Attached files
file | filename |
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EX-32.1 - EXHIBIT 32.1 - PROCERA NETWORKS, INC. | ex32_1.htm |
EX-31.1 - EXHIBIT 31.1 - PROCERA NETWORKS, INC. | ex31_1.htm |
EX-31.2 - EXHIBIT 31.2 - PROCERA NETWORKS, INC. | ex31_2.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
(Mark
one)
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For
the quarterly period ended September 30, 2009
or
¨
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For
the transition period from to .
Commission
File Number: 000-49862
PROCERA
NETWORKS, INC.
(Exact
name of registrant as specified in its charter)
Nevada
|
33-0974674
|
(State
or other jurisdiction 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 £
|
Accelerated
filer T
|
Non-accelerated
filer £
|
Smaller
reporting company £
|
|
|
(Do
not check if a smaller reporting company)
|
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes £ No
T
As of
November 3, 2009, the registrant had 94,082,724 shares of its common stock, par
value $0.001, outstanding.
1
PROCERA NETWORKS, INC.
INDEX
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Page
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3
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Item
1.
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3
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3
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6
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Item
2.
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16
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Item
3.
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23
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Item
4.
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24
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24
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Item
1.
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24
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Item
1A.
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24
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Item
2.
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35
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Item
3.
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36
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Item
4.
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36
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Item
5.
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36
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Item
6.
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36
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37
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PART I. FINANCIAL INFORMATION
Item 1.
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Consolidated
Financial Statements
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Procera Networks, Inc.
CONDENSED
CONSOLIDATED BALANCE SHEETS
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September
30,
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December
31,
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|||||
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2009
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2008
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|||||
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(Unaudited)
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ASSETS
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Current
Assets:
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Cash
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$
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2,389,449
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$
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1,721,225
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Accounts
receivable, less allowance of $212,004 and $182,760, at September 30, 2009
and December 31, 2008
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5,677,625
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5,454,745
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Inventories,
net
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2,104,103
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3,445,802
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Prepaid
expenses and other
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546,521
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824,340
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Total
current assets
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10,717,698
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11,446,112
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Property
and equipment, net
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732,419
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2,573,045
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Purchased
intangible assets, net
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—
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964,405
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Goodwill
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960,209
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960,209
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Other
non-current assets
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47,223
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47,294
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Total
assets
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$
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12,457,549
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$
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15,991,065
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LIABILITIES
AND STOCKHOLDERS’ EQUITY
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Current
liabilities:
|
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Accounts
payable
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$
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1,302,241
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$
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2,457,430
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Deferred
revenue
|
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1,923,597
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1,313,092
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Accrued
liabilities
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1,525,608
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1,841,442
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Notes
payable
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500,000
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550,000
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Capital
leases payable-current portion
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—
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11,543
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Total
current liabilities
|
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5,251,446
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6,173,507
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Non-current
liabilities
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Deferred
rent
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38,450
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24,234
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Deferred
tax liability
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—
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695,239
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Capital
leases payable - non-current portion
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—
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39,584
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Total
liabilities
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5,289,986
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6,932,564
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Commitments
and contingencies (Note 12)
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—
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—
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Stockholders’
equity:
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Common
stock, $0.001 par value; 130,000,000 shares authorized; 94,082,724 and
84,498,491 shares issued and outstanding at September 30, 2009 and
December 31, 2008, respectively
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94,083
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84,498
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Additional
paid-in capital
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67,356,581
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61,142,430
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Accumulated
other comprehensive loss
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(281,086
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)
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(428,107
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)
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Accumulated
deficit
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(60,002,015
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)
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(51,740,320
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)
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Total
stockholders’ equity
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7,167,563
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9,058,501
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Total
liabilities and stockholders’ equity
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$
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12,457,549
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$
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15,991,065
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See
accompanying notes to interim condensed consolidated financial
statements.
Procera Networks, Inc.
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
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Three
Months Ended
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Nine
Months Ended
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|||||||||||||
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September 30,
2009
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September 30,
2008
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September 30,
2009
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September 30,
2008
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Sales:
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Product
Sales
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$
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3,787,205
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$
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2,209,605
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$
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8,509,093
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$
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5,748,372
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Support
Sales
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796,279
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479,568
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2,255,444
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1,271,874
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Total
net sales
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4,583,484
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2,689,173
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10,764,537
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7,020,246
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Cost
of sales:
|
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Product
cost of sales
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2,969,853
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1,788,622
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6,909,181
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4,209,445
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Support
cost of sales
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125,699
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125,654
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330,188
|
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423,797
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Total
cost of sales
|
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3,095,552
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1,914,276
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7,239,369
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4,633,242
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Gross
profit
|
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1,487,932
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774,897
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3,525,168
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2,387,004
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Operating
expenses:
|
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Engineering
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583,738
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809,201
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1,903,187
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2,497,734
|
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Sales
and Marketing
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1,622,291
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2,094,101
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4,961,082
|
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|
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6,435,501
|
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General
and Administrative
|
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|
1,088,302
|
|
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1,896,837
|
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3,807,342
|
|
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5,392,988
|
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Total
operating expenses
|
|
|
3,294,331
|
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4,800,139
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|
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10,671,611
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14,326,223
|
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Loss
from operations
|
|
|
(1,806,399
|
)
|
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(4,025,242
|
)
|
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|
(7,146,443
|
)
|
|
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(11,939,219
|
)
|
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|
||||
Other
income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
and other income
|
|
|
11,234
|
|
|
|
27,371
|
|
|
|
36,503
|
|
|
53,254
|
|
|
Interest
and other expense
|
|
|
(75,752
|
)
|
|
|
(14,569
|
)
|
|
|
(1,843,205
|
)
|
|
|
(49,373
|
)
|
Total
other income (expense)
|
|
|
(64,518
|
)
|
|
|
12,802
|
|
|
(1,806,702
|
)
|
|
|
3,881
|
||
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Loss
before income taxes
|
|
|
(1,870,917
|
)
|
|
|
(4,012,440
|
)
|
|
|
(8,953,145
|
)
|
|
|
(11,935,338
|
)
|
Income
tax benefit
|
|
|
275,870
|
|
|
259,904
|
|
|
|
691,450
|
|
|
|
782,295
|
|
|
Net
loss
|
|
$
|
(1,595,047
|
)
|
|
$
|
(3,752,536
|
)
|
|
$
|
(8,261,695
|
)
|
|
$
|
(11,153,043
|
)
|
|
|
|
|
|
|
|
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|
||||||||
Net
loss per share - basic and diluted
|
|
$
|
(0.02
|
)
|
|
$
|
(0.05
|
)
|
|
$
|
(0.09
|
)
|
|
$
|
(0.14
|
)
|
Shares
used in computing net loss per share-basic and diluted
|
|
|
94,082,724
|
|
|
|
79,018,207
|
|
|
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88,516,837
|
|
|
|
77,424,517
|
|
See
accompanying notes to interim condensed consolidated financial
statements.
Procera Networks, Inc.
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine
Months Ended
|
||||||||
|
September
30,
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||||||
|
2009
|
2008
|
|
|||||
Cash
flows from operating activities:
|
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|
|
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Net
loss
|
|
$
|
(8,261,695
|
)
|
|
$
|
(11,153,043
|
)
|
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
|
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Depreciation
|
|
|
1,875,585
|
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1,885,042
|
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Amortization
of intangibles
|
|
|
964,405
|
|
|
|
1,079,250
|
|
Common
stock issued for services rendered
|
|
|
—
|
|
|
|
736,000
|
|
Compensation
related to stock-based awards
|
|
|
885,952
|
|
|
|
1,289,196
|
|
Interest
expense related to conversion option embedded in convertible
notes
|
|
|
1,664,756
|
|
|
|
—
|
|
Warrants
issued to non-employees
|
|
|
—
|
|
|
|
306,484
|
|
Provision
for excess and obsolete inventory
|
|
|
82,755
|
|
|
|
9,636
|
|
Deferred
income taxes
|
|
|
(695,239
|
)
|
|
|
(779,712
|
)
|
Loss
on retirement of fixed assets
|
7,508
|
—
|
||||||
Changes
in assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(74,847
|
)
|
|
|
(1,659,264
|
)
|
Inventories
|
|
|
1,388,696
|
|
|
|
(1,530,681
|
)
|
Prepaid
expenses and other current assets
|
|
|
313,713
|
|
|
|
(508,876
|
)
|
Accounts
payable
|
|
|
(1,198,981
|
)
|
|
|
604,633
|
|
Accrued
liabilities and deferred rent
|
|
|
(431,601
|
)
|
|
|
(154,058
|
)
|
Deferred
revenue
|
|
|
519,195
|
|
|
|
177,651
|
|
Net
cash used in operating activities
|
|
|
(2,959,798
|
)
|
|
|
(9,697,742
|
)
|
|
|
|
|
|
|
|||
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
Purchase
of equipment
|
|
|
(66,789
|
)
|
|
|
(724,362
|
)
|
Net
cash used in investing activities
|
|
|
(66,789
|
)
|
|
|
(724,362
|
)
|
|
|
|
|
|
|
|
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Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
Proceeds
from issuance of common stock
|
|
|
3,538,227
|
|
|
|
5,829,118
|
|
Proceeds
from exercise of warrants
|
|
|
—
|
|
|
|
2,175,572
|
|
Proceeds
from exercise of stock options
|
|
|
134,800
|
|
|
|
318,712
|
|
Proceeds
from issuance of debt instruments
|
|
|
500,000
|
|
|
|
550,000
|
|
Payments
on debt instruments
|
|
|
(550,000
|
)
|
|
|
—
|
|
Capital
lease payments
|
|
|
(1,682
|
)
|
|
|
(28,298
|
)
|
Net
cash provided by financing activities
|
|
|
3,621,345
|
|
|
|
8,845,104
|
|
|
|
|
|
|
|
|
||
Effect
of exchange rates on cash and cash equivalents
|
|
|
73,466
|
|
|
|
538,026
|
|
|
|
|
|
|
|
|||
Net
increase (decrease) in cash and cash equivalents
|
|
|
668,224
|
|
|
|
(1,038,974
|
)
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, beginning of period
|
|
|
1,721,225
|
|
|
|
5,864,648
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, end of period
|
|
$
|
2,389,449
|
|
|
$
|
4,825,674
|
|
See
accompanying notes to interim condensed consolidated financial
statements.
Procera Networks, Inc
Notes
to Interim Condensed Consolidated Financial Statements (unaudited)
1.
|
DESCRIPTION
OF BUSINESS
|
Procera
Networks, Inc. ("Procera" or the "Company") is a leading provider of bandwidth
management and control products 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.
|
SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
|
Basis of
Presentation
Procera
has prepared the consolidated financial statements included herein pursuant to
the rules and regulations of the Securities and Exchange Commission (“SEC”)
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, 2008 has been derived from the audited
consolidated financial statements at that date but does not include all of the
information and footnotes required by generally accepted accounting principles
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 fiscal year ended December 31, 2008 filed with the SEC on March 16,
2009.
The
accompanying financial statements have been prepared in conformity with
accounting principles generally accepted in the United States. 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.
