     We have expanded our research and development capabilities and expect to continue to expand these capabilities in the future. We are committed to increasing the level of innovative design and development of new products as we strive to enhance our ability to serve our existing commercial and federal government markets as well as new markets for security solutions. To meet the changing requirements of our customers, we will need to fund investments in several development projects in parallel. Accordingly, we anticipate that our research and development expenses will continue to increase in absolute dollars for the year ending December 31, 2010; however, we expect these expenses to remain flat or decline slightly as a percentage of revenue.
     Sales and Marketing. Sales and marketing expenses consist primarily of salaries, incentive compensation and allocated overhead costs for sales and marketing personnel; trade show, advertising, marketing and other brand-building costs; marketing consultants and other professional services; training, seminars and conferences; and travel and related costs.
     As we continue to focus on increasing our market penetration, expanding internationally, increasing our indirect sales channel and building brand awareness, we anticipate that selling and marketing expenses will continue to increase in absolute dollars for the year ending December 31, 2010 but remain relatively flat as a percentage of our revenue.
     General and Administrative. General and administrative expenses consist primarily of salaries, incentive compensation and allocated overhead costs for executive, legal, finance, information technology, human resources and administrative personnel; corporate development expenses and professional fees related to legal, audit, tax and regulatory compliance; travel and related costs; and corporate insurance. We anticipate that general and administrative expenses will increase in absolute dollars for the year ending December 31, 2010.
     Stock-Based Compensation. Stock-based compensation expense is based on the grant date fair value of stock awards granted or modified after January 1, 2006 using the prospective transition method.
     We use the Black-Scholes option pricing model to estimate the fair value of stock options granted and employee stock purchases. For a prior option award that contained a market condition relating to our stock price achieving specified levels, we used a Lattice option pricing model. The use of option valuation models requires the input of highly subjective assumptions, including the expected term and the expected stock price volatility. Based on the estimated grant date fair value of stock-based awards, we recognized aggregate stock-based compensation expense of $1.9 million and $1.2 million for the three months ended March 31, 2010 and 2009, respectively.
Results of Operations
     Revenue. The following table shows products and technical support and professional services revenue (in thousands):
                                 
    Three Months Ended        
    March 31,     Variance  
    2010     2009     $     %  
Products
  $ 14,338     $ 9,868     $ 4,470       45 %
Percentage of total revenue
    56 %     53 %                
Technical support and professional services
    11,493       8,732       2,761       32 %
Percentage of total revenue
    44 %     47 %                
 
                       
Total revenue
  $ 25,831     $ 18,600     $ 7,231       39 %
 
                       
     The increase in our product revenue for the three months ended March 31, 2010, as compared to the prior-year period, was primarily due to higher volume demand for our sensor products, mainly our higher performance products, and increased sales of our software licenses. For 2010, sensor product revenue increased $2.3 million over the prior-year period, including a $1.2 million increase in revenue from our higher performance products, and software licenses increased $1.8 million, including $431,000 in revenue from our virtual appliances that became generally available in the fourth quarter of 2009.
     The increase in our services revenue for the three months ended March 31, 2010, as compared to the prior-year period, resulted from an increase in our installed customer base due to new product sales in which associated support was purchased, as well as technical support renewals by our existing customers.

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     Cost of revenue. The following table shows products and technical support and professional services cost of revenue (in thousands):
                                 
    Three Months Ended        
    March 31,     Variance  
    2010     2009     $     %  
Products
  $ 3,796     $ 2,767     $ 1,029       37 %
Percentage of total revenue
    15 %     15 %                
Technical support and professional services
    1,405       1,382       23       2 %
Percentage of total revenue
    5 %     7 %                
 
                       
Total cost of revenue
  $ 5,201     $ 4,149     $ 1,052       25 %
 
                       
Percentage of total revenue
    20 %     22 %                
     The increase in our product cost of revenue for the three months ended March 31, 2010, as compared to the prior-year period, was primarily due to higher volume demand for our sensor products, for which we must procure and provide the hardware platform to our customers.
     The increase in our services cost of revenue for the three months ended March 31, 2010, as compared to the prior-year period, was primarily attributable to our hiring of additional personnel to both service our larger installed customer base and to provide training and professional services to our customers, partially offset by decreased hardware service expense we pay to our third-party integrators to help maintain our install base.
     Gross profit. The following table shows products and technical support and professional services gross profit (in thousands):
                                 
    Three Months Ended        
    March 31,     Variance  
    2010     2009     $     %  
Products
  $ 10,542     $ 7,101     $ 3,441       48 %
Products gross margin
    74 %     72 %                
Technical support and professional services
    10,088       7,350       2,738       37 %
Technical support and professional services gross margin
    88 %     84 %                
 
                       
Total gross profit
  $ 20,630     $ 14,451     $ 6,179       43 %
 
                       
Total gross margin
    80 %     78 %                
     Products gross margin for the three months ended March 31, 2010 increased compared to the prior-year period primarily due to the product mix sold favoring products with higher gross margins and a decrease in inventory write-downs related to evaluation units and excess and obsolete inventory.
     Technical support and professional services gross margin for the three months ended March 31, 2010, as compared to the prior-year period, increased primarily due to service revenue increasing at a higher rate than service expense.
     Operating expenses. The following table highlights our operating expenses (in thousands):
                                 
    Three Months Ended        
    March 31,     Variance  
    2010     2009     $     %  
Research and development
  $ 3,795     $ 3,320     $ 475       14 %
Percentage of total revenue
    15 %     18 %                
Sales and marketing
    10,619       7,870       2,749       35 %
Percentage of total revenue
    41 %     42 %                
General and administrative
    4,319       3,843       476       12 %
Percentage of total revenue
    17 %     21 %                
Depreciation and amortization
    814       821       (7 )     (1 %)
Percentage of total revenue
    3 %     4 %                
 
                       
Total operating expenses
  $ 19,547     $ 15,854     $ 3,693       23 %
 
                       
Percentage of total revenue
    76 %     85 %                

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     Research and development expenses for the three months ended March 31, 2010 increased over the prior-year period, primarily due to an increase of $308,000 in salaries, incentive compensation, benefits and allocated overhead costs as a result of additional personnel and increased overhead costs and an increase of $113,000 in stock-based compensation expense.
     Sales and marketing expenses for the three months ended March 31, 2010 increased over the prior-year period, primarily due to an increase of $1.7 million in salaries, commissions and incentive compensation, benefits and allocated overhead costs as a result of additional sales and marketing personnel, increased revenue and increased overhead costs, an increase of $390,000 in advertising, promotion, partner-marketing programs and trade show expenses and an increase of $283,000 in stock-based compensation expense.
     General and administrative expenses for the three months ended March 31, 2010 increased from the prior-year period, primarily due to an increase of $401,000 in salaries, incentive compensation, benefits and allocated overhead costs for personnel hired in our accounting, information technology, human resources and legal departments and increased overhead costs and an increase of $270,000 in stock-based compensation expense, offset by a decrease of $116,000 in professional fees related to legal, accounting, information technology, audit and tax services, as well as reduced regulatory compliance and corporate development expenses.
     Depreciation and amortization expense for the three months ended March 31, 2010 remained relatively flat over the prior-year period.
     Other income, net and provision for income taxes. The following table shows our other income, net and provision for income taxes (in thousands):
                 
    Three Months Ended
    March 31,
    2010   2009
Other income, net
  $     $ 361  
Percentage of total revenue
    0 %     2 %
Provision for income taxes
    273       75  
Percentage of total revenue
    1 %     0 %
     Other income, net for the three months ended March 31, 2010 decreased from the prior-year period, primarily due to a decrease in interest and investment income as a result of lower average interest rates on invested cash and investment balances.
     Our provision for income taxes for the three months ended March 31, 2010 was $273,000, which is calculated using a projected effective tax rate as of March 31, 2010 of 25%. Our projected effective tax rate differs from the U.S. federal statutory rate of 34% primarily due to the benefit of projected net operating loss utilization, adjustments for book stock compensation expense and foreign income taxed at different rates. The provision for income taxes for the three months ended March 31, 2010 consisted of $213,000 of federal and state income tax expense and $60,000 of foreign income tax expense. Our provision for income taxes for the three months ended March 31, 2009 was $75,000, which resulted in an annual effective tax rate of negative 7%. Our annual effective tax rate for the three months ended March 31, 2009 differed from the U.S. federal statutory rate of 34% primarily due to the increase of the valuation allowance on certain deferred tax assets, state income taxes and the foreign income taxed at different rates. The provision for income taxes for the three months ended March 31, 2009, consisted of $75,000 of foreign income tax expense.
     We continue to assess the realizability of our deferred tax assets, which primarily consists of net operating loss, or NOL, carry-forwards, stock-based compensation expense and deferred revenue. In assessing the realizability of these deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. As of March 31, 2010 and December 31, 2009, our deferred tax assets were fully reserved except for foreign deferred tax assets of $63,000, which are expected to be available to offset foreign tax liabilities in the future.
     If our recent trend of profitability continues, we may determine, based on generally accepted accounting principles, that there is sufficient positive evidence to support a reversal of, or decrease in, the valuation allowance. If we were to reverse all or some part of our valuation allowance and recognize all or part of our deferred tax assets, we would likely record an increase in assets on our consolidated balance sheet in the period of reversal and a corresponding tax benefit in our consolidated statement of operations for the amount of the reversal. Such amounts could be material to our financial statements and could occur as soon as our quarter ending June 30, 2010.

