UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
x
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period ended June 30, 2010
or
¨
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the transition period from
to
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Commission File Number: 000-49862
PROCERA NETWORKS, INC.
(Exact name of registrant as specified in its charter)
Nevada
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33-0974674
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(State or other jurisdiction of incorporation or organization)
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(I.R.S. employer identification number)
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100-C Cooper Court, Los Gatos, California
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95032
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(Address of principal executive offices)
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(Zip code)
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(408) 890-7100
(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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes
o
No
o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See 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
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Accelerated filer
T
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Non-accelerated filer
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Smaller reporting company
£
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(Do not check if a smaller reporting company)
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes
£
No
þ
As of August 6, 2010, the registrant had 112,082,724 shares of its common stock, par value $0.001, outstanding.
PR
OCERA NETWORKS, INC.
INDEX
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Page
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PART I. FINANCIAL INFORMATION
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Item 1.
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Consolidated Financial Statements
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PART II. OTHER INFORMATION
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PART I. FINANCIAL INFORMATION
Item 1.
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Consolidated Financial Statements
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Pr
ocera Networks, Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
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June 30, 2010
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December 31, 2009
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(Unaudited)
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ASSETS
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Current Assets:
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Cash and cash equivalents
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Accounts receivable, less allowance of $286,002 and $281,140 at June 30, 2010 and December 31, 2009, respectively
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Prepaid expenses and other
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Property and equipment, net
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LIABILITIES AND STOCKHOLDERS’ EQUITY
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Total current liabilities
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Commitments and contingencies (Note 11)
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Common stock, $0.001 par value; 130,000,000 shares authorized; 112,082,724 and 94,082,724 shares issued and outstanding at June 30, 2010 and December 31, 2009, respectively
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Additional paid-in capital
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Accumulated other comprehensive loss
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Total stockholders’ equity
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Total liabilities and stockholders’ equity
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See accompanying notes to condensed consolidated financial statements.
Pr
ocera Networks, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
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Three Months Ended
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Six Months Ended
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June 30, 2010
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June 30, 2009
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June 30, 2010
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June 30, 2009
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Sales:
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Product sales
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$
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3,713,591
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$
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2,550,845
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$
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6,096,555
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$
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4,721,888
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Support sales
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1,063,167
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682,874
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1,973,812
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1,459,165
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Total net sales
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4,776,758
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3,233,719
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8,070,367
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6,181,053
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Cost of sales:
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Product cost of sales
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1,923,380
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2,270,580
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3,375,315
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3,939,328
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Support cost of sales
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133,441
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85,317
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260,926
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204,489
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Total cost of sales
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2,056,821
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2,355,897
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3,636,241
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4,143,817
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Gross profit
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2,719,937
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877,822
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4,434,126
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2,037,236
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Operating expenses:
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Research and development
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790,626
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683,307
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1,411,120
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1,319,449
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Sales and marketing
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1,760,005
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1,653,930
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3,217,501
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3,338,791
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General and administrative
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958,484
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1,389,595
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2,065,859
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2,719,040
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Total operating expenses
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3,509,115
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3,726,832
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6,694,480
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7,377,280
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Loss from operations
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(789,178
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(2,849,010
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(2,260,354
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(5,340,044
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Interest and other income (expense), net
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(32,479
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(1,718,348
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(75,451
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(1,742,184
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Loss before income taxes
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(821,657
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(4,567,358
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(2,335,805
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(7,082,228
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Income tax provision (benefit)
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—
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(234,763
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1,256
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(415,580
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Net loss
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$
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(821,657
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$
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(4,332,595
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$
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(2,337,061
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$
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(6,666,648
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Net loss per share - basic and diluted
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$
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(0.01
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$
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(0.05
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$
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(0.02
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$
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(0.08
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Shares used in computing net loss per share-basic and diluted
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112,082,724
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86,943,149
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105,817,531
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85,687,768
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See accompanying notes to condensed consolidated financial statements.
Pr
ocera Networks, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
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Six Months Ended
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June 30,
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2010
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2009
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Cash flows from operating activities:
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Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
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Amortization of intangibles
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Compensation related to stock-based awards
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Interest expense related to conversion option embedded in convertible notes
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Provision for excess and obsolete inventory
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Changes in assets and liabilities:
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Prepaid expenses and other current assets
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Accrued liabilities and deferred rent
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Net cash provided by (used in) operating activities
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Cash flows from investing activities:
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Purchase of property and equipment
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Net cash used in investing activities
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Cash flows from financing activities:
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Proceeds from issuance of common stock
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Proceeds from exercise of stock options
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Proceeds from issuance of notes payable
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Repayments on line of credit
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Payments on notes payable
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Principal payments on capital leases
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Net cash provided by financing activities
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Effect of exchange rates on cash and cash equivalents
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Net increase in cash and cash equivalents
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Cash and cash equivalents, beginning of period
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Cash and cash equivalents, end of period
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See accompanying notes to condensed consolidated financial statements.
Pr
ocera Networks, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited)
1.
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DESCRIPTION OF BUSINESS
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Procera Networks, Inc. ("Procera" or the "Company") is a leading provider of bandwidth management and control products that deliver a broad set of capabilities, which include congestion management, operational intelligence and service creation capabilities, for broadband service providers worldwide. Procera’s products offer network administrators intelligent network traffic identification, control and service management.
The Company sells its products through its direct sales force, resellers, distributors and system integrators in the Americas, Asia Pacific and Europe. PacketLogic™, the Company’s principal product, is deployed at more than 600 broadband service providers, telephone companies, colleges and universities worldwide. The common stock of Procera began trading on the NYSE Amex Equities U.S. under the trading symbol “PKT” in 2007.
The Company was incorporated in 2002. In 2006, Procera acquired the stock of Netintact AB, a Swedish corporation and acquired the effective ownership of the stock of Netintact PTY, an Australian company. The Company has operations in California, Sweden and Australia.
2.
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SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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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”) applicable to interim financial information. 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. The consolidated balance sheet at December 31, 2009 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by United States generally accepted accounting principles (“GAAP”) for complete financial statements. 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 year ended December 31, 2009, filed with the SEC on March 12, 2010.
The accompanying financial statements have been prepared in conformity with GAAP. Certain amounts from prior periods have been reclassified to conform to the current period presentation. These reclassifications had no impact on stockholders' equity, previously reported net loss, or the net change in cash and cash equivalents.
The consolidated financial statements present the accounts of Procera and its wholly-owned subsidiaries, Netintact AB and Netintact PTY. All significant inter-company balances and transactions have been eliminated.
Significant Accounting Policies
The accounting and reporting policies of the Company conform to GAAP and to the practices within the telecommunications industry. There have been no significant changes in the Company's significant accounting policies during the six months ended June 30, 2010 compared to what was previously disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2009.
Use of Estimates
. The preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. The Company believes its estimates of inventory reserves, allowance for bad debts, recoverability of long-lived assets, fair value of intangible assets and recognition and measurement of current and deferred income taxes to be the most sensitive estimates impacting financial position and results of operations in the near term.
Inventory Reserves
. Each quarter, the Company evaluates its inventories for excess quantities and obsolescence. Inventories that are considered obsolete are written off. Remaining inventory balances are adjusted to approximate the lower of cost or market value. The valuation of inventories at the lower of cost or market requires the use of estimates as to the amounts of current inventories that will be sold. These estimates are dependent on management’s assessment of current and expected orders from the Company’s customers.
Accounting for Stock-Based Compensation.
The Company accounts for stock-based compensation based on the fair value of all option grants or stock issuances made to employees or directors. These amounts are expensed over the respective vesting periods of each award using the straight-line attribution method. The Company calculates the fair value of each option using the Black-Scholes option pricing model.
Fair Value of Financial Instruments.
Financial instruments include cash and cash equivalents, accounts receivable and payable, other current liabilities and debt. The carrying amounts reported in the balance sheets for cash and cash equivalents, accounts receivable and payable and other current liabilities approximate fair value due to the short-term nature of these items.
3.
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RECENT ACCOUNTING PRONOUNCEMENTS
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In October 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2009-13, “Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force” (“ASU 2009-13”). It updates the existing multiple-element revenue arrangements guidance currently included under Accounting Standards Codification (“ASC”) 605-25, which originated primarily from the guidance in EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables”. The revised guidance primarily provides two significant changes: 1) eliminates the need for objective and reliable evidence of the fair value for the undelivered element in order for a delivered item to be treated as a separate unit of accounting, and 2) eliminates the residual method to allocate the arrangement consideration. In addition, the guidance also expands the disclosure requirements for revenue recognition. ASU 2009-13 will be effective for the first annual reporting period beginning on or after June 15, 2010, with early adoption permitted provided that the revised guidance is retroactively applied to the beginning of the year of adoption. The Company is currently assessing the future impact of this new accounting update on its consolidated financial statements.
