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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION  FORM 10-Q (Mark One) [X]
    
    Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004or[   ]
    
    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 000-26785 PACKETEER, INC.  DELAWARE
    
    77-0420107(State of incorporation)
    
    (I.R.S. Employer Identification No.)
 10201 North De Anza Boulevard, Cupertino, CA 95014
(Address of principal executive offices) Registrants telephone number, including area code: (408) 873-4400 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 [X]      No [   ] Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X]       No [   ] The number of shares outstanding of Registrants common stock, $0.001 par
value, was 32,988,951 at July 26, 2004. 1




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TABLE OF CONTENTS PART I FINANCIAL INFORMATIONItem 1. Financial Statements:Unaudited Condensed Consolidated Balance Sheets as of June 30, 2004 and December 31, 2003
    
    
    3Unaudited Condensed Consolidated Statements of Operations for the Three Months and Six
Months Ended June 30, 2004 and June 30, 2003
    
    
    4Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 2004 and June 30, 2003
    
    
    5Notes to Unaudited Condensed Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    9Factors That May Affect Future Results
    
    
    18Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    25Item 4. Controls and Procedures
    
    
    26PART II OTHER INFORMATION
    
    
    26Item 1. Legal Proceedings
    
    
    26Item 4. Submission of Matters to a Vote of Security Holders
    
    
    26Item 6. Exhibits and Reports on Form 8-K
    
    
    27Signatures
    
    
    27ExhibitsEXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  In addition to historical information, this Form 10-Q contains
forward-looking statements regarding our strategy, financial performance and
revenue sources that involve a number of risks and uncertainties, including
those discussed below at Factors That May Affect Future Results and in the
Risk Factors section of Packeteers Annual Report on Form 10-K as filed with
the SEC on March 5, 2004. Forward-looking statements in this report include,
but are not limited to, those relating to the general expansion of our
business, future revenues, revenue growth and profitability, our ability to
develop multiple applications, our planned introduction of new products and
services, the possibility of acquiring complementary businesses, products,
services and technologies, our development of relationships with providers of
leading Internet technologies, our competition and our business model targets.
While this outlook represents our current judgment on the future direction of
the business, such risks and uncertainties could cause actual results to differ
materially from any future performance suggested below. Readers are cautioned
not to place undue reliance on the forward-looking statements, which speak only
as of the date of this Form 10-Q. Packeteer undertakes no obligation to
publicly release any revisions to forward-looking statements to reflect events
or circumstances arising after the date of this document. 2




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PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS PACKETEER, INC. 
 
 June 30,
    
    December 31,2004
    
    2003ASSETSCurrent assets:Cash and cash equivalents
    
    $
    32,895
    
    
    $
    25,664Short-term investments
    
    
    60,292
    
    
    
    54,317Accounts receivable, net of allowance for doubtful accounts
of $149 and $149, respectively
    
    
    11,012
    
    
    
    11,042Other receivables
    
    
    224
    
    
    
    187Inventories
    
    
    3,100
    
    
    
    2,691Prepaids and other current assets
    
    
    813
    
    
    
    1,133Total current assets
    
    
    108,336
    
    
    
    95,034Property and equipment, net
    
    
    2,887
    
    
    
    2,593Long-term investments
    
    
    6,316
    
    
    
    6,726Other assets
    
    
    336
    
    
    
    346Total assets
    
    $
    117,875
    
    
    $
    104,699LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Current portion of capital lease obligations
    
    $
    230
    
    
    $
    457Current portion of note payable
    
    
    36
    
    
    
    139Accounts payable
    
    
    3,358
    
    
    
    2,229Accrued compensation
    
    
    4,495
    
    
    
    4,241Other accrued liabilities
    
    
    5,090
    
    
    
    4,398Deferred revenue
    
    
    10,731
    
    
    
    8,297Total current liabilities
    
    
    23,940
    
    
    
    19,761Long-term liabilities:Deferred revenue
    
    
    2,465
    
    
    
    1,295Deferred rent
    
    
    295
    
    
    
    225Total liabilities
    
    
    26,700
    
    
    
    21,281Stockholders equity:Common stock, $0.001 par value;
85,000 shares authorized; 32,989 and 32,501 shares
issued and outstanding, respectively
    
    
    33
    
    
    
    32Additional paid-in capital
    
    
    178,374
    
    
    
    175,820Accumulated other comprehensive loss
    
    
    (248
    )
    
    
    (12
    )Notes receivable from stockholders
    
    
    (6
    )
    
    
    (6
    )Accumulated deficit
    
    
    (86,978
    )
    
    
    (92,416
    )Total stockholders equity
    
    
    91,175
    
    
    
    83,418Total liabilities and stockholders equity
    
    $
    117,875
    
    
    $
    104,699
 See accompanying notes to condensed consolidated financial statements. 3




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PACKETEER, INC. 
 
 Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net revenues:Product revenues
    
    $
    17,342
    
    
    $
    14,558
    
    
    $
    35,053
    
    
    $
    28,718Service revenues

    
    
    4,300
    
    
    
    2,930
    
    
    
    8,093
    
    
    
    5,538Total net revenues
    
    
    21,642
    
    
    
    17,488
    
    
    
    43,146
    
    
    
    34,256Cost of revenues:Product costs
    
    
    4,147
    
    
    
    3,045
    
    
    
    7,704
    
    
    
    5,922Service costs
    
    
    1,485
    
    
    
    1,108
    
    
    
    2,825
    
    
    
    2,120Total cost of revenues
    
    
    5,632
    
    
    
    4,153
    
    
    
    10,529
    
    
    
    8,042Gross profit
    
    
    16,010
    
    
    
    13,335
    
    
    
    32,617
    
    
    
    26,214Operating expenses:Research and development
    
    
    3,791
    
    
    
    3,052
    
    
    
    7,265
    
    
    
    5,867Sales and marketing
    
    
    8,679
    
    
    
    6,323
    
    
    
    16,840
    
    
    
    12,844General and administrative
    
    
    1,397
    
    
    
    1,370
    
    
    
    2,835
    
    
    
    2,705Total operating expenses
    
    
    13,867
    
    
    
    10,745
    
    
    
    26,940
    
    
    
    21,416Income from operations
    
    
    2,143
    
    
    
    2,590
    
    
    
    5,677
    
    
    
    4,798Other income, net
    
    
    171
    
    
    
    289
    
    
    
    364
    
    
    
    469Income before provision for income taxes
    
    
    2,314
    
    
    
    2,879
    
    
    
    6,041
    
    
    
    5,267Provision for income taxes
    
    
    230
    
    
    
    288
    
    
    
    603
    
    
    
    527Net income
    
    $
    2,084
    
    
    $
    2,591
    
    
    $
    5,438
    
    
    $
    4,740Basic net income per share
    
    $
    0.06
    
    
    $
    0.08
    
    
    $
    0.17
    
    
    $
    0.15Diluted net income per share
    
    $
    0.06
    
    
    $
    0.08
    
    
    $
    0.16
    
    
    $
    0.15Shares used in computing basic net income per
share
    
    
    32,921
    
    
    
    31,481
    
    
    
    32,797
    
    
    
    31,154Shares used in computing diluted net income
per share
    
    
    34,428
    
    
    
    32,550
    
    
    
    34,552
    
    
    
    32,248
 See accompanying notes to condensed consolidated financial statements. 4




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PACKETEER, INC. 
 
 Six months endedJune 30,2004
    
    2003Cash flows from operating activities:Net income
    
    $
    5,438
    
    
    $
    4,740Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation
    
    
    798
    
    
    
    719Other non-cash charges
    
    
    
    
    
    
    19Changes in operating assets and liabilities:Accounts receivable, net
    
    
    30
    
    
    
    (546
    )Inventories
    
    
    (409
    )
    
    
    342Prepaids and other current assets
    
    
    283
    
    
    
    426Accounts payable
    
    
    1,129
    
    
    
    (78
    )Accrued compensation and other accrued liabilities
    
    
    1,016
    
    
    
    169Deferred revenue
    
    
    3,604
    
    
    
    1,787Net cash provided by operating activities
    
    
    11,889
    
    
    
    7,578Cash flows from investing activities:Purchases of property and equipment
    
    
    (1,092
    )
    
    
    (337
    )Purchases of investments
    
    
    (41,915
    )
    
    
    (45,908
    )Proceeds from sales and maturities of investments
    
    
    36,114
    
    
    
    30,973Other assets
    
    
    10
    
    
    
    (2
    )Net cash used in investing activities
    
    
    (6,883
    )
    
    
    (15,274
    )Cash flows from financing activities:Net proceeds from issuance of common stock
    
    
    1,981
    
    
    
    4,747Sale of stock to employees under the ESPP
    
    
    574
    
    
    
    334Payments from stockholders notes receivable
    
    
    
    
    
    
    47Repayments of line of credit
    
    
    
    
    
    
    (1,000
    )Payments of notes payable
    
    
    (103
    )
    
    
    (91
    )Principal payments of capital lease obligations
    
    
    (227
    )
    
    
    (283
    )Net cash provided by financing activities
    
    
    2,225
    
    
    
    3,754Net increase (decrease) in cash and cash equivalents
    
    
    7,231
    
    
    
    (3,942
    )Cash and cash equivalents at beginning of period
    
    
    25,664
    
    
    
    46,144Cash and cash equivalents at end of period
    
    $
    32,895
    
    
    $
    42,202Supplemental disclosures of cash flow information:Cash paid during period for taxes
    
    $
    394
    
    
    $
    343Cash paid during period for interest
    
    $
    21
    
    
    $
    71
 See accompanying notes to condensed consolidated financial statements. 5




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PACKETEER, INC. 
 
