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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

FORM 10-Q
 
(Mark one)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2012
 
or

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from   to   .

Commission File Number: 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)
 
(I.R.S. employer identification number)

4121 Clipper Court, Fremont, California
 
94538
(Address of principal executive offices)
 
(Zip code)

(510) 230-2777
 (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 þ   No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  o
Accelerated filer  þ
Non-accelerated filer  o
Smaller reporting company  o
 
 
(Do not check if a smaller
reporting company)
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o   No þ
 
As of May 7, 2012, the registrant had 19,262,405 shares of its common stock, par value $0.001, outstanding.
 


 
1

 
 
PROCERA NETWORKS, INC.
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2012
INDEX
 
 
 
 
 
Page
PART I. FINANCIAL INFORMATION
 
 
 
 
   
 
 
 
Item 1.
 
Consolidated Financial Statements
 
 
 
 
   
 
 
 
 
 
3
 
 
 
   
 
 
 
 
 
4
 
 
 
   
 
 
 
 
 
5
 
 
 
   
 
 
 
 
 
6
 
 
 
   
 
 
 
 
 
7
 
 
 
   
 
 
 
Item 2.
 
17
 
 
 
   
 
 
 
Item 3.
 
23
 
 
 
   
 
 
 
Item 4.
 
23
 
 
 
   
 
 
PART II. OTHER INFORMATION
 
 
 
 
   
 
 
 
Item 1.
 
24
 
 
 
   
 
 
 
Item 1A.
 
24
 
 
 
   
 
 
 
Item 2.
 
35
 
 
 
   
 
 
 
Item 3.
 
36
 
 
 
   
 
 
 
Item 4.
 
36
 
 
 
   
 
 
 
Item 5.
 
36
 
 
 
   
 
 
 
Item 6.
 
36
 
 
 
   
 
 
37
 
 
 
2


PART I. FINANCIAL INFORMATION

Item 1.
Consolidated Financial Statements

Procera Networks, Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
 
   
March 31,
   
December 31,
 
   
2012
   
2011
 
   
(unaudited)
   
(note)
 
ASSETS            
Current Assets:            
Cash and cash equivalents
  $ 27,991     $ 23,900  
Short-term investments
    13,223       13,504  
Accounts receivable, net
    8,355       11,403  
Inventories, net
    8,412       7,625  
Prepaid expenses and other
    1,146       938  
Total current assets
    59,127       57,370  
                 
Property and equipment, net
    1,875       1,806  
Goodwill
    960       960  
Other non-current assets
    20       20  
Total assets
  $ 61,982     $ 60,156  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable
  $ 3,082     $ 3,366  
Deferred revenue
    5,368       5,505  
Accrued liabilities
    3,640       3,845  
Total current liabilities
    12,090       12,716  
                 
Non-current liabilities:
               
Deferred revenue
    1,067       873  
Total liabilities
    13,157       13,589  
                 
Commitments and contingencies (Note 10)
           
                 
                 
Stockholders’ equity:
               
Preferred stock, $0.001 par value; 15,000 shares authorized: none issued and outstanding
           
Common stock, $0.001 par value; 32,500 shares authorized; 14,754 and 14,628 shares issued and outstanding at March 31, 2012 and December 31, 2011, respectively
    15       15  
Additional paid-in capital
    106,751       105,205  
Accumulated other comprehensive loss
    (257 )     (390 )
Accumulated deficit
    (57,684 )     (58,263 )
Total stockholders’ equity
    48,825       46,567  
Total liabilities and stockholders’ equity
  $ 61,982     $ 60,156  
 
Note: Amounts have been derived from the December 31, 2011 audited consolidated financial statements.
 
See accompanying notes to condensed consolidated financial statements.
 
 
3

 
Procera Networks, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)

 
 
Three Months Ended
March 31,
 
 
 
2012
 
 
2011
 
 
 
 
 
 
 
 
Sales:
 
 
 
 
 
 
Product sales
 
$
9,829
 
 
$
5,616
 
Support sales
 
 
2,503
 
 
 
1,307
 
Total net sales
 
 
12,332
 
 
 
6,923
 
Cost of sales:
 
 
 
 
 
 
 
 
Product cost of sales
 
 
3,447
 
 
 
2,584
 
Support cost of sales
 
 
222
 
 
 
136
 
Total cost of sales
 
 
3,669
 
 
 
2,720
 
 
 
 
 
 
 
 
 
 
Gross profit
 
 
8,663
 
 
 
4,203
 
 
 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
 
Research and development
 
 
1,691
 
 
 
1,038
 
Sales and marketing
 
 
4,006
 
 
 
2,065
 
General and administrative
 
 
2,360
 
 
 
1,276
 
Total operating expenses
 
 
8,057
 
 
 
4,379
 
 
 
 
 
 
 
 
 
 
Income (loss) from operations
 
 
606
 
 
 
(176
)
Interest and other income (expense), net
 
 
1
 
 
 
(30
)
 
 
 
 
 
 
 
 
 
Income (loss) before income taxes
 
 
607
 
 
 
(206
)
Income tax provision
 
 
28
 
 
 
24
 
Net income (loss)
 
$
579
 
 
$
(230
)
 
 
 
 
 
 
 
 
 
Net income (loss) per share:
 
 
 
 
 
 
 
 
Basic
 
$
0.04
 
 
$
(0.02
)
Diluted
 
$
0.04
 
 
$
(0.02
)
 
 
 
 
 
 
 
 
 
Shares used in computing net income (loss) per share:
 
 
 
 
 
 
 
 
Basic
 
 
14,547
 
 
 
11,277
 
Diluted
 
 
15,064
 
 
 
11,277
 
 
See accompanying notes to condensed consolidated financial statements.
 