In October 2009, the FASB issued ASU 2009-14, “Certain Revenue Arrangements that Include Software Elements—a consensus of the FASB Emerging Issues Task Force” (“ASU 2009-14”). ASU 2009-14 amends the scope of pre-existing software revenue guidance by removing from the guidance non-software components of tangible products and certain software components of tangible products. ASU 2009-14 will be effective for the first annual reporting period beginning on or after June 15, 2010, with early adoption permitted provided that the revised guidance is retroactively applied to the beginning of the year of adoption. The Company is currently assessing the future impact of this new accounting update on its consolidated financial statements.
In January 2010, the FASB issued ASU 2010-06 (“ASU 2010-06”), Fair Value Measurements and Disclosures (Topic 820) – Improving Disclosures about Fair Value Measurements. ASU 2010-06 requires an entity to disclose separately the amounts of significant transfers in and out of Level I and II fair value measurements, and describe the reasons for the transfers. It also requires additional disclosures regarding purchases, sales, issuances and settlements of Level III measurements. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for the additional disclosure of Level III measurements, which is effective for fiscal years beginning after December 15, 2010. The Company does not expect the adoption of this standard to have a material impact on its consolidated financial statements.
In April 2010, the FASB issued ASU 2010-17, which establishes authoritative guidance permitting use of the milestone method of revenue recognition for research or development arrangements that contain payment provisions or consideration contingent on the achievement of specified events. This guidance is effective for milestones achieved in fiscal years beginning on or after June 15, 2010 and allows for either prospective or retrospective application, with early adoption permitted. The Company is currently evaluating the impact that adoption of this guidance will have on its consolidated financial statements.
Other recent accounting pronouncements issued by the FASB, the American Institute of Certified Public Accountants, and the SEC did not or are not believed by management to have a material impact on the Company's consolidated financial statements.
4.
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STOCK-BASED COMPENSATION
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The Company has an equity incentive plan that provides for the grant of incentive stock options to eligible employees. Stock-based employee compensation expense recognized pursuant to this plan on the Company’s condensed consolidated statements of operations for the three and six-month periods ended June 30, 2010 and 2009 was as follows:
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Three Months Ended
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Six Months Ended
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June 30, 2010
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June 30, 2009
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June 30, 2010
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June 30, 2009
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Cost of goods sold
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$
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22,123
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$
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16,395
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$
|
43,850
|
|
|
$
|
34,454
|
|
Research and development
|
|
|
3,272
|
|
|
|
8,563
|
|
|
|
8,519
|
|
|
|
17,284
|
|
Sales and marketing
|
|
|
78,755
|
|
|
|
77,987
|
|
|
|
141,701
|
|
|
|
159,597
|
|
General and administrative
|
|
|
231,134
|
|
|
|
184,735
|
|
|
|
445,817
|
|
|
|
398,773
|
|
Total stock-based compensation expense
|
|
$
|
335,284
|
|
|
$
|
287,680
|
|
|
$
|
639,887
|
|
|
$
|
610,108
|
|
No income tax benefits were recognized in the three and six months ended June 30, 2010 and 2009 due to the Company’s continuing losses. 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 six months ended June 30, 2010:
|
|
Number of Options
|
|
|
Weighted Average Exercise Price
|
|
|
Weighted Average Remaining Contractual Life
(in years)
|
|
Aggregate Intrinsic Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at June 30, 2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and expected to vest at June 30, 2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at June 30, 2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
No options were exercised during the six months ended June 30, 2010. The total intrinsic value of options exercised during the six months ended June 30, 2009, was $70,200.
As of June 30, 2010, total unrecognized compensation cost related to unvested stock options was $2,142,382, net of estimated forfeitures, which is expected to be recognized over an estimated weighted average amortization period of 2.34 years.
The weighted average grant date fair value of options granted during the six months ended June 30, 2010 and 2009 was $0.33 and $0.53, respectively.
Valuation Assumptions
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option valuation model while the expense is recognized over the requisite service period using the straight-line attribution approach.
The following assumptions were used in determining the fair value of stock-based awards granted during the three and six months ended June 30, 2010 and 2009:
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
Expected term (years)
|
|
|
4.66
|
|
|
|
4.15
|
|
|
|
4.62
|
|
|
|
4.25
|
|
Expected volatility
|
|
|
94.9
|
%
|
|
|
98.5
|
%
|
|
|
95.8
|
%
|
|
|
98.7
|
%
|
Risk-free interest rate
|
|
|
2.22
|
%
|
|
|
1.55
|
|
|
|
2.19
|
%
|
|
|
1.61
|
%
|
Expected dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
0
|
%
|
The Company calculated the expected term of stock options granted using historical exercise data. The Company used the exact number of days between the grant and the exercise dates to calculate a weighted average of the holding periods for all awards (i.e., the average interval between the grant and exercise or post-vesting cancellation dates) adjusted as appropriate. Expected volatilities were estimated using the historical share price performance over a period equivalent to the expected term of the option. The risk-free interest rate for a period equivalent to the expected term of the option was extrapolated from the U.S. Treasury yield curve in effect at the time of the grant. The Company has never paid cash dividends and does not anticipate paying cash dividends in the foreseeable future.
5.
|
NET INCOME (LOSS) PER SHARE
|
The following table sets forth the computation of basic and diluted net income (loss) per share and potential shares of common stock that are not included in the computation of diluted net income (loss) per share because their effect is antidilutive:
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
Numerator - basic and diluted
|
|
$
|
(821,657
|
)
|
|
$
|
(4,332,595
|
)
|
|
$
|
(2,337,061
|
)
|
|
$
|
(6,666,648
|
)
|
Denominator - basic and diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
|
|
112,082,724
|
|
|
|
86,943,149
|
|
|
|
105,817,531
|
|
|
|
85,687,768
|
|
Net loss per share - basic and diluted
|
|
$
|
(0.01
|
)
|
|
$
|
(0.05
|
)
|
|
$
|
(0.02
|
)
|
|
$
|
(0.08
|
)
|
Antidilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options issued and outstanding
|
|
|
9,268,495
|
|
|
|
7,741,192
|
|
|
|
9,268,495
|
|
|
|
7,741,192
|
|
Warrants
|
|
|
4,164,604
|
|
|
|
4,185,021
|
|
|
|
4,164,604
|
|
|
|
4,185,021
|
|
Total
|
|
|
13,433,099
|
|
|
|
11,926,213
|
|
|
|
13,433,099
|
|
|
|
11,926,213
|
|
6.
|
COMPREHENSIVE INCOME (LOSS)
|
The components of comprehensive income (loss) for the three and six months ended June 30, 2010 and 2009 are as follows:
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
Net loss
|
|
$
|
(821,657
|
)
|
|
$
|
(4,332,595
|
)
|
|
$
|
(2,337,061
|
)
|
|
$
|
(6,666,648
|
)
|
Foreign currency translation adjustments
|
|
|
(97,770
|
)
|
|
|
263,748
|
|
|
|
(91,020
|
)
|
|
|
272,356
|
|
Comprehensive loss
|
|
$
|
(919,427
|
)
|
|
$
|
(4,068,847
|
)
|
|
$
|
(2,428,081
|
)
|
|
$
|
(6,394,292
|
)
|
Inventories are stated at the lower of cost, which approximates actual costs on a first in, first out basis, or market. Inventories at June 30, 2010 and December 31, 2009 consisted of the following:
|
|
June 30, 2010
|
|
|
December 31, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrued liabilities at June 30, 2010 and December 31, 2009 consisted of the following:
|
|
June 30, 2010
|
|
|
December 31, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warranty Reserve
The Company warrants its products against material defects for a specific period of time, generally twelve months. The Company provides for the estimated future costs of warranty obligations in cost of sales when the related revenue is recognized. The accrued warranty costs represent the best estimate at the time of sale of the total costs that the Company expects to incur to repair or replace product parts which fail while still under warranty. The amount of accrued estimated warranty costs are primarily based on current information on repair costs. The Company periodically reviews the accrued balances and updates the historical warranty cost trends.
Changes in the warranty reserve during the six months ended June 30, 2010 were as follows:
Warranty obligation at December 31, 2009
|
|
|
|
|
Provision for current period sales
|
|
|
|
|
Deductions for warranty claims processed during the period
|
|
|
|
|
Warranty obligation at June 30, 2010
|
|
|
|
|
On March 4, 2010, the Company closed a registered placement of its common stock primarily to institutional investors. The offering price of the Company’s common stock was $0.40 per share. The Company sold 18 million shares of common stock at a gross sales price of $7.2 million, and received net proceeds of approximately $6.5 million after deducting the placement agent’s commission and legal and other offering costs. The placement agent also received a warrant to purchase 180,000 shares of the Company’s common stock at an exercise price of $0.40 per share which expires on March 4, 2013. The warrant had an estimated fair value of $44,547 calculated using the Black-Scholes option pricing model.