 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements
have been prepared by Packeteer, Inc., pursuant to the rules and regulations of
the Securities and Exchange Commission (SEC) and include the accounts of
Packeteer, Inc. and its wholly-owned subsidiaries (Packeteer or collectively
the Company). All significant intercompany accounts and transactions have
been eliminated in consolidation. Certain information and footnote disclosures,
normally included in financial statements prepared in accordance with generally
accepted accounting principles, have been condensed or omitted pursuant to such
rules and regulations. While in the opinion of the Companys management, the
unaudited condensed financial statements reflect all adjustments (consisting
only of normal recurring adjustments) necessary for a fair statement of interim
periods presented, these financial statements and notes should be read in
conjunction with its audited consolidated financial statements and notes
thereto, included in the Companys Annual Report on Form 10-K for the year
ended December 31, 2003 filed with the SEC on March 5, 2004. The results of operations for the three and six months ended June 30, 2004
are not necessarily indicative of results that may be expected for any other
interim period or for the full year ending December 31, 2004. 2. STOCK-BASED COMPENSATION The Company adopted Statement of Financial Accounting Standards (SFAS) No.
148, Accounting for Stock-Based Compensation  Transition and Disclosure,
which amended SFAS 123, Accounting for Stock-Based Compensation, in December
2002. As permitted under SFAS 148, Packeteer has elected to continue to follow
the intrinsic value method in accounting for its stock-based employee
compensation arrangements. The following table illustrates the effect on net
income and net income per share if the Company had applied the fair value
recognition provisions of SFAS 123 to stock-based employee compensation (in
thousands, except per share data): Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net income as reported
    
    $
    2,084
    
    
    $
    2,591
    
    
    $
    5,438
    
    
    $
    4,740Add: Stock-based
compensation under APB 25,
net of tax
    
    
    
    
    
    
    8
    
    
    
    
    
    
    
    19Deduct: Stock-based
compensation expense
determined under fair
value-based method for all awards, net of tax
    
    
    (2,988
    )
    
    
    (1,831
    )
    
    
    (4,426
    )
    
    
    (3,318
    )Net income (loss) pro forma
    
    $
    (904
    )
    
    $
    768
    
    
    $
    1,012
    
    
    $
    1,441Net income (loss) per share:Basic  as reported
    
    $
    0.06
    
    
    $
    0.08
    
    
    $
    0.17
    
    
    $
    0.15Diluted  as reported
    
    $
    0.06
    
    
    $
    0.08
    
    
    $
    0.16
    
    
    $
    0.15Basic  pro forma
    
    $
    (0.03
    )
    
    $
    0.02
    
    
    $
    0.03
    
    
    $
    0.05Diluted  pro forma
    
    $
    (0.03
    )
    
    $
    0.02
    
    
    $
    0.03
    
    
    $
    0.05
 3. CONTINGENCIES In November 2001, a putative class action lawsuit was filed in the United
States District Court for the Southern District of New York against the
Company, certain officers and directors of the Company, and the underwriters of
the Companys initial public offering. An amended complaint, captioned In re
Packeteer, Inc. Initial Public Offering Securities Litigation,01-CV-10185
(SAS), was filed on April 20, 2002. The amended complaint alleges violations of the federal securities laws on
behalf of a purported class of those who acquired the Companys common stock
between the date of the Companys initial public offering, or IPO, and December
6, 2000. The amended complaint alleges that the description in the prospectus
for the Companys IPO was materially false and misleading in describing the
compensation to be earned by the underwriters of the Companys IPO, and in not
describing certain alleged arrangements among 6




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underwriters and initial purchasers of the Companys common stock. The
amended complaint seeks damages and certification of a plaintiff class
consisting of all persons who acquired shares of the Companys common stock
between July 27, 1999 and December 6, 2000. In July 2002, the Company and the individual defendants joined in an
omnibus motion to dismiss challenging the legal sufficiency of plaintiffs
claims. The motion was filed on behalf of hundreds of issuer and individual
defendants named in similar lawsuits. Plaintiffs opposed the motion, and the
Court heard oral argument on the motion in early November 2002. On February
19, 2003, the Court issued an Opinion and Order denying the motion to dismiss
as to the Company. In addition, in October 2002, the individual defendants
were dismissed without prejudice. A special committee of the board of directors has authorized the Company
to negotiate a settlement of the pending claims substantially consistent with a
memorandum of understanding negotiated among class plaintiffs, all issuer
defendants and their insurers.The parties have negotiated a settlement, which
is subject to approval by the Court. If the settlement is not approved, we
intend to vigorously defend ourselves against plaintiffs allegations. We do
not currently believe that the outcome of this proceeding will have a material
adverse impact on our financial condition, results of operations or cash flows. We are routinely involved in legal and administrative proceedings
incidental to our normal business activities and believe that these matters
will not have a material adverse effect on our financial position, results of
operations or cash flows. 4. GUARANTEES The Companys standard warranty period is twelve months. We record a
liability for estimated warranty obligations at the date products are sold.
This warranty reserve approximates the aggregate amount of expected replacement
and repair costs for our products. Our warranty reserve is based on historical
product repair and replacement information. The following provides a
reconciliation of the changes in Packeteers warranty reserve from December 31,
2003 to June 30, 2004 (in thousands): Accrued warranty obligations at December 31, 2003
    
    $
    303Provision for current period sales
    
    
    211Warranty costs incurred
    
    
    (225
    )Accrued warranty obligations at June 30, 2004
    
    $
    289
 We occasionally provide guarantees that could require us to make future
payments in the event that the third party primary obligor does not make its
required payments. In March 2004, we entered into such an agreement
guaranteeing the performance of our contract manufacturer in meeting their
obligations on a specific purchase order that covers a 15-month supply of a
particular component. At June 30, 2004, our maximum remaining liability under
this guarantee is $1.1 million. In accordance with the Financial Accounting
Standards Board (FASB) Interpretation No. 45, Guarantors Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others (FIN 45), we have not recorded a liability for this
guarantee. Additionally, our distributor and reseller agreements generally include a
provision for indemnifying such parties against certain liabilities if our
products are claimed to infringe a third partys intellectual property rights.
To date we have not incurred any costs as a result of such indemnifications and
have not accrued any liabilities related to such obligations in the
accompanying condensed consolidated financial statements. 5. INCOME TAXES Our income tax provision for the periods ended June 30, 2004 and 2003 is
primarily attributable to income taxes payable in foreign jurisdictions. The
effective tax rate for the six-month periods ended June 30, 2004 and 2003 is
approximately 10%. As of December 31, 2003, deferred tax assets of approximately $23.6
million were available to the Company to offset future taxable income. Due to
the uncertainty regarding the realizability of the deferred tax assets, a full
valuation allowance has been recorded. Management will re-evaluate the need for
the valuation allowance in future periods. The Company does not expect to
recognize a significant tax provision until after a substantial portion of the
net operating losses are utilized. 7




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6. NET INCOME PER SHARE Basic net income per share has been computed using the weighted-average
number of common shares outstanding during the period. Diluted net income per
share has been computed using the weighted average number of common and
potential common shares outstanding during the period. At June 30, 2004 and
2003, there were 1,904,561 and 433,213 shares, respectively, issuable upon the
exercise of stock options excluded from the computation because the exercise
price was greater than the average market price. The following table presents the calculation of basic and diluted net
income per share (in thousands, except per share amounts): Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Numerator:Net income
    
    $
    2,084
    
    
    $
    2,591
    
    
    $
    5,438
    
    
    $
    4,740Denominator:Basic weighted-average common shares outstanding
    
    
    32,921
    
    
    
    31,481
    
    
    
    32,797
    
    
    
    31,154Add: potentially dilutive common shares from stock
options
    
    
    1,483
    
    
    
    1,045
    
    
    
    1,729
    
    
    
    1,075Add: potentially dilutive common shares from warrants
    
    
    24
    
    
    
    24
    
    
    
    26
    
    
    
    19Diluted weighted-average common shares outstanding
    
    
    34,428
    
    
    
    32,550
    
    
    
    34,552
    
    
    
    32,248Basic net income per share
    
    $
    0.06
    
    
    $
    0.08
    
    
    $
    0.17
    
    
    $
    0.15Diluted net income per share
    
    $
    0.06
    
    
    $
    0.08
    
    
    $
    0.16
    
    
    $
    0.15
 7. COMPREHENSIVE INCOME (LOSS) The Company reports comprehensive income (loss) in accordance with the
provisions of SFAS 130, Reporting Comprehensive Income. SFAS 130 establishes
standards for reporting comprehensive income and its components in financial
statements. The difference between reported net income and comprehensive income
(loss) is not considered material for the periods presented. 8. SEGMENT REPORTING The Company has adopted the provisions of SFAS 131, Disclosures about
Segments of an Enterprise and Related Information. The Companys chief
operating decision maker is considered to be the Companys Chief Executive
Officer (CEO). The CEO reviews financial information presented on a
consolidated basis substantially similar to the accompanying condensed
consolidated financial statements. Therefore, the Company has concluded that it
operates in one segment and accordingly has provided only the required
enterprise-wide disclosures. The Company operates in the United States and internationally and derives
its revenues from the sale of products and software licenses and maintenance
contracts related to these products. For the three months ended June 30, 2004,
sales to two customers, Alternative Technology, Inc., and Westcon, Inc.,
accounted for 23% and 17% of total net revenues, respectively. For the six
months ended June 30, 2004, sales to the same two customers each accounted for
21% of total net revenues. The same two customers accounted for 24% and 13% of
total net revenues, respectively, for the three months ended June 30, 2003, and
23% and 14% of total net revenues, respectively for the six months ended June
30, 2003. 8




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Geographic information (in thousands): Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net revenues:Americas
    
    $
    10,230
    
    
    $
    7,398
    
    
    $
    17,676
    
    
    $
    15,457Asia Pacific
    
    
    4,392
    
    
    
    5,243
    
    
    
    10,744
    
    
    
    10,018Europe, Middle East, Africa
    
    
    7,020
    
    
    
    4,847
    
    
    
    14,726
    
    
    
