Back to GetFilings.com

Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission File Number      -            

Packeteer, Inc.

10201 North De Anza

Registrant’s telephone number, including area code: (408) 873-4400

Securities registered pursuant to Section 12(b) of the Act: None

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

Common Stock, $0.001 Par Value

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

     Indicate by checkmark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes þ         No o

     Based on the closing sale price of the common stock on the Nasdaq National Market System on June 28, 2002, the aggregate market value of the voting common stock held by non-affiliates of the Registrant was $102,465,770. Shares of common stock held by each officer and director and by each person known by the Registrant to own 10% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

     The number of shares outstanding of Registrant’s common stock, $0.001 par value, was 31,016,186 at February 28, 2003.

DOCUMENTS INCORPORATED BY REFERENCE

     Information required by Part III, Items 10, 11, 12 and 13, of this Form 10-K is incorporated by reference from the Registrant’s definitive Proxy Statement for the Registrant’s 2003 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after December 31, 2002.

Table of Contents

TABLE OF CONTENTS

Table of Contents

PART I

Item 1. Business

      In addition to historical information, this Annual Report on Form 10-K contains forward-looking statements regarding our strategy, financial performance and revenue sources that involve a number of risks and uncertainties, including those discussed below in “Risk Factors.” Forward-looking statements in this report include, but are not limited to, those relating to our ability to develop multiple applications, our planned introduction of new products and services, the possibility of acquiring complementary businesses, products, services and technologies and our development of relationships with providers of leading Internet technologies. While this outlook represents our current judgment on the future direction of the business, such risks and uncertainties could cause actual results to differ materially from any future performance suggested below. Readers are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this Annual Report. Packeteer undertakes no obligation to publicly release any revisions to forward-looking statements to reflect events or circumstances arising after the date of this document. See “Risk Factors.”

Overview

      Packeteer is a leading provider of application traffic management systems designed to enable enterprises to gain visibility and control of networked applications, extend network resources and align application performance with business priorities. For service providers, Packeteer systems provide a platform for delivering application-intelligent network services that control quality of service, or QoS, expand revenue opportunities and offer compelling differentiation from other potential solutions. Our PacketShaper family of products, including the PacketShaper®, PacketSeeker^TM and PacketShaper Xpress^TM, integrates application discovery, analysis, control, acceleration and reporting technologies that are required for proactive application performance and bandwidth management. Our AppCelera^TM family of Internet acceleration appliances employs secure socket layer (SSL) offload and advanced content compression, transformation and caching technologies to improve response times of mission critical enterprise, eBusiness and eCommerce web applications. Our ReportCenter and PolicyCenter software products are designed to enable management of large deployments of our PacketShaper systems.

      Packeteer’s products are deployed by Global 2000 corporations and service providers, and are sold through an established network of more than 100 resellers, distributors, system-integrators and OEMs in more than 50 countries. Our products are built on hardware platforms based on Intel-compatible microprocessor technologies. In addition, our PacketWise® software is licensed by several communications industry partners who integrate the software into specific strategic networking solutions. We primarily use indirect channels to leverage the reach of our sales force to obtain worldwide coverage. Our sales force and marketing efforts are used to develop brand awareness and support our indirect channels. We have subsidiaries or branch offices in Australia, Caymans, Canada, Denmark, France, Germany, Hong Kong, Japan, Singapore, Spain, South Korea, The Netherlands and the United Kingdom. To date we have shipped more than 24,000 units.

      We were incorporated in Delaware in January 1996 and began shipping our products in February 1997. In this report, “Company”, “Packeteer,” “we,” “us,” and “our” refer to Packeteer, Inc. and its subsidiaries. Investors may access our filings with the Securities and Exchange Commission on our website, which is located on the Internet at www.packeteer.com, but the information on our website does not constitute part of this Annual Report.

Industry Background

     The Emergence of Internet Computing

      Today, both the Internet and its underlying protocol, TCP/IP, have grown to positions of prominence in enterprise networking. Protocols are predefined mechanisms for computers to communicate over networks. From its origins as a network connecting academic and government institutions, the Internet has evolved into an interactive communications and commerce platform supporting businesses’ daily operations. Originally

1

Table of Contents

      The rapid emergence of Internet computing has had a significant effect on today’s enterprise networks and has created new challenges for information technology managers. As more interactive business applications are developed using web-enabled versions of enterprise software platforms, such as SAP, Oracle, PeopleSoft and Siebel, the amount of network data is increasing dramatically. eCommerce extends the confines of the enterprise network across the Internet, making application performance difficult to ensure. Enterprise users access graphic-intensive web sites, download large files, view streaming media presentations, monitor news and stock quotes and access other non-critical information over the Internet. The resulting traffic deluge impacts network resources that serve point-of-sale, order processing, enterprise resource planning, supply-chain management and other vital business functions.

      Internet computing relies on TCP/ IP as the underlying protocol to support distributed enterprise applications and the delivery of electronic services. The Internet Protocol, or IP, provides for routing of packets across networks that utilize TCP/ IP as their underlying protocol. The Transmission Control Protocol, or TCP, provides flow control for, and reliable ordered delivery of, Internet Protocol packets. Unlike early non-interactive applications that did not require real-time responsiveness, today’s enterprise and eCommerce applications depend on timely access to data and real-time transaction responses to ensure productivity and a high quality of experience for end users. The shift toward real-time, delay-sensitive data is accelerating as corporations begin to converge database transactions and multimedia traffic onto their enterprise networks. TCP/ IP is unable to differentiate between traffic types and is designed so that each transmission attempts to consume all available bandwidth. These characteristics, which make TCP/ IP suitable for non-interactive traffic, threaten the performance of today’s mission-critical applications.