The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern. The Company has sustained
recurring losses and negative cash flows from operations. Management
believes that the Company’s losses in recent years have primarily resulted from
a combination of insufficient product and service revenue to support the
Company’s skilled and diverse technical staff believed to be necessary to
support exploitation of the Company’s technologies. Historically, the Company’s
growth and working capital needs have been funded through a combination of
private equity, debt and lease financing. As of September 30, 2009, the Company
had approximately $2,389,000 of unrestricted cash, $5,466,000 of working
capital, and $60 million in accumulated deficit. As further explained in Note
12 the Company could not borrow against the $3.0 million Secured Line of
Credit with the Peninsula Bank as of September 30, 2009.
As
discussed in Note 10, in May 2009, the Company entered into agreements with a
group of private institutional and accredited investors whereby the Company
received approximately $4.0 million by selling shares of its common stock and
promissory notes. Management is focused on managing costs in line
with estimated total revenue for the balance of fiscal 2009 and beyond,
including contingencies for cost reductions if projected revenue is not fully
realized. However, there can be no assurance that anticipated revenue will be
realized or that the Company will successfully implement its
plans. The Company has experienced negative operating margins and
negative cash flow from operations, and if this trend continues, the Company may
have an ongoing requirement for additional capital investment. The
Company may need to raise substantial additional capital to accomplish all
of its business objectives over the next several years. In addition, the Company
may in the future selectively pursue possible acquisitions of businesses,
technologies, content, or products complementary to those of the Company in
order to expand its presence in the marketplace and achieve operating
efficiencies. The Company can make no assurance with respect to either the
availability or terms of such financing and capital when it may be
required.
Significant Accounting
Policies
The
accounting and reporting policies of the Company conform to U.S. generally
accepted accounting principles (“GAAP”) and to the practices within the
telecommunications industry. There have been no significant changes
in the Company's significant accounting policies during the three and nine
months ended September 30, 2009 compared to what was previously disclosed in the
Company's Annual Report on Form 10-K for the year ended December 31,
2008.
Subsequent Events. The
Company evaluates events that occur subsequent to the balance sheet date of
periodic reports, but before financial statements are issued for periods ending
on such balance sheet dates, for possible adjustment to such financial
statements or other disclosure. This evaluation generally occurs through the
date at which the Company’s financial statements are electronically prepared for
filing with the SEC. For the financial statements as of and for the periods
ending September 30, 2009, this date was November 9, 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 on or after its implementation date (the beginning of fiscal 2006), as
well as a portion of the fair value of each option and stock grant made to
employees or directors prior to the implementation date that represents the
unvested portion of these share-based awards as of such implementation date, to
be recognized as an expense, as codified in ASC 718. These amounts are expensed
over the respective vesting periods of each award using the straight-line
attribution method. The Company calculates stock option-based compensation by
estimating the fair value of each option as of its date of grant using the
Black-Scholes option pricing model. The Company has historically
issued stock options and vested and nonvested stock grants to employees and
outside directors whose only condition for vesting has been continued employment
or service during the related vesting or restriction period.
Warrant Valuation and Beneficial
Conversion Feature. The Company calculates the fair value of warrants
issued with debt using the Black-Scholes valuation method. The total proceeds
received in the sale of debt and related warrants is allocated among these
financial instruments based on their relative fair values. The debt discount
arising from assigning a portion of the total proceeds to the warrants issued is
recognized as interest expense from the date of issuance to the earlier of the
maturity date of the debt or the conversion dates using the effective yield
method. Additionally, when issuing convertible debt, including convertible debt
issued with detachable warrants, the Company tests for the existence of a
beneficial conversion feature, as codified in ASC 470-20. The Company records
the amount of any beneficial conversion feature (“BCF”), calculated in
accordance with these accounting standards, whenever it issues convertible debt
that has conversion features at fixed rates that are in the money using the
effective per share conversion price when issued. The calculated amount of the
BCF is accounted for as a contribution to additional paid-in capital and as a
debt discount that is recognized as interest expense from the date of issuance
to the earlier of the maturity date of the debt or the conversion dates using
the effective yield method. The maximum amount of BCF that can be recognized is
limited to the amount that will reduce the net carrying amount of the debt to
zero.
Statements of Cash Flows. For
purposes of the Consolidated Statements of Cash Flows, the Company considers all
demand deposits and certificates of deposit with original maturities of 90 days
or less to be cash equivalents.
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.
Derivatives. A derivative is
an instrument whose value is “derived” from an underlying instrument or index
such as a future, forward, swap, option contract, or other financial instrument
with similar characteristics, including certain derivative instruments embedded
in other contracts (“Embedded Derivatives”) and for hedging activities. As a
matter of policy, the Company does not invest in separable financial derivatives
or engage in hedging transactions. However, complex transactions that the
Company entered into in order to originally finance its operations, and the
subsequent financing transactions, involved financial instruments containing
certain features that have resulted in the instruments being deemed derivatives
or containing embedded derivatives. The Company may engage in other similar
complex debt transactions in the future, but not with the intention to enter
into derivative instruments. Derivatives and Embedded Derivatives, if
applicable, are measured at fair value and marked to market through earnings, as
codified in ASC 815-15. However, such new and/or complex instruments may have
immature or limited markets. As a result, the pricing models used for valuation
often incorporate significant estimates and assumptions, which may impact the
level of precision in the financial statements.
3.
|
RECENT
ACCOUNTING PRONOUNCEMENTS
|
In
February 2008, the Financial Accounting Standards Board (“FASB”) issued an
accounting standard update that delayed the effective date of fair value
measurements accounting for all non-financial assets and non-financial
liabilities, except for items that are recognized or disclosed at fair value in
the financial statements on a recurring basis (at least annually), until the
beginning of the first quarter of 2009. The Company adopted this accounting
standard update effective January 1, 2009. The adoption of this update to
non-financial assets and liabilities, as codified in ASC 820-10, did not have
any impact on the Company’s consolidated financial statements. The
Company’s non-financial assets, such as goodwill, intangible assets, and
property, plant and equipment, are measured at fair value when there is an
indicator of impairment and recorded at fair value only when an impairment
charge is recognized. No impairment indicators were present during the three and
nine month periods ended September 30, 2009. When impairment
indicators are present, the Company utilizes various methods to determine the
fair value of its non-financial assets. For example, to value
property plant and equipment, we would use the cost method for determining fair
value; for goodwill we would use a combination of analyzing the Company’s market
capitalization based on the market price of the Company’s common stock and a
determination of discounted cash flows of the Company’s operations.
Effective
January 1, 2009, the Company adopted an accounting standard that requires
unvested share-based payments that entitle employees to receive nonrefundable
dividends to also be considered participating securities, as codified in ASC
260. The adoption of this accounting standard had no impact on the calculation
of our earnings per share because the Company has not issued participating
securities.
Effective
April 1, 2009, the Company adopted three accounting standard updates which were
intended to provide additional application guidance and enhanced disclosures
regarding fair value measurements and impairments of securities. They also
provide additional guidelines for estimating fair value in accordance with fair
value accounting. The first update, as codified in ASC 820-10-65, provides
additional guidelines for estimating fair value in accordance with fair value
accounting. The second accounting update, as codified in ASC 320-10-65, changes
accounting requirements for other-than-temporary-impairment for debt securities
by replacing the current requirement that a holder have the positive intent and
ability to hold an impaired security to recovery in order to conclude an
impairment was temporary with a requirement that an entity conclude it does not
intend to sell an impaired security and it will not be required to sell the
security before the recovery of its amortized cost basis. The third accounting
update, as codified in ASC 825-10-65, increases the frequency of fair value
disclosures. These updates were effective for fiscal years and interim periods
ended after June 15, 2009. The adoption of these accounting updates did not have
any impact on the Company’s consolidated financial statements.
Effective
April 1, 2009, the Company adopted a new accounting standard for subsequent
events, as codified in ASC 855-10. The update modifies the names of the two
types of subsequent events either as recognized subsequent events (previously
referred to in practice as Type I subsequent events) or non-recognized
subsequent events (previously referred to in practice as Type II subsequent
events). In addition, the standard modifies the definition of subsequent events
to refer to events or transactions that occur after the balance sheet date, but
before the financial statements are issued (for public entities) or available to
be issued (for nonpublic entities). It also requires the disclosure of the date
through which subsequent events have been evaluated. The update did not result
in significant changes in the practice of subsequent event disclosures, and
therefore the adoption did not have any impact on the Company’s consolidated
financial statements.
Effective
July 1, 2009, the Company adopted the “FASB Accounting Standards Codification”
and the Hierarchy of Generally Accepted Accounting Principles (“ASC 105”). This
standard establishes only two levels of U.S. GAAP, authoritative and
nonauthoritative. The FASB Accounting Standards Codification (the
“Codification”) became the source of authoritative, nongovernmental GAAP, except
for rules and interpretive releases of the SEC, which are sources of
authoritative GAAP for SEC registrants. All other non-grandfathered, non-SEC
accounting literature not included in the Codification became nonauthoritative.
The Company began using the new guidelines and numbering system prescribed by
the Codification when referring to GAAP in the third quarter of 2009. As the
Codification was not intended to change or alter existing GAAP, it did not have
any impact on the Company’s consolidated financial statements.
In
October 2009, the FASB issued Update No. 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 ASC 605-25, which originated primarily from
the guidance in EITF Issue No. 00-21, “Revenue Arrangements with Multiple
Deliverables” (“EITF 00-21”). 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 to its
consolidated financial statements.
In
October 2009, the FASB issued Update No. 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 to its consolidated financial statements.
Other
recent accounting pronouncements issued by the FASB, the American Institute of
Certified Public Accountants ("AICPA"), and the SEC did not or are not believed
by management to have a material impact on the Company's present condensed
consolidated financial statements.
4.
|
STOCK-BASED
COMPENSATION
|
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 nine month periods ended
September 30, 2009 and 2008 was as follows:
|
Three
Months Ended
|
Nine
Months Ended
|
|
|||||||||||||
|
September 30,
2009
|
September 30,
2008
|
September 30,
2009
|
September 30,
2008
|
|
|||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Cost
of goods sold
|
|
$
|
15,943
|
|
|
$
|
18,193
|
|
|
$
|
50,397
|
|
|
$
|
31,434
|
|
Research
and development
|
|
|
8,585
|
|
|
|
72,267
|
|
|
|
25,869
|
|
|
|
213,136
|
|
Sales
and marketing
|
|
|
57,694
|
|
|
|
110,358
|
|
|
|
217,291
|
|
|
|
346,223
|
|
General
and administrative
|
|
|
193,622
|
|
|
|
264,692
|
|
|
|
592,395
|
|
|
|
698,403
|
|
Total
stock-based compensation expense
|
|
|
275,844
|
|
|
|
465,510
|
|
|
|
885,952
|
|
|
|
1,289,196
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax benefit
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Total
stock-based compensation expense, net of income tax
|
|
$
|
275,844
|
|
|
$
|
465,510
|
|
|
$
|
885,952
|
|
|
$
|
1,289,196
|
|
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 nine
months ended September 30, 2009:
|
Number
of Options
|
|
|
Weighted
Average Exercise Price
|
|
|
Weighted
Average Remaining Contractual Life (in years)
|
|
Aggregate
Intrinsic Value
|
|
||||||
|
|
|
|
|
|
|
|
|
|
|
||||||
Outstanding
at December 31, 2008
|
|
|
7,988,274
|
|
|
$
|
1.25
|
|
|
|
|
|
|
|||
Authorized
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|||
Granted
|
|
|
1,781,944
|
|
|
$
|
0.74
|
|
|
|
|
|
|
|||
Exercised
|
|
|
(215,000
|
)
|
|
|
0.63
|
|
|
|
|
|
|
|||
Cancelled
|
|
|
(1,904,687
|
)
|
|
$
|
1.31
|
|
|
|
|
|
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Outstanding
at September 30, 2009
|
|
|
7,650,531
|
|
|
$
|
1.13
|
|
|
|
8.13
|
|
|
$
|
48,600
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested
and expected to vest at September 30, 2009
|
|
|
7,319,722
|
|
|
$
|
1.12
|
|
|
|
8.04
|
|
|
$
|
48,030
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable
at September 30, 2009
|
|
|
3,870,113
|
|
|
$
|
1.18
|
|
|
|
7.65
|
|
|
$
|
44,800
|
|
The total
intrinsic value of options exercised during the nine months ended September 30,
2009 and 2008, was $70,200 and $311,328, respectively.
