UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
(Mark
one)
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For
the quarterly period ended March 31, 2008
or
¨
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For
the transition period from
to
.
Commission
File Number: 000-49862
PROCERA
NETWORKS, INC.
(Exact
name of registrant as specified in its charter)
|
|
Nevada
|
33-0974674
|
(State
or other jurisdiction ofincorporation or organization)
|
(I.R.S.
EmployerIdentification Number)
|
100
Cooper Court, Los Gatos, California 95032
|
(408)
354-7200
|
(Address
of principal executive offices, including zip code)
|
(Registrant’s
telephone number, including area
code)
|
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 is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):
Large
accelerated filer
o
|
Accelerated
filer
þ
|
Non-accelerated
filer
o
|
Smaller
reporting company
o
|
|
|
(Do
not check if a smaller reporting company)
|
|
Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes
o
No
þ
As of
April 30, 2008, the registrant had 76,416,883 shares of its common stock, par
value $0.001, outstanding.
PROCERA
NETWORKS, INC.
INDEX
|
|
|
|
|
Page
|
PART I. FINANCIAL
INFORMATION
|
1
|
|
|
|
|
|
1
|
|
|
|
|
|
1
|
|
|
|
|
|
2
|
|
|
|
|
|
3
|
|
|
|
|
|
4
|
|
|
|
|
|
14
|
|
|
|
|
|
23
|
|
|
|
|
|
23
|
|
|
PART II. OTHER
INFORMATION
|
24
|
|
|
|
|
|
24
|
|
|
|
|
|
24
|
|
|
|
|
|
35
|
|
|
|
|
|
35
|
|
|
|
|
|
35
|
|
|
|
|
|
36
|
|
|
|
|
|
36
|
|
|
|
38
|
EXHIBIT
3.3
|
EXHIBIT
3.4
|
EXHIBIT
10.1
|
EXHIBIT
10.2
|
EXHIBIT
31.1
|
EXHIBIT
31.2
|
EXHIBIT
32.1
|
PART
I. FINANCIAL INFORMATION
Item
1.
|
Consolidated
Financial
Statements
|
Procera
Networks, Inc.
CONSOLIDATED
BALANCE
SHEETS
|
|
March 31,
2008
(Unaudited)
|
|
|
December 31,
2007
|
|
ASSETS
|
|
|
|
|
|
|
|
|
Current
Assets:
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
3,324,586
|
|
|
$
|
5,864,648
|
|
Accounts
receivable, less allowance of $24,690 and $11,672 for March 31, 2008 and
December 31, 2007
|
|
|
1,925,237
|
|
|
|
1,819,272
|
|
Inventories,
net
|
|
|
1,597,087
|
|
|
|
1,320,022
|
|
Prepaid
expenses and other
|
|
|
449,706
|
|
|
|
520,137
|
|
|
|
|
|
|
|
|
|
|
Total
current assets
|
|
|
7,296,616
|
|
|
|
9,524,079
|
|
|
|
|
|
|
|
|
|
|
Property
and equipment, net
|
|
|
3,898,610
|
|
|
|
4,476,224
|
|
Purchased
intangible assets, net
|
|
|
1,559,236
|
|
|
|
1,918,986
|
|
Goodwill
|
|
|
960,209
|
|
|
|
960,209
|
|
Other
non-current assets
|
|
|
47,907
|
|
|
|
47,805
|
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
$
|
13,762,578
|
|
|
$
|
16,927,303
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
623,413
|
|
|
$
|
668,289
|
|
Deferred
revenue
|
|
|
1,106,207
|
|
|
|
957,891
|
|
Accrued
liabilities
|
|
|
1,346,398
|
|
|
|
1,572,975
|
|
Capital
Leases payable-current portion
|
|
|
32,564
|
|
|
|
33,867
|
|
|
|
|
|
|
|
|
|
|
Total
current liabilities
|
|
|
3,108,582
|
|
|
|
3,233,022
|
|
|
|
|
|
|
|
|
|
|
Non-current
liabilities
|
|
|
|
|
|
|
|
|
Deferred
rent
|
|
|
16,321
|
|
|
|
7,797
|
|
Deferred
tax liability
|
|
|
1,474,951
|
|
|
|
1,734,855
|
|
Capital
leases payable - non-current portion
|
|
|
62,776
|
|
|
|
62,773
|
|
|
|
|
|
|
|
|
|
|
Total
liabilities
|
|
|
4,662,630
|
|
|
|
5,038,447
|
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies (Note 13)
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’
equity:
|
|
|
|
|
|
|
|
|
Preferred
stock, $0.001 par value; 15,000,000 shares authorized: none issued and
outstanding
|
|
|
—
|
|
|
|
—
|
|
Common
stock, $0.001 par value; 130,000,000 shares authorized; 76,384,292 and
76,069,233 shares issued and outstanding at March 31, 2008 and December
31, 2007
|
|
|
76,384
|
|
|
|
76,069
|
|
Additional
paid-in capital
|
|
|
50,214,518
|
|
|
|
49,574,141
|
|
Accumulated
other comprehensive gain (loss)
|
|
|
131,198
|
|
|
|
76,861
|
|
Accumulated
deficit
|
|
|
(41,322,152
|
)
|
|
|
(37,838,215
|
)
|
|
|
|
|
|
|
|
|
|
Total
stockholders’ equity
|
|
|
9,099,948
|
|
|
|
11,888,856
|
|
|
|
|
|
|
|
|
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
13,762,578
|
|
|
$
|
16,927,303
|
|
See
accompanying notes to interim consolidated financial statements
Procera
Networks, Inc.
CONSOLIDATED
STATEMENTS OF OPERATIONS and
COMPREHENSIVE
INCOME
(Unaudited)
|
|
For the three months ended
March 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
$
|
1,715,774
|
|
|
$
|
1,984,930
|
|
Cost
of goods sold
|
|
|
707,339
|
|
|
|
436,335
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
1,008,435
|
|
|
|
1,548,595
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
Research
and development
|
|
|
662,122
|
|
|
|
842,614
|
|
Sales
and marketing
|
|
|
1,806,810
|
|
|
|
1,195,655
|
|
General
and administrative
|
|
|
2,266,343
|
|
|
|
1,625,898
|
|
|
|
|
|
|
|
|
|
|
Total
operating expenses
|
|
|
4,735,275
|
|
|
|
3,664,167
|
|
|
|
|
|
|
|
|
|
|
Loss
from operations
|
|
|
(3,726,840
|
)
|
|
|
(2,115,572
|
)
|
|
|
|
|
|
|
|
|
|
Interest
and other income (expense)
|
|
|
3,057
|
|
|
|
16,561
|
|
|
|
|
|
|
|
|
|
|
Loss
before benefit from income taxes
|
|
|
(3,723,783
|
)
|
|
|
(2,099,011
|
)
|
|
|
|
|
|
|
|
|
|
Income
tax benefit
|
|
|
239,846
|
|
|
|
240,401
|
|
|
|
|
|
|
|
|
|
|
Net
loss after tax
|
|
$
|
(3,483,937
|
)
|
|
$
|
(1,858,610
|
)
|
|
|
|
|
|
|
|
|
|
Other
comprehensive income: Change in foreign currency translation
adjustment
|
|
|
54,337
|
|
|
|
21,259
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
loss
|
|
$
|
(3,429,600
|
)
|
|
$
|
(1,879,869
|
)
|
|
|
|
|
|
|
|
|
|
Net
loss per share of common stock - basic and diluted
|
|
$
|
(0.05
|
)
|
|
$
|
(0.03
|
)
|
|
|
|
|
|
|
|
|
|
Average
weighted number of common shares outstanding - basic and
diluted
|
|
|
76,118,175
|
|
|
|
68,377,963
|
|
See
accompanying notes to interim consolidated financial statements
Procera
Networks, Inc.
CONSOLIDATED
STATEMENTS OF
CASH
FLOWS
(Unaudited)
|
|
For the three months ended
March 31,
|
|
|
|
2008
|
|
|
2007
|
|
Cash
flow from operating activities:
|
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(3,483,937
|
)
|
|
$
|
(1,858,610
|
)
|
Adjustments
to reconcile net loss to net cash provided by (used in) operating
activities:
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
40,683
|
|
|
|
30,183
|
|
Amortization
of intangibles
|
|
|
944,860
|
|
|
|
926,581
|
|
Deferred
income taxes
|
|
|
(259,904
|
)
|
|
|
(258,648
|
)
|
Common
stock issued for services rendered
|
|
|
–
|
|
|
|
96,247
|
|
Compensation
related to stock-based awards
|
|
|
438,132
|
|
|
|
291,061
|
|
Fair
value of warrants issued to non-employees
|
|
|
–
|
|
|
|
–
|
|
Changes
in assets and liabilities, net of acquired assets and assumed
liabilities:
|
|
|
|
|
|
|
|
|
Trade
accounts receivable
|
|
|
(33,305
|
)
|
|
|
(674,913
|
)
|
Inventories
|
|
|
(270,804
|
)
|
|
|
(148,033
|
)
|
Prepaid
expenses and other current assets
|
|
|
79,409
|
|
|
|
(55,170
|
)
|
Accounts
payable
|
|
|
(56,562
|
)
|
|
|
130,440
|
|
Accrued
liabilities, deferred rent
|
|
|
(274,683
|
)
|
|
|
374,723
|
|
Deferred
revenue
|
|
|
101,178
|
|
|
|
243,379
|
|
Net
cash (used in) operating activities
|
|
|
(2,774,933
|
)
|
|
|
(902,760
|
)
|
|
|
|
Cash
flows used in investing activities:
|
|
|
|
|
|
|
|
|
Purchase
of equipment
|
|
|
(16,978
|
)
|
|
|
(131,535
|
)
|
Net
cash used in investing activities
|
|
|
(16,978
|
)
|
|
|
(131,535
|
)
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
Proceeds
from exercise of stock options
|
|
|
202,559
|
|
|
|
–
|
|
Proceeds
from exercise of warrants
|
|
|
–
|
|
|
|
79,710
|
|
Capital
lease payments
|
|
|
(9,259
|
)
|
|
|
(5115
|
)
|
Net
cash provided by financing activities
|
|
|
193,300
|
|
|
|
74,595
|
|
|
|
|
|
|
|
|
|
|
Effect
of exchange rates on cash and cash equivalents
|
|
|
58,549
|
|
|
|
(21,617
|
)
|
|
|
|
|
|
|
|
|
|
Net
decrease in cash and cash equivalents
|
|
|
(2,540,062
|
)
|
|
|
(981,317
|
)
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, beginning of period
|
|
|
5,864,648
|
|
|
|
5,214,177
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, end of period
|
|
$
|
3,324,586
|
|
|
$
|
4,232,860
|
|
See
accompanying notes to interim consolidated financial statements
Procera
Networks, Inc
Notes
to Interim Condensed Consolidated Financial Statements
(unaudited)
|
1
|
DESCRIPTION
OF BUSINESS
|
Procera
Networks, Inc. ("Procera" or the "Company") is a leading provider of bandwidth
management and control products for broadband service providers worldwide.
Procera’s products offer network administrators unique accuracy in identifying
applications running on their network, and the ability to optimize the
experience of the service provider’s subscribers based on management of the
identified traffic.
The
company sells its products through its direct sales force, resellers,
distributors and system integrators in the Americas, Asia Pacific and Europe.
PacketLogic™ is deployed at more than 400 broadband service providers (“BSP’s”),
telephone companies, colleges and universities worldwide. The common stock of
Procera is listed on the American Stock Exchange under the trading symbol
“PKT”.
The
Company was incorporated in 2002. On August 18, 2006, Procera acquired the stock
of Netintact AB, a Swedish corporation. On September 29, 2006, Procera acquired
the effective ownership of the stock of Netintact PTY, an Australian
company.
|
2.
|
SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
|
Basis of
Presentation
Procera
has prepared the consolidated financial statements included herein pursuant to
the rules and regulations of the Securities and Exchange Commission
(“SEC”). Certain information and footnote disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States have been condensed or
omitted pursuant to such rules and regulations. However, Procera
believes that the disclosures are adequate to ensure the information presented
is not misleading. These unaudited consolidated financial statements should be
read in conjunction with the audited consolidated financial statements and the
notes thereto included in Procera’s Annual Report on Form 10-K for the fiscal
year ended December 31, 2007 filed with the SEC on April 2,
2008.
Procera
believes that all necessary adjustments, which consist of normal recurring
items, have been included in the accompanying consolidated financial statements
to state fairly the results of the interim periods. The results of operations
for the interim periods presented are not necessarily indicative of the
operating results to be expected for any subsequent interim period or for
Procera’s fiscal year ending December 31, 2008.
Basis of
Presentation
The
consolidated financial statements present the accounts of Procera and its
wholly-owned subsidiaries, Netintact AB and
Netintact PTY. All significant inter-company accounts and
transactions have been eliminated.
Significant
Accounting
Policies
There
have been no significant changes in Procera's significant accounting policies
during the three months ended March 31, 2008 as compared to what was
previously disclosed in Procera's Annual Report on Form 10-K for the year ended
December 31, 2007 as filed with the Securities and Exchange Commission on April
2, 2008.
Adoption of New Accounting
Standards
In
September 2006, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value
Measurements.” SFAS 157 defines fair value, establishes a framework for
measuring fair value in generally accepted accounting principles and expands
disclosure related to the use of fair value measures in financial statements.
The provisions of SFAS No. 157 were to be effective for fiscal years beginning
after November 15, 2007. On February 6, 2008, the FASB agreed to defer the
effective date of SFAS No. 157 for one year for certain nonfinancial assets and
nonfinancial liabilities, except those that are recognized or disclosed at fair
value in the financial statements on a recurring basis (at least annually).
Effective January 1, 2008, the Company adopted SFAS No. 157 except as it applies
to those nonfinancial assets and nonfinancial liabilities. The adoption of SFAS
No. 157 did not have a material impact on the Company’s results of operations or
financial position.
Effective
January 1, 2008, the Company adopted SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities – including an amendment of FASB
Statement No. 115.” SFAS No. 159 allows an entity the irrevocable option to
elect fair value for the initial and subsequent measurement of certain financial
assets and liabilities under an instrument-by-instrument election. Subsequent
measurements for the financial assets and liabilities an entity elects to fair
value will be recognized in the results of operations. SFAS No. 159 also
establishes additional disclosure requirements. The Company did not elect the
fair value option under SFAS No. 159 for any of its financial assets or
liabilities upon adoption. The adoption of SFAS No. 159 did not have a material
impact on the Company’s results of operations or financial
position.
Foreign
Currency
The
functional currency of the Company is the U.S. dollar. The financial position
and results of operations of the Company’s foreign subsidiaries are measured
using the foreign subsidiary’s local currency as the functional currency.
Revenues and expenses of such subsidiaries have been translated into U.S.
dollars at average exchange rates prevailing during the period. Assets and
liabilities have been translated at the rates of exchange on the balance sheet
date. The resulting translation gain and loss adjustments are recorded directly
as a separate component of shareholders’ equity. Foreign currency translation
adjustments resulted in other comprehensive income of $54,337 and $21,259 during
the three months period ending March 31, 2008 and 2007,
respectively.
Use of
Estimates
The
preparation of consolidated financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses and related disclosures of contingent assets and liabilities. On an
ongoing basis, we evaluate the Company’s estimates, including those related to
allowance for doubtful accounts and sales returns, the value and marketability
of inventory, allowances for expected warranty costs, valuation of long-lived
assets, including intangible assets and goodwill, income taxes and stock-based
compensation, among others. We base the Company’s estimates on experience and
other criteria assumptions we believe are reasonable under expected business
conditions. Actual results may differ from these estimates if alternative
conditions are realized.
Revenue
Recognition
The
Company derives its revenue primarily from its integration of the Company’s
software and hardware appliances. The software is essential to the functionality
of the product. The Company accounts for this revenue in accordance with
Statement of Position, or SOP, 97-2, Software Revenue Recognition, as amended by
SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect
to Certain Transactions, for all transactions involving software. We recognize
product revenue when all of the following have occurred: (1) the Company has
entered into a legally binding arrangement with a customer resulting in the
existence of persuasive evidence of an arrangement; (2) when product title
transfers to the customer as identified by the passage of responsibility in
accordance with the International Chamber of Commerce shipping term (“Incoterms
2000”); (3) customer payment is deemed fixed or determinable and free of
contingencies and significant uncertainties; and (4) collection is
probable.
The
Company’s product revenue consists of revenue from sales of the Company’s
appliances and software licenses. Product sales include a perpetual license to
the Company’s software. Shipping charges billed to customers are included in
product revenue and the related shipping costs are included in cost of product
revenue. Virtually all of the Company’s sales include support services which
consist of software updates and customer support. Software updates provide
customers access to a constantly growing library of electronic internet traffic
identifiers (signatures) and rights to non-specific software product upgrades,
maintenance releases and patches released during the term of the support period.
Support includes internet access to technical content, telephone and internet
access to technical support personnel and hardware support.
Receipt
of a customer purchase order is the primary method of determining that
persuasive evidence of an arrangement exists.
Delivery
generally occurs when product title has transferred to the customer as
identified by the passage of responsibility per the International Chamber of
Commerce shipping term (INCOTERMS 2000). The Company’s standard delivery terms
contemplate that the product is delivered to a common carrier from Procera or
its subsidiaries (ex-works). However, product revenue based on channel partner
purchase orders are recorded based on sell-through to the end user customers
until such time as the Company has established significant experience with the
channel partner’s ability to complete the sales process. Additionally, when the
Company introduces new products for which there is no historical evidence of
acceptance history, revenue is recognized on the basis of end-user acceptance
until such history has been established.