      In recent years, the adoption of Fast Ethernet and Gigabit Ethernet technologies has reduced network congestion on the local area network, or LAN. Simultaneously, the deployment of fiber infrastructure in the service provider backbone has also reduced bandwidth contention in that portion of the network. However, the bridge between the two, the wide area network, or WAN, access link, has remained the slow, weak link in the chain, forming a bandwidth bottleneck. WAN access link capacity is often constrained, expensive and difficult to upgrade. When faced with bandwidth contention at the bottleneck, TCP/ IP provides neither a means to give preferential treatment to select applications nor a good mechanism to effectively control data flows because TCP flow control is handled only by end systems. TCP/ IP reacts to network congestion by discarding data packets and sporadically reducing packet transmissions from the host computer. In enterprise networks that are overwhelmed by increasing amounts of both non-critical and mission-critical traffic, unmanaged congestion at the WAN access link undermines application performance and can result in impaired productivity and lost revenues.

      Today’s enterprise networks require solutions that ensure mission-critical application performance, increase network efficiency, and enable the convergence of data, voice and video traffic. Enterprises are seeking to align their networks with their business priorities by making them adaptive to the unique requirements of the growing mix of mission-critical applications. At the same time, they seek to leverage investments in application software and proactively control recurring network costs by optimizing bandwidth utilization.

2

Table of Contents

      Many existing and newly emerging telecommunications service providers are also seeking to address the needs of enterprises that are adopting Internet computing. Service providers have traditionally functioned as WAN bandwidth suppliers, leasing data lines and selling Internet access to businesses and consumers. In the face of heightened competition, service providers are seeking to differentiate themselves by offering tiered services in order to attract and retain customers and increase profitability. These offerings include web hosting, application outsourcing and managed network services. To deliver these services, service providers must be able to ensure network and application performance and better manage and allocate network resources.

      Businesses and service providers currently employ several approaches in an attempt to alleviate network congestion at the WAN access link. These approaches include the following:

      Adding bandwidth and infrastructure to over-provision the network. This approach requires expensive upgrades to WAN access links and associated network equipment. Moreover, incremental increases in bandwidth only temporarily alleviate network congestion, leaving the following problems unresolved:

	•	Increases in bandwidth tend to be consumed quickly by latent demand within LAN and backbone infrastructure, and often disproportionately by non-mission critical traffic;
	•	Deployment costs and increases in recurring service charges can be prohibitively expensive, especially for networks with many remote sites and for international networks;
	•	There is no application performance visibility to enable effective capacity planning; and
	•	Over-provisioning results in under-utilization of the network during non-peak periods.

      Implementing queuing-based features. Queuing technologies provide some degree of prioritization and are frequently incorporated in routers, which are devices that forward data packets from one LAN or WAN to another. These implementations engage only after queues form, and attempt to provide QoS by reordering packets and then discarding packets when the queues overflow. Queuing-based approaches typically identify and prioritize traffic based on rudimentary characteristics such as port number, a simplistic mechanism to coordinate the transmission of application data, IP address or protocol type. While these approaches can alleviate some of the bandwidth contention problems, they are inadequate to handle an increasingly complex mix of interactive and real-time mission-critical applications for the following reasons:

	•	Queuing-based approaches do not control inbound traffic flowing from the WAN to the LAN;
	•	Queuing-based approaches are reactive in nature and can only address congestion after the fact, rather than preventing it from occurring;
	•	Congested queues result in packet loss, retransmissions and delays that waste bandwidth and undermine application response times;
	•	Limited traffic classification capabilities inadequately distinguish between different types of applications, resulting in sub-optimal prioritization of traffic; and
	•	Queuing does not directly control end-to-end application performance.

      Deploying traditional compression technologies. Products are available which compress traffic. Although compression can increase available bandwidth, which effectively increases network capacity and avoids bandwidth upgrades, the network and application performance problems are not necessarily eliminated. As TCP/ IP protocol is inherently bursty, non critical applications, even though compressed, may still consume

3

Table of Contents

	•	Latency, which can negatively affect performance;
	•	Non selective compression, which results in some already compressed application traffic being delayed with no discernable benefit to performance; and
	•	Difficulty in configuring and maintaining compression tunnels.

      Installing network-management tools. Several vendors provide software that analyzes and monitors network traffic. While these products enable network administrators to determine how bandwidth is being utilized, thereby identifying where bandwidth management is required, they do not comprise a complete solution for the following reasons:

	•	Traditional network-management tools only monitor and report network performance and bandwidth utilization, offering no means of fixing or resolving performance problems; and
	•	As is the case with queuing-based approaches, traditional network management tools are reactive in nature in that they detect problems once they occur and do not prevent similar problems in the future.

      As Internet computing is more widely adopted, both businesses and service providers are seeking ways to cost-effectively manage bandwidth, ensure application performance and increase network efficiency. As mission-critical applications compete with bandwidth-hungry non-critical traffic for limited network resources, enterprises require a solution that not only monitors and reports on network performance problems, but also provides the means to fix such problems. As the complexity of their network infrastructures increases, enterprises seek solutions that integrate easily into the existing network and are cost-effective to deploy and maintain. In response to growing competition, service providers are looking to create new revenue streams by offering differentiated network and application-based services that meet the needs of enterprise customers. Whether the solution is implemented by the enterprise or purchased from a service provider, effectively managing the performance of mission-critical applications is essential to businesses relying on Internet computing.