As of
September 30, 2009, total unrecognized compensation cost related to unvested
stock options was $2,541,172, net of estimated forfeitures, which is expected to
be recognized over an estimated weighted average amortization period of 2.88
years.
The
weighted average grant date fair value of options granted during the nine months
ended September 30, 2009 and 2008 was $0.52 and $1.10,
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 nine months ended September 30, 2009 and
2008:
Three
Months
|
Nine
Months
|
|||||||||||||||
|
|
Ended
September 30,
|
Ended
September 30,
|
|
||||||||||||
|
|
2009
|
2008
|
2009
|
2008
|
|
||||||||||
Expected
term (years)
|
|
|
4.61
|
|
|
|
6.8
|
|
|
|
4.27
|
|
|
|
6.9
|
|
Expected
volatility
|
|
|
97.4
|
%
|
|
|
93
|
%
|
|
|
98.6
|
%
|
|
|
94
|
%
|
Risk-free
interest rate
|
|
|
2.10
|
%
|
|
|
3.70
|
|
|
|
1.64
|
%
|
|
|
3.09
|
%
|
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
LOSS PER SHARE
|
Basic
earnings (loss) per share ("EPS") is computed by dividing net loss by the
weighted average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur from common shares issuable
through stock options, warrants and other convertible securities, if dilutive.
The following table is a reconciliation of the numerator (net loss) and the
denominator (number of shares) used in the basic and diluted EPS calculations
and sets forth potential shares of common stock that are not included in the
diluted net loss per share calculation because their effect is
antidilutive:
Three
Months
|
Nine
Months
|
|||||||||||||||
|
Ended
September 30,
|
Ended
September 30,
|
|
|||||||||||||
|
2009
|
2008
|
2009
|
2008
|
|
|||||||||||
Numerator
- basic and diluted
|
|
$
|
(1,595,047
|
)
|
|
$
|
(3,752,536
|
)
|
|
$
|
(8,261,695
|
)
|
|
$
|
(11,153,043
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator
- basic and diluted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average common shares outstanding
|
|
|
94,082,724
|
|
|
|
79,018,207
|
|
|
|
88,516,837
|
|
|
|
77,424,517
|
|
Total
|
|
|
94,082,724
|
|
|
|
79,018,207
|
|
|
|
88,516,837
|
|
|
|
77,424,517
|
|
Net
loss per share - basic and diluted
|
|
$
|
(0.02
|
)
|
|
$
|
(0.05
|
)
|
|
$
|
(0.09
|
)
|
|
$
|
(0.14
|
)
|
Antidilutive
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
issued and outstanding
|
|
|
7,650,531
|
|
|
|
9,368,727
|
|
|
|
7,650,531
|
|
|
|
9,368,727
|
|
Warrants
|
|
|
3,660,021
|
|
|
|
4,302,414
|
|
|
|
3,660,021
|
|
|
|
4,302,414
|
|
Total
|
|
|
11,310,552
|
|
|
|
13,671,141
|
|
|
|
11,310,552
|
|
|
|
13,671,141
|
|
6.
|
COMPREHENSIVE
INCOME (LOSS)
|
The
components of comprehensive income (loss) for the three and nine months ended
September 30, 2009 and 2008 are as follows:
Three
Months
|
Nine
Months
|
|||||||||||||||
|
Ended
September 30,
|
Ended
September 30,
|
|
|||||||||||||
|
2009
|
2008
|
2009
|
2008
|
|
|||||||||||
Net
loss
|
|
$
|
(1,595,047
|
)
|
|
$
|
(3,752,536
|
)
|
|
$
|
(8,261,695
|
)
|
|
$
|
(11,153,043
|
)
|
Foreign
currency translation adjustment
|
|
|
(125,335
|
)
|
|
|
(480,689
|
)
|
|
|
147,021
|
|
|
|
(388,878
|
)
|
Comprehensive
loss
|
|
$
|
(1,720,382
|
)
|
|
$
|
(4,233,225
|
)
|
|
$
|
(8,114,674
|
)
|
|
$
|
(11,541,921
|
)
|
7.
|
INVENTORIES
|
Inventories
are stated at the lower of cost, which approximates actual costs on a first in,
first out basis, or market. Inventories at September 30, 2009 and December 31,
2008 consisted of the following:
|
September 30,
2009
|
|
|
December 31,
2008
|
|
|||
Finished
goods
|
|
$
|
2,064,327
|
|
|
$
|
3,149,155
|
|
Work
in process
|
|
|
--
|
|
|
|
74,892
|
|
Raw
materials
|
|
|
39,776
|
|
|
|
221,755
|
|
Inventories,
net
|
|
$
|
2,104,103
|
|
|
$
|
3,445,802
|
|
Because
the Company in 2009 began to obtain inventory in a form that requires minimal
modification by the Company, it has only a minimal amount of raw materials and
no work-in-process inventory.
8.
|
GOODWILL
AND OTHER INTANGIBLES
|
The
following is a summary of other intangibles as of September 30, 2009 and
December 31, 2008:
|
|
September 30,
2009
|
December 31,
2008
|
|
||||||||||||||||||||
|
|
Gross
Intangible
|
Accumulated
Amortization
|
Net
Intangible Assets
|
Gross
Intangible
|
Accumulated
Amortization
|
Net
Intangible Assets
|
|
||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
Customer
base
|
|
$
|
4,317,000
|
|
|
$
|
(4,317,000
|
)
|
|
$
|
—
|
|
|
$
|
4,317,000
|
|
|
$
|
(3,352,595
|
)
|
|
$
|
964,405
|
|
Amortization
expense relating to purchased intangible assets was $244,905 and $964,405,
respectively, for the three and nine months ended September 30, 2009 and
$359,750 and $1,079,250, respectively, for the three and nine months ended
September 30, 2008.
Goodwill
as of September 30, 2009 and December 31, 2008 was $960,209.
9.
|
ACCRUED
LIABILITIES
|
Accrued
liabilities at September 30, 2009 and December 31, 2008 consisted of the
following:
|
|
September 30,
2009
|
|
|
December 31,
2008
|
|
||
Payroll
and related
|
|
$
|
760,095
|
|
|
$
|
770,655
|
|
Audit
and legal services
|
|
|
32,229
|
|
|
|
253,580
|
|
Sales,
VAT, income tax
|
|
|
101,886
|
|
|
|
78,599
|
|
Sales
commissions
|
|
|
287,032
|
|
|
|
547,867
|
|
Warranty
|
|
|
202,003
|
|
|
|
129,763
|
|
Other
|
|
|
142,363
|
|
|
|
60,978
|
|
Total
|
|
$
|
1,525,608
|
|
|
$
|
1,841,442
|
|
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 nine months ended September 30, 2009 were as
follows:
Warranty
obligation at December 31, 2008
|
|
$
|
129,763
|
|
Provision
for current period sales
|
|
|
96,248
|
|
Deductions
for warranty claims processed during the period
|
|
|
(24,008
|
)
|
Warranty
obligation at September 30, 2009
|
|
$
|
202,003
|
|
10.
|
STOCKHOLDERS’
EQUITY
|
Private Placement of Common
Stock and Convertible Promissory Notes and Promissory Notes
On May 4,
2009, the Company entered into subscription agreements (“the Subscription
Agreements”) with certain institutional and accredited individual investors
(each, and “Investor” and collectively, the “Investors”), pursuant to which the
Company closed a private placement (the “Private Placement”) of the Company’s
common stock, convertible promissory notes and promissory notes. The
Private Placement included the sale of 4,587,500 shares of the Company’s
restricted common stock at $0.40 per share on June 3, 2009 for total proceeds of
$1,835,000. In May 2009, the private placement also included the
issuance of convertible promissory notes in the aggregate principal amount of
$1,860,000. The convertible promissory notes bore interest at a 10%
per annum interest rate and included a clause whereby these promissory notes
would be automatically converted into shares of common stock at a conversion
price of $0.40 per share upon the conclusion of the sale of restricted common
stock. On June 3, 2009, the Company automatically converted these convertible
promissory notes into 4,713,082 shares of restricted common
stock. The private placement also included the issuance of $500,000
of nonconvertible debt (see Note 12).
The
completion of the Private Placement resulted in the Company realizing net
proceeds of $3.5 million from the sale of common stock and issuance of 10%
convertible promissory notes. In consideration for services rendered by the
placement agents in the Private Placement, the Company issued three-year
warrants to the placement agents to purchase 208,875 shares of the Company’s
Common Stock at an exercise price of $0.40 per share (“the Placement Agent
Warrants”). The Placement Agent Warrants had an estimated fair value of $92,438
calculated using the Black-Scholes option pricing model. The company also
incurred direct financing fees of approximately $190,000, which were paid to the
placement agent for management fees and expenses, and other direct transactional
expenses.
Convertible Promissory
Notes
The 10%
convertible note agreements issued for a total principal amount of $1,860,000
were converted into common stock of the Company on June 3, 2009. On
the issuance date, the Company recognized the value of the embedded beneficial
conversion feature of $1,664,756 as additional paid-in capital and an equivalent
debt discount. This debt discount is recorded as interest expense in the nine
month period September 30, 2009.
The
Company accounts for conversion options embedded in convertible notes in
accordance with ASC 815-15. ASC 815-15 generally requires companies to separate
conversion features embedded in convertible notes from their host instruments
and to account for them as free standing derivative financial instruments. ASC
815-15 provides for an exception to this rule when convertible notes, as host
instruments, are deemed to be conventional as that term is defined.
Furthermore,
the Company accounts for convertible notes (if deemed conventional) in
accordance with the provisions of ASC 470-20. Accordingly, the
Company records the intrinsic value of such conversion options as a discount to
convertible notes, based upon the difference between the fair value of the
underlying common stock at the commitment date of the note transaction and the
effective conversion price embedded in the note. Debt discounts under
these arrangements are amortized over the term of the related debt to their
earliest date of redemption.