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     Seasonality
     Our product revenue has tended to be seasonal, with a significant portion generated in the third and fourth quarters. Revenue from our government customers has been influenced by the September 30th fiscal year-end of the U.S. federal government, which has historically resulted in our revenue from government customers being highest in the second half of the year. In the fourth quarter, revenues have historically been strong due to purchases by North American enterprise customers, which operate on a calendar year budget and often wait until the fourth quarter to make their most significant capital equipment purchases. In addition, increased fourth quarter sales in Europe have historically resulted in higher fourth quarter revenues following a decline in sales in the summer months due to vacation practices in Europe and the resulting delay in capital purchase activities until the fall. While we expect these historical trends to continue, they could be affected by a number of factors, including another decline in general economic conditions, changes in the timing or amounts of U.S. government spending, and our planned international expansion. The timing of transactions could materially affect our quarterly or annual product revenue.
     Quarterly Timing
     On a quarterly basis, we have usually generated the majority of our sales in the final month of the quarter. We believe this occurs for two reasons. First, many customers wait until the end of the quarter to extract favorable pricing terms from their vendors, including Sourcefire. Second, our sales personnel, who have a strong incentive to meet quarterly sales targets, have tended to increase their sales activity as the end of a quarter nears, while their participation in sales management review and planning activities is typically scheduled at the beginning of a quarter. The timing of our quarter-end and year-end shipments also affects our quarterly and annual product revenue, since we typically recognize revenue upon shipment of the product.
Non-GAAP Financial Measures
     In evaluating the operating performance of our business, we exclude certain charges and credits that are required by GAAP. These non-GAAP results provide useful information to us and investors by excluding (i) stock-based compensation, which does not involve the expenditure of cash, and (ii) items that we believe may not be indicative of our operating performance, because either they are unusual and we do not expect them to recur in the ordinary course of our business or they are unrelated to the ongoing operation of the business in the ordinary course. The non-GAAP results have also been adjusted to reflect the effect of an assumed tax rate of 35%, which differs from our GAAP tax rate. We believe this adjustment provides useful information to us and investors because it more accurately reflects our expected long-term tax rate. These non-GAAP financial measures should be considered in addition to results prepared in accordance with GAAP, but should not be considered a substitute for, or superior to, GAAP results.

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     The following table shows a reconciliation of non-GAAP financial measures to the nearest GAAP measure (in thousands, except share and per share amounts):
                 
    Three Months Ended  
    March 31,  
    2010     2009  
Reconciliation to adjusted income (loss) from operations:
               
GAAP income (loss) from operations
  $ 1,083     $ (1,403 )
Stock-based compensation expense
    1,926       1,202  
 
           
Adjusted income (loss) from operations
  $ 3,009     $ (201 )
 
           
Adjusted income (loss) from operations as % of revenue
    11.6 %   NA  
 
               
Reconciliation to adjusted net income:
               
GAAP net income (loss)
  $ 810     $ (1,117 )
Stock-based compensation expense
    1,926       1,202  
Income tax adjustment *
    (780 )     19  
 
           
Adjusted net income
  $ 1,956     $ 104  
 
           
 
               
Adjusted net income per share — basic
  $ 0.07     $  
Adjusted net income per share — diluted
  $ 0.07     $  
 
           
 
               
Weighted average shares outstanding — basic
    27,220,667       25,934,259  
Weighted average shares outstanding — diluted **
    29,060,559       27,012,955  
 
           
 
*   Income tax adjustment is used to adjust the GAAP provision for income taxes to a non-GAAP provision for income taxes utilizing an estimated tax rate of 35%.
 
**   For the three months ended March 31, 2009, the effect of dilutive securities was excluded from GAAP diluted weighted average shares outstanding due to the reported net loss under GAAP, but is included for non-GAAP diluted weighted average shares outstanding since we have non-GAAP net income.
Liquidity and Capital Resources
Cash Flows
     The following table summarizes our cash flow activities for the periods indicated (in thousands):
                 
    Three Months Ended  
    March 31,  
    2010     2009  
Cash and cash equivalents:
               
Provided by operating activities
  $ 10,987     $ 4,269  
(Used in) provided by investing activities
    (7,484 )     6,676  
Provided by financing activities
    1,448       96  
 
           
Increase in cash and cash equivalents
    4,951       11,041  
Cash and cash equivalents at beginning of period
    53,071       39,768  
 
           
Cash and cash equivalents at end of period
    58,022       50,809  
Investments
    76,136       54,492  
 
           
Total cash, cash equivalents and investments
  $ 134,158     $ 105,301  
 
           
     Operating Activities. Cash provided by operating activities for the three months ended March 31, 2010 is the result of our net income of $810,000, $2.9 million of net non-cash revenues and expenses and changes in our operating assets and liabilities of $7.3 million. Cash provided by operating activities for the three months ended March 31, 2009 is the result of $1.9 million of net non-cash revenues and expenses and changes in our operating assets and liabilities of $3.5 million, offset by our net loss of $1.1 million.

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     Investing Activities. Cash used in investing activities for the three months ended March 31, 2010 was primarily the result of purchases of investments of $30.5 million and capital expenditures of $1.2 million, offset by maturities of investments of $24.2 million. Cash provided by investing activities for the three months ended March 31, 2009 was primarily the result of maturities of investments of $22.7 million, offset by purchases of investments of $15.3 million and capital expenditures of $639,000.
     Financing Activities. Cash provided by financing activities for the three months ended March 31, 2010 and 2009 was primarily the result of proceeds from the issuance of common stock under our employee stock-based plans.
Liquidity Requirements
     We manufacture our products through contract manufacturers and other third parties. This approach provides us with the advantage of relatively low capital expenditure requirements and significant flexibility in scheduling production and managing inventory levels. The majority of our products are delivered to our customers directly from our contract manufacturers. Accordingly, our contract manufacturers are responsible for purchasing and stocking the components required to produce our products, and they invoice us when the finished goods are shipped. By leasing our office facilities, we also minimize the cash needed for expansion. Our capital spending is generally limited to leasehold improvements, computers, office furniture and lab and test equipment.
     Our short-term liquidity requirements through March 31, 2011 consist primarily of the funding of working capital requirements and capital expenditures. We expect to meet these short-term requirements primarily through cash flow from operations. To the extent that cash flow from operations is not sufficient to meet these requirements, we expect to fund these amounts through the use of existing cash and investment resources. As of March 31, 2010, we had cash, cash equivalents and investments of $134.2 million and working capital of $103.6 million.
     As described above, our product sales are, and are expected to continue to be, highly seasonal. We believe that our current cash reserves are sufficient for any short-term needs arising from the seasonality of our business.
     Our long-term liquidity requirements consist primarily of obligations under our operating leases. We expect to meet these long-term requirements primarily through cash flow from operations.
     In addition, we may utilize cash resources, equity financing or debt financing to fund acquisitions or investments in complementary businesses, technologies or product lines.
Critical Accounting Policies and Estimates
     Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates.
     We believe that, of our significant accounting policies, which are described in Note 2 to the consolidated financial statements contained in this report, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, we believe that the following accounting policies are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of operations.
     Revenue Recognition. We derive revenue from arrangements that include hardware products with embedded software, software licenses and royalties, technical support, and professional services. Revenue from products in the accompanying consolidated statements of operations consists primarily of sales of software-based appliances, but also includes fees and royalties for the license of our technology in a software-only format and subscriptions to receive rules released by the VRT that are used to update the appliances for current exploits and vulnerabilities. Technical support, which generally has a contractual term of 12 months, includes telephone and web-based support, software updates, and rights to software upgrades on a when-and-if-available basis. Professional services include training and consulting.
     For each arrangement, we recognize revenue when: (a) persuasive evidence of an arrangement exists (e.g., a signed contract); (b) delivery of the product has occurred and there are no remaining obligations or substantive customer acceptance provisions; (c) the fee is fixed or determinable; and (d) collection of the fee is deemed probable.

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     We allocate the total arrangement fee among each deliverable based on the fair value of each of the deliverables, determined based on vendor-specific objective evidence, or VSOE. If VSOE of fair value does not exist for each of the deliverables, all revenue from the arrangement is deferred until the earlier of the point at which sufficient VSOE of fair value can be determined for any undelivered elements or all elements of the arrangement have been delivered. If the only undelivered elements are elements for which we currently have VSOE of fair value, we recognize revenue for the delivered elements based on the residual method. When VSOE of fair value does not exist for undelivered elements such as maintenance and support, the entire arrangement fee is recognized ratably over the performance period.
     We have established VSOE of fair value for substantially all of our technical support based upon actual renewals of each type of technical support that is offered and for each customer class. Technical support and technical support renewals are currently priced based on a percentage of the list price of the respective product or software and historically have not varied from a narrow range of values in the substantial majority of our arrangements. Revenue related to technical support is deferred and recognized ratably over the contractual period of the technical support arrangement, which is generally 12 months. The VSOE of fair value of our other services is based on the price for these same services when they are sold separately. Revenue for professional services that are sold either on a stand-alone basis or included in multiple element arrangements is deferred and recognized as the services are performed.
     All amounts billed or received in excess of the revenue recognized are included in deferred revenue. In addition, we defer all direct costs associated with revenue that has been deferred. These amounts are included in either prepaid expenses and other current assets or inventory in the accompanying balance sheets, depending on the nature of the costs and the reason for the deferral.
     For sales through resellers and distributors, we recognize revenue upon the shipment of the product only if those resellers and distributors provide us, at the time of placing their order, with the identity of the end-user customer to whom the product has been sold. To the extent that a reseller or distributor requests an inventory or stock of products, we defer revenue on that product until we receive notification that it has been sold through to an identified end-user.
     Changes in our judgments and estimates about these assumptions could materially impact the timing of our revenue recognition.
     Accounting for Stock-Based Compensation. Stock-based awards granted include stock options, restricted stock awards, restricted stock units and stock purchased under our Amended and Restated 2007 Employee Stock Purchase Plan, or ESPP. Stock-based compensation expense is measured at the grant date, based on the fair value of the awards, and is recognized as expense over the requisite service period, net of estimated forfeitures.
     We use the Black-Scholes option pricing model for estimating the fair value of stock options granted and for employee stock purchases under the ESPP. For a prior option award that contained a market condition relating to our stock price achieving specified levels, we used a Lattice option pricing model. The use of option valuation models requires the input of highly subjective assumptions, including the expected term and the expected stock price volatility. Additionally, the recognition of expense requires the estimation of the number of options that will ultimately vest and the number of options that will ultimately be forfeited. The fair value of stock-based awards is recognized as expense over the requisite service period, net of estimated forfeitures. We rely on historical experience of employee turnover to estimate our expected forfeitures.
     Average risk-free interest rate — This is the average U.S. Treasury rate, with a term that most closely resembles the expected life of the option, as of the grant date.
     Expected dividend yield — We use an expected dividend yield of zero, as we have never declared or paid dividends on our common stock and do not anticipate paying dividends in the foreseeable future.
     Expected life — This is the period of time that the stock options granted under our equity incentive plans and ESPP grants are expected to remain outstanding.
     We have elected to use the simplified method of determining the expected term of stock options. This estimate is derived from the average midpoint between the weighted-average vesting period and the contractual term. In future periods, we expect

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to begin to incorporate our own data in estimating the expected life as we develop appropriate historical experience of employee exercise and post-vesting termination behavior considered in relation to the contractual life of the option.
     For ESPP grants, the expected life is the plan period.
     Expected volatility — Volatility is a measure of the amount by which a financial variable such as a share price has fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period.
     For stock options granted, since we only have historical stock data from our IPO in March 2007, which is less than the expected life of the stock options, we have used a blended volatility to estimate expected volatility. The blended volatility includes a weighting of our historical volatility from the date of our IPO to the respective grant date and an average of our peer group historical volatility consistent with the expected life of the option. Our peer group historical volatility includes the historical volatility of companies that are similar in revenue size, in the same industry or are competitors. We expect to continue to use a larger proportion of our historical volatility in future periods as we develop additional historical experience of our own stock price fluctuations considered in relation to the expected life of the option.
     For ESPP grants, we use our historical volatility since we have historical data available since our IPO, which is consistent with the expected life.
     If we were to employ different assumptions for estimating stock-based compensation expense in future periods, or if we were to decide to use a different valuation model, the amount of expense recorded in future periods could differ significantly from what we have recorded in recent periods.
     The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable, which are characteristics that are not present in our option grants. Existing valuation models, including the Black-Scholes and Lattice models, may not provide reliable measures of the fair values of our stock-based compensation awards. Consequently, there is a risk that our estimates of the fair values of our stock-based compensation awards on the grant dates may be significantly different than the actual values upon the exercise, expiration, early termination or forfeiture of those stock-based payments in the future. Certain stock-based payments, such as employee stock options, may expire worthless or otherwise result in zero intrinsic value as compared to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, values may be realized from these instruments that are significantly higher than the fair values originally estimated on the grant date and reported in our financial statements.
     The application of these principles may be subject to further interpretation and refinement over time. There are significant differences among valuation models, and there is a possibility that we will adopt different valuation models in the future. This may result in a lack of consistency between past and future periods and materially affect the fair value estimate of stock-based payments. It may also result in a lack of comparability with other companies that use different models, methods, and assumptions.
     Accounting for Income Taxes. We account for income taxes using the liability method, which requires the recognition of deferred tax assets or liabilities for the temporary differences between financial reporting and tax bases of our assets and liabilities and for tax carry-forwards at enacted statutory tax rates in effect for the years in which the differences are expected to reverse.
     We continue to assess the realizability of our deferred tax assets, which primarily consists of net operating loss, or NOL, carry-forwards, stock-based compensation expense and deferred revenue. In assessing the realizability of these deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. As of March 31, 2010 and December 31, 2009, our deferred tax assets were fully reserved except for foreign deferred tax assets of $63,000, which are expected to be available to offset foreign tax liabilities in the future. Our provision for income taxes for the three months ended March 31, 2010 consists principally of federal, state and foreign income tax expense. Our provision for income taxes for the three months ended March 31, 2009 consists principally of foreign income tax expense.
     If our recent trend of profitability continues, we may determine, based on generally accepted accounting principles, that there is sufficient positive evidence to support a reversal of, or decrease in, the valuation allowance. If we were to reverse all or some part of our valuation allowance and recognize all or part of our deferred tax assets, we would likely record an increase in assets on our consolidated balance sheet in the period of reversal and a corresponding tax benefit in our consolidated statement of operations for the amount of the reversal. Such amounts could be material to our financial statements and could occur as soon as our quarter ending June 30, 2010.

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     With respect to foreign earnings, it is our policy to invest the earnings of foreign subsidiaries indefinitely outside the U.S. With respect to stock-based compensation expense, the benefit of the deferred tax asset is being recognized as the related stock options are exercised. The excess tax benefit from the exercise of stock options is recorded in additional paid-in-capital in the consolidated balance sheets to the extent that cash taxes payable are reduced.
     We have determined that there are no material uncertain tax positions that would require a reserve as of March 31, 2010.
     Because tax laws are complex and subject to different interpretations, significant judgment is required. As a result, we make certain estimates and assumptions in (i) calculating our provision for income taxes, deferred tax assets and deferred tax liabilities, (ii) determining any valuation allowance recorded against deferred tax assets and (iii) evaluating the amount of unrecognized tax benefits, if any, as well as the interest and penalties related to such uncertain tax positions. Our estimates and assumptions may differ significantly from tax benefits ultimately realized.
     Allowance for Doubtful Accounts and Sales Return Allowance. We make estimates regarding the collectability of our accounts receivable. When we evaluate the adequacy of our allowance for doubtful accounts, we consider multiple factors, including historical write-off experience, the need for specific customer reserves, the aging of our receivables, customer creditworthiness and changes in customer payment cycles. Historically, our allowance for doubtful accounts has been adequate based on actual results. If any of the factors used to calculate the allowance for doubtful accounts change or if the allowance does not reflect our future ability to collect outstanding receivables, additional provisions for doubtful accounts may be needed, and our future results of operations could be materially affected. As of March 31, 2010 and December 31, 2009, the allowance for doubtful accounts was $360,000 and $777,000, respectively.
     We also use our judgment to make estimates regarding potential future product returns related to reported product revenue in each period. We analyze factors such as our historical return experience, current product sales volumes, and changes in product warranty claims when evaluating the adequacy of the sales returns allowance. If any of the factors used to calculate the sales return allowance were to change, we may experience a material difference in the amount and timing of our product revenue for any given period. As of March 31, 2010 and December 31, 2009, the sales return allowance was $340,000 and $380,000, respectively.
     Inventories. Inventories consist of hardware and related component parts and are stated at the lower of cost on a first-in, first-out basis, or market, except for evaluation and advance replacement units which are stated at the lower of cost, on a specific identification basis, or market. Evaluation units are used for customer testing and evaluation and are predominantly located at the customers’ premises. Advance replacement units, which include replacement units and spare parts, are used to provide replacement units under technical support arrangements if a customer’s unit is not functioning. In prior periods, advance replacement units were included in other assets and depreciated using the straight-line method. In the third quarter of 2009, we reclassified these assets to inventory to better reflect the nature of the assets. We make estimates of forecasted demand for our products, and inventory that is obsolete or in excess of our estimated demand is written down to its estimated net realizable value based on historical usage, expected demand, the timing of new product introductions and age. It is reasonably possible that our estimate of future demand for our products could change in the near term and result in additional inventory write-downs, which would negatively impact our gross margin.
     Inventory write-downs, mostly related to evaluation units and excess and obsolete inventory, are reflected as cost of revenues and amounted to approximately $43,000 and $211,000 for the three months ended March 31, 2010 and 2009, respectively.
     Investments. We determine the appropriate classification of our investments at the time of purchase and reevaluate such classification as of each balance sheet date. Our investments are comprised of money market funds, corporate debt investments, commercial paper, government-sponsored enterprise securities, government securities and certificates of deposit. These investments have been classified as available-for-sale. Available-for-sale investments are stated at fair value, with the unrealized gains and losses, net of tax, reported in accumulated other comprehensive income. The amortization of premiums and accretion of discounts to maturity are computed using the effective interest method. Amortization is included in interest and investment income. Interest on securities classified as available-for-sale is also included in interest and investment income. See Note 3 for further discussion of the classification of our investments.
     We evaluate our investments on a regular basis to determine whether an other-than-temporary decline in fair value has occurred. If an investment is in an unrealized loss position and we have the intent to sell the investment, or it is more likely than