Warrants
A summary of warrant activity for the six months ended June 30, 2010 is as follows:
|
|
Warrants
|
|
|
|
Number of
Shares
|
|
|
Weighted Average
Purchase Price
|
|
Outstanding December 31, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding June 30, 2010
|
|
|
|
|
|
|
|
|
The chart below shows the outstanding warrants as of June 30, 2010 by exercise price and the average contractual life before expiration.
Exercise Price
|
|
|
Number Outstanding
|
|
|
Weighted Average Remaining Contractual Life (Years)
|
|
|
Number Exercisable
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At June 30, 2010 and December 31, 2009, the Company had $236,794 of unrecognized tax benefits, none of which would affect the Company’s effective tax rate if recognized.
The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. As of March 31, 2010, the Company had no accrued interest or penalties related to uncertain tax positions. The tax years 2004-2009 remain open to examination by one or more of the major taxing jurisdictions to which the Company is 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, 2011.
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. A valuation allowance is required to 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.
11.
|
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 does not believe that any of its currently outstanding legal actions and claims 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 2013 and provide for renewal options ranging from month-to-month to 5 year terms. The Company expects that these leases will be renewed or replaced in the normal course of business 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 entered into office lease agreements for its headquarters in Los Gatos, California; Netintact, AB offices in Varberg, Sweden; and Netintact PTY offices in Melbourne, Australia.
As of June 30, 2010, future minimum lease payments under operating leases are as follows:
Six months ending December 31, 2010
|
|
|
|
|
Years ending December 31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total minimum lease payments
|
|
|
|
|
Secured Line of Credit
On December 10, 2009, the Company entered into a two-year loan and security agreement for a secured line of credit facility (“Secured Credit Facility”) for short-term working capital purposes with Silicon Valley Bank. The Secured Credit Facility provides borrowings of up to $2.0 million through December 10, 2011. Borrowings under the facility bear interest at the prime rate plus 1%, but not less than 5% per annum. If the Company’s cash balance falls below $2,000,000, outstanding borrowings will bear an additional interest charge of 0.6875% per month, or 8.25% per annum. Under the terms of the Secured Credit Facility, the Company will pay Silicon Valley Bank a $17,000 fee in each of the two years of the agreement and will pay a minimum monthly interest charge of $3,000 per month. The Company also issued a warrant to Silicon Valley Bank for the purchase of 500,000 shares of the Company’s common stock with an exercise price of $0.40 per share and a fair value of $166,302, which is being amortized to interest expense over the two-year term of the Secured Credit Facility. The Secured Credit Facility is secured by substantially all of the Company’s assets. The terms of the Secured Credit Facility include financial covenants requiring minimum quarterly revenue and restrictions on the Company’s ability to incur certain additional indebtedness, pay dividends, create or permit liens on assets or engage in mergers, consolidations or dispositions. At June 30, 2010, the Company had no borrowings outstanding on its Secured Credit Facility.
Notes Payable
In April 2009, the Company received loan proceeds totaling $500,000 through a private placement of nonconvertible debt. Such nonconvertible debt bore interest at 10% per annum, which interest was due and payable on a quarterly basis. The nonconvertible debt was repaid by the Company during the quarter ended March 31, 2010.
The Company operates in one segment, using one measure of profitability to manage its business. Sales for geographic regions were based upon the customer’s location. The location of long-lived assets is based on the physical location of the Company’s regional offices. The following are summaries of sales and long-lived assets by geographical region:
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
Sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
2,566,400
|
|
|
$
|
1,036,701
|
|
|
$
|
4,531,290
|
|
|
$
|
1,533,251
|
|
Europe, Middle East and Africa
|
|
|
1,543,469
|
|
|
|
1,556,617
|
|
|
|
1,958,149
|
|
|
|
2,570,089
|
|
Asia Pacific
|
|
|
666,889
|
|
|
|
640,401
|
|
|
|
1,580,928
|
|
|
|
2,077,713
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
4,776,758
|
|
|
$
|
3,233,719
|
|
|
$
|
8,070,367
|
|
|
$
|
6,181,053
|
|
|
|
June 30, 2010
|
|
|
December 31, 2009
|
|
Long-lived assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales made to customers located outside the United States as a percentage of total net revenues were 46% and 44% for the three and six months ended June 30, 2010, respectively and 68% and 77% for the three and six months ended June 30, 2009, respectively.
For the three and six month periods ended June 30, 2010, revenue from one customer (Cox Communications, Inc.) represented 23% and 21% of net revenues, respectively, and for the six month period ended June 30, 2010, revenue from another customer represented 11% of net revenues, with no other single customer representing more than 10% of net revenues. For the three month period ended June 30, 2009, revenue from three customers represented 29%, 14% and 10%, of net revenues, respectively, and for the six month period ended June 30, 2009, revenue from three customers represented 20%, 15% and 12%, of net revenues, respectively, with no other single customer representing more than 10% of net revenues.
At June 30, 2010, accounts receivable from two customers represented 18% and 10%, respectively, of total accounts receivable, with no other single customer representing more than 10% of the accounts receivable balance. At December 31, 2009, accounts receivable from two customers represented 55% and 14%, respectively, of total accounts receivable with no other single customer representing more than 10% of the accounts receivable balance. As of June 30, 2010 and December 31, 2009, approximately 47% and 27%, respectively, of the Company’s total accounts receivable were due from customers outside the United States.
It
em 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, 2009.
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, as amended (the “Exchange Act”). 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”, “initial” 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, 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. We also 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 Exchange Act. 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, identified under the caption "Risk Factors" and 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.
Overview
We are a leading provider of evolved network traffic awareness, analysis and control solutions based on Deep Packet Inspection (DPI) technology for a broad range of broadband service providers worldwide. Our products offer network operators: network traffic identification, control and service management.
We have more than 600 customers who have installed over 1,300 of our systems in total. Our customers include cable multi-system operators, mobile service providers, telecommunications companies, universities and other entities.
Our products are marketed under the PacketLogic™ brand name. We have multiple products, performing at speeds from 2 megabits per second up to 80 gigabits per second, which are designed to address a broad market spectrum of customers.
Our PacketLogic family of products offers:
|
●
|
Accuracy.
Our proprietary DRDL software solution allows us to provide our customers with a high degree of application identification accuracy and the flexibility to regularly update the software to keep up with the rapid introduction of new Internet applications;
|
|
●
|
Scalability.
Our family of products is scalable from a few hundred megabits to 80 gigabits of traffic per second, up to 5 million subscribers and up to 48 million simultaneous data flows, which is critical to service providers as they upgrade to DOCSIS 3.0 (a high bandwidth broadband cable standard), FTTX (high bandwidth fiber to the home or neighborhood used by telecom broadband network providers) and LTE (enabling higher bandwidth mobile phone networks) technologies in the access network; and
|
|
●
|
Platform Flexibility.
Our products are deployable in many locations in a network and leverage off-the-shelf hardware, and can rapidly leverage advances in computing technology which we believe to be a better solution than those which are dependent on specific network silicon processors or hardware platforms.
|
We face competition from suppliers of standalone DPI products including Allot Communications, Arbor Networks, Blue Coat Systems, Brocade Communications Systems, Cisco Systems, Ericsson, Huawei Technologies Company, Juniper Networks, and Sandvine Corporation. Some of our competitors also supply platform products with different degrees of DPI functionality, such as switch/routers, routers, session border controllers and VoIP switches.
Most of our competitors are larger and more established enterprises with substantially greater financial and other resources. Some competitors may be willing to reduce prices and accept lower profit margins to compete with us. As a result of such competition, we could lose market share and sales, or be forced to reduce our prices to meet competition. However, we do not believe there is a dominant supplier in our market. Based on our belief in the superiority of our technology, we believe that we have an opportunity to capture meaningful market share and benefit from what we believe will be growth in the DPI market.
We were incorporated in 2002, and in October 2003, we merged with Zowcom, Inc., a publicly-traded Nevada corporation. We acquired Netintact AB, a Swedish corporation, and Netintact PTY, an Australian company, in 2006.
Following the acquisitions of Netintact AB and Netintact PTY, our core products and business changed substantially to focus on DPI solutions. PacketLogic, the flagship product and technology of Netintact, now is the Company’s principal product offering. We sell our products through our direct sales force, resellers, distributors and systems integrators in the Americas, Asia Pacific and Europe.
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 (“GAAP”). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate these estimates. We base our estimates on historical experience and on 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 to our audited financial statements in our Annual Report on Form 10-K for the year ended December 31, 2009 filed with the SEC on March 12, 2010.