Conversion of Stock Options
and Warrants into Common Stock
During
the nine months ended September 30, 2009, option holders exercised rights to
purchase 215,000 shares of common stock at prices ranging from $0.52 to $0.92
per share, resulting in net proceeds to the Company of $134,800.
During
the nine months ended September 30, 2009, a warrant holder exercised rights to
purchase 148,704 shares of common stock at a price of $0.01per share in a
cashless exercise.
Warrants
A summary
of warrant activity for the nine months ended September 30, 2009 is as
follows:
|
|
Warrants
|
|
|||||
|
|
Number of Shares
|
|
|
Weighted Average Purchase
Price
|
|
||
Outstanding
December 31, 2008
|
|
|
4,302,414
|
|
|
$
|
1.05
|
|
Issued
|
|
|
208,875
|
|
|
|
0.40
|
|
Exercised
|
|
|
(148,704
|
)
|
|
|
0.01
|
|
Cancelled/expired
|
|
|
(702,564
|
)
|
|
|
1.18
|
|
Outstanding
September 30, 2009
|
|
|
3,660,021
|
|
|
$
|
1.04
|
|
The chart
below shows the outstanding warrants as of September 30, 2009 by exercise price
and the average contractual life before expiration.
Exercise
Price
|
|
|
Number
Outstanding
|
|
|
Weighted
Average Remaining Contractual Life (Years)
|
|
|
Number
Exercisable
|
|
||||
$
|
0.40
|
|
|
|
1,247,750
|
|
|
|
1.62
|
|
|
|
1,247,750
|
|
|
0.60
|
|
|
|
569,107
|
|
|
|
1.88
|
|
|
|
569,107
|
|
|
1.12
|
|
|
|
70,000
|
|
|
|
0.83
|
|
|
|
70,000
|
|
|
1.50
|
|
|
|
1,380,000
|
|
|
|
2.17
|
|
|
|
1,380,000
|
|
|
1.75
|
|
|
|
17,759
|
|
|
|
1.96
|
|
|
|
17,759
|
|
|
1.78
|
|
|
|
100,000
|
|
|
|
0.40
|
|
|
|
--
|
|
|
2.00
|
|
|
|
199,988
|
|
|
|
2.80
|
|
|
|
199,988
|
|
|
2.14
|
|
|
|
75,417
|
|
|
|
0.32
|
|
|
|
75,417
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1.03
|
|
|
|
3,660,021
|
|
|
|
1.86
|
|
|
|
3,560,021
|
|
11.
|
INCOME
TAXES
|
At
September 30, 2009 and December 31, 2008, the Company had $194,775 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 September 30, 2009, the Company had no accrued
interest or penalties related to uncertain tax positions. The tax years
2001-2008 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
September 30, 2010.
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.
12.
|
COMMITMENTS
AND CONTINGENCIES
|
Legal
The
Company is periodically involved in legal actions and claims that arise as a
result of events that occur in the normal course of operations. The Company is
not currently aware of any legal proceedings or claims that the Company believes
will have, individually or in the aggregate, a material adverse effect on the
Company's financial position or results of operations.
Operating
Leases
The
Company leases its operating and office facilities for various terms under
long-term, non-cancelable operating lease agreements. The leases expire at
various dates through 2013 and provide for renewal options ranging from
month-to-month to 5 year terms. In the normal course of business, it is expected
that these leases will be renewed or replaced by leases on other properties. The
leases provide for increases in future minimum annual rental payments based on
defined increases which are generally meant to correlate with the Consumer Price
Index, subject to certain minimum increases. Also, the agreements generally
require the Company to pay executory costs (real estate taxes, insurance and
repairs).
The
Company and its subsidiaries have various lease agreements for its headquarters
in Los Gatos, California; Netintact, AB offices in Varberg, Sweden; and
Netintact PTY offices in Melbourne, Australia.
As of
September 30, 2009, future minimum lease payments under operating leases are as
follows:
|
Operating
Leases
|
|
||
|
|
|
||
Three
months ending December 31, 2009
|
|
$
|
83,690
|
|
Years
ending December 31,
|
|
|
|
|
2010
|
|
|
391,306
|
|
2011
|
|
|
279,764
|
|
2012
|
|
|
139,389
|
|
2013
|
|
|
34,847
|
|
Total
minimum lease payments
|
|
$
|
928,996
|
|
Capital
Leases
The
Company retired substantially all of its capital leases during the three months
ended March 31, 2009.
Secured Line of
Credit
On March
13, 2009, the Company entered into a secured line of credit agreement (“Secured
Line of Credit”) for working capital purposes with Peninsula Bank Business
Funding, a division of The Private Bank of the Peninsula (“Peninsula Bank”). The
Secured Line of Credit provides for maximum borrowings of $3 million through
March 12, 2010. Borrowings will bear interest at the bank’s prime rate plus 3.5%
but not less than 8% per annum. The maximum amount that may be outstanding under
this credit facility is $3,000,000. The Secured Line of Credit is secured by
substantially all of the Company’s assets and contains covenants requiring,
among other things, certain minimum financial covenants, as well as 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 September 30, 2009, because the
Company was not in compliance with the minimum covenant for earnings before
interest, taxes, depreciation and amortization, the Company could not borrow
against the Secured Line of Credit, and there was no debt outstanding under the
Secured Line of Credit.
Notes
Payable
In April
2009, the Company received loan proceeds totaling $500,000 through a private
placement of nonconvertible debt. Such nonconvertible debt bears
interest at 10% per annum, which interest is due and payable on a quarterly
basis. The nonconvertible debt is due together with any unpaid
accrued interest on April 30, 2010. As of September 30, 2009, other accrued
liabilities included $12,603 of accrued interest associated with the
nonconvertible debt.
In August
2008, the Company received loan proceeds totaling $550,000 from an individual
and a financial institution and issued promissory notes in that amount. These
notes bore interest at a rate of 10% per annum. The Company made
principal repayments of $250,000 in February 2009, $150,000 in April 2009, and
the remaining outstanding principal of $150,000 was repaid in August,
2009.
13.
|
SEGMENT
INFORMATION
|
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
|
|
|
Nine
Months Ended
|
|
|||||||||||
|
September
30,
|
|
|
September
30,
|
|
|||||||||||
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
|||||
Sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
United
States
|
|
$
|
3,827,743
|
|
|
$
|
698,109
|
|
|
$
|
5,243,319
|
|
|
$
|
1,695,927
|
|
Latin
America
|
|
|
—
|
|
|
|
165,225
|
|
|
|
117,676
|
|
|
|
447,305
|
|
Europe,
Middle East and Asia
|
|
|
755,741
|
|
|
1,825,839
|
|
|
|
5,403,542
|
|
|
|
4,877,014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
Total
|
|
$
|
4,583,484
|
|
|
$
|
2,689,173
|
|
|
$
|
10,764,537
|
|
|
$
|
7,020,246
|
|
|
September 30,
2009
|
|
|
December 31,
2008
|
|
|||
Long-lived assets
|
|
|
|
|
|
|
||
United
States
|
|
$
|
1,477,606
|
|
|
$
|
1,725,733
|
|
Europe
|
|
|
192,853
|
|
|
|
2,747,667
|
|
Australia
|
|
|
69,392
|
|
|
|
71,553
|
|
Total
|
|
$
|
1,739,851
|
|
|
$
|
4,544,953
|
|
Sales
made to customers located outside the United States as a percentage of total net
revenues were 16% and 51% for the three and nine months ended September 30,
2009, respectively, and 74% and 76% for the three and nine months ended
September 30, 2008, respectively.
For the
three and nine months ended September 30, 2009, revenue from one customer
accounted for 73% and 32% of net revenue, respectively, with no other single
customer accounting for more than 10% of net revenue. For the three and nine
months ended September 30, 2008, revenue from two customers accounted for 27%
and 23% of net revenue, respectively, with no other single customer accounting
for more than 10% of net revenue.
At
September 30, 2009, accounts receivable from one customer accounted for 39% of
total accounts receivable with no other single customer accounting for more than
10% of the accounts receivable balance. At December 31, 2008, accounts
receivable from four customers accounted for 44% of total accounts receivable
with no other single customer accounting for more than 10% of the accounts
receivable balance. As of September 30, 2009 and December 31, 2008,
approximately 55% and 82%, respectively, of the Company’s total accounts
receivable were due from customers outside the United States.
ITEM 2.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The
following is a discussion of our results of operations and current financial
position. This discussion should be read in conjunction with our unaudited
consolidated financial statements and related notes included elsewhere in this
report and the audited consolidated financial statements and related notes
included in our Annual Report on Form 10-K for the year ended December 31,
2008.
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. Also note that we provide the following cautionary discussion of
risks and uncertainties related to our businesses. These are factors that we
believe, individually or in the aggregate, could cause our actual results to
differ materially from expected and historical results. We note these factors
for investors as permitted by Section 21E of the 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
Headquartered
in Los Gatos, CA, 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. The Company’s products offer network administrators of service
providers, governments, universities and enterprises intelligent network traffic
identification, control and service management solutions.
The
Company’s proprietary software application, PacketLogic, offers users the
ability to monitor network use on an application and user-specific basis in
real-time, and offers improvements over existing deep packet inspection, or DPI,
solutions. This capability allows network administrators to improve network
utilization, reducing the need for additional infrastructure investment.
PacketLogic's modular, traffic and service management software is comprised of
five individual modules: traffic identification and classification, traffic
shaping, traffic filtering, flow statistics and web-based
statistics.
More than
600 service providers, higher-education institutions and other organizations
(with over 1,300 systems installed) have chosen PacketLogic as their network
traffic management solution.
The
Company faces competition from suppliers of standalone DPI products such as
Allot Communications, Arbor Networks, Blue Coat Systems, Brocade Communications
Systems, Cisco Systems, Ericsson, Juniper Networks, and Sandvine Corporation.
Some of our competitors supply platform products with different degrees of DPI
functionality, such as switch/routers, routers, session border controllers and
VoIP switches.
Most of
the Company’s 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
the Company. As a result of such competition, the Company could lose
market share and sales, or be forced to reduce its prices to meet
competition. However, the Company does not believe there is a
dominant supplier in its market. Based on the Company’s belief in the
superiority of its technology, the Company sees an opportunity to capture
meaningful market share and benefit from what the Company believes will be
growth in the DPI market.
Following
the acquisition of Netintact AB and Netintact PTY in 2006, the Company’s core
products and business changed substantially. PacketLogic, the
flagship product and technology of Netintact, now forms the core of the
Company’s sales and product offering. The Company sells its products through its
direct sales force, resellers, distributors and system integrators in the
Americas, Asia Pacific and Europe.
The
Company continues to monitor the current unfavorable and uncertain domestic and
global economic conditions, and the potential impact on IT spending, including
spending for the products it sells. While the Company believes that its products
may be less affected by current conditions than many other network products, the
Company also believes that its customers are more carefully scrutinizing
spending decisions, which could negatively impact its future
revenues.
Critical
Accounting Estimates
Our
discussion and analysis of our financial condition and results of operations are
based upon financial statements which have been prepared in accordance with
Generally Accepted Accounting Principles in the United States. The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenue 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, 2008 filed with the SEC on March 16, 2009.
Management
believes that there have been no significant changes during the nine months
ended September 30, 2009 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, 2008, filed with the SEC on March 16,
2009. 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:
|
·
|
Revenue
Recognition;
|
|
·
|
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, 2008.
Recent
Accounting Pronouncements
In
February 2008, the Financial Accounting Standards Board (“FASB”) issued an
accounting standard update that delayed the effective date of fair value
measurements accounting for all non-financial assets and non-financial
liabilities, except for items that are recognized or disclosed at fair value in
the financial statements on a recurring basis (at least annually), until the
beginning of the first quarter of 2009. The Company adopted this accounting
standard update effective January 1, 2009. The adoption of this update to
non-financial assets and liabilities, as codified in ASC 820-10, did not have
any impact on our consolidated financial statements. Our
non-financial assets, such as goodwill, intangible assets, and property, plant
and equipment, are measured at fair value when there is an indicator of
impairment and recorded at fair value only when an impairment charge is
recognized. No impairment indicators were present during the three and nine
month periods ended September 30, 2009. When impairment
indicators are present, we utilize various methods to determine the fair value
of its non-financial assets. For example, to value property plant and
equipment, we would use the cost method for determining fair value; for goodwill
we would use a combination of analyzing our market capitalization based on the
market price of our common stock and a determination of discounted cash flows of
our operations.
Effective
January 1, 2009, we adopted an accounting standard that requires unvested
share-based payments that entitle employees to receive nonrefundable dividends
to also be considered participating securities, as codified in ASC 260. The
adoption of this accounting standard had no impact on the calculation of our
earnings per share because we have not issued participating
securities.
Effective
April 1, 2009, we adopted three accounting standard updates which were intended
to provide additional application guidance and enhanced disclosures regarding
fair value measurements and impairments of securities. They also provide
additional guidelines for estimating fair value in accordance with fair value
accounting. The first update, as codified in ASC 820-10-65, provides additional
guidelines for estimating fair value in accordance with fair value accounting.
The second accounting update, as codified in ASC 320-10-65, changes accounting
requirements for other-than-temporary-impairment for debt securities by
replacing the current requirement that a holder have the positive intent and
ability to hold an impaired security to recovery in order to conclude an
impairment was temporary with a requirement that an entity conclude it does not
intend to sell an impaired security and it will not be required to sell the
security before the recovery of its amortized cost basis. The third accounting
update, as codified in ASC 825-10-65, increases the frequency of fair value
disclosures. These updates were effective for fiscal years and interim periods
ended after June 15, 2009. The adoption of these accounting updates did not have
any impact on our consolidated financial statements.
Effective
April 1, 2009, we adopted a new accounting standard for subsequent events, as
codified in ASC 855-10. The update modifies the names of the two types of
subsequent events either as recognized subsequent events (previously referred to
in practice as Type I subsequent events) or non-recognized subsequent events
(previously referred to in practice as Type II subsequent events). In addition,
the standard modifies the definition of subsequent events to refer to events or
transactions that occur after the balance sheet date, but before the financial
statements are issued (for public entities) or available to be issued (for
nonpublic entities). It also requires the disclosure of the date through which
subsequent events have been evaluated. The update did not result in significant
changes in the practice of subsequent event disclosures, and therefore the
adoption did not have any impact on our consolidated financial
statements.
Effective
July 1, 2009, we adopted the “FASB Accounting Standards Codification” and the
Hierarchy of Generally Accepted Accounting Principles (ASC 105). This standard
establishes only two levels of U.S. GAAP, authoritative and nonauthoritative.
The FASB Accounting Standards Codification (the “Codification”) became the
source of authoritative, nongovernmental GAAP, except for rules and interpretive
releases of the SEC, which are sources of authoritative GAAP for SEC
registrants. All other non-grandfathered, non-SEC accounting literature not
included in the Codification became nonauthoritative. We began using the new
guidelines and numbering system prescribed by the Codification when referring to
GAAP in the third quarter of 2009. As the Codification was not intended to
change or alter existing GAAP, it did not have any impact on the our
consolidated financial statements.
In
October 2009, the FASB issued Update No. 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 ASC 605-25, which originated primarily from the guidance in EITF
Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” (EITF 00-21).
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 to our consolidated financial
statements.
In
October 2009, the FASB issued Update No. 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 to our consolidated financial statements.
Results
of Operations
Comparison
of Three and Nine Months ended September 30, 2009 and 2008
Revenue
|
Three
Months Ended
|
|
|
|
|
|
Nine
Months Ended
|
|
|
|
|
|||||||||||||
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|||||||||||||
|
2009
|
|
|
2008
|
|
|
Increase
|
|
|
2009
|
|
|
2008
|
|
|
Increase
|
|
|||||||
|
($
in thousands)
|
|
|
|
|
|
($
in thousands)
|
|
|
|
|
|||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Net
product revenue
|
|
$
|
3,787
|
|
|
$
|
2,210
|
|
|
|
71
|
%
|
|
$
|
8,509
|
|
|
$
|
5,748
|
|
|
|
48
|
%
|
Net
support revenue
|
|
|
796
|
|
|
|
480
|
|
|
|
66
|
%
|
|
|
2,255
|
|
|
|
1,272
|
|
|
|
77
|
%
|
Total
revenue
|
|
$
|
4,583
|
|
|
$
|
2,689
|
|
|
|
70
|
%
|
|
$
|
10,765
|
|
|
$
|
7,020
|
|
|
|
53
|
%
|
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 71% and 48% for the three and nine months ended
September 30, 2009, respectively, compared with the same periods in 2008
reflected increased sales volume of our high-end PL10000 series product, which
was introduced in the second quarter of 2008.
The
increased support revenue of 66% and 77% for the three and nine months ended
September 30, 2009, respectively, when compared with the same periods in 2008
reflected the continued expansion of the installed base of our product to which
we have sold ongoing support services.
Based on
our current sales growth and recent new product introductions such as the
PL10000, we believe that our revenue will continue to grow in the fourth quarter
of 2009 as compared with the same period in 2008.
Cost
of Sales
Cost of
sales included: (i) direct labor and direct 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
|
|
|
|
|
|
Nine
Months Ended
|
|
|
|
|
|||||||||||||
|
September
30,
|
|
|
|
|
|
September 30,
|
|
|
|
|
|||||||||||||
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|||||||
|
($
in thousands)
|
|
|
|
|
|
($
in thousands)
|
|
|
|
|
|||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||
Materials
and per-use licenses
|
|
$
|
2,347
|
|
|
$
|
916
|
|
|
|
|
|
$
|
4,077
|
|
|
$
|
2,049
|
|
|
|
|
||
Percent
of net product revenue
|
|
|
62
|
%
|
|
|
41
|
%
|
|
|
21
|
%
|
|
|
48
|
%
|
|
|
36
|
%
|
|
|
12
|
%
|
Applied
labor and overhead
|
|
|
223
|
|
|
|
302
|
|
|
|
|
|
|
|
1,124
|
|
|
|
703
|
|
|
|
|
|
Percent
of net product revenue
|
|
|
6
|
%
|
|
|
14
|
%
|
|
|
(8
|
)%
|
|
|
13
|
%
|
|
|
12
|
%
|
|
|
4
|
%
|
Other
indirect costs
|
|
|
146
|
|
|
|
188
|
|
|
|
|
|
|
|
691
|
|
|
|
312
|
|
|
|
|
|
Percent
of net product revenue
|
|
|
4
|
%
|
|
|
9
|
%
|
|
|
(5
|
)%
|
|
|
8
|
%
|
|
|
5
|
%
|
|
|
3
|
%
|
Product
Costs
|
|
|
2,716
|
|
|
|
1,406
|
|
|
|
|
|
|
|
5,892
|
|
|
|
3,064
|
|
|
|
|
|
Percent
of net product revenue
|
|
|
72
|
%
|
|
|
64
|
%
|
|
|
8
|
%
|
|
|
69
|
%
|
|
|
53
|
%
|
|
|
19
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Support
costs
|
|
|
126
|
|
|
|
126
|
|
|
|
|
|
|
|
330
|
|
|
|
424
|
|
|
|
|
|
Percent
of net support revenue
|
|
|
16
|
%
|
|
|
26
|
%
|
|
|
(10
|
)%
|
|
|
15
|
%
|
|
|
33
|
%
|
|
|
(18
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization
of acquired assets
|
|
|
254
|
|
|
|
382
|
|
|
|
|
|
|
|
1,017
|
|
|
|
1,145
|
|
|
|
|
|
Percent
of total net revenue
|
|
|
6
|
%
|
|
|
14
|
%
|
|
|
(8
|
)%
|
|
|
9
|
%
|
|
|
16
|
%
|
|
|
(9
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
costs of sales
|
|
$
|
3,096
|
|
|
$
|
1,914
|
|
|
|
|
|
|
$
|
7,239
|
|
|
$
|
4,633
|
|
|
|
|
|
Percent
of total net revenue
|
|
|
68
|
%
|
|
|
71
|
%
|
|
|
(3
|
)%
|
|
|
67
|
%
|
|
|
66
|
%
|
|
|
1
|
%
|
Total
cost of sales increased during the three and nine months ended September 30,
2009 compared to the same periods in 2008, as a result of material costs
associated with increased product revenues, per-use technology license fees
negotiated in the second quarter of 2009 of approximately $260,000 and consigned
inventory write-offs of $175,000, both of which were recorded in the second
quarter of 2009.
Gross
Profit
Gross
profit for the three and nine month periods ended September 30, 2009 and 2008
was as follows:
|
Three
Months Ended
|
|
|
Nine
Months Ended
|
|
|||||||||||||||||||
|
September
30,
|
|
|
September
30,
|
|
|||||||||||||||||||
|
2009
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
||||||||
|
($
in thousands)
|
|
|
|
|
|
($
in thousands)
|
|
|
|
|
|||||||||||||
Gross
profit
|
|
$
|
1,488
|
|
|
$
|
775
|
|
|
|
92
|
%
|
|
$
|
3,525
|
|
|
$
|
2,387
|
|
|
|
48
|
%
|
Percent
of total net revenue
|
|
|
32
|
%
|
|
|
29
|
%
|
|
|
|
|
|
|
33
|
%
|
|
|
34
|
%
|
|
|
|
|
Gross
profit margin for the three months ended September 30, 2009, increased by 3
percentage points to 32% from 29% in the comparable period in the prior
year. This increase reflected a decrease in amortization of
acquisition related intangible assets to $254,333 in the three months ended
September 30, 2009, compared with $381,500 in the three months ended September
30, 2008.
Gross
profit margin for the nine months ended September 30, 2009, decreased by 1
percentage point to 33% from 34% in the comparable period in the prior
year. This decrease reflects the impact of increased technology
license fees of approximately $260,000 and consigned inventory write-offs of
approximately $175,000 that were recorded in the second quarter of 2009;
partially offset by the margin rate benefit of fairly flat overhead against
increased sales.
Operating
Expense
Operating
expenses for the three and nine month periods ended September 30, 2009 and 2008
were as follows:
|
Three
Months Ended
|
|
|
Nine
Months Ended
|
|
|||||||||||||||||||
|
September
30,
|
|
|
September
30,
|
|
|||||||||||||||||||
|
2009
|
|
|
2008
|
|
|
Decrease
|
|
|
2009
|
|
|
2008
|
|
|
Decrease
|
|
|||||||
|
($
in thousands)
|
|
|
|
|
|
($
in thousands)
|
|
|
|
|
|||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||
Research
and development
|
|
$
|
584
|
|
|
$
|
809
|
|
|
|
(28)
|
%
|
|
$
|
1,903
|
|
|
$
|
2,498
|
|
|
|
(24)
|
%
|
Sales
and marketing
|
|
|
1,622
|
|
|
|
2,094
|
|
|
|
(23)
|
%
|
|
|
4,961
|
|
|
|
6,436
|
|
|
|
(23)
|
%
|
General
and administrative
|
|
|
1,088
|
|
|
|
1,897
|
|
|
|
(43)
|
%
|
|
|
3,807
|
|
|
|
5,393
|
|
|
|
(29)
|
%
|
Total
|
|
$
|
3,294
|
|
|
$
|
4,800
|
|
|
|
(31)
|
%
|
|
$
|
10,672
|
|
|
$
|
14,326
|
|
|
|
(26)
|
%
|
Research
and Development
Research
and development expenses consisted of 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 new products.
|
Three
Months Ended
|
|
|
Nine
Months Ended
|
|
|||||||||||||||||||
|
September
30,
|
|
|
September
30,
|
|
|||||||||||||||||||
|
2009
|
|
|
2008
|
|
|
Decrease
|
|
|
2009
|
|
|
2008
|
|
|
Decrease
|
|
|||||||
|
($
in thousands)
|
|
|
|
|
|
($
in thousands)
|
|
|
|
|
|||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||
Research
and development
|
|
$
|
584
|
|
|
$
|
809
|
|
|
|
(28)
|
%
|
|
$
|
1,903
|
|
|
$
|
2,498
|
|
|
|
(24)
|
%
|
As
a percentage of net revenue
|
|
|
13
|
%
|
|
|
30
|
%
|
|
|
|
|
|
|
18
|
%
|
|
|
36
|
%
|
|
|
|
|
Research
and development expenses for the three and nine months ended September 30, 2009
decreased by $225,463 and $594,547, respectively, compared to the same periods
in 2008 as a result of reduced research and development headcount and employee
compensation costs, and decreased stock-based compensation costs. These
reductions related to the outsourcing of hardware development while retaining
software development. Stock-based compensation recorded to research
and development expense in the three and nine months ended September 30, 2009
was $8,585 and $25,869, respectively, a decrease from $72,267 and $213,136 in
the same periods in 2008.
Sales
and Marketing
Sales and
marketing expenses primarily included personnel costs, sales commissions, and
marketing expenses such as trade shows, channel development and
literature.
|
Three
Months Ended
|
|
|
Nine
Months Ended
|
|
|||||||||||||||||||
|
September
30,
|
|
|
September
30,
|
|
|||||||||||||||||||
|
2009
|
|
|
2008
|
|
|
Decrease
|
|
|
2009
|
|
|
2008
|
|
|
Decrease
|
|
|||||||
|
($
in thousands)
|
|
|
|
|
|
($
in thousands)
|
|
|
|
|
|||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||
Sales
and marketing
|
|
$
|
1,622
|
|
|
$
|
2,094
|
|
|
|
(23)
|
%
|
|
$
|
4,961
|
|
|
$
|
6,436
|
|
|
|
(23)
|
%
|
As
a percentage of net revenue
|
|
|
35
|
%
|
|
|
78
|
%
|
|
|
|
|
|
|
46
|
%
|
|
|
92
|
%
|
|
|
|
|
Sales and
marketing expenses for the three and nine months ended September 30, 2009
decreased by $471,810 and $1,474,419, compared to the same periods in 2008,
reflecting decreased headcount and employee compensation costs, decreases in
stock-based compensation costs, decreases in acquisition related intangible
asset amortization expense and reductions in discretionary marketing spending,
such as expenses related to trade shows. Acquisition related
intangible asset amortization expense recorded to sales and marketing expense in
the three and nine months ended September 30, 2009 was $244,905 and $964,405,
respectively, a decrease from $359,750 and $1,079,250 in the same periods of
2008. Stock-based compensation recorded to sales and marketing
expense in the three and nine months ended September 30, 2009 was $57,694 and
$217,291, respectively, a decrease from $110,358 and $346,223 in the same
periods in 2008.
General
and Administrative
General
and administrative expenses consisted primarily of personnel and facilities
costs related to our executive, finance, human resources and legal
organizations, fees for professional services and amortization of intangible
assets. Professional services include costs associated with legal,
audit and investor relations consulting costs.
|
|
Three
Months Ended
|
|
|
Nine
Months Ended
|
|
||||||||||||||||||
|
|
September
30,
|
|
|
September
30,
|
|
||||||||||||||||||
|
|
2009
|
|
|
2008
|
|
|
Decrease
|
|
|
2009
|
|
|
2008
|
|
|
Decrease
|
|
||||||
|
|
($
in thousands)
|
|
|
|
|
|
($
in thousands)
|
|
|
|
|
||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
General
and administrative
|
|
$
|
1,088
|
|
|
$
|
1,897
|
|
|
|
(43)
|
%
|
|
$
|
3,807
|
|
|
$
|
5,393
|
|
|
|
(29)
|
%
|
As
a percentage of net revenue
|
|
|
24
|
%
|
|
|
71
|
%
|
|
|
|
|
|
|
35
|
%
|
|
|
77
|
%
|
|
|
|
|
General
and administrative expenses for the three and nine months ended September 30,
2009 decreased by $808,535 and $1,585,646, respectively, compared to the same
periods in 2008, reflecting reduced headcount and employee compensation costs,
decreases in acquisition related intangible asset amortization expense,
decreases in stock-based compensation costs and reduced consulting and outside
service costs. Acquisition related intangible asset amortization
expense recorded to general and administrative expense in the three and nine
months ended September 30, 2009 was $126,169 and $496,835, respectively, a
decrease from $185,333 and $556,000 in the same periods of
2008. Stock-based compensation recorded to general and administrative
expense in the three and nine months ended September 30, 2009 was $193,622 and
$592,395, respectively, a decrease from $264,692 and $698,403 in the same
periods in 2008.
Interest
and Other Expense
|
|
Three
Months Ended
|
|
|
Nine
Months Ended
|
|
||||||||||||||||||
|
|
September
30,
|
|
|
September
30,
|
|
||||||||||||||||||
|
|
2009
|
|
|
2008
|
|
|
Increase
|
|
|
2009
|
|
|
2008
|
|
|
Increase
|
|
||||||
|
|
($
in thousands)
|
|
|
|
|
|
($
in thousands)
|
|
|
|
|
||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
Interest
and other expense
|
|
$
|
76
|
|
|
$
|
15
|
|
|
$
|
61
|
|
|
$
|
1,843
|
|
|
$
|
49
|
|
|
$
|
1,794
|
|
Interest
expense in the nine months ended September 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
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) 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 the states of California and Massachusetts. We recorded a
tax benefit primarily from the amortization of acquisition related intangible
assets. 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 SFAS No. 109, “Accounting for Income Taxes,”
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:
|
Nine
Months Ended
|
|
||||||
|
September
30,
|
|
||||||
|
2009
|
|
|
2008
|
|
|||
|
(in
thousands)
|
|
||||||
|
|
|
|
|
|
|||
Net
cash used in operating activities
|
|
$
|
(2,960
|
)
|
|
$
|
(9,698
|
)
|
Net
cash used in investing activities
|
|
|
(67
|
)
|
|
|
(724
|
)
|
Net
cash provided by financing activities
|
|
|
3,621
|
|
|
|
8,845
|
|
Effect
of exchange rate changes on cash and cash equivalents
|
|
|
73
|
|
|
|
538
|
|
Net
increase (decrease) in cash and cash equivalents
|
|
$
|
668
|
|
|
$
|
(1,039
|
)
|
During
the nine months ended September 30, 2009, we used $3.0 million of cash in
operating activities which was $6.7 million less than the $9.7 million use of
cash in operating activities in same period in 2008. This reduction in the use
of cash in operating activities resulted from reduced operating expenses from
cost reduction efforts, as well as cash provided by
inventories. During the nine months ended September 30, 2009, the
primary uses of cash in operating activities was our $8.3 million net loss, $1.2
million decrease in accounts payable and $431,601 in decreased accruals offset
by cash provided by a $1.4 million reduction in inventories, a $313,713
reduction in prepaid expenses and a $519,195 increase in deferred
revenue. Net cash provided by financing activities during
the nine months ended September 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 $550,000) and proceeds from stock option exercises of
$134,800.
During
the nine months ended September 30, 2008, we used $9.7 million of cash in
operating activities. The primary uses of cash in operating
activities was our $11.2 million net loss, $1.5 million increase in inventories
and $1.7 million increase in accounts receivable. Net cash provided
by financing activities during the first nine months of 2008 reflected $5.8
million from the issuance of common stock, $2.2 million from the exercise of
warrants, $550,000 of notes issued and proceeds from stock option exercises of
$318,712.
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 March
13, 2009, we entered into a secured line of credit (“Secured Line”) for working
capital purposes with Peninsula Bank. The Secured Line provides for maximum
borrowings of $3 million through March 12, 2010. Borrowings will bear interest
at the bank’s prime rate plus 3.5% but not less than 8% per annum. The Secured
Line is secured by substantially all of our assets and contains covenants
requiring, among other things, certain minimum financial covenants, as well as
restrictions on our ability to incur certain additional indebtedness, pay
dividends, create or permit liens on assets, or engage in mergers,
consolidations or dispositions. At September 30, 2009, because we were not in
compliance with the minimum covenant for earnings before interest, tax,
depreciation and amortization, we could not borrow against the Secured
Line. At September 30, 2009 there was no debt outstanding under the
Secured Line.
On May 4,
2009, we entered into subscription agreements and note purchase agreements with
certain institutional and accredited investors related to a private placement of
our common stock, convertible promissory notes and nonconvertible promissory
notes. The private placement included the sale of an aggregate of
4,587,500 shares of our restricted common stock, which were sold at $0.40 per
share, for a total of $1,835,000. The private placement also included
the issuance of a principal amount of $1,860,000 of convertible promissory
notes. These notes and the interest accrued at 10% per annum were
automatically converted into 4,713,082 shares of restricted common stock at a
per-share conversion price of $0.40 on June 3, 2009, which was the same day that
we completed the sale of the restricted common stock. The private
placement also included the issuance of $500,000 of nonconvertible
debt. Such nonconvertible debt is subject to a 10% per annum interest
rate and must be repaid together with unpaid accrued interest on April 30,
2010.
In
connection with the private placement, we paid placement agents fees amounting
to $190,506 and as additional compensation, we issued warrants to the placement
agents exercisable for an aggregate of 208,875 shares at an exercise price of
$0.40 per share.
