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, 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)	(I.R.S. Employer Identification Number)

100-C Cooper Court, Los Gatos, California	95032
(Address of principal executive offices)	(Zip code)
(408) 354-7200
(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  o	Accelerated filer  þ	Non-accelerated filer  o	Smaller reporting company  o
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes  o      No  þ

As of April 30, 2009, the registrant had 84,617,142 shares of its common stock, par value $0.001, outstanding.

1

PROCERA NETWORKS, INC.

INDEX

		Page
PARTI. FINANCIAL INFORMATION		3
Item 1.	Consolidated Financial Statements:	3
	Consolidated Balance Sheets as of March 31, 2009  and December 31, 2008  (unaudited)	3
	Consolidated Statements of Operations and Other Comprehensive Income for the three months ended March 31, 2009 and 2008 (unaudited)	4
	Consolidated Statements of Cash Flows for the three months ended March 31, 2009 and 2008 (unaudited)	5
	Notes to Interim Consolidated Financial Statements (unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	22
Item 4.	Controls and Procedures	23
PART II. OTHER INFORMATION		23
Item 1.	Legal Proceedings	23
Item 1A.	Risk Factors	23
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	35
Item 3.	Defaults Upon Senior Securities	35
Item 4.	Submission of Matters to a Vote of Security Holders	35
Item 5.	Other Information	35
Item 6.	Exhibits	35
SIGNATURES		36
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1

2

PART I. FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

 Procera Networks, Inc.

CONDENSED CONSOLIDATED BALANCE SHEETS

	March 31,			December 31,
	2009			2008
	(Unaudited)			(Note 2)
ASSETS
Current Assets:
Cash and cash equivalents	$	860,840		$	1,721,225
Accounts receivable, less allowance of $195,109 and $182,760 for March 31, 2009 and December 31, 2008		5,287,015			5,454,745
Inventories, net		3,042,434			3,445,802
Prepaid expenses and other		665,273			824,340
Total current assets		9,855,562			11,446,112
Property and equipment, net		1,851,309			2,573,045
Purchased intangible assets, net		604,655			964,405
Goodwill		960,209			960,209
Other non-current assets		47,278			47,294
Total assets	$	13,319,013		$	15,991,065
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	2,482,957		$	2,457,430
Deferred revenue		1,492,106			1,313,092
Accrued liabilities		1,520,701			1,841,442
Notes payable		300,000			550,000
Capital leases payable-current portion		--			11,543
Total current liabilities		5,795,764			6,173,507
Non-current liabilities
Deferred rent		23,929			24,234
Deferred tax liability		435,335			695,239
Capital leases payable - non-current portion		--			39,584
Total liabilities		6,255,028			6,932,564
Commitments and contingencies (Note 11)		—			—
Stockholders’ equity:
Preferred stock, $0.001 par value; 15,000,000 shares authorized: none issued and outstanding		—			—
Common stock, $0.001 par value; 130,000,000 shares authorized; 84,498,491 shares issued and outstanding at March 31, 2009 and December 31, 2008		84,498			84,498
Additional paid-in capital		61,473,359			61,142,430
Accumulated other comprehensive loss		(419,499	)		(428,107	)
Accumulated deficit		(54,074,373	)		(51,740,320	)
Total stockholders’ equity		7,063,985			9,058,501
Total liabilities and stockholders’ equity	$	13,319,013		$	15,991,065

See accompanying notes to interim condensed consolidated financial statements.

3

Procera Networks, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS and COMPREHENSIVE INCOME

(Unaudited)

	For the three months ended March 31,
	2009			2008
Sales
Product Sales	$	2,171,043		$	1,333,774
Support Sales		776,291			382,000
Total sales		2,947,334			1,715,774
Cost of sales
Product cost of sales		1,668,748			1,089,000
Support cost of sales		119,172			142,000
Total cost of sales		1,787,920			1,231,000
Gross profit		1,159,414			484,774
Operating expenses:
Research and development		636,142			662,122
Sales and marketing		1,684,861			2,024,492
General and administrative		1,329,445			1,525,000
Total operating expenses		3,650,448			4,211,614
Loss from operations		(2,491,034	)		(3,726,840	)
Interest and other income (expense)		(23,836	)		3,057
Loss before benefit from income taxes		(2,514,870	)		(3,723,783	)
Income tax benefit		180,817			239,846
Net loss after tax	$	(2,334,053	)	$	(3,483,937	)
Other comprehensive income: Foreign currency translation adjustment		8,608			54,337
Comprehensive loss	$	(2,325,445	)	$	(3,429,600	)
Net loss per share of common stock - basic and diluted	$	(0.03	)	$	(0.05	)
Average weighted number of common shares outstanding - basic and diluted		84,498,491			76,118,175

See accompanying notes to interim condensed consolidated financial statements.

4

Procera Networks, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	For the three months ended March 31,
	2009			2008
Cash flow from operating activities:
Net loss	$	(2,334,053	)	$	(3,483,937	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		699,337			40,683
Amortization of intangibles		359,750			944,860
Compensation related to stock-based awards		322,428			438,132
Reserve for obsolete inventory		50,000			–
Deferred income taxes		(258,647	)		(259,904	)
Changes in assets and liabilities:
Inventories		353,368			(270,804	)
Deferred revenue		179,014			101,178
Trade accounts receivable		167,730			(33,305	)
Prepaid expenses and other current assets		159,083			79,409
Accounts payable		25,527			(56,562	)
Accrued liabilities, deferred rent		(301,796	)		(274,683	)
Net cash used in operating activities		(578,259	)		(2,774,933	)
Cash flows used in investing activities:
Purchase of equipment		(35,848	)		(16,978	)
Net cash used in investing activities		(35,848	)		(16,978	)
Cash flows from financing activities:
Proceeds from exercise of stock options		­–			202,559
Loan payment		(250,000	)		–
Capital lease payments		(1,632	)		(9,259	)
Net cash provided by (used in) financing activities		(251,632	)		193,300
Effect of exchange rates on cash and cash equivalents		5,354			58,549
Net decrease in cash and cash equivalents		(860,385	)		(2,540,062	)
Cash and cash equivalents, beginning of period		1,721,225			5,864,648
Cash and cash equivalents, end of period	$	860,840		$	3,324,586

See accompanying notes to interim condensed consolidated financial statements.

5

 Procera Networks, Inc

Notes to Interim Condensed Consolidated Financial Statements (unaudited)

1. DESCRIPTION OF BUSINESS

Procera Networks, Inc. ("Procera" or the "Company") is a leading provider of bandwidth management and control products for broadband service providers worldwide. Procera’s products offer network administrators unique accuracy in identifying applications running on their network, and the ability to optimize the experience of the service provider’s subscribers based on management of the identified traffic.

The company sells its products through its direct sales force, resellers, distributors and system integrators in the Americas, Asia Pacific and Europe. PacketLogic™ is deployed at more than 400 broadband service providers, 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. On August 18, 2006, Procera acquired the stock of Netintact AB, a Swedish corporation. On September 29, 2006, Procera acquired the effective ownership of the stock of Netintact PTY, an Australian company. 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”) for Form 10-Q.  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, which contemplate the Company’s continuation as a going concern. Certain amounts from prior periods have been reclassified to conform to the current period presentation.  This reclassification has resulted in no changes to the Company’s accumulated deficit or net losses presented.

The consolidated financial statements present the accounts of Procera and its wholly-owned subsidiaries, Netintact AB and Netintact PTY.  All significant inter-company accounts and transactions have been eliminated.

Significant Accounting Policies

There have been no changes in Procera's significant accounting policies during the three months ended March 31, 2009 as compared to what was previously disclosed in Procera's Annual Report on Form 10-K for the year ended December 31, 2008.

Foreign Currency

Monetary assets and liabilities denominated in foreign currencies are translated into United States dollars at rates of exchange in effect at the balance sheet date. Revenue and expenses and cash flows of Procera’s subsidiaries have been translated into U.S. dollars at average exchange rates prevailing during the period.  Transactional gains or losses are included in income for the year, except gains or losses relating to long-term debt, which are deferred and amortized over the remaining term of the debt.  Non-monetary assets, liabilities and items recorded in income arising from transactions denominated in foreign currencies are translated at rates of exchange in effect at the date of the transaction.

Cumulative translation adjustments associated with net assets or liabilities are recognized within other comprehensive income and reported as a separate component in the statement of changes in stockholders’ equity.  The resulting translation gain and loss adjustments are recorded directly as a separate component of stockholders’ equity.  Foreign currency translation adjustments (non-owner equity) resulted in gains of $8,608 and $54,337 during the three month period ending March 31, 2009 and 2008, respectively. Changes in cash resulting from the translations are presented as a separate item in the statements of cash flows.