 
4

 
 Procera Networks, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(unaudited)

 
 
Three Months Ended
March 31,
 
 
 
2012
 
 
2011
 
 
 
 
 
 
 
 
Net income (loss)
 
$
579
 
 
$
(230
)
 
 
 
 
 
 
 
 
 
Other comprehensive income, net of tax:
 
 
 
 
 
 
 
 
Unrealized loss on short-term investments
 
 
(1
)
 
 
 
Foreign currency translation adjustments
 
 
134
 
 
 
88
 
Other comprehensive income
 
 
133
 
 
 
88
 
Comprehensive income (loss)
 
$
712
 
 
$
(142
)
 
See accompanying notes to condensed consolidated financial statements.
 
 
5


Procera Networks, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

 
 
Three Months Ended
March 31,
 
 
 
2012
 
 
2011
 
Cash flows from operating activities:
 
 
 
 
 
 
Net income (loss)
 
$
579
 
 
$
(230
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
 
 
 
 
 
Depreciation
 
 
133
 
 
 
92
 
Stock-based compensation expense:
 
 
         
 
Stock options
 
 
583
 
 
 
330
 
Restricted stock awards
 
 
128
 
 
 
35
 
Amortization of premium on investments
 
 
68
 
 
 
 
Provision for bad debts
 
 
6
 
 
 
 
Provision for excess and obsolete inventory
 
 
83
 
 
 
82
 
Changes in assets and liabilities:
 
 
 
 
 
 
 
 
Accounts receivable
 
 
3,185
 
 
 
2,531
 
Inventories
 
 
(838
)
 
 
(148
)
Prepaid expenses and other current assets
 
 
(198
)
 
 
150
 
Accounts payable
 
 
200
 
 
 
(200
)
Accrued liabilities and deferred rent
 
 
(254
)
 
 
(147
)
Deferred revenue
 
 
(28
)
 
 
(101
)
Net cash provided by operating activities
 
 
3,647
 
 
 
2,394
 
 
 
 
 
 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
 
 
 
 
Purchase of property and equipment
 
 
(645
)
 
 
(71
)
Purchase of short-term investments
 
 
(4,538
)
 
 
 
Sales of short-term investments
 
 
2,002
 
 
 
 
Maturities of short-term investments
 
 
2,750
 
 
 
 
Net cash used in investing activities
 
 
(431
)
 
 
(71
)
 
 
 
 
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
 
 
 
 
Proceeds from issuance of common stock
 
 
835
 
 
 
217
 
Cash paid for fractional shares
 
 
 
 
 
(1
)
Proceeds from line of credit
 
 
 
 
 
717
 
Payments on line of credit
 
 
 
 
 
(1,718
)
Net cash provided by (used in) financing activities
 
 
835
 
 
 
(785
)
 
 
 
 
 
 
 
 
 
Effect of exchange rates on cash and cash equivalents
 
 
40
 
 
 
(48
)
 
 
 
 
 
 
 
 
 
Net increase in cash and cash equivalents
 
 
4,091
 
 
 
1,490
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents, beginning of period
 
 
23,900
 
 
 
7,876
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents, end of period
 
$
27,991
 
 
$
9,366
 
 
See accompanying notes to condensed consolidated financial statements.
 
 
6

 
Procera Networks, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)

1.
DESCRIPTION OF BUSINESS

Procera Networks, Inc. (Procera” or the Company”), is a leading provider of Intelligent Policy Enforcement (“IPE”), solutions based on Deep Packet Inspection technology, that enable mobile and broadband network operators and entities managing private networks including higher education institutions, businesses and government entities (collectively referred to as network operators) to gain enhanced visibility into, and control of, their networks and to create and deploy new services for their end user subscribers.  The Company sells its products through its direct sales force, resellers, distributors and system integrators in the Americas, Asia Pacific and Europe.
 
Procera was incorporated in 2002 and currently trades on the NASDAQ Global Stock Market LLC under the trading symbol “PKT”. Prior to December 29, 2011, the Company’s common stock traded on the NYSE Amex Equities exchange under the same trading symbol.

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, in the opinion of management, the financial statements include all the normal and recurring adjustments that are necessary to fairly present the results of the interim periods presented. The interim results presented are not necessarily indicative of results for any subsequent interim period, the year ending December 31, 2012, or any other future period. The consolidated balance sheet at December 31, 2011 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by United States generally accepted accounting principles (“U.S. GAAP”) for complete financial statements. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in Procera’s Annual Report on Form 10-K for the year ended December 31, 2011, filed with the SEC on March 15, 2012 as amended by Form 10-K/A, filed with the SEC on April 6, 2012.
 
The consolidated financial statements present the accounts of Procera and its wholly-owned subsidiaries.  All significant inter-company balances and transactions have been eliminated.
 
Significant Accounting Policies

The accounting and reporting policies of the Company conform to U.S. 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 months ended March 31, 2012 compared to what was previously disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.
 
Recent Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”).” The amendments in this ASU generally represent clarification of Topic 820, but also include instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This update results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and IFRS. The amendments are effective for interim and annual periods beginning after December 15, 2011 and are to be applied prospectively. Early application is not permitted. The adoption of ASU 2011-04 did not have a material impact on the Company’s consolidated financial statements.

In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income.” Specifically, the new guidance allows an entity to present components of net income or other comprehensive income in one continuous statement, referred to as the statement of comprehensive income, or in two separate, but consecutive statements. The new guidance eliminates the option to report other comprehensive income and its components in the statement of changes in equity. While the new guidance changes the presentation of comprehensive income, there are no changes to the components that are recognized in net income or other comprehensive income under current accounting guidance. The new guidance is effective for fiscal years and interim periods beginning after December 15, 2011 and is to be applied retrospectively. The adoption of ASU 2011-05 did not have a material impact on the Company’s consolidated financial statements.
 
 
7

 
3.
CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS

The following is a summary of cash equivalents and short-term investments by type of instrument at March 31, 2012 and December 31, 2011 (in thousands):

 
 
March 31, 2012
 
 
 
Amortized
 
 
Gross Unrealized
 
 
Fair
 
 
 
Cost
 
 
Gains
 
 
Losses
 
 
Value
 
Money market funds
 
$
11,219
 
 
$
 
 
$
 
 
$
11,219
 
Certificate of deposit
 
 
800
 
 
 
 
 
 
 
 
 
800
 
Commercial paper
 
 
3,346
 
 
 
 
 
 
 
 
 
3,346
 
U.S. agency securities
 
 
3,380
 
 
 
2
 
 
 
 
 
 
3,382
 
Corporate bonds
 
 
5,699
 
 
 
 
 
 
(4
)
 
 
5,695
 
Total investments
 
$
24,444
 
 
$
2
 
 
$
(4
)
 
$
24,442
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Reported as:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash equivalents
 
$
11,219
 
 
$
 
 
$
 
 
$
11,219
 
Short-term investments
 
 
13,225
 
 
 
2
 
 
 
(4
)
 
 
13,223
 
Total investments
 
$
24,444
 
 
$
2
 
 
$
(4
)
 
$
24,442
 

 
 
December 31, 2011
 
 
 
Amortized
 
 
Gross Unrealized
 
 
Fair
 
 
 
Cost
 
 
Gains
 
 
Losses
 
 
Value
 
Money market funds
 
$
9,388
 
 
$
 
 
$
 
 
$
9,388
 
Certificate of deposit
 
 
800
 
 
 
 
 
 
(1
)
 
 
799
 
Commercial paper
 
 
3,247
 
 
 
 
 
 
 
 
 
3,247
 
U.S. agency securities
 
 
6,558
 
 
 
3
 
 
 
 
 
 
6,561
 
Corporate bonds
 
 
4,401
 
 
 
1
 
 
 
(4
)
 
 
4,398
 
Total investments
 
$
24,394
 
 
$
4
 
 
$
(5
)
 
$
24,393
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Reported as:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash equivalents
 
$
10,888
 
 
$
1
 
 
$
 
 
$
10,889
 
Short-term investments
 
 
13,506
 
 
 
3
 
 
 
(5
)
 
 
13,504
 
Total investments
 
$
24,394
 
 
$
4
 
 
$
(5
)
 
$
24,393
 

As of March 31, 2012, all investments were classified as available-for-sale with unrealized gains and losses recorded as a separate component of accumulated other comprehensive income (loss) within stockholders’ equity. Cash equivalents consist of highly liquid investments with remaining maturities of three months or less at the date of purchase.  Short-term investments have a remaining maturity of greater than three months at the date of purchase and an effective maturity of less than one year.  None of our short-term investments have been at a continuous unrealized loss position for greater than 12 months.

The Company reviews its investments for impairment quarterly. For investments with an unrealized loss, the factors considered in the review include the credit quality of the issuer, the duration that the fair value has been less than the adjusted cost basis, severity of impairment, reason for the decline in value and potential recovery period, the financial condition and near-term prospects of the investees, and whether the Company would be required to sell an investment due to liquidity or contractual reasons before its anticipated recovery.  Based on its review, the Company did not identify any investments that were other-than-temporarily impaired during the three months ended March 31, 2012.

The Company did not incur any material realized gains or losses in the three months ended March 31, 2012 and did not have short-term investments at March 31, 2011.  The cost of securities sold was determined based on the specific identification method.

4.
FAIR VALUE MEASUREMENTS

The fair value is the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining fair value, the Company considers the principal or most advantageous market in which it would transact, and considers assumptions that market participants would use when pricing the asset or liability.
 
 
8

 
The three levels of inputs that may be used to measure fair value are as follows:
 
 
Level 1-
Quoted prices in active markets for identical assets or liabilities.

 
Level 2-
Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets with insufficient volume or infrequent transactions (less active markets), or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated with observable market data for substantially the full term of the assets or liabilities.

 
Level 3-
Unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of assets or liabilities.
 
The following is a summary of cash equivalents and short-term investments by type of instruments as of March 31, 2012 and December 31, 2011 measured at fair value on a recurring basis (in thousands):

 
 
March 31, 2012
 
 
 
Level 1
 
 
Level 2
 
 
Level 3
 
 
Total
 
Money market funds
 
$
11,219
 
 
$
 
 
$
 
 
$
11,219
 
Certificates of deposit
 
 
 
 
 
800
 
 
 
 
 
 
800
 
Commercial paper
 
 
 
 
 
3,346
 
 
 
 
 
 
3,346
 
U.S. agency securities
 
 
 
 
 
3,382
 
 
 
 
 
 
3,382
 
Corporate bonds
 
 
 
 
 
5,695
 
 
 
 
 
 
5,695
 
Total assets measured at fair value
 
$
11,219
 
 
$
13,223
 
 
$
 
 
$
24,442
 
 
 
 
December 31, 2011
 
 
 
Level 1
 
 
Level 2
 
 
Level 3
 
 
Total
 
Money market funds
 
$
9,388
 
 
$
 
 
$
 
 
$
9,388
 
Certificates of deposit
 
 
 
 
 
799
 
 
 
 
 
 
799
 
Commercial paper
 
 
 
 
 
3,247
 
 
 
 
 
 
3,247
 
U.S. agency securities
 
 
 
 
 
6,561
 
 
 
 
 
 
6,561
 
Corporate bonds
 
 
 
 
 
4,398
 
 
 
 
 
 
4,398
 
Total assets measured at fair value
 
$
9,388
 
 
$
15,005
 
 
$
 
 
$
24,393
 

In general, and where applicable, the Company uses quoted market prices in active markets for identical assets to determine fair value.  This pricing methodology applies to Level 1 investments which are comprised of money market funds. If quoted prices in active markets for identical assets are not available, then the Company uses quoted prices for similar assets or inputs other than quoted prices that are observable, either directly or indirectly.  These investments are included in Level 2 and consist of certificates of deposit, commercial paper, U.S. agency securities and corporate bonds. U.S. agency securities and corporate bonds are valued at a consensus price, which is a weighted average price based on market prices from a variety of industry standard data providers used as inputs to a distribution-curve based algorithm. Certificates of deposit and commercial paper are valued using market prices where available, adjusting for accretion of the purchase price to face value at maturity.

During the three months ended March 31, 2012, the Company did not have any transfers between Level 1 and Level 2 fair value instruments.

5.
CERTAIN FINANCIAL STATEMENT INFORMATION
 
Accounts receivable:

Account receivables at March 31, 2012 and December 31, 2011 consisted of the following (in thousands):

 
 
March 31,
2012
 
 
December 31,
2011
 
Accounts receivable
 
$
8,460
 
 
$
11,501
 
Less: allowance for doubtful accounts
 
 
(105
)
 
 
(98
)
Total
 
$
8,355
 
 
$
11,403
 

 
9

 
Inventories:
 
Inventories are stated at the lower of cost, which approximates actual costs on a first in, first out basis, or market. Inventories at March 31, 2012 and December 31, 2011 consisted of the following (in thousands):

 
 
March 31,
2012
 
 
December 31,
2011
 
Finished goods
 
$
8,138
 
 
$
7,386
 
Raw materials
 
 
274
 
 
 
239
 
Inventories, net
 
$
8,412
 
 
$
7,625
 
 
Accrued Liabilities:

Accrued liabilities at March 31, 2012 and December 31, 2011 consisted of the following (in thousands):

 
 
March 31,
2012
 
 
December 31,
2011
 
Payroll and related
 
$
1,702
 
 
$
1,668
 
Warranty
 
 
501
 
 
 
565
 
Sales commissions
 
 
418
 
 
 
939
 
Professional services
 
 
213
 
 
 
181
 
Other
 
 
806
 
 
 
492
 
Total accrued liabilities
 
$
3,640
 
 
$
3,845
 
 
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 is primarily based on current information on repair costs.  The Company periodically reviews the accrued balances and updates the historical warranty cost trends.

The following table summarizes warranty reserve activity during the three months ended March 31, 2012 and 2011 (in thousands):

 
 
Three Months Ended
March 31,
 
 
 
2012
 
 
2011
 
Warranty accrual, beginning of period
 
$
565
 
 
$
531
 
Provision for current period sales
 
 
 
 
 
58
 
Deductions for warranty claims processed during the period
 
 
(64
)
 
 
 
Warranty accrual, end of period
 
$
501
 
 
$
589
 
 
Accumulated Other Comprehensive Income (Loss):
 
The components of accumulated other comprehensive loss at March 31, 2012 and December 31, 2011 were as follows (in thousands):

 
 
March 31,
2012
 
 
December 31,
2011
 
Accumulated net unrealized loss on short-term investments
 
$
(2
)
 
$
(1
)
Accumulated foreign currency translation adjustments
 
 
(255
)
 
 
(389
)
Accumulated other comprehensive loss
 
$
(257
)
 
$
(390
)
 
 
10

 
6.
NET INCOME (LOSS) PER SHARE

Basic net income (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period. Diluted net income per share reflects the potential dilution that could occur from common shares issuable upon the exercise of outstanding stock options or warrants and the vesting of restricted stock awards (“RSAs”), which are reflected in diluted earnings per share by application of the treasury stock method.  Under the treasury stock method, the amount that the employee must pay for exercising stock options or warrants, the amount of stock-based compensation cost for future services that the Company has not yet recognized, and the amount of tax benefit that would be recorded in additional paid-in capital upon exercise are assumed to be used to repurchase shares.

The following table sets forth the computation of basic and diluted net income (loss) per share and potential shares of common stock that are not included in the diluted net income (loss) per share calculation because their effect is anti-dilutive (in thousands, except per share data):

    Three Months Ended
March 31,
 
 
 
2012
 
 
2011
 
Numerator:
 
 
 
 
 
 
 
 
Net income (loss)
 
$
579
 
 
$
(230
)
                 
Denominator:
 
 
 
 
 
 
 
 
Weighted average common shares - basic
 
 
14,547
 
 
 
11,277
 
Dilutive effect of employee equity incentive plans
 
 
483
 
 
 
 
Dilutive effect of warrants
 
 
34
 
 
 
 
Weighted average common shares - diluted
 
 
15,064
 
 
 
11,277
 
 
 
 
 
 
 
 
 
 
Net income (loss) per share:
 
 
 
 
 
 
 
 
Basic
 
$
0.04
 
 
$
(0.02
)
Diluted
 
$
0.04
 
 
$
(0.02
)
 
 
 
 
 
 
 
 
 
Anti-dilutive securities:
 
 
 
 
 
 
 
 
Options and restricted stock
 
 
260
 
 
 
1,016
 
Warrants
 
 
20
 
 
 
306
 
Total anti-dilutive securities
 
 
280
 
 
 
1,322
 

7.
STOCKHOLDERS’ EQUITY
 
Common Stock Transactions

On April 25, 2012, the Company completed a registered offering of 4.5 million shares of common stock.  The shares were sold to the public at $21.00 per share for a gross sales price of $94.5 million.  The Company received net proceeds of approximately $88.0 million after deducting underwriting commissions and other offering expenses.  The underwriters have an option to purchase up to an additional 675,000 shares of common stock which expires on May 19, 2012. All of the shares in the offering are being sold by the Company.

On June 24, 2011, the Company completed a registered offering of 3.0 million shares of common stock, which included the exercise in full of the underwriters’ overallotment option to purchase 394,800 shares of common stock.  The shares were sold to the public at $9.50 per share for a gross sales price of $28.8 million.  The Company received net proceeds of approximately $26.5 million after deducting underwriting commissions and other offering expenses.
 
Warrants

The following table summarizes the warrant activity for the three months ended March 31, 2012 and 2011 (in thousands, except per share data):

 
 
Three Months Ended March 31,
 
 
 
2012
 
 
2011
 
 
 
Number
of
Shares
 
 
Weighted
Average
Purchase
Price
 
 
Number
Of
Shares
 
 
Weighted
Average
Purchase
Price
 
Outstanding at the beginning of the period
 
 
85
 
 
$
7.75
 
 
 
409
 
 
$
8.39
 
Exercised
 
 
(55
)
 
 
4.00
 
 
 
(102
)
 
 
4.00
 
Cancelled or expired
 
 
 —
 
 
 
 —
 
 
 
(1
)
 
 
4.00
 
Outstanding at the end of the end of the period
 
 
30
 
 
$
14.72
 
 
 
306
 
 
$
9.88
 
 
 
11

 
The following table summarizes the outstanding warrants for our common stock issued in conjunction with raising capital as of March 31, 2012 (in thousands, except exercise prices and years):
 
Date of Grant
 
Shares
Outstanding
and
Exercisable
 
Expiration
Date
 
Weighted
Average
Remaining
Contractual Life
(years)
 
Weighted
Average
Exercise
Price
 
July 2007
 
 
20
 
July 2012
 
0.30
 
$
20.00
 
June 2009
 
 
10
 
June 2012
 
0.18
 
 
4.00
 
 
 
 
30
 
 
 
0.26
 
$
14.72
 
 
Equity Incentive Plan Activity

The Company has an equity incentive plan that provides for the grant of incentive stock options and restricted stock awards to eligible employees.  As of March 31, 2012, 183,845 shares were available for future grant under the Plan.

The following table summarizes the Company’s stock option activity for the three months ended March 31, 2012 and 2011 (in thousands, except per share data):

 
 
Three Months Ended March 31,
 
 
 
2012
 
 
2011
 
 
 
Options
 
 
Weighted
Average
Exercise
Price
 
 
Options
 
 
Weighted
Average
Exercise
Price
 
Outstanding at the beginning of the period
 
 
1,198
 
 
$
10.35
 
 
 
975
 
 
$
8.93
 
Granted
 
 
65
 
 
 
19.16
 
 
 
53
 
 
 
9.18
 
Exercised
 
 
(78
)
 
 
10.36
 
 
 
(2
)
 
 
4.96
 
Cancelled
 
 
(24
)
 
 
11.39
 
 
 
(10
)
 
 
4.79
 
Outstanding at the end of the period
 
 
1,161
 
 
$
10.87
 
 
 
1,016
 
 
$
9.01
 
Vested and expected to vest at the end of the period
 
 
1,114
 
 
$
10.79
 
 
 
979
 
 
$
9.10
 
Exercisable at the end of the period
 
 
689
 
 
$
10.42
 
 
 
640
 
 
$
9.91
 

As of March 31, 2012, the aggregate intrinsic value of options outstanding, options vested and expected to vest and options exercisable was $13.4 million, $13.0 million and $8.3 million, respectively. As of March 31, 2012, the weighted average remaining contractual life of options outstanding, options vested and expected to vest and options exercisable was 7.13 years, 7.04 years and 5.89 years, respectively. The total intrinsic value of options exercised during the three months ended March 31, 2012 and 2011 was $0.7 million and $9,252, respectively.

The weighted average remaining contractual life and weighted average per share exercise price of options outstanding and of options exercisable as of March 31, 2012 were as follows (in thousands, except exercise prices and years):

   
Options Outstanding
 
Options Exercisable
 
Range of Exercise Prices
 
 
Number of
Shares
 
 
Weighted
Average
Remaining
Contractual
Life
 
 
Weighted
Average
Exercise Price
 
 
Number of
Shares
 
 
Weighted
Average
Exercise Price
 
$ 4.30  –   $ 5.80  
 
 
282
 
 
 
7.57
 
 
$
5.06
 
 
 
164
 
 
$
5.02
 
   6.00  –      9.72  
 
 
271
 
 
 
6.30
 
 
 
7.77
 
 
 
198
 
 
 
7.59
 
   9.93  –    14.49  
 
 
306
 
 
 
6.22
 
 
 
13.08
 
 
 
253
 
 
 
13.66
 
 14.50  –    33.50  
 
 
302
 
 
 
8.52
 
 
 
16.85
 
 
 
74
 
 
 
18.79
 
$ 4.30  – $ 33.50  
 
 
1,161
 
 
 
7.13
 
 
$
10.87
 
 
 
689
 
 
$
10.42
 
 
 
12

 
The following table summarizes the Company’s RSA activity for the three months ended March 31, 2012 and 2011 (in thousands, except per share data):

 
 
Three Months Ended March 31,
 
 
 
2012
 
 
2011
 
 
 
Awards
 
 
Weighted
Average
Grant Date
Fair Value
 
 
Awards
 
 
Weighted
Average
Grant Date
Fair Value
 
Outstanding at the beginning of the period
 
 
136
 
 
$
9.24
 
 
 
60
 
 
$
5.30
 
Granted
 
 
3
 
 
 
15.64
 
 
 
10
 
 
 
6.40
 
Vested
 
 
(10
)
 
 
6.40
 
 
 
 
 
 
 
Outstanding at the end of the period
 
 
129
 
 
$
9.61
 
 
 
70
 
 
$
5.46
 

The weighted average remaining contractual term for the RSAs outstanding as of March 31, 2012 was 2.18 years. As of March 31, 2012, the aggregate pre-tax intrinsic value of RSAs outstanding was $2.9 million. The aggregate pre-tax intrinsic values were calculated based on the closing price of the Company’s common stock of $22.36 on March 31, 2012.

The aggregate pre-tax intrinsic value of RSAs vested during the three months ended March 31, 2012 was $0.2 million. This intrinsic value represents the fair market value of the Company’s common stock on the date of release. No RSAs vested during the three months ended March 31, 2011.

8.
STOCK-BASED COMPENSATION

The following table summarizes employee stock-based compensation expense, net of income tax, as it relates to the Company’s statement of operations for the three months ended March 31, 2012 and 2011 (in thousands):

 
 
Three Months Ended
March 31,
 
 
 
2012
 
 
2011
 
Cost of sales
 
$
34
 
 
$
25
 
Research and development
 
 
97
 
 
 
43
 
Sales and marketing
 
 
322
 
 
 
109
 
General and administrative
 
 
258
 
 
 
188
 
Total stock-based compensation expense
 
$
711
 
 
$
365
 
 
No income tax benefits were recognized in the three months ended March 31, 2012 due to operating loss carry-forwards available to offset current income.  No income tax benefits were recognized in the three months ended March 31, 2011 due to losses incurred.  No stock-based compensation has been capitalized in inventory due to the immateriality of such amounts.

As of March 31, 2012, total unrecognized compensation cost related to unvested stock options was $3.4 million, net of estimated forfeitures, which is expected to be recognized over an estimated weighted average period of 3.20 years, and total unrecognized compensation cost related to non-vested RSAs was $0.8 million, net of estimated forfeitures, which is expected to be recognized over an estimated weighted average period of 2.14 years.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option valuation model. The fair value of each RSA is calculated based upon the closing stock price of the Company’s common stock on the date of the grant. The expense for stock-based awards 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 options granted during the three months ended March 31, 2012 and 2011:

 
 
Three Months Ended
March 31,
 
 
2012
 
 
2011
 
Expected term (years)
 
 
4.80
 
 
 
4.80
 
Expected volatility
 
 
72.0
%
 
 
68.1
%
Risk-free interest rate
 
 
1.02
%
 
 
1.52
%
Expected dividend yield
 
 
%
 
 
%

The weighted average grant date fair value of options granted during the three months ended March 31, 2012 and 2011 was $9.54 and $3.98, respectively
 
 
13

 
The Company calculated the expected term of stock options granted using historical exercise data.  The Company used the 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.

9.
RELATED PARTY TRANSACTIONS

On July 19, 2010, the Company entered into a Master OEM Purchase and Sales Agreement with GENBAND US LLC and GENBAND Ireland Ltd. (collectively, “GENBAND”), pursuant to which GENBAND may purchase any of the Company’s existing software and hardware products, as well as procure licenses and services related to such products from Procera.  Pursuant to this agreement, the Company’s Board of Directors supported the election of Mark Pugerude, President of Global Sales and Business Development of GENBAND, as a director of the Company.

During the three months ended March 31, 2012 and 2011, the Company recognized revenue of approximately $0.4 million and $0.5 million, respectively, on sales to GENBAND.  At March 31, 2012 and December 31, 2011, the Company had accounts receivable of approximately $0.2 million and $0.1 million, respectively, from GENBAND.

10.
COMMITMENTS AND CONTINGENCIES
 
Legal

The Company is periodically involved in legal actions and claims that arise as a result of events that occur in the normal course of operations. The Company does not believe that any of its legal actions and claims will have, individually or in the aggregate, a material adverse effect on the Company’s financial position or results of operations.
 
Operating Leases
 
The Company leases its operating and office facilities for various terms under long-term, non-cancelable operating lease agreements. The leases expire at various dates through 2016 and provide for renewal options ranging from month-to-month to three 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).

As of March 31, 2012, future minimum lease payments due under operating leases are as follows (in thousands):
 
 
Fiscal years ending December 31,
 
 
 
 
2012 (remaining)
 
 
$
256
 
2013  
 
 
291
 
2014  
 
 
258
 
2015  
 
 
258
 
2016  
 
 
233
 
Total minimum lease payments
 
 
$
1,296
 
 
Secured Line of Credit

On December 10, 2009, the Company entered into a two-year loan and security agreement for a secured line of credit facility for short-term working capital purposes with Silicon Valley Bank. On February 3, 2012, the loan and security agreement was amended and restated (the “Amended Secured Credit Facility”), to increase the secured line of credit facility from $2.0 million to $10.0 million and to provide for borrowings through February 2, 2014. Pursuant to the Amended Secured Credit Facility, borrowings bear interest at the prime rate plus 1%, but not less than 4.25% on an annual basis. The Company will pay Silicon Valley Bank a $35,000 commitment fee in each of the two years under the agreement. The Amended Secured Credit Facility is secured by substantially all of the Company’s assets. The terms of the Amended Secured Credit Facility include a financial covenant requiring a minimum company liquidity ratio and restrictions on the Company’s ability to incur certain additional indebtedness, pay dividends, create or permit liens on assets or engage in mergers, consolidations or dispositions. The Amended Secured Credit Facility may be terminated at any time by the Company during the term of the agreement, to take effect three business days after the Company provides written notice to Silicon Valley Bank. In connection with such termination, the Company would be obligated to pay Silicon Valley Bank a $50,000 termination fee. The Company was in compliance with the financial covenants as of March 31, 2012. At March 31, 2012 and December 31, 2011, the Company had no outstanding balance under the Amended Secured Credit Facility.
 