Off
Balance Sheet Arrangements
As of
September 30, 2009, we had no off-balance sheet items as described in Item
303(a)(4)(i) 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
retired substantially all of our capital leases during the three months ended
March 31, 2009. 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 12 to
interim 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 September 30, 2009, we had open non-cancelable purchase
orders amounting to $3.2 million with our third-party contract
manufacturers.
Deferred
Revenue
The
following table represents our deferred revenue for the periods ended September
30, 2009 and December 31, 2008.
|
|
September 30,
2009
|
|
|
December 31,
2008
|
|
|
Increase
|
|
|||
Deferred
revenue
|
|
$
|
1,923,597
|
|
|
$
|
1,313,092
|
|
|
$
|
610,505
|
|
Revenue
contracts typically include maintenance and hardware support services that are
deferred until earned. Maintenance and support service contract periods
typically are one year but can range as long as three
years. Additionally, when we introduce new products for which there
is no historical evidence of acceptance history, revenue is deferred until
receipt of end-user acceptance or until acceptance history has been
established. The increase in deferred revenue at September 30, 2009,
as compared with December 31, 2008 reflects an increased base of customers with
maintenance and support contracts that are either new or have been
renewed.
Item 3.
|
Quantitative
and Qualitative Disclosures about Market
Risk.
|
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 $2,389,449 at September 30, 2009. The unrestricted
cash is held for working capital purposes. All of our cash is currently held in
demand deposit 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.
Item 4.
|
Controls
and Procedures.
|
Evaluation
of Disclosure Controls and Procedures
As
required by Rule 13a-15(b) and 15d-15(e), 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 September 30, 2009 that has materially affected, or is reasonably likely
to materially affect, our internal control over financial
reporting.
PART II. OTHER INFORMATION
Item 1.
|
Legal
Proceedings.
|
We may at
times be involved in litigation and other legal claims in the ordinary course of
business. We may also, from time to time, when appropriate in management’s
estimation, record reserves in our financial statements for pending litigation
and other claims. Currently, there are no pending material legal proceedings to
which we are a party or to which any of our property is subject.
Item 1A.
|
Risk
Factors.
|
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 fiscal year ended December 31, 2008 filed with the Securities and
Exchange Commission on March 16, 2009.
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
nine months ended September 30, 2009 and the year ended December 31, 2008 we
incurred losses from operations of approximately $7.1 million and $15.0 million,
respectively. We expect to continue to incur losses from operations in future
periods. If we achieve profitability in a subsequent quarter, that 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.
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, together with
debt financing that management currently believes is available, will be
sufficient to meet our anticipated cash needs for working capital and capital
expenditures through the end of 2010.
However,
a number of factors may negatively impact our expectations, including, without
limitation:
|
●
|
lower
than anticipated revenues;
|
|
●
|
higher
than expected cost of goods sold or operating expenses;
or
|
|
●
|
the
inability of our customers to pay for the goods and services
ordered.
|
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 cancel product development programs, lay-off employees
and/or take other steps to reduce our operating expenses. The 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.
Our
PacketLogic family of products is currently our only suite of products. All of
our current revenues and a significant portion of our future growth depend on
our ability to continue its commercialization.
All of
our current revenues and much of our anticipated future growth depend on our
ability to continue and grow the commercialization of our PacketLogic family of
products. We do not currently have plans or resources to develop additional
product lines, so our future growth will largely be determined by 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 introduction and acceptance of our
PL10000 product line and our future generations of 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
competitiveness may be harmed and the average selling prices for our products
may decrease over time. Such a decrease would generally result from the
introduction of competing products and from the standardization of DPI
technology. To counter this trend, we endeavor to enhance our products by
offering higher system speeds and additional features, such as additional
protection functionality, supporting additional applications and enhanced
reporting tools. We may also need to reduce our per unit manufacturing costs at
a rate equal to or faster than the rate at which selling prices decline. If we
are unable to reduce these costs or to offer increased functionally and
features, our profitability may be adversely affected.
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 its 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
have a limited operating history on which to evaluate our company.
We were
founded in 2002 and became a public company in October 2003 upon our merger with
Zowcom, Inc., a publicly-traded Nevada corporation having 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 Netintact. While we have the experience of Netintact
operations on a stand-alone basis, we have had limited operating history on a
combined basis upon which we can evaluate our business and prospects. We have
yet to develop sufficient experience regarding actual revenues to be achieved
from our combined operations.
We have
only recently launched many of our products and services on a worldwide basis.
Therefore, investors should consider the risks and uncertainties frequently
encountered by companies in new and rapidly evolving markets, which include the
following:
|
·
|
successfully
introducing new products;
|
|
·
|
successfully
servicing and upgrading new products once
introduced;
|
|
·
|
increasing
brand name recognition;
|
|
·
|
developing
new, strategic relationships and
alliances;
|
|
·
|
managing
expanding operations and sales
channels;
|
|
·
|
successfully
responding to competition; and
|
|
·
|
attracting,
retaining and motivating qualified
personnel.
|
If we are
unable to address these risks and uncertainties, our business, results of
operations and financial condition could be materially and adversely
affected.
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 will suffer
if it encounters delays in hiring these additional personnel.
Our
performance is substantially dependent on the continued services and on the
performance of our executive officers and other key employees, 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 the key
officers, we must attract, hire, and retain an equally competent person to take
his or her place. There is no assurance that we would be able to find such an
employee in a timely fashion. If we fail to recruit an equally qualified
replacement or incur a significant delay, our business plans may slow down or
stop. We could fail to implement our strategy or lose sales and marketing and
development momentum.
Also, in
early 2008 we reorganized our sales and marketing efforts, including a
significant reduction in workforce in these areas and the announcement of two
new senior sales management personnel. In April 2009, as a result of outsourcing
our hardware engineering and operations functions, we reduced headcount in our
Los Gatos, California and Varberg, Sweden offices, resulting in the reduction of
approximately 25% of our workforce. These reductions in our workforce
may impair our ability to recruit and retain qualified employees in the future,
and there can be no assurance that these personnel additions or our
reorganization efforts will have the positive effect on our business operations
as planned by management.
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 other companies in our market sector
which are substantially larger and more established and have greater
resources.*
We
compete in a rapidly evolving and highly competitive sector of the networking
technology market, 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, 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. These competitors may be able to respond more rapidly to
new or emerging technologies and changes in customer requirements or devote
greater resources to the development, promotion and sale of their products than
we can. We have encountered, and expect to encounter, customers who
are extremely confident in, and committed to, the product offerings of our
competitors. Furthermore, some of our competitors may make strategic
acquisitions or establish cooperative relationships among themselves or with
third parties to increase their ability to rapidly gain market share by
addressing the needs of our prospective customers. These competitors
may enter our existing or future markets with solutions that may be less
expensive, provide higher performance or additional features or be introduced
earlier than our solutions. Given the potential opportunity in the bandwidth
management solutions market, we also expect that other companies may enter with
alternative products and technologies, which could reduce the sales or market
acceptance of our products and services, perpetuate intense price competition or
make our products obsolete. If any technology that is competing with
ours is or becomes more reliable, higher performing, less expensive or has other
advantages over our technology, then the demand for our products and services
would decrease, which would harm our business.
If
we are unable to effectively manage our anticipated growth, we may experience
operating inefficiencies and have difficulty meeting demand for our
products.
We seek
to manage our growth so as not to exceed our available capital resources. If our
customer base and market grow rapidly, we would need to expand to meet this
demand. This expansion could place a significant strain on our management,
products and support operations, sales and marketing personnel and other
resources, which could harm our business.
If demand
for our products and services grows rapidly, we may experience difficulties
meeting the demand. For example, the installation and use of our products
requires training. If we are unable to provide training and support for our
products, the implementation process will be longer and customer satisfaction
may be lower. In addition, our management team may not be able to achieve the
rapid execution necessary to fully exploit the market for our products and
services. We cannot assure you that our systems, procedures or controls will be
adequate to support the anticipated growth in our operations. The failure to
meet the challenges presented by rapid customer and market expansion would cause
us to miss sales opportunities and otherwise have a negative impact on our sales
and profitability.
We may
not be able to install management information and control systems in an
efficient and timely manner, and our current or planned personnel, systems,
procedures and controls may not be adequate to support our future
operations.
Unstable
market and economic conditions may have serious adverse consequences on our
business.*
Our
general business strategy may be adversely affected by the current global
economic downturn and volatile business environment and continued unpredictable
and unstable market conditions. If the current financial markets continue to
experience volatility or further deterioration, it may make any necessary debt
or equity financing more difficult, more costly, and more
dilutive. In addition, a prolonged 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.
For our
primary line of PacketLogic products, we rely primarily on trade secret law,
contractual rights and trademark law to protect our intellectual property
rights. We cannot assure you that the actions we have taken will adequately
protect our intellectual property rights or that other parties will not
independently develop similar or competing products that do not infringe on our
patents. We enter into confidentiality or license agreements with our employees,
consultants and corporate partners, and control access to and distribution of
our software, documentation and other proprietary information. Despite our
efforts to protect our proprietary rights, unauthorized parties may attempt to
copy or otherwise misappropriate or use our products or technology.
In an
effort to protect our unpatented proprietary technology, processes and know-how,
we require our employees, consultants, collaborators and advisors to execute
confidentiality agreements. These agreements, however, may not provide us with
adequate protection against improper use or disclosure of confidential
information. These agreements may be breached, and we may not become aware of,
or have adequate remedies in the event of, any such breach. In addition, in some
situations, these agreements may conflict with, or be subject to, the rights of
third parties with whom our employees, consultants, collaborators or advisors
have previous employment or consulting relationships. Also, others may
independently develop substantially equivalent proprietary information and
techniques or otherwise gain access to our trade secrets.
Our
industry is characterized by the existence of a large number of patents and
frequent claims and related litigation regarding patent and other intellectual
property rights. If we are found to infringe on the proprietary rights of
others, or if we agree to settle any such claims, we could be compelled to pay
damages or royalties and either obtain a license to those intellectual property
rights or alter our products so that they no longer infringe upon such
proprietary rights. Any license could be very expensive to obtain or may not be
available at all. Similarly, changing our products or processes to avoid any
claims of infringement may be costly or impractical. Litigation resulting from
claims that we are infringing the proprietary rights of others could result in
substantial costs and a diversion of resources, and could have a material
adverse effect on our business, financial condition and results of
operations.
If
we are unable to have our products manufactured quickly enough to keep up with
demand, our operating results could be harmed.
If the
demand for our products grows, we will need to increase our capacity for
material purchases, production, test and quality control functions. Any
disruptions in product flow could limit our revenue growth and adversely affect
our competitive position and reputation, and result in additional costs or
cancellation of orders under agreements with our customers.
While our
PacketLogic products are software based, we rely on independent contractors to
manufacture the hardware components on which are products are installed and
operate. We are reliant on the performance of these contractors to meet business
demand, and may experience delays in product shipments from contract
manufacturers. Contract manufacturer performance problems may arise in the
future, such as inferior quality, insufficient quantity of products, or the
interruption or discontinuance of operations of a manufacturer, any of which
could have a material adverse effect on our business and operating
results.