The Packeteer Solution

      Packeteer is a leading provider of application traffic management systems that are designed to enable enterprises, service providers, and other organizations to align network resources with business priorities. Packeteer systems monitor, control, and accelerate application performance over WANs and the Internet. Our systematic, application-intelligent approach is designed to ensure that mission-critical applications perform efficiently and reliably and that existing network resources are extended to support business needs. Packeteer’s application traffic management system is based on the following:

	I.     Application Traffic Monitoring: Packeteer’s monitoring capabilities serve as the backbone for PacketSeeker, an application-intelligent traffic monitoring system, as well as PacketShaper, a traffic management system that incorporates both monitoring and policy control. Packeteer’s monitoring capabilities involve automatic identification and classification of traffic through Layer 7, the applications layer, which is the highest layer in the industry standard OSI (Open Systems Interconnection) model. This application-layer insight is designed to enable organizations to analyze application performance and network utilization accurately. Packeteer’s performance analysis determines response times, delays, link utilization, and many more crucial metrics. Depending on the size of the Packeteer deployment, performance analysis may be captured via onboard or centralized reporting.
	II.     Application Traffic Shaping: Packeteer’s PacketShaper systems allow the user to set policy control that aligns application performance in support of business needs. PacketShaper systems allow mission-critical applications to perform efficiently and reliably by allocating varying amounts of bandwidth to applications depending on their relative importance. For instance, network managers can

4

Table of Contents

	tailor policy management and bandwidth allocation to suit the requirements of particular applications or traffic, such as Citrix, SAP, Siebel, Video over IP and Voice over IP. Meanwhile, peer-to-peer file sharing, casual web browsing, and other unsanctioned traffic can be eliminated or minimized, depending on an organization’s available network resources and business priorities.
	III.     Application Traffic Acceleration: Packeteer also enhances application performance through its acceleration technologies. PacketShaper Xpress provides a software option that utilizes application-intelligent compression, latency management and tunnel management to accelerate policy-managed business traffic. Packeteer also offers AppCelera ICX, an intranet acceleration system that addresses the trend of application “webification”. Utilizing a combination of compression, conversion, and caching, AppCelera ICX optimizes content to suit each user’s connection speed and browser. Its content-intelligent approach overcomes inherent last-mile obstacles reducing potential latency.
	IV.     Report Performance: PacketShaper systems provide reports describing current and historical network performance. Comprehensive reports, graphs and tables enable network managers to refine bandwidth management policies, evaluate efficiency and plan capacity. PacketShaper systems automatically measure per-transaction response times for each application. Managers can set, enforce and monitor service-level agreements, which quantify desired QoS for a particular application or customer. Packeteer’s ReportCenter is designed to provide centralized analysis and reporting for large PacketSeeker and PacketShaper system deployments.

      Our application traffic management systems are designed to enable businesses and service providers to realize the following key benefits:

	•	Gain Network Performance Visibility and Insight. PacketSeeker and PacketShaper provide valuable historical and real-time information about application performance and network utilization through an easy-to-use browser interface. Network managers gain a better understanding of the nature of traffic running on their networks and the problems and inefficiencies associated with that traffic.
	•	Ensure Bandwidth to Mission-Critical Applications. Policy-based bandwidth allocation protects bandwidth for mission-critical applications such as SAP, Oracle, PeopleSoft and Siebel, preventing disruptions from bandwidth-hungry but less urgent applications such as file transfers, peer-to-peer file sharing or casual web browsing.
	•	Permit Easy Deployment. PacketShaper installs easily, and automatically starts to discover, classify and analyze network traffic and suggest policies to optimize performance. It complements the existing network infrastructure, requires no router reconfiguration or desktop changes and is designed not to disrupt network connectivity in the event of software or hardware failure.
	•	Increase Effective Bandwidth. PacketShaper Xpress intelligently increases effective bandwidth and, through integration with PacketShaper’s advanced monitoring and shaping capabilities, enables the additional bandwidth to be utilized by mission-critical applications.
	•	Enable Interactive Services. Voice over IP, or VoIP, videoconferencing and other streaming media require guaranteed bandwidth in order to achieve minimum quality requirements. By using PacketShaper to set minimum bandwidth guarantees and priority, enterprises and service providers can deliver smooth and predictable performance of these delay-sensitive multimedia services.
	•	Increase Network Efficiency. PacketShaper improves network efficiency and helps delay expensive capacity upgrades by managing non-critical traffic to reduce retransmission overhead and smooth the variability in bandwidth utilization.
	•	Accelerate Web Applications. AppCelera applies content compression and optimization technologies to reduce bandwidth utilization and improve response times for web-enabled applications.

5

Table of Contents

Strategy

      Our objective is to be the leading provider of application traffic management systems that give enterprises and service providers a new layer of control for applications delivered across intranets, extranets and the Internet. Key elements of our strategy include:

      Focus on Bandwidth Management Needs of Enterprises. We are focused on providing high performance, easy-to-use and cost-effective bandwidth management solutions to enterprises whose businesses are based on Internet computing. For these businesses, managing mission-critical application performance and optimizing the value of the network will continue to be competitive requirements. As the Internet proliferates and new Internet-based applications and services emerge, we believe businesses will continue to adopt Internet computing business models at a rapid rate and that effective bandwidth management will become an increasingly important requirement for maintaining an efficient enterprise network. We believe we have established a differentiated market position based on our development of a comprehensive solution that provides for effective bandwidth management and our early market leadership and brand awareness. We intend to continue to direct our development, sales and marketing efforts toward addressing the bandwidth management needs of the Internet computing market.

      Expand Presence in Telecommunications Service Provider Market. We are actively pursuing opportunities in the telecommunications service provider market and currently have numerous telecommunications service provider customers, including: AT&T, Equant, Fujitsu Cable, Hughes Network Systems, NTT Communications and Singapore Cable. We believe service providers are under increasing pressure to attract new subscribers, reduce subscriber turnover, improve operating margins and develop new revenue streams. Specifically, service providers seek to differentiate themselves through value-added service offerings, such as web hosting, application outsourcing and application service-level management. We believe our PacketShaper and PacketWise solutions enable service providers to deliver these higher value services by enhancing network and application performance and better managing and allocating network resources. Our goal is to increase demand for our solutions with service providers by leveraging our strong enterprise presence.

      Expand Presence in the Managed Application Services Market. We are actively pursuing opportunities in the managed application services market and currently have several managed application service provider customers, including NTT Communications, Equant and AT&T using our managed application service features. Our software’s policy based application subscriber management features are designed to enable managed application service providers to quickly and cost-effectively deliver secure, measured and performance-assured application services tailored to the needs of specific markets and customers. Such features deliver a clearly defined service demarcation point between service providers and their customers and delivery-chain partners; provide and enforce QoS application-specific service level agreements (SLAs); and enable application-specific billing.

      Continue to Build Indirect Distribution Channels. We currently have over 100 resellers, distributors, systems integrators and OEMs, that sell our products in over 50 countries. These relationships include: Allasso, Alternative Technology; Equant, Kanematsu USA, Lan Systems Pty. Ltd., Macnica, Inc, Net One Systems Co., Ltd., Nissho Electronics Corporation, RBR Networks Pte. Ltd. and Westcon, Inc. We intend to continue to develop and support new reseller and distribution relationships, as well as to establish additional indirect channels with service providers, systems integrators and OEMs. We believe this strategy will enable us to increase the worldwide deployment of our products.

      Extend Bandwidth Management Technology Leadership. Our technological leadership is based on our sophisticated traffic classification, flexible policy setting capabilities, precise rate control expertise, web content acceleration and compression technologies and ability to measure response time and network performance. We intend to invest our research and development resources to increase performance by handling higher speed WAN connections, increase functionality by identifying and managing additional applications or traffic types, and increase modularity by taking individual components of PacketWise together or on a stand-alone basis with our existing bandwidth management solutions. We also plan to invest our research and development resources to develop new leading-edge technologies for emerging markets. These development plans include extending our bandwidth management solutions to incorporate in-depth application-management techniques

6

Table of Contents

Products

      Packeteer’s family of products — powered by our PacketWise software — enable enterprises and service providers to measure, control, accelerate and validate the performance of networked applications and managed application services.

      PacketSeeker System. PacketSeeker is an application traffic-monitoring system that builds on the Company’s industry-leading Layer-7 traffic classification, analysis and reporting technology. It features a new PacketCapture^TM capability that enables effective remote problem diagnosis. PacketSeeker further distinguishes itself from “passive” monitoring solutions currently available by giving the user the ability to seamlessly upgrade the software to become a PacketShaper when traffic shaping is required to enforce quality of service.

      PacketShaper System. PacketShaper is an application-based traffic and bandwidth management system designed to deliver predictable, efficient performance for applications running over the WAN and Internet. The PacketShaper Enterprise Edition is designed to provide effective application QoS using state-of-the-art bandwidth, traffic, service-level and policy management technology. The PacketShaper ISP Edition is designed to enable service providers to create differentiated services through fast and efficient bandwidth provisioning and management. With over 24,000 units shipped worldwide to enterprises and service providers, PacketShaper is a market leader in application traffic management systems. The PacketShaper family currently includes the 1500, 2500, 4500, 6500 and 8500 Enterprise Editions and 4500, 6500 and 8500 ISP Editions.

      PacketShaper Xpress System. The PacketShaper Xpress is a product that provides application traffic acceleration. By leveraging its expertise in advanced Web acceleration and content compression technology, Packeteer has created a “universal” traffic acceleration solution that is highly efficient, scalable and simple to administer. Combining Layer 7 classification, traffic shaping and application-intelligent acceleration raises the level of control customers have over the performance of their networked applications and associated bandwidth costs.

      AppCelera System. A product designed to accelerate the performance of Internet applications, AppCelera ICX (Internet Content Accelerator) is an advanced content acceleration product that can reduce web response-times by up to 50% by accelerating web content delivery all the way to the user’s desktop. It combines content compression, transformation and caching technologies to improve web application performance across the bandwidth-constrained last mile connections while reducing both server and bandwidth resource consumption.

      PolicyCenter^TM Software. A directory-based policy management application that enables Packeteer’s enterprise and service provider customers to broadly deploy, scale and manage application QoS throughout the network, PolicyCenter is an LDAP directory-enabled application running under Windows 2000 or Windows NT that enables customers to centrally administer and update PacketShaper policies, software versions, and device status for Packeteer-based networks.

      ReportCenter^TM Software. An application that aggregates metrics from large deployments and creates organization–wide reports to manage trends and provide support for capacity planning and usage analysis, ReportCenter lowers the cost of ownership for large deployments of PacketWise-enabled appliances, improves the quality of information and eases administrative overhead.

Technology

      We differentiate our solution by combining our knowledge of enterprise applications with our expertise in underlying network protocols. We have invested heavily in developing valuable, proprietary software and

7

Table of Contents

      We believe the ability to automatically detect and classify an extensive collection of applications and protocols differentiates PacketSeeker and PacketShaper systems from other bandwidth management technologies. Sophisticated traffic classification is crucial to understanding network congestion and to targeting appropriate bandwidth-allocation policies. Network software or devices that claim QoS features typically offer rudimentary solutions that can identify traffic based only on protocol type or port numbers. This approach limits application-specific QoS capabilities because these products do not recognize the detailed information required to make intelligent classification decisions. PacketSeeker and PacketShaper systems discover and classify traffic by focusing on content and applications where value to the end user lies.

      Relying only on more basic traffic classification prevents network managers from discovering important traffic trends and limits policy setting. Sophisticated traffic types such as voice calls over networks based on Internet Protocol, or VoIP, Oracle 8i, TN3270, Citrix, and Microsoft DCOM cannot be identified using rudimentary traffic classification schemes. PacketSeeker and PacketShaper systems identify traffic markers, detect changing or dynamic port assignments and track transactions with changing port assignments. This sophisticated traffic classification allows network managers with PacketShaper systems to set policies and control the traffic related to an individual application, session, client, server or traffic type. PacketSeeker and PacketShaper systems permit a network manager to isolate each published application running on a centralized server and can also differentiate among various applications using the same port. This ability to individually classify applications is a highly valuable tool for network managers, since both non-critical applications such as web browsing and music downloading through peer-to-peer applications and mission-critical applications such as Citrix, Oracle or SAP and critical web sites may all be assigned to the same TCP port number on a network but can be individually classified using a PacketShaper system.