6

Use of Estimates

The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. On an ongoing basis, management evaluates the Company’s estimates, including those related to allowance for doubtful accounts and sales returns, the value and marketability of inventory, allowances for expected warranty costs, valuation of long-lived assets, including intangible assets and goodwill, income taxes and stock-based compensation, among others. Management based its estimates on experience and other assumptions the Company believes are reasonable under expected business conditions. Actual results may differ from these estimates if alternative conditions are realized.

Revenue Recognition

The Company’s most common sale involves the integration of software and a hardware appliance.  The software is essential to the functionality of the solution sold by the Company.  The Company accounts for revenue from these sales in accordance with Statement of Position (“SOP”) 97-2, Software Revenue Recognition, as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions, for all transactions involving software. The Company recognizes product revenue when all of the following have occurred: (1) the Company has entered into a legally binding arrangement with a customer resulting in the existence of persuasive evidence of an arrangement; (2) product title has transferred to the customer as identified by the passage of responsibility in accordance with Incoterms 2000; (3) customer payment is deemed fixed or determinable and free of contingencies and significant uncertainties; and (4) collection is probable.

Product revenue consists of revenue from sales of hardware appliances and software licenses. Product sales include a perpetual license to the Company’s software. Shipping charges billed to customers are included in product revenue and the related shipping costs are included in cost of product revenue.  Virtually all sales include optional post-contract support (“PCS”) services (Service Revenue) which may consist of software updates, hardware support and technical support. Software updates provide customers access to a growing library of electronic internet traffic identifiers (also referred to as signatures) and rights to non-specific software product upgrades, maintenance releases and patches released during the term of the support period. Technical support includes internet access to technical content, telephone and internet access to technical support personnel and hardware support. Hardware support may include onsite repairs or replacement.

Receipt of a customer purchase order is the primary method of determining that persuasive evidence of an arrangement exists.

Delivery generally occurs when product title has transferred as identified by the passage of responsibility per the International Chamber of Commerce shipping term (INCOTERMS 2000).  The Company’s standard delivery terms allow revenue to be recognized when product is delivered to a common carrier from Procera or from one its subsidiaries.   Additionally, when the Company introduces new products for which there is no historical evidence of acceptance history, revenue is recognized on the basis of end-user acceptance until such history has been established.

Since customer orders often include multiple items such as hardware, software, and services which are delivered at varying times, the Company determines whether the delivered items can be considered separate units of accounting following the guidance in EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”).  EITF 00-21 states that delivered items should be considered separate units of accounting if delivered items have value to the customer on a standalone basis, there is objective and reliable evidence of the fair value of undelivered items and if delivery of undelivered items is probable and substantially in the Company’s control.

In these circumstances, Procera allocates revenue to each separate element based on its vendor specific objective evidence of fair value (“VSOE”). VSOE of fair value for elements of an arrangement is based upon the normal pricing and discounting practices for those services when sold separately and for support and updates is additionally measured by the renewal rate offered to the customer. Through March 31, 2009, in virtually all of the Company’s contracts, the only elements that remained undelivered at the time of product delivery were PCS and unspecified software updates. The Company determines VSOE for PCS based on sales prices charged to customers based upon renewal pricing for PCS.  Each contract or purchase order entered into includes a stated rate for PCS. The renewal rate is equal to the stated rate in the original contract. The Company has a history of such renewals, the vast majority of which are at the stated renewal rate on a customer by customer basis.

When the Company establishes VSOE for all elements of the sales order it separately accounts for deferred items.  Revenue for the deferred items is recognized using either the completed-contract or percentage-of-completion method depending on the terms of the service agreement.  When there are acceptance provisions, the Company uses the completed-contract method of revenue recognition, which is measured by the customer’s acceptance.  The Company uses the percentage-of-completion method when a service contract specifies activities to be performed by the Company and those acts have been repeatedly demonstrated to be within its core competency.   Under this approach, PCS revenue is recognized ratably over the life of the contract.  The majority of service revenue is recognized using the percentage-of-completion method recognizing revenue ratably over the life of the contract. A small portion of service revenue is derived from providing training on products and the Company uses the completed-contract method to recognize such revenue.  When the Company does not have sufficient VSOE to allocate the fee to the separate elements and the only undelivered element is PCS, the entire arrangement fee will be recognized ratably over (a) the contractual PCS period (for those arrangements with explicit rights to PCS) or (b) the period during which PCS is expected to be provided (for those arrangements with implicit rights to PCS).

7

Certain contracts contain billing/payment terms based upon performance milestones such as the execution of measurement tests, a partial delivery or the completion of a specified service.  Payments received before the unconditional acceptance of a specific set of deliverables are recorded as deferred revenue until the performance acceptance has been received.

Fees are typically considered to be fixed or determinable at the inception of an arrangement, generally based on specific products and quantities to be delivered. Substantially all of the Company’s contracts do not include rights of return or acceptance provisions. To the extent that agreements contain such terms, the Company recognizes revenue once the acceptance provisions or right of return lapses. Payment terms to customers generally range from net 30 to 90 days. In the event payment terms are provided that differ from the Company’s standard business practices, the fees may be deemed to be not fixed or determinable and revenue recognized when the payments become due, provided the remaining criteria for revenue recognition have been met.

Procera assesses the ability to collect from its customers based on a number of factors, including credit worthiness of the customer and past transaction history with the customer. If the customer is not deemed credit worthy, the Company defers all revenue from the arrangement until payment is received and all other revenue recognition criteria have been met.

Deferred Revenue

Most of the Company’s sales are for multiple-elements, including a perpetual license for software installed on a hardware appliance along with PCS and unspecified updates.  When VSOE of fair value for all elements is established, the revenue for the hardware and software elements is recognized upon shipment and the PCS is initially included in deferred revenue and recognized ratably over the term of the agreement on a straight-line basis.  If the VSOE of fair value for all elements is not established, the revenue is recognized over the term of the agreement.  At March 31, 2009 and December 31, 2008 deferred revenue was $1,492,106 and $1,313,092, respectively, and included as “Deferred revenue” in the accompanying Balance Sheets.

New Pronouncements

In April 2009, the Financial Accounting Standards Board (“FASB”) issued three related Staff Positions: (i) FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP FAS 157-4”), (ii) FSP FAS 115-2 and FSP FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (“FSP FAS 115-2” and “FSP FAS 124-2”), and (iii) FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP FAS 107-1” and “APB 28-1”), which will be effective for interim and annual periods ending after June 15, 2009. FSP FAS 157- 4 provides guidance on how to determine the fair value of financial assets and liabilities under SFAS No. 157, “Fair Value Measurements” (“SFAS 157”) in the current economic environment and reemphasizes that the objective of a fair value measurement remains an exit price. If there has been a significant decrease in the volume and level of activity of the asset or liability in relation to normal market activities, quoted market values may not be representative of fair value. As a result, a change in valuation technique or the use of multiple valuation techniques may be appropriate. FSP FAS 115-2 and FSP FAS 124-2 modify the requirements for recognizing other-than-temporarily impaired debt securities and revise the existing impairment model for such securities, by modifying the current intent and ability indicator in determining whether a debt security is other-than-temporarily impaired. FSP FAS 107-1 and APB 28-1 enhance the disclosure of instruments under the scope of SFAS 157 for both interim and annual periods. The Company does not anticipate any material impact of adopting these Staff Positions.

3. STOCK-BASED COMPENSATION

The Company accounts for stock-based compensation in accordance with the provisions of SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123(R)"), which requires that the costs resulting from all share-based payment transactions be recognized in the financial statements at their fair values.  Accordingly, stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized as an expense over the requisite service period. All of the Company’s stock compensation is accounted for as an equity instrument.

Stock Option Plans

In August 2003, October 2004 and October 2007 the Company’s board of directors and stockholders adopted the 2003 Stock Option Plan, the 2004 Stock Option Plan and the 2007 Equity Incentive Plan, respectively.  The aggregate number of shares authorized for issuance under the 2003 Stock Option Plan and the 2004 Stock Option Plan (together, the “Prior Plans”) was 2,500,000 and, 5,000,000, respectively.  The 2007 Equity Incentive Plan (the “Plan”) consolidated and replaced the Prior Plans.

Subject to adjustment upon certain changes in capitalization, the aggregate number of shares of common stock of the Company that may be issued pursuant to stock awards under the Plan shall not exceed 5,000,000 shares of Common Stock, plus an additional number of shares in an amount not to exceed 7,389,520 comprised of: (i) that number of shares subject to the Prior Plans on the date the Plan was adopted by the Board and available for future grants plus (ii) the number of shares subject to currently outstanding stock awards issued under the Prior Plans that return to the share reserve from time to time after the date the Plan was adopted by the Board. The following description of the Plan is a summary and qualified in its entirety by the text of the Plan. The purpose of the Plan is to enhance the Company’s profitability and stockholder value by enabling the Company to offer stock-based incentives to employees, directors and consultants. The Plan authorizes the grant of incentive stock options, nonstatutory stock options, restricted stock awards, restricted stock unit awards, stock appreciation rights, performance stock awards, performance cash awards, and other stock-based award to employees, directors and consultants. Under the Plan, the Company may grant incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986 and non-qualified stock options. Incentive stock options may only be granted to the Company’s employees.