    8,781Total net revenues
    
    $
    21,642
    
    
    $
    17,488
    
    
    $
    43,146
    
    
    $
    34,256
 Net revenues reflect the destination of the shipped product. The Americas
net revenue includes Latin America and South America, which have historically
accounted for between 1% and 2% of total net revenues. These revenues were
previously included in Europe and Rest of World (ROW). Long-lived assets are primarily located in North America. Assets located
outside North America are not significant. 9. RECENT ACCOUNTING PRONOUNCEMENTS In March 2004, the Emerging Issues Task Force (EITF) reached a consensus
on the remaining portions of EITF 03-01, The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments with an effective date
of June 15, 2004. EITF 03-01 provides new disclosure requirements for
other-than-temporary impairments on debt and equity investments. Investors are
required to disclose quantitative information about: (i) the aggregate amount
of unrealized losses, and (ii) the aggregate related fair values of investments
with unrealized losses, segregated into time periods during which the
investment has been in an unrealized loss position of less than 12 months and
greater than 12 months. In addition, investors are required to disclose the
qualitative information that supports their conclusion that the impairments
noted in the qualitative disclosure are not other-than temporary. The Company
adopted the initial portions of EITF 03-01 in December 2003. The adoption of
the remaining portions in June 2004 did not have a material impact on the
Companys results of operations or financial condition. 
 ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW Packeteer is a leading provider of application traffic management systems
designed to deliver a broad set of visibility, control, and compression
capabilities to enterprise customers and service providers. For enterprise
customers, the system is designed to enable IT organizations to effectively
align application and network resources with the priorities of the business,
while providing measurable cost savings in WAN infrastructure investments. For
service providers, the Packeteer systems are designed to provide a platform for
delivering application-intelligent network services that control quality of
service, or QoS, expand revenue opportunities and offer compelling
differentiation from other potential solutions. The Packeteer application traffic management system consists of a family
of appliances with performance capabilities that make them capable of
deployment within large data centers as well as smaller remote sites throughout
a distributed enterprise. Each appliance can be configured to deliver the full
range of application traffic management solutions, from visibility with
PacketSeeker®, to control with PacketShaper®, to compression with PacketShaper
Xpress. In addition, each appliance can be managed individually or in context
of a completely integrated policy-based application traffic management system
distributed across multiple locations, using our ReportCenter or PolicyCenter
software products. Packeteers products are deployed at more than 5,000 enterprises and
service providers worldwide, and are sold through an established network of
more than 100 resellers, distributors and system-integrators in more than 50
countries, complemented by our direct sales force. Our sales force and
marketing efforts are used to develop brand awareness drive demand for system
solutions and support our indirect channels. Although we have reported net income for ten consecutive quarters, we have
a limited positive operating history. As of June 30, 2004, we had an
accumulated deficit of $87.0 million. We earned net income of $5.4 million for
the six months ended June 30, 2004, and $11.0 million and $3.7 million for the
years ended December 31, 2003 and 2002, respectively, however we incurred
losses since we commenced operations in 1996 until 2002, and profitability
could be difficult to sustain. We expect to continue to incur significant sales
and marketing, product development and administrative expenses and, as a
result, will need to generate significant quarterly 9




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revenues to maintain profitability. With the increase in our installed
base, we plan to continue to invest in our customer support group. We plan to
continue to invest in the development and support of our reseller and
distributor relationships. We also plan to continue to invest in various
marketing campaigns and expand our international sales operations. We plan to
continue to invest in research and development activities to enhance existing
products and develop new features in response to customer demands. We will also
add to our infrastructure to support our growing business. We believe that our current value proposition, which enables our
enterprise customers to get more value out of existing network resources and
improved performance of their critical applications, should allow us to
continue to grow our business during the remainder of 2004. Our growth rate and
net revenues depend significantly on continued growth in the application
traffic management market, our ability to develop and maintain strong
partnering relationships with our indirect channel partners and our ability to
expand or enhance our current product offerings or respond to technological
change. Our growth in service revenues is dependent upon increasing the number
of units under maintenance, which is dependent on both growing our installed
base and renewing existing maintenance contracts. Our future profitability and
rate of growth, if any, will be directly affected by the continued acceptance
of our product in the marketplace, as well as the timing and size of orders and
shipments, product mix, average selling price of our products and general
economic conditions. Our failure to successfully convince the market of our
value proposition and maintain strong relationships with our indirect channel
partners to ensure the success of their selling efforts on our behalf, would
adversely impact our net revenues and operating results. SOURCES OF REVENUE We derive our revenue from two sources, product revenues and service
revenues. Product revenues consist primarily of sales of our application
traffic management systems. Service revenues consist primarily of maintenance
revenues and, to a lesser extent, training revenues. Product revenues accounted
for 80% and 81% of our net revenues for the three and six months ended June 30,
2004, respectively, and 83% and 84% of our net revenues for the three and six
months ended June 30, 2003, respectively. Service revenues continue to increase
as our installed base grows, accounting for 20% and 19% of net revenues for the
three and six months ended June 30, 2004, respectively, and 17% and 16% of net
revenues for the three and six months ended June 30, 2003, respectively.
Maintenance revenues are recognized on a monthly basis, over the life of the
contract. The typical subscription and support term is twelve months, although
multi-year contracts are sold. COST OF REVENUES AND OPERATING EXPENSES Cost of Revenues. Our cost of revenues consists of the cost of finished
products purchased from our contract manufacturer, overhead costs and service
support costs. For finished product, we outsource all of our manufacturing to one
contract manufacturer, SMTC Manufacturing Corporation, or SMTC. We design and
develop a majority of the key components of our products, including printed
circuit boards and software. In addition, we determine the components that are
incorporated into our products and select the appropriate suppliers of these
components. Our overhead costs consist primarily of personnel related costs for
our product operations and order fulfillment groups and other product costs
such as warranty and fulfillment charges. Service support costs consist
primarily of personnel related costs for our customer support and training
groups, as well as fees paid to third-party service providers to facilitate
next business day replacement for end user customers located outside the United
States. Additionally, we allocate overhead such as facilities, depreciation and
IT costs to all departments based on headcount and usage. As such, general
overhead costs are reflected in each cost of revenue and operating expense
category. We must continue to work closely with our contract manufacturer as we
develop and introduce new products and try to reduce production costs for
existing products. To the extent our customer base continues to grow, we intend
to continue to invest additional resources in our customer support group and
expect that our fees to third-party service providers will continue to increase
as our international installed base grows. Research and Development. Research and development expenses consist
primarily of salaries and related personnel expenses, allocated overhead,
consultant fees and prototype expenses related to the design, development,
testing and enhancement of our products and software. We have historically
focused our research and development efforts on developing and enhancing our
application traffic management solutions. We expect that in the future, our
research and development spending will increase in absolute dollars as we
continue to develop and maintain competitive products and enhance our current
products by adding innovative features that differentiate our products from
those of our competitors. We believe that continued investment in research and
development is critical to attaining our strategic product and cost control
objectives. We expect somewhat higher absolute spending 10




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levels in the upcoming quarters, and expect to approximate our current
long-term business model target of 18% of net revenues for the remainder of
2004. Sales and Marketing. Sales and marketing expenses consist primarily of
salaries, commissions and related personnel expenses for those engaged in the
sales, marketing and support of the product, as well as related trade show,
promotional and public relations expenses and allocated overhead. Sales and
marketing is our largest cost, accounting for 40% and 39% of net revenues for
the three and six months ended June 30, 2004, respectively. We plan to continue
to increase sales and marketing headcount in the remainder of 2004, as we
continue to expand our global presence. We intend to continue to invest in
various sales and marketing campaigns and, expect expenses in absolute dollars
to increase in the second half of 2004. Particularly, we have introduced new
channel marketing programs, replacing previous channel rebate programs, and
will see the impact of these changes in operating expenses for the remainder of
2004. We expect that sales and marketing expenses will continue to exceed our
revised long-term business model target of 30% to 32% of net revenues for at
least the next twelve to eighteen months. General and Administrative. General and administrative expenses consist
primarily of salaries and related personnel expenses for administrative
personnel, professional fees, allocated overhead and other general corporate
expenses. We expect general and administrative expenses to continue to be in
line with our long-term targets of 6% to 7% of net revenues. CRITICAL ACCOUNTING POLICIES Our discussion and analysis of our financial condition and results of
operations are based upon our condensed consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted 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, revenues and expenses and related disclosures of
contingent assets and liabilities. On an ongoing basis, we evaluate our
estimates, including those related to inventory valuation, valuation allowances
including sales return reserves and allowance for doubtful accounts, and other
liabilities, specifically warranty reserves. We base our estimates on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances. Actual results may differ from these
estimates under different assumptions or conditions. We believe that of our significant accounting policies, which are
described in Note 1 of the Notes to Consolidated Financial Statements included
in the Companys Annual Report on Form 10-K for the year ended December 31,
2003, the following accounting policies involve a greater degree of judgment
and complexity. Accordingly, we believe the accounting policies below are the
most critical to aid in fully understanding and evaluating our condensed
consolidated results of operations and financial condition. Revenue recognition. The Company applies the provisions of 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, to all transactions involving the sale of hardware and
software products. Revenue is generally recognized when all of the following
criteria are met as set forth in paragraph 8 of SOP 97-2:  
    
    persuasive evidence of an arrangement exists,  
    
    delivery has occurred,  
    
    the fee is fixed or determinable, and  
    
    collectibility is probable. Receipt of a customer purchase order is persuasive evidence of an
arrangement. Sales through our distribution channel are evidenced by an
agreement governing the relationship together with purchase orders on a
transaction-by-transaction basis. Delivery generally occurs when product is delivered to a common carrier
from Packeteer or its designated fulfillment house. For maintenance contracts,
delivery is deemed to occur ratably over the contract period. The Companys fees are typically considered to be fixed or determinable at
the inception of the arrangement and are negotiated at the outset of an
arrangement, generally based on specific products and quantities to be
delivered. In the event payment terms are provided that differ significantly
from our standard business practices, the fees are deemed to not be fixed or
determinable and revenue is recognized as the fees become due and payable. We assess collectibility based on a number of factors, including credit
worthiness of the customer and past transaction history with the customer. 11