Since the
Company’s customer orders contain multiple items such as hardware, software, and
services which are delivered at varying times, the Company determines whether
the delivered items can be considered separate units of accounting as prescribed
under Emerging Issues Task Force (“EITF”) Issue No. 00-21, “Revenue Arrangements
with Multiple Deliverables” (“EITF 00-21”). EITF 00-21 states that delivered
items should be considered separate units of accounting if delivered items have
value to the customer on a standalone basis, there is objective and reliable
evidence of the fair value of undelivered items, and if delivery of undelivered
items is probable and substantially in the Company’s control.
In these
circumstances, the Company allocates revenue to each separate element based on
its vendor specific objective evidence of fair value (“VSOE”). VSOE of fair
value for elements of an arrangement is based upon the normal pricing and
discounting practices for those services when sold separately; VSOE for support
and updates is additionally measured by the renewal rate offered to the
customer. Through March 31, 2008, in virtually all of the Company’s contracts,
the only elements that remained undelivered at the time of product delivery were
post contract hardware and software support and unspecified software
updates.
When the
Company is able to establish VSOE for all elements of the sales order, the
Company separates the deferred items accordingly. Revenue is recognized on the
deferred items using either the completed-performance or
proportional-performance method depending on the terms of the service agreement.
When the amount of services to be performed in the last series of acts is so
significant in relation to the entire service contract, that performance is
deemed not to have occurred until the final act is completed or when there are
acceptance provisions based on customer-specified objectives. Under these
conditions, the Company uses the completed-performance method of revenue
recognition which is measured by the customer’s acceptance. The Company uses the
proportional-performance method of deferred revenue recognition when a service
contract specifies activities to be performed by the Company and those acts have
been repeatedly demonstrated to be within the Company’s core competency. Under
this scenario, post contract support revenue is recognized ratably over the life
of the contract. The majority of the revenue associated with the Company’s post
contract support and service contracts is recognized under the
proportional-performance method using the straight line method with the revenue
being earned over the life of the contract. If evidence of the fair value of one
or more undelivered elements does not exist, all revenue is generally deferred
and recognized when delivery of those elements occurs or when fair value can be
established. When the undelivered element for which the Company does not have a
fair value is support, revenue for the entire arrangement is bundled and
recognized ratably over the support period.
In
certain contracts, billing terms are agreed upon based on performance milestones
such as the execution of measurement test, a partial delivery or the completion
of a specified service. Payments received before the unconditional acceptance of
a specific set of deliverables are recorded as deferred revenue until the
conditional acceptance has been waived.
The
Company’s fees are typically considered to be fixed or determinable at the
inception of an arrangement, generally based on specific products and quantities
to be delivered. Substantially all of the Company’s contracts do not include
rights of return or acceptance provisions. To the extent that the Company’s
agreements contain such terms, the Company recognizes revenue once the
acceptance provisions or right of return lapses. Payment terms to customers
generally range from net 30 to 90 days. In the event payment terms are provided
that differ from the Company’s standard business practices, the fees are deemed
to not be fixed or determinable and revenue is recognized when the payments
become due, provided the remaining criteria for revenue recognition have been
met.
The
Company assesses the ability to collect from the Company’s customers based on a
number of factors, including credit worthiness and past transaction history of
the customer. If the customer is not deemed credit worthy, the Company defers
all revenue from the arrangement until payment is received and all other revenue
recognition criteria have been met.
|
3.
|
STOCK-BASED
COMPENSATION
|
The
Company accounts for stock-based compensation in accordance with the provisions
of SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123(R)"), which
requires that the costs resulting from all share-based payment transactions be
recognized in the financial statements at their fair values. The Company adopted
SFAS No. 123(R) using the modified prospective application method under which
the provisions of SFAS No. 123(R) apply to new awards and to awards modified,
repurchased, or cancelled after the adoption date. Additionally, compensation
cost for the portion of the awards for which the requisite service has not been
rendered that are outstanding as of the adoption date is recognized in the
Statement of Operations over the remaining service period after the adoption
date based on the award's original estimate of fair value. Accordingly,
stock-based compensation cost is measured at grant date, based on the fair value
of the award, and is recognized as an expense over the employee requisite
service period. All of the Company’s stock compensation is accounted for as an
equity instrument.
Stock
Option
Plans
In August
2003, October 2004 and October 2007 our board of directors and stockholders
adopted the 2003 Stock Option Plan, the 2004 Stock Option Plan and the 2007
Equity Incentive Plan, respectively. The aggregate number of shares
authorized for issuance under each of the 2003 Stock Option Plan and the 2004
Stock Option Plan (together, the “Prior Plans”) was 2,500,000 and, 5,000,000,
respectively. The 2007
Equity
Incentive Plan (the “2007 Plan”)
consolidates and replaces the
Prior Plans.
Subject
to adjustment upon certain changes in capitalization, the aggregate number of
shares of common stock of the Company that may be issued pursuant to stock
awards under the 2007 Plan shall not exceed 5,000,000 shares of Common Stock,
plus an additional number of shares in an amount not to exceed 7,389,520
comprised of: (i) that number of shares subject to the Prior Plans on the date
the 2007 Plan was adopted by the Board and available for future grants plus (ii)
the number of shares subject to currently outstanding stock awards issued under
the Prior Plans that return to the share reserve from time to time after the
date the 2007 Plan was adopted by the Board. The following description of the
2007 Plan is a summary and qualified in our entirety by the text of the Plan.
The purpose of the Plan is to enhance our profitability and stockholder value by
enabling us to offer stock-based incentives to employees, directors and
consultants. The Plan authorizes the grant incentive stock options, nonstatutory
stock options, restricted stock awards, restricted stock unit awards, stock
appreciation rights, performance stock awards, performance cash awards, and
other stock-based award (collectively, “stock awards”) to employees, directors
and consultants. Under the Plan, we may grant incentive stock options within the
meaning of Section 422 of the Internal Revenue Code of 1986 and non-qualified
stock options. Incentive stock options may only be granted to our
employees.
As of
March 31, 2008, 8,871,908 shares were available for future grants under the 2007
Plan. The options under the 2007 Plan and Prior Plans vest over varying lengths
of time pursuant to various option agreements that we have entered into with the
grantees of such options. The Plan is administered by the board of directors.
Subject to the provisions of the Plan, the board of directors has authority to
determine the employees, directors and consultants who are to be awarded stock
awards and the terms of such awards, including the number of shares subject to
such awards, the fair market value of the common stock subject to options, the
exercise price per share and other terms.
Incentive
stock options must have an exercise price equal to at least 100% of the fair
market value of a share on the date of the award and generally cannot have a
duration of more than 10 years. If the grant is to a stockholder holding
more than 10% of our voting stock, the exercise price must be at least 110% of
the fair market value on the date of grant. Terms and conditions of awards are
set forth in written agreements between us and the respective option holders.
Awards under the Plan may not be made after the tenth anniversary of the
date of our adoption but awards granted before that date may extend beyond that
date.
Optionees
have no rights as stockholders with respect to shares subject to option prior to
the issuance of shares pursuant to the exercise thereof. An option becomes
exercisable at such time and for such amounts as determined by the board of
directors. An optionee may exercise a part of the option from the date
that part first becomes exercisable until the option expires. The purchase
price for shares to be issued to an employee upon his exercise of an option is
determined by the board of directors on the date the option is granted.
The Plan provides for adjustment as to the number and kinds of shares
covered by the outstanding options and the option price therefore to give effect
to any stock dividend, stock split, stock combination or other
reorganization.
The fair
value of options granted is estimated on the date of grant using a Black-Scholes
option pricing model. Expected volatilities are calculated based on
the historical volatility of the Company's Common Stock. Management monitors
share option exercise and employee termination patterns to estimate forfeiture
rates within the valuation model. The expected holding period of options is
based on the simplified method noted in SAB 107. The risk-free interest rate for
periods within the expected life of the option is based on the interest rate of
U.S. Treasury notes in effect on the date of the grant.
The
weighted average assumptions used for three months ended March 31, 2008 and 2007
are as follows:
|
|
Three months ended March 31,
|
|
|
|
2008
|
|
|
2007
|
|
Risk
free interest rate
|
|
2.93%
– 3.13%
|
|
|
4.81%
|
|
Expected
life of option
|
|
5.0
– 7.0 years
|
|
|
4.0
– 6.25 years
|
|
Dividend
yield
|
|
0%
|
|
|
0%
|
|
Volatility
|
|
94%
|
|
|
102%
|
|
The
dividend yield of zero is based on the fact that the Company has never paid cash
dividends and has no present intention to pay cash dividends. Expected
volatility is based on historical volatility of the Company’s common stock. The
risk-free interest rates are taken from the 3-year and 7-year daily constant
maturity rate as of the grant dates as published by the Federal Reserve Bank of
St. Louis and represent the yields on actively traded Treasury securities
comparable to the expected term of the options. The expected life of the options
granted in 2007 is calculated using the simplified method which uses the
midpoint between the vesting period and the contractual grant date.
The
Company recorded $438,132 and $291,061 of stock compensation expense for the
three months ended March 31, 2008 and 2007, respectively. The amounts of
share-based compensation expense are classified in the consolidated statements
of operations as follows:
|
|
Three months ended March 31,
|
|
|
|
2008
|
|
|
2007
|
|
Cost
of goods sold
|
|
$
|
6,396
|
|
|
$
|
5,156
|
|
Research
and development
|
|
|
68,853
|
|
|
|
72,939
|
|
Selling,
general and administrative
|
|
|
362,883
|
|
|
|
212,966
|
|
Stock
based compensation before income tax benefit
|
|
|
438,132
|
|
|
|
291,061
|
|
Income
tax benefit
|
|
|
–
|
|
|
|
–
|
|
Total
stock-based compensation expenses after income taxes
|
|
$
|
438,132
|
|
|
$
|
291,061
|
|
No
stock-based compensation has been capitalized in inventory due to the
immateriality of such amounts.
General Share-Based
Award
Information
The
following table summarizes the Company’s stock option activity for the three
months ended March 31, 2008:
|
|
Shares
Available For Grant
|
|
|
Number
of Options Outstanding
|
|
|
Weighted
Average Exercise Price
|
|
|
Weighted
Average Remaining Contractual Life (in years)
|
|
Aggregate
Intrinsic Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at December 31, 2007
|
|
|
714,357
|
|
|
|
6,675,163
|
|
|
$
|
1.42
|
|
|
|
|
|
|
Authorized
|
|
|
5,000,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
Granted
|
|
|
(4,306,791
|
)
|
|
|
4,306,791
|
|
|
$
|
1.36
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
(357,977
|
)
|
|
$
|
1.22
|
|
|
|
|
|
|
Cancelled
|
|
|
1,752,069
|
|
|
|
(1,752,069
|
)
|
|
$
|
1.66
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at March 31, 2008
|
|
|
3,159,635
|
|
|
|
8,871,908
|
|
|
$
|
1.47
|
|
|
|
|
|
$
|
2,960,776
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
vested and expected to vest at March 31, 2008
|
|
|
|
|
|
|
|
|
|
$
|
1.36
|
|
|
|
8.9
|
|
|
$
|
2,899,177
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
vested and exercisable
|
|
|
|
|
|
|
|
|
|
$
|
1.38
|
|
|
|
8.4
|
|
|
$
|
1,683,520
|
|
During
the first quarter of 2008, 385,445 options vested. The total fair
value of the options that vested (including those canceled) during the quarter
ended March 31, 2008 was approximately $436,000. The weighted average
grant date fair value of options granted during the three months ended March 31,
2008 was $1.10.
As of
March 31, 2008, the total compensation cost related to non-vested stock option
awards not yet recognized was $5,039,432, net of estimated
forfeitures. Total compensation cost will be recognized over an
estimated weighted average amortization period of 3.4 years. The
Company has not capitalized any compensation cost, or modified any of its stock
option grants during the three months ended March 31, 2008. During
the three months ended March 31, 2008, 357,977 options were exercised and no
cash was used to settle equity instruments granted under the Plans.
The Company’s closing stock price on
the last trading day of the three months which ended March 31, 2008 was $1.54
per share. The intrinsic value of stock options outstanding as of
March 31, 2008 is $2,960,776.
Dilutive Effect of Employee
Stock
Options
Basic
shares outstanding for the three months ended March 31, 2008 and 2007 were
8,871,908 shares and 5,533,784 shares, respectively; no incremental shares were
included in the calculation of diluted net income per share for the periods as
to do so would be antidilutive. SFAS No. 128, “Earnings per Share,”
requires that employee equity share options, nonvested shares and similar equity
instruments granted by the Company be treated as potential common shares in
computing diluted earnings per share. Diluted shares outstanding include the
dilutive effect of
in-the-money options
which is calculated based on the average share price for each fiscal period
using the treasury stock method. There was no dilutive effect of in-the-money
employee stock options as of March 31, 2008 and 2007 due to the Company
incurring a net loss for the three months ended March 31, 2008 and 2007,
respectively.
Basic
earnings per share ("EPS") is computed by dividing net loss by the weighted
average number of common shares outstanding for the period. Diluted EPS reflects
the potential dilution that could occur from common shares issuable through
stock options, warrants and other convertible securities, if dilutive. The
following table is a reconciliation of the numerator (net loss) and the
denominator (number of shares) used in the basic and diluted EPS calculations
and sets forth potential shares of common stock that are not included in the
diluted net loss per share calculation as their effect is
antidilutive:
|
|
Three
Months Ended March 31,
|
|
|
|
2008
|
|
|
2007
|
|
Numerator
- basic and diluted
|
|
$
|
(3,483,937
|
)
|
|
$
|
(1,858,610
|
)
|
|
|
|
|
|
|
|
|
|
Denominator
- basic and diluted
|
|
|
|
|
|
|
|
|
Weighted
average common shares outstanding
|
|
|
76,118,175
|
|
|
|
68,377,963
|
|
Total
|
|
|
76,118,175
|
|
|
|
68,377,963
|
|
|
|
|
|
|
|
|
|
|
Net
loss per share - basic and diluted
|
|
$
|
(0.05
|
)
|
|
$
|
(0.05
|
)
|
Antidilutive
securities:
|
|
|
|
|
|
|
|
|
Options
issued
|
|
|
8,871,908
|
|
|
|
5,533,784
|
|
Warrants
|
|
|
7,729,534
|
|
|
|
8,878,102
|
|
Incentive
shares and warrants
|
|
|
–
|
|
|
|
4,974,727
|
|
Total
|
|
|
16,601,442
|
|
|
|
19,386,613
|
|
|
5.
|
RECENT
ACCOUNTING PRONOUNCEMENTS
|
In
December 2007, the FASB issued SFAS No. 141 (revised 2007), or SFAS No. 141(R),
Business Combinations. Under SFAS No. 141(R), an entity is required to recognize
the assets acquired, liabilities assumed, contractual contingencies, and
contingent consideration at their fair value on the acquisition date. It further
requires that acquisition-related costs be recognized separately from the
acquisition and expensed as incurred, restructuring costs generally be expensed
in periods subsequent to the acquisition date, and changes in accounting for
deferred tax asset valuation allowances and acquired income tax uncertainties
after the measurement period impact income tax expense. In addition, acquired
in-process research and development, or IPR&D is capitalized as an
intangible asset and amortized over its estimated useful life. We are required
to adopt the provisions of SFAS No. 141(R) beginning with our fiscal quarter
ending April 26, 2009. SFAS 141(R) is to be applied prospectively to business
combinations for which the acquisition date is on or after January 1, 2009.
Early adoption is not permitted. Generally, the effect of SFAS 141(R) will
depend on future acquisitions.
Also in
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements — an amendment of ARB No. 51 (“SFAS 160”).
SFAS 160 establishes new accounting and reporting standards for noncontrolling
interest (minority interest) in a subsidiary, provides guidance on the
accounting for and reporting of the deconsolidation of a subsidiary, and
increases transparency through expanded disclosures. Specifically, SFAS 160
requires the recognition of minority interest as equity in the consolidated
financial statements and separate from the parent company’s equity. It also
requires consolidated net earnings in the consolidated statement of earnings to
include the amount of net earnings attributable to minority interest. This
statement will be effective for the Company as of the beginning of fiscal year
2009. Early adoption is not permitted. The Company believes there will be no
material impact from SFAS No. 160 on our consolidated financial
statements.
In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities” (“FAS 161”). FAS 161 requires entities to provide
enhanced disclosures about (a) how and why an entity uses derivative
instruments, (b) how derivative instruments and related hedged items are
accounted for under SFAS No. 133, “Accounting for Derivative Instruments and
Hedging Activities” (“FAS 133”) and its related interpretations, and (c) how
derivative instruments and related hedged items affect an entity’s financial
position, financial performance, and cash flows. FAS 161 is effective for fiscal
years and interim periods beginning after November 15, 2008, and early adoption
is permitted. The Company does not believe that the adoption of FAS161 will have
any material affect on our financial condition and results of operations but may
require additional disclosures if the Company enters into derivative and hedging
activities.
In April
2008, the FASB issued FASB Staff Position (“FSP”) No. FAS 142-3, “Determination
of the Useful Life of Intangible Assets,” (“FSP No. 142-3”). The intent of this
FSP is to improve consistency between the useful life of a recognized intangible
asset under SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No.
142”), and the period of expected cash flows used to measure the fair value of
the intangible asset under SFAS No. 141R. FSP No. 142-3 will require that the
determination of the useful life of intangible assets acquired after the
effective date of this FSP shall include assumptions regarding renewal or
extension, regardless of whether such arrangements have explicit renewal or
extension provisions, based on an entity’s historical experience in renewing or
extending such arrangements. In addition, FSP No. 142-3 requires expanded
disclosures regarding intangible assets existing as of each reporting period.
FSP 142-3 is effective for financial statements issued for fiscal years
beginning after December 15, 2008, and interim periods within those years. Early
adoption is prohibited. The Company is currently evaluating the impact that FSP
No. 142-3 will have on our financial statements
Other
recent accounting pronouncements issued by the FASB (including its Emerging
Issues Task Force ("EITF"), the American Institute of Certified Public
Accountants ("AICPA"), and the SEC did not or are not believed by management to
have a material impact on the Company's present or future financial
statements.
Inventories
are stated at the lower of cost, which approximates actual costs on a first in,
first out basis, or market. Inventories at March 31, 2008 and December 31, 2007
consisted of the following:
|
|
March 31,
2008
|
|
|
December 31,
2007
|
|
Finished
goods
|
|
$
|
1,051,515
|
|
|
$
|
1,062,398
|
|
Work
in process
|
|
|
321,959
|
|
|
|
21,287
|
|
Raw
materials
|
|
|
325,082
|
|
|
|
292,825
|
|
Reserve
for obsolescence
|
|
|
(101,469
|
)
|
|
|
(56,488
|
)
|
|
|
|
|
|
|
|
|
|
Inventories,
net
|
|
$
|
1,597,087
|
|
|
$
|
1,320,022
|
|
|
7.
|
PROPERTY
AND EQUIPMENT
|
Property
and equipment at March 31, 2008 and December 31, 2007 consists of the
following:
|
|
March 31,
2008
|
|
|
December 31,
2007
|
|
Machinery
and equipment
|
|
$
|
773,722
|
|
|
$
|
736,439
|
|
Office
furniture and equipment
|
|
|
90,478
|
|
|
|
90,672
|
|
Computer
equipment
|
|
|
288,046
|
|
|
|
356,850
|
|
Software
|
|
|
6,852,568
|
|
|
|
6,856,063
|
|
Auto
|
|
|
82,530
|
|
|
|
75,877
|
|
Accumulated
depreciation
|
|
|
(4,188,734
|
)
|
|
|
(3,539,677
|
)
|
|
|
|
|
|
|
|
|
|
Property
and equipment, net
|
|
$
|
3,898,610
|
|
|
$
|
4,476,224
|
|
Depreciation
and amortization expense is $40,683 and $30,183 for the three months ended March
31, 2008 and 2007, respectively.
Accrued
liabilities at March 31, 2008 and December 31, 2007 consisted of the
following:
|
|
March 31,
2008
|
|
|
December 31,
2007
|
|
Payroll
and related
|
|
$
|
565,168
|
|
|
$
|
620,191
|
|
Audit
and legal services
|
|
|
217,333
|
|
|
|
196,000
|
|
Sales,
VAT, income tax
|
|
|
143,032
|
|
|
|
140,175
|
|
Sales
commissions
|
|
|
229,828
|
|
|
|
299,926
|
|
Warranty
|
|
|
69,971
|
|
|
|
64,864
|
|
Inventory
not invoiced
|
|
|
77,977
|
|
|
|
211,606
|
|
Other
|
|
|
43,260
|
|
|
|
40,213
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,346,569
|
|
|
$
|
1,572,975
|
|
Warranty
Reserve
The
Company provides a warrant for its products and establishes an allowance at the
time of sale which is sufficient to cover costs during the warranty
period. The warranty period is generally 90 days. This
reserve is included in accrued liabilities.
Changes
in the warranty reserve during the three months ended March 31, 2008 and
2007 were as follows:
|
|
Three
Months Ended
March 31,
|
|
|
|
2008
|
|
|
2007
|
|
Beginning
balance
|
|
$
|
64,868
|
|
|
$
|
14,237
|
|
Warranty
expenditures
|
|
|
–
|
|
|
|
–
|
|
Provision
for current period sales
|
|
|
5,103
|
|
|
|
15,204
|
|
|
|
|
|
|
|
|
|
|
Ending
balance
|
|
$
|
69,971
|
|
|
$
|
29,441
|
|
|
9.
|
CONCENTRATION
OF CREDIT RISK
|
For the
three months ended March 31, 2008, revenues from one customer accounted for
22% of revenues, with no other single customer accounting for more than 10% of
revenues. At March 31, 2008, accounts receivable from one customer accounted for
20% of total accounts receivable with no other single customer accounting for
more than 10% of the accounts receivable balance.
As of
March 31, 2008 and 2007, approximately 69% and 42%, respectively, of the
Company’s total accounts receivable were due from customers outside the United
States.
Common
Stock
During
the three month period ending March 31, 2008, option holders exercised rights to
purchase 357,977 shares of common stock at prices ranging from $0.45 to $0.83
per share, resulting in net proceeds to the Company of
$202,559. During the three month period ending March 31, 2007,
warrant holders exercised rights to purchase 100,000 of common stock at prices
ranging from $0.75 to $0.80 per share resulting in net proceed to the Company of
$79,710.
Warrants
During
the three months ended March 31, 2008, the board of directors approved the
issuance of a warrant to an employee to purchase an aggregate of 54,720 shares
of the Company’s common stock with a fair market value of
$56,361. The warrant is exercisable at a price of $0.60 per share,
vests immediately, and expires in 2011.
A summary
of warrant activity for the three months ended March 31, 2008 is as
follows:
|
|
Warrants
|
|
|
|
Number
of
Shares
|
|
|
Weighted Average
Purchase
Price
|
|
Outstanding
December 31, 2007
|
|
|
7,714,407
|
|
|
$
|
1.15
|
|
Issued
|
|
|
54,720
|
|
|
|
0.60
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
Cancelled/expired
|
|
|
(39,583
|
)
|
|
|
2.33
|
|
|
|
|
|
|
|
|
|
|
Outstanding
March 31, 2008
|
|
|
7,729,534
|
|
|
$
|
1.14
|
|
The chart
below illustrates the outstanding warrants as of March 31, 2008 by exercise
price and the average contractual life before expiration.
|
|
|
|
Weighted
Average
|
|
|
|
|
|
|
|
Remaining
|
|
|
|
Exercise
|
|
Number
|
|
Contractual
Life
|
|
Number
|
|
Price
|
|
Outstanding
|
|
(Years)
|
|
Exercisable
|
|
|
|
|
|
|
|
|
|
$
|
0.01
|
|
201,268
|
|
|
1.2
|
|
201,268
|
|
|
0.40
|
|
1,163,875
|
|
|
0.3
|
|
1,163,875
|
|
|
0.50
|
|
50,000
|
|
|
0.2
|
|
50,000
|
|
|
0.60
|
|
623827
|
|
|
3.4
|
|
623,827
|
|
|
0.68
|
|
15,000
|
|
|
0.3
|
|
15,000
|
|
|
0.75
|
|
50,000
|
|
|
0.2
|
|
50,000
|
|
|
1.12
|
|
70,000
|
|
|
2.3
|
|
70,000
|
|
|
1.25
|
|
1,560,706
|
|
|
0.3
|
|
1,560,706
|
|
|
1.37
|
|
1,729,453
|
|
|
0.3
|
|
1,729,453
|
|
|
1.40
|
|
400,000
|
|
|
2.0
|
|
400,000
|
|
|
1.42
|
|
100,000
|
|
|
0.2
|
|
100,000
|
|
|
1.50
|
|
1,380,000
|
|
|
3.7
|
|
1,380,000
|
|
|
1.78
|
|
100,000
|
|
|
1.9
|
|
100,000
|
|
|
1.86
|
|
10,000
|
|
|
0.1
|
|
10,000
|
|
|
2.00
|
|
199,988
|
|
|
4.3
|
|
199,988
|
|
|
2.14
|
|
75,417
|
|
|
1.8
|
|
75,417
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1.14
|
|
7,729,534
|
|
|
1.3
|
|
7,729,534
|
|
The
Company adopted the provisions of FASB Interpretation No. 48 Accounting for
Uncertainty in Income Taxes (“FIN 48”) an interpretation of FASB Statement No.
109 (“SFAS 109”) on January 1, 2007. As a result of the implementation of FIN
48, the Company recognized no material adjustment in the liability for
unrecognized income tax benefits. At December 31, 2007 and 2006, the Company had
$194,775 and $176,639 of unrecognized tax benefits respectively, none of which
would affect our effective tax rate if recognized.
The
Company recognizes interest and penalties related to uncertain tax positions in
income tax expense. As of March 31, 2008, the Company has no accrued interest or
penalties related to uncertain tax positions. The tax years 2001-2007 remain
open to examination by one or more of the major taxing jurisdictions to which we
are subject. The Company does not anticipate that the total unrecognized tax
benefits will significantly change due to the settlement of audits and the
expiration of statutes of limitations prior to March 31, 2009.
In 2002,
the Company established a valuation allowance for substantially all of its
deferred tax assets. Since that time, the Company has continued to record a
valuation allowance. The valuation allowance was calculated in accordance with
the provisions of SFAS 109,
“Accounting for Income Taxes,”
which require that a valuation allowance be established or maintained
when it is “more likely than not” that all or a portion of deferred tax assets
will not be realized. The Company will continue to reserve for substantially all
net deferred tax assets until there is sufficient evidence to warrant
reversal.
|
12.
|
COMMITMENTS
AND CONTINGENCIES
|
Legal
The
Company is periodically involved in legal actions and claims that arise as a
result of events that occur in the normal course of operations. The Company is
not currently aware of any legal proceedings or claims that the Company believes
will have, individually or in the aggregate, a material adverse effect on the
Company's financial position or results of operations.
Operating
Leases
The
Company leases its operating and office facilities for various terms under
long-term, non-cancelable operating lease agreements. The leases expire at
various dates through 2014 and provide for renewal options ranging from
month-to-month to 5 year terms. In the normal course of business, it is expected
that these leases will be renewed or replaced by leases on other properties. The
leases provide for increases in future minimum annual rental payments based on
defined increases which are generally meant to correlate with the Consumer Price
Index, subject to certain minimum increases. Also, the agreements generally
require the Company to pay executory costs (real estate taxes, insurance and
repairs).
The
Company and its subsidiaries have various lease agreements for its headquarters
in Los Gatos, California; Netintact, AB offices in Varberg, Sweden; Netintact
PTY offices in Melbourne, Australia; and certain office equipment. The leases
begin expiring in 2008.
Capital
Leases
The
Company leases certain equipment under operating leases that expire at various
dates through 2014. During the three months ended March 31, 2008.
During
the three months ended March 31, 2008, there were no material changes to the
Company’s operating lease or capital lease commitments.
The
Company operates in one segment, using one measure of profitability to manage
its business. Revenues for geographic regions are based upon the
customer’s location. The location of long lived assets is based on
physical location of our regional offices. The following are
summaries of revenue and long lived assets by geographical region:
|
|
Three
Months Ended March 31,
|
|
|
|
2008
|
|
|
2007
|
|
REVENUES
|
|
|
|
|
|
|
|
|
United
States
|
|
$
|
632,362
|
|
|
$
|
780,209
|
|
Australia
|
|
|
229,781
|
|
|
|
150,531
|
|
Asia
|
|
|
439,258
|
|
|
|
262,811
|
|
Europe
|
|
|
40,667
|
|
|
|
40,315
|
|
South
America
|
|
|
–
|
|
|
|
26,621
|
|
Scandinavia
|
|
|
373,706
|
|
|
|
681,799
|
|
West
Indies
|
|
|
–
|
|
|
|
42,644
|
|
Total
|
|
$
|
1,715,774
|
|
|
$
|
1,984,930
|
|
|
|
Period
Ended March 31,
|
|
|
|
2008
|
|
|
2007
|
|
Long-lived
assets;
|
|
|
|
|
|
|
|
|
United
States
|
|
$
|
1,282,323
|
|
|
$
|
1,078,088
|
|
Sweden
|
|
|
5,132,771
|
|
|
|
8,745,830
|
|
Australia
|
|
|
50,766
|
|
|
|
45,613
|
|
Total
|
|
$
|
6,465,860
|
|
|
$
|
9,869,531
|
|
Foreign
sales as a percentage of total revenues were 73% and 61% for the three months
ended March 31, 2008, and 2007, respectively.
The
Company’s accounts receivable are derived from revenue earned from customers
located in the United States, Australia, Asia, Europe, and the Middle East. The
Company performs ongoing credit evaluations of certain customers’ financial
condition and, generally, requires no collateral from its
customers.
The
Company has sustained recurring losses and negative cash flows from operations.
Historically, the Company’s growth has been funded through a combination of
private equity and lease financing. As of March 31, 2008, the Company had
approximately $3,300,000 of unrestricted cash. During the period starting April
1, 2008 through May 9, 2008, the Company received cash proceeds of approximately
$872,000 from the exercise of warrants. The Company believes that, as a result
of this, it currently has sufficient cash and financing commitments to meet its
funding requirements over the next year. However, the Company has experienced
and continues to experience negative operating margins and negative cash flows
from operations, as well as an ongoing requirement for additional capital
investment. The Company expects that it will need to raise substantial
additional capital to fully accomplish its business plan over the next several
years. In addition, the Company may wish to selectively pursue possible
acquisitions of businesses, technologies, content, or products complementary to
those of the Company in the future in order to expand its presence in the
marketplace and achieve further operating efficiencies. The Company expects to
seek to obtain additional funding through a bank credit facility or private
equity. There can be no assurance as to the availability or terms upon which
such financing and capital might be available.
During
the period starting April 1, 2008 through May 9, 2008, the Company issued
667,500 shares of its common stock due to the exercise of warrants at an average
exercise of $1.31 per share. The Company received cash proceeds of approximately
$872,000, which will be used for working capital purposes.
ITEM
2.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The
following is a discussion of our results of operations and current financial
position. This discussion should be read in conjunction with our unaudited
consolidated financial statements and related notes included elsewhere in this
report and the audited consolidated financial statements and related notes
included in our Annual Report on Form 10-K for the year ended December 31,
2007.
As used
in this quarterly report on Form 10-Q, references to the “Company,” “we,” “us,”
“our” or similar terms include Procera Networks, Inc. and its consolidated
subsidiaries.
Cautionary
Note Regarding Forward-Looking Statements
Our
disclosure and analysis in this quarterly report on Form 10-Q contain certain
“forward-looking statements,” as such term is defined in Section 21E of the
Securities Exchange Act of 1934. These statements set forth anticipated results
based on management’s plans and assumptions. From time to time, we also provide
forward-looking statements in other materials we release to the public as well
as oral forward-looking statements. Such statements give our current
expectations or forecasts of future events; they do not relate strictly to
historical or current facts. We have attempted to identify such statements by
using words such as “anticipate,” “estimate,” “expect,” “project,” “intend,”
“plan,” “believe,” “will,” “could” and similar expressions in connection with
any discussion of future events or future operating or financial performance or
strategies. Such forward-looking statements include, but are not limited to,
statements regarding:
|
•
|
our services, including the
development and deployment of products and services and strategies to
expand our targeted customer base and broaden our sales
channels;
|
|
•
|
the
operation of our company with respect to the development of products and
services;
|
|
•
|
our
liquidity and financial resources, including anticipated capital
expenditures, funding of capital expenditures and anticipated levels of
indebtedness and the ability to raise capital through financing
activities;
|
|
•
|
trends
related to and management’s expectations regarding results of operations,
required capital expenditures, integration of acquired businesses,
revenues from existing and new products and sales channels, and cash
flows, including but not limited to those statements set forth below in
this Item 2; and
|
|
•
|
sales
efforts, expenses, interest rates, foreign exchange rates, and the outcome
of contingencies, such as legal
proceedings.
|
We cannot
guarantee that any forward-looking statement will be realized. Achievement of
future results is subject to risks, uncertainties and potentially inaccurate
assumptions. Should known or unknown risks or uncertainties materialize, or
should underlying assumptions prove inaccurate, actual results could vary
materially from past results and those anticipated, estimated or projected.
Investors should bear this in mind as they consider forward-looking
statements.
We
undertake no obligation to publicly update forward-looking statements, whether
as a result of new information, future events or otherwise. You are advised,
however, to consult any further disclosures we make on related subjects in our
annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports
on Form 8-K. Also note that we provide the following cautionary discussion of
risks and uncertainties related to our businesses. These are factors that we
believe, individually or in the aggregate, could cause our actual results to
differ materially from expected and historical results. We note these factors
for investors as permitted by Section 21E of the Securities Exchange Act of
1934. You should understand that it is not possible to predict or identify all
such factors. Consequently, you should not consider the following to be a
complete discussion of all potential risks or uncertainties.
Our
forward-looking statements are subject to a variety of factors that could cause
actual results to differ significantly from current beliefs and expectations. In
addition to the risk factors identified under the captions below, the operations
and results of our business are subject to risks and uncertainties identified
elsewhere in this quarterly report on Form 10-Q as well as general risks and
uncertainties such as those relating to general economic conditions and demand
for our products and services.