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not that we will have to sell the investment before recovery of its amortized cost basis, the decline in value is deemed to be other-than-temporary and is charged against earnings for the period. For investments that we do not intend to sell or it is more likely than not that we will not have to sell the investment, but we expect that we will not fully recover the amortized cost basis, the credit component of the other-than-temporary impairment is charged against earnings for the applicable period and the non-credit component of the other-than-temporary impairment is recognized in other comprehensive income on our statement of stockholders’ equity. Unrealized losses entirely caused by non-credit related factors related to investments for which we expect to fully recover the amortized cost basis are recorded in accumulated other comprehensive income.
Recent Accounting Pronouncements
     In October 2009, the FASB clarified the accounting guidance for sales of tangible products containing both software and hardware elements and issued new guidance that amends the criteria for evaluating the individual items in a multiple deliverable revenue arrangement and how to allocate the consideration received to the individual items. The guidance is effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. We believe this literature is applicable to our revenue arrangements. We are currently evaluating the impact this guidance will have on our consolidated financial statements.
     In January 2010, the FASB issued revised guidance intended to improve disclosures related to fair value measurements. This guidance requires new disclosures as well as clarifies certain existing disclosure requirements. New disclosures under this guidance require separate information about significant transfers in and out of Level 1 and Level 2 and the reason for such transfers, and also require purchases, sales, issuances, and settlements information for Level 3 measurement to be included in the rollforward of activity on a gross basis. The guidance also clarifies the requirement to determine the level of disaggregation for fair value measurement disclosures and the requirement to disclose valuation techniques and inputs used for both recurring and nonrecurring fair value measurements in either Level 2 or Level 3. This accounting guidance is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the rollforward of activity in Level 3 fair value measurements, which is effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of this guidance did not have an affect on our consolidated financial statements.

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Item 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
     No material changes in our market risk occurred from December 31, 2009 through March 31, 2010. Information regarding our market risk at December 31, 2009, is contained in Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” in our Annual Report on Form 10-K for the year ended December 31, 2009.
Item 4.   CONTROLS AND PROCEDURES
     Evaluation of Disclosure Controls and Procedures. We maintain “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”), which are controls and other procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. In addition, the design of any system of controls also is based in part upon 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 the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a control system, misstatements due to error or fraud may occur and not be detected.
     Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective at the reasonable assurance level.
     Changes in Internal Control Over Financial Reporting. No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION
Item 1.   LEGAL PROCEEDINGS
     On May 29, 2009 and August 3, 2009, Enhanced Security Research, LLC, or ESR, filed two nearly identical complaints in the United States District Court for the District of Delaware against 10 defendants, including Cisco Systems, Inc., International Business Machines Corporation, Check Point Software Technologies, Ltd., Check Point Software Technologies, Inc., SonicWALL, Inc., 3Com Corporation, Nokia Corporation, Nokia, Inc., Fortinet, Inc., and us. The only significant difference between the first and second complaints is the addition of Security Research Holdings LLC as a plaintiff. The complaints allege, among other things, that our network security appliances and software infringe two U.S. patents. Plaintiffs seek unspecified damages, enhancement of those damages, an attorney’s fee award and an injunction against further infringement. We believe that the allegations of infringement against us are without merit, and we intend to defend this case vigorously on that basis. Both patents in this litigation are currently undergoing reexamination by the United States Patent and Trademark Office (“USPTO”), and the USPTO has rejected all claims of one of the patents as not patentable, and the patent owner has filed a response arguing that the claims are patentable. The USPTO has not yet issued its final decision on that patent. In the other of the two patents, the USPTO only recently agreed to reexamine the patent, determining that new information brought to the attention of the USPTO raises a “substantial question of patentability” of the patent claims. The patent owner now has the opportunity to file a response arguing why the patentability of the claims should be confirmed. Given the inherent unpredictability of litigation and jury trials, we cannot at this early stage of the matter estimate the possible outcome of this litigation. Because patent litigation is time consuming and costly to defend, we may incur significant costs related to this matter in future periods. In addition, an unfavorable outcome in this matter could have a material adverse effect on our future results of operations or cash flows.
Item 1A.   RISK FACTORS
     Set forth below and elsewhere in this report and in other documents we file with the Securities and Exchange Commission are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this report. The descriptions below include any material changes to and supersede the description of the risk factors affecting our business previously disclosed in “Part I, Item 1A. Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2009.
Risks Relating to Our Business, Operations and Industry
Economic, market and political conditions, including the global recession, may adversely affect our revenue and results of operations.
     Our business depends significantly on a range of factors that are beyond our control. These include:
    general economic and business conditions;
    the overall demand for network security products and services; and
    constraints on budgets and changes in spending priorities of corporations and government agencies.
     The global financial recession has resulted in the significant weakening of the U.S. and global economies, the lack of availability of credit, the reduction in business confidence and activity, and other factors that may affect one or more of the industries to which we sell our products and services. Our customers include, but are not limited to, financial institutions, defense contractors, health care providers, information technology companies, telecommunications companies and retailers. These customers may suffer from reduced operating budgets, which could cause them to defer or forego purchases of our products or services. In addition, negative effects on the financial condition of our resellers and distributors could affect their ability or willingness to market our product and service offerings; negative effects on the financial condition of our product manufacturers could affect their ability to manufacture our products; and declines in economic and market conditions could impair our short-term investment portfolio. Any of these developments could adversely affect our revenue and results of operations.

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We face intense competition in our market, especially from larger, better-known companies, and we may lack sufficient financial or other resources to maintain or improve our competitive position.
     The market for network security monitoring, detection, prevention and response solutions is intensely competitive, and we expect competition to increase in the future. We may not compete successfully against our current or potential competitors, especially those with significantly greater financial resources or brand name recognition. Our chief competitors include: large software companies; software or hardware network infrastructure companies; smaller software companies offering applications for network and Internet security monitoring, detection, prevention or response; and small and large companies offering point solutions that compete with components of our product offerings.
     For example, Cisco Systems, Inc., IBM Corporation, Juniper Networks, Inc., Hewlett-Packard Company as a result of its acquisition of 3Com Corporation, Check Point Software Technologies, Ltd. and McAfee, Inc., have intrusion detection or prevention technologies that compete with our product offerings. Large companies may have advantages over us because of their longer operating histories, greater brand name recognition, larger customer bases or greater financial, technical and marketing resources. As a result, they may be able to adapt more quickly to new or emerging technologies and changes in customer requirements. They also have greater resources to devote to the promotion and sale of their products than we have. In addition, in some cases our competitors have aggressively reduced, and could continue to reduce, the price of their security monitoring, detection, prevention and response products, managed security services, and maintenance and support services which intensifies pricing pressures within our market.
     Several companies currently sell software products (such as encryption, firewall, operating system security and virus detection software) that our customers and potential customers have broadly adopted. Some of these companies sell products that perform functions comparable to some of our products. In addition, the vendors of operating system software or networking hardware may enhance their products to include functions similar to those that our products currently provide. The widespread inclusion of features comparable to our software in operating system software or networking hardware could render our products less competitive or obsolete, particularly if such features are of a high quality. Even if security functions integrated into operating system software or networking hardware are more limited than those of our products, a significant number of customers may accept more limited functionality to avoid purchasing additional products such as ours.
     One of the characteristics of open source software is that anyone can offer new software products for free under an open source licensing model in order to gain rapid and widespread market acceptance. Such competition can develop without the degree of overhead and lead time required by traditional technology companies. It is possible for new competitors with greater resources than ours to develop their own open source security solutions, potentially reducing the demand for our solutions. We may not be able to compete successfully against current and future competitors. Competitive pressure and/or the availability of open source software may result in price reductions, reduced revenue, reduced operating margins and loss of market share, any one of which could seriously harm our business.
New competitors could emerge and could impair our sales.
     New sources of competition for sales of our products could emerge. These include:
    emerging companies as well as larger companies who have not previously entered the market for network security products;
    established companies that develop their own network intrusion detection and prevention products, or acquire or establish product integration, distribution or other cooperative relationships with our current competitors; and
    new competitors or alliances among competitors that emerge and rapidly acquire significant market share due to factors such as greater brand name recognition, a larger installed customer base and significantly greater financial, technical, marketing and other resources and experience.
We achieved profitability on an annual basis for the first time in 2009, which we may not be able to maintain.
     We incurred operating losses each year from our inception in 2001 through 2008. We achieved profitability on an annual basis for the first time in 2009. Maintaining profitability will depend in large part on our ability to generate and sustain increased revenue levels in future periods. Although our revenue has generally been increasing, there can be no assurances that we will maintain or increase our level of profitability. Our operating expenses may continue to increase as we seek to expand