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Our standard revenue recognition policy includes modifications under
certain circumstances as follows: Product revenue on sales to major new
distributors is recorded based on sell-through to the end user customers until
such time as the Company has established significant experience with the
distributors product exchange activity. Additionally, when the Company
introduces a new product into its distribution channel for which there is no
historical customer demand or acceptance history, revenue is recognized on the
basis of sell-through to end user customers until such time as demand or
acceptance history has been established. The Company has analyzed all of the elements included in its multiple
element arrangements and has determined that it has sufficient vendor specific
objective evidence, or VSOE, of fair value to allocate revenue to the
maintenance component of its product and to training. VSOE is based upon
separate sales of maintenance renewals and training to customers. Accordingly,
assuming other revenue recognition criteria are met, revenue from product sales
is recognized upon delivery using the residual method in accordance with SOP
98-9. Revenue from maintenance is recognized ratably over the maintenance term
and revenue from training is recognized when the training has taken place. To
date, training revenues have not been material. Inventory valuation. Inventories consist primarily of finished goods and
are stated at the lower of cost (on a first-in, first-out basis) or market. We
currently contract with SMTC for the manufacture of all of our products. We
record inventory reserves for excess and obsolete inventories based on
historical usage and forecasted demand. Factors which could cause our
forecasted demand to prove inaccurate include our reliance on indirect sales
channels and the variability of our sales cycle; the potential of announcements
of our new products or enhancements to replace or shorten the life cycle of our
current products, or cause customers to defer their purchases; loss of sales
due to product shortages; and the potential of new or alternative technologies
achieving widespread market acceptance and thereby rendering our existing
products obsolete. If future demand or market conditions are less favorable
than our projections, additional inventory write-downs may be required and
would be reflected in cost of sales in the period the revision is made. Sales return reserve and allowance for doubtful accounts. In accordance
with Statement of Financial Accounting Standards (SFAS) 48, Revenue
Recognition When Right of Return Exists, management must use judgment and make
estimates of potential future product returns related to current period product
revenue. When providing for sales return reserves, we analyze historical return
rates as they are the primary indicator for estimating future returns.
Material differences may result in the amount and timing of our revenue if for
any period actual returns differ from our judgments or estimates. The sales
return reserve balances at June 30, 2004 and December 31, 2003 were $738,000
and $713,000, respectively. We must also make estimates of the uncollectibility
of accounts receivable. When evaluating the adequacy of the allowance for
doubtful accounts, we review the aged receivables on an account-by-account
basis, taking into consideration such factors as the age of the receivables,
customer history and estimated continued credit-worthiness, as well as general
economic and industry trends. If the financial condition of our customers were
to deteriorate, resulting in an impairment of their ability to make payments,
additional allowances could be required. The allowance for doubtful accounts
was $149,000 at both June 30, 2004 and December 31, 2003. Rebate Reserves. Certain distributors and resellers can earn rebates under
several Packeteer programs. The rebates earned are recorded as a reduction to
revenues in accordance with Emerging Issues Task Force (EITF) 01-9, Accounting
for Consideration Given by a Vendor to a Customer (Including a Reseller of the
Vendors Products). For established programs, the Companys estimates for
rebates are based on historical usage rates. For new programs, rebate reserves
are calculated to cover the Companys maximum exposure until such time as
historical usage rates are developed. When sufficient historical experience is
established, there may be a reversal of previously accrued rebates if rebate
claims are less than the maximum exposure. Additionally, there may be a
reversal of previously accrued rebate reserves if rebates are not claimed
before the expiration dates established for each program. During the three
months ended June 30, 2004, we determined that sufficient historical experience
had been established on several newer programs and therefore, the accruals
established for the current quarter reflect the actual historical usage rates,
rather than the maximum exposure rates previously used. Additionally, accruals
were reduced by $423,000 for rebate claims that were not submitted by the
required expiration date. Rebate reserves at June 30, 2004 and December 31,
2003 were $919,000 and $877,000, respectively. Warranty reserves. Upon shipment of products to our customers, we provide
for the estimated cost to repair or replace products that may be returned under
warranty. Our warranty period is typically 12 months from the date of shipment
to the end user customer. For existing products, the reserve is estimated based
on actual historical experience. For new products, the warranty reserve is
based on historical experience of similar products until such time as
sufficient historical data has been collected on the new product. Factors that
may impact our warranty costs in the future include our reliance on our
contract manufacturer to provide quality products and the fact that our
products are complex and may contain undetected defects, errors or failures in
either the hardware or the software. To date, these problems have not
materially adversely affected us. Warranty reserves at June 30, 2004 and
December 31, 2003 were $289,000 and $303,000, respectively. 12




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RESULTS OF OPERATIONS The following table sets forth certain financial data as a percentage of
total net revenues for the periods indicated. These historical operating
results are not necessarily indicative of the results for any future period. Three months
    
    Six Monthsended
    
    endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net revenues:Product revenues
    
    
    80
    %
    
    
    83
    %
    
    
    81
    %
    
    
    84
    %Service revenues
    
    
    20
    
    
    
    17
    
    
    
    19
    
    
    
    16Total net revenues
    
    
    100
    
    
    
    100
    
    
    
    100
    
    
    
    100Cost of revenues:Product costs
    
    
    19
    
    
    
    18
    
    
    
    18
    
    
    
    17Service costs
    
    
    7
    
    
    
    6
    
    
    
    6
    
    
    
    6Total cost of revenues
    
    
    26
    
    
    
    24
    
    
    
    24
    
    
    
    23Gross margin
    
    
    74
    
    
    
    76
    
    
    
    76
    
    
    
    77Operating expenses:Research and development
    
    
    18
    
    
    
    17
    
    
    
    17
    
    
    
    17Sales and marketing
    
    
    40
    
    
    
    36
    
    
    
    39
    
    
    
    38General and administrative
    
    
    6
    
    
    
    8
    
    
    
    7
    
    
    
    8Total operating expenses
    
    
    64
    
    
    
    61
    
    
    
    63
    
    
    
    63Income from operations
    
    
    10
    
    
    
    15
    
    
    
    13
    
    
    
    14Other income, net
    
    
    1
    
    
    
    2
    
    
    
    1
    
    
    
    1Income before provision for income taxes
    
    
    11
    
    
    
    17
    
    
    
    14
    
    
    
    15Provision for income taxes
    
    
    1
    
    
    
    2
    
    
    
    1
    
    
    
    1Net income
    
    
    10
    %
    
    
    15
    %
    
    
    13
    %
    
    
    14
    %
 OVERVIEW OF RESULTS Net revenues for the three months ended June 30, 2004 were $21.6 million,
an increase of 24% over the same period in 2003. Gross profit during this
period was $16.0 million, or 74%, and operating income was $2.1 million. During
the comparable period a year ago, net revenues were $17.5 million, gross profit
was $13.3 million, or 76%, and operating income was $2.6 million. The decline
in gross profit percentage between the three months ended June 30, 2004 and the
three months ended June 30, 2003 was due to a combination of a change in
product mix, particularly higher unit sales of our low end products; increased
manufacturing overhead costs; and some increase in discounting associated with
larger implementations. Net revenues for the six months ended June 30, 2004
were $43.1 million, an increase of 26% over the same period in 2003. Gross
profit during this period was $32.6 million, or 76%, and operating income was
$5.7 million. During the comparable period a year ago, net revenues were $34.3
million, gross profit was $26.2 million, or 77%, and operating income was $4.8
million. The increase in revenues from the prior year for both the three months and
six months ended June 30, 2004 was due to both an increase in the number of
units shipped and the number of units under maintenance contracts. Net revenues
for the three months ended June 30, 2004 were adversely impacted by weakness in
the Asia Pacific region, both in Japan and our other Asia Pacific territories.
For the three months ended June 30, 2004, sales in the Asia Pacific region
accounted for 21% of net revenues, compared to 30% of net revenues for the
three months ended March 31, 2004 and all of 2003. The weakness in our Asia
Pacific region was offset by strong sales in our Americas and Europe, Middle
East and Africa, or EMEA, regions. We believe the weakness we experienced in
Asia was temporary and one time in nature, and as a result expect to see a more
normal contribution from the Asia Pacific region in the remainder of 2004,
along with a continued strong performance in our Americas and EMEA regions. 13




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During the first half of 2004, we continued to invest in our operations.
During the three months ended June 30, 2004, operating expenses of $13.9
million, increased $3.1 million, or 29%, from $10.7 million reported in the
comparable period of 2003. During the six months ended June 30, 2004, operating
expenses of $26.9 million, increased $5.5 million, or 26%,from $21.4 million
reported in the comparable period of 2003. Compared to June 30 a year ago,
headcount has increased 48, or 23%, primarily in operations, sales and
marketing and research and development. We expect to continue to add headcount
in operations, sales and marketing and research and development during the
second half of 2004, although at a somewhat slower pace. During the six months ended June 30, 2004, we generated $11.9 million of
cash from operating activities, compared to $7.6 million in the comparable
period a year ago. At June 30, 2004, we had cash, cash equivalents and
investments of $99.5 million, accounts receivable of $11.0 million and deferred
revenues of $13.2 million. NET REVENUES Total net revenues of $21.6 million in the three months ended June 30,
2004 increased $4.1 million, or 24%, from $17.5 million in the same period last
year. Total net revenues of $43.1 million in the six months ended June 30, 2004
increased $8.8 million, or 26%, from $34.3 million in the same period last
year. Product revenues of $17.3 million for the three months ended June 30,
2004 increased $2.7 million, or 19%, from $14.6 million for the three months
ended June 30, 2003. Product revenues of $35.1 million for the six months ended
June 30, 2004 increased $6.4 million, or 22%, from $28.7 million for the six
months ended June 30, 2003. For the three and six month periods ended June 30,
2004, the increase in product revenues is primarily the result of an increase
in the number of units shipped, and to a lesser extent, a lower accrual rate
used for rebates earned under several newer rebate programs where we had
established sufficient historical experience to accrue at less than the maximum
exposure and $423,000 reversal of rebates for claims not submitted by the
required expiration date. There were no significant selling price changes
during any of the periods presented. Service revenues of $4.3 million in the three months ended June 30, 2004,
increased $1.4 million, or 47%, from $2.9 million in the same period last year.
Service revenues of $8.1 million in the six months ended June 30, 2004,
increased $2.6 million, or 46%, from $5.5 million in the same period last year.
Increases for both the three months and six months ended June 30, 2004 are
mainly due to an increase in the number of units under maintenance contracts
compared to the same periods in 2003. For the three months ended June 30, 2004, net revenues in the Americas of
$10.2 million increased $2.8 million, from $7.4 million in the same period last
year, and accounted for 47% of total net revenues, compared to 42% for the same
period last year. Net revenues in Asia Pacific of $4.4 million for the three
months ended June 30, 2004 accounted for 21% of total net revenues compared to
$5.2 million, or 30%, of total net revenues for the same period last year. Net
revenues in EMEA of $7.0 million for the three months ended June 30, 2004,
accounted for 32% of total net revenues, compared to $4.9 million, or 28%, of
total net revenues for the three months ended June 30, 2003. For the six months
ended June 30, 2004, net revenues in the Americas of $17.7 million increased
$2.2 million, from $15.5 million in the same period last year, and accounted
for 41% of total net revenues, compared to 45% for the same period last year.
Net revenues in Asia Pacific of $10.7 million for the six months ended June 30,
2004 accounted for 25% of total net revenues compared to $10.0 million, or 29%,
of total net revenues for the same period last year. Net revenues in EMEA of
$14.7 million for the six months ended June 30, 2004, accounted for 34% of
total net revenues, compared to $8.8 million, or 26%, of total net revenues for
the six months ended June 30, 2003. For the three months ended June 30, 2004, sales to two customers,
Alternative Technology, Inc., and Westcon, Inc., accounted for 23% and 17% of
total net revenues, respectively. For the six months ended June 30, 2004, sales
to the same two customers each accounted for 21% of total net revenues. During
the three months ended June 30, 2003, two customers, Alternative Technology,
Inc. and Westcon, Inc., accounted for 24% and 13% of total net revenues,
respectively. For the six months ended June 30, 2003, the same two customers
accounted for 23% and 14% of total net revenues, respectively. COST OF REVENUES Our cost of revenues was $5.6 million in the three months ended June 30,
2004, an increase of $1.5 million, or 36%, from $4.2 million in the same period
last year. Our cost of revenues was $10.5 million in the six months ended June
30, 2004, an increase of $2.5 million, or 31%, from $8.0 million in the same
period last year. The increase in costs was due to an increase in units
shipped, as well as higher overhead costs and service support costs. The cost
of revenues represented 26% and 24% of total net revenues for the three and six
months ended June 30, 2004, respectively, consistent with 24% for the three and
six months ended June 30, 2003. 14