Risks
Related to Liquidity and Financial Resources
•
|
Historically, we have incurred
substantial operating losses and will continue to generate negative cash
flows from operating and investing activities in the short term. We may be
unable to improve operating results and/or achieve positive cash flows in
the future, which could prevent us from meeting our long-term liquidity
requirements.
|
•
|
If
our cash flows do not improve, we would need to arrange financing
facilities in order to continue as a going concern. We may be unable to
arrange financing facilities on acceptable terms or at
all.
|
•
|
Our
cash flow expectations for 2008 are based in part on raising additional
capital through debt or equity financings. Our ability to arrange such
financings is subject to negotiating acceptable terms from financing
parties. This could prove more difficult given recent adverse changes in
the credit markets. If we are unable to arrange such financings, we may
not be able to make all necessary or desirable capital and working capital
expenditures to run and grow our
business.
|
•
|
We
believe that economies of scale will allow us to grow revenues while
incurring incremental costs that are proportionately lower than those
applicable to our current level. If the increased costs required to
support our revenue growth turn out to be greater than anticipated, we may
be unable to improve our profitability and/or cash flows even if revenue
growth goals are achieved. The current changes in economic activity in the
U.S. and elsewhere could temper our growth, even though our products offer
value to our current, and prospective
customers.
|
Risks Related to
our Operations
•
|
While capital expenditures have
remained relatively stable at levels such levels may not be sustainable in
the future, particularly as our business volume and product offerings
continue to increase.
|
•
|
Intellectual
property and proprietary rights of others could prevent us from using
necessary technology.
|
•
|
We
may not realize the benefits originally anticipated from our
acquisitions.
|
•
|
We
have substantial international operations and face potential political,
legal, tax, regulatory and other risks from our operations in foreign
jurisdictions.
|
•
|
We
are exposed to currency exchange rate risks and our net loss may suffer
due to currency translations.
|
Risks Related to
Competition and our Industry
•
|
The prices that we charge for our
products and services could
decrease.
|
•
|
Technological
advances could increase the competition we face and put downward pressure
on prices or sales.
|
•
|
Many
of our competitors have superior resources, which could place us at a cost
and price disadvantage.
|
Risks Related to
our Common Stock
•
|
Future sales of our common stock
could cause substantial dilution which may negatively affect the market
price of our shares and impact our ability to raise
capital.
|
For a
more detailed description of many of these risks and important additional risk
factors, see Part II, Item 1A, “Risk Factors,” in this report.
Overview
Headquartered
in Los Gatos, CA, Procera Networks, Inc. ("Procera" or the "Company") is a
leading provider of bandwidth management and control products for broadband
service providers worldwide. Procera’s products offer network administrators
unique accuracy in identifying applications running on their network and the
ability to optimize the experience of the service provider’s subscribers based
on management of the identified traffic.
Procera’s
solutions are purpose built to provide the most advanced network intelligence.
Procera’s development team in Sweden has developed a particularly effective
variation of deep packet inspection (“DPI”) technology based on the analysis of
packet flows (“DFI”). Procera’s DFI looks at the flow of packets in both
directions (which may be occurring on different network paths) to make decisions
about application type, and is believed to provide significantly more accurate
identification of applications when compared to simpler packet-based (DPI)
approaches. Application identification is the all important starting point for a
smart network.
PacketLogic
is a modular traffic management software system that consists of five modules.
The base module, which is required in all systems, is the Surveillance module.
Four other software modules whichare optional but offering very powerful
capabilities, include the Filtering, Traffic Shaping, Statistics, and Web
Statistics. When these modules are combined with the PacketLogic hardware
platform, they deliver a very unique, powerful and scalable network traffic
management solution for broadband service providers. Service providers can
select from multiple PacketLogic hardware platforms offering a range of
configurations and capabilities.
On August
18, 2006, Procera acquired the stock of Netintact AB, a Swedish corporation. On
September 29, 2006, Procera acquired the effective ownership of the stock of
Netintact PTY, an Australian company. During the three months ended October 1,
2006, we emerged from the development stage.
As a
result of the Netintact AB and Netintact PTY transactions, the core products and
business of Procera have changed dramatically. Netintact’s flagship product and
technology, PacketLogic, now forms the core of Procera’s product offering. The
company sells its products through its direct sales force, resellers,
distributors, and system integrators in the Americas, Asia Pacific, and Europe.
PacketLogic is deployed at more than 400 broadband service providers, telephone
companies, colleges and universities worldwide. The common stock of Procera is
listed on the American Stock Exchange under the trading symbol
“PKT”.
Critical
Accounting Estimates
Our
discussion and analysis of our financial condition and results of operations are
based upon financial statements which have been prepared in accordance with
generally accepted accounting principles in the United States. The preparation
of these financial statements requires us to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenue, expenses, and other
related disclosure of contingent assets and liabilities. On an ongoing basis, we
evaluate these estimates, and we base our estimates on historical experience and
on various other assumptions that are believed to be reasonable. These estimates
and assumptions provide a basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions, and these differences may be material. Our significant accounting
policies are summarized in Note 2 in our Annual Report on Form 10-K for the year
ended December 31, 2007 files with the SEC on April 2, 2008.
Management
believes that there have been no significant changes during the three months
ended March 31, 2008 to the items that we disclosed as our critical accounting
policies and estimates in the Management’s Discussion and Analysis of Financial
Condition and Results of Operations section of our Annual Report on Form 10-K
for the year ended December 31, 2007, filed with the SEC on April 2, 2008. In
accordance with SEC guidance, we believe the following critical accounting
policies reflect our most significant estimates, judgments and assumptions used
in the preparation of our consolidated financial statements. These critical
accounting policies and related disclosures appear in our Annual Report on Form
10-K for the year ended December 31, 2007.
|
·
|
Stock-based
compensation expense;
|
|
·
|
Long-lived
assets, including finite lived purchased intangible assets;
and
|
|
·
|
Deferred
tax valuation allowance.
|
Results
of Operations
From the
date of our inception on May 1, 2002 through July 2, 2006, we were a development
stage company, devoting all of our efforts and resources to developing and
testing new products and preparing for introduction of our products into the
market place. During this period, we generated insignificant revenues from
actual sales of our products.
After the
Company acquired Netintact AB on August 18, 2006 and Netintact PTY on September
29, 2006, we began to recognize increased revenues, costs, and expenses
associated with the acquired companies and the introduction of Netintact’s
PacketLogic product line to a broader customer base. Beginning with the three
months which ended October 1, 2006, we emerged from our development
stage.
The
following table sets forth our unaudited historical operating results, in dollar
amounts and as a percentage of net revenue for the periods
indicated:
|
|
Three
Months Ended March 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
(in
thousands, except percentages)
|
|
Net
sales
|
|
$
|
1,716
|
|
|
|
100
|
%
|
|
$
|
1,985
|
|
|
|
100
|
%
|
Cost
of goods sold
|
|
|
708
|
|
|
|
41
|
|
|
|
436
|
|
|
|
22
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
1,008
|
|
|
|
59
|
|
|
|
1,549
|
|
|
|
78
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research
and development
|
|
|
662
|
|
|
|
29
|
|
|
|
843
|
|
|
|
43
|
|
Sales
and marketing
|
|
|
1,807
|
|
|
|
105
|
|
|
|
1,196
|
|
|
|
60
|
|
General
and administrative
|
|
|
2,266
|
|
|
|
132
|
|
|
|
1,626
|
|
|
|
820
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
operating expenses
|
|
|
4,735
|
|
|
|
276
|
|
|
|
3,665
|
|
|
|
185
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) from operations
|
|
|
(3,727
|
)
|
|
|
(217
|
)
|
|
|
(2,116
|
)
|
|
|
(107
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
and other income (expense) net
|
|
|
3
|
|
|
|
–
|
|
|
|
17
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) before income taxes
|
|
|
(3,724
|
)
|
|
|
(217
|
)
|
|
|
(2,099
|
)
|
|
|
(106
|
)
|
Provision
for income taxes
|
|
|
261
|
|
|
|
15
|
|
|
|
240
|
|
|
|
12
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
(3,463
|
)
|
|
|
(202
|
)%
|
|
$
|
(1,859
|
)
|
|
|
(94
|
)%
|
Comparison
of Three Months ended March 31, 2008 and March 31, 2007
Revenues
Our
revenue is derived from sales of our hardware appliances, bundled software
licenses, and from product support, training, and other services. The Company
currently operates from three legal entities including Procera (Americas),
Netintact (Europe, Middle East, Africa or EMEA), and Netintact PTY (Asia Pacific
or APAC). The table below presents the breakdown of revenue by
entity.
|
Three
Months Ended March 31,
|
|
Variance
|
|
Variance
|
|
|
2008
|
|
2007
|
|
In
dollars
|
|
In
Percent
|
|
|
(dollar
amounts in thousands)
|
|
Americas
|
|
$
|
633
|
|
|
$
|
928
|
|
|
$
|
(295
|
)
|
|
|
(32
|
)%
|
EMEA
|
|
|
414
|
|
|
|
722
|
|
|
|
(308
|
)
|
|
|
(43
|
)
|
APAC
|
|
|
669
|
|
|
|
335
|
|
|
|
334
|
|
|
|
100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,716
|
|
|
$
|
1,985
|
|
|
$
|
(269
|
)
|
|
|
(14
|
)%
|
Our net
revenue for the first quarter of 2008 was $1,716,000 as compared to our net
revenue in the first quarter of 2007 of $1,985,000. In 2007, one large order
represented 21% of the total revenue for the first quarter. In addition, during
the first quarter of 2008, the Company underwent a significant change in sales
and marketing management and support personnel, resulting in what we expect will
be short term sales productivity changes. The company expanded its channel
presence in the APAC region in 2007, resulting in improved sales performance in
this area.
Cost
of Sales
Costs of
sales include direct material costs for products sold, direct labor and
manufacturing overhead, and adjustments to inventory values, including reserves
for slow moving, obsolete inventory, engineering changes, and adjustments to
reflect the company’s policy of valuing inventory at lower of cost or market on
a first-in, first-out basis. The following tables present the
breakdown of cost of sales by entity and by category.
By
Entity
|
Three
Months Ended March 31,
|
|
|
|
Amount
|
|
|
Percent
of Net Product Sales
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
(dollar
amounts in thousands)
|
|
|
|
|
Americas
|
|
$
|
405
|
|
|
$
|
267
|
|
|
|
64
|
%
|
|
|
29
|
%
|
EMEA
|
|
|
96
|
|
|
|
108
|
|
|
|
23
|
|
|
|
15
|
|
APAC
|
|
|
207
|
|
|
|
61
|
|
|
|
31
|
|
|
|
18
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
708
|
|
|
$
|
436
|
|
|
|
41
|
%
|
|
|
22
|
%
|
By
Category
|
Three
Months Ended March 31,
|
|
|
Amount
|
|
|
Percent
of Net Product Sales
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
(dollar
amounts in thousands)
|
|
|
|
|
Direct
materials
|
|
$
|
391
|
|
|
$
|
310
|
|
|
|
23
|
%
|
|
|
16
|
%
|
Applied
labor and manufacturing overhead
|
|
|
174
|
|
|
|
116
|
|
|
|
10
|
|
|
|
6
|
|
Inventory
adjustments and other costs
|
|
|
143
|
|
|
|
11
|
|
|
|
8
|
|
|
|
–
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
708
|
|
|
$
|
436
|
|
|
|
41
|
%
|
|
|
22
|
%
|
Our cost
of goods sold in the first quarter of 2008 was 41% of sales as compared to cost
of goods sold in the first quarter of 2007 of 22% of sales in that
quarter. Direct material costs increased due to primarily due to
product mix. During the first quarter of 2008, we had higher than
normal hardware expansion orders which have much lower margins than our typical
order consisting of hardware and software licenses. Manufacturing
overhead increased year over year as we have expanded production and testing
capabilities during this period. Inventory adjustments and other
costs increased in 2008 primarily as a result of product and component changes,
associated with product improvements.
Costs of
goods sold in Americas increased as a percentage of net revenue from 2007 to
2008 as the costs associated with manufacturing overhead and inventory
adjustments are a function of US manufacturing operation. EMEA costs
of goods sold increased due to a large hardware only sale during the first
quarter of 2008. APAC costs of goods sold increased due to the growth
of lower margin channel sales in 2008.
Gross
Profit
Our gross
profit was 59% in the first quarter of 2008, compared to 78% in the first
quarter of 2007. The primary elements as identified above were (i)
inventory adjustments associated with product improvements, (ii) product mix
(iii) increased sales from lower margin channel markets and (iv) restructuring
of the sales and marketing organizations during the first quarter of
2008.
The
following table represents our gross profit by entity.
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended March 31,
|
|
|
Variance
|
|
|
Variance
|
|
|
|
2008
|
|
|
2007
|
|
|
In
dollars
|
|
|
In
Percent
|
|
|
(dollar
amounts in thousands)
|
|
Americas
|
|
$
|
228
|
|
|
$
|
661
|
|
|
$
|
(433
|
)
|
|
|
(64
|
)%
|
EMEA
|
|
|
318
|
|
|
|
614
|
|
|
|
(296
|
)
|
|
|
(48
|
)
|
APAC
|
|
|
462
|
|
|
|
274
|
|
|
|
188
|
|
|
|
69
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,008
|
|
|
$
|
1,549
|
|
|
$
|
(541
|
)
|
|
|
(35
|
)%
|
Operating
Expense
Operating
expenses for the first three months ended March 31, 2008 and 2007 are as
follows;
|
Three
Months Ended March 31,
|
|
|
Variance
|
|
|
Variance
|
|
|
|
2008
|
|
|
2007
|
|
|
In
dollars
|
|
|
In
Percent
|
|
|
(dollar
amounts in thousands)
|
|
Research
and development
|
|
$
|
662
|
|
|
$
|
843
|
|
|
$
|
181
|
|
|
|
21
|
%
|
Sales
and marketing
|
|
|
1,807
|
|
|
|
1,196
|
|
|
|
(611
|
)
|
|
|
(51
|
)
|
General
and administrative
|
|
|
2,266
|
|
|
|
1,626
|
|
|
|
(640
|
)
|
|
|
(39
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
4,735
|
|
|
$
|
3,665
|
|
|
$
|
(1,070
|
)
|
|
|
(29
|
)%
|
Research
and Development
Research
and development expenses consisted of costs associated with personnel, prototype
materials, initial product certifications and equipment
costs. Research and development costs are primarily categorized as
either sustaining (efforts for products already released) or development costs
(associated with new products).
|
Three Months Ended March 31,
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
(Increase)
Decrease
|
|
|
(in
thousands, except percentages)
|
|
Research
and development
|
|
$
|
662
|
|
|
$
|
843
|
|
|
$
|
181
|
|
Percentage
of net revenue
|
|
|
39
|
%
|
|
|
43
|
|
|
|
4
|
%
|
Research
and development expense for the first quarter of 2008 decreased by $181,000 as
compared to the first quarter of 2007. The Company reorganized its
hardware and software development resources after the first quarter of 2007 as a
result of the acquisition of Netintact. Offsetting the favorable
personnel costs, the Company increased spending on product improvement projects
including prototype materials, initial product certifications, and product
characterization equipment. For the periods ending March 31, 2008 and
2007, non-cash costs associated with stock based compensation expense included
in research and development were $73,000 and $69,000 respectively.
Sales
and Marketing
Sales and
marketing expenses primarily included personnel costs, sales commissions, and
marketing expenses such as trade shows, channel development, and
literature.
|
Three Months Ended March 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
(Increase)
Decrease
|
|
(in
thousands, except percentages)
|
Sales
and marketing
|
|
$
|
1,807
|
|
|
$
|
1,196
|
|
|
$
|
(611
|
)
|
Percentage
of net revenue
|
|
|
105
|
%
|
|
|
60
|
%
|
|
|
(45
|
)%
|
Sales and
marketing expenses for first quarter of 2008 increased by $611,000, as compared
to the first quarter of 2007. The staff of the sales and marketing
team grew 50% from 22 at the beginning of 2007 to 33 by the end of
2007. During the first quarter of 2008 the Company reorganized its
sales and marketing organization on a worldwide basis and incurred one-time
severance related costs. The company incurred additional costs to
support the recruitment and hiring of new management and staff personnel during
the first quarter of 2008. For the periods ending March 31 2008 and
2007, non-cash costs associated with stock-based compensation included in sales
and marketing expenses were $125,000 and $189,000 respectively.
General
and Administrative
General
and administrative expenses consisted primarily of personnel and facilities
costs related to our executive, finance, human resources, and legal
organizations, fees for professional services, and amortization of intangible
assets. Professional services included costs associated with legal,
audit, and investor relations consulting costs.
|
|
Three Months Ended March 31,
|
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
(Increase)
Decrease
|
|
|
|
(in
thousands, except percentages)
|
General
and administrative
|
|
$
|
2,266
|
|
|
$
|
1,626
|
|
|
$
|
(640
|
)
|
Percentage
of net revenue
|
|
|
132
|
%
|
|
|
82
|
%
|
|
|
(50
|
)%
|
General
and administrative expenses for the first quarter of 2008 increased by $640,000,
when compared to the first quarter of 2007. Expense increases in 2008
included payroll and related costs of $261,000, professional services of
$142,000, stock based compensation of approximately $99,000, facility expenses
including insurance of $85,000, investor relations of $26,000, and travel and
other related spending of $27,000. For the period ending March 31
2008 and 2007, non-cash costs included in G&A were $1,119,000 and $1,111,000
respectively including intangible amortization and stock based compensation
expenses.
Interest
and Other Income (Expense), Net
During
the first quarter of 2008 the company maintained lower cash balances than in the
same quarter of 2007. As a result, net cash interest and other income
decreased by approximately $14,000 during this period. Net interest
and other income for the first quarter of 2008 and 2007 were $3,000 and $16,000
respectively.
Provision
for Income Taxes
The
Company is subject to taxation primarily in the U.S., Sweden, and Australia, as
well as State of California. The tax benefit results primarily from the
amortization of a purchase accounting adjustment less the tax incurred in
Australia. The Company’s effective tax rates in Australia for the three months
ended March 31, 2008 and 2007 were 15% and 30%,
respectively. Our effective tax rate for the three months ended March
31, 2008 was less than the statutory rate because we utilized net operating loss
carry forwards to offset taxable income in Australia. The Company has
established a valuation allowance for substantially all of its deferred tax
assets. The valuation allowance was calculated in accordance with the
provisions of SFAS 109, which require that a valuation allowance be established
or maintained when it is “more likely than not” that all or a portion of
deferred tax assets will not be realized. The Company will continue
to reserve for substantially all net deferred tax assets until there is
sufficient evidence to warrant reversal.
Liquidity
and Capital Resources
Cash
and Cash Equivalents and Investments
The
following table summarizes our cash and cash equivalents and investments, which
were classified as “available for sale” and consisted of highly liquid financial
instruments:
|
|
Three Months Ended March 31,
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Increase (Decrease)
|
|
|
|
(in
thousands, except percentages)
|
|
Cash
and cash equivalents
|
|
$
|
3,325
|
|
|
$
|
4,233
|
|
|
$
|
(908
|
)
|
|
|
(21
|
)%
|
The cash
and cash equivalents balance decreased during the quarter ending March 31,
2008 and 2007 by $2,540,000 and $981,000 as follows:
|
|
Three Months Ended March 31,
|
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Increase (Decrease)
|
|
|
|
(in
thousands, except percentages)
|
|
Net
cash (used in) by operating activities
|
|
$
|
(2,775
|
)
|
|
$
|
(903
|
)
|
|
$
|
(1,872
|
)
|
|
|
(207
|
)%
|
Net
cash provided by (used in) investing activities
|
|
|
(17
|
)
|
|
|
(131
|
)
|
|
|
114
|
|
|
|
87
|
%
|
Net
cash provided by financing activities
|
|
|
193
|
|
|
|
75
|
|
|
|
118
|
|
|
|
157
|
%
|
Effect
of exchange rate changes on cash and cash equivalents
|
|
|
59
|
|
|
|
(22
|
)
|
|
|
81
|
|
|
|
368
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
increase (decrease) on cash and cash equivalents
|
|
$
|
(2,540
|
)
|
|
$
|
(981
|
)
|
|
$
|
(1,559
|
)
|
|
|
(159
|
)%
|
During
the three month period ending March 31, 2008, our cash used in operating
activities was $2,775,000. Major elements of operating activity cash
usage were $3,484,000 net loss, $271,000 from increased inventories, $33,000
from increased accounts receivable and $331,000 in decreased accounts payable
and accruals. Operating cash flow for the three month period ending
March 31, 2008 increased as a result of expenses not requiring the use of cash
of $1,164,000 and $110,000 from increased deferred revenue. In the
first quarter of 2008, net cash used in investing activities of $17,000 was
primarily for the purchase of equipment. Net cash provided by
financing activities during the first quarter of 2008 increased by $203,000 from
the exercise of stock options offset by capital lease payments of
$9,000.
We
believe that our existing cash, cash equivalents and short-term investments,
along with the cash that we expect to generate from operations, will be
sufficient to meet our anticipated cash needs for working capital and capital
expenditures through March 31, 2009. If these sources of cash are
insufficient to satisfy our liquidity requirements, we will seek to sell
additional equity or debt securities, obtain a credit facility or enter into
development or license agreements with third parties. The sale of
additional equity or convertible debt securities could result in dilution to our
stockholders. If additional funds are raised through the issuance of
debt securities, these securities could have rights senior to those associated
with our common stock and could contain covenants that would restrict our
operations. Any corporate collaboration or licensing arrangements may
require us to relinquish valuable rights. Additional financing may
not be available at all, or in amounts or upon terms acceptable to
us. If adequate funds are not available, we may be required to delay,
reduce the scope of or eliminate our commercialization efforts or one or more of
our research and development programs.
Our
management routinely and actively pursues various funding options, including
equity offerings, equity-like financing, strategic corporate alliances, business
combinations and even the establishment of product related research
and development limited partnerships, to obtain additional financing to continue
the development of its products and bring them to commercial
markets. Should the Company be unable to raise adequate financing or
generate sufficient revenue in the future, short-term and long-term operations
may need to be scaled back or discontinued.
Off
Balance Sheet Arrangements
As of
March 31, 2008, the Company had no off-balance sheet items as described by Item
303(c)(a)(4) of Securities and Exchange Commission Regulation S-K. We
have not entered into any transactions with unconsolidated entities whereby we
have financial guarantees, subordinated retained interests, derivative
instruments, or other contingent arrangements that expose us to material
continuing risks, contingent liabilities, or any other obligations under a
variable interest in an unconsolidated entity that provides us with financing,
liquidity, market risk, or credit risk support.
Contractual
Obligations
As of
March 31, 2008, the Company had obligations for leased equipment from various
sources as shown below. Interest rates on such debt range from 9% to
10%. Procera also leases office space and equipment under non-cancellable
operating and capital leases with various expiration dates through
2014.
The
following table describes our principal contractual cash obligations as of
March 31, 2008:
|
|
Capital
Leases
|
|
|
Operating
Leases
|
2008
|
|
$
|
27,086
|
|
|
$
|
286,181
|
|
2009
|
|
|
15,317
|
|
|
|
382,121
|
|
2010
|
|
|
12,680
|
|
|
|
389,183
|
|
2011
|
|
|
12,680
|
|
|
|
276,173
|
|
2012
and thereafter
|
|
|
33,832
|
|
|
|
199,536
|
|
Total
minimum lease payments
|
|
$
|
101,595
|
|
|
$
|
1,533,194
|
|
Deferred
Revenue
The
following table describes our deferred revenue for the first quarter of 2008 and
2007 respectively.
|
|
Three Months Ended March 31,
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Increase (Decrease)
|
|
|
(in
thousands, except percentages)
|
|
Deferred
revenue
|
|
$
|
1,106
|
|
|
$
|
625
|
|
|
$
|
481
|
|
|
77
|
%
|
Product
sales include post contract support and hardware maintenance services which are
deferred until earned. The contract period typically is one year but
can range up to three years. Additionally, when we introduce new
products for which there is no historical evidence of acceptance history,
revenue is deferred until receipt of end-user acceptance until such history has
been established. The increase in deferred revenue of $0.5 million is
reflective of an increasing base of customers and related support contract
renewals on historical sales.
Material
Commitments of Capital
We use
third-party contract manufacturers to assemble and test our
products. In order to reduce manufacturing lead-times and ensure an
adequate supply of inventories, our agreements with some of these manufacturers
allow them to procure long lead-time component inventory on its behalf based on
a rolling production forecast provided by the company. We may be
contractually obligated to purchase long lead-time component inventory procured
by certain manufacturers in accordance with its forecasts. In addition, we issue
purchase orders to our third-party manufacturers that may not be cancellable at
any time. As of March 31, 2008, we had no open non-cancellable
purchase orders with third-party manufacturers.
New
Accounting Pronouncements
Financial Accounting Standard
No. 157 -
Fair Value
Measurements
In
September 2006, the FASB issued SFAS No. 157, “Fair Value
Measurements,” (SFAS 157). SFAS 157 establishes a framework for
measuring fair value in accordance with generally accepted accounting principles
and expands disclosures about fair value measurements. The statement defines
fair value as the exit price that would be received to sell an asset or paid to
transfer a liability. Fair value is a market-based measurement that
should be determined using assumptions that market participants would use in
pricing an asset or liability. The statement establishes a three-level
hierarchy to prioritize the inputs used in measuring fair
value.
In
February 2008, the FASB issued FASB Staff Position (FSP) 157-b which
delayed the effective date of SFAS 157 for one year for all nonfinancial
assets and nonfinancial liabilities, except those that are recognized or
disclosed at fair value in the financial statements on a recurring basis (at
least annually). SFAS 157 and FSP 157-b are effective for financial
statements issued for fiscal years beginning after November 15, 2007. We
have elected a partial deferral of Statement 157 under the provisions of FSP
157-b and, effective January 1, 2008, the Company adopted SFAS 157 for
those assets and liabilities that are remeasured at fair value on a recurring
basis. Our partial adoption of SFAS 157 did not have a material effect on our
consolidated financial statements as of and for the three months ended
March 31, 2008.
Financial
Accounting Standard No. 159—The Fair Value Option for Financial Assets and
Financial Liabilities
In
February 2007, the FASB issued Financial Accounting Standard No. 159, “The
Fair Value Option for Financial Assets and Financial Liabilities,” or FAS 159.
FAS 159 permits an entity to choose, at specified election dates, to measure
eligible financial instruments and certain other items at fair value that are
not currently required to be measured at fair value. An entity shall report
unrealized gains and losses on items for which the fair value option has been
elected in earnings at each subsequent reporting date. Upfront costs and fees
related to items for which the fair value option is elected shall be recognized
in earnings as incurred and not deferred. FAS 159 also establishes presentation
and disclosure requirements designed to facilitate comparisons between entities
that choose different measurement attributes for similar types of assets and
liabilities. FAS 159 are effective for financial statements issued for fiscal
years beginning after November 15, 2007 and interim periods within those
fiscal years. At the effective date, an entity may elect the fair value option
for eligible items that exist at that date. The entity shall report the effect
of the first re-measurement to fair value as a cumulative-effect adjustment to
the opening balance of retained earnings. We have elected not to apply the fair
value option to any eligible assets or liabilities held as of December 31,
2007 or for any eligible assets or liabilities arising during the three months
ended March 31, 2008.
Financial
Accounting Standard No. 160—Noncontrolling Interests in Consolidated
Financial Statements – an Amendment of Accounting Research Bulletin
No. 51
In
December 2007, the FASB issued Financial Accounting Standard No. 160,
“Noncontrolling Interests in Consolidated Financial Statements—an Amendment of
Accounting Research Bulletin No. 51,” or FAS 160. FAS 160 requires
reporting entities to present noncontrolling (minority) interests as equity (as
opposed to as a liability or mezzanine equity) and provides guidance on the
accounting for transactions between an entity and noncontrolling interests. FAS
160 is effective for fiscal years beginning on or after December 15, 2008,
except for the presentation and disclosure requirements which will be applied
retrospectively for all periods presented. We do not believe that FAS 160 will
have any material impact on our consolidated financial statements.
Financial
Accounting Standard No. 141(R)—Business Combinations (Revised)
In
December 2007, the FASB issued Financial Accounting Standard No. 141(R),
“Business Combinations,” or FAS 141(R). FAS 141(R) requires the acquiring entity
in a business combination to recognize the full fair value of assets acquired
and liabilities assumed in the transaction (whether a full or partial
acquisition); establishes the acquisition-date fair value as the measurement
objective for all assets acquired and liabilities assumed; requires expensing of
most transaction and restructuring costs; and requires the acquirer to disclose
to investors and other users all of the information needed to evaluate and
understand the nature and financial effect of the business combination.
FAS 141(R) applies to all transactions or other events in which the
reporting entity obtains control of one or more businesses, including those
sometimes referred to as “true mergers” or “mergers of equals” and combinations
achieved without the transfer of consideration, for example, by contract alone
or through the lapse of minority veto rights. FAS 141(R) applies prospectively
to business combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after
December 15, 2008. We do not believe that FAS 141R will have any material
impact on our consolidated financial statements.
In
December 2007, the SEC issued Staff Accounting Bulletin No. 110 (“SAB
110”). SAB 110 expresses the views of the staff regarding the use of a
“simplified” method, as discussed in SAB No. 107, “Share-Based Payment”, in
developing an estimate of the expected term of “plain vanilla” share options in
accordance with SFAS No. 123 (R). We do not expect SAB 110 to have a
material impact on our results of operations or financial
condition.
Item 3.
|
Quantitative
and
Qualitative Disclosures about Market
Risk.
|
Market
risk represents the risk of loss that may impact our financial position, results
of operations or cash flows due to adverse changes in market prices, including
interest rate risk and other relevant market rate or price risks. We do not use
derivative financial instruments in our investment portfolio.
We are
exposed to some market risk through interest rates related to our investment of
current cash and cash equivalents of approximately $3.5 million at
March 31, 2008. Based on this balance, a change of one percent in interest
rate would cause an annual change in interest income of $37,000. The risk is not
considered material and we manage such risk by continuing to evaluate the best
investment rates available for short-term high quality investments.
Foreign
Currency
Rate
Fluctuations
The
Company's earnings and cash flows at its subsidiaries Netintact AB and Netintact
PTY are subject to fluctuations due to changes in foreign currency rates. The
Company believes that changes in the foreign currency exchange rate would not
have a material adverse effect on its results of operations as the majority of
its foreign transactions are delineated in subsidiary's functional
currency.
Item 4.
|
Controls
and
Procedures.
|
Management
of the Company is responsible for establishing and maintaining adequate internal
control over financial reporting (“Internal Control”) as defined in
Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as
amended (the “Exchange Act”). Management understands that a material weakness is
a significant deficiency (within the meaning of Public Company Accounting
Oversight Board Auditing Standard No. 2), or combination of significant
deficiencies, that results in there being more than a remote likelihood that a
material misstatement of the annual or interim financial statements will not be
prevented or detected.
Management
assessed the effectiveness of the company’s Internal Control as of
December 31, 2007 using the criteria issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal
Control-Integrated Framework and identified a material weakness in its Annual
Report on Form 10-K for the fiscal year ended December 31, 2007.
Additionally, our independent registered public accounting firm has tested our
internal control over financial reporting for the year ended December 31, 2007,
and has provided an adverse audit opinion on the Company’s control over
financial reporting.
This
material weakness was described as follows, and this information should be read
together with management’s complete report as included with the company’s Annual
Report on Form 10-K:
Material
Weakness
|
1.
|
We did not complete our 10-K and
financial reports in sufficient time to allow for review and comment which
resulted in a significant number of last minute changes. We intend to
implement a plan for the year end close that permits earlier completion of
financial statements and required filings with the SEC in a timely
manner.
|
Based on
the assessment conducted and the evaluation of relevant criteria, management
concluded that, as of December 31, 2007, the company’s Internal Control was
not effective.
Evaluation of Disclosure Controls and
Procedures
We
maintain disclosure controls and procedures (“Disclosure Controls”), as such
term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act
that are designed to ensure that information required to be disclosed in our
Exchange Act reports, including the company’s Quarterly Report on Form 10-Q, is
recorded, processed, summarized and reported within the time periods specified
in the SEC’s rules and forms, and that such information is accumulated and
communicated to our management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure.
In
designing and evaluating the Disclosure Controls, our management recognized that
any controls and procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired control objectives,
and our management necessarily was required to apply its judgment in evaluating
the cost-benefit relationship of possible controls and procedures.
As
required by Rule 13a-15(b) and 15d-15(b) under the Exchange Act, we carried
out an evaluation, under the supervision and with the participation of our
management, including our Chief Executive Officer and our Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures as of the end of the period covered by this
report. As described above, we identified a material weakness as of
December 31, 2007 that we had not fully remediated as of March 31, 2007.
The company’s Chief Executive Officer and Chief Financial Officer have concluded
that, as a result of that material weakness that remains outstanding, the
Company’s Disclosure Controls, as of March 31, 2008, were, therefore, still
not effective.
Our
independent registered public accounting firm PMB Helin Donovan, LLP
has not audited the financial statements and notes thereto included elsewhere in
this Quarterly Report on Form 10-Q, nor have they attested to, or reported on,
our remediation efforts.
Changes
in Internal Control Over Financial Reporting
Based on
the findings noted above, management has initiated an evaluation process and
initial remediation actions to address the material weakness as well as
significant deficiencies. These remediation efforts, which are discussed below,
are reasonably likely to materially affect our Internal Control.
Remediation
of Certain Controls Associated with the Financial Reporting and Preparation of
Financial Statements
Management
introduced new procedures in the first quarter of 2008 to address the financial
reporting issues.
These new
procedures require the Company’s financial group to collect, analyze and monitor
all necessary and relevant supporting documentation for account balances and any
adjustments. Management also introduced additional procedures to ensure a more
thorough review of financial data in the financial reporting and close process.
Management believes that these additional procedures may have effectively
remediated certain aspects of this material weakness, although management
continues to assess the efficacy of these changes.
In the
first quarter of 2008, management began to evaluate its personnel, develop a
plan to enhance the current staff’s capabilities and assess whether additional
resources with appropriate accounting knowledge and experience were required.
Management will continue to evaluate and to implement remediation efforts with
respect to the identified weaknesses. Management does not expect to be able to
report that its Internal Control is effective until it is able to remediate
these matters.
PART
II. OTHER
INFORMATION
Item
1.
|
Legal
Proceedings.
|
We may at
times be involved in litigation in the ordinary course of business. We will
also, from time to time, when appropriate in management’s estimation, record
adequate reserves in our financial statements for pending litigation. Currently,
there are no pending material legal proceedings to which we a party or to which
any of our property is subject.
We have marked with an asterisk (*)
those risk factors below that reflect material changes from the risk factors
included in our 2007 Annual Report on Form 10-K filed with the Securities and
Exchange Commission on April 2, 2008.
We
have a limited operating history on which to evaluate our company.
*
We were
founded in 2002 and became a public company in October 2003, upon our merger
with Zowcom, Inc., a publicly-traded Nevada corporation. Prior to our
acquisitions of the Netintact companies, we were a development stage company,
devoting substantially all our efforts and resources to developing and testing
new products and preparing for introduction of our products into the market
place. During this period, we generated insignificant revenues from
sales of our products. We completed our merger with Netintact on
August 18, 2006 and Netintact PTY on September 29, 2006. The products
we sell are exclusively from Netintact. While we have the experience
of Netintact operations on a stand alone basis, we have had limited operating
history on a combined basis upon which we can evaluate our business and
prospects. We have yet to develop sufficient experience regarding
actual revenues to be achieved from our combined operations.