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our customer base, increase our sales and marketing efforts and continue to invest in research and development of our technologies and products. These efforts may be more costly than we expect and we may not be able to increase our revenue to offset our operating expenses. If we cannot increase our revenue at a greater rate than our expenses, we will not remain profitable.
Our quarterly operating results are likely to vary significantly and be unpredictable, in part because of the purchasing and budget practices of our customers, which could cause the trading price of our stock to decline.
     Our operating results have historically varied significantly from period to period, and we expect that they will continue to do so as a result of a number of factors, most of which are outside of our control, including:
    the budgeting cycles, internal approval requirements and funding available to our existing and prospective customers for the purchase of network security products;
 
    the timing, size and contract terms of orders received, which have historically been highest in the fourth quarter, but may fluctuate seasonally in different ways;
 
    the level of perceived threats to network security, which may fluctuate from period to period;
 
    the level of demand for products sold by resellers, distributors, MSSPs, government integrators and other partners;
 
    the market acceptance of open source software solutions;
 
    the announcement or introduction of new product offerings by us or our competitors, and the levels of anticipation and market acceptance of those products;
 
    price competition;
 
    general economic conditions, both domestically and in our foreign markets;
 
    the product mix of our sales; and
 
    the timing of revenue recognition for our sales.
     In particular, the network security technology procurement practices of many of our customers have had a measurable influence on the historical variability of our operating performance. Our prospective customers usually exercise great care and invest substantial time in their network security technology purchasing decisions. As a result, our sales cycles are long, generally between six and twelve months or sometimes longer, which further impacts the variability of our results. Additionally, many of our customers have historically finalized purchase decisions in the last weeks or days of a quarter. A delay in even one large order beyond the end of a particular quarter can substantially diminish our anticipated revenue for that quarter. In addition, many of our expenses must be incurred before we generate revenue. As a result, the negative impact on our operating results would increase if our revenue fails to meet expectations in any period.
     The cumulative effect of these factors may result in larger fluctuations and unpredictability in our quarterly operating results than in the operating results of many other software and technology companies. This variability and unpredictability could result in our failing to meet the revenue or operating results expectations of securities industry analysts or investors for a particular period. If we fail to meet or exceed such expectations for these or any other reasons, the market price of our shares could fall substantially, and we could face costly securities class action suits as a result. Therefore, you should not rely on our operating results in any quarter as being indicative of our operating results for any future period, nor should you rely on other expectations, predictions or projections of our future revenue or other aspects of our results of operations.
Federal and state governmental agencies have contributed to our revenue growth and have become important customers for us. If we cannot attract sufficient government agency customers, our revenue and competitive position will suffer.
     Federal and state governments have become important customers for the network security market and for us. There can be no assurance that we will maintain or grow our revenue from these customers. Contracts with the U.S. federal and state government

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agencies collectively accounted for 29%, 21% and 11% of our total revenue for the years ended December 31, 2009, 2008 and 2007, respectively. Our reliance on government customers subjects us to a number of risks, including:
    Procurement. Contracting with public sector customers is highly competitive and can be expensive and time-consuming, often requiring that we incur significant upfront time and expense without any assurance that we will win a contract;
 
    Budgetary Constraints and Cycles. Demand and payment for our products and services are impacted by public sector budgetary cycles and funding availability. Reductions or delays in funding, including delays caused by continuing resolutions or other temporary funding arrangements, could adversely impact public sector demand for our products;
 
    Modification or Cancellation of Contracts. Public sector customers often have contractual or other legal rights to terminate current contracts for convenience or due to a default. If a contract is cancelled for convenience, which can occur if the customer’s product needs change, we may only be able to collect for products and services delivered prior to termination. If a contract is cancelled because of our default, we may only be able to collect for products and alternative products and services delivered to the customer;
 
    Governmental Audits. National governments and state and local agencies routinely investigate and audit government contractors’ administrative processes. They may audit our performance and pricing and review our compliance with applicable rules and regulations. If they find that we improperly allocated costs, they may require us to refund those costs or may refuse to pay us for outstanding balances related to the improper allocation. An unfavorable audit could result in a reduction of revenue, and may result in civil or criminal liability if the audit uncovers improper or illegal activities; and
 
    Replacing Existing Products. Many government agencies already have installed network security products of our competitors. It can be very difficult to convince government agencies or other prospective customers to replace their existing network security solutions with our products, even if we can demonstrate the superiority of our products.
If we do not continue to establish and effectively manage our indirect distribution channels, or if our resellers, distributors and other partners fail to perform as expected, our revenue could suffer.
     Our ability to sell our network security software products in new markets and to increase our share of existing markets will be impaired if we fail to manage or expand our indirect distribution channels. Our sales strategy involves the establishment of multiple distribution channels domestically and internationally through strategic resellers, distributors, MSSPs, government integrators and other partners. We have agreements with third parties for the distribution of our products and we cannot predict the extent to which these companies will be successful in marketing or selling our products. There is a risk that our pace of entering into such agreements may slow. In addition, our agreements with these companies could be terminated on short notice, and the agreements do not prevent these companies from selling the network security software of other companies, including our competitors. Any distributor of our products could give higher priority to other companies’ products or to their own products than they give to ours, which could cause our revenue to decline. There is also a risk that some or all of our resellers, distributors and other partners may be acquired, change their business models or go out of business, any of which could adversely affect our business.
We are subject to risks of operating internationally that could impair our ability to grow our revenue abroad.
     We market and sell our software in the United States and internationally, and we plan to increase our international sales presence. Therefore, we are subject to risks associated with having worldwide operations. Sales to customers located outside of the United States accounted for 23%, 24% and 25% of our total revenue for the years ended December 31, 2009, 2008 and 2007, respectively. The expansion of our existing operations and entry into additional worldwide markets will require significant management attention and financial resources. We are also subject to a number of risks customary for international operations, including:
    economic or political instability in foreign markets;
 
    greater difficulty in accounts receivable collection and longer collection periods;
 
    unexpected changes in regulatory requirements;

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    difficulties and costs of staffing and managing foreign operations;
 
    import and export controls;
 
    the uncertainty of protection for intellectual property rights in some countries;
 
    costs of compliance with foreign laws and laws applicable to companies doing business in foreign jurisdictions;
 
    management communication and integration problems resulting from cultural differences and geographic dispersion;
 
    compliance with tax laws in multiple jurisdictions; and
 
    foreign currency exchange rate fluctuations.
     To date, a substantial portion of our sales have been denominated in U.S. dollars, although the majority of our expenses that we incur in our international operations are denominated in local currencies. To date, we have not used risk management techniques or “hedged” the risks associated with fluctuations in foreign currency exchange rates. As a result, our results of operations are subject to losses from fluctuations in foreign currency exchange rates.
The market for network security products is rapidly evolving, and the complex technology incorporated in our products makes them difficult to develop. If we do not accurately predict, prepare for and respond promptly to technological and market developments and changing customer needs, our competitive position and prospects could be harmed.
     The market for network security products is expected to continue to evolve rapidly. Moreover, many customers operate in markets characterized by rapidly changing technologies and business plans, which require them to add numerous network access points and adapt increasingly complex enterprise networks, incorporating a variety of hardware, software applications, operating systems and networking protocols. In addition, computer hackers and others who try to attack networks employ increasingly sophisticated techniques to gain access to and attack systems and networks. Customers look to our products to continue to protect their networks against these threats in this increasingly complex environment without sacrificing network efficiency or causing significant network downtime. The software in our products is especially complex because it needs to effectively identify and respond to new and increasingly sophisticated methods of attack, without impeding the high network performance demanded by our customers. Although the market expects speedy introduction of software to respond to new threats, the development of these products is difficult and the timetable for commercial release of new products is uncertain. Therefore, in the future we may experience delays in the introduction of new products or new versions, modifications or enhancements of existing products. If we do not quickly respond to the rapidly changing and rigorous needs of our customers by developing and introducing on a timely basis new and effective products, upgrades and services that can respond adequately to new security threats, our competitive position and business prospects will be harmed.
If our new products and product enhancements do not achieve sufficient market acceptance, our results of operations and competitive position could suffer.
     We spend substantial amounts of time and money to research and develop new products and enhance versions of our open source and proprietary commercial products. We incorporate additional features, improve functionality or add other enhancements in order to meet our customers’ rapidly evolving demands for network security in our highly competitive industry. When we develop a new product or an advanced version of an existing product, we typically expend significant money and effort upfront to market, promote and sell the new offering. Therefore, when we develop and introduce new or enhanced products, they must achieve high levels of market acceptance in order to justify the amount of our investment in developing and bringing the products to market.
     Our new products or enhancements could fail to attain sufficient market acceptance for many reasons, including:
    delays in introducing new, enhanced or modified products;
 
    defects, errors or failures in any of our products;
 
    inability to operate effectively with the networks of our prospective customers;

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    inability to protect against new types of attacks or techniques used by hackers;
 
    negative publicity about the performance or effectiveness of our network security products;
 
    reluctance of customers to purchase products based on open source software; and
 
    disruptions or delays in the availability and delivery of our products, including products from our contract manufacturers.
     If our new products or enhancements do not achieve adequate acceptance in the market, our competitive position could be impaired, our revenue will be diminished and the effect on our operating results may be particularly acute because of the significant research, development, marketing, sales and other expenses we incurred in connection with the new product.
If existing customers do not make subsequent purchases from us or renew their support arrangements with us, or if our relationships with our largest customers are impaired, our revenue could decline.
     For the years ended December 31, 2009 and 2008, existing customers that purchased additional products and services from us, whether for new locations or additional technology to protect existing networks and locations, generated a majority of our total revenue. Part of our growth strategy is to sell additional products to our existing customers. We may not be effective in executing this or any other aspect of our growth strategy. Our revenue could decline if our current customers do not continue to purchase additional products from us. In addition, as we deploy new versions of our existing products or introduce new products, our current customers may not require the functionality of these products and may not purchase them.
     We also depend on our installed customer base for future service revenue from annual maintenance fees. Our maintenance and support agreements typically have durations of one year. If customers choose not to continue their maintenance service or seek to renegotiate the terms of maintenance and support agreements prior to renewing such agreements, our revenue may decline.
Defects, errors or vulnerabilities in our products could harm our reputation and business and divert our resources.
     Because our products are complex, they may contain defects, errors or vulnerabilities that are not detected until after our commercial release and installation by our customers. We may not be able to correct any errors or defects or address vulnerabilities promptly, or at all. Any defects, errors or vulnerabilities in our products could result in:
    expenditure of significant financial and product development resources in efforts to analyze, correct and eliminate defects, to address and eliminate vulnerabilities or to create alternative solutions;
 
    loss of existing or potential customers;
 
    delayed or lost revenue;
 
    failure to timely attain or maintain market acceptance;
 
    increased service, warranty, product replacement and product liability insurance costs; and
 
    negative publicity, which could harm our reputation.
     In addition, because our products and services provide and monitor network security and may protect valuable information, we could face claims for product liability, tort or breach of warranty. Anyone who circumvents our customers’ security measures using our products could misappropriate the confidential information or other valuable property of, or interrupt the operations of our customers. If that happens, affected customers or others could sue us. In addition, we may face liability for breaches of our product warranties or product failures. Provisions in our contracts relating to warranty disclaimers and liability limitations may be deemed by a court to be unenforceable. 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 divert management attention from the operation of our business. Our business liability insurance coverage may be inadequate or future coverage may be unavailable on acceptable terms or at all.

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Our networks, products and services may be targeted by hackers.
     Like other companies, our websites, networks, information systems, products and services may be targets for sabotage, disruption or misappropriation by hackers. As a leading network security solutions company, we are a high profile target and our networks, products and services may be targeted by hackers. Although we believe we have sufficient controls in place to prevent disruption and misappropriation, and to respond to such situations, we expect these efforts by hackers to continue. If these efforts are successful, our operations, reputation and sales could be adversely affected.
We may acquire additional businesses, products or technologies as part of our long-term growth strategy, and such acquisitions may not ultimately be successful or may not result in expected strategic benefits.
     We may seek to buy or make investments in complementary or competitive businesses, products or technologies as part of our long-term growth strategy. We may not be successful in making these acquisitions. We may face competition for acquisition opportunities from other companies, including larger companies with greater financial resources. We may incur substantial expenses in identifying and negotiating acquisition opportunities, whether or not completed.
     Acquisitions may not result in the expected strategic benefits, and completed acquisitions, if any, could negatively affect our operating results and financial position because of the following and other factors:
    we may not effectively integrate an acquired business, product or technology into our existing business and operations;
 
    completing a potential acquisition and integrating an acquired business into our existing business could significantly divert management’s time and resources from the operation of our business;
 
    a completed acquisition may not be accretive to earnings;
 
    acquisitions may result in substantial accounting charges for restructuring and other expenses, write-offs of in-process research and development, amortization of intangible assets and stock-based compensation expense;
 
    acquired companies, particularly privately held and non-U.S. companies, may have internal controls, policies and procedures that do not meet the requirements of the Sarbanes-Oxley Act of 2002 and public company accounting standards;
 
    we may use a significant portion of our cash resources to fund acquisitions; and
 
    we may issue stock to fund acquisitions, which could dilute the interests of our existing stockholders.
In the future, we may not be able to secure financing necessary to make acquisitions or to operate and grow our business as planned.
     In the future, we may need to raise additional funds to make acquisitions or to expand our sales and marketing and research and development efforts. Additional equity or debt financing may not be available on favorable terms, or at all. If adequate funds are not available on acceptable terms, we may be unable to take advantage of acquisition or other opportunities or to fund the expansion of our sales and marketing and research and development efforts, which could seriously harm our business and operating results. If we issue debt, the debt holders could have rights senior to common stockholders to make claims on our assets and the terms of any debt could restrict our operations, including our ability to pay dividends on our common stock. Furthermore, if we issue additional equity securities, stockholders would experience dilution, and the new equity securities could have rights senior to those of our common stock.
If other parties claim commercial ownership rights to Snort or ClamAV, our reputation, customer relations and results of operations could be harmed.
     While we created a majority of the current Snort code base and the current ClamAV code base, a portion of the current code for both Snort and ClamAV was created by the combined efforts of Sourcefire and the open source software community, and a portion was created solely by the open source community. We believe that the portions of the Snort code base and the ClamAV code base created by anyone other than us are required to be licensed by us pursuant to the GNU General Public License, or GPL, which is how we currently license Snort and ClamAV. There is a risk, however, that a third party could claim some ownership rights in Snort or ClamAV, attempt to prevent us from commercially licensing Snort or ClamAV in the future (rather than pursuant to the GPL as currently licensed) or claim a right to licensing royalties. Any such claim, regardless of its merit or

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outcome, could be costly to defend, harm our reputation and customer relations or result in our having to pay substantial compensation to the party claiming ownership.
We rely on software licensed from other parties, the loss of which could increase our costs and delay delivery of our products.
     We utilize various types of software licensed from unaffiliated third parties. For example, we license MySQL database software that we use in our products. Our agreement with Oracle Corporation permits us to distribute MySQL software on our products to our customers worldwide until June 30, 2014. Our agreement with Oracle gives us the unlimited right to distribute MySQL software in exchange for a one-time lump-sum payment. We believe that the MySQL agreement is material to our business because we have spent a significant amount of development resources to allow the MySQL software to function in our products. If we were forced to find replacement database software or replacements for any of the other software we license from others for our products, our business would be disrupted and we could be required to expend significant resources, and there would be no guarantee that we would be able to procure the replacement on the same or similar commercial terms and conditions, or at all.
     Additionally, we would be required to either redesign our products to function with software available from other parties or develop these components ourselves, which could result in increased costs and could result in delays in our product shipments and the release of new product offerings. Furthermore, we might be forced to limit the features available in our current or future products. If we fail to maintain or renegotiate any of these software licenses, we could face significant delays and diversion of resources in attempting to license and integrate a functional equivalent of the software.
Our inability to hire or retain key personnel, or to effectively manage headcount increases, could impair our intended growth.
     Our business is dependent on our ability to hire, retain, motivate and manage highly qualified personnel, including senior management and sales and technical professionals. In particular, as part of our growth strategy, we intend to expand the size of our sales force domestically and internationally and to hire additional customer support and professional services personnel. However, competition for qualified services personnel is intense, and if we are unable to attract, train or retain the number of highly qualified sales and services personnel that our business needs, our reputation, customer satisfaction and potential revenue growth could be seriously harmed. To the extent that we hire personnel from competitors, we may also be subject to allegations that they have been improperly solicited or divulged proprietary or other confidential information. Our intended future growth may also place a significant strain on our management, financial, personnel and other resources.
     In addition, our future success will depend to a significant extent on the continued services of our executive officers and senior personnel. Although we have adopted retention plans applicable to certain of these officers, there can be no assurance that we will be able to retain their services. The loss of the services of one or more of these individuals could adversely affect our business and could divert other senior management time in searching for their replacements.
Our business is subject to corporate governance, public disclosure, accounting and tax requirements that have increased both our costs and the risk of noncompliance.
     Because our common stock is publicly traded, we are subject to the rules and regulations of federal, state and financial market exchange entities, such as the Public Company Accounting Oversight Board, the SEC, and the Nasdaq stock exchange, that are charged with the protection of investors and the oversight of companies whose securities are publicly traded. Our efforts to comply with these rules and regulations have resulted in, and are likely to continue resulting in, increased general and administrative expenses and diversion of management time and attention from revenue-generating activities to compliance activities.
     We completed our evaluation of our internal controls over financial reporting for the fiscal year ended December 31, 2009 as required by the Sarbanes-Oxley Act of 2002. Although our assessment, testing and evaluation resulted in our conclusion that as of December 31, 2009, our internal controls over financial reporting were effective, we cannot predict the outcome of our testing in future periods. If our internal controls are ineffective in future periods, our business and reputation could be harmed. We may incur additional expenses and commitment of management’s time in connection with further evaluations, either of which could materially increase our operating expenses.