Management believes that there have been no significant changes during the six months ended June 30, 2010 to the items that we disclosed as our critical accounting policies and estimates in 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, 2009, filed with the SEC on March 12, 2010. In accordance with SEC guidance, the Company believes the following critical accounting policies reflect our most significant estimates, judgments and assumptions used in the preparation of our consolidated financial statements:
|
·
|
Valuation of Goodwill, Intangible and Long-Lived Assets;
|
|
·
|
Allowance for Doubtful Account;
|
|
·
|
Stock-Based Compensation; and
|
|
·
|
Accounting for Income Taxes.
|
These critical accounting policies and related disclosures appear in our Annual Report on Form 10-K for the year ended December 31, 2009.
Recent Accounting Pronouncements
In October 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2009-13, “Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force” (ASU 2009-13). It updates the existing multiple-element revenue arrangements guidance currently included under Accounting Standards Codification (“ASC”) 605-25, which originated primarily from the guidance in EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables”. The revised guidance primarily provides two significant changes: 1) eliminates the need for objective and reliable evidence of the fair value for the undelivered element in order for a delivered item to be treated as a separate unit of accounting, and 2) eliminates the residual method to allocate the arrangement consideration. In addition, the guidance also expands the disclosure requirements for revenue recognition. ASU 2009-13 will be effective for the first annual reporting period beginning on or after June 15, 2010, with early adoption permitted provided that the revised guidance is retroactively applied to the beginning of the year of adoption. We are currently assessing the future impact of this new accounting update on our consolidated financial statements.
In October 2009, the FASB issued ASU 2009-14, “Certain Revenue Arrangements that Include Software Elements—a consensus of the FASB Emerging Issues Task Force” (“ASU 2009-14”). ASU 2009-14 amends the scope of pre-existing software revenue guidance by removing from the guidance non-software components of tangible products and certain software components of tangible products. ASU 2009-14 will be effective for the first annual reporting period beginning on or after June 15, 2010, with early adoption permitted provided that the revised guidance is retroactively applied to the beginning of the year of adoption. We are currently assessing the future impact of this new accounting update on our consolidated financial statements.
In January 2010, the FASB issued ASU 2010-06 (“ASU 2010-06”), Fair Value Measurements and Disclosures (Topic 820) – Improving Disclosures about Fair Value Measurements. ASU 2010-06 requires an entity to disclose separately the amounts of significant transfers in and out of Level I and II fair value measurements, and describe the reasons for the transfers. It also requires additional disclosures regarding purchases, sales, issuances and settlements of Level III measurements. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for the additional disclosure of Level III measurements, which is effective for fiscal years beginning after December 15, 2010. We do not expect the adoption of this standard to have a material impact on our consolidated financial statements.
In April 2010, the FASB issued ASU 2010-17, which establishes authoritative guidance permitting use of the milestone method of revenue recognition for research or development arrangements that contain payment provisions or consideration contingent on the achievement of specified events. This guidance is effective for milestones achieved in fiscal years beginning on or after June 15, 2010 and allows for either prospective or retrospective application, with early adoption permitted. We are currently evaluating the impact that adoption of this guidance will have on our consolidated financial statements.
Results of Operations
Comparison of Three and Six Months Ended June 30, 2010 and 2009
Revenue
|
|
Three Months Ended
|
|
|
|
|
|
Six Months Ended
|
|
|
|
|
|
|
June 30,
|
|
|
|
|
|
June 30,
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Increase
|
|
|
2010
|
|
|
2009
|
|
|
Increase
|
|
|
|
($ in thousands)
|
|
|
|
|
|
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net product revenue
|
|
$
|
3,714
|
|
|
$
|
2,551
|
|
|
|
46
|
%
|
|
$
|
6,097
|
|
|
$
|
4,722
|
|
|
|
29
|
%
|
Net support revenue
|
|
|
1,063
|
|
|
|
683
|
|
|
|
56
|
%
|
|
|
1,974
|
|
|
|
1,459
|
|
|
|
35
|
%
|
Total revenue
|
|
$
|
4,777
|
|
|
$
|
3,234
|
|
|
|
48
|
%
|
|
$
|
8,070
|
|
|
$
|
6,181
|
|
|
|
31
|
%
|
Our revenue is derived from two sources: product revenue, which includes sales of our hardware appliances bundled with software licenses, and service revenue, which includes revenue from support and services.
The increase in product revenue of 46% and 29% for the three and six months ended June 30, 2010, compared with the same periods in 2009, reflected increased sales of our high-end PL10000 series product and sales of the PL8720 introduced in the second quarter of 2010.
The increase in support revenue of 56% and 35% for the three and six months ended June 30, 2010, compared with the same periods in 2009, reflected the continued expansion of the installed base of our product to which we have sold ongoing support services.
Cost of Sales
Cost of sales includes: (i) direct labor and material costs for products sold, (ii) costs expected to be incurred for warranty, and (iii) adjustments to inventory values, including the write-down of slow moving or obsolete inventory.
The following table presents the breakdown of cost of sales by category:
|
|
Three Months Ended
|
|
|
|
|
|
Six Months Ended
|
|
|
|
|
|
|
June 30,
|
|
|
|
|
|
June 30,
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Change
|
|
|
2010
|
|
|
2009
|
|
|
Change
|
|
|
|
($ in thousands)
|
|
|
|
|
|
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Materials and per-use licenses
|
|
$
|
1,634
|
|
|
$
|
689
|
|
|
|
|
|
$
|
2,819
|
|
|
$
|
1,731
|
|
|
|
|
Percent of net product revenue
|
|
|
44
|
%
|
|
|
27
|
%
|
|
|
17
|
%
|
|
|
46
|
%
|
|
|
37
|
%
|
|
|
9
|
%
|
Applied labor and overhead
|
|
|
191
|
|
|
|
773
|
|
|
|
|
|
|
|
404
|
|
|
|
900
|
|
|
|
|
|
Percent of net product revenue
|
|
|
5
|
%
|
|
|
30
|
%
|
|
|
(25
|
)%
|
|
|
7
|
%
|
|
|
19
|
%
|
|
|
(12)
|
%
|
Other indirect costs
|
|
|
98
|
|
|
|
427
|
|
|
|
|
|
|
|
152
|
|
|
|
546
|
|
|
|
|
|
Percent of net product revenue
|
|
|
3
|
%
|
|
|
17
|
%
|
|
|
(14
|
)%
|
|
|
2
|
%
|
|
|
12
|
%
|
|
|
(10)
|
%
|
Product costs
|
|
|
1,923
|
|
|
|
1,889
|
|
|
|
|
|
|
|
3,375
|
|
|
|
3,177
|
|
|
|
|
|
Percent of net product revenue
|
|
|
52
|
%
|
|
|
74
|
%
|
|
|
(22)
|
%
|
|
|
55
|
%
|
|
|
67
|
%
|
|
|
(12)
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Support costs
|
|
|
133
|
|
|
|
85
|
|
|
|
|
|
|
|
261
|
|
|
|
204
|
|
|
|
|
|
Percent of net support revenue
|
|
|
13
|
%
|
|
|
13
|
%
|
|
|
—
|
%
|
|
|
13
|
%
|
|
|
14
|
%
|
|
|
(1)
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of acquired assets
|
|
|
—
|
|
|
|
382
|
|
|
|
|
|
|
|
—
|
|
|
|
763
|
|
|
|
|
|
Percent of total net revenue
|
|
|
—
|
%
|
|
|
12
|
%
|
|
|
(12)
|
%
|
|
|
—
|
%
|
|
|
12
|
%
|
|
|
(12)
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs of sales
|
|
$
|
2,057
|
|
|
$
|
2,356
|
|
|
|
|
|
|
$
|
3,636
|
|
|
$
|
4,144
|
|
|
|
|
|
Percent of total net revenue
|
|
|
43
|
%
|
|
|
73
|
%
|
|
|
(30)
|
%
|
|
|
45
|
%
|
|
|
67
|
%
|
|
|
(22)
|
%
|
Total cost of sales during the three and six months ended June 30, 2010 decreased by $299,000 and $508,000, respectively; and as a percentage of net revenue by 30% and 22%, respectively, compared to the same periods in 2009. The decrease in cost of sales reflected lower acquisition-related intangible asset amortization cost because the corresponding intangible assets became fully amortized in the third quarter of 2009. The acquisition related intangible asset amortization classified as cost of sales was $381,500 and $763,000 in the three and six months ended June 30, 2009. The benefit of the lower amortization cost was partially offset by higher material costs associated with increased product revenues and higher fees for technology interfaces.