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Product costs for the three months ended June 30, 2004 increased by $1.1
million, or 36%, to $4.1 million from $3.0 million in the same period last
year. For the three months ended June 30, 2004, manufacturing costs increased
$775,000 from the same period of the prior year due primarily to an increase in
units shipped and to a lesser extent, product mix. Overhead and other product
costs increased $327,000 from the prior year, primarily reflecting headcount
increases in the overhead departments, and increases in fulfillment costs,
parts and warranty costs of $105,000, $58,000 and $36,000, respectively,
partially offset by a $45,000 decrease in rework costs. Product costs for the
six months ended June 30, 2004 increased $1.8 million, or 30%, to $7.7 million
from $5.9 million in the same period last year. For the six months ended June
30, 2004, manufacturing costs increased $1.4 million from the same period of
the prior year due primarily to an increase in units shipped and to a lesser
extent, product mix. Overhead and other product costs increased $425,000 from
the prior year, primarily reflecting headcount increases in overhead
departments and increases in fulfillment costs of $171,000, partially offset by
a $74,000 decrease in rework costs. Service costs for the three months ended June 30, 2004 increased by
$377,000, or 34%, to $1.5 million from $1.1 million in the same period of last
year. Service costs for the six months ended June 30, 2004 increased by
$705,000, or 33%, to $2.8 million from $2.1 million in the same period of last
year. The increased service costs in both the three and six month periods ended
June 30, 2004 are due to increased personnel costs as a result of increased
headcount in both our support and training groups, as well as an increase in
our third-party maintenance service provider costs, including service fees and
spare parts. Increases in third party service provider costs were $191,000 and
$292,000 for the three and six-month periods ended June 30, 2004, respectively. RESEARCH AND DEVELOPMENT Research and development expenses of $3.8 million in the three months
ended June 30, 2004, were up $747,000, or 25%, from $3.0 million in the same
period last year. The increase was primarily attributable to a $603,000
increase in salaries and personnel related expenses and a $103,000 increase in
project material costs. Research and development expenses of $7.3 million in
the six months ended June 30, 2004, were up $1.4 million, or 24%, from $5.8
million in the same period last year. The increased cost was primarily
attributable to increased salaries and related personnel expenses, and to a
lesser extent, professional service fees and project material costs.
Specifically, personnel related expenses increased $1.1 million as headcount
increased from 68 at June 30, 2003 to 86 at June 30, 2004. Professional service
fees increased $210,000, primarily for project related consultants and patent
related legal costs. Project material costs increased $74,000. Research and
development expenses represented 18% and 17% of total net revenues for the
three and six months ended June 30, 2004, respectively. Research and
development expenses represented 17% of sales for both the three and six months
ended June 30, 2003. SALES AND MARKETING Sales and marketing expenses increased to $8.7 million in the three months
ended June 30, 2004, an increase of $2.4 million, or 37%, from $6.3 million in
the same period last year. Personnel related costs, including salaries, bonuses
and commissions increased $930,000 due to headcount increases. Other increases
included $470,000 in travel and $557,000 related to various marketing programs.
Sales and marketing expenses increased to $16.8 million in the six months ended
June 30, 2004, an increase of $4.0 million, or 31%, from $12.8 million in the
same period last year. Increases included personnel costs, travel costs and
various marketing program related costs. Personnel related costs, including
salaries, bonuses and commissions increased $1.8 million as headcount increased
from 84 at June 30, 2003 to 104 at June 30, 2004. Travel costs were up $690,000
reflecting both the headcount increase and an increase in sales meeting
expenses. The cost of various marketing programs increased $936,000 as we
introduced new channel marketing programs, replacing previous channel rebate
programs. Sales and marketing expenses represented 40% and 39% of total net
revenues for the three and six months ended June 30, 2004, respectively. Sales
and marketing expenses represented 36% and 38% of total net revenues for the
three and six months ended June 30, 2003, respectively. 15




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GENERAL AND ADMINISTRATIVE General and administrative expenses were $1.4 million in the three months
ended June 30, 2004, up $27,000, or 2%, from the same period of last year. The
increases included personnel costs, specifically salaries, of $60,000 and
consulting fees, particularly audit and tax related expenses, of $113,000,
partially offset by increased overhead allocations. General and administrative
expenses increased to $2.8 million in the six months ended June 30, 2004, from
$2.7 million in the same period of last year, an increase of $130,000, or 5%.
Increases included personnel costs, specifically salaries, of $158,000 and
consulting fees, particularly audit and tax related expenses, of $312,000.
General and administrative expenses represented 6% and 7% of total net revenues
for the three and six months ended June 30, 2004, respectively. General and
administrative expenses represented 8% of total net revenues for the three and
six months ended June 30, 2003. OTHER INCOME, NET Other income, net consists primarily of investment income from our cash,
cash equivalents and investments, less interest expense related to debt and
capital lease obligations. Other income, net decreased to $171,000 in the three
months ended June 30, 2004 from $289,000 for the same period last year. Other
income, net decreased to $364,000 in the six months ended June 30, 2004 from
$469,000 for the same period last year. The decreases in both the three and six
months ended June 30, 2004 were due to a combination of lower yields on
invested funds and increased foreign currency losses on intercompany balances. INCOME TAX PROVISION Our income tax provision is primarily attributable to income taxes payable
in foreign jurisdictions. The effective tax rate for the three months ended
June 30, 2004, and the expected annual rate for the remainder of 2004, is
approximately 10%. As of December 31, 2003, deferred tax assets of approximately $23.6
million were available to the Company to offset future taxable income. Due to
the uncertainty regarding the realizability of the deferred tax assets, a full
valuation allowance has been recorded. Management will re-evaluate the need for
the valuation allowance in future periods. The Company does not expect to
recognize a significant tax provision until after a substantial portion of the
net operating losses are utilized. LIQUIDITY AND CAPITAL RESOURCES Cash Requirements During the past three years, we have had sufficient financial resources to
meet our operating requirements, to fund our capital spending and to repay our
bank line of credit. We expect to experience growth in our working capital needs for at least
the next twelve months in order to execute our business plan. We anticipate
that operating activities, as well as planned capital expenditures, will
constitute a partial use of our cash resources. In addition, we may utilize
cash resources to fund acquisitions or investments in complementary businesses,
technologies or products. We believe that our current cash, cash equivalents
and investments of $99.5 million at June 30, 2004 will be sufficient to meet
our anticipated cash requirements for working capital and capital expenditures
for at least the next twelve months. However, we may need to raise additional
funds if our estimates of revenues, working capital or capital expenditure
requirements change or prove inaccurate or in order for us to respond to
unforeseen technological or marketing hurdles or to take advantage of
unanticipated opportunities. These funds may not be available at the time or
times needed, or available on terms acceptable to us. If adequate funds are not
available, or are not available on acceptable terms, we may not be able to take
advantage of market opportunities to develop new products or to otherwise
respond to competitive pressures. 16




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We have contractual obligations in the form of operating and capital
leases and notes payable. These are described in further detail in Notes 6 and
7 of the Notes to the Consolidated Financial Statements in the Companys Annual
Report on Form 10-K for the year ended December 31, 2003. Additionally, we have
purchase obligations reflecting open purchase order commitments. The following
chart details our contractual obligations as of June 30, 2004 (in thousands): Payments due by periodRemainder
    
    1  3
    
    3  5
    
    More than 5Contractual Obligations
    
    Total
    
    of 2004
    
    years
    
    years
    
    yearsAmounts reflected in Balance SheetCapital lease obligations
    
    $
    240
    
    
    $
    240
    
    
    $
    
    
    
    $
    
    
    
    $
    Note payable
    
    
    36
    
    
    
    36
    
    
    
    
    
    
    
    
    
    
    
    276
    
    
    
    276
    
    
    
    
    
    
    
    
    
    
    
    Other cash obligations not reflected in Balance SheetOperating lease obligations
    
    
    5,089
    
    
    
    858
    
    
    
    2,795
    
    
    
    1,327
    
    
    
    109Purchase obligations
    
    
    3,542
    
    
    
    3,542
    
    
    
    
    
    
    
    
    
    
    
    8,631
    
    
    
    4,400
    
    
    
    2,795
    
    
    
    1,327
    
    
    
    109Total
    
    $
    8,907
    
    
    $
    4,676
    
    
    $
    2,795
    
    
    $
    1,327
    
    
    $
    109
 Sources and Uses of Cash Overview. Our cash, cash equivalents and investments, which are classified
as available for sale and consist of highly liquid financial instruments,
increased $12.8 million during the six months ended June 30, 2004 to $99.5
million. The increase was primarily due to net cash provided by operating
activities of $11.9 million and cash provided by financing activities,
specifically proceeds from the issuance of stock through option exercises and
the Employee Stock Purchase Plan, totaling $2.6 million. This increase was
partially offset by $1.1 million in cash used to purchase capital equipment and
$330,000 to repay debt and capital lease obligations. Operating Activities.Cash provided by operating activities was $11.9
million in the six months ended June 30, 2004, up from $7.6 million in the same
period last year. The increase was primarily due to an increase in accounts
payable, accrued liabilities and deferred revenue over the same period a year
ago. Investing Activities.Cash used in investing activities in the six months
ended June 30, 2004 was $6.9 million, compared to cash used in investing
activities of $15.3 million in the same period last year, primarily reflecting
transactions in marketable securities. Among our investment policy objectives
are preserving of principal, meeting liquidity needs and delivering good yields
in relationship to the policy guidelines and market conditions. Changes in our
investment portfolio are made in response to the market outlook and
fluctuations in interest rates. Financing Activities.Cash provided by financing activities included $2.6
million in proceeds from employee option exercises and the Employee Stock
Purchase Plan for the six months ended June 30, 2004, compared to $5.1 million
for the same period last year. Cash used in financing activities included
$330,000 in the six months ended June 30, 2004, compared to $1.4 million in the
same period last year, to repay borrowings under our line of credit, note
payable and capital lease obligations. We paid down the remaining balance on
our line of credit during the first quarter of 2003 and allowed the line to
expire in May 2003. Both the note payable and our remaining capital lease
obligations will be completely repaid during the remainder of 2004. RECENT ACCOUNTING PRONOUNCEMENTS The impact of recent accounting pronouncements is discussed in Note 9 of
the Notes to the Condensed Consolidated Financial Statements. 17