We have
only recently launched many of our products and services on a worldwide
basis. Therefore, investors should consider the risks and
uncertainties frequently encountered by companies in new and rapidly evolving
markets, which include the following:
|
·
|
successfully
introducing new products;
|
|
·
|
successfully
servicing and upgrading new products once
introduced;
|
|
·
|
increasing
brand name recognition;
|
|
·
|
developing
new, strategic relationships and
alliances;
|
|
·
|
managing
expanding operations and sales
channels;
|
|
·
|
successfully
responding to competition; and
|
|
·
|
attracting,
retaining and motivating qualified
personnel.
|
If we are
unable to address these risks and uncertainties, our business, results of
operations and financial condition could be materially and adversely
affected.
We
expect losses for the foreseeable future.*
For the
fiscal years ending December 31, 2007, December 31, 2006 and January 1, 2006 we
had losses from operations of $13.6 million, $7.8 million and $6.7 million,
respectively. We expect to continue to incur losses from operations
for the foreseeable future. These losses will result primarily from
costs related to investment in sales and marketing, product development and
administrative expenses. Our management believes these expenditures
are necessary to build and maintain hardware and software technology and to
further penetrate the markets for our products. If our revenue growth
is slower than anticipated or our operating expenses exceed expectations, our
losses will be greater. We may never achieve
profitability.
We
may need to raise further capital.
Based on
our reserves and anticipated cash flow from operations, our working capital may
not be sufficient to meet the needs of our business through the end of
2008. However a number of factors, including, without
limitation:
|
·
|
lower
than anticipated revenues,
|
|
·
|
higher
than expected cost of goods sold or operating expenses,
or
|
|
·
|
the
inability of our customers to pay for the goods and services
ordered
|
may
negatively impact our expectations. As a result, we anticipate
raising additional funds through the issuance of equity or convertible debt
securities. If we do so, the percentage ownership of our stockholders
will be reduced, stockholders may experience additional dilution and such
securities may have rights, preferences and privileges senior to those of our
common stock. There can be no assurance that additional financing
will be available on terms favorable to us or at all. If adequate
funds are not available on acceptable terms, we may not be able to fund
expansion, take advantage of unanticipated growth or acquisition opportunities,
develop or enhance services or products or respond to competitive
pressures. In addition, we may be required to cancel product
development programs and/or lay-off employees. Such inability to
raise additional financing could have a material adverse effect on our business,
results of operations and financial condition.
Our
PacketLogic™ family of products is currently our only suite of
products. All of our current revenues and a significant portion of
our future growth depend on our ability to continue its commercialization.
*
All of
our current revenues and our anticipated future growth depend on our ability to
continue and grow the commercialization of our PacketLogic™ family of
products. We do not currently have plans or resources to develop
additional product lines, so our future growth will largely be determined by the
market’s acceptance of our PacketLogic™ products. If customers do not
adopt, purchase and deploy our PacketLogic™ products, our revenues will not grow
and may decline.
Future
financial performance will depend on the introduction and acceptance of our next
generation PacketLogic products.
We
believe our current products address the needs of small to medium sized service
providers. Our future financial performance will also depend on the
development, introduction and market acceptance of new and enhanced products
that address additional market requirements in a timely and cost-effective
manner. In the past, we have experienced delays in product development and such
delays may occur in the future.
When we
announce new products or product enhancements that have the potential to replace
or shorten the life cycle of our existing products, customers may defer
purchasing our existing products. These actions could harm our
operating results by unexpectedly decreasing sales and exposing us to greater
risk of product obsolescence.
Competition
for experienced personnel is intense and our inability to attract and retain
qualified personnel could significantly interrupt our business operations.
*
Our
future performance will depend, to a significant extent, on the ability of our
management to operate effectively, both individually and as a
group. We are dependent on our ability to attract, retain and
motivate high caliber key personnel. We have recently expanded and
plan to continue to expand in all areas and will require experienced personnel
to augment our current staff. We expect to recruit experienced
professionals in such areas as software and hardware development, sales,
technical support, product marketing and management. We currently
plan to expand our indirect channel partner program and we need to attract
qualified business partners to broaden these sales channels. Economic
conditions may result in significant competition for qualified personnel and we
may not be able to attract and retain such personnel. Our business
will suffer if it encounters delays in hiring these additional
personnel.
Our
performance is substantially dependent on the continued services and on the
performance of our executive officers and other key employees. The
loss of the services of any of our executive officers or other key employees
could materially and adversely affect our business. We believe we
will need to attract, retain and motivate talented management and other highly
skilled employees in order to execute on our business plan. We may be
unable to retain our key employees or attract, assimilate and retain other
highly qualified employees in the future. Competitors and others have
in the past, and may in the future, attempt to recruit our
employees. In California, where we are headquartered,
non-competition agreements with employees are generally
unenforceable. As a result, if a California employee leaves Procera
he or she will generally be able to immediately compete against
us.
We
currently do not have key person insurance in place. If we lose one
of the key officers, we must attract, hire, and retain an equally competent
person to take his or her place. There is no assurance that we would
be able to find such an employee in a timely fashion. If we fail to
recruit an equally qualified replacement or incur a significant delay, our
business plans may slow down or stop. We could fail to implement our
strategy or lose sales and marketing and development
momentum.
Also, we
have recently reorganized our sales and marketing efforts, including a
significant reduction in workforce in these areas and the announcement of two
new senior sales management personnel. This reduction in our
workforce may impair our ability to recruit and retain qualified employees in
the future, and there can be no assurance that these personnel additions or our
reorganization efforts will have the positive effect on our business operations
as planned by management.
We
need to increase the functionality
of our products and offer additional features in order to be competitive.
*
The
market in which we operate is highly competitive and unless we continue to
enhance the functionality of our products and add additional features, our
competitiveness may be harmed and the average selling prices for our products
may decrease over time. Such a decrease would generally result from
the introduction of competing products and from the standardization of DPI
technology. To counter this trend, we endeavor to enhance our
products by offering higher system speeds, and additional features, such as
additional protection functionality, supporting additional applications and
enhanced reporting tools. We may also need to reduce our per unit manufacturing
costs at a rate equal to or faster than the rate at which selling prices
decline. If we are unable to reduce these costs or to offer increased
functionally and features, our profitability may be adversely
affected.
Failure
to expand our sales teams or educate them about technologies and our product
families may harm our operating results. *
The sale
of our products requires a concerted effort that is frequently targeted at
several levels within a prospective customer’s organization. We may
not be able to increase net revenue unless we expand our sales teams to address
all of the customer requirements necessary to sell our products. We
have recently reorganized our sales and marketing efforts, including a
significant reduction in workforce in these areas and the addition of two senior
sales management personnel. We expect to continue hiring in this
area, but there can be no assurance that these personnel additions or our
reorganization efforts will have the positive effect on our business operations
as planned by management.
We cannot
assure you that we will be able to integrate our employees into the company or
to educate current and future employees in regard to rapidly evolving
technologies and our product families. Failure to do so may hurt our
revenue growth and operating results.
Increased
customer demands on our technical
support services may adversely affect our relationships with our customers and
our
financial
results.
We offer
technical support services with our products. We may be unable to
respond quickly enough to accommodate short-term increases in customer demand
for support services. We also may be unable to modify the format of
our support services to compete with changes in support services provided by
actual or potential competitors. Further customer demand for these
services, without corresponding revenues, could increase costs and adversely
affect our operating results. If we experience financial
difficulties, do not maintain sufficiently skilled workers and resources to
satisfy our contracts, or otherwise fail to perform at a sufficient level under
these contracts, the level of support services to our customers may be
significantly disrupted, which could materially harm our relationships with
these customers and our results of operations.
We
must continue to develop and increase the productivity of our indirect
distribution channels to increase net revenue and improve our operating
results.
A key
focus of our distribution strategy is developing and increasing the productivity
of our indirect distribution channels through resellers and
distributors. If we fail to develop and cultivate relationships with
significant resellers, or if these resellers are not able to execute on their
sales efforts, sales of our products may decrease and our operating results
could suffer. Many of our resellers also sell products from other
vendors that compete with our products. We cannot assure you that we
will be able to enter into additional reseller and/or distribution agreements or
that we will be able to manage our product sales channels. Our
failure to do any of these could limit our ability to grow or sustain
revenue. In addition, our operating results will likely fluctuate
significantly depending on the timing and amount of orders from our
resellers. We cannot assure you that our resellers and/or
distributors will continue to market or sell our products effectively or
continue to devote the resources necessary to provide us with effective sales,
marketing and technical support. Such failure would negatively affect revenue
and our potential to achieve profitability.
We
may be unable to compete effectively with other companies in our market sector
which are substantially larger and more established and have greater
resources.
We
compete in a rapidly evolving and highly competitive sector of the networking
technology market. We expect competition to persist and intensify in
the future from a number of different sources. Increased competition
could result in reduced prices and gross margins for our products and could
require increased spending by us on research and development, sales and
marketing and customer support, any of which could have a negative financial
impact on our business. We compete with Cisco Systems/P-Cube, Allot,
Ellacoya, and Sandvine, as well as other companies which sell products
incorporating competing technologies. In addition, our products and
technology compete for information technology budget allocations with products
that offer monitoring capabilities, such as probes and related
software. Lastly, we face indirect competition from companies that
offer service providers increased bandwidth and infrastructure upgrades that
increase the capacity of their networks, which may lessen or delay the need for
bandwidth management solutions.
Some of
our competitors are substantially larger than we are and have significantly
greater financial, sales and marketing, technical, manufacturing and other
resources and more established distribution channels. These
competitors may be able to respond more rapidly to new or emerging technologies
and changes in customer requirements or devote greater resources to the
development, promotion and sale of their products than we can. We
have encountered, and expect to encounter, customers who are extremely confident
in and committed to the product offerings of our
competitors. Furthermore, some of our competitors may make strategic
acquisitions or establish cooperative relationships among themselves or with
third parties to increase their ability to rapidly gain market share by
addressing the needs of our prospective customers. These competitors
may enter our existing or future markets with solutions that may be less
expensive, provide higher performance or additional features or be introduced
earlier than our solutions. Given the potential opportunity in the bandwidth
management solutions market, we also expect that other companies may enter with
alternative products and technologies, which could reduce the sales or market
acceptance of our products and services, perpetuate intense price competition or
make our products obsolete. If any technology that is competing with
ours is or becomes more reliable, higher performing, less expensive or has other
advantages over our technology, then the demand for our products and services
would decrease, which would harm our business.
If
we are unable to effectively manage our anticipated growth, we may experience
operating inefficiencies and have difficulty meeting demand for our
products.
We seek
to manage our growth so as not to exceed our available capital
resources. If our customer base and market grow rapidly, we would
need to expand to meet this demand. This expansion could place a
significant strain on our management, products and support operations, sales and
marketing personnel and other resources, which could harm our
business.
If demand
for our products and services grows rapidly, we may experience difficulties
meeting the demand. For example, the installation and use of our
products requires training. If we are unable to provide training and
support for our products, the implementation process will be longer and customer
satisfaction may be lower. In addition, our management team may not
be able to achieve the rapid execution necessary to fully exploit the market for
our products and services. We cannot assure you that our systems,
procedures or controls will be adequate to support the anticipated growth in our
operations. The failure to meet the challenges presented by rapid
customer and market expansion would cause us to miss sales opportunities and
otherwise have a negative impact on our sales and profitability.
We may
not be able to install management information and control systems in an
efficient and timely manner, and our current or planned personnel, systems,
procedures and controls may not be adequate to support our future
operations.
We
have limited ability to protect our intellectual property and defend against
claims which may adversely affect our ability to compete.
For our
primary line of PacketLogic™ products, we rely on trade secret law, contractual
rights and trademark law to protect our intellectual property
rights. We cannot assure you that the actions we have taken
will adequately protect our intellectual property rights or that other parties
will not independently develop similar or competing products that do not
infringe on our patents. We enter into confidentiality or license
agreements with our employees, consultants and corporate partners, and control
access to and distribution of our software, documentation and other proprietary
information. Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy or otherwise misappropriate or use our
products or technology.
In an
effort to protect our unpatented proprietary technology, processes and know-how,
we require our employees, consultants, collaborators and advisors to execute
confidentiality agreements. These agreements, however, may not
provide us with adequate protection against improper use or disclosure of
confidential information. These agreements may be breached, and we
may not become aware of, or have adequate remedies in the event of, any such
breach. In addition, in some situations, these agreements may
conflict with, or be subject to, the rights of third parties with whom our
employees, consultants, collaborators or advisors have previous employment or
consulting relationships. Also, others may independently develop
substantially equivalent proprietary information and techniques or otherwise
gain access to our trade secrets.
Our
industry is characterized by the existence of a large number of patents and
frequent claims and related litigation regarding patent and other intellectual
property rights. If we are found to infringe on the proprietary
rights of others, or if we agree to settle any such claims, we could be
compelled to pay damages or royalties and either obtain a license to those
intellectual property rights or alter our products so that they no longer
infringe upon such proprietary rights. Any license could be very
expensive to obtain or may not be available at all. Similarly,
changing our products or processes to avoid any claims of infringement may be
costly or impractical. Litigation resulting from claims that we are
infringing the proprietary rights of others could result in substantial costs
and a diversion of resources, and could have a material adverse effect on our
business, financial condition and results of operations.
If
we are unable to have our products manufactured quickly enough to keep up with
demand, our operating results could be harmed.
If the
demand for our products grows, we will need to increase our capacity for
material purchases, production, test and quality control
functions. Any disruptions in product flow could limit our revenue
growth and adversely affect our competitive position and reputation, and result
in additional costs or cancellation of orders under agreements with our
customers.
While our
PacketLogic products are software based, we rely on independent contractors to
manufacture the hardware components on which are products are installed and
operate. We are reliant on the performance of these contractors to meet business
demand, and may experience delays in product shipments from contract
manufacturers. Contract manufacturer performance problems may arise
in the future, such as inferior quality, insufficient quantity of products, or
the interruption or discontinuance of operations of a manufacturer, any of which
could have a material adverse effect on our business and operating
results.
We do not
know whether we will effectively manage our contract manufacturers or that these
manufacturers will meet our future requirements for timely delivery of product
components of sufficient quality and quantity. We also intend to
regularly introduce new products and product enhancements, which will require
that we rapidly achieve volume production by coordinating our efforts with those
of our suppliers and contract manufacturers. The inability of our
contract manufacturers to provide us with adequate supplies of high-quality
product components may cause a delay in our ability to fulfill orders and may
have a material adverse effect on our business, operating results and financial
condition.
As part
of our cost-reduction efforts, we will endeavor to lower per unit product costs
from our contract manufacturers by means of volume efficiencies and the
utilization of manufacturing sites in lower-cost
geographies. However, we cannot be certain when or if such price
reductions will occur. The failure to obtain such price reductions
would adversely affect our gross margins and operating results.
If
our products contain undetected software or hardware errors, we could incur
significant unexpected expenses and lose sales.
Network
products frequently contain undetected software or hardware errors, failures or
bugs when new products or new versions or updates of existing products are first
released to the marketplace. We expect that such errors or component
failures will be found from time to time in the future in new or existing
products, including the components incorporated therein, after the commencement
of commercial shipments. These problems may have a material adverse
effect on our business by causing us to incur significant warranty and repair
costs, diverting the attention of our engineering personnel from new product
development efforts, delaying the recognition of revenue and causing significant
customer relations problems. Further, if our products are not
accepted by customers due to defects, and such returns exceed the amount we
accrued for defect returns based on our historical experience, our operating
results would be adversely affected.
Our
products must properly interface with products from other vendors. As
a result, when problems occur in a computer or communications network, it may be
difficult to identify the sources of these problems. The occurrence
of hardware and software errors, whether or not caused by our products, could
result in the delay or loss of market acceptance of our products and any
necessary revisions may cause us to incur significant expenses. The
occurrence of any such problems would likely have a material adverse effect on
our business, operating results and financial condition.
Some
of our customers may not have the resources to pay for our
products.
Some of
our customers may experience serious cash flow problems and, as a result, find
it increasingly difficult to finance their operations. If some of
these customers are not able to generate sufficient revenue or securing
alternate financing arrangements, they may not be able to pay, or may delay
payment for, the amounts that they owe us. Furthermore, they may not
order as many products from us as forecast, or cancel orders entirely. The
inability of some of our potential customers to pay us for our products may
adversely affect our cash flow, the timing of our revenue recognition and the
amount of revenue, which may cause our stock price to decline.
Sales
of our products to large service
providers can involve a lengthy sales cycle, which may cause our revenues to
fluctuate from period to
period
and could result in us expending
significant resources without making any sales.
*
Our sales
cycles are generally lengthy, as our customers undertake significant testing to
assess the performance of our products within their networks. As a result, we
may invest significant time from initial contact with a customer until that
end-customer decides to incorporate our products in its network. We
may also expend significant resources attempting to persuade large service
providers to incorporate our products into their networks without any measure of
success. Even after deciding to purchase our products, initial
network deployment of our products by a large service provider may last several
years. Carriers, especially in North America, often require that
products they purchase meet Network Equipment Building System (NEBS)
certification requirements, which relate the reliability of telecommunications
equipment. While our PacketLogic™ products and future products are
and are expected to be designed to meet NEBS certification requirements, they
may fail to do so.