Gross Profit
Gross profit for the three and six-month periods ended June 30, 2010 and 2009 was as follows:
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2010
|
|
2009
|
|
|
Increase
|
|
|
2010
|
|
|
2009
|
|
|
Increase
|
|
|
|
($ in thousands)
|
|
|
|
|
|
($ in thousands)
|
|
|
|
|
Gross profit
|
|
$
|
2,720
|
|
|
$
|
878
|
|
|
|
210
|
%
|
|
$
|
4,434
|
|
|
$
|
2,037
|
|
|
|
118
|
%
|
Percent of total net revenue
|
|
|
57
|
%
|
|
|
27
|
%
|
|
|
|
|
|
|
55
|
%
|
|
|
33
|
%
|
|
|
|
|
Gross profit margin for the three months ended June 30, 2010, increased by 30 percentage points to 57% from 27% in the comparable period in the prior year. Gross profit margin for the six months ended June 30, 2010, increased by 22 percentage points to 55% from 33% in the comparable period in the prior year. These increases reflected lower acquisition-related intangible asset amortization cost because the corresponding intangible assets became fully amortized in the third quarter of 2009. The acquisition-related intangible asset amortization classified as cost of sales was $381,500 and $763,000 in the three and six months ended June 30, 2009. Excluding the impact of acquisition-related intangible asset amortization, the gross profit margin rate improved by 18 percentage points and 9 percentage points in the three and six months ended June 30, 2010, respectively as compared with the comparable periods in the prior year. These margin rate increases reflects the introduction of the PL8720 product, which has a higher margin compared with our other appliance class products, and lower inventory charges and other cost of sales, partially offset by higher materials costs as a percentage of sales as compared to the three and six months ended June 30, 2009.
Operating Expense
Operating expenses for the three and six-month periods ended June 30, 2010 and 2009 were as follows:
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
Change
|
|
|
2010
|
|
|
2009
|
|
|
Change
|
|
|
|
($ in thousands)
|
|
|
|
|
|
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development
|
|
$
|
791
|
|
|
$
|
683
|
|
|
|
16
|
%
|
|
$
|
1,411
|
|
|
$
|
1,319
|
|
|
|
7
|
%
|
Sales and marketing
|
|
|
1,760
|
|
|
|
1,654
|
|
|
|
6
|
%
|
|
|
3,218
|
|
|
|
3,339
|
|
|
|
(4)
|
%
|
General and administrative
|
|
|
958
|
|
|
|
1,390
|
|
|
|
(31)
|
%
|
|
|
2,066
|
|
|
|
2,719
|
|
|
|
(24)
|
%
|
Total
|
|
$
|
3,509
|
|
|
$
|
3,727
|
|
|
|
(6)
|
%
|
|
$
|
6,694
|
|
|
$
|
7,377
|
|
|
|
(9)
|
%
|
Research and Development
Research and development expenses include costs associated with personnel focused on the development or improvement of our products, prototype materials, initial product certifications and equipment costs. Research and development costs include sustaining efforts for products already released and development costs associated with planned new products.
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
Increase
|
|
|
2010
|
|
|
2009
|
|
|
Increase
|
|
|
|
($ in thousands)
|
|
|
|
|
|
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development
|
|
$
|
791
|
|
|
$
|
683
|
|
|
|
16
|
%
|
|
$
|
1,411
|
|
|
$
|
1,319
|
|
|
|
7
|
%
|
As a percentage of net revenue
|
|
|
17
|
%
|
|
|
21
|
%
|
|
|
|
|
|
|
17
|
%
|
|
|
21
|
%
|
|
|
|
|
Research and development expenses for the three and six months ended June 30, 2010 increased by 16% and 7%, respectively, as compared to the same periods in 2009. These increases reflect the impact of new hires in the first half of 2010. Research and development expenses decreased as a percentage of sales by 4 percentage points to 17% for the three and six months ended June 30, 2010, compared to the same periods in 2009 because revenue increased at a faster pace compared with the increased spending on research and development.
As a result of planned additional hiring in research and development, we expect research and development expenses to increase in the third and fourth quarters of 2010, as compared to the same periods of 2009.
.
Sales and Marketing
Sales and marketing expenses primarily include personnel costs, sales commissions and marketing expenses, such as trade shows, channel development and literature.
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
Change
|
|
|
2010
|
|
|
2009
|
|
|
Change
|
|
|
|
($ in thousands)
|
|
|
|
|
|
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales and marketing
|
|
|
1,760
|
|
|
|
1,654
|
|
|
|
6
|
%
|
|
|
3,218
|
|
|
|
3,339
|
|
|
|
(4)
|
%
|
As a percentage of net revenue
|
|
|
37
|
%
|
|
|
51
|
%
|
|
|
|
|
|
|
40
|
%
|
|
|
54
|
%
|
|
|
|
|
Sales and marketing expenses for the three months ended June 30, 2010 increased by $106,000, compared to the same period in 2009. Sales and marketing expenses for the six months ended June 30, 2010 decreased by $121,000, compared to the same period in 2009. The changes in sales and marketing expenses include the impact of lower acquisition-related intangible asset amortization cost because the corresponding intangible assets became fully amortized in the third quarter of 2009. The acquisition-related intangible asset amortization classified as sales and marketing expenses was $359,750 and $719,500 in the three and six months ended June 30, 2009. The benefit of the lower amortization costs was offset by an increase in compensation costs due to an increase in commissions connected with higher sales as well as an increase in costs connected with an increase in sales and marketing employees and contractors. Stock-based compensation recorded to sales and marketing expense in the three and six months ended June 30, 2010 was $78,755 and $141,701, respectively; as compared with $77,987 and $159,597 in the three and six months ended June 30, 2009, respectively.
General and Administrative
General and administrative expenses consist primarily of personnel and facilities costs related to our executive, finance function, service fees for professional services and amortization of intangible assets. Professional services include costs for legal, independent auditors and investor relations.
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
Change
|
|
|
2010
|
|
|
2009
|
|
|
Change
|
|
|
|
($ in thousands)
|
|
|
|
|
|
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative
|
|
|
958
|
|
|
|
1,390
|
|
|
|
(31)
|
%
|
|
|
2,066
|
|
|
|
2,719
|
|
|
|
(24)
|
%
|
As a percentage of net revenue
|
|
|
20
|
%
|
|
|
43
|
%
|
|
|
|
|
|
|
26
|
%
|
|
|
44
|
%
|
|
|
|
|
General and administrative expenses for the three and six months ended June 30, 2010 decreased by $432,000, and $653,000, respectively, as compared to the same periods in 2009. These decreases in general and administrative expenses reflected lower acquisition-related intangible asset amortization cost because the corresponding intangible assets became fully amortized in the third quarter of 2009. The acquisition-related intangible asset amortization classified as general and administrative expenses was $185,333 and $370,666 in the three and six months ended June 30, 2009, respectively. The decrease in general and administrative expenses also reflects a decrease in the cost of investor relations services. Stock-based compensation recorded to general and administrative expense in the three and six months ended June 30, 2010, was $231,134 and $445,817, respectively; as compared with $184,735 and $398,773, respectively, in the three and six months ended June 30, 2009.
Interest and Other Income (Expense), Net
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Three Months Ended
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Six Months Ended
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June 30,
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June 30,
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2010
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2009
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Change
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2010
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2009
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Change
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($ in thousands)
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($ in thousands)
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|
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|
Interest and other income (expense), net
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|
$
|
(32
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)
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|
$
|
(1,718
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)
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|
$
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(98)
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%
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|
$
|
(75
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)
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|
$
|
(1,742
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)
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|
$
|
(96)
|
%
|
Interest and other income (expense), net in the three and six months ended June 30, 2009 included $1,664,756 of interest expense related to the conversion option embedded in the convertible promissory notes that were issued and then converted into 4,713,082 shares of common stock in the quarter ended June 30, 2009. This interest expense was calculated based on the intrinsic value of the embedded option on the date that each convertible promissory note was executed. The intrinsic value was based on the difference between the $0.40 embedded option exercise price and the approximately $0.75 average price of our common stock on the issuance date of the promissory notes. The calculated interest (or discount) is amortized over the life of the promissory notes. Therefore, because the notes were converted to common stock in the same quarter that they were issued, all of the interest related to the embedded option was recorded (or fully amortized) during the quarter ended June 30, 2009.