      Packeteer systems need no assistance from network managers to automatically detect and identify approximately 400 different traffic types. Without a sophisticated identification and classification capability, managers are usually unaware of the diversity of their own network traffic. In addition, managers can use our technology to define proprietary applications so that their traffic can be recognized and reported. Our technology is differentiated by its ability to recognize older enterprise protocols, such as AppleTalk, DECnet, IPX and SNA. We frequently enhance our classification capability to include new traffic types. Any traffic category can be made even more specific by adding more detailed criteria — for example, Oracle traffic to or from a particular database. Some of the traffic types which Packeteer’s technology automatically detects and classifies are listed below. The traffic types are named either with their associated protocol or application and are grouped according to the class of application that generated that traffic. Each traffic type has an associated protocol that allows it to be recognized on the network.

8

Table of Contents

      PacketShaper systems provide network managers flexible tools to tailor solutions for different applications or traffic types. Unlike queuing-based approaches, PacketShaper systems allow network managers to do more than just prioritize one traffic type over another. Our policy features offer the flexibility required to tune bandwidth to specific applications and dynamically utilize available bandwidth. These policy features, which may be used individually or in conjunction with each other, include:

	•	Per-session Rate Policies. These policies enable network managers to limit or guarantee bandwidth to each individual session of an application’s traffic. Per-session policies allocate each session an appropriate amount of bandwidth and prevent one large session from inappropriately impacting others. Network managers specify a minimum-guaranteed rate and allow the session scaled access to additional available bandwidth. For example, a bandwidth cap for traffic prevents web browsers from competing for bandwidth required by mission-critical applications. Likewise, a guaranteed rate for

9

Table of Contents

		audio or video streams ensures that they are not interrupted by traffic that tends to consume any available bandwidth.
	•	Partitions. Partitions allow for the creation of a separate, exclusive channel within a WAN access link. Partitions represent aggregate bandwidth minimums or maximums governing how much of the network can be used by a single application or traffic category. Partitions can be fixed, creating dedicated virtual circuits, or burstable, creating virtual circuits whose unused bandwidth can be shared.
	•	Dynamic Subscriber Bandwidth Provisioning. Dynamic Subscriber Bandwidth Provisioning allocates bandwidth and enforces QoS policies automatically by mapping a subscriber’s traffic profile (e.g. source/ destination IP address, traffic type, URL, etc.) to a prescribed policy. This feature is a scaleable and easy-to-deploy solution that actively provisions minimum and maximum bandwidth to up to 20,000 subscribers accessing the network concurrently. Using a 5-to-1 over subscription model, not uncommon in today’s service provider market, bandwidth for as many as 100,000 subscribers can be managed with a single PacketShaper. This feature also gives service providers additional revenue opportunities through multi-tiered Internet access services (e.g. bronze, silver, gold) for dial-up, DSL, cable and wireless subscribers.
	•	Priority Policies. This policy feature enables network managers to assign one of eight possible priority levels to each application or traffic category. Priority policies are ideal for traffic that does not burst, non-IP traffic and traffic characterized by small, high-priority flows.
	•	Admission-control Policies. Network managers can use admission-control policy features to determine the response if a bandwidth guarantee cannot be satisfied. Such responses may include denying access, accommodating an additional user with less than guaranteed performance, or, for web requests, redirecting the request to another server. For example, if an online streaming-video service suffers a high-demand period and all available bandwidth is consumed, an admission-control policy could present a web page explaining that resources are busy. This allows a maximum number of users to receive a targeted service quality without degradation as new users seek to access the service.
	•	Discard and Never-admit Policies. These policies intentionally block traffic. Discard policies toss packets without sending feedback to the sender. Never-admit policies are similar to discard policies except that the policy informs the sender that service is blocked.

      One of TCP/ IP’s primary weaknesses is an inability to guarantee QoS. Unlike systems network architecture, or SNA, and asynchronous transfer mode, or ATM, protocols, which have an embedded concept of rate, TCP/ IP’s attempt to consume all available bandwidth conflicts with the goal of predictable, consistent, mission-critical application performance. PacketShaper’s standards-based TCP rate control technology overcomes TCP/ IP’s shortcomings by proactively preventing congestion on both inbound and outbound traffic flows and increasing overall network throughput. Rather than discarding packets from a congested queue, TCP rate control paces packet delivery to prevent congestion. Rate control uses the remote user’s access speed and real-time network latency to calculate the optimal transmission speed. Evenly paced packet transmissions, instead of packet bursts which consume all available bandwidth, yield significant efficiency gains in the network. TCP rate control is a proactive and precise way to increase network efficiency by avoiding retransmissions and packet loss. TCP rate control also creates a smooth and even flow rate that maximizes throughput. By employing TCP rate control, PacketShaper systems manage the majority of traffic at the WAN access link before network congestion occurs.

      For non-TCP-based traffic, such as UDP, or User Datagram Protocol, alternative rate-based management techniques must be implemented. Typically UDP does not rely on acknowledgments to signal successful receipt of data, and it therefore offers no means for flow control. By directly controlling other TCP flows, however, PacketShaper systems are designed to effectively make bandwidth available for UDP flows. The combination of per flow rate scheduling and explicit delay boundaries removes latency and variability, or jitter, for the UDP flows traversing the WAN access link.

10

Table of Contents

      For example, VoIP is a UDP-based application that is particularly latency-sensitive, requiring packets to be evenly spaced to eliminate jitter. PacketShaper enhances VoIP performance in two ways. First, PacketShaper manages competing traffic by using rate control to constrain bursty TCP traffic. In addition, a rate policy for VoIP gives a minimum bandwidth guarantee to each flow, ensuring that each voice stream gets the bandwidth it needs for predictable performance. When there is a lull in the conversation, any unused bandwidth is re-allocated to other traffic.