8

As of March 31, 2009, 3,772,762 shares were available for future grants under the Plan. The options under the Plan and Prior Plans vest over varying lengths of time pursuant to various option agreements that the Company has entered into with the grantees of such options. The Plan is administered by the board of directors. Subject to the provisions of the Plan, the board of directors has authority to determine the employees, directors and consultants who are to be awarded stock awards and the terms of such awards, including the number of shares subject to such awards, the fair market value of the common stock subject to options, the exercise price per share and other terms.

Incentive stock options must have an exercise price equal to at least 100% of the fair market value of a share on the date of the award and generally cannot have duration of more than 10 years.  If the grant is to a stockholder holding more than 10% of the Company’s voting stock, the exercise price must be at least 110% of the fair market value on the date of grant. Terms and conditions of awards are set forth in written agreements between us and the respective option holders.  Awards under the Plan may not be made after the tenth anniversary of the date of the Company’s adoption but awards granted before that date may extend beyond that date.

Optionees have no rights as stockholders with respect to shares subject to option prior to the issuance of shares pursuant to the exercise thereof.  An option becomes exercisable at such time and for such amounts as determined by the board of directors.  An optionee may exercise a part of the option from the date that part first becomes exercisable until the option expires.  The purchase price for shares to be issued to an employee upon his exercise of an option is determined by the board of directors on the date the option is granted.  The Plan provides for adjustment as to the number and kinds of shares covered by the outstanding options and the option price therefore to give effect to any stock dividend, stock split, stock combination or other reorganization.

The fair value of each option grant is estimated on the date of grant while the expense is recognized over the requisite service period using the straight-line attribution approach. The fair value of each option award was estimated using the Black-Scholes option-pricing model using the assumptions provided in the table below.

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 Black-Scholes model requires a single expected dividend yield as an input. The Company does not anticipate paying any dividends in the near future and has never paid cash dividends.

The following assumptions were used in determining the fair value of stock based awards granted during the three months ended March 31, 2009 and 2008:

	Three months ended March 31,
	2009	2008
Risk free interest rate	1.68%	2.44%
Expected life of option	4.44 years	4.08 years
Dividend yield	0%	0%
Volatility	98.9%	99.%

The Company recorded $322,428 and $435,132 of stock compensation expense for the three months ended March 31, 2009 and 2008, respectively. The amounts of share-based compensation expense are classified in the consolidated statements of operations as follows:

	Three months ended March 31,
	2009		2008
Cost of goods sold	$	18,059	$	6,396
Research and development		5,991		68,853
Selling, general and administrative		298,378		359,883
Total stock-based compensation expenses after income taxes	$	322,428	$	435,132

9

No stock-based compensation has been capitalized in inventory due to the immateriality of such amounts.

General Share-Based Award Information

The following table summarizes the Company’s stock option activity for the three months ended March 31, 2009:

	Shares Available For Grant			Number of Options Outstanding			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)		Aggregate Intrinsic Value
Balance at December 31, 2008		3,558,447			7,988,274		$	1.25
Authorized		-			-			-
Granted		(606,521	)		606,521		$	0.87
Exercised		-			-			-
Cancelled		820,836			(820,836	)	$	1.49
Balance at March 31, 2009		3,772,762			7,773,959		$	1.20	8.18			$	107,683
Options vested and expected to vest at  March 31, 2009					7,198,380		$	1.19		8.11		$	105,351
Options vested and exercisable					3,767,995		$	1.11		7.34		$	92,133

946,401 options vested during the first quarter of 2009.   The weighted average grant date fair value of options granted during the three months ended March 31, 2009 was $0.87.

As of March 31, 2009, the total compensation cost related to non-vested stock option awards not yet recognized was $3,739,561, net of estimated forfeitures.  Total compensation cost will be recognized over an estimated weighted average amortization period of 2.99 years.  The Company has not capitalized any compensation cost, or modified any of its stock option grants during the three months ended March 31, 2009.  During the three months ended March 31, 2009, no options were exercised and no cash was used to settle equity instruments granted under the Plans.

The Company’s closing stock price on the last trading day of the three months which ended March 31, 2009 was $0.63 per share.  The intrinsic value of stock options outstanding as of March 31, 2009 was $107,683.

4. NET LOSS PER SHARE

Basic earnings per share ("EPS") is computed by dividing net loss by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur from common shares issuable through stock options, warrants and other convertible securities, if dilutive. The following table is a reconciliation of the numerator (net loss) and the denominator (number of shares) used in the basic and diluted EPS calculations and sets forth potential shares of common stock that are not included in the diluted net loss per share calculation as their effect is antidilutive: 

	Three Months Ended March 31,
	2009			2008
Numerator - basic and diluted	$	(2,334,053	)	$	(3,483,937	)
Denominator - basic and diluted
Weighted average common shares outstanding		84,498,491			76,118,175
Total		84,498,491			76,118,175
Net loss per share - basic and diluted	$	(0.03	)	$	(0.05	)
Antidilutive securities:
Options outstanding		7,773,959			8,871,908
Warrants		4,302,414			7,729,534
Total		12,076,373			16,601,442

Dilutive Effect of Employee Stock Options

Basic shares outstanding for the three months ended March 31, 2009 and 2008 were 7,773,959 shares and 8,871,908 shares, respectively.  No incremental shares were included in the calculation of diluted net income per share for the periods as to do so would be antidilutive. SFAS No. 128, “Earnings per Share,” requires that employee equity share options, nonvested shares and similar equity instruments granted by the Company be treated as potential common shares in computing diluted earnings per share. Diluted shares outstanding include the dilutive effect ofin-the-money options which is calculated based on the average share price for each fiscal period using the treasury stock method. There was no dilutive effect of in-the-money employee stock options as of March 31, 2009 and 2008 due to the Company incurring a net loss for the three months ended March 31, 2009 and 2008, respectively.

10

 5.           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, 2009 and December 31, 2008 consisted of the following:

	March 31, 2009			December 31, 2008
Finished goods	$	3,190,865		$	3,247,586
Work in process		--			74,892
Raw materials		--			221,755
Reserve for obsolescence		(148,431	)		(98,431	)
Inventories, net	$	3,042,434		$	3,445,802

In 2009, the Company obtains inventory in a form that requires minimal modification by the Company, thus it no longer has raw materials or work-in-process.

 6.           PROPERTY AND EQUIPMENT

Property and equipment at March 31, 2009 and December 31, 2008 consisted of the following:

	March 31, 2009			December 31, 2008
Machinery and equipment	$	1,283,880		$	1,281,806
Office furniture and equipment		151,174			155,348
Computer equipment		273,801			275,123
Software		6,853,705			6,853,705
Auto		--			62,194
Accumulated depreciation		(6,711,251	)		(6,055,131	)
Property and equipment, net	$	1,851,309		$	2,573,045

Depreciation and amortization expense was $1,044,059 and $985,543 for the three months ended March 31, 2009 and 2008, respectively. The Company’s property and equipment have depreciable lives of between two and five years.

7. ACCRUED LIABILITIES

Accrued liabilities at March 31, 2009 and December 31, 2008 consisted of the following: 

	March 31, 2009		December 31, 2008
Payroll and related	$	557,406	$	770,655
Audit and legal services		171,483		253,580
Sales, VAT, income tax		1,526		78,599
Sales commissions		559,250		547,867
Warranty		146,019		129,763
Other		85,017		60,978
Total	$	1,520,701	$	1,841,442

 Warranty Reserve

The Company warrants its products for a specific period of time, generally twelve months, against material defects. 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.  

11

Changes in the warranty reserve during the three months ended March 31, 2009 and 2008 were as follows:

	Three Months Ended March 31,
	2009		2008
Beginning balance	$	129,763	$	64,868
Provision for current period sales		16,256		5,103
Ending balance	$	146,019	$	69,971

8. CONCENTRATION OF CREDIT RISK

The financial instruments utilized by the Company that potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents. Cash and cash equivalents are deposited in demand and money market accounts in major financial institutions in the United States, Sweden and Australia. These financial institutions are considered creditworthy and the Company has not experienced any material losses on its deposits of cash and cash equivalents. Additionally, the Company has established guidelines to limit its exposure to credit risk by placing its deposits with high credit quality financial institutions and placing investments with maturities that maintain safety and liquidity within the Company's liquidity needs.