Provision for Income Taxes
The Company is subject to taxation primarily in the U.S., Sweden, and Australia, as well as in various states. We recorded a tax benefit in the three and six months ended June 30, 2009 primarily from the amortization of acquisition-related intangible assets, which were fully amortized in the third quarter of 2009. We have established a valuation allowance for substantially all of our deferred tax assets. We calculated the valuation allowance in accordance with the provisions of ASC 740 which requires 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 the changes in our cash balance for the periods indicated:
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Six Months Ended
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June 30,
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2010
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2009
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(in thousands)
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Net cash provided by (used in) operating activities
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Net cash used in investing activities
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Net cash provided by financing activities
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Effect of exchange rate changes on cash and cash equivalents
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Net increase in cash and cash equivalents
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During the six months ended June 30, 2010, our operations provided $3.1 million of cash, compared with a $3.4 million use of cash in operating activities in the same period in 2009. The $3.1 million of cash provided by our operating activities during the six months ended June 30, 2010 reflected $3.7 million of cash provided by the collection of accounts receivable, $1.1 million of cash provided by an increase in accounts payable and an $850,000 increase in deferred revenue, partially offset by our use of cash connected with our $2.3 million net loss for the period and in buying inventory, which increased by $1.1 million. By comparison, the $3.4 million cash used in the six months ended June 30, 2009, reflected our use of cash connected with our $6.7 million net loss for the period that was partially offset by non-cash costs included in the net loss. The cash used in investing activities during the six months ended June 30, 2010 was $578,000, mostly for the purchase of testing equipment used in research and development and recorded as fixed assets. The net cash provided by our financing activities during the six months ended June 30, 2010 was $4.1 million, which included proceeds from the issuance of common stock of $6.5 million, a $1.9 million repayment of the borrowings against our secured credit facility and a $500,000 repayment of notes. Net cash provided by financing activities during the six months ended June 30, 2009 included proceeds from the issuance of common stock of $3.5 million, $500,000 of notes issued (partially offset by loan repayments of $400,000) and proceeds from stock option exercises of $135,000.
Based on our current cash balances and anticipated cash flow from operations, we believe our working capital will be sufficient to meet the cash needs of our business for at least the next twelve months. Our future capital requirements will depend on many factors, including our rate of growth, the expansion of our sales and marketing activities, development of additional channel partners and sales territories, introduction of new products, enhancement of existing products and the continued acceptance of our products. We may also enter into arrangements that require investment such as complimentary businesses, service expansion, technology partnerships or acquisitions.
On December 10, 2009, we entered into a two-year loan and security agreement for a secured credit facility of $2.0 million for short-term working capital purposes with Silicon Valley Bank. At December 31, 2009, we had $1.9 million outstanding under our credit facility with Silicon Valley Bank. Borrowings under this facility bear interest at the prime rate plus 1%, but not less than 5% on an annual basis. If our cash balance falls below $2,000,000, outstanding borrowings will bear an additional interest charge of 0.6875% per month, or 8.25% per annum. At June 30, 2010, we had no borrowings outstanding on our Secured Credit Facility.
On March 4, 2010, we closed a registered placement of our common stock primarily to institutional investors. The offering price of our common stock was $0.40 per share. We sold 18 million shares of common stock at a gross sales price of $7.2 million, and received net proceeds of approximately $6.5 million after deducting the placement agent’s commission and legal and other offering costs. The placement agent also received a warrant to purchase 180,000 shares of our common stock at an exercise price of $0.40 per share which expires on March 4, 2013.
Off Balance Sheet Arrangements
As of June 30, 2010, we had no off-balance sheet items as described in Item 303(a)(4)(ii) of SEC 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
We lease facility space under non-cancelable operating leases in California, Sweden and Australia that extend through 2013. The details of these contractual obligations are further explained in Note 11 of the Notes to Condensed Consolidated Financial Statements.
We use third-party contract manufacturers to assemble and test our hardware 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 based on rolling production forecasts provided by us. We may be contractually obligated to purchase long lead-time component inventory procured by certain manufacturers in accordance with our forecasts. In addition, we issue purchase orders to our third-party manufacturers that may not be cancelable at any time. As of June 30, 2010, we had open non-cancelable purchase orders amounting to $0.4 million with our third-party contract manufacturers.
It
em 3.
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Quantitative and Qualitative Disclosures about Market Risk.
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Foreign Currency Risk
Our sales contracts are denominated predominantly in U.S. Dollars, Swedish Krona, Australian Dollars and the Euro. We incur operating expenses in U.S. Dollars, Swedish Krona and Australian Dollars. Therefore, we are subject to fluctuations in these foreign currency exchange rates. However, to date, exchange rate fluctuations have had minimal impact on our operating results and cash flows, and we have not used derivative instruments to hedge our foreign currency exposures.
Interest Rate Sensitivity
We had unrestricted cash totaling approximately $9.7 million at June 30, 2010. The unrestricted cash is held for working capital purposes. All of our cash is currently held in demand deposit and savings accounts. Therefore, we do not believe that we have any material exposure to changes in the fair market value as a result of changes in interest rates. We do not enter into investments for trading or speculative purposes.
It
em 4.
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Controls and Procedures.
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Evaluation of Disclosure Controls and Procedures
As required by Rules 13a-15(b) and 15d-15(b), under the Exchange Act, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and 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. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective, as of the end of the period covered by this report, in ensuring that material information relating to us, including our consolidated subsidiaries, required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that it is accumulated and communicated to our management, including our principal executive and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting during the period ended March 31, 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
It
em 1.
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Legal Proceedings.
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We are at times involved in litigation and other legal claims in the ordinary course of business. When appropriate in management’s estimation, we may record reserves in our financial statements for pending litigation and other claims. Although it is not possible to predict with certainty the outcome of litigation, we do not believe that any of the current pending legal proceedings to which we are a party or to which any of our property is subject will have a material impact on our results of operations or financial condition.
We have marked with an asterisk (*) those risk factors below that reflect material changes from the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2009 filed with the Securities and Exchange Commission on March 12, 2010.
You should carefully consider the risks described below, together with all of the other information included in this Form 10-Q, in considering our business and prospects. Set forth below and elsewhere in this report and in other documents we file with the SEC are descriptions of the risks and uncertainties that could cause our actual results to differ materially from the results contemplated by the forward-looking statements contained in this report. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. Each of these risk factors could adversely affect our business, operating results and financial condition, as well as adversely affect the value of an investment in our common stock.
Risks Related to Our Business
We expect to incur losses in future periods.
For the years ended December 31, 2009, 2008 and 2007, we incurred losses from operations of approximately $6.2 million, $15.0 million and $13.6 million, respectively. For the six months ended June 30, 2010, we incurred losses from operations of approximately $2.3 million. We expect to continue to incur losses from operations in future periods. Any profitability we may achieve in the future may not be indicative of sustained profitability. Any losses incurred in the future may result primarily from costs related to continued investments in sales and marketing, product development and administrative expenses. If our revenue growth does not occur or is slower than anticipated or our operating expenses exceed expectations, our losses will be greater. We may never achieve profitability.
Our PacketLogic family of products is our only product line. 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 much of our anticipated future growth depend on our ability to continue and grow the commercialization of our PacketLogic product line. We do not currently have plans or resources to develop additional product lines, and as a result, our future growth will largely be determined by market 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 acceptance of our PL10000 product line and our future PacketLogic products.
Our future financial performance will 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.
We introduced our PL10000 product line in early 2008. 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.
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 competitive position nay deteriorate 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 results of operations and financial condition may be adversely affected.
If our products contain undetected software or hardware errors or performance deficiencies, we could incur significant unexpected expenses, experience purchase order cancellations 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. Because we frequently introduce new versions and updates to our product line, previously unaddressed errors in the accuracy or reliability of our products, or issues with their performance, may arise. We expect that such errors or performance deficiencies 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 requiring us to incur significant warranty repair costs and support related replacement costs, diverting the attention of our engineering personnel from new product development efforts, delaying the recognition of revenue and causing significant customer relations problems.
In addition, if our products are not accepted by customers due to defects or performance deficiencies, purchase orders contingent upon acceptance may be cancelled, which could result in a significant lost sales opportunity or warranty 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.
We may need to raise further capital, which could dilute or otherwise adversely affect your interest in our company.*
We believe that our existing cash, cash equivalents and short term investments, along with the cash that we expect to generate from operations and any required debt financing that management currently believes is available, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for the next twelve months.
However, a number of factors may negatively impact our level of cash availability and working capital requirements, including, without limitation:
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lower than anticipated revenues;
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higher than expected cost of goods sold or operating expenses; or
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the inability of our customers to pay for the goods and services ordered.
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We believe that current general economic conditions and the recent global credit market crisis have created a significantly more difficult environment for obtaining both equity and debt financing. If additional funds are raised through the issuance of equity or convertible debt securities, 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, especially in light of the current economic environment. 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 defer or cancel product development programs, lay-off employees and/or take other steps to reduce our operating expenses. Our inability to raise additional financing or the terms of any financing we do raise could have a material adverse effect on our business, results of operations and financial condition.
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 following our merger with Zowcom, Inc., a publicly-traded Nevada corporation that had no operations. 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 the introduction of our products into the marketplace. During this period, we generated insignificant revenues from sales of our products. We completed our share exchange with Netintact AB on August 18, 2006 and Netintact PTY on September 29, 2006. The products we sell today are derived primarily from the Netintact acquisitions. 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 not developed sufficient experience to estimate the actual revenues that may 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:
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successfully introducing new products;
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successfully servicing and upgrading new products once introduced;
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increasing brand recognition;
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developing strategic relationships and alliances;
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managing expanding operations and sales channels;
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successfully responding to competition; and
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attracting, retaining and motivating qualified personnel.
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If we are unable to address these risks and uncertainties, our business, results of operations and financial condition could be materially and adversely affected.
