##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-Q
  þ
    
    Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006
 or
 o
    
    Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 for the transition period from  to .
  PACKETEER, INC.
  DELAWARE
(State of incorporation)
    
    77-0420107
(I.R.S. Employer Identification No.)
 
   þ o
  o þ o
  o þ




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##### 



PART I
    
    FINANCIAL INFORMATIONItem 1.
    
    Financial Statements:Unaudited Condensed Consolidated Balance Sheets as of March 31, 2006 and December 31, 2005
    
    
    3Unaudited Condensed Consolidated Income Statements for the Three Months Ended
March 31, 2006 and March 31, 2005
    
    
    4Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2006 and March 31, 2005
    
    
    5Notes to Unaudited Condensed Consolidated Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    16Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    24Item 4.
    
    Controls and Procedures
    
    
    24PART II
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    25Item 1A.
    
    Risk Factors
    
    
    25Item 6.
    
    Exhibits
    
    
    34Signatures
    
    
    34ExhibitsEXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
   2




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March 31,
    
    
    December 31,2006
    
    
    2005ASSETSCurrent assets:Cash and cash equivalents
    
    $
    36,672
    
    
    $
    36,221Short-term investments
    
    
    89,779
    
    
    
    81,228Accounts receivable, net of allowance for doubtful accounts
of $172 and $175, respectively
    
    
    17,183
    
    
    
    15,759Other receivables
    
    
    238
    
    
    
    207Inventories
    
    
    3,777
    
    
    
    4,979Prepaids and other current assets
    
    
    2,622
    
    
    
    2,148Total current assets
    
    
    150,271
    
    
    
    140,542Property and equipment, net of accumulated depreciation and
amortization of $8,205 and $7,663, respectively
    
    
    2,859
    
    
    
    2,681Long-term investments
    
    
    8,249
    
    
    
    5,228Goodwill
    
    
    9,527
    
    
    
    9,527Other intangible assets, net
    
    
    5,212
    
    
    
    5,606Other non-current assets
    
    
    5,048
    
    
    
    5,073Total assets
    
    $
    181,166
    
    
    $
    168,657LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    3,277
    
    
    $
    2,808Accrued compensation
    
    
    5,301
    
    
    
    6,551Other accrued liabilities
    
    
    5,341
    
    
    
    4,716Income tax payable
    
    
    4,252
    
    
    
    3,520Deferred revenue
    
    
    19,731
    
    
    
    18,986Total current liabilities
    
    
    37,902
    
    
    
    36,581Long-term liabilities:Deferred revenue, less current portion
    
    
    3,535
    
    
    
    3,129Deferred rent and other
    
    
    293
    
    
    
    340Total liabilities
    
    
    41,730
    
    
    
    40,050Stockholders equity:Preferred stock, $0.001 par value;
5,000 shares authorized; no shares issued and
outstanding as of March 31, 2006 and December 31,
2005
    
    
    
    
    
    
    Common stock, $0.001 par value;
85,000 shares authorized; 34,676 and 34,197 shares
issued and outstanding as of March 31, 2006 and
December 31, 2005, respectively
    
    
    35
    
    
    
    34Additional paid-in capital
    
    
    193,812
    
    
    
    188,046Deferred stock-based compensation
    
    
    
    
    
    
    (567
    )Accumulated other comprehensive loss
    
    
    (201
    )
    
    
    (182
    )Accumulated deficit
    
    
    (54,210
    )
    
    
    (58,724
    )Total stockholders equity
    
    
    139,436
    
    
    
    128,607Total liabilities and stockholders equity
    
    $
    181,166
    
    
    $
    168,657
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Three months endedMarch 31,2006
    
    
    2005Net revenues:Product revenues
    
    $
    24,694
    
    
    $
    22,299Service revenues
    
    
    7,591
    
    
    
    5,779Total net revenues
    
    
    32,285
    
    
    
    28,078Cost of revenues:Product costs (includes stock-based compensation of
$96 and $0 for the three months ended March 31, 2006
and 2005, respectively)
    
    
    5,104
    
    
    
    4,989Service costs (includes stock-based compensation of
$169 and $0 for the three months ended March 31, 2006
and 2005, respectively)
    
    
    2,321
    
    
    
    1,825Amortization of purchased intangible assets
    
    
    394
    
    
    
    356Total cost of revenues
    
    
    7,819
    
    
    
    7,170Gross profit
    
    
    24,466
    
    
    