For the three months ended March 31, 2009, revenue from four customers accounted for 73% of revenue, with no other single customer accounting for more than 10% of revenue. For the three months ended March 31, 2008, revenue from one customer accounted for 22% of revenues, with no other single customer accounting for more than 10% of revenue. At March 31, 2009, accounts receivable from two customers accounted for 28% 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 March 31, 2009 and December 31, 2008, approximately 86% and 82%, respectively, of the Company’s total accounts receivable were due from customers outside the United States.

9. STOCKHOLDERS’ EQUITY

Warrants

A summary of warrant activity for the three months ended March 31, 2009 is as follows:

	Warrants
	Number of Shares		Weighted Average Purchase Price
Outstanding December 31, 2008		4,302,414	$	1.05
Issued		—		—
Exercised		—		—
Cancelled/expired		—		—
Outstanding March 31, 2009		4,302,414	$	1.05

The chart below illustrates the outstanding warrants as of March 31, 2009 by exercise price and the average contractual life before expiration.

Exercise Price		Number Outstanding		Weighted Average Remaining Contractual Life (Years)		Number Exercisable
$	0.01		151,268		0.47		151,268
	0.40		1,038,875		2.16		1,038,875
	0.49		165,000		0.68		165,000
	0.60		569,107		2.63		569,107
	0.75		50,000		0.50		50,000
	1.12		70,000		1.58		70,000
	1.40		360,000		0.59		360,000
	1.42		75,000		0.45		75,000
	1.50		1,380,000		2.92		1,380,000
	1.75		17,759		2.71		17,759
	1.78		100,000		1.20		--
	1.86		10,000		0.28		10,000
	2.00		239,988		3.04		239,988
	2.14		75,417		1.07		75,417
$	1.05		4,302,414		1.92		4,202,414

12

10.           INCOME TAXES

At both December 31, 2008 and 2007, the Company had $194,775 of unrecognized tax benefits respectively, none of which would affect the Company’s effective tax rate if recognized.

The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. As of March 31, 2009, the Company has 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 March 31, 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. The valuation allowance was calculated in accordance with the provisions of SFAS 109, “Accounting for Income Taxes,” which require that a valuation allowance be established or maintained when it is “more likely than not” that all or a portion of deferred tax assets will not be realized. The Company will continue to reserve for substantially all net deferred tax assets until there is sufficient evidence to warrant reversal.

11. COMMITMENTS AND CONTINGENCIES

Legal

The Company is periodically involved in legal actions and claims that arise as a result of events that occur in the normal course of operations. The Company 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; Netintact PTY offices in Melbourne, Australia.

Capital Leases

The Company retired substantially all of its capital leases during the three months ended March 31, 2009.   

As of March 31, 2009, future minimum lease payments are as follows:

	Operating Leases
Nine months ending December 31, 2009	$	286,304
Years ending December 31,
2010		370,855
2011		333,648
2012		113,846
2013		9,487
Total minimum lease payments	$	1,114,140

13

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. Under the terms of the Secured Line of Credit, the Company will pay Peninsula Bank $30,000 as a fee during the term of the line of credit agreement. 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 March 31, 2009, the Company was limited in its borrowing to up to $1,000,000 until several financial reporting and insurance requirements were met.  At March 31, 2009 there was no debt outstanding under the Secured Line of Credit.

Notes Payable

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 (the “Notes”). The Notes bear interest at a rate of 10% per annum, which interest is due and payable each calendar quarter.  A $250,000 payment was made in February 2009. Of the remaining $300,000 balance outstanding $150,000 is due in April 2009 and $150,000 due in August 2009.  As of March 31, 2009, accounts payable included $7,479 of interest payable related to the Notes.

12. 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 was 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 March 31,
	2009		2008
Sales
United States	$	496,550	$	632,362
Australia		65,108		229,781
Asia		1,372,203		439,258
Europe		396,837		40,667
Scandinavia		616,636		373,706
Total	$	2,947,334	$	1,715,774

The Company’s accounts receivable were derived from sales made to customers located in the United States, Australia, Europe, Asia, Canada and the Middle East.  Sales made to customers located outside the United States as a percentage of total sales were 83% and 73% for the three months ended March 31, 2009, and 2008, respectively. The Company performs ongoing credit evaluations of the financial condition of certain customers and, generally, requires no collateral from its customers.

	Period Ended March 31,
	March 31, 2009		December 31, 2008
Long-lived assets
United States	$	1,632,525	$	1,725,733
Sweden		1,759,967		2,747,667
Australia		70,959		71,553
Total	$	3,463,451	$	4,544,953

13.           FINANCIAL INSTRUMENTS

On January 1, 2008, the Company adopted SFAS No. 157 “Fair Value Measurements,” (“SFAS 157”), for all financial assets and financial liabilities. SFAS 157 defines fair value, establishes a framework for measuring fair value, and enhances fair value measurement disclosure. The adoption of SFAS 157 did not have a significant impact on the condensed consolidated financial statements, and the resulting fair values calculated under SFAS 157 after adoption were not significantly different than the fair values that would have been calculated under previous guidance. The Company did not elect to adopt SFAS 157 for acquired non-financial assets and assumed non-financial liabilities. On January 1, 2008, the Company also adopted SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115,” (SFAS 159). SFAS 159 permits companies to choose to measure certain financial instruments and other items at fair value using an instrument-by-instrument election. The standard requires that unrealized gains and losses are reported in earnings for items measured using the fair value option. SFAS 159 also requires cash flows from purchases, sales, and maturities of trading securities to be classified based on the nature and purpose for which the securities were acquired. As the Company did not elect to fair value any of the Company’s current financial instruments under the provisions of SFAS 159, the adoption of this statement did not have an impact on the Company’s financial statements.

14

SFAS 157 establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. There are three levels of inputs to fair value measurements: Level 1, the use of quoted prices for identical instruments in active markets; Level 2, the use of quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active or are directly or indirectly observable or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities; and Level 3, the use of unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities.

The Company’s financial assets at March 31, 2009 and December 31, 2008 consisted of cash and cash equivalents only.

14. LIQUIDITY

The Company has sustained recurring losses and negative cash flows from operations.  Historically, the Company’s growth has been funded through a combination of private equity, notes and lease financing. As of March 31, 2009, the Company had approximately $861,000 of unrestricted cash, $4,059,798 of working capital, and $54.0 million in accumulated deficit. As fully explained in Note 11 above, the Company obtained a $3.0 million Secured Line of Credit from the Peninsula Bank in March 2009.  Subsequent to March 31, 2009, management took several additional actions designed to ensure that the Company will continue as a going concern through March 31, 2010, including headcount reductions and additional reductions in discretionary expenditures. In May 2009, the Company executed an agreement with a group of private investors whereby the Company received approximately $4.0 million by selling shares of its common stock.  The Company believes that, as a result of these actions, it currently has sufficient cash and financing commitments to meet its funding requirements over the next year. However, the Company has experienced and continues to experience negative operating margins and negative cash flows from operations, as well as an ongoing requirement for additional capital investment. The Company expects that it will need to raise substantial additional capital to accomplish all of its business objectives over the next several years. In addition, the Company may wish to selectively pursue possible acquisitions of businesses, technologies, content, or products complementary to those of the Company in the future in order to expand its presence in the marketplace and achieve operating efficiencies. There can be no assurance as to the availability or terms upon which such financing and capital might be available.

15. SUBSEQUENT EVENTS

Change of CFO

On April 7, 2009, the Company’s then serving interim CFO announced his resignation from the positions of interim Chief Financial Officer and Principal Accounting Officer effective April 8, 2009. The Board of Directors appointed the Company’s current CEO to the additional role of Chief Financial Officer on an interim basis.

On April 27, 2009, the board of directors appointed a new Chief Financial Officer, effective May 11, 2009, replacing the Company’s Chief Executive Officer, who had served as Chief Financial Officer on an interim basis.  The Company’s Chief Executive Officer remains the Company’s President and Chief Executive Officer.

Outsourced Operations

On April 13, 2009, the Company entered into an agreement with Continuous Computing Corporation of San Diego, California, to substantially outsource the Company’s operations and logistics functions, formerly handled at the Company’s Los Gatos, California, facility, to Continuous Computing.  Continuous Computing is a leading hardware supplier to the telecom industry and, since 2008, has provided the hardware for the Company’s new PL10000 product line.  Continuous Computing provides customers with turnkey operations, logistics and quality assurance support from facilities in China and San Diego.  Under the terms of the agreement, Continuous Computing will receive an up-front payment from the Company and will be compensated by the Company based on an hourly rate and/or fixed fee to load the Company’s software into servers and other hardware devices, perform testing and inspection services and ship directly to the Company’s customers.