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 hired new employees and our plans to expand in all areas 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 may suffer if we encounter material delays in hiring additional personnel.
Our performance is substantially dependent on the continued services and on the performance of our executive officers and other key employees, including our CEO, James Brear, and our Chief Technical Officer, Alexander Havang. Mr. Brear joined the Company and became our CEO in February 2008. 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 an employee based in California leaves the Company for any reason, he or she will generally be able to begin employment with one of our competitors or otherwise to compete immediately against us.
We currently do not have key person insurance in place. If we lose one of our 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. We could fail to implement our strategy or lose sales and marketing and development momentum.
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 reorganized our sales and marketing efforts in 2008, 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 offered 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 competitors 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, on the basis of price, service, warranty and the performance of our products. 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, Allot, Arbor Networks, Blue Coat, Juniper, Ericsson, Huawei Technologies Company, Brocade Communications Systems 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. We also face indirect competition from companies that offer broadband 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.
Most of our competitors are substantially larger than we are and have significantly greater name recognition and financial, sales and marketing, technical, manufacturing and other resources and more established distribution channels than we do. In addition, some potential customers have in the past advised us that they were concerned about our ability to meet their minimum balance sheet requirements, and therefore were not able to compete for their business. While we have attempted to address balance sheet concerns with our recent financing activity, it is possible that a potential customer could raise similar concerns in the future. Our 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.
From period to period, a substantial portion of our revenues may be dependent on a concentrated number of customers, specifically Tier-1 service providers that purchase in large quantities. If we are unable to maintain or replace our relationships with these customers, our revenues may fluctuate and our growth may be limited. *
Beginning in 2008, as we established customer relations with Tier-1 service providers, a significant portion of our revenues has come from a limited number of customers. There can be no guarantee that we will be able to sustain our revenue levels from these customers because our revenues have largely been generated in connection with these customers’ decisions to deploy our DPI products, and we expect that their capacity requirements have become or will become fulfilled. For this reason, we do not expect that any single customer will generally remain a significant customer from year to year, and therefore we believe that generally any significant business generated by a single customer will have to later be replaced by new business from another customer. For example, for the year ended December 31, 2009, revenue from one customer accounted for 44% of net revenue
with no other single customer accounting for more than 10% of net revenue.
For the three and six month periods ended June 30, 2010, revenue from that same customer represented 23% and 21% of net revenue, respectively, and for the six month period ended June 30, 2010, revenue from another customer represented 11% of net revenue, with no other single customer representing more than 10% of net revenue.
Moreover, the proportion of our revenues derived from a limited number of customers may be even higher in any future quarter. If we cannot maintain or replace the customers that purchase large amounts of our products, or if they do not purchase products at the levels or at the times that we anticipate, our ability to maintain or grow our revenues will be adversely affected.
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 customer training. If we are unable to provide adequate 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.
Unstable market and economic conditions may have serious adverse consequences on our business.
Our general business strategy may be adversely affected by the current volatile global business environment and continued unpredictable and unstable market conditions. If financial markets continue to experience volatility or deterioration, it may make any debt or equity financing that we require more difficult, more costly, and more dilutive. In addition, a renewed or deeper economic downturn may result in reduced demand for our products, or adversely impact our customers’ ability to pay for our products, which would harm our operating results. There is also a risk that one or more of our current service providers, manufacturers and other partners may not survive in the current economic environment, which would directly affect our ability to attain our operating goals on schedule and on budget. Failure to secure any necessary financing in a timely manner and on favorable terms could have a material adverse effect on our financial performance and stock price and could require us to change our business plans.
We have limited ability to protect our intellectual property and defend against claims which may adversely affect our ability to compete.
We rely primarily on trade secret law, contractual rights and trademark law to protect our intellectual property rights in our PacketLogic product line. 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 contract manufacturers 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 cost reductions will occur. The failure to obtain such cost reductions would adversely affect our gross margins and operating results.
Most of our operations and logistics functions are outsourced to a single third party service provider, and any disruption to the services provided by this third party could disrupt the availability or quality of our products, which would negatively impact our business
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In April 2009, we entered into an agreement to outsource substantially all our operations and logistics functions to Continuous Computing Corporation of San Diego, California. These operations and logistics functions were formerly handled in our Los Gatos, California facility. Continuous Computing loads Procera’s software into servers and other hardware devices, performs testing and inspection services and ships directly to Procera’s customers.
Outsourcing may not yield the benefits we expect, and instead could result in increased product costs and product delivery delays. Outsourced operations and logistics could create disruptions in the availability of our products if the timeliness or quality of products delivered does not meet our requirements or our customers’ expectations. Such problems or delays could be caused by a number of factors including, but not limited to: financial viability of an outsourced vendor, availability of components to the outsourced vendor, improper product specifications and the learning curve to commence operations and logistics functions at a new outsourced site. If product supply is adversely affected because of problems in outsourcing, we may lose sales.
If our agreement with Continuous Computing terminates or if Continuous Computing does not perform its obligations under our agreement, it could take a significant period of time in which to find and establish an alternative relationship with another outsource manufacturer to provide these services, or to re-establish this capability ourselves. During this time, we may not be able to fulfill our customers’ orders for most of our products in a timely manner. The cost of establishing alternative capabilities to replace those offered by Continuous Computing could be prohibitive.
Any delays in meeting customer demand or quality problems resulting from product loaded, tested, inspected and prepared for shipping by Continuous Computing could result in lost or reduced future sales to key customers and could have a material negative impact on our net sales and results of operations.
If our suppliers fail to adequately supply us with certain original equipment manufacturer, or OEM, sourced components, our product sales may suffer.
Reliance upon OEMs, as well as industry supply conditions generally involves several additional risks, including the possibility of a shortage of components and reduced control over delivery schedules (which can adversely affect our distribution schedules), and increases in component costs (which can adversely affect our profitability). Most of our hardware products, or the components of our hardware components, are based on industry standards and are therefore available from multiple manufacturers. If our supplier were to fail to deliver, alternative suppliers are available, although qualification of the alternative manufacturers and establishment of reliable suppliers could result in delays and a possible loss of sales, which could affect operating results adversely. However, in some specific cases we have single-sourced components, because alternative sources are not currently available. If these components were to become not available, we could experience more significant, though temporary, supply interruptions, delays, or inefficiencies, adversely affecting our results of operations.
Sales of our products to large broadband service providers often 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 often are lengthy, because our prospective 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 before that end-customer decides to purchase and incorporate our products in its network. We may also expend significant resources attempting to persuade large broadband service providers to incorporate our products into their networks without any measure of success. Even after deciding to purchase our products, initial network deployment and acceptance testing of our products by a large broadband service provider may last several years. Carriers, especially in North America, often require that products they purchase meet Network Equipment Building System, or 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 significantly from period to period. In pursuing sales opportunities with larger enterprises, we expect that we will make fewer sales to larger entities, but that the magnitude of individual sales will be greater. We may report substantial revenue growth in the period that we recognize the revenue from a large sale, which may not be repeated in an immediately subsequent period. Because our revenues may fluctuate materially from period to period, the price of our common stock may decline. In addition, even after 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 broadband 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 for which we have exchange rate fluctuation exposure are the European Union Euro, the Swedish Krona and the Australian Dollar. If our revenues continue to grow, 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 our foreign currency risk.
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. 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:
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pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;
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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
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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.
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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 with our internal controls under Item 9A of our Annual Report for the year ended December 31, 2007, and also identified other significant deficiencies in our internal controls. For the years ended December 31, 2009 and 2008, we did not identify any material weaknesses.
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. We have a small accounting staff and limited resources and expect that we will continue to be subject to the risk of additional material weaknesses and significant deficiencies.
Even after corrective actions are implemented, the effectiveness of our controls and procedures may be limited by a variety of risks including:
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faulty human judgment and simple errors, omissions or mistakes;
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collusion of two or more people;
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inappropriate management override of procedures; and
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the risk that enhanced controls and procedures may still not be adequate to assure timely and reliable financial information.
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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 which could negatively impact the market price of our common stock.
Our financial results may be materially affected by non-cash and other accounting charges. Such accounting charges may include:
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amortization of intangible assets, including acquired product rights;
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impairment of goodwill;
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stock-based compensation expense; and
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impairment of long-lived assets.
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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:
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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;
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changing tax laws, regulations and interpretations in multiple jurisdictions in which we operate, as well as the requirements of certain tax rulings;
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changes in accounting and tax treatment of stock-based compensation;
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the tax effects of purchase accounting for acquisitions and restructuring charges that may cause fluctuations between reporting periods; and
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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.
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The price of our common stock could decline if 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 is 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. Although we currently have significant redundant capacity in Sweden in the event of a natural disaster or catastrophic event in Silicon Valley, 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 acquisitions of the Netintact entities. Any future acquisitions could distract our management and employees and increase our expenses.