    20,908Operating expenses:Research and development (includes stock-based
compensation of $817 and $218 for the three
months ended March 31, 2006 and 2005,
respectively)
    
    
    6,456
    
    
    
    5,188Sales and marketing (includes stock-based
compensation
of $1,059 and $10 for the three months ended
March 31, 2006 and 2005, respectively)
    
    
    10,954
    
    
    
    9,909General and administrative (includes stock-based
compensation of $695 and $2 for the three months
ended March 31, 2006 and 2005, respectively)
    
    
    2,922
    
    
    
    1,951Total operating expenses
    
    
    20,332
    
    
    
    17,048Income from operations
    
    
    4,134
    
    
    
    3,860Other income, net
    
    
    1,240
    
    
    
    502Income before provision for income taxes
    
    
    5,374
    
    
    
    4,362Provision for income taxes
    
    
    860
    
    
    
    785Net income
    
    $
    4,514
    
    
    $
    3,577Basic net income per share
    
    $
    0.13
    
    
    $
    0.11Diluted net income per share
    
    $
    0.13
    
    
    $
    0.10Shares used in computing basic net income per
share
    
    
    34,416
    
    
    
    33,546Shares used in computing diluted net income
per share
    
    
    35,377
    
    
    
    35,211
  4




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Three months endedMarch 31,2006
    
    
    2005Cash flows from operating activities:Net income
    
    $
    4,514
    
    
    $
    3,577Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation
    
    
    542
    
    
    
    665Amortization of purchased intangible assets
    
    
    394
    
    
    
    356Gain on disposal of property and equipment
    
    
    
    
    
    
    10Stock-based compensation related to acquisition
    
    
    102
    
    
    
    230Stock-based compensation related to stock options and ESPP
    
    
    2,734
    
    
    
    Changes in operating assets and liabilities:Accounts receivable, net
    
    
    (1,424
    )
    
    
    (1,059
    )Other receivables
    
    
    (31
    )
    
    
    1,741Inventories
    
    
    1,202
    
    
    
    (896
    )Prepaids and other current assets
    
    
    (474
    )
    
    
    (92
    )Other assets
    
    
    25
    
    
    
    24Accounts payable
    
    
    469
    
    
    
    693Accrued compensation
    
    
    (1,250
    )
    
    
    (1,589
    )Other accrued liabilities
    
    
    578
    
    
    
    (24
    )Income tax payable
    
    
    732
    
    
    
    416Deferred revenue
    
    
    1,151
    
    
    
    5,098Net cash provided by operating activities
    
    
    9,264
    
    
    
    9,150Cash flows from investing activities:Purchases of property and equipment
    
    
    (720
    )
    
    
    (539
    )Purchases of investments
    
    
    (24,723
    )
    
    
    (14,829
    )Proceeds from sales and maturities of investments
    
    
    13,132
    
    
    
    16,850Acquisition, net of cash acquired
    
    
    
    
    
    
    (1,808
    )Net cash used in investing activities
    
    
    (12,311
    )
    
    
    (326
    )Cash flows from financing activities:Proceeds from issuance of common stock
    
    
    2,209
    
    
    
    1,883Sale of stock to employees under the ESPP
    
    
    1,289
    
    
    
    1,126Net cash provided by financing activities
    
    
    3,498
    
    
    
    3,009Net increase in cash and cash equivalents
    
    
    451
    
    
    
    11,833Cash and cash equivalents at beginning of period
    
    
    36,221
    
    
    
    10,672Cash and cash equivalents at end of period
    
    $
    36,672
    
    
    $
    22,505Supplemental disclosures of cash flow information:Cash paid during period for taxes
    
    $
    116
    
    
    $
    369
  5




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Stock Options
  Three Months EndedMarch 31, 2006Stock Options:Expected life (years)
    
    
    4.65Expected volatility
    
    
    62
    %Risk-free interest rate
    
    
    4.83
    %
   WeightedWeighted
    
    
    AverageAverage
    
    
    Remaining
    
    
    AggregateExercise
    
    
    Contractual
    
    
    IntrinsicShares
    
    
    Price
    
    
    Term (Years)
    
    
    Value(In thousands, except per share amounts)Options outstanding at December 31, 2005
    
    
    6,329
    
    
    $
    12.33Granted
    
    
    1,179
    
    
    
    9.61Exercised
    
    
    (322
    )
    
    
    6.86Canceled /forfeited/expired
    
    
    (239
    )
    
    
    14.45
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WeightedWeighted
    
    
    AverageAverage
    
    
    Remaining
    
    
    AggregateExercise
    
    
    Contractual
    
    
    IntrinsicShares
    
    
    Price
    
    
    Term (Years)
    
    
    Value(In thousands, except per share amounts)Options outstanding at March 31, 2006
    
    
    6,947
    
    
    
    12.05
    
    
    
    7.71
    
    
    $
    13,821Options
vested and expected to vest at March 31, 2006
    
    
    6,146
    
    
    
    12.10
    
    
    
    7.71
    
    
    $
    12,803Options exercisable at March 31, 2006
    
    
    3,358
    
    
    
    12.13
    
    
    
    6.46
    
    
    $
    9,332
   Range ofExercise Prices
    
    
    Options Outstanding
    
    
    Options ExercisableWeighted-
    
    
    Weighted-
    
    
    
    
    
    
    Weighted-Average
    
    
    Average
    
    
    
    
    
    
    AverageRemaining
    
    
    Exercise
    
    
    
    
    
    
    ExerciseNumber
    
    
    Contractual
    
    
    Price per
    
    
    Number
    
    
    Price perOutstanding
    
    
    Life (in Years)
    
    
    Share
    
    
    Exercisable
    
    
    Share$
    1.504.71
    
    
    
    829
    
    
    
    5.72
    
    
    $
    3.81
    
    
    
    738
    
    
    $
    3.854.758.35
    
    
    
    757
    
    
    
    6.52
    
    
    
    6.93
    
    
    
    495
    
    
    
    6.358.368.36
    
    
    
    324
    
    
    
    6.88
    
    
    
    8.36
    
    
    
    227
    
    
    
    8.368.389.51
    
    
    
    1,137
    
    
    
    9.73
    
    
    
    9.48
    
    
    
    15
    
    
    
    9.069.5412.15
    
    
    
    837
    
    
    
    7.63
    
    
    
    11.41
    
    
    
    393
    
    
    
    11.2212.1913.99
    
    
    
    387
    
    
    
    8.45
    
    
    
    12.97
    
    
    
    139
    
    
    
    13.0314.0014.00
    
    
    
    880
    
    
    
    8.82
    
    
    
    14.00
    
    
    
    262
    
    
    
    14.0014.0116.88
    
    
    
    811
    
    
    
    7.41
    
    
    
    15.33
    
    
    
    483
    
    
    
    15.6016.9148.06
    
    
    
    985
    
    
    
    7.29
    
    
    
    22.83
    
    
    
    606
    
    
    
    25.24Total
    
    
    6,947
    
    
    
    7.71
    
    
    $
    12.05
    
    
    
    3,358
    
    
    $
    12.13
 Employee Stock Purchase Plans
  Three Months EndedMarch 31, 2006ESPP Grants:Expected life (years)
    
    
    0.50Expected volatility
    
    
    81
    %Risk-free interest rate
    
    
    4.60
    %
 8




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Restricted Stock Issued in Acquisition
  Pro Forma Information under SFAS 123 for Periods Prior to 2006
  Three MonthsEnded March 31,2005Net income as reported
    
    $
    3,577Deduct: Stock-based compensation
expense determined under fair
value-based method for all awards,
net of tax
    
    
    (3,163
    )Net income pro forma
    
    $
    414Net income per share:Basic  as reported
    
    $
    0.11Diluted  as reported
    
    $
    0.10Basic  pro forma
    
    $
    0.01Diluted  pro forma
    
    $
    0.01
   Expected life (years)
    
    
    3.39Expected volatility
    
    
    92
    %Risk-free interest rates
    
    
    4.00
    %
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
    
    persuasive evidence of an arrangement exists,
    
    delivery has occurred,
    
    the fee is fixed or determinable, and
    
    collectibility is probable.
     10




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March 31, 2006
    
    
    December 31, 2005Completed products
    
    $
    3,449
    
    
    $
    4,584Raw materials and components
    
    
    328
    
    
    
    395$
    3,777
    
    
    $
    4,979
  Goodwill
 Other intangibles
  March 31, 2006
    
    
    December 31, 2005Gross
    
    
    
    
    
    
    
    
    
    
    GrossCarrying
    
    
    Accumulated
    
    
    Net
    
    
    Carrying
    
    
    Accumulated
    
    
    NetAmount
    
    
    Amortization
    
    
    Amount
    
    
    Amount
    
    
    Amortization
    
    
    AmountDeveloped technology
    
    $
    5,100
    
    
    $
    (1,302
    )
    