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FACTORS THAT MAY AFFECT FUTURE RESULTS You should carefully consider the risks described below before making an
investment decision. If any of the following risks actually occur, our
business, financial condition or results of operations could be materially and
adversely affected. In such case, the trading price of our common stock could
decline, and you may lose all or part of your investment. WE HAVE A HISTORY OF LOSSES AND PROFITABILITY COULD BE DIFFICULT TO SUSTAIN We have an accumulated deficit of $87.0 million at June 30, 2004. Although
we earned net income of $2.1 million and $5.4 million for the three and six
months ended June 30, 2004, respectively, and $11.0 million and $3.7 million in
2003 and 2002, respectively, we incurred net losses since we commenced
operations until 2002 and our profitability could be difficult to sustain. If
revenues grow slower than we anticipate or if operating expenditures exceed our
expectations or cannot be adjusted accordingly, we may experience additional
losses on a quarterly and annual basis. IF THE APPLICATION TRAFFIC MANAGEMENT SOLUTIONS MARKET FAILS TO GROW, OUR
BUSINESS WILL FAIL The market for application traffic management solutions is in an early
stage of development and its success is not guaranteed. Therefore, we cannot
accurately assess the size of the market, the products needed to address the
market, the optimal distribution strategy, or the competitive environment that
will develop. In order for us to be successful, our potential customers must
recognize the value of more sophisticated bandwidth management solutions,
decide to invest in the management of their networks and the performance of
important business software applications and, in particular, adopt our
bandwidth management solutions. OUR FUTURE OPERATING RESULTS MAY NOT MEET ANALYSTS EXPECTATIONS AND MAY
FLUCTUATE SIGNIFICANTLY, WHICH COULD ADVERSELY AFFECT OUR STOCK PRICE We believe that period-to-period comparisons of our operating results
cannot be relied upon as an indicator of our future performance. Our operating
results may be below the expectations of public market analysts or investors in
some future quarter. If this occurs, the price of our common stock would likely
decrease. Our operating results are likely to fluctuate in the future on both a
quarterly and an annual basis due to a number of factors, many of which are
outside our control. Factors that could cause our operating results to
fluctuate include variations in:  -
    
    the timing and size of orders and shipments of our products;  -
    
    the mix of products we sell;  -
    
    the mix of channels through which those products are sold;  -
    
    the average selling prices of our products; and  -
    
    the amount and timing of our operating expenses. In the past, we have experienced fluctuations in operating results.
Revenue fluctuations resulted primarily from variations in the volume and mix
of products sold and variations in channels through which products were sold.
Operating expenses in total may fluctuate between quarters due to the timing of
spending. For example, research and development expenses, specifically
prototype expenses, consulting fees and other program costs, have fluctuated
relative to the specific stage of product development of the various projects
underway. Sales and marketing expenses have fluctuated due to the timing of
specific events such as sales meetings or tradeshows, or the launch of new
products. Additionally, operating costs outside the United States are incurred
in local currencies, and are remeasured from the local currency to the U.S.
dollar upon consolidation. As exchange rates vary, these operating costs, when
remeasured, may differ from our prior performance and our expectations. See
Managements Discussion and Analysis of Financial Condition and Results of
Operations for detailed information on our operating results. 18




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IF WE DO NOT EXPAND OR ENHANCE OUR PRODUCT OFFERINGS OR RESPOND EFFECTIVELY AND
ON A TIMELY BASIS TO TECHNOLOGICAL CHANGE, OUR BUSINESS MAY NOT GROW OR WE MAY
LOSE CUSTOMERS AND MARKET SHARE Our future performance will depend on the successful development,
introduction and market acceptance of new and enhanced products that address
customer requirements in a cost-effective manner. We cannot assure you that our
technological approach will achieve broad market acceptance or that other
technologies or solutions will not supplant our approach. The application
traffic management solutions market is characterized by ongoing technological
change, frequent new product introductions, changes in customer requirements
and evolving industry standards. The introduction of new products, market
acceptance of products based on new or alternative technologies, or the
emergence of new industry standards, could render our existing products
obsolete or make it easier for other products to compete with our products.
Developments in router-based queuing schemes or alternative compression
technologies could also significantly reduce demand for our product. Our future
success will depend in part upon our ability to:  -
    
    develop and maintain competitive products;  -
    
    enhance our products by adding innovative features that differentiate our products from those of our competitors;  -
    
    bring products to market on a timely basis at competitive prices;  -
    
    identify and respond to emerging technological trends in the market; and  -
    
    respond effectively to new technological changes or new product announcements by others. We have in the past experienced delays in product development which to
date have not materially adversely affected us. However, these delays may occur
in the future and could result in a loss of customers and market share. WE MAY BE UNABLE TO COMPETE EFFECTIVELY WITH OTHER COMPANIES IN OUR MARKET
SECTOR WHO OFFER, OR MAY IN THE FUTURE OFFER, COMPETING TECHNOLOGIES We compete in a rapidly evolving and highly competitive sector of the
networking technology market. We expect competition to persist and intensify in
the future from a number of different sources. Increased competition could
result in reduced prices and gross margins for our products and could require
increased spending by us on research and development, sales and marketing and
customer support, any of which could harm our business. We compete with Cisco
Systems, Inc., other switch/router vendors and several small private companies
that utilize competing technologies to provide bandwidth management and
compression. 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 enterprise customers and service providers increased
bandwidth and infrastructure upgrades that increase the capacity of their
networks, which may lessen or delay the need for application traffic management
solutions. Some of our competitors and potential competitors are substantially larger
than we are and have significantly greater financial, sales and marketing,
technical, manufacturing and other resources and more established distribution
channels. 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. Our 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
market opportunity in the application traffic management solutions market, we
also expect that other companies may enter or announce an intention to enter
our market 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. 19




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THE AVERAGE SELLING PRICES OF OUR PRODUCTS COULD DECREASE RAPIDLY, WHICH MAY
NEGATIVELY IMPACT GROSS MARGINS AND REVENUES We may experience substantial period-to-period fluctuations in future
operating results due to the erosion of our average selling prices. The average
selling prices of our products could decrease in the future in response to
competitive pricing pressures, increased sales discounts, new product
introductions by us or our competitors or other factors. Therefore, to maintain
our gross margins, we must develop and introduce on a timely basis new products
and product enhancements and continually reduce our product costs. Our failure
to do so would cause our revenue and gross margins to decline. IF OUR INTERNATIONAL SALES EFFORTS ARE UNSUCCESSFUL, OUR BUSINESS WILL FAIL TO
GROW The failure of our indirect partners to sell our products internationally
will harm our business. Sales to customers outside of the Americas accounted
for 53% and 59% of net revenues for the three and six months ended June 30,
2004, respectively, and 55% and 56% of net revenues in 2003 and 2002,
respectively. Our ability to grow will depend in part on the expansion of
international sales, which will require success on the part of our resellers,
distributors and systems integrators in marketing our products. We intend to expand operations in our existing international markets and
to enter new international markets, which will demand management attention and
financial commitment. We may not be able to successfully sustain and expand our
international operations. In addition, a successful expansion of our
international operations and sales in foreign markets will require us to
develop relationships with suitable indirect channel partners operating abroad.
We may not be able to identify, attract or retain these indirect channel
partners. Furthermore, to increase revenues in international markets, we will need
to continue to establish foreign operations, to hire additional personnel to
run these operations and to maintain good relations with our foreign indirect
channel partners. To the extent that we are unable to successfully do so, our
growth in international sales will be limited. Our international sales are currently all U.S. dollar-denominated. As a
result, an increase in the value of the U.S. dollar relative to foreign
currencies could make our products less competitive in international markets.
In the future, we may elect to invoice some of our international customers in
local currency. Doing so will subject us to fluctuations in exchange rates
between the U.S. dollar and the particular local currency and could negatively
affect our financial performance. IF WE ARE UNABLE TO DEVELOP AND MAINTAIN STRONG PARTNERING RELATIONSHIPS WITH
OUR INDIRECT CHANNEL PARTNERS, OR IF THEIR SALES EFFORTS ON OUR BEHALF ARE NOT
SUCCESSFUL, OR IF THEY FAIL TO PROVIDE ADEQUATE SERVICES TO OUR END USER
CUSTOMERS, OUR SALES MAY SUFFER AND OUR REVENUES MAY NOT INCREASE We rely primarily on an indirect distribution channel consisting of
resellers, distributors and systems integrators for our revenues. Because many
of our indirect channel partners also sell competitive products, our success
and revenue growth will depend on our ability to develop and maintain strong
cooperative relationships with significant indirect channel partners, as well
as on the sales efforts and success of those indirect channel partners. We cannot assure you that our indirect channel partners will market our
products effectively or continue to devote the resources necessary to provide
us with effective sales, marketing and technical support. In order to support
and develop leads for our indirect distribution channels, we plan to continue
to expand our field sales and support staff as needed. We cannot assure you
that this internal expansion will be successfully completed, that the cost of
this expansion will not exceed the revenues generated or that our expanded
sales and support staff will be able to compete successfully against the
significantly more extensive and well-funded sales and marketing operations of
many of our current or potential competitors. In addition, our indirect channel
agreements are generally not exclusive and one or more of our channel partners
may compete directly with another channel partner for the sale of our products
in a particular region or market. This may cause such channel partners to stop
or reduce their efforts in marketing our products. Our inability to effectively
establish or manage our distribution channels would harm our sales. In addition, our indirect channel partners may provide services to our end
user customers that are inadequate or do not meet expectations. Such failures
to provide adequate services could result in customer dissatisfaction with us
or our products and services due to delays in maintenance and replacement,
decreases in our customers network availability and other losses. These
occurrences could result in the loss of customers and repeat orders and could
delay or limit market acceptance of our products, which would negatively affect
our sales and results of operations. 20




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SALES TO LARGE CUSTOMERS WOULD BE DIFFICULT TO REPLACE IF LOST A limited number of indirect channel partners have accounted for a large part
of our revenues to date and we expect that this trend will continue. Because
our expense levels are based on our expectations as to future revenue and to a
large extent are fixed in the short term, any significant reduction or delay in
sales of our products to any significant indirect channel partner or unexpected
returns from these indirect channel partners could harm our business. For the
three months ended June 30, 2004, sales to two customers, Alternative
Technology, Inc., and Westcon, Inc., accounted for 23% and 17% of total net
revenues, respectively. For the six months ended June 30, 2004, sales to the
same two customers each accounted for 21% of total net revenues. For the three
months ended June 30, 2003, two customers, Alternative Technology, Inc. and
Westcon, Inc., accounted for 24% and 13% of total net revenues, respectively.
For the six months ended June 30, 2003, the same two customers accounted for
23% and 14% of total net revenues, respectively. We expect that our largest
customers in the future could be different from our largest customers today.
End users can stop purchasing and indirect channel partners can stop marketing
our products at any time. We cannot assure you that we will retain these
indirect channel partners or that we will be able to obtain additional or
replacement partners. The loss of one or more of our key indirect channel
partners or the failure to obtain and ship a number of large orders each
quarter could harm our operating results. OUR RELIANCE ON SALES OF OUR PRODUCTS BY OTHERS MAKES IT DIFFICULT TO PREDICT
OUR REVENUES AND RESULTS OF OPERATIONS The timing of our revenues is difficult to predict because of our reliance
on indirect sales channels and the variability of our sales cycle. The length
of our sales cycle for sales through our indirect channel partners to our end
users may vary substantially depending upon the size of the order and the
distribution channel through which our products are sold. We generally do not have significant unfulfilled product orders at any
point in time. Substantially all of our revenues in any quarter depend upon
customer orders that we receive and fulfill in that quarter. To the extent that
an order that we anticipate will be received and fulfilled in a quarter is not
actually received in time to fulfill prior to the end of that quarter, we will
not be able to recognize any revenue associated with that order in the quarter.
If revenues forecasted in a particular quarter do not occur in that quarter,
our operating results for that quarter could be adversely affected. The greater
the volume of an anticipated order that is not timely received in a quarter,
the more material the potential adverse impact on our operating results.
Furthermore, because our expense levels are based on our expectations as to
future revenue and to a large extent are fixed in the short term, a substantial
reduction or delay in sales of our products or the loss of any significant
indirect channel partner could harm our business. WE FACE RISKS RELATED TO INVENTORIES OF OUR PRODUCTS HELD BY OUR DISTRIBUTORS Many of our distributors maintain inventories of our products. We work
closely with these distributors to monitor channel inventory levels so that
appropriate levels of products are available to resellers and end users.
However, if distributors reduce their levels of inventory or if they do not
maintain sufficient levels to meet customer demand, our sales could be
negatively impacted. Additionally, although we monitor and track channel inventory with our
distributors, overstocking could occur if the demand for our products were to
rapidly decline due to economic downturns, increased competition,
underperformance of distributors or the introduction of new products by our
competitors or ourselves. This could cause sales and cost of sales to fluctuate
from quarter to quarter. WE HAVE RELIED AND EXPECT TO CONTINUE TO RELY ON A LIMITED NUMBER OF PRODUCTS
FOR A SIGNIFICANT PORTION OF OUR REVENUES Most of our revenues have been derived from sales of our application
traffic management systems and related maintenance and training services. We
currently expect that our system-related revenues will continue to account for
a substantial percentage of our revenues in the remainder of 2004 and for the
foreseeable future thereafter. Our future operating results are significantly
dependent upon the continued market acceptance of our products and enhanced
applications. Our business will be harmed if our products do not continue to
achieve market acceptance or if we fail to develop and market improvements to
our products or new and enhanced products. A decline in demand for our
application traffic management systems as a result of competition,
technological change or other factors would harm our business. 21




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INTRODUCTION OF OUR NEW PRODUCTS MAY CAUSE CUSTOMERS TO DEFER PURCHASES OF OUR
EXISTING PRODUCTS WHICH COULD HARM OUR OPERATING RESULTS 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, increasing our
inventory levels of older products and exposing us to greater risk of product
obsolescence. OUR RELIANCE ON SMTC FOR ALL OF OUR MANUFACTURING REQUIREMENTS COULD CAUSE US
TO LOSE ORDERS IF THIS THIRD-PARTY MANUFACTURER FAILS TO SATISFY OUR COST,
QUALITY AND DELIVERY REQUIREMENTS We currently contract with SMTC for all of our manufacturing requirements.
Any manufacturing disruption could impair our ability to fulfill orders. Our
future success will depend, in significant part, on our ability to have SMTC or
others manufacture our products cost-effectively and in sufficient volumes. We
face a number of risks associated with our dependence on third-party
manufacturers including:  -
    
    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. We have no long-term contracts or arrangements with SMTC that guarantee
product availability, the continuation of particular payment terms or the
extension of credit limits. We have experienced in the past, and may experience
in the future, problems with our contract manufacturer, such as inferior
quality, insufficient quantities and late delivery of product. To date, these
problems have not materially adversely affected us. We may not be able to
obtain additional volume purchase or manufacturing arrangements with SMTC on
terms that we consider acceptable, if at all. If we enter into a high-volume or
long-term supply arrangement and subsequently decide that we cannot use the
products or services provided for in the agreement, our business will be
harmed. We cannot assure you that we can effectively manage SMTC or that SMTC
will meet our future requirements for timely delivery of products of sufficient
quality or quantity. Any of these difficulties could harm our relationships
with customers and cause us to lose orders. In the future, we may seek to use additional contract manufacturers. We
may experience difficulty in locating and qualifying suitable manufacturing
candidates capable of satisfying our product specifications or quantity
requirements, or we may be unable to obtain terms that are acceptable to us.
Further, new third-party manufacturers may encounter difficulties in the
manufacture of our products resulting in product delivery delays. MOST OF THE COMPONENTS FOR OUR PRODUCTS COME FROM SINGLE OR LIMITED SOURCES,
AND WE COULD LOSE SALES IF THESE SOURCES FAIL TO SATISFY OUR SUPPLY
REQUIREMENTS Almost all of the components used in our products are obtained from single
or limited sources. Our products have been designed to incorporate a particular
set of components. As a result, our desire to change the components of our
products or our inability to obtain suitable components on a timely basis would
require engineering changes to our products before we could incorporate
substitute components. Any such changes could be costly and result in lost
sales. We do not have any long-term supply contracts with any of our vendors to
ensure sources of supply. If our contract manufacturer fails to obtain
components in sufficient quantities when required, our business could be
harmed. Our suppliers also sell products to our competitors. Our suppliers may
enter into exclusive arrangements with our competitors, stop selling their
products or components to us at commercially reasonable prices or refuse to
sell their products or components to us at any price. Our inability to obtain
sufficient 22




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quantities of single-sourced or limited-sourced components, or to develop
alternative sources for components or products would harm our ability to
maintain and expand our business. POTENTIAL NEW ACCOUNTING PRONOUNCEMENTS ARE LIKELY TO IMPACT OUR FUTURE
FINANCIAL POSITION AND RESULTS OF OPERATIONS Proposed initiatives could result in changes in accounting rules,
including legislative and other proposals to account for employee stock options
as compensation expense. These and other potential changes could materially
increase the expenses we report under generally accepted accounting principles,
and adversely affect our operating results. ANY ACQUISITIONS WE MAKE COULD RESULT IN DILUTION TO OUR EXISTING STOCKHOLDERS
AND DIFFICULTIES IN SUCCESSFULLY MANAGING OUR BUSINESS We continually evaluate strategic acquisitions of other businesses. Our
consummation of the acquisition of other businesses would subject us to a
number of risks, including the following:  -
    
    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; and  -
    
    limitations on our ability to successfully incorporate
acquired technology and rights into our product and service offerings
and maintain uniform standards, controls,
procedures, and policies. Furthermore, we may incur indebtedness or issue equity securities to pay
for future acquisitions. The issuance of equity or convertible debt securities
could be dilutive to our existing stockholders. OUR INABILITY TO ATTRACT AND RETAIN QUALIFIED PERSONNEL COULD SIGNIFICANTLY
INTERRUPT OUR BUSINESS OPERATIONS Our future success 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. Competition for qualified personnel and management in the networking
industry, including engineers, sales and service and support personnel, is
intense, and we may not be successful in attracting and retaining such
personnel. There may be only a limited number of persons with the requisite
skills to serve in these key positions and it may become increasingly difficult
to hire such persons. Competitors and others have in the past and may in the
future attempt to recruit our employees. With the exception of our CEO, we do
not have employment contracts with any of our personnel. Our business will
suffer if we encounter delays in hiring additional personnel as needed. IF WE ARE UNABLE TO EFFECTIVELY MANAGE OUR GROWTH, WE MAY EXPERIENCE OPERATING
INEFFICIENCIES AND HAVE DIFFICULTY MEETING DEMAND FOR OUR PRODUCTS In the past, we have experienced rapid and significant expansion of our
operations. If further rapid and significant expansion is required to address
potential growth in our customer base and market opportunities, 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. In the future, we may experience difficulties meeting the demand for our
products and services. The use of our products requires training, which is
provided by our channel partners, as well as ourselves. If we are unable to
provide training and support for our products in a timely manner, 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. 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. 23




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OUR PRODUCTS MAY HAVE ERRORS OR DEFECTS THAT WE FIND AFTER THE PRODUCTS HAVE
BEEN SOLD, WHICH COULD INCREASE OUR COSTS AND NEGATIVELY AFFECT OUR REVENUES
AND THE MARKET ACCEPTANCE OF OUR PRODUCTS Our products are complex and may contain undetected defects, errors or
failures in either the hardware or software. In addition, because our products
plug into our end users existing networks, they can directly affect the
functionality of the network. Furthermore, end users rely on our products to
maintain acceptable service levels. We have in the past encountered errors in
our products, which in a few instances resulted in network failures and in a
number of instances resulted in degraded service. To date, these errors have
not materially adversely affected us. Additional errors may occur in our
products in the future. The occurrence of defects, errors or failures could
result in the failure of our customers network or mission-critical
applications, delays in installation, product returns and other losses to us or
to our customers or end users. In addition, we would have limited experience
responding to new problems that could arise with any new products that we
introduce. These occurrences could also result in the loss of or delay in
market acceptance of our products, which could harm our business. We may also be subject to liability claims for damages related to product
errors. While we carry insurance policies covering this type of liability,
these policies may not provide sufficient protection should a claim be
asserted. A material product liability claim may harm our business. FAILURE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY WOULD RESULT IN
SIGNIFICANT HARM TO OUR BUSINESS Our success depends significantly upon our proprietary technology and our
failure or inability to protect our proprietary technology would result in
significant harm to our business. We rely on a combination of patent, copyright
and trademark laws, and on trade secrets, confidentiality provisions and other
contractual provisions to protect our proprietary rights. These measures afford
only limited protection. As of June 30, 2004, we have 13 issued U.S. patents
and 46 pending U.S. patent applications. Currently, none of our technology is
patented outside of the United States. Our means of protecting our proprietary
rights in the U.S. or abroad may not be adequate and competitors may
independently develop similar technologies. Our future success will depend in
part on our ability to protect our proprietary rights and the technologies used
in our principal products. Despite our efforts to protect our proprietary
rights and technologies unauthorized parties may attempt to copy aspects of our
products or to obtain and use trade secrets or other information that we regard
as proprietary. Legal proceedings to enforce our intellectual property rights
could be burdensome and expensive and could involve a high degree of
uncertainty. These legal proceedings may also divert managements attention
from growing our business. In addition, the laws of some foreign countries do
not protect our proprietary rights as fully as do the laws of the U.S. Issued
patents may not preserve our proprietary position. If we do not enforce and
protect our intellectual property, our business will suffer substantial harm. CLAIMS BY OTHERS THAT WE INFRINGE ON THEIR INTELLECTUAL PROPERTY RIGHTS COULD
BE COSTLY TO DEFEND AND COULD HARM OUR BUSINESS We may be subject to claims by others that our products infringe on their
intellectual property rights. These claims, whether or not valid, could require
us to spend significant sums in litigation, pay damages, delay product
shipments, reengineer our products or acquire licenses to such third-party
intellectual property. We may not be able to secure any required licenses on
commercially reasonable terms, or at all. We expect that we will increasingly
be subject to infringement claims as the number of products and competitors in
the application traffic management solutions market grows and the functionality
of products overlaps. Any of these claims or resulting events could harm our
business. IF OUR PRODUCTS DO NOT COMPLY WITH EVOLVING INDUSTRY STANDARDS AND GOVERNMENT
REGULATIONS, OUR BUSINESS COULD BE HARMED The market for application traffic management solutions is characterized
by the need to support industry standards as these different standards emerge,
evolve and achieve acceptance. In the United States, our products must comply
with various regulations and standards defined by the Federal Communications
Commission and Underwriters Laboratories. Internationally, products that we
develop must comply with standards established by the International
Electrotechnical Commission as well as with recommendations of the
International Telecommunication Union. To remain competitive we must continue
to introduce new products and product enhancements that meet these emerging
U.S. and international standards. However, in the future 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. 24




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Failure to comply with existing or evolving industry standards or to
obtain timely domestic or foreign regulatory approvals or certificates could
harm our business. OUR GROWTH AND OPERATING RESULTS WOULD BE IMPAIRED IF WE ARE UNABLE TO MEET OUR
FUTURE CAPITAL REQUIREMENTS We currently anticipate that our existing cash and investment balances
will be sufficient to meet our liquidity needs for the foreseeable future.
However, we may need to raise additional funds if our estimates of revenues,
working capital or capital expenditure requirements change or prove inaccurate
or in order for us to respond to unforeseen technological or marketing hurdles
or to take advantage of unanticipated opportunities. In addition, we expect to review potential acquisitions that would
complement our existing product offerings or enhance our technical
capabilities. While we have no current agreements or negotiations underway with
respect to any such acquisition, any future transaction of this nature could
require potentially significant amounts of capital. These funds may not be
available at the time or times needed, or available on terms acceptable to us.
If adequate funds are not available, or are not available on acceptable terms,
we may not be able to take advantage of market opportunities to develop new
products or to otherwise respond to competitive pressures. CERTAIN PROVISIONS OF OUR CHARTER AND OF DELAWARE LAW MAKE A TAKEOVER OF
PACKETEER MORE DIFFICULT, WHICH COULD LOWER THE MARKET PRICE OF THE COMMON
STOCK Our corporate documents and Section 203 of the Delaware General
Corporation Law could discourage, delay or prevent a third- party or a
significant stockholder from acquiring control of Packeteer. In addition,
provisions of our certificate of incorporation may have the effect of
discouraging, delaying or preventing a merger, tender offer or proxy contest
involving Packeteer. Any of these anti-takeover provisions could lower the
market price of the common stock and could deprive our stockholders of the
opportunity to receive a premium for their common stock that they might
otherwise receive from the sale of Packeteer. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS Fixed Income Investments Our exposure to market risks for changes in interest rates and principal
relates primarily to investments in debt securities issued by U.S. government
agencies and corporate debt securities. We place our investments with high
credit quality issuers and, by policy, limit the amount of the credit exposure
to any one issuer. Our investment securities are classified as
available-for-sale and consequently are recorded on the balance sheet at fair
value with unrealized gains and losses reported as a separate component of
accumulated other comprehensive income (loss). We do not use derivative financial instruments. In general our policy is
to limit the risk of principal loss and ensure the safety of invested funds by
limiting market and credit risk. All highly liquid investments with less than
three months to maturity from date of purchase are considered to be cash
equivalents; investments with maturities between three and twelve months are
considered to be short-term investments; and investments with maturities in
excess of twelve months from the balance sheet date are considered to be
long-term investments. The following table presents the amortized cost, fair
value and related weighted-average interest rates by year of maturity for our
investment portfolio as of June 30, 2004 and comparable fair values as of
December 31, 2003 (in thousands): Amortized Cost at June 30, 2004
    
    June 30,2004
    
    December31, 2003Expected Maturity Date
    
    2004
    
    2005
    
    2006
    
    Total
    
    Fair Value
    
    Fair ValueCash equivalents
    
    $
    30,516
    
    
    $
    
    
    
    $
    
    
    
    $
    30,516
    
    
    $
    30,496
    
    
    $
    24,102Weighted-average rate
    
    
    1.14
    %
    
    
    
    
    
    
    Short-term investments
    
    
    35,020
    
    
    
    25,440
    
    
    
    
    
    
    
    60,460
    
    
    
    60,292
    
    
    
    54,317Weighted-average rate
    
    
    1.38
    %
    
    
    1.46
    %
    
    
    Long-term investments
    
    
    
    
    
    
    4,272
    
    
    
    2,103
    
    
    
    6,375
    
    
    
    6,316
    
    
    
    6,726Weighted-average rate
    
    
    
    
    
    
    1.33
    %
    
    
    2.07
    %Total investment portfolio
    
    $
    65,536
    
    
    $
    29,712
    
    
    $
    2,103
    
    
    $
    97,351
    
    
    $
    97,104
    
    
    $
    85,145
 25




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Foreign Exchange We develop products in North America and sell in the Americas, Asia,
Europe and the rest of the world. As a result, our financial results could be
affected by factors such as changes in foreign currency exchange rates or weak
economic conditions in worldwide markets. All sales are currently made in U.S.
dollars; and as a result, a strengthening of the dollar could make our products
less competitive in foreign markets. All operating costs outside the United
States are incurred in local currencies, and are remeasured from the local
currency to U.S. dollars upon consolidation. As exchange rates vary, these
operating costs, when remeasured, may differ from our prior performance and our
expectations. We have no foreign exchange contracts, option contracts or other
foreign currency hedging arrangements. 
 ITEM 4. CONTROLS AND PROCEDURES We have performed an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and
Chief Financial Officer, 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
management, including our Chief Executive Officer and Chief Financial Officer,
concluded that our disclosure controls and procedures were effective as of the
end of the period covered by this quarterly report.There has been no change in
our internal control over financial reporting during the three months ending
June 30, 2004 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 The information set forth under Note 3, entitled Contingencies, of the
Notes to Condensed Consolidated Financial Statements, is incorporated herein by
reference. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Annual Stockholders Meeting was held on May 26, 2004 for the
following purposes: (1) to elect one director to serve until the 2007 Annual
Meeting of Stockholders, and until his successor is duly elected and qualified
and (2) to ratify the appointment of KPMG LLP as our independent auditors for
the year ending December 31, 2004.  1.
    
    The following person was elected as director of the Company to serve until
the 2007 Annual Stockholders Meeting, and until
his successor is duly elected and qualified, with the votes indicated
below: Votes For
    
    Votes WithheldDave Côté
    
    
    29,379,604
    
    
    
    446,898
  Proxies were solicited pursuant to Section 14(a) of the Securities Exchange
Act of 1934 and there was no solicitation in opposition to managements
nominee. 26




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2.
    
    The proposal to ratify the appointment of KPMG LLP as the Companys
independent auditors for the fiscal year ending December
31, 2004 was approved with the following votes: For:
    
    
    28,892,209Against or Withheld:
    
    
    928,993Abstain:
    
    
    5,300
 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS Exhibit 31.1 Sarbanes-Oxley Section 302 Certification  CEO Exhibit 31.2 Sarbanes-Oxley Section 302 Certification   CFO Exhibit 32.1 Sarbanes-Oxley Section 906 Certification  CEO Exhibit 32.2 Sarbanes-Oxley Section 906 Certification  CFO (b) REPORTS ON FORM 8-K The Company filed a Current Report on Form 8-K dated April 22, 2004,
furnishing under Item 12 a press release reporting the Companys results of
operations for the quarter ended March 31, 2004. 
 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this Quarterly[TSL1]
Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Cupertino, State of California, on this 30th
day of July, 2004. PACKETEER, INC.By:
    
    /s/ DAVE CÔTÉDave CôtéPresident and Chief Executive OfficerBy:
    
    /s/ DAVID YNTEMADavid YntemaChief Financial Officer and Secretary
 27