As a result of the Company outsourcing its operations and logistics functions to Continuous Computing, the Company reduced headcount in its Los Gatos, California, and Varberg, Sweden, offices, resulting in approximately a 25% overall reduction in the Company’s workforce effective April 20,2009.  The Company does not expect to incur material costs in connection with the work force reduction.

15

Subscription, Note Purchase Agreements and Promissory Notes

On May 4, 2009, the Company entered into subscription agreements and note purchase agreements with certain institutional and accredited investors related to a private placement of the Company’s common stock, convertible promissory notes and nonconvertible promissory notes.  The private placement included the sale of an aggregate of 4,587,000 shares of the Company’s 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.  Such notes are subject to a 10% per annum interest rate and will automatically be converted into shares of restricted common stock at a per-share conversion price of $0.40 on the day that the Company completes the sale of the restricted common stock.  The Company estimates that 4,700,000 shares of common stock will be issued pursuant to the convertible notes. 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 all unpaid accrued interest on April 30, 2010.

Pending approval of the listing of additional shares by the NYSE Amex Equities, the Company expects to complete the sale of the restricted common stock and the conversion of the convertible promissory notes by approximately May 29, 2009.  The Company expects to realize net proceeds of approximately $4.0 million after deducting fees payable to the placement agents and other transaction expenses payable by the Company in the private placement.  The Company agreed to pay certain placement agents fees amounting to $192,510 and to issue such placement agents warrants exercisable for an aggregate of approximately 208,875 shares at an exercise price of $0.40 per share in connection with the private placement.

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. 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, integration of acquired businesses, revenues from existing and new products and sales channels, and cash flows, including but not limited to those statements set forth below in this Item 2; and

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

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

16

We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. Also note that we provide the following cautionary discussion of risks and uncertainties related to our businesses. These are factors that we believe, individually or in the aggregate, could cause our actual results to differ materially from expected and historical results. We note these factors for investors as permitted by Section 21E of the Securities Exchange Act of 1934. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties.

Our forward-looking statements are subject to a variety of factors that could cause actual results to differ significantly from current beliefs and expectations, 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 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 solution, PacketLogic, offers users the ability to monitor network use on an application and user-specific basis in real-time, and offers real improvements over existing deep packet inspection, or DPI, solutions. This capability allows network administrators to maximize 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 serious competition from suppliers of standalone DPI products such as Allot Communications, Sandvine, Arbor/Ellacoya and BlueCoat (acquirer of Packeteer). The Company also faces competition from vendors supplying platform products with some limited DPI functionality, such as switch/routers, routers, session border controllers and VoIP switches. In addition, the Company faces competition from vendors that integrate an advertised "full" DPI solution into their products such as Cisco Systems, Juniper, Ericsson and Foundry (recently acquired by Brocade Communications Systems).

Most of the Company’s competitors are larger, more established and have 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 this 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 an entrenched dominant supplier in its market. Based on the Company’s belief in the superiority of its technology, the Company sees an opportunity for it 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 dramatically.  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 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 for the year ended December 31, 2008 filed with the SEC on March 16, 2009.

17

Management believes that there have been no significant changes during the three months ended March 31, 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. These critical accounting policies and related disclosures appear in our Annual Report on Form 10-K for the year ended December 31, 2008:

· Revenue recognition;

· Stock-based compensation expense;

· Valuation of Long-Lived and Intangible Assets and Goodwill

· Allowance for Doubtful Account;

· Stock-Based Compensation; and

· Accounting for Income Taxes.

Results of Operations

Comparison of Three Months ended March 31, 2009 and March 31, 2008

Revenue

	Three Months Ended March 31,				Variance			Variance
	2009		2008		In dollars			In Percent
	(dollar amounts in thousands)
Net product revenue	$	2,171	$	1,334	$	837			63	%
Net support revenue		776		382		394			103
Total revenue	$	2,947	$	1,716	$	1,231			72	%
	Three Months Ended March 31,				Variance			Variance
	2009		2008		In dollars			In Percent
	(dollar amounts in thousands)
Americas	$	497	$	633	$	(136	)		(21	) %
EMEA (Europe, Middle East and Africa)		1,013		414		599			186
APAC (Asia-Pacific)		1,437		669		768			145
Total	$	2,947	$	1,716	$	1,231			72	%

Our revenue was derived from two sources: product revenue which includes sales of our hardware appliances and bundled software licenses and service revenue, which included revenue from PCS and services. Product revenue accounted for 74% and 78% of our net revenue in the three months ended March 31, 2009 and 2008, respectively.  Product revenue increased in the three months ended March 31, 2009 as a result of the increasing volume of sales from our new product line, the PL10000.  The first shipments of this product line were made in the second quarter of 2008.  Therefore, there was no revenue attributable to these products during the comparable quarter of last fiscal year.   

Service revenue was primarily derived from PCS or maintenance and, to a lesser extent, training.  Service revenue was recognized ratably over the service period. The typical support term is twelve months. Service revenue increased in the three months ended March 31, 2009 and 2008 as a result of the continued expansion of our customer base.

Based on our current sales growth and recent new product introductions such as the PL10000, we believe that our revenue will continue to grow throughout 2009 as compared with 2008.

Cost of Sales

Cost of goods sold included: (i) direct material costs for products sold and direct labor and manufacturing overhead, (ii) costs expected to be incurred for warranty, and (iii) adjustments to inventory values, including reserves for slow moving, inactive inventory, engineering changes and adjustments to reflect the Company’s policy of valuing inventory at lower of cost or market on a first-in, first-out basis.  The following tables present the breakdown of cost of sales by entity and cost of sales by category.

18

By Region

	Three Months Ended March31,
	Amount
					Variance in		Variance in
	2009		2008		Dollars		Percent
	(dollar amounts in thousands)
Americas	$	1,075	$	928	$	147		16	%
EMEA		191		96		95		99
APAC		522		207		315		152
Total	$	1,788	$	1,231	$	557		45	%

By Category

	Three Months Ended March 31,
	Amount
							Variance in			Variance in
	2009			2008			Dollars			Percent
	(dollar amounts in thousands)
Materials	$	1,040		$	390		$	650			167	%
Percent of net product revenue		48	%		29	%
Applied labor and overhead		128			174			(46	)		(26	)%
Percent of net product revenue		6	%		13	%
Other indirect costs		119			143			(24	)		(17	) %
Percent of net product revenue		5	%		11	%
Product Costs		1,287			707			580			82	%
Percent of net product revenue		59	%		53	%
Support costs		119			142			(23	)		(16	)%
Percent of net support revenue		15	%		37	%
Amortization of Acquired Assets		382			382			0			0	%
Percent of net total revenue		13	%		22	%
Total cost of goods sold		1,788			1,231			557			45	%
Percent of net total revenue		61	%		72	%

Total cost of goods sold increased during the three months ended March 31, 2009 by $557,000 as compared to the same period in 2008 and decreased as a percentage of total revenue to 61% from 72%.  Total cost of product revenue increased by $580,000 during the three months ended March 31, 2009 compared to the same period in 2008.  The increase in product costs resulted from the growth of sales of our PL10000 product line where hardware makes up a larger portion of each sale. 

Gross Profit or Loss and Margins

The following table represents gross margin by entity:

	Three Months Ended March 31,						Variance			Variance
	2009			2008			In dollars			In Percent
	(dollar amounts in thousands)
Americas	$	(197	)	$	87		$	(284	)		(326	)%
EMEA		822			318			504			158
APAC		916			462			454			98
Amortization of Acquired Assets		(382	)		(382	)		0			0
Total	$	1,159		$	485		$	674			139	%
Percent of net product sales

Gross profit for the three months ended March 31, 2009 increased by $674,000 over the same period in 2008, primarily due to increased sales volume associated with the PacketLogic family of products.  

19

Operating Expense

	Three Months Ended March 31,					Variance			Variance
		2009		2008		In dollars			In Percent
	(dollar amounts in thousands)
Research and development		$	636	$	662	$	(26	)		(4)	%
Sales and marketing			1,685		2,024		(340	)		(17	)
General and administrative			1,329		1,525		(195	)		(13	)
Total		$	3,650	$	4,211	$	(561	)		(13	)%

 Research and Development

Research and development 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 March 31,
	2009			2008			(Increase) Decrease
	(in thousands, except percentages)
Research and development	$	636		$	662		$	(26
Percentage of net revenue		22	%		39	%

            Research and development expenses for the three months ended March 31, 2009 decreased by $26,000 when compared to the same period in 2008 as a result of decreased use certification services.

Sales and Marketing

    Sales and marketing expenses primarily included personnel costs, sales commissions, and marketing expenses such as trade shows, channel development and literature.

	Three Months Ended March 31,
	2009			2008			(Increase) Decrease
	(in thousands, except percentages)
Sales and marketing	$	1,685		$	2,024		$	(340	)
Percentage of net revenue		57	%		118	%

Sales and marketing expenses for the three months ended March 31, 2009 decreased by $340,000 compared to the same period in 2008.  Sales and marketing expenses decreased due to decreased use of consultants and reductions in other discretionary spending.  Non cash items included in the three months ended March 31, 2009 were stock based compensation expense of $84,000, a $104,000 decrease from the same period 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 March 31,
	2009			2008			(Increase)  Decrease
	(in thousands, except percentages)
General and administrative	$	1,329		$	1,525		$	(196	)
Percentage of net revenue		45	%		89	%

General and administrative expenses for the three months ended March 31, 2009 decreased by $196,000 when compared to the same period in 2008.  Decreases in general and administrative expenses included a decrease of $138,000 in recruiting expenses and $83,000 in legal expenses.  

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.  The tax benefit results primarily from the amortization of a purchase accounting adjustment. The Company has established a valuation allowance for substantially all of its deferred tax assets. The valuation allowance was calculated in accordance with the provisions of SFAS No. 109, which require that a valuation allowance be established or maintained when it is “more likely than not” that all or a portion of deferred tax assets will not be realized. The Company will continue to reserve for substantially all net deferred tax assets until there is sufficient evidence to warrant reversal.

20

Liquidity and Capital Resources

Cash and Cash Equivalents and Investments

The following table summarizes our cash and cash equivalents and investments, which were classified as “available for sale” and consisted of highly liquid financial instruments:

	Three Months Ended March 31,
	2009		2008		Increase (Decrease)
	(in thousands, except percentages)
Cash and cash equivalents	$	861	$	3,325	$	(2,464	)	(74	)%

The cash and cash equivalents balance decreased during the quarter ending March 31, 2009 and 2008 by $860,000 and $2.5 million, respectively, as follows:

	Three Months Ended March 31,
	2009			2008
	(in thousands, except percentages)
Net cash used in by operating activities	$	(578	)	$	(2,775	)
Net cash used in investing activities		(36	)		(17	)
Net cash (used in) provided by financing activities		(251	)		193
Effect of exchange rate changes on cash and cash equivalents		5			59
Net  decrease in cash and cash equivalents	$	(860	)	$	(2,540	)

During the three months ended March 31, 2009, we used $578,000 of cash in operating activities, which was $2.2 million less than the $2.8 million use of cash in operating activities in same period in 2008. This reduction in the use of cash in operating activities resulted from higher comparative sales and gross profits and reduced operating expenses from cost reduction efforts; as well as cash provided by inventories.  During the three months ended March 31, 2009, the primary use of cash in operating activities was our $2.3 million net loss and $302,000 in decreased accruals offset by cash provided by a $353,000 reduction in inventories and a $179,000 increase in deferred revenue.    Net cash used in financing activities during the first quarter of 2009 included a loan repayment of $250,000.

During the three months ended March 31, 2008, we used $2.8 million of cash in operating activities.  The primary use of cash in operating activities was our $3.5 million net loss, $271,000 increase in inventories, and $331,000 decrease in accounts payable and accruals.    Net cash provided by financing activities during the first quarter of 2008 reflected $203,000 from the exercise of stock options.

Based on our current cash balances, anticipated cash flow from operations and access to the secured line of credit and subscription agreements, 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 of Credit Agreement 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. Under the terms of the Secured Line, we will pay Peninsula Bank $30,000 as a fee during the term of the line of credit agreement. 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 March 31, 2009, we were limited in our borrowing of up to $1,000,000 until several financial reporting and insurance requirements were met.  At March 31, 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 4,587,000 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.  Such notes are subject to a 10% per annum interest rate and will automatically be converted into shares of restricted common stock at a per-share conversion price of $0.40 on the day that we completes the sale of the restricted common stock.  We estimate that 4,700,000 shares of common stock will be issued pursuant to the convertible notes.  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 all unpaid accrued interest on April 30, 2010.

21

Pending approval of the listing of additional shares by the NYSE Amex Equities, we expect to complete the sale of the restricted common stock and the conversion of the convertible promissory notes by approximately May 29, 2009.  We expect to realize net proceeds of approximately $4.0 million after deducting fees payable to the placement agents and other transaction expenses payable in the private placement.  We agreed to pay certain placement agents fees amounting to $192,510 and to issue such placement agents warrants exercisable for an aggregate of approximately 208,875 shares at an exercise price of $0.40 per share in connection with the private placement.

Off Balance Sheet Arrangements

As of March 31, 2009, we had no off-balance sheet items as described by Item 303(c)(a)(4) of Securities and Exchange Commission Regulation S-K.  We have not entered into any transactions with unconsolidated entities whereby we have financial guarantees, subordinated retained interests, derivative instruments, or other contingent arrangements that expose us to material continuing risks, contingent liabilities, or any other obligations under a variable interest in an unconsolidated entity that provides us with financing, liquidity, market risk, or credit risk support.

Contractual Obligations

 We retired substantially all of our capital leases during the three months ended March 31, 2009. We lease facility space under non-cancelable operating leased in California, Sweden and Australia that extend through 2013.

The details of these contractual obligations are further explained in note 11 to interim condensed consolidated financial statements.

Deferred Revenue

The following table represents our deferred revenue for the periods ended March 31, 2009 and December 31, 2008.

	March 31, 2009		December 31, 2008		Increase
Deferred revenue	$	1,492,106	$	1,313,092	$	179,014

Product sales included PCS and hardware support services that are deferred until earned. The contract period typically is 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 until acceptance history has been established.  The increase in deferred revenue during the three months ended March 31, 2009 reflects an increased base of customers and related support contract renewals on historical sales as well as one-time service sales.

Material Commitments of Capital

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 on their behalf based on a rolling production forecast 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 March 31, 2009, we had no open non-cancelable purchase orders with our third-party manufacturers.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

Foreign Currency Risk

Our sales contracts are denominated predominantly in United States dollars, Swedish kroner, Australian dollars and the EURO.  We incur operating expenses in United States dollars, Swedish kroner and Australian dollars.  Therefore, we are subject to volatility in cash flows due to fluctuations in foreign currency exchange rates, particularly changes in the aforementioned currencies. To date, we have not entered into any hedging contracts and exchange rate fluctuations have had minimal impact on our operating results and cash flows.

Interest Rate Sensitivity

We had unrestricted cash and cash equivalents totaling approximately $861,000 at March 31, 2009. The unrestricted cash and cash equivalents are held for working capital purposes. We do not enter into investments for trading or speculative purposes. Cash and cash equivalents include highly liquid investments with a maturity of ninety days or less at the time of purchase. Cash equivalents consist primarily of money market securities. Due to the high investment quality and short duration of these investments, 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. Declines in interest rates, however, will reduce future investment income. A one percentage point change in interest rate would be immaterial to us. 

22

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

Our principal executive officer and principal accounting officer reviewed and evaluated our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). Based on that evaluation, our principal executive officer and principal accounting officer concluded that our disclosure controls and procedures were effective as of March 31, 2009 to ensure the information required to be disclosed by us in this Quarterly Report on Form 10-Q is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our first quarter ended March 31, 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 in the ordinary course of business. We will also, from time to time, when appropriate in management’s estimation, record adequate reserves in our financial statements for pending litigation. Currently, there are no pending material legal proceedings to which we 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 2008 Annual Report on Form 10-K 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 losses for the foreseeable future.*

For the three months ended March 31, 2009 and the year ended December 31, 2008 we had losses from operations of approximately $2.3 million and $15.0 million, respectively. We expect to continue to incur losses from operations for the foreseeable future. These losses will result primarily from costs related to investment in sales and marketing, product development and administrative expenses. 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 believes is available, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures through the end of 2010.

23

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 and credit market crisis have created a significantly more difficult environment for obtaining 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 and/or lay-off employees. Such inability to raise additional financing could have a material adverse effect on our business, results of operations and financial condition.

Our PacketLogic family of products is currently our only suite of products. All of our current revenues and a significant portion of our future growth depend on our ability to continue its commercialization.

All of our current revenues and 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 recently introduced our PL10000 product line. 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.

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 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.

24

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 plan to expand in all areas and will require experienced personnel to augment our current staff. We expect to recruit experienced professionals in such areas as software and hardware development, sales, technical support, product marketing and management. We currently plan to expand our indirect channel partner program and we need to attract qualified business partners to broaden these sales channels. Economic conditions may result in significant competition for qualified personnel and we may not be able to attract and retain such personnel. Our business will suffer if it encounters delays in hiring these additional personnel.

Our performance is substantially dependent on the continued services and on the performance of our executive officers and other key employees, including our CEO, James Brear, and our CTO, Alexander Haväng. 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 a California employee leaves the Company, he or she will generally be able to immediately compete against us.