    $
    3,798
    
    
    $
    5,100
    
    
    $
    (1,047
    )
    
    $
    4,053Customer contracts and relationships
    
    
    1,900
    
    
    
    (601
    )
    
    
    1,299
    
    
    
    1,900
    
    
    
    (479
    )
    
    
    1,421Trade name
    
    
    200
    
    
    
    (85
    )
    
    
    115
    
    
    
    200
    
    
    
    (68
    )
    
    
    132Purchased intangible assets
    
    $
    7,200
    
    
    $
    (1,988
    )
    
    $
    5,212
    
    
    $
    7,200
    
    
    $
    (1,594
    )
    
    $
    5,606
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Year
    
    AmountRemainder of 2006
    
    $
    1,0212007
    
    
    1,3602008
    
    
    1,2952009
    
    
    1,2682010
    
    
    268$
    5,212
        12




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Accrued warranty obligations at December 31, 2005
    
    $
    234Provision for current period sales
    
    
    66Warranty costs incurred
    
    
    (64
    )Accrued warranty obligations at March 31, 2006
    
    $
    236
          13




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Three Months EndedMarch 31,2006
    
    
    2005Numerator:Net income
    
    $
    4,514
    
    
    $
    3,577Denominator:Basic:Weighted-average shares of common stock outstanding
    
    
    34,482
    
    
    
    33,653Less: shares subject to repurchase
    
    
    (66
    )
    
    
    (107
    )Basic weighted-average common shares outstanding
    
    
    34,416
    
    
    
    33,546Diluted:Basic weighted-average common shares outstanding
    
    
    34,416
    
    
    
    33,546Add: potentially dilutive common shares from stock
options and shares subject to repurchase
    
    
    940
    
    
    
    1,639Add: potentially dilutive common shares from warrants
    
    
    21
    
    
    
    26Diluted weighted-average common shares outstanding
    
    
    35,377
    
    
    
    35,211Basic net income per share
    
    $
    0.13
    
    
    $
    0.11Diluted net income per share
    
    $
    0.13
    
    
    $
    0.10
      14




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Three months endedMarch 31,2006
    
    
    2005Net revenues:Americas
    
    $
    15,343
    
    
    $
    11,905Asia Pacific
    
    
    8,814
    
    
    
    7,978Europe, Middle East, Africa
    
    
    8,128
    
    
    
    8,195Total net revenues
    
    $
    32,285
    
    
    $
    28,078
     15




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® ® ®
 ®
      16




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Cost of Revenues
  Research and Development
 Sales and Marketing .
 General and Administrative
    17




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Revenue recognition
 
    
    persuasive evidence of an arrangement exists,
    
    delivery has occurred,
    
    the fee is fixed or determinable, and
    
    collectibility is probable.
        Inventory valuation
 Valuation of long-lived and intangible assets and goodwill
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Sales return reserve
 Rebate reserves.
 Warranty reserves
 Accounting for income taxes .
  Stock-based compensation- Employee stock plans and employee stock purchase plans
 19




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Three months endedMarch 31,2006
    
    2005Net revenues:Product revenues
    
    
    76
    %
    
    
    79
    %Service revenues
    
    
    24
    
    
    
    21Total net revenues
    
    
    100
    
    
    
    100Cost of revenues:Product costs
    
    
    16
    
    
    
    18Service costs
    
    
    7
    
    
    
    7Amortization of purchased intangible
assets
    
    
    1
    
    
    
    1Total cost of revenues
    
    
    24
    
    
    
    26Gross margin
    
    
    76
    
    
    
    74Operating expenses:Research and development
    
    
    20
    
    
    
    18Sales and marketing
    
    
    34
    
    
    
    35General and administrative
    
    
    9
    
    
    
    7Total operating expenses
    
    
    63
    
    
    
    60Income from operations
    
    
    13
    
    
    
    14Other income, net
    
    
    4
    
    
    
    2Income before provision for income taxes
    
    
    17
    
    
    
    16Provision for income taxes
    
    
    3
    
    
    
    3Net income
    
    
    14
    %
    
    
    13
    %
 20




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Contractual Obligations
    
    Payments due by periodRemainder
    
    
    1 - 3
    
    
    3 - 5
    
    

    More thanTotal
    
    

of 2006
    
    
Years



    Years
    
    
    5 YearsCash obligations not reflected in Balance Sheet:Operating lease obligations
    
    $
    3,362
    
    
    $
    1,542
    
    
    $
    1,630
    
    
    $
    136
    
    
    $
    54Purchase obligations
    
    
    6,516
    
    
    
    6,516
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    9,878
    
    
    $
    8,058
    
    
    $
    1,630
    
    
    $
    136
    
    
    $
    54
  Overview
 Operating Activities.
 Investing Activities.
 Financing Activities.
   23




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a.
    