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     Because new and modified laws, regulations and standards are subject to varying interpretations in many cases due to their lack of specificity, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This evolution may result in continuing uncertainty regarding compliance matters and additional costs necessitated by ongoing revisions to our disclosure and governance practices.
Any material disruption or problem with the operation of our information systems may adversely impact our business, operating processes and internal controls.
     The efficient operation of our business is dependent on the successful operation of our information systems. In particular, we rely on our information systems to process financial information, manage inventory and administer our sales transactions. In recent years, we have experienced a considerable growth in transaction volume and headcount, and we are increasingly relying upon international resources in our operations. Our information systems need to be sufficiently scalable to support the continued growth of our operations and the efficient management of our business. In an effort to improve the efficiency of our operations, achieve greater automation and support the growth of our business, we have implemented an enterprise resource planning, or ERP, system and a customer resource management, or CRM, system.
     These information systems may not work as we currently intend. Any material disruption or similar problems with the operation of our information systems could have a material negative effect on our business and results of operations. In addition, if our information system resources are inadequate, we may be required to undertake costly modifications and the growth of our business could be harmed.
Potential uncertainty resulting from unsolicited acquisition proposals and related matters may adversely affect our business.
     In the past we have received, and in the future we may receive, unsolicited proposals to acquire our company or our assets. The review and consideration of acquisition proposals and related matters could require the expenditure of significant management time and personnel resources. Such proposals may also create uncertainty for our employees, customers and business partners. Any such uncertainty could make it more difficult for us to retain key employees and hire new talent, and could cause our customers and business partners to not enter into new arrangements with us or to terminate existing arrangements. Additionally, we and members of our board of directors could be subject to future lawsuits related to unsolicited proposals to acquire us. Any such future lawsuits could become time consuming and expensive. These matters, alone or in combination, may harm our business.
Risks Relating to Our Intellectual Property and Litigation
Our products contain open source software, and failure to comply with the terms of the underlying open source software licenses could restrict our ability to sell our products.
     Like many other software companies, we use and distribute “open source” software in order to expedite development of new products and features. Open source software is generally licensed by its authors or other third parties under “open source” licenses, including, for example, the GNU General Public License, or GPL, the GNU Lesser Public License, or LGPL, the BSD License and the Apache License. This open source software includes, without limitation, Snort, ClamAV, Linux, Apache, OpenSSL, Etheral, IPTables, Tcpdump and Tripwire. These license terms may be ambiguous, in many instances have not been interpreted by the courts and could be interpreted in a manner that results in unanticipated obligations regarding our products. Depending upon how the open source software is deployed by our developers and the underlying licenses are interpreted by the courts, we could be required to offer our products that use the open source software for no cost, make available the source code for modifications or derivative works, or secure an additional license to the underlying patent rights. Any of these obligations could have an adverse impact on our intellectual property rights and revenue from products incorporating the open source software.
     Our use of open source code could also result in us developing and selling products that infringe third-party intellectual property rights. It may be difficult for us to accurately determine the developers of the open source code and whether the code incorporates proprietary software or otherwise infringes another party’s intellectual property rights (including patent rights). We have processes and controls in place that are designed to address these risks and concerns, including a review process for screening requests from our development organizations for the use of open source. However, we cannot be sure that all open source is submitted for approval prior to use in our products.

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     We also have processes and controls in place to review the use of open source in the products developed by companies that we may acquire. Even if we conduct due diligence prior to completing an acquisition, the acquired products or technologies may nonetheless include open source software that was not identified during the initial due diligence. Our ability to commercialize products or technologies of any companies we may acquire that incorporate open source software or to otherwise fully realize the anticipated benefits of any such acquisition may be restricted in the same manner as if the open source software had been incorporated into our own software.
Our intellectual property rights may be difficult to enforce, which could enable others to compete with us or to copy or use aspects of our products without compensating us.
     We rely primarily on a combination of copyright, trademark, patent and trade secret laws, confidentiality procedures and contractual provisions to establish and protect our proprietary rights in our technology. However, the steps we have taken to protect our proprietary rights and technology may not deter its misuse, theft or misappropriation. Competitors may independently develop technologies or products that are substantially equivalent or superior to our products or that inappropriately incorporate our proprietary technology into their products. Our products incorporate open source Snort software, which is readily available to the public. To the extent that our proprietary software is included by others in what are purported to be open source products, it may be difficult and expensive to enforce our intellectual property rights in such software. Competitors also may hire our former employees who may misappropriate our proprietary technology.
     In addition, from time to time, we become aware that users of our security products may not have paid adequate license, technical support, or subscription fees to us. However, some jurisdictions may not provide an adequate legal infrastructure for effective protection or enforcement of our intellectual property rights. Furthermore, changing legal interpretations of liability for unauthorized use of our software or lessened sensitivity by corporate, government or institutional users to refraining from intellectual property piracy or other infringements of intellectual property could also harm our business.
     In limited instances we have agreed to place, and in the future may agree to place, source code for our proprietary software in escrow. In most cases, the escrowed source code may be made available to certain of our customers and partners in the event that we were to file for bankruptcy or materially fail to support our products in the future. Release of our source code upon any such event would increase the likelihood of misappropriation or other misuse of our software. We have rarely agreed to source code escrow arrangements in the past and usually only in connection with prospective customers considering a significant purchase of our products and services.
     If we acquire technology to include in our products from third parties, our exposure to infringement actions may increase because we must rely upon these third parties to verify the origin and ownership of such technology. Similarly, we face exposure to infringement actions if we hire software engineers who were previously employed by competitors and those employees inadvertently or deliberately incorporate proprietary technology of our competitors into our products despite efforts by our competitors and us to prevent such infringement.
Efforts to assert intellectual property ownership rights in our products could impact our standing in the open source community, which could limit our product innovation capabilities.
     If we were to undertake actions to protect and maintain ownership and control over our intellectual property rights, our standing in the open source community could be diminished. This could in turn limit our ability to rely on this community as a resource to identify and defend against new viruses, threats and techniques to attack secure networks, explore new ideas and concepts and further our research and development efforts.
Claims that our products infringe the proprietary rights of others could harm our business and cause us to incur significant costs.
     If we are unable to protect our intellectual property rights in our technologies, we may find ourselves at a competitive disadvantage to others who need not incur the additional expense, time and effort required to create competitive technologies. As a result, litigation may be necessary to enforce and protect our intellectual property rights.
     Similarly, the security technology industry has increasingly been subject to patent and other intellectual property rights litigation, particularly from special purpose entities that seek to monetize their intellectual property rights by asserting claims