Due to
our lengthy sales cycle, particularly to larger customers, and our
revenue recognition practices, we expect our revenue may fluctuate dramatically
from period to period. In pursuing sales opportunities larger
enterprises, we expect that we will make fewer sales to larger entities, but
that the magnitude of individual sales will be greater. As
such, when we recognize a large sale, particularly given our small size, we may
report rapid revenue growth in the period that the revenue from the large sale
was recognized larger, which may not be repeated in an immediately subsequent
period. As such, our revenues could fluctuate dramatically from period to
period, which could cause the price of our common stock to similarly
fluctuate. In addition, even once we have received commitments from a
customer to purchase our products, in accordance with our revenue recognition
practices we may not be able to recognize and report the revenue from that
purchase for months or years. As a result, there could be significant
delays in our receipt and recognition of revenue following sales orders for our
products
In
addition, if a competitor succeeds in convincing a large service provider to
adopt that competitor’s product, it may be difficult for us to displace the
competitor because of the cost, time, effort and perceived risk to network
stability involved in changing solutions. As a result we may incur significant
expense without generating any sales.
Our
operating results could be adversely affected by product sales occurring outside
the United States and fluctuations in the value of the United States Dollar
against foreign currencies.
A
significant percentage of PacketLogic™ sales are generated outside of the United
States. PacketLogic™ sales and operating expenses denominated in foreign
currencies could affect our operating results as foreign currency exchange rates
fluctuate. Changes in exchange rates between these foreign currencies and the
U.S. Dollar will affect the recorded levels of our assets and liabilities as
foreign assets and liabilities are translated into U.S. Dollars for presentation
in our financial statements, as well as our net sales, cost of goods sold, and
operating margins. The primary foreign currencies in which we have exchange rate
fluctuation exposure are the European Union Euro, the Swedish Krona and the
Australian Dollar. As we expand, we could be exposed to exchange rate
fluctuations in other currencies. Exchange rates between these currencies and
U.S. Dollars have fluctuated significantly in recent years and may do so in the
future. Hedging foreign currencies can be difficult. We cannot predict the
impact of future exchange rate fluctuations on our operating results. We
currently do not hedge any foreign currencies
Legislative
actions, higher insurance costs and new accounting pronouncements are likely to
impact our future financial position and results of operations.
Legislative
and regulatory changes and future accounting pronouncements and regulatory
changes have and will continue to have an impact on our future financial
position and results of operations. In addition,
insurance costs, including health and workers’ compensation insurance premiums,
have been increasing on an historical basis and are likely to continue to
increase in the future. Recent and future pronouncements associated
with expensing executive compensation and employee stock option may also impact
operating results. These and other potential changes could materially
increase the expenses we report under generally accepted accounting principles,
and adversely affect our operating results.
Our
internal controls may be insufficient to ensure timely and reliable financial
information.*
Effective
internal controls over financial reporting are necessary for us to provide
reliable financial reports and effectively prevent fraud. We believe
we need to correct a material weakness and significant deficiencies in our
internal controls and procedures for financial reporting. A company’s
internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that:
|
·
|
pertain
to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the
company;
|
|
·
|
provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of management and
directors of the company; and
|
|
·
|
provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the company’s assets that
could have a material effect on the financial
statements.
|
A
material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected.
We
described a material weakness and significant deficiencies with our internal
controls under Item 9A of our Annual Report for the year ended December 31,
2007, as follows:
Material
Weakness
|
·
|
We
did not complete our annual report 10-K and financial reports in
sufficient time to allow for review and comment, which resulted in a
significant number of last minute changes and could have resulted in
material errors to the financial
statements.
|
Significant
Deficiencies
|
·
|
We
did not formally document many of the reviews conducted by the financial
department in the processing and preparation of the company financial
statements; these processes include journal entries, account
reconciliations, consolidations, equity reconciliations, disclosure
checklists and tax return
preparation;
|
|
·
|
the
company did not conduct sufficient testing in 2007 to satisfy COSO
requirements for an accelerated
filer;
|
|
·
|
we
did not have an adequate control over shipments and receipts of goods and
services;
|
|
·
|
we
did not have sufficient segregation of duties over a variety of financial
processes;
|
|
·
|
we
did not maintain Human Resource documents current in such areas as job
descriptions, employee handbooks, training, compensation and performance
reviews;
|
|
·
|
we
did not have in place a detailed budget versus actual review process for
departmental management;
|
|
·
|
we
do not have a “financial expert’ on the audit committee as defined by
Section 407 of SOX; and
|
|
·
|
the
Whistleblower contact is not a person independent
person.
|
Our
management concluded that, as of December 31, 2007, our internal control over
financial reporting was not effective.
Failure
to address the identified weakness and deficiencies in a timely manner might
increase the risk of future financial reporting misstatements and may prevent us
from being able to meet our filing deadlines with the SEC. Under the supervision
of our Audit Committee, we are continuing the process of identifying and
implementing corrective actions where required to improve the design and
effectiveness of our internal control over financial reporting, including the
enhancement of systems and procedures. Significant additional
resources will be required to establish and maintain appropriate controls and
procedures and to prepare the required financial and other information during
this process.
Even
after corrective actions are implemented, the effectiveness of our controls and
procedures may be limited by a variety of risks including:
|
·
|
faulty
human judgment and simple errors, omissions or
mistakes;
|
|
·
|
collusion
of two or more people;
|
|
·
|
inappropriate
management override of procedures;
and
|
|
·
|
the
risk that enhanced controls and procedures may still not be adequate to
assure timely and reliable financial
information.
|
If we
fail to have effective internal controls and procedures for financial reporting
in place, we could be unable to provide timely and reliable financial
information. Additionally, if we fail to have effective internal controls and
procedures for financial reporting in place, it could adversely affect our
financial reporting requirements under future government contracts.
Accounting
charges may cause fluctuations in our annual and quarterly financial
results.
Our
financial results may be materially affected by non-cash and other accounting
charges. Such accounting charges may include:
|
·
|
amortization
of intangible assets, including acquired product
rights;
|
|
·
|
impairment
of goodwill;
|
|
·
|
stock-based
compensation expense; and
|
|
·
|
impairment
of long-lived assets.
|
The
foregoing types of accounting charges may also be incurred in connection with or
as a result of business acquisitions. The price of our common stock
could decline to the extent that our financial results are materially affected
by the foregoing accounting charges. Our effective tax rate may
increase, which could increase our income tax expense and reduce our net
income. Our effective tax rate could be adversely affected by several
factors, many of which are outside of our control, including:
|
·
|
changes
in the relative proportions of revenues and income before taxes in the
various jurisdictions in which we operate that have differing statutory
tax rates,
|
|
·
|
changing
tax laws, regulations and interpretations in multiple jurisdictions in
which we operate, as well as the requirements of certain tax
rulings,
|
|
·
|
changes
in accounting and tax treatment of stock-based
compensation,
|
|
·
|
the
tax effects of purchase accounting for acquisitions and restructuring
charges that may cause fluctuations between reporting periods,
and
|
|
·
|
tax
assessments, or any related tax interest or penalties, which could
significantly affect our income tax expense for the period in which the
settlements take place.
|
The price
of our common stock could decline to the extent that our financial results are
materially affected by the foregoing.
Our
headquarters are located in Northern California where disasters may occur that
could disrupt our operations and harm our business.
Our
corporate headquarters are located in Silicon Valley in Northern
California. Historically, this region has been vulnerable to natural
disasters and other risks, such as earthquakes, which at times have disrupted
the local economy and posed physical risks to us and our local
suppliers. In addition, terrorist acts or acts of war targeted at the
United States, and specifically Silicon Valley, could cause damage or disruption
to us, our employees, facilities, partners, suppliers, distributors and
resellers, and customers, which could have a material adverse effect on our
operations and financial results. We currently have significant
redundant capacity in Sweden in the event of a natural disaster or catastrophic
event in Silicon Valley. In the event of such an occurrence, our
business could nonetheless suffer. The operations in Sweden are
subject to disruption by extreme winter weather.
Acquisitions
may disrupt or otherwise have a negative impact on our
business. *
We may
seek to acquire or make investments in complementary businesses, products,
services or technologies on an opportunistic basis when we believe they will
assist us in executing our business strategy. Growth through
acquisitions has been a viable strategy used by other network control and
management technology companies. In 2006, we completed mergers with
the Netintact entities. These and any future acquisitions could
distract our management and employees and increase our expenses.
In
addition, following any acquisition, including our merger with the Netintact
entities, the integration of the acquired business, product, service or
technology is complex, time consuming and expensive, and may disrupt our
business. These challenges include the timely and efficient execution
of a number of post-transaction integration activities, including:
|
·
|
integrating
the operations and technologies of the two
companies;
|
|
·
|
retaining
and assimilating the key personnel of each
company;
|
|
·
|
retaining
existing customers of both companies and attracting additional
customers;
|
|
·
|
leveraging
our existing sales channels to sell new products into new
markets;
|
|
·
|
developing
an appropriate sales and marketing organization and sales channels to sell
new product into new markets;
|
|
·
|
retaining
strategic partners of each company and attracting new strategic partners;
and
|
|
·
|
implementing
and maintaining uniform standards, internal controls, processes,
procedures, policies and information
systems.
|
The
process of integrating operations and technology could cause an interruption of,
or loss of momentum in, our business and the loss of key personnel. The
diversion of management’s attention and any delays or difficulties encountered
in connection with an acquisition and the integration of our operations and
technology could have an adverse effect on our business, results of operations
or financial condition. Furthermore, the execution of these post-transaction
integration activities will involve considerable risks and may not come to pass
as we envision. The inability to integrate the operations, technology
and personnel of an acquired business with ours, or any significant delay in
achieving integration, could have a material adverse effect on our business and,
as a result, on the market price of our common stock.
Furthermore,
we issued equity securities to pay for the Netintact acquisitions which had a
dilutive effect on its existing shareholders and we may have to incur debt or
issue equity securities to pay for any future acquisitions, the issuance of
which could be dilutive to our existing stockholders.
Risks
Related to Our Industry
Demand
for our products depends in part on the rate of adoption of bandwidth-intensive
broadband applications, such as peer-to-peer, or P2P, and latency-sensitive
applications, such as voice-over-Internet protocol, or VoIP, Internet video and
online video gaming applications. *
Our
products are used by service providers and enterprises to provide awareness,
control and protection of internet traffic by examining and identifying packets
of data as they pass an inspection point in the network, particularly
bandwidth-intensive applications that cause congestion in broadband networks and
impact the quality of experience of users. In addition to the general increase
in applications delivered over broadband networks that require large amounts of
bandwidth, such as P2P applications, demand for our products is driven
particularly by the growth in applications which are highly sensitive to network
delays and therefore require efficient network management. These applications
include VoIP, Internet video and online video gaming applications. If the rapid
growth in adoption of VoIP and in the popularity of Internet video and online
video gaming applications does not continue, the demand for our products may not
grow as anticipated.
If
the bandwidth management solutions market fails to grow, our business will be
adversely affected.
The
market for bandwidth management solutions is in an early stage of
development. We cannot accurately predict the future size of the
market, the products needed to address the market, the optimal distribution
strategy, or the competitive environment that will develop. In order
for us to execute our strategy, our potential customers must recognize the value
of more sophisticated bandwidth management solutions, decide to invest in the
management of their networks and the performance of important business software
applications and, in particular, adopt our bandwidth management
solutions. The growth of the bandwidth management solutions market
also depends upon a number of factors, including the availability of inexpensive
bandwidth, especially in international markets, and the growth of wide area
networks. The failure of the market to rapidly grow would adversely
affect our sales and sales prospects, leading to sustained financial losses and
a decline in the trading price of our common stock.
The
market for our products in the network provider market is still emerging and our
growth may be harmed if carriers do not adopt DPI solutions. *
The
market for DPI technology is still emerging and the majority of our sales to
date have been to small and midsize service providers and enterprises. We
believe that the Tier 1 carriers, as well as cable and mobile operators, present
a significant market opportunity and are an important element of our long term
strategy, but they are still in the early stages of adopting and evaluating the
benefits and applications of DPI technology. Carriers may decide that
full visibility into their networks or highly granular control over content
based applications is not critical to their business. They may also
determine that certain applications, such as VoIP or video, can be adequately
prioritized in their networks by using router and switch infrastructure products
without the use of DPI technology. They may also, in some instances, face
regulatory constraints that could change the characteristics of the
markets. Carriers may also seek an embedded DPI solution in capital
equipment devices such as routers rather than the stand-alone solution offered
by us. Furthermore, widespread adoption of our products by carriers
will require that they migrate to a new business model based on offering
subscriber and application-based tiered services. If carriers decide not to
adopt DPI technology, our market opportunity would be reduced and our growth
rate may be harmed.
The
network equipment market is subject to rapid technological progress and to
compete we must continually introduce new products or upgrades that achieve
broad market acceptance.
The
network equipment market is characterized by rapid technological progress,
frequent new product introductions, changes in customer requirements and
evolving industry standards. If we do not regularly introduce new
products or upgrades in this dynamic environment, our product lines will become
obsolete. Developments in routers and routing software could also
significantly reduce demand for our products. Alternative
technologies could achieve widespread market acceptance and displace the
technology on which we have based our product architecture. We cannot
assure you that our technological approach will achieve broad market acceptance
or that other technology or devices will not supplant our products and
technology.
Our
products must comply with evolving industry standards and complex government
regulations or else our products may not be widely accepted, which may prevent
us from growing our net revenue or achieving profitability.
The
market for network equipment products is characterized by the need to support
new standards as they emerge, evolve and achieve acceptance. We will
not be competitive unless we continually introduce new products and product
enhancements that meet these emerging standards. We may not be able to
effectively address the compatibility and interoperability issues that arise as
a result of technological changes and evolving industry
standards. Our products must be compliant with various United States
federal government requirements and regulations and standards defined by
agencies such as the Federal Communications Commission, in addition to standards
established by governmental authorities in various foreign countries and
recommendations of the International Telecommunication
Union. If we do not comply with existing or evolving industry
standards or if we fail to obtain timely domestic or foreign regulatory
approvals or certificates we will not be able to sell our products where these
standards or regulations apply, which may prevent us from sustaining our net
revenue or achieving profitability.
Risks
Related to Ownership of Our Common Stock
Our
common stock price is likely to be highly volatile.
The
market price of our common stock is likely to be highly volatile as is the stock
market in general, and the market for small cap and micro cap technology
companies, such as Procera, in particular, has been highly
volatile. For example, since January 1, 2008, the closing price of
our common stock has ranged from a high of $0.90 per share to a low of $2.07 per
share. Investors may not be able to resell their shares of our
common stock following periods of volatility because of the market’s adverse
reaction to volatility. In addition our stock is thinly
traded. We cannot assure you that our stock will trade at the same
levels of other stocks in our industry or that in general, stocks in our
industry will sustain their current market prices. Factors that could
cause such volatility may include, among other things:
|
·
|
actual
or anticipated fluctuations in our quarterly operating
results;
|
|
·
|
announcements
of technological innovations by our
competitors;
|
|
·
|
changes
in financial estimates by securities
analysts;
|
|
·
|
conditions
or trends in the network control and management
industry;
|
|
·
|
changes
in the market valuations of other such industry related
companies;
|
|
·
|
the
acceptance by institutional investors of our
stock;
|
|
·
|
rumors,
announcements or press articles regarding our operations, management,
organization, financial condition or financial
statements;
|
|
·
|
our
gain or loss of a significant customer;
or
|
|
·
|
the
stock market in general, and the market prices of stocks of technology
companies in particular, have experienced extreme price volatility that
has adversely affected, and may continue to adversely affect, the market
price of our common stock for reasons unrelated to our business or
operating results.
|
Holders
of our common stock may be diluted in the future. *
We are
authorized to issue up to 130,000,000 shares of common stock and 15,000,000
shares of preferred stock. Our Board of Directors will have the ability, without
seeking stockholder approval, to issue additional shares of common stock and/or
preferred stock in the future for such consideration as our Board of Directors
may consider sufficient. The issuance of additional common stock
and/or preferred stock in the future will reduce the proportionate ownership and
voting power of our common stock held by existing stockholders. At
March 31, 2007 there were 76,384,292, shares of common stock outstanding,
warrants to purchase 7,729,534 shares of common stock, and stock options to
purchase 8,871,908 shares of common stock. In addition, there are
ungranted stock options to purchase 3,159,635 shares of common stock pursuant to
our stock option plans.
Of all
our outstanding warrants, warrants exercisable for 4,993,233 shares of our
common stock at a weighted average exercise price of $1.30 will expire before
July 31, 2008. On May 9, 2008, the last reported exercise price
of one share of our common stock was $1.86. Since the per share
exercise price of these outstanding warrants is currently lower than the current
market price of our common stock, it is likely that the holders of these
warrants will exercise them prior to their expiration on or before July 31,
2008. The shares of common stock issuable on exercise of these
warrants are currently registered for immediate re-sale under an effective
registration statement. If the holders of these expiring warrants
exercise them and immediately sell the resulting shares, it could cause the
price of our common stock to decline.
Any
future issuances of our common stock would similarly dilute the relative
ownership interest of our current stockholders, and could also cause the trading
price of our common stock to decline.
Shares
eligible for future sale by our current stockholders may adversely affect our
stock price.
Sales of
substantial amounts of common stock, including shares issued upon the exercise
of outstanding options and warrants, could adversely affect the prevailing
market price of our common stock and could impair our ability to raise capital
at that time through the sale of our securities.
Sales of
a substantial number of shares of common stock after the date of this report
could adversely affect the market price of our common stock and could impair our
ability to raise capital through the sale of additional equity
securities. As of March 31, 2008, we had 76,384,292 shares of common
stock outstanding.