In April 2009, our then serving interim CFO resigned and our Board of Directors appointed our current CEO to the additional role of Chief Financial Officer, on an interim basis. In April 2009, our board of directors appointed a new Chief Financial Officer, effective May 11, 2009.

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, we as a result of outsourcing our operations and logistics functions, we reduced headcount in our Los Gatos, California and Varberg, Sweden offices, resulting in approximately a 25% overall reduction in 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.

25

We cannot assure you that we will be able to integrate our employees into the company or to educate current and future employees in regard to rapidly evolving technologies and our product families. Failure to do so may hurt our revenue growth and operating results.

Increased customer demands on our technical support services may adversely affect our relationships with our customers and our financial results.

We offer technical support services with our products. We may be unable to respond quickly enough to accommodate short-term increases in customer demand for support services. We also may be unable to modify the format of our support services to compete with changes in support services provided by actual or potential competitors. Further customer demand for these services, without corresponding revenues, could increase costs and adversely affect our operating results. If we experience financial difficulties, do not maintain sufficiently skilled workers and resources to satisfy our contracts, or otherwise fail to perform at a sufficient level under these contracts, the level of support services to our customers may be significantly disrupted, which could materially harm our relationships with these customers and our results of operations.

We must continue to develop and increase the productivity of our indirect distribution channels to increase net revenue and improve our operating results.

A key focus of our distribution strategy is developing and increasing the productivity of our indirect distribution channels through resellers and distributors. If we fail to develop and cultivate relationships with significant resellers, or if these resellers are not able to execute on their sales efforts, sales of our products may decrease and our operating results could suffer. Many of our resellers also sell products from other vendors that compete with our products. We cannot assure you that we will be able to enter into additional reseller and/or distribution agreements or that we will be able to manage our product sales channels. Our failure to do any of these could limit our ability to grow or sustain revenue. In addition, our operating results will likely fluctuate significantly depending on the timing and amount of orders from our resellers. We cannot assure you that our resellers and/or distributors will continue to market or sell our products effectively or continue to devote the resources necessary to provide us with effective sales, marketing and technical support. Such failure would negatively affect revenue and our potential to achieve profitability.

We may be unable to compete effectively with other companies in our market sector which are substantially larger and more established and have greater resources.

We compete in a rapidly evolving and highly competitive sector of the networking technology market, 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/P-Cube, Allot, Arbor/Ellacoya, BlueCoat/Packeteer, Juniper, Ericsson, Brocade Communications Systems/Foundry Networks and Sandvine, as well as other companies which sell products incorporating competing technologies.  In addition, our products and technology compete for information technology budget allocations with products that offer monitoring capabilities, such as probes and related software.  Lastly, we face indirect competition from companies that offer 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.

Some 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.

26

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 recent economic downturn and volatile business environment and continued unpredictable and unstable market conditions. If the current equity and credit markets deteriorate further, or do not improve, it may make any necessary debt or equity financing more difficult, more costly, and more dilutive.  In addition, a prolonged or profound economic downturn may result in adverse changes to demand for our products, or 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 these difficult economic times, 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 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.

27

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 several months to establish an alternative relationship with a third party to provide these services, or even longer 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.  If our agreement with Continuous Computing terminates, we may be unable to find another suitable outsource manufacturer.

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.

If our products contain undetected software or hardware errors, we could incur significant unexpected expenses and lose sales.

Network products frequently contain undetected software or hardware errors, failures or bugs when new products or new versions or updates of existing products are first released to the marketplace. For example, we recently introduced our PL10000 product line. As with any new product introduction, previously unaddressed errors in our PL10000 product line's accuracy or reliability, or issues with its performance, may arise. We expect that such errors or component failures will be found from time to time in the future in new or existing products, including the components incorporated therein, after the commencement of commercial shipments. These problems may have a material adverse effect on our business by causing us to incur significant warranty and repair costs, diverting the attention of our engineering personnel from new product development efforts, delaying the recognition of revenue and causing significant customer relations problems. Further, if our products are not accepted by customers due to defects, and such returns exceed the amount we accrued for defect returns based on our historical experience, our operating results would be adversely affected.

28

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.

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 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. As such, when we recognize a large sale, particularly given our small size, we may report rapid revenue growth in the period that the revenue from the large sale, which may not be repeated in an immediately subsequent period. As such, our revenues could fluctuate dramatically from period to period, which could cause the price of our common stock to similarly fluctuate. In addition, even once we have received commitments from a customer to purchase our products, in accordance with our revenue recognition practices we may not be able to recognize and report the revenue from that purchase for months or years. As a result, there could be significant delays in our receipt and recognition of revenue following sales orders for our products.

In addition, if a competitor succeeds in convincing a large 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:

29

●  pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;

●  provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with Generally Accepted Accounting Principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and

●  provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

We described a material weakness with our internal controls under Item 9A of our Annual Report for the year ended December 31, 2007, as follows: we did not complete our annual report on Form 10-K and financial reports in sufficient time to allow for review and comment, which resulted in a significant number of last minute changes and could have resulted in material errors to the financial statements. We also identified significant deficiencies in our internal controls. For the year ended December 31, 2008 and the quarter ended March 31, 2009, we did not identify any material weaknesses.

Failure to address the identified weakness and significant deficiencies in a timely manner might increase the risk of future financial reporting misstatements and may prevent us from being able to meet our filing deadlines with the SEC. Under the supervision of our Audit Committee, we are continuing the process of identifying and implementing corrective actions where required to improve the design and effectiveness of our internal control over financial reporting, including the enhancement of systems and procedures. Significant additional resources will be required to establish and maintain appropriate controls and procedures and to prepare the required financial and other information. 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:

●  faulty human judgment and simple errors, omissions or mistakes;

●  collusion of two or more people;

●  inappropriate management override of procedures; and

●  the risk that enhanced controls and procedures may still not be adequate to assure timely and reliable financial information.

If we fail to have effective internal controls and procedures for financial reporting in place, we could be unable to provide timely and reliable financial information. Additionally, if we fail to have effective internal controls and procedures for financial reporting in place, it could adversely affect our financial reporting requirements under future government contracts.

Accounting charges may cause fluctuations in our annual and quarterly financial results 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:

●  amortization of intangible assets, including acquired product rights;

●  impairment of goodwill;

●  stock-based compensation expense; and

●  impairment of long-lived assets.

30

The foregoing types of accounting charges may also be incurred in connection with or as a result of business acquisitions. The price of our common stock could decline to the extent that our financial results are materially affected by the foregoing accounting charges. Our effective tax rate may increase, which could increase our income tax expense and reduce our net income. Our effective tax rate could be adversely affected by several factors, many of which are outside of our control, including:

●  changes in the relative proportions of revenues and income before taxes in the various jurisdictions in which we operate that have differing statutory tax rates;

●  changing tax laws, regulations and interpretations in multiple jurisdictions in which we operate, as well as the requirements of certain tax rulings;

● changes in accounting and tax treatment of stock-based compensation;

● the tax effects of purchase accounting for acquisitions and restructuring charges that may cause fluctuations between reporting periods; and

●  tax assessments, or any related tax interest or penalties, which could significantly affect our income tax expense for the period in which the settlements take place.

The price of our common stock could decline to the extent that our financial results are materially affected by the foregoing.

Our headquarters are located in Northern California where disasters may occur that could disrupt our operations and harm our business.

Our corporate headquarters are located in Silicon Valley in Northern California. Historically, this region has been vulnerable to natural disasters and other risks, such as earthquakes, which at times have disrupted the local economy and posed physical risks to us and our local suppliers. In addition, terrorist acts or acts of war targeted at the United States, and specifically Silicon Valley, could cause damage or disruption to us, our employees, facilities, partners, suppliers, distributors and resellers, and customers, which could have a material adverse effect on our operations and financial results. We currently have significant redundant capacity in Sweden in the event of a natural disaster or catastrophic event in Silicon Valley. In the event of such an occurrence, our business could nonetheless suffer. The operations in Sweden are subject to disruption by extreme winter weather.

Acquisitions may disrupt or otherwise have a negative impact on our business.

We may seek to acquire or make investments in complementary businesses, products, services or technologies on an opportunistic basis when we believe they will assist us in executing our business strategy. Growth through acquisitions has been a viable strategy used by other network control and management technology companies. In 2006, we completed 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:

●  integrating the operations and technologies of the two companies;

●  retaining and assimilating the key personnel of each company;

●  retaining existing customers of both companies and attracting additional customers;

●  leveraging our existing sales channels to sell new products into new markets;

●  developing an appropriate sales and marketing organization and sales channels to sell new products into new markets;

●  retaining strategic partners of each company and attracting new strategic partners; and

●  implementing and maintaining uniform standards, internal controls, processes, procedures, policies and information systems.