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against others. We expect this trend to continue and accelerate and expect that we may from time to time be required to defend against this type of litigation. For example, as described under “Legal Proceedings” below, we and nine other network security companies have been named as defendants in a patent infringement lawsuit. Third party asserted claims or initiated litigation can include claims against us or our customers, end-users, manufacturers, suppliers, partners or distributors, alleging infringement of intellectual property rights with respect to our existing or future products or components of those products. The litigation process can be costly and is subject to inherent uncertainties, so we may not prevail in litigation matters regardless of the merits of our position. In addition to the expense and distraction associated with litigation, adverse determinations could cause us to lose our proprietary rights, prevent us from manufacturing or selling our products, require us to obtain licenses to patents or other intellectual property rights that our products are alleged to infringe, which licenses may not be available on reasonable commercial terms or at all, and subject us to significant liabilities including indemnities to our customers and others for losses resulting from such claims.
Future litigation could have a material adverse impact on our results of operations, financial condition and liquidity.
     From time to time we have been, and may be in the future, subject to litigation, including stockholder derivative actions. Risks associated with legal liability are difficult to assess and quantify, and their existence and magnitude can remain unknown for significant periods of time. While we maintain director and officer insurance, the amount of insurance coverage may not be sufficient to cover a claim, and there can be no assurance as to the continued availability of this insurance. We may in the future be the target of additional proceedings, with or without merit, and these proceedings may result in substantial costs and divert management’s attention and resources.
Risks Relating to Manufacturing
We primarily utilize a just-in-time contract manufacturing and inventory process and depend on a limited number of manufacturers of our hardware products, which increases our vulnerability to supply disruption.
     We primarily utilize a just-in-time contract manufacturing and inventory process. Therefore, our ability to meet our customers’ demand for our products depends upon obtaining adequate hardware platforms on a timely basis and integrating them with our software. We purchase hardware platforms from a limited number of contract manufacturers. The unexpected termination of our relationship with any of these manufacturers would be disruptive to our business and our reputation, and could result in a material decline in our revenue as well as shipment delays and possible increased costs as we seek and implement production with an alternative manufacturer.
     In addition, we rely on our contract manufacturers to source the components for our hardware platforms and they in turn obtain materials from a limited number of suppliers. These suppliers may extend lead times, limit the supply to our manufacturers or increase prices due to capacity constraints or other factors. Although we work closely with our manufacturers and suppliers to avoid shortages, we may encounter these problems in the future. Our results of operations would be adversely affected if we were unable to obtain adequate supplies of hardware platforms in a timely manner or if there were significant increases in the costs of hardware platforms or problems with the quality of those hardware platforms.
In some cases, we purchase products from contract manufacturers and hold them in inventory pending sale to our customers. If demand for these products does not meet our expectations, or if these products become obsolete, we could be required to write down the value of our inventory, which could adversely affect our results of operations.
     Although we primarily utilize a just-in-time contract manufacturing and inventory process, in some cases we purchase products from contract manufacturers based on our expectations of future demand. We then hold these products in inventory pending sale to our customers. Demand for these products may not meet our expectations as a result of a number of factors, including weakness in general economic conditions, reductions in our customers’ purchasing budgets, discounting of prices on competitive products, defects or perceived defects in the products or the introduction by us or our competitors of new or enhanced products. In the past, we have recognized expenses related to inventory write-offs and, in the future, if we reduce our estimate of future demand for our products held in inventory, or if our inventory becomes obsolete, we may be required to record additional inventory write-offs, which could negatively impact our gross margin and results of operations.

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Risks Relating to Our Common Stock
The price of our common stock may be subject to wide fluctuations.
     Since the time of our initial public offering in March 2007, the market price of our common stock has been subject to significant fluctuations, and we expect this volatility to continue for the foreseeable future. For example, during the year ended December 31, 2009, our stock traded between a high of $27.80 per share and a low of $5.12 per share. Among the factors that could affect our common stock price are the risks described in this “Risk Factors” section and other factors, including:
    quarterly variations in our operating results compared to market expectations;
 
    changes in expectations as to our future financial performance, including financial estimates or reports by securities analysts;
 
    changes in market valuations of similar companies or of our competitors;
 
    liquidity and activity in the market for our common stock;
 
    actual or expected sales of our common stock by our stockholders;
 
    strategic moves by us or our competitors, such as acquisitions or restructurings;
 
    general market conditions; and
 
    domestic and international economic, legal and regulatory factors unrelated to our performance.
     Stock markets in general, and the stocks of technology companies in particular, have experienced extreme volatility that has often been unrelated to the operating performance of a particular company. These broad market fluctuations may adversely affect the trading price of our common stock, regardless of our operating performance.
Sales of substantial amounts of our common stock in the public markets, or the perception that they might occur, could reduce the price that our common stock might otherwise attain.
     As of April 30, 2010, we had 27,473,833 outstanding shares of common stock. This number includes shares held by institutional investors who own a significant majority of our common stock. This number also includes shares held by directors and officers who may sell such shares at their discretion, subject to volume limitations contained in federal securities laws. Sales of substantial amounts of our common stock in the public market, or the perception that such sales could occur, could adversely affect the market price of our common stock and may make it more difficult for you to sell your common stock at a time and price that you deem appropriate.
Anti-takeover provisions in our charter documents and under Delaware law and our adoption of a stockholder rights plan could make an acquisition of our company, which may be beneficial to our stockholders, more difficult and may prevent attempts by our stockholders to replace or remove our current management.
     Our certificate of incorporation and our bylaws contain provisions that may delay or prevent an acquisition of our company or a change in our management. These provisions include a classified board of directors, a prohibition on actions by written consent of our stockholders and our ability to issue preferred stock without stockholder approval. In addition, we have adopted a stockholder rights plan under which we would issue preferred stock rights upon specified events, which could substantially dilute the stock ownership of a person or group attempting to take us over without the approval of our board of directors. Although we believe these provisions of our certificate of incorporation, bylaws, Delaware corporate law and our stockholder rights plan collectively provide for an opportunity to receive higher bids by requiring potential acquirers to negotiate with us, they would apply even if stockholders consider the offer to be beneficial. In addition, these provisions may frustrate or prevent attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management.

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Item 2.   UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Use of Proceeds
     In March 2007, we completed the initial public offering of shares of our common stock. Our portion of the net proceeds from the initial public offering was approximately $83.9 million after deducting underwriting discounts and commissions of $6.5 million and $2.4 million in offering expenses.
     We intend to use the net proceeds from the offering for working capital and other general corporate purposes, including financing our growth, developing new products and funding capital expenditures. Pending such usage, we have invested the net proceeds primarily in short-term, interest-bearing investment grade securities.
Repurchase of Equity Securities During the Period Ended March 31, 2010
     The following table provides information about purchases by us during the period ended March 31, 2010 of equity securities that are registered by us pursuant to Section 12 of the Securities Exchange Act.
     Repurchases are made under the terms of our 2007 Equity Incentive Plan. Under this plan, we may award shares of restricted stock to our employees. These shares of restricted stock typically are subject to a lapsing right of repurchase by us. We may exercise this right of repurchase in the event that a restricted stock recipient’s service to us is terminated. If we exercise this right, we are required to repay the purchase price paid by or on behalf of the recipient for the repurchased restricted shares, which typically is the par value per share of $0.001. Repurchased shares are returned to the 2007 Equity Incentive Plan and are available for future awards under the terms of that plan.
     These were the only repurchases of equity securities made by us during the three months ended March 31, 2010. We do not currently have a stock repurchase program.
                                 
                            Maximum
                    Total Number of   Number of
                    Shares   Shares that May
    Total           Purchased as   Yet Be
    Number of   Average   Part of Publicly   Purchased Under
    Shares   Price Paid   Announced Plans   the Plans or
Period   Purchased   per Share   or Programs   Programs
2/1/10 – 2/28/10
    1,749  (1)   $ 0.001              
3/1/10 – 3/31/10
    624  (1)   $ 0.001              
 
(1)   Reflects the repurchase of restricted stock from employees that was unvested at the time of termination of employment. The purchase price represents the original price paid for the shares by the employee, which is equal to the par value of our common stock.
Item 3.   DEFAULTS UPON SENIOR SECURITIES
     Not applicable.
Item 4.   RESERVED
Item 5.   OTHER INFORMATION
     None.
Item 6.   EXHIBITS
     The exhibits listed on the accompanying Exhibit Index are filed or incorporated by reference as part of this report and such Exhibit Index is incorporated herein by reference.

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SIGNATURES
     Pursuant to the requirements of Section 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, on May 6, 2010.
             
    SOURCEFIRE, INC.    
 
           
 
  By:   /s/ John C. Burris    
 
           
 
      John C. Burris    
 
      Chief Executive Officer    
 
      (duly authorized officer)    
 
           
 
  By:   /s/ Todd P. Headley    
 
           
 
      Todd P. Headley    
 
      Chief Financial Officer    
 
      and Treasurer    
 
      (principal financial and accounting officer)    

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Exhibit Index
                                 
            Incorporation by Reference  
Exhibit           File               Filed with
Number   Exhibit Description   Form   Number   Exhibit   File Date   this 10-Q
  3.1    
Sixth Amended and Restated Certificate of Incorporation
  10-Q   1-33350     3.1     5/4/2007    
       
 
                       
  3.2    
Fifth Amended and Restated Bylaws
  10-K   1-33350     3.2     3/16/2009    
       
 
                       
  3.3    
Certificate of Designation of the Series A Junior Participating Preferred Stock
  8-A   1-33350     3.1     10/30/2008    
       
 
                       
  4.1    
Form of stock certificate of common stock
  S-1/A   333-138199     4.1     3/6/2007    
       
 
                       
  4.2    
Rights Agreement, dated as of October 30, 2008, by and between the Company and Continental Stock Transfer & Trust Co., as rights agent
  8-A   1-33350     4.1     10/30/2008    
       
 
                       
  10.1    
Non-Employee Director Compensation Policy, as amended effective May 20, 2010
                      X
       
 
                       
  31.1    
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
                      X
       
 
                       
  31.2    
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
                      X
       
 
                       
  32.1    
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
                      X