      The PacketShaper system’s position in the enterprise network — monitoring and controlling all the traffic that passes — gives it an opportunity to provide accurate response-time measurements. Because it already handles and classifies every packet, the PacketShaper system can easily calculate the amount of time traffic spends traveling between a client and a server and the amount of time used by the server itself.

      The PacketShaper system breaks each response-time measurement into network delay, which is the amount of time spent in transit, and server delay, which is the amount of time the server is used to process the request. It can highlight clients and servers with the slowest performance. The PacketShaper system allows network managers to set acceptability standards and then track whether performance adheres to the standards.

      Sophisticated classification and control of high-speed traffic must be accomplished in an efficient manner. Adding significant delay in the process of managing traffic flows would negate the resulting performance improvements. Packeteer has developed expertise in the development of high-speed, software-based packet engines running on real-time operating systems that can efficiently process thousands of simultaneous high-speed connections with minimal delay. This core-engine software technology scales to take advantage of ever-increasing microprocessor performance to manage faster access links.

      Large deployments require tools to ease the process of updating tens or hundreds of PacketShapers that are distributed throughout the network. To address these requirements, Packeteer offers its own centralized management tools, PolicyCenter and ReportCenter. In addition to working with PacketShaper systems, PolicyCenter and ReportCenter were designed to align with industry standards and therefore integrate with third-party tools such as InfoVista, HP Open View and Micromuse.

      Traffic can be accelerated by compression. Compression reduces traffic primarily by eliminating repeated sequences. Although compression effectively increases network capacity and avoids bandwidth upgrades, introducing compression or bandwidth upgrades does not necessarily eliminate network and application performance problems. As TCP/ IP is an inherently bursty protocol, non-critical applications frequently consume all available bandwidth. Therefore, applying compression may increase the “virtual size” of a WAN connection, but does not ensure that mission-critical application traffic takes advantage of the newly created bandwidth. In addition, standard compression adds latency to the compressed traffic. This latency, which is caused by the act of compressing itself and by trying to compress traffic that cannot be compressed further, increases configuration and management complexity.

      PacketShaper Xpress merges application traffic management with acceleration using compression, active tunnel management and latency management. The integration of PacketShaper Xpress with the PacketShaper traffic management technology is designed to ensure that increased WAN capacity is utilized by mission-

11

Table of Contents

	•	making compression decisions based on application type;
	•	utilizing application specific algorithms, and;
	•	working with TCP rate control and other traffic management technology to manage flows of data through the compression engine to ensure consistent, predictable responses.

      PacketShaper Xpress also reduces configuration and management complexity of compression through the use of the active tunnel management feature. This feature uses dynamic discovery and automatic establishment of tunnels to simplify deployment and ongoing maintenance costs.

      While traffic management prioritizes mission-critical applications and smoothes bursty traffic, PacketShaper Xpress enhances performance by fostering greater throughput, faster performance, and increased network capacity.

      Our technology includes several network appliances (hardware and software systems), represented by the AppCelera ICX-55, ICX-75 and ICX-75s, ICX-95 and ICX-95s that accelerate the transmission and rendering speed of Internet applications by compressing traffic from end-to-end and dynamically increasing the throughput of the low and medium speed connections, and in the case of the ICX-75s and ICX-95s, provide the ability to offload secure socket layer (SSL) processing. The software embedded in these appliances achieves these results by using dynamic, static and variant content caching together with content-aware compression and transformation techniques for an increase in performance. These products also determine the type of content, speed of access, and type of browser and automatically optimize the speed of delivery and rendering of information. By combining caching with compression, this technology accelerates delivery of business content and Internet applications to the user. AppCelera ICX is designed to accelerate content as it overcomes the worst sources of performance impact — first mile SSL overload and last-mile bandwidth constraints — that limit the effectiveness of stand-alone caches and load balancers.

Customers

      We sell all of our products primarily through indirect channel partners. The following is a representative list of our indirect channel partners by geographic region:

12

Table of Contents

     The following is a representative list of end users that have deployed multiple PacketShapers:

      In 2002, sales to Alternative Technology, Inc., Westcon, Inc., and Macnica, Inc. accounted for 21%, 13% and 11% of net revenues respectively. In 2001 and 2000, one customer, Alternative Technology, Inc., accounted for 22% and 12% of net revenues, respectively. No other customer accounted for 10% or more of revenues in 2001 or 2000. Sales to the top 10 indirect channel partners accounted for 66%, 59%, and 46% of net revenues for the years ended December 31, 2002, 2001 and 2000, respectively.

Manufacturing

      We outsource all of our manufacturing, including warranty repair, to one contract manufacturer, SMTC Manufacturing Corporation (SMTC) located in San Jose, California. The manufacturing processes and procedures for this manufacturer are ISO 9002 certified. Outsourcing our manufacturing enables us to reduce fixed costs and to provide flexibility in meeting market demand.

      We design and develop a majority of the key components of our products, including printed circuit boards and software. In addition, we determine the components that are incorporated into our products and select the appropriate suppliers of these components. Product testing and burn-in is performed by our contract manufacturer using tests and automated testing equipment that we specify. We also use inspection testing and statistical process controls to assure the quality and reliability of our products.

      We use a rolling six-month forecast based on anticipated product orders to determine our material requirements. Lead times for the materials and components we order vary significantly and depend on factors such as specific supplier, contract terms and demand for a component at a given time. We submit purchase orders for quantities needed within the next 90 days. SMTC or Packeteer may terminate the contract without cause at any time. At that time the terminating party must honor all open purchase orders.