The process of integrating operations and technology could cause an interruption of, or loss of momentum in, our business and the loss of key personnel. The diversion of management's attention and any delays or difficulties encountered in connection with an acquisition and the integration of our operations and technology could have an adverse effect on our business, results of operations or financial condition. Furthermore, the execution of these post-transaction integration activities will involve considerable risks and may not come to pass as we envision. The inability to integrate the operations, technology and personnel of an acquired business with ours, or any significant delay in achieving integration, could have a material adverse effect on our business and, as a result, on the market price of our common stock.

31

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.

The market for bandwidth management solutions is in an early stage of development. We cannot accurately predict the future size of the market, the products needed to address the market, the optimal distribution strategy, or the competitive environment that will develop. In order for us to execute our strategy, our potential customers must recognize the value of more sophisticated bandwidth management solutions, decide to invest in the management of their networks and the performance of important business software applications and, in particular, adopt our bandwidth management solutions. The growth of the bandwidth management solutions market also depends upon a number of factors, including the availability of inexpensive bandwidth, especially in international markets, and the growth of wide area networks. The failure of the market to rapidly grow would adversely affect our sales and sales prospects, leading to sustained financial losses and a decline in the trading price of our common stock.

The market for our products in the network provider market is still emerging and our growth may be harmed if carriers do not adopt DPI solutions.

The market for DPI technology is still emerging and the majority of our sales to date have been to small and midsize 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.

32

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 technological innovations by our competitors;

● changes in financial estimates by securities analysts;

● conditions or trends in the network control and management industry;

● changes in the market valuations of other such industry related companies;

● the acceptance by institutional investors of our stock;

● rumors, announcements or press articles regarding our operations, management, organization, financial condition or financial statements;

● 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 will have the ability, without seeking stockholder approval, to issue additional shares of common stock and/or preferred stock in the future for such consideration as our Board of Directors may consider sufficient. The issuance of additional common stock and/or preferred stock in the future will reduce the proportionate ownership and voting power of our common stock held by existing stockholders. At March 31, 2009, there were 84,498,491 shares of common stock outstanding, outstanding warrants to purchase 4,302,414 shares of common stock, and outstanding stock options to purchase 7,773,959 shares of common stock. In addition, at March 31, 2009, we have an authorized reserve of 3,772,762 shares of common stock which we may grant as stock options or other equity awards pursuant to our stock option plans.

Additionally, 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 promissory notes.  The private placement included the sale of an aggregate of 4,587,000 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.  Such notes are subject to a 10% per annum interest rate and will automatically be converted into shares of restricted common stock at a per-share conversion price of $0.40 on the day that we complete 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 all unpaid accrued interest on April 30, 2010.  Pending approval of the listing of additional shares by the NYSE Amex Equities, we expect to complete the sale of the restricted common stock and the conversion of the convertible promissory notes by approximately May 29, 2009.  We expect to realize net proceeds of approximately $4.0 million after deducting fees payable to the placement agents and other transaction expenses payable by us in the private placement.  We agreed to pay certain placement agents fees amounting to $192,510 and to issue such placement agents warrants exercisable for an aggregate of approximately 208,875 shares at an exercise price of $0.40 per share in connection with the private placement.

33

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, you will experience dilution to your holdings. In addition, shares issuable upon exercise of our outstanding warrants and stock options may be immediately sold pursuant to an effective registration statement. If a warrant or option holder exercises a warrant or an option at an exercise price that is less than the 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.  One-third of the shares and shares issuable on exercise of warrants, or approximately 6,333,333 shares, were released from the lock-up on the first year anniversaries of the acquisitions, on August 18, 2007 and September 29, 2007. An additional third was released on the second anniversaries of the acquisitions, with 6,040,000 shares being released on August 18, 2008 and 293,334 shares being released on September 29, 2008. The balance of the shares will be released on the third year anniversaries of the acquisitions, with 6,040,000 shares being released on August 18, 2009 and 293,333 shares being released on September 29, 2009. Once released from lock-up, 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 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:

· a limited availability for market quotations for our securities;

· reduced liquidity with respect to our securities;

· a determination that our ordinary share is a “penny stock,” which will require brokers trading in our ordinary shares to adhere to more stringent rules and possibly result in a reduced level of trading activity in the secondary trading market for our ordinary shares;

· 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 $5,000,000 or less, the open-market trading of our common stock will be subject to the “penny stock” rules promulgated under the Securities Exchange Act of 1934. If our shares become subject to the “penny stock” rules, broker-dealers may find it difficult to effectuate customer transactions and trading activity in our securities may be adversely affected. Under these rules, broker-dealers who recommend such securities to persons other than institutional accredited investors must:

· make a special written suitability determination for the purchaser;

· receive the purchaser’s written agreement to the transaction prior to sale;

· provide the purchaser with risk disclosure documents which identify certain risks associated with investing in “penny stocks” and which describe the market for these “penny stocks” as well as a purchaser’s legal remedies; and

· obtain a signed and dated acknowledgment from the purchaser demonstrating that the purchaser has actually received the required risk disclosure document before a transaction in a “penny stock” can be completed.

34

As a result of these requirements, the market price of our securities may be depressed, and you may find it more difficult to sell our securities.

Nevada law and our articles of incorporation and bylaws contain provisions that may discourage, delay or prevent a change in our management team that our stockholders may consider favorable or otherwise have the potential to impact our stockholders’ ability to control our company.

Nevada law and our articles of incorporation and bylaws contain provisions that may have the effect of preserving our current management or may impact our stockholders’ ability to control our company, such as:

· authorizing the issuance of “blank check” preferred stock without any need for action by stockholders;

· eliminating the ability of stockholders to call special meetings of stockholders;

· restricting the ability of stockholders to take action by written consent; and

· establishing advance notice requirements for nominations for election to the Board of Directors or for proposing matters that can be acted on by stockholders at stockholder meetings.

These provisions could allow our Board of Directors to affect your rights as a stockholder since our Board of Directors can make it more difficult for common stockholders to replace members of the Board. Because our Board of Directors is responsible for appointing the members of our management team, these provisions could in turn affect any attempt to replace our current management team. In addition, the issuance of preferred stock could make it more difficult for a third party to acquire us and may impact the rights of common stockholders. All of the foregoing could adversely affect your rights as a stockholder of our company and/or prevailing market prices for our common stock.

To date, we have not paid any cash dividends and no cash dividends will be paid in the foreseeable future. We do not anticipate paying cash dividends on our common stock in the foreseeable future, and we cannot assure an investor that funds will be legally available to pay dividends, or that, even if the funds are legally available, the dividends will be paid.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3. Defaults Upon Senior Securities.

No.

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 form SB-2 filed on February 11, 2002 and incorporated herein by reference.*
3.2	Certificate of Amendment to Articles of Incorporation filed on October 12, 2005, filed as Exhibit 99.1 to our form 8-K filed on October 13, 2005 and incorporated herein by reference.*
3.3	Certificate of Amendment to Articles of Incorporation filed on April 28, 2008, filed as Exhibit 3.3 to our form 10-Q filed on May 12, 2008 and incorporated herein by reference.*
3.4	Amended and Restated Bylaws adopted on August 16, 2007, filed as Exhibit 3.4 to our form 10-Q filed on May 12, 2008 and incorporated herein by reference.*
10.1	Loan and Security Agreement by and between Procera Networks, Inc. and Peninsula Bank Business Funding, included as Exhibit 10.1 to our current report on Form 8-K filed on March 19, 2009 and incorporated herein by reference.*
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.

* Previously filed

35

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
Date: May 18, 2009		Charles Constanti, Chief Financial Officer
		(Principal Financial Officer)

36

Exhibit Index

3.1	Articles of Incorporation filed on July 16, 2001, filed as Exhibit 3.1 to our form SB-2 filed on February 11, 2002 and incorporated herein by reference.*
3.2	Certificate of Amendment to Articles of Incorporation filed on October 12, 2005, filed as Exhibit 99.1 to our form 8-K filed on October 13, 2005 and incorporated herein by reference.*
3.3	Certificate of Amendment to Articles of Incorporation filed on April 28, 2008, filed as Exhibit 3.3 to our form 10-Q filed on May 12, 2008 and incorporated herein by reference.*
3.4	Amended and Restated Bylaws adopted on August 16, 2007, filed as Exhibit 3.4 to our form 10-Q filed on May 12, 2008 and incorporated herein by reference.*
10.1	Loan and Security Agreement by and between Procera Networks, Inc. and Peninsula Bank Business Funding, included as Exhibit 10.1 to our current report on Form 8-K filed on March 19, 2009 and incorporated herein by reference.*
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.

* Previously filed

37