    Under the supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, we conducted an evaluation of the
effectiveness of our disclosure controls and procedures, as such term is defined under Rule
13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based upon
that evaluation, our Chief Executive Officer and Chief Financial Officer, have concluded
that our disclosure controls and procedures were sufficiently effective to ensure that the
information required to be disclosed by us in this Quarterly Report on Form 10-Q was
recorded, processed, summarized and reported within the time periods specified in the SECs
rules and instructions for Form 10-Q.b.
    
    We reported the following material weakness as of December 31, 2005 in our annual
report on Form 10-K: we did not maintain effective control over: (i) the reconciliation
of the income tax accounts to the supporting schedules, and (ii) the review of the income
tax account reconciliation by someone other than the preparer. During the three months
ended March 31, 2006, to remediate that weakness, we implemented the following changes in
our internal control over financial reporting that have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting: (i)
income tax accounts are reconciled to the supporting schedules, (ii) the income tax
reconciliations are reviewed by individuals other than the preparer, and (iii) we have
increased our use of third party tax experts. We believe that the corrective steps taken
above have sufficiently remediated this material weakness.
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-
    
    the timing and size of orders and shipments of our products;-
    
    the mix of products we sell;-
    
    the mix and effectiveness of the channels through which those products are sold;-
    
    the geographical mix of the markets in which our products are sold;-
    
    the average selling prices of our products;-
    
    the amount and timing of our operating expenses; and-
    
    the impact of acquisitions.
  25




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-
    
    develop and maintain competitive products;-
    
    enhance our products by adding innovative features that differentiate our products from
those of our competitors and meet the needs of our larger customers;-
    
    bring products to market and introduce new features on a timely basis at competitive prices;-
    
    integrate acquired technology into our products;-
    
    identify and respond to emerging technological trends in the market; and-
    
    respond effectively to new technological changes or new product announcements by others.
    -
    
    difficulty in integrating the acquired operations and retaining acquired personnel;-
    
    limitations on our ability to retain acquired distribution channels and customers;-
    
    diversion of managements attention and disruption of our ongoing business;-
    
    difficulties in managing software development activities to define a combined product
roadmap, ensuring timely development of new products, timely release of new products to
market, and the development of efficient integration and migration tools;-
    
    the potential product liability associated with selling the acquired companys products;
and-
    
    the potential write-down of impaired goodwill and intangible and other assets. In
particular, we recorded approximately $9.6 million in goodwill related to the acquisition of
Mentat that will be subject to impairment testing rather than being amortized over a fixed
period. To the extent that the business acquired in that transaction does not remain
competitive, some or all of the goodwill related to that acquisition could be charged
against future earnings.
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-
    
    reduced control over delivery schedules;-
    
    the potential lack of adequate capacity during periods of excess demand;-
    
    decreases in manufacturing yields and increases in costs;-
    
    the potential for a lapse in quality assurance procedures;-
    
    increases in prices; and-
    
    the potential misappropriation of our intellectual property.
      31




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Exhibit 31.1
    
    Sarbanes-Oxley Section 302 Certification  CEOExhibit 31.2
    
    Sarbanes-Oxley Section 302 Certification  CFOExhibit 32.1
    
    Sarbanes-Oxley Section 906 Certification  CEOExhibit 32.2
    
    Sarbanes-Oxley Section 906 Certification  CFO
 
   PACKETEER, INC.By:
    /s/  DAVE CÔTÉDave CôtéPresident and Chief Executive Officer By:
    /s/   DAVID YNTEMADavid YntemaChief Financial Officer and Secretary 34




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Exhibit
No.
    

DescriptionExhibit 31.1
    
    Sarbanes-Oxley Section 302 Certification  CEOExhibit 31.2
    
    Sarbanes-Oxley Section 302 Certification  CFOExhibit 32.1
    
    Sarbanes-Oxley Section 906 Certification  CEOExhibit 32.2
    
    Sarbanes-Oxley Section 906 Certification  CFO