Marketing and Sales

      We target our marketing and sales efforts at enterprises and service providers. Marketing and sales activities focus on reaching the corporate information technology organization managers responsible for the performance of mission-critical applications and maintenance of network performance in the enterprise. We also focus on reaching service providers that provide valued-added service offerings, such as application performance monitoring and management.

      Our marketing programs support the sale and distribution of our products and educate existing and potential enterprise and service provider customers about the benefits of our application traffic management systems. Our marketing efforts include the following:

	•	publication of technical, educational and business articles in industry magazines;
	•	public speaking opportunities at international tradeshows, conferences and analyst events;

13

Table of Contents

	•	electronic marketing including web site-based communication programs, electronic newsletters and on-line end-user seminars;
	•	industry tradeshows, technical conferences and technology seminars; and
	•	focused advertising, direct mail, public relations and analyst outreach.

      We classify our distribution channels in the following categories:

	•	Channel Partners. Packeteer has teamed with value-added resellers and distributors in the industry that are distinguished by their ability to deliver comprehensive QoS solutions, their industry expertise, and their commitment to customer satisfaction. We have established an indirect distribution channel, which is comprised of a network of over 100 resellers, distributors and system integrators that sell our solutions in over 50 countries. These partners sell our systems and software products as well as other third-party products that are complementary to our application traffic management systems.
	•	Alliance Partners. Our Alliance Partners Program (APP) unites Packeteer with organizations whose product offerings enhance, extend and advance Packeteer technology in the marketplace. In exchange, Packeteer presents APP partners with the opportunity to extend to its customers our industry-leading application performance and quality of service solutions. The APP has three designations, differentiated by the partner’s customer focus: Technology Alliance Partner, Solutions Alliance Partner, and Strategic Integration Partner. Technology Alliance Partners include partnerships that provide customers with more sophisticated classification, control, reporting and management of their applications. Solutions Alliance Partners include companies whose product/ solution offerings require performance enhancing technologies, such as QoS or content acceleration. Strategic Alliance Partners include integration and consulting organizations that seek to offer Packeteer products as part of a whole solution offering. Some of these Alliance Partners include Citrix, Compaq Computer Corporation/ Hewlett Packard, Concord and InfoVista.

      As of December 31, 2002, our worldwide sales and marketing organization consisted of 83 individuals, including managers, sales representatives and technical and administrative support personnel. We have domestic sales offices located in California, Illinois, Massachusetts, New Jersey and Texas. In addition, we have international sales offices located in Australia, Denmark, England, France, Germany, Hong Kong, Japan, Singapore, South Korea, Spain and The Netherlands.

      We believe there is a strong international market for our application traffic management solutions. Our international sales are conducted primarily through our overseas offices. Sales to customers outside of North America accounted for 58%, 55% and 54% of our net revenues in 2002, 2001 and 2000, respectively.

Research and Development

      As of December 31, 2002, our research and development organization consisted of 63 employees providing expertise in different areas of our software: core functionality, classification, central management, user interface and platform engineering. Since inception, we have focused our research and development efforts on developing and enhancing our application performance solutions.

Customer Service and Technical Support

      Our customer service and support organization provides technical support services. Our technical support staff is strategically located in five regional service centers: California, Hong Kong, Japan, Australia and The Netherlands. These services, which may include telephone/ web support, next business day advance replacement and access to all software updates and upgrades, are typically sold as single or multi-year contracts to our resellers and end users. In addition, Packeteer has formal agreements with two third party service providers to facilitate next business day replacement for end-user customers outside the United States covered by maintenance agreements providing this service level. We believe that these programs will improve service levels and lead to increased customer satisfaction.

14

Table of Contents

Competition

      We compete in a rapidly evolving and highly competitive sector of the Internet application infrastructure system market. We expect competition to persist and intensify in the future from a number of different sources. Increased competition could result in reduced prices and gross margins for our products and could require increased spending by us on research and development, any of which could harm our business. We compete with Cisco, CheckPoint and several small private companies that sell products that utilize competing technologies to provide bandwidth management. In addition, our products and technology compete for information technology budget allocations with products that offer monitoring technologies, such as probes and related software. Lastly, we face indirect competition from companies that offer enterprises and service providers’ increased bandwidth and infrastructure upgrades that increase the capacity of their networks, and thereby may lessen or delay the need for bandwidth management.

      We believe the principal competitive factors in the traffic management market are:

	•	expertise and in-depth knowledge of applications;
	•	timeliness of new product introductions;
	•	ability to integrate in the existing network architecture without requiring network reconfigurations or desktop changes;
	•	ability to ensure end-user performance in addition to aggregate performance of the WAN access link;
	•	ability to compress traffic without decreasing throughput, performance or network capacity;
	•	ability to integrate traffic classification, management, reporting and acceleration into a single platform;
	•	compatibility with industry standards;
	•	products that do not increase latency and packet loss;
	•	size and scope of distribution network;
	•	brand name; and
	•	access to customers and size of installed customer base.

Intellectual Property

      We rely on a combination of patent, copyright and trademark laws, and on trade secrets, confidentiality provisions and other contractual provisions to protect our proprietary rights. These measures afford only limited protection. As of December 31, 2002 we have 11 issued U.S. patents and 34 pending U.S. patent applications. We cannot assure you that our means of protecting our proprietary rights in the U.S. or abroad will be adequate or that competitors will not independently develop similar technologies. Our future success depends in part on our ability to protect our proprietary rights to the technologies used in our principal products. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use trade secrets or other information that we regard as proprietary. In addition, the laws of some foreign countries do not protect our proprietary rights as fully as do the laws of the U.S. We cannot assure you that any issued patent will preserve our proprietary position, or that competitors or others will not develop technologies similar to or superior to our technology. Our failure to enforce and protect our intellectual property rights could harm our business, operating results and financial condition.