Following any acquisition, 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:
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integrating the operations and technologies of the two companies;
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retaining and assimilating the key personnel of each company;
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retaining existing customers of both companies and attracting additional customers;
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leveraging our existing sales channels to sell new products into new markets;
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developing an appropriate sales and marketing organization and sales channels to sell new products into new markets;
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retaining strategic partners of each company and attracting new strategic partners; and
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implementing and maintaining uniform standards, internal controls, processes, procedures, policies and information systems.
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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, if we were to issue equity securities to pay for any future acquisitions, the issuance of such equity securities would have a dilutive effect on our existing shareholders.
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 broadband 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.
We believe that 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 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 customers to date have been small and midsize broadband service providers and universities. 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 Internet 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.
Recently proposed regulatory actions may result in reduced capital spending by broadband service providers, which could adversely impact our opportunities for continued revenue growth.*
The Federal Communications Commission (FCC) has been considering different proposals for prohibiting or limiting broadband service providers from providing data prioritization services to their customers. These proposals are referred to generally as relating to "net neutrality". The FCC originally considered proposals that would require broadband service providers to treat all Internet content equally in all circumstances and to prohibit them from providing any data prioritization services. The FCC currently is considering the "Third Way" proposal that would include adopting a rule prohibiting any practice under which Internet access service is provided on unreasonably discriminatory terms and which could result in broad authority to regulate broadband service. It is very uncertain what rules, if any, may be adopted by the FCC regarding net neutrality. In the event that the FCC exercises such broad regulatory authority, it is likely that there may be legislative and/or legal challenges to the FCC's regulatory authority, and while the issues remain unresolved, broadband service providers may lessen their capital investments in their networks. In such a circumstance, we may have fewer opportunities to sell our products to both current and prospective customers, and our opportunity for continued revenue growth could be adversely impacted. If our revenue growth slows or our revenues decrease, our results of operations and our financial condition also may be adversely impacted.
Risks Related to Ownership of Our Common Stock
Our common stock price is likely to continue to be highly volatile.
The market price of our common stock is likely to continue to be highly volatile. The market for small cap and micro cap technology companies, including us, and generally for stocks priced below $5.00 per share, has been particularly volatile in recent years. Because our stock is thinly traded, investors may not be able to resell their shares of our common stock following periods of volatility. 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:
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actual or anticipated fluctuations in our quarterly operating results;
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announcements of technology innovations by our competitors;
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changes in financial estimates by securities analysts;
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conditions or trends in the network control and management industry;
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changes in the market valuations of other such industry related companies;
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the acceptance by institutional investors of our stock;
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rumors, announcements or press articles regarding our operations, management, organization, financial condition or financial statements;
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the gain or loss of a significant customer; or
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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.
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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 has the authority, 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. In addition, we recently received stockholder approval for a series of alternative amendments to our Articles of Incorporation, to effect, at the discretion of our board of directors, a reverse stock split of our common stock which would have the effect of proportionately increasing the number of authorized but unissued shares available for future issuance. 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 June 30, 2010, there were 112,082,724 shares of our common stock outstanding, outstanding warrants to purchase 4,164,604 shares of our common stock, and outstanding stock options to purchase 9,268,495 shares of our common stock. At June 30, 2010, we had an authorized reserve of 4,252,746 shares of common stock which we may grant as stock options or other equity awards pursuant to our existing stock option plans.
Any future issuances of our common stock would 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 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. If, and to the extent, outstanding options or warrants are exercised, current stockholders will experience dilution to their 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 prevailing 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.
In March 2010 we sold 18,000,000 shares in a registered direct offering, all of which shares are immediately saleable. Sales of large volumes of our stock, including those shares described above, could cause the trading price of our common stock to decline.
The NYSE Amex Equities
may delist our securities, 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 NYSE Amex Equities. Maintaining our listing on the NYSE Amex Equities requires that we fulfill certain continuing listing standards, including maintaining a minimum equity level of $6 million, maintaining a trading price for our common stock that the NYSE Amex Equities does not consider unduly low and adhering to specified corporate governance requirements. If the NYSE Amex Equities delists our securities from trading, we could face significant consequences, including:
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a limited availability for market quotations for our securities;
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reduced liquidity with respect to our securities;
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a determination that our common stock 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;
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a limited amount of news and analyst coverage for our company; and
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a decreased ability to issue additional securities or obtain additional financing in the future.
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In addition, we would no longer be subject to NYSE Amex Equities 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 NYSE Amex Equities 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 NYSE Amex Equities or another national exchange, the trading price of our common stock is below $5.00 per share and we have net tangible assets of $6,000,000 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, as amended. 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:
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make a special written suitability determination for the purchaser;
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receive the purchaser’s written agreement to the transaction prior to sale;
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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
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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.
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As a result of these requirements, the market price of our securities may be adversely impacted, and current stockholders 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:
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authorizing the issuance of “blank check” preferred stock without any need for action by stockholders;
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eliminating the ability of stockholders to call special meetings of stockholders;
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restricting the ability of stockholders to take action by written consent; and
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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.
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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 impact the price of our common stock and your rights as a stockholder.
We do not pay and do not expect to pay cash dividends on our common stock.
We have not paid any cash dividends. 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.
It
em 2.
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Unregistered Sales of Equity Securities and Use of Proceeds.
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None
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Defaults Upon Senior Securities.
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None.
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em 4.
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(Removed and Reserved)
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em 5.
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Other Information.
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On August 4, 2010, our Board of Directors approved and adopted Amended and Restated Bylaws, which became effective immediately upon adoption. The Amended and Restated Bylaws, among other things, amend Section 2 to establish notice requirements and process for submission of shareholder proposals, including director nominations, modify the process by which special meetings of shareholders may be called and modify the terms governing the organization and adjournment of shareholders’ meetings; amend Section 3 to clarify that certain communications by electronic means are permissible; and amend Sections 3 and 4 to clarify the role of the Chairman of the Board of Directors.
The foregoing description of the Amended and Restated Bylaws is not intended to be complete and is qualified in it its entirety by reference to the Amended and Restated Bylaws, a copy of which is attached to this Form 10-Q as Exhibit 3.4 and incorporated herein by reference.
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Articles of Incorporation filed on July 16, 2001, filed as Exhibit 3.1 to our registration statement on Form SB-2 filed on February 11, 2002 and incorporated herein by reference. (1)
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Certificate of Amendment to Articles of Incorporation filed on October 12, 2005, filed as Exhibit 99.1 to our current report on Form 8-K filed on October 13, 2005 and incorporated herein by reference. (1)
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Certificate of Amendment to Articles of Incorporation filed on April 28, 2008, filed as Exhibit 3.3 to our quarterly report on Form 10-Q filed on May 12, 2008 and incorporated herein by reference.(1)
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Amended and Restated Bylaws adopted on August 4, 2010.
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Form of Subscription Agreement for March 2010 offering, filed as Exhibit 1.2 to our current report on Form 8-K filed on March 2, 2010 and incorporated herein by reference.(1)
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Form of Warrant for March 2010 offering, filed as Exhibit 4.1 to our current report on Form 8-K filed on March 2, 2010 and incorporated herein by reference.(1)
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Second Amendment to Lease by and between the Company and Vasona Business Park, dated April 1, 2010.
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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.
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Certification of Charles Constanti, 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.
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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 Charles Constanti, Principal Financial Officer.
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SI
GNATURES
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.
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Procera Networks, Inc.
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By:
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/s/ Charles Constanti
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August 9, 2010
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Charles Constanti, Chief Financial Officer
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(Principal Financial and Accounting Officer)
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Exhibit Index
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Articles of Incorporation filed on July 16, 2001, filed as Exhibit 3.1 to our registration statement on Form SB-2 filed on February 11, 2002 and incorporated herein by reference.(1)
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Certificate of Amendment to Articles of Incorporation filed on October 12, 2005, filed as Exhibit 99.1 to our current report on Form 8-K filed on October 13, 2005 and incorporated herein by reference.(1)
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Certificate of Amendment to Articles of Incorporation filed on April 28, 2008, filed as Exhibit 3.3 to our quarterly report on Form 10-Q filed on May 12, 2008 and incorporated herein by reference.(1)
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Amended and Restated Bylaws adopted on August 4, 2010.
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Form of Subscription Agreement for March 2010 offering, filed as Exhibit 1.2 to our current report on Form 8-K filed on March 2, 2010 and incorporated herein by reference.(1)
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Form of Warrant for March 2010 offering, filed as Exhibit 4.1 to our current report on Form 8-K filed on March 2, 2010 and incorporated herein by reference.(1)
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Second Amendment to Lease by and between the Company and Vasona Business Park, dated April 1, 2010.
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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.
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Certification of Charles Constanti, 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.
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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 Charles Constanti, Principal Financial Officer.
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(1) Previously filed
36
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