 
14

 
Concentrations
 
For the three months ended March 31, 2012, revenue from Shaw Communications, Inc. and Cox Communications, Inc. represented 21% and 20% of net revenue, respectively. Revenue from a third customer represented 12% of net revenues, with no other single customer representing more than 10% of net revenue. For the three months ended March 31, 2011, revenue from Shaw Communications, Inc. represented 28% of net revenue and revenue from a second customer represented 22% of net revenue, with no other single customer representing more than 10% of net revenue.
 
At March 31, 2012, accounts receivable from two customers represented 26% and 19%, respectively, of total accounts receivable, with no other single customer accounting for more than 10% of the accounts receivable balance. At December 31, 2011, accounts receivable from two customers represented 45% and 20%, respectively, of total accounts receivable with no other single customer accounting for more than 10% of the accounts receivable balance.  As of March 31, 2012 and December 31, 2011, approximately 34% and 37%, respectively, of the Company’s total accounts receivable were due from customers outside the United States.

11.
INCOME TAXES
 
The Company's effective tax rate was 5% for the three months ended March 31, 2012 and 12% for the three months ended March 31, 2011. For the three months ended March 31, 2012, the Company recorded an income tax provision of $28,000 on an income before provision for income taxes of $0.6 million. For the three months ended March 31, 2011, the Company recorded an income tax provision of $24,000 on a loss before provision for income taxes of $0.2 million.  The effective tax rate for the three months ended March 31, 2012 differs from the federal statutory tax rate as a result of state taxes and earnings taxed in foreign jurisdictions and the anticipated tax expense in the U.S. was offset by the utilization of federal tax attributes.

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.

The Company recognizes interest and penalties related to uncertain tax positions in income tax expense.  As of March 31, 2012, the Company had no accrued interest or penalties related to uncertain tax positions.   The federal returns for the years ended 2008 through the current period and most state returns for the years ended 2007 through the current period remain open to examination.  In addition, all of the net operating losses and research and development credit carryforwards that may be used in future years are still subject to adjustment.  The Company is also subject to examinations in other foreign jurisdictions including Australia and Sweden beginning in 2005 through the current period.

At March 31, 2012, the Company had $245,000 of unrecognized tax benefits, a total of $210,000 which would affect the Company’s effective tax rate if recognized. The Company does not anticipate that the total unrecognized tax benefits will change significantly over the next twelve months.
 
12.
SEGMENT INFORMATION

The Company operates in one business segment providing specialized products and related services that enable network operators to manage and control their networks . Sales for geographic regions are 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 net sales by geographical region (in thousands):

 
 
Three Months Ended
 
 
 
March 31,
 
 
 
2012
 
 
2011
 
Net sales:
 
 
 
 
 
 
United States
 
$
7,624
 
 
$
3,683
 
Europe, Middle East and Africa
 
 
3,084
 
 
 
1,049
 
Asia Pacific
 
 
1,624
 
 
 
2,191
 
Total
 
$
12,332
 
 
$
6,923
 
 
 
15

 
The following are summaries of long-lived assets by geographical region (in thousands):

 
 
March 31,
2012
 
 
December 31,
2011
 
Long-lived assets:
 
 
 
 
 
 
United States
 
$
329
 
 
$
341
 
Europe
 
 
1,547
 
 
 
1,465
 
Australia
 
 
19
 
 
 
20
 
Total
 
$
1,895
 
 
$
1,826
 

13.
SUBSEQUENT EVENTS

On April 25, 2012, the Company completed a registered offering of 4.5 million shares of common stock.  The shares were sold to the public at $21.00 per share for a gross sales price of $94.5 million.  The Company received net proceeds of approximately $88.0 million after deducting underwriting commissions and other offering expenses.  The underwriters have an option to purchase up to an additional 675,000 shares of common stock which expires on May 19, 2012. All of the shares in the offering are being sold by the Company. The Company intends to use the net proceeds for general working capital and corporate purposes, including potential acquisition.
 
 
16

 
 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, 2011, filed with the SEC on March 15, 2012.

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,” “future,” “may,” “predict,” “potential,” “should” 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;

 
trends related to and management’s expectations regarding results of operations, required capital expenditures, revenues from existing and new products and sales channels, and cash flows, including but not limited to those statements set forth below in this Item 2; and

 
sales efforts, expenses, interest rates, foreign exchange rates, and the outcome of contingencies, such as legal proceedings.

We cannot guarantee that any forward-looking statement will be realized. Achievement of future results is subject to risks, uncertainties and potentially inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could vary materially from past results and those anticipated, estimated or projected. Investors should bear this in mind as they consider forward-looking statements.

We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. We also provide the following cautionary discussion of risks and uncertainties related to our businesses. These are factors that we believe, individually or in the aggregate, could cause our actual results to differ materially from expected and historical results. We note these factors for investors as permitted by Section 21E of the Exchange Act. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties.

Our forward-looking statements are subject to a variety of factors that could cause actual results to differ significantly from current beliefs and expectations, identified under the caption ”Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q, as well as general risks and uncertainties such as those relating to general economic conditions and demand for our products and services.