We do not
know whether we will effectively manage our contract manufacturers or that these
manufacturers will meet our future requirements for timely delivery of product
components of sufficient quality and quantity. We also intend to regularly
introduce new products and product enhancements, which will require that we
rapidly achieve volume production by coordinating our efforts with those of our
suppliers and contract manufacturers. The inability of our contract
manufacturers to provide us with adequate supplies of high-quality product
components may cause a delay in our ability to fulfill orders and may have a
material adverse effect on our business, operating results and financial
condition.
As part
of our cost-reduction efforts, we will endeavor to lower per unit product costs
from our contract manufacturers by means of volume efficiencies and the
utilization of manufacturing sites in lower-cost geographies. However, we cannot
be certain when or if such price reductions will occur. The failure to obtain
such price reductions would adversely affect our gross margins and operating
results.
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.*
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 many months 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 can involve a lengthy sales
cycle, which may cause our revenues to fluctuate from period to period and could
result in us expending significant resources without making any
sales.*
Our sales
cycles are generally lengthy, as our customers undertake significant testing to
assess the performance of our products within their networks. As a result, we
may invest significant time from initial contact with a customer until that
end-customer decides to incorporate our products in its network. We may also
expend significant resources attempting to persuade large 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 dramatically 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. As such, our revenues could
fluctuate materially from period to period, which may cause the price of our
common stock to 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 in which we have exchange rate
fluctuation exposure are the European Union Euro, the Swedish Krona and the
Australian Dollar. As we expand, we could be exposed to exchange rate
fluctuations in other currencies. Exchange rates between these currencies and
U.S. Dollars have fluctuated significantly in recent years and may do so in the
future. Hedging foreign currencies can be difficult. We cannot predict the
impact of future exchange rate fluctuations on our operating results. We
currently do not hedge any foreign currencies.
Legislative
actions, higher insurance costs and new accounting pronouncements are likely to
impact our future financial position and results of operations.
Legislative
and regulatory changes and future accounting pronouncements and regulatory
changes have, and will continue to have, an impact on our future financial
position and results of operations. In addition, insurance costs, including
health and workers' compensation insurance premiums, have been increasing on an
historical basis and are likely to continue to increase in the future. Recent
and future pronouncements associated with expensing executive compensation and
employee stock option may also impact operating results. These and other
potential changes could materially increase the expenses we report under
generally accepted accounting principles, and adversely affect our operating
results.
Our
internal controls may be insufficient to ensure timely and reliable financial
information.*
Effective
internal controls over financial reporting are necessary for us to provide
reliable financial reports and effectively prevent fraud. 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 year ended December
31, 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 are located in Silicon Valley in Northern California.
Historically, this region has been vulnerable to natural disasters and other
risks, such as earthquakes, which at times have disrupted the local economy and
posed physical risks to us and our local suppliers. In addition, terrorist acts
or acts of war targeted at the United States, and specifically Silicon Valley,
could cause damage or disruption to us, our employees, facilities, partners,
suppliers, distributors and resellers, and customers, which could have a
material adverse effect on our operations and financial results. 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. These
and any future acquisitions could distract our management and employees and
increase our expenses.
In
addition, following any acquisition, including our acquisition of the Netintact
entities, the integration of the acquired business, product, service or
technology is complex, time consuming and expensive, and may disrupt our
business. These challenges include the timely and efficient execution of a
number of post-transaction integration activities, including:
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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,
we issued equity securities to pay for the Netintact acquisitions which had a
dilutive effect on its existing stockholders and we may have to incur debt or
issue equity securities to pay for any future acquisitions, the issuance of
which could be dilutive to our existing stockholders.
Risks
Related to Our Industry
Demand
for our products depends, in part, on the rate of adoption of
bandwidth-intensive broadband applications, such as peer-to-peer, or P2P, and
latency-sensitive applications, such as voice-over-Internet protocol, or VoIP,
Internet video and online video gaming applications.
Our
products are used by 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 sales to
date have been to small and midsize broadband service providers and enterprises.
We believe that the Tier 1 carriers, as well as cable and mobile operators,
present a significant market opportunity and are an important element of our
long term strategy, but they are still in the early stages of adopting and
evaluating the benefits and applications of DPI technology. Carriers may decide
that full visibility into their networks or highly granular control over content
based applications is not critical to their business. They may also determine
that certain applications, such as VoIP or 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.
Risks
Related to Ownership of Our Common Stock
Our
common stock price is likely to be highly volatile.
The
market price of our common stock is likely to be highly volatile as is the stock
market in general, and the market for small cap and micro cap technology
companies, such as ours, in particular, has been highly
volatile. Investors may not be able to resell their shares of our
common stock following periods of volatility because of the market’s adverse
reaction to volatility. In addition our stock is thinly traded. We
cannot assure you that our stock will trade at the same levels of other stocks
in our industry or that in general, stocks in our industry will sustain their
current market prices. Factors that could cause such volatility may
include, among other things:
|
·
|
actual
or anticipated fluctuations in our quarterly operating
results;
|
|
·
|
announcements
of technology innovations by our
competitors;
|
|
·
|
changes
in financial estimates by securities
analysts;
|
|
·
|
conditions
or trends in the network control and management
industry;
|
|
·
|
changes
in the market valuations of other such industry related
companies;
|
|
·
|
the
acceptance by institutional investors of our
stock;
|
|
·
|
rumors,
announcements or press articles regarding our operations, management,
organization, financial condition or financial
statements;
|
|
·
|
the
gain or loss of a significant customer;
or
|
|
·
|
the
stock market in general, and the market prices of stocks of technology
companies, in particular, have experienced extreme price volatility that
has adversely affected, and may continue to adversely affect, the market
price of our common stock for reasons unrelated to our business or
operating results.
|
Holders
of our common stock may be diluted in the future.*
We are
authorized to issue up to 130,000,000 shares of common stock and 15,000,000
shares of preferred stock. Our Board of Directors 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. 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 September 30, 2009,
there were 94,082,724 shares of our common stock outstanding, outstanding
warrants to purchase 3,660,021 shares of our common stock, and outstanding stock
options to purchase 7,650,531 shares of our common stock. In addition, at
September 30, 2009, we had an authorized reserve of 3,597,856 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 similarly dilute the relative
ownership interest of our current stockholders, and could also cause the trading
price of our common stock to decline.
Shares
eligible for future sale by our current stockholders may adversely affect our
stock price.*
Sales of
substantial amounts of common stock, including shares issued upon the exercise
of outstanding options and warrants, could adversely affect the prevailing
market price of our common stock and could impair our ability to raise capital
at that time through the sale of our securities.
Sales of
a substantial number of shares of common stock 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
connection with our acquisition of the Netintact entities in 2006, we entered
into a lock-up agreement with the former Netintact stockholders under which they
agreed not to sell the approximately 19,000,000 shares of our common stock that
were issued to them as consideration for the acquisition or issuable upon
exercise of warrants issued in connection with the
acquisition. Because all of these shares now have been released from
the lock-up restrictions, the shares are freely tradable and may generally be
sold without restriction, which 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;
|
|
·
|
reduced liquidity
with respect to our securities;
|
|
·
|
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;
|
|
·
|
a limited amount of
news and analyst coverage for our company;
and
|
|
·
|
a decreased ability
to issue additional securities or obtain additional financing in the
future.
|
In
addition, we would no longer be subject to 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;
|
|
·
|
receive
the purchaser’s written agreement to the transaction prior to
sale;
|
|
·
|
provide
the purchaser with risk disclosure documents which identify certain risks
associated with investing in “penny stocks” and which describe the market
for these “penny stocks” as well as a purchaser’s legal remedies;
and
|
|
·
|
obtain
a signed and dated acknowledgment from the purchaser demonstrating that
the purchaser has actually received the required risk disclosure document
before a transaction in a “penny stock” can be
completed.
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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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·
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authorizing
the issuance of “blank check” preferred stock without any need for action
by stockholders;
|
|
·
|
eliminating
the ability of stockholders to call special meetings of
stockholders;
|
|
·
|
restricting
the ability of stockholders to take action by written consent;
and
|
|
·
|
establishing
advance notice requirements for nominations for election to the Board of
Directors or for proposing matters that can be acted on by stockholders at
stockholder meetings.
|
These
provisions could allow our Board of Directors to affect your rights as a
stockholder since our Board of Directors can make it more difficult for common
stockholders to replace members of the Board. Because our Board of Directors is
responsible for appointing the members of our management team, these provisions
could in turn affect any attempt to replace our current management team. In
addition, the issuance of preferred stock could make it more difficult for a
third party to acquire us and may impact the rights of common stockholders. All
of the foregoing could adversely 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.
To date,
we have not paid any cash dividends and no cash dividends will be paid in the
foreseeable future. We do not anticipate paying cash dividends on our common
stock in the foreseeable future, and we cannot assure an investor that funds
will be legally available to pay dividends, or that, even if the funds are
legally available, the dividends will be paid.
Item 2.
|
Unregistered
Sales of Equity Securities and Use of
Proceeds.
|
None
Item 3.
|
Defaults
Upon Senior Securities.
|
None.
Item 4.
|
Submission
of Matters to a Vote of Security
Holders.
|
None
Item 5.
|
Other
Information.
|
None.
Item 6.
|
Exhibits
|
3.1
|
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)
|
|
3.2
|
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)
|
|
3.3
|
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)
|
|
3.4
|
Amended
and Restated Bylaws adopted on August 16, 2007, filed as Exhibit 3.4 to
our quarterly report on Form 10-Q filed on May 12, 2008 and incorporated
herein by reference.(1)
|
|
31.1
|
Certification
of James F. Brear, Principal Executive Officer, pursuant to Rule 13a-14(a)
or 15d-14(a) of the Securities and Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
|
|
31.2
|
Certification
of 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.
|
|
32.1
|
Certification
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002, executed by James F. Brear, Principal
Executive Officer, and Charles Constanti, Principal Financial
Officer.
|
(1)
|
Previously
filed
|
(2)
|
Indicates
management contract or compensatory plan or
arrangement.
|
(3)
|
Confidential
treatment has been sought for portions of this
document.
|
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
|
Procera
Networks, Inc.
|
|
|
|
|
|
By:
|
/s/
Charles Constanti
|
November 9,
2009
|
|
Charles
Constanti, Chief Financial Officer
|
|
|
(Principal
Financial and Accounting
Officer)
|
Exhibit
Index
3.1
|
|
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)
|
3.2
|
|
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)
|
3.3
|
|
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)
|
3.4
|
|
Amended
and Restated Bylaws adopted on August 16, 2007, filed as Exhibit 3.4 to
our quarterly report on Form 10-Q filed on May 12, 2008 and incorporated
herein by reference.(1)
|
|
Certification
of James F. Brear, Principal Executive Officer, pursuant to Rule 13a-14(a)
or 15d-14(a) of the Securities and Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
|
|
|
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.
|
|
|
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.
|
(1)
|
Previously
filed
|
(2)
|
Indicates
management contract or compensatory plan or
arrangement.
|
(3)
|
Confidential
treatment has been sought for portions of this
document.
|
38