As of
March 31, 2007, we have warrants outstanding that are exercisable for the
purchase of an aggregate of 7,729,534 shares of our common stock, and
outstanding options that are exercisable for the purchase of an aggregate of
8,871,908 shares of our common stock. If, and to the
extent, outstanding options or warrants are exercised, or additional shares
are issued to the former shareholders of Netintact, you will experience dilution
to your holdings. In addition, shares issuable upon exercise of our
outstanding warrants and stock options may be immediately sold pursuant to an
effective registration statement. If a warrant or option holder
exercises a warrant or an option at an exercise price that is less than the
current market value of our common stock, the holder may be motivated to
immediately sell the resulting shares to realize an immediate gain, which could
cause the trading price of our common stock to decline.
The
American Stock Exchange may delist our securities, causing our shares to become
“penny stock,” which could limit investors’ ability to transact in our
securities and subject us to additional trading restrictions.*
Our
shares of common stock are listed on the American Stock
Exchange. Maintaining our listing on the American Stock Exchange
requires that we fulfill certain continuing listing standards including a
minimum share price of $3.00 and corporate governance
requirements. If the American Stock Exchange delists our securities
from trading, we could face significant consequences, including:
|
·
|
a
limited availability for market quotations for our
securities;
|
|
·
|
reduced
liquidity with respect to our
securities;
|
|
·
|
a
determination that our ordinary share is a “penny stock,” which will
require brokers trading in our ordinary shares to adhere to more stringent
rules and possibly result in a reduced level of trading activity in the
secondary trading market for our ordinary
shares;
|
|
·
|
limited
amount of news and analyst coverage for our company;
and
|
|
·
|
a
decreased ability to issue additional securities or obtain additional
financing in the future.
|
In
addition, we would no longer be subject to American Stock Exchange rules,
including rules requiring us to have a certain number of independent directors
and to meet other corporate governance standards. Our failure to be
listed on the American Stock Exchange or another established securities market
would have a material adverse effect on the value of your investment in
us.
If our
common stock is not listed on the American Stock Exchange or another national
exchange, the trading price of our common stock is below $5.00 per share and we
have net tangible assets of $5,000,000 or less, the open-market trading of our
common stock will be subject to the “penny stock” rules promulgated under the
Securities Exchange Act of 1934. If our shares become subject to the
“penny stock” rules, broker-dealers may find it difficult to effectuate customer
transactions and trading activity in our securities may be adversely
affected. Under these rules, broker-dealers who recommend such
securities to persons other than institutional accredited investors
must:
|
·
|
make
a special written suitability determination for the
purchaser;
|
|
·
|
receive
the purchaser’s written agreement to the transaction prior to
sale;
|
|
·
|
provide
the purchaser with risk disclosure documents which identify certain risks
associated with investing in “penny stocks” and which describe the market
for these “penny stocks” as well as a purchaser’s legal remedies;
and
|
|
·
|
obtain
a signed and dated acknowledgment from the purchaser demonstrating that
the purchaser has actually received the required risk disclosure document
before a transaction in a “penny stock” can be
completed.
|
As a
result of these requirements, the market price of our securities may be
depressed, and you may find it more difficult to sell our
securities.
Nevada
law and our articles of incorporation and bylaws contain provisions that may
discourage, delay or prevent a change in our management team that our
stockholders may consider favorable or otherwise have the potential to impact
our stockholders’ ability to control our company
.*
Nevada
law and our articles of incorporation and bylaws
contain
provisions that may have the effect of preserving our current management or may
impact our stockholders’ ability to control our company, such as:
|
·
|
authorizing
the issuance of “blank check” preferred stock without any need for action
by stockholders;
|
|
·
|
eliminating
the ability of stockholders to call special meetings of
stockholders;
|
|
·
|
restricting
the ability of stockholders to take action by written consent;
and
|
|
·
|
establishing
advance notice requirements for nominations for election to the board of
directors or for proposing matters that can be acted on by stockholders at
stockholder meetings.
|
These
provisions could allow our board of directors to affect your rights as a
stockholder since our board of directors can make it more difficult for common
stockholders to replace members of the board. Because our board of
directors is responsible for appointing the members of our management team,
these provisions could in turn affect any attempt to replace our current
management team. In addition, the issuance of preferred stock could
make it more difficult for a third party to acquire us and may impact the rights
of common stockholders. All of the foregoing could adversely affect
your rights as a stockholder of our company and/or prevailing market prices for
our common stock.
To date,
we have not paid any cash dividends and no cash dividends will be paid in the
foreseeable future.
We do not
anticipate paying cash dividends on our common stock in the foreseeable future,
and we cannot assure an investor that funds will be legally available to pay
dividends, or that, even if the funds are legally available, the dividends will
be paid.
Item 2.
|
Unregistered
Sales of Equity Securities and Use of
Proceeds.
|
None.
Item 3.
|
Defaults
Upon Senior Securities.
|
Not
applicable.
Item 4.
|
Submission
of
Matters to a Vote of Security
Holders.
|
The
Company’s Annual Meeting of Stockholders was held on January 30, 2008 (“Annual
Meeting”). A total of 64,672,823 shares of common stock, or 85% of
the outstanding shares, were represented in person or by proxy. The
results of the matters voted on at the Annual Meeting are as
follows:
(1)
a proposal to elect (a) two directors to serve as directors for one year and
until their respective successors are elected, (b) two directors to serve as
directors for a term of two years and until their respective successors are
elected and (c) two directors to serve as directors for a term of three years
and until their respective successors are elected;
However,
if proposal 5 is approved, the terms of all directors will expire immediately
prior to the election of directors at the next annual meeting and directors will
stand annually for election beginning thereafter;
|
|
Number
of Shares
|
|
Name
|
|
|
For
|
|
Withheld
|
|
Staffan
Hillberg
|
|
|
60,343,932
|
|
4,328,891
|
|
Mary
Losty
|
|
|
60,338,432
|
|
4,334,391
|
|
Scott
McClendon
|
|
|
64,432,902
|
|
239,921
|
|
Tom
Saponas
|
|
|
60,345,732
|
|
4,327,091
|
|
Thomas
Williams
|
|
|
64,436,372
|
|
236,451
|
|
Sven
Nowicki
|
|
|
60,346,402
|
|
4,326,421
|
|
The
nominated directors were elected.
(2) a
proposal to approve and adopt the Company’s 2007 Equity Incentive
Plan;
For
|
|
Against
|
|
Abstain
|
|
Broker
Non Votes
|
42,170,000
|
|
1,688,511
|
|
268,000
|
|
20,546,312
|
The 2007
Equity Incentive Plan was approved.
(3) a
proposal to ratify the selection by the Audit Committee of PMB Helin Donovan,
LLP as independent auditors of the company for its fiscal year ending December
31, 2007;
For
|
|
Against
|
|
Abstain
|
64,293,605
|
|
172,907
|
|
206,311
|
The
selection was ratified.
(4) a
proposal to approve an amendment to the Company’s Articles of Incorporation to
increase the authorized number of shares from 100,000,000 to 130,000,000;
and
For
|
|
Against
|
|
Abstain
|
|
Broker
Non Votes
|
42,135,994
|
|
1,925,017
|
|
65,500
|
|
20,546,312
|
The
amendment was approved.
(5) a
proposal to approve an amendment to the Company’s Articles of Incorporation to
declassify the Board of Directors.
For
|
|
Against
|
|
Abstain
|
63,918,395
|
|
318,513
|
|
435,915
|
The
amendment was approved.
Item 5.
|
Other
Information.
|
Subsequent
Event
On May 6,
2008, we issued 17, 500 unregistered shares of our common stock to a warrant
holder upon the cash exercise of the warrant by the holder at a per share
exercise price of $1.25, for net proceeds to us of $21,875.
On May 7,
2008, we issued 37,500 unregistered shares of our common stock to a warrant
holder upon the cash exercise of the warrant by the holder at a per share
exercise price of $1.25, for net proceeds to us of $46,875.
On May 7,
2008, we issued 37,500 unregistered shares of our common stock to a warrant
holder upon the cash exercise of the warrant by the holder at a per share
exercise price of $1.37, for net proceeds to us of $51,375.
On May 9,
2008, we issued 297,500 unregistered shares of our common stock to a warrant
holder upon the cash exercise of the warrant by the holder at a per share
exercise price of $1.25, for net proceeds to us of $371,875.
On May 9,
2008, we issued 277,500 unregistered shares of our common stock to a warrant
holder upon the cash exercise of the warrant by the holder at a per share
exercise price of $1.37, for net proceeds to us of $380,175.
For each
of the foregoing issuances, we relied on the exemption provided by Section 4(2)
of the Securities Act of 1933, as amended.
3.1
|
|
Articles
of Incorporation included as Exhibit 3.1 to our form SB-2 filed on
February 11, 2002 and incorporated herein by reference.
|
|
|
3.2
|
|
Certificate
of Amendment to Articles of Incorporation filed on October 13, 2005
included as Exhibit 99.1 to our form 8-K filed on October 12, 2005 and
incorporated herein by reference.
|
|
|
|
3.3
|
|
Certificate
of Amendment to Articles of Incorporation filed on April 28,
2008.*
|
|
|
3.4
|
|
Amended
and Restated Bylaws adopted on August 16, 2007.*
|
|
|
4.1
|
|
Form
of Subscription Agreement for July 2007 offering included as Exhibit 10.1
to our form 8-K filed on July 17, 2007 and incorporated herein
by reference.
|
|
|
4.2
|
|
Form
of Registration Rights Agreement for July 2007 offering included as
Exhibit 10.2 to our form 8-K filed on July 17, 2007 and incorporated
herein by reference.
|
|
|
4.3
|
|
Form
of Warrant Agreement for July 2007 offering included as Exhibit 4.3 to our
form SB-2 filed on October 5, 2007 and incorporated herein by
reference.
|
|
|
4.4
|
|
Form
of Subscription Agreement for November 2006 offering included as Exhibit
2.1 to our form 8-K filed on November 30, 2006 and incorporated
herein by reference.
|
|
|
4.5
|
|
Form
of Registration Rights Agreement for November 2006 offering included as
Exhibit 2.3 to our form 8-K filed on November 30, 2006 and incorporated
herein by reference.
|
|
|
4.6
|
|
Form
of Warrant agreement for November 2006 offering included as Exhibit 2.2 to
our form 8-K filed on November 30, 2006 and incorporated herein by
reference.
|
|
|
4.7
|
|
Form
of Subscription Agreement for February 2006 offering included as Exhibit
10.1 to our form 8-K filed on March 1, 2006 and incorporated
herein by reference.
|
|
|
4.8
|
|
Form
of Amendment to Stock Subscription Agreement for February 2006 offering
included as Exhibit 10.2 to our form 8-K filed on March 1, 2006 and
incorporated herein by reference.
|
|
|
4.9
|
|
Form
of Registration Rights Agreement for February 2006 offering included as
Exhibit 10.4 to our on Form 8-K filed on March 1, 2006 and incorporated
herein by reference.
|
|
|
4.10
|
|
Form
of Subscription Agreement for December 2004 offering included as Exhibit
10.1 to our form 8-K filed on January 4, 2005 and incorporated
herein by reference.
|
|
|
4.11
|
|
Form
of Registration Rights Agreement for December 2004 offering included as
Exhibit 10.2 to our form 8-K filed on January 4, 2005 and
incorporated herein by reference.
|
|
|
4.12
|
|
Form
of Warrant agreement for December 2004 offering included as Exhibit 10.3
to our current report form 8-K filed on January 4, 2005 and incorporated
herein by reference.
|
|
|
4.13
|
|
Form
of Subscription Agreement for June 2003 offering included as Exhibit 4.13
to our form SB-2 filed on October 5, 2007 and incorporated herein by
reference.
|
|
|
4.14
|
|
Form
of Registration Rights Agreement for June 2003 offering included as
Exhibit 4.14 to our form SB-2 filed on October 5, 2007 and incorporated
herein by reference.
|
|
|
4.15
|
|
Form
of Warrant Agreement for June 2003 offering included as Exhibit 4.15 to
our form SB-2 filed on October 5, 2007 and incorporated herein by
reference.
|
|
|
+10.1
|
|
2007
Equity Incentive Plan.*
|
|
|
|
+10.2
|
|
Executive
Employment Agreement for James F. Brear dated as of February 11,
2008.*
|
31.1
|
|
Certification
of James F. Brear, Principal Executive Officer, pursuant to Rule 13a-14(a)
or 15d-14(a) of the Securities and
Exchange
Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.*
|
|
|
31.2
|
|
Certification
of Thomas H. Williams, Principal Financial Officer, pursuant to Rule
13a-14(a) or 15d-14(a) of the Securities and Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.*
|
|
|
32.1
|
|
Certification
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, executed by James F.
Brear, Principal Executive Officer, and Thomas H. Williams, Principal
Financial Officer.*
|
*
|
Filed concurrently
herewith.
|
+
|
Indicates
management contract or compensatory plan or
arrangement.
|
SIGNATURES
Pursuant
to the requirements 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.
|
|
|
|
Procera
Networks, Inc.
|
|
|
|
|
By:
|
|
Date:
May 12, 2008
|
|
Thomas
H. Williams, Chief Financial Officer
|
|
|
(Principal
Financial Officer)
|
Exhibit
Index
3.1
|
|
Articles
of Incorporation included as Exhibit 3.1 to our form SB-2 filed on
February 11, 2002 and incorporated herein by reference.
|
|
|
3.2
|
|
Certificate
of Amendment to Articles of Incorporation filed on October 13, 2005
included as Exhibit 99.1 to our form 8-K filed on October 12, 2005 and
incorporated herein by reference.
|
|
|
|
|
|
Certificate
of Amendment to Articles of Incorporation filed on April 28,
2008.*
|
|
|
|
|
Amended
and Restated Bylaws adopted on August 16, 2007.*
|
|
|
4.1
|
|
Form
of Subscription Agreement for July 2007 offering included as Exhibit 10.1
to our form 8-K filed on July 17, 2007 and incorporated herein
by reference.
|
|
|
4.2
|
|
Form
of Registration Rights Agreement for July 2007 offering included as
Exhibit 10.2 to our form 8-K filed on July 17, 2007 and incorporated
herein by reference.
|
|
|
4.3
|
|
Form
of Warrant Agreement for July 2007 offering included as Exhibit 4.3 to our
form SB-2 filed on October 5, 2007 and incorporated herein by
reference.
|
|
|
4.4
|
|
Form
of Subscription Agreement for November 2006 offering included as Exhibit
2.1 to our form 8-K filed on November 30, 2006 and incorporated
herein by reference.
|
|
|
4.5
|
|
Form
of Registration Rights Agreement for November 2006 offering included as
Exhibit 2.3 to our form 8-K filed on November 30, 2006 and incorporated
herein by reference.
|
|
|
4.6
|
|
Form
of Warrant agreement for November 2006 offering included as Exhibit 2.2 to
our form 8-K filed on November 30, 2006 and incorporated herein by
reference.
|
|
|
4.7
|
|
Form
of Subscription Agreement for February 2006 offering included as Exhibit
10.1 to our form 8-K filed on March 1, 2006 and incorporated
herein by reference.
|
|
|
4.8
|
|
Form
of Amendment to Stock Subscription Agreement for February 2006 offering
included as Exhibit 10.2 to our form 8-K filed on March 1, 2006 and
incorporated herein by reference.
|
|
|
4.9
|
|
Form
of Registration Rights Agreement for February 2006 offering included as
Exhibit 10.4 to our on Form 8-K filed on March 1, 2006 and incorporated
herein by reference.
|
|
|
4.10
|
|
Form
of Subscription Agreement for December 2004 offering included as Exhibit
10.1 to our form 8-K filed on January 4, 2005 and incorporated
herein by reference.
|
|
|
4.11
|
|
Form
of Registration Rights Agreement for December 2004 offering included as
Exhibit 10.2 to our form 8-K filed on January 4, 2005 and
incorporated herein by reference.
|
|
|
4.12
|
|
Form
of Warrant agreement for December 2004 offering included as Exhibit 10.3
to our current report form 8-K filed on January 4, 2005 and incorporated
herein by reference.
|
|
|
4.13
|
|
Form
of Subscription Agreement for June 2003 offering included as Exhibit 4.13
to our form SB-2 filed on October 5, 2007 and incorporated herein by
reference.
|
|
|
4.14
|
|
Form
of Registration Rights Agreement for June 2003 offering included as
Exhibit 4.14 to our form SB-2 filed on October 5, 2007 and incorporated
herein by reference.
|
|
|
4.15
|
|
Form
of Warrant Agreement for June 2003 offering included as Exhibit 4.15 to
our form SB-2 filed on October 5, 2007 and incorporated herein by
reference.
|
|
|
|
|
2007
Equity Incentive Plan.*
|
|
|
|
|
Executive
Employment Agreement for James F. Brear dated as of February 11,
2008.*
|
|
|
|
|
Certification
of James F. Brear, Principal Executive Officer, pursuant to Rule 13a-14(a)
or 15d-14(a) of the Securities and
Exchange
Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.*
|
|
|
|
|
Certification
of Thomas H. Williams, Principal Financial Officer, pursuant to Rule
13a-14(a) or 15d-14(a) of the Securities and Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.*
|
|
|
|
|
Certification
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, executed by James F.
Brear, Principal Executive Officer, and Thomas H. Williams, Principal
Financial Officer.*
|
____________
*
|
Filed concurrently
herewith.
|
+
|
Indicates
management contract or compensatory plan or
arrangement.
|
39
Procera Networks, Inc. (AMEX:PKT)
Historical Stock Chart
From Jul 2024 to Aug 2024
Procera Networks, Inc. (AMEX:PKT)
Historical Stock Chart
From Aug 2023 to Aug 2024