Overview

We are a leading provider of Intelligent Policy Enforcement (“IPE”) solutions that enable mobile and broadband network operators and entities managing private networks including higher education institutions, businesses and government entities (collectively referred to as network operators), to gain enhanced visibility into, and control of, their networks.  Our solutions provide granular network intelligence intended to enable network operators to improve the quality and longevity of their networks, better monetize their network infrastructure investments, control security hazards and create and deploy new services for their users.  We believe that the intelligence we provide about users and their usage enables qualified business decisions.  Our network operator customers include mobile service providers, broadband service providers, cable multiple system operators (“MSOs”), Internet Service Providers (“ISPs”), educational institutions, enterprises and government agencies.
 
 
17

 
Our IPE products are part of the market for mobile packet and broadband core products.  According to Infonetics Research, the market for IPE products is expected to grow from $344 million in 2010 to $2.1 billion in 2015, a compound annual growth rate of 43%.  Our bundled products deliver a solution that is a key element of the mobile packet and broadband core ecosystems.  Our solutions are often integrated with additional elements in the mobile packet and broadband core including Policy Management, Charging and Network Monitoring, Optimization and Assurance functions and are compliant with the widely adopted 3rd Generation Partnership Program (“3GPP”) standard.  In order to respond to rapidly increasing demand for network capacity due to increasing subscribers and usage, network operators are seeking higher degrees of intelligence, optimization, network management, service creation and delivery in order to differentiate their offerings and deliver a high quality of experience to their subscribers.  We believe the need to create more intelligent and innovative mobile and broadband networks will continue to drive demand for our products.

Our products are marketed under the PacketLogic brand name.  We have a broad spectrum of products delivering IPE at the access, edge and core layers of the network.  Our products are designed to offer maximum flexibility to our customers and enable differentiated services and revenue-enhancing applications, all while delivering a high quality of service for subscribers.

We face competition from suppliers of standalone IPE and deep packet inspection (“DPI”) products including Allot Communications Ltd., Arbor Networks (a subsidiary of Tektronix), Blue Coat Systems, Inc., Brocade Communications Systems, Inc., Cisco Systems, Inc., Cloudshield Technologies, Inc. (a subsidiary of SAIC, Inc.), Ericsson, Huawei Technologies Company, Ltd., Juniper Networks, Inc. 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 our competitors are larger and more established enterprises with substantially greater financial and other resources. Some competitors may be willing to reduce prices and accept lower profit margins to compete with us.  As a result of such competition, we could lose market share and sales, or be forced to reduce our prices to meet competition.  However, we do not believe there is a dominant supplier in our market.  Based on our belief in the superiority of our technology, we believe that we have an opportunity to capture meaningful market share and benefit from what we believe will be growth in the DPI market.

We were incorporated in 2002 and became a public company in October 2003 following our merger with Zowcom, Inc., a publicly-traded Nevada corporation. In 2006, we completed acquisitions of the Netintact entities. Our Company is headquartered in Fremont, California and we have regional headquarters in Varberg, Sweden and Singapore.  We sell our products through our direct sales force, resellers, distributors and systems integrators in the Americas, Asia Pacific and Europe.

Critical Accounting Estimates

Our discussion and analysis of our financial condition and results of operations are based upon financial statements which have been prepared in accordance with Generally Accepted Accounting Principles in the United States (“U.S. GAAP”).  The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities.  On an ongoing basis, we evaluate these estimates.  We base our estimates on historical experience and on assumptions that are believed to be reasonable.  These estimates and assumptions provide a basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates under different assumptions or conditions, and these differences may be material.
 
We believe 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 Accounts;
 
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, 2011.

Results of Operations

Comparison of Three Months Ended March 31, 2012 and 2011
 
Revenue
 
Revenue for the three months ended March 31, 2012 and 2011 was as follows (in thousands, except percentages):
 
 
18

 
 
 
Three Months Ended
       
 
 
March 31,
       
 
 
2012
   
2011
   
Increase
 
Net product revenue
  $ 9,829     $ 5,616       75 %
Net support revenue
    2,503       1,307       92 %
Total revenue
  $ 12,332     $ 6,923       78 %

Our revenue is derived from two sources: product revenue, which includes sales of our hardware products bundled with software licenses, and service revenue, which consists primarily of software maintenance and customer support revenue. Maintenance and customer support revenue is recognized over the support period, which is typically twelve months.

Total revenue in three months ended March 31, 2012 was $12.3 million, an increase of 78% compared with $6.9 million in the three months ended March 31, 2011, and reflected a 75% increase in product revenue and a 92% increase in support revenue.  The increase in product revenue in 2012 compared to the first quarter of 2011 reflected substantial follow-on orders from existing customers and included increased sales to cable and mobile service provider customers.  The increase in product revenue also continued to reflect increased sales of our mid-range PL8000 series products.  The increase in support revenue in 2012 compared to the first quarter of 2011 reflected the continued expansion of the installed base of our product to which we have sold ongoing support services. In the three months ended March 31, 2012, sales to three customers, Shaw Communications, Inc., Cox Communications, Inc and a third customer, represented 21%, 20% and 12% of total net revenues, respectively.

Sales to customers located in the United States as a percentage of total revenues were 62% and 53% for the three months ended March 31, 2012 and 2011, respectively.

We believe that our revenue will continue to grow in each of the remaining quarters of the fiscal year ending December 31, 2012, as compared with the same periods in the fiscal year ended December 31, 2011.
 
Cost of Sales

Cost of sales includes direct labor and material costs for products sold, costs expected to be incurred for warranty, adjustments to inventory values, including the write-down of slow moving or obsolete inventory and costs for support personnel.

The following table presents the breakdown of cost of sales by category for the three months ended March 31, 2012 and 2011 (in thousands, except percentages):

   
Three Months Ended
       
    March 31,        
 
 
2012
 
 
2011
 
 
Increase
 
Product costs
 
$
3,447
 
 
$
2,584
 
 
 
33
%
Percent of net product revenue
 
 
35