      From time to time, third parties, including our competitors, have asserted patent, copyright and other intellectual property rights to technologies that are important to us. We expect that we will increasingly be subject to infringement claims as the number of products and competitors in the application-adaptive bandwidth management market grows and the functionality of products overlaps. The results of any litigation matter are inherently uncertain. In the event of an adverse result in any litigation with third parties that could arise in the future, we could be required to pay substantial damages, including treble damages if we are held to have willfully infringed, to cease the manufacture, use and sale of infringing products, to expend significant

15

Table of Contents

Employees

      As of December 31, 2002, Packeteer employed a total of 203 full-time employees. Of the total number of employees, 63 were in research and development, 67 in sales and system engineering, 16 in marketing, 30 in operations and 27 in administration. Our employees are not represented by any collective bargaining agreement with respect to their employment by Packeteer.

RISK FACTORS

      You should carefully consider the risks described below before making an investment decision. If any of the following risks actually occur, our business, financial condition or results of operations could be materially and adversely affected. In such case, the trading price of our common stock could decline, and you may lose all or part of your investment.

Our limited operating history and the rapidly evolving market we serve makes evaluating our business prospects difficult

      We were incorporated in January 1996 and began shipping our products commercially in February 1997. Because of our limited operating history and the uncertain nature of the rapidly changing market that we serve, we believe the prediction of future results of operations is difficult. As an investor in our common stock, you should consider the risks and difficulties that we face as an early stage company in a new and rapidly evolving market. Some of the specific risks we face include our ability to:

	•	execute our sales and marketing strategy;
	•	maintain current and develop new relationships with key resellers, distributors, systems integrators and original equipment manufacturers, or OEMs; and
	•	expand our domestic and international sales efforts.

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

      Although we earned a net income of $3.7 million in 2002, we incurred net losses of $71.0 and $9.4 million in 2001 and 2000 respectively. As of December 31, 2002, we had an accumulated deficit of $103.4 million. Our recent profitability could be difficult to sustain. If revenues grow slower than we anticipate or if operating expenditures exceed our expectations or cannot be adjusted accordingly, we may experience additional losses on a quarterly and annual basis.

If the application traffic management solutions market fails to grow, our business will fail

      The market for application traffic management solutions is in an early stage of development and its success is not guaranteed. Therefore, we cannot accurately assess the 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 be successful, 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.

Our future operating results may not meet analysts’ expectations and may fluctuate significantly, which could adversely affect our stock price

      We believe that period-to-period comparisons of our operating results cannot be relied upon as an indicator of our future performance. Our operating results may be below the expectations of public market

16

Table of Contents

	•	the timing and size of orders and shipments of our products;
	•	the mix of products we sell;
	•	the mix of channels through which those products are sold;
	•	the average selling prices of our products; and
	•	the amount and timing of our operating expenses.

      In the past, we have experienced fluctuations in operating results. These fluctuations resulted primarily from variations in the mix of products sold and variations in channels through which products were sold. Research and development expenses, specifically prototype expenses, consulting fees and other program costs, have fluctuated relative to the specific stage of product development of the various projects underway. Sales and marketing expenses have fluctuated due to increased personnel expenses, expenditures related to trade shows and the launch of new products. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for detailed information on our operating results.

The average selling prices of our products could decrease rapidly which may negatively impact gross margins and revenues

      We may experience substantial period-to-period fluctuations in future operating results due to the erosion of our average selling prices. The average selling prices of our products could decrease in the future in response to competitive pricing pressures, increased sales discounts, new product introductions by us or our competitors or other factors. Therefore, to maintain our gross margins, we must develop and introduce on a timely basis new products and product enhancements and continually reduce our product costs. Our failure to do so would cause our revenue and gross margins to decline.

If our international sales efforts are unsuccessful, our business will fail to grow

      The failure of our indirect partners to sell our products internationally will harm our business. Sales to customers outside of North America accounted for 58%, 55% and 54% of our total net revenues in fiscal 2002, 2001 and 2000, respectively. Our ability to grow will depend in part on the expansion of international sales, which will require success on the part of our resellers, distributors and systems integrators in marketing our products.

      We intend to expand operations in our existing international markets and to enter new international markets, which will demand management attention and financial commitment. We may not be able to successfully sustain and expand our international operations. In addition, a successful expansion of our international operations and sales in foreign markets will require us to develop relationships with suitable indirect channel partners operating abroad. We may not be able to identify, attract or retain these indirect channel partners.

      Furthermore, to increase revenues in international markets, we will need to continue to establish foreign operations, to hire additional personnel to run these operations and to maintain good relations with our foreign indirect channel partners. To the extent that we are unable to successfully do so, our growth in international sales will be limited.

      Our international sales are currently all U.S. dollar-denominated. As a result, an increase in the value of the U.S. dollar relative to foreign currencies could make our products less competitive in international markets. In the future, we may elect to invoice some of our international customers in local currency. Doing so will subject us to fluctuations in exchange rates between the U.S. dollar and the particular local currency and could negatively affect our financial performance.

17

Table of Contents

If we are unable to develop and maintain strong partnering relationships with our indirect channel partners, or if their sales efforts on our behalf are not successful, or if they fail to provide adequate services to our end-user customers, our sales may suffer and our revenues may not increase

      We rely primarily on an indirect distribution channel consisting of resellers, distributors and systems integrators for our revenues. Because many of our indirect channel partners also sell competitive products, our success and revenue growth will depend on our ability to develop and maintain strong cooperative relationships with significant indirect channel partners, as well as on the sales efforts and success of those indirect channel partners.

      We cannot assure you that our indirect channel partners will market our products effectively or continue to devote the resources necessary to provide us with effective sales, marketing and technical support. In order to support and develop leads for our indirect distribution channels, we plan to continue to expand our field sales and support staff as needed. We cannot assure you that this internal expansion will be successfully completed, that the cost of this expansion will not exceed the revenues generated or that our expanded sales and support staff will be able to compete successfully against the sig