**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-KSB**







(Mark
      One)


x  Annual
      report under Section 13 or 15(d) of the Securities Exchange Act of 1934 for
      the
      fiscal year ended December 31, 2006





 ̈  Transition
      report under Section 13 or 15(d) of the Securities Exchange Act of 1934 for
      the
      transition period from ____ to______.








Commission
      file number: 000-49862





PROCERA
      NETWORKS, INC.





(Name
      of
      small business issuer in its charter)





Nevada
            
            33-0974674(State
                or other jurisdiction of incorporation or organization)
            
            (IRS
                Employer Identification No.)





100
                Cooper Court, Los Gatos, California
            
            95032(Address
                of principal executive offices)
            
            (Zip
                Code)





Issuer's
                telephone Number
            (408)
                354-7200




Securities
      registered under Section 12(b) of the Exchange Act:





Common
      Stock, $0.001 par value Common





Check
      whether the issuer is not required to file reports pursuant to Section 13 or
      15
      (d) of the Exchange Act.  ̈





Check
      whether the issuer: (1) filed all reports required to be filed by Section 13
      or
      15(d) of the Exchange Act during the past 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  ̈





Check
      if
      there is no disclosure of delinquent filers in response to Item 405 of
      Regulation S-B contained in this form, and no disclosure will be contained,
      to
      the best of registrant’s knowledge, in definitive proxy or information
      statements incorporated by reference in Part III of this Form 10-KSB or any
      amendment to this form 10-KSB.  ̈





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





State
      issuer’s consolidated revenue for its most recent fiscal year: $1,915,760 for
      the fiscal year ended December 31, 2006.





The
      aggregate market value of common shares of voting and non-voting common shares
      held by non-affiliates, based on the price at which common equity was sold
      as of
      March 30, 2007 was $161,849,784. Shares of common stock held by each officer,
      director and holder of 5% or more of the outstanding common stock have been
      excluded in that such persons may be deemed to be affiliates. This determination
      of affiliate status is not necessarily a conclusive determination for other
      purposes.







1





**TABLE
      OF CONTENTS**




PagePART
                IItem
                1
            Description
                of Business
            3Item
                2
            Description
                of Property
            12Item
                3
            Legal
                Proceedings
            12Item
                4
            Submission
                of Matters to a Vote of Security
                Holders
            12PART
                IIItem
                5
            Market
                for Common Equity and Related Stockholder
                Matters
            12Item
                6
            Management's
                Discussion and Analysis of Financial Condition and
                Results of Operation
            14Item
                7
            Financial
                Statements
            23Item
                8
            Changes
                in and Disagreements with Accountants on Accounting and
                Financial Disclosures
            67Item
                8A
            Controls
                and Procedures
            67Item
                8B
            Other
                Information
            68PART
                IIIItem
                9
            Directors
                and Executive Officers of the
                Registrant
            68Item
                10
            Executive
                Compensation
            71Item
                11
            Security
                Ownership of Certain Beneficial Owners and Management
                and Related Stockholder Matters
            73Item
                12
            Certain
                Relationships and Related
                Transactions
            74Item
                13
            Exhibits
            74Item
                14
            Principal
                Accounting Fees and Services
            75SignaturesIndex
                to ExhibitsCertification




2





**PART
      I**




This
      report contains forward-looking statements within the meaning of Section 21E
      of
      the Securities Exchange Act of 1934 (the "Exchange Act"). We have based these
      forward-looking statements largely on our current expectations and projections
      about future events and financial trends affecting the financial condition
      of
      our business. These forward-looking statements are subject to a number of risks,
      uncertainties and assumptions, including, among other things:





-
            general
                economic and business conditions, both nationally and internationally
                and
                in our markets,


-
            our
                history of losses,


-
            our
                expectations and estimates concerning future financial performance,
                financing plans and the impact of
                competition,


-
            our
                ability to implement our growth
                strategy,


-
            anticipated
                trends in our business,


-
            advances
                in technologies, and


-
            other
                risk factors set forth under "Risk Factors" in this annual
                report.





In
      addition, in this report, we use words such as "anticipates," "believes,"
      "plans," "expects," "future," "intends," and similar expressions to identify
      forward-looking statements.





We
      undertake no obligation to update publicly or revise any forward-looking
      statements, whether as a result of new information, future events or otherwise
      after the date of this report. In light of these risks and uncertainties, the
      forward-looking events and circumstances discussed in this report may not occur
      and actual results could differ materially from those anticipated or implied
      in
      the forward-looking statements.





For
      the
      purpose of this annual report on Form 10-KSB, all reference to “we”, “our”, “us”
or similar references are for the combined business operations of Procera,
      Netintact AB and Netintact PTY (all as defined below).





**ITEM
                1****.**
            **DESCRIPTION
                OF BUSINESS****.**





Corporate
      History





Procera
      Networks, Inc. (“ ***Procera*** ”)
      is a
      Nevada corporation and is headquartered in Los Gatos, California. Procera was
      spun out from Digi International of Eden Prairie, Minnesota by Douglas Glader
      on
      May 1, 2002. On October 16, 2003, Procera merged with Zowcom, Inc, a
      publicly-traded Nevada corporation. The merged company started trading under
      the
      symbol OTC: BB:PRNW.OB.





On
      June
      28, 2006, Procera and all shareholders of Netintact AB, a Swedish corporation
      (" ***Netintact*** ")
      entered into a First Amended and Restated Stock Exchange Agreement and Plan
      of
      Reorganization (the " ***Agreement*** "),
      and
      closed the transaction effective August 18, 2006, making Netintact a wholly
      owned subsidiary of Procera. The Agreement was amended on January 24, 2007
      to,
      among other things, amend several of the terms and conditions of the incentive
      warrants and closing date warrants. A copy of amended is attached hereto to
      this
      Report.





On
      September 29, 2006, Procera and two of the three shareholders of Netintact
      PTY,
      an Australian company (“ ***Netintact
      PTY*** ”)
      entered into a certain Stock Exchange Agreement and Plan of Reorganization
      for
      the purchase of forty-nine percent (49%) of the issued and outstanding
      securities of Netintact PTY and closed the transaction effective as of September
      29, 2006. Netintact, the remaining shareholder of Netintact PTY, owns 51 shares
      of Common Stock of Netintact PTY, constituting fifty-one (51%) of the issued
      and
      outstanding securities of Netintact PTY. At the close of this transaction,
      Procera owned 100% of the outstanding shares of Netintact, PTY.





Netintact,
      AB developed a deep packet flow based product family, called PacketLogic, and
      sold this product family over a period of 3 years to some 200 customers mainly
      in Scandinavia (at the time of the merger). As a result of the Netintact AB
      and
      Netintact PTY mergers, the nature of our business has changed dramatically.
      The
      PacketLogic family of products now forms the core of our product offerings.
      There are now over 600 PacketLogic installations at more than 300 customers
      worldwide.





Industry
      Background





According
      to a May 2006 report by International Data Corporation, or IDC, a provider
      of
      information about the telecommunications market, the number of broadband
      subscribers globally is expected to reach 396 million by 2010, representing
      a
      compound annual growth rate of 14% of the 206 million estimated subscribers
      in
      2005. There has been tremendous growth in broadband network access in recent
      years as both home and business users worldwide demand faster and more reliable
      access to the Internet.





It
      is
      widely reported in both industry press and the popular press that a crisis
      on
      the network will emerge in 2007, driven primarily by the very large increase
      in
      the number of video applications that are now being used by internet users.
      Popular reports indicate that this looming crisis will strongly affect Internet
      Service Providers (“ ***ISP's*** ”)
      and
      enterprises worldwide. Triple-play networks (video, voice, and data) are now
      common, with mobile devices and applications increasingly being supported.
      Today's applications are incorporating voice and video freely as demonstrated
      by
      You Tube, Skype, Slingbox, Joost, Internet TV, Voice-over-IP, and Internet
      Gaming. These new applications demand more bandwidth and are less tolerant
      of
      network delays. Furthermore, many of these applications are increasingly
      difficult to detect often disguising themselves, jumping ports, or encrypting
      to
      avoid detection. The impact can be ruinous for the enterprise, e-mail, CRM,
      ERP,
      and other mission-critical applications and for service providers. To compound
      matters, regulatory compliance requirements from CALEA are now mandating an
      unprecedented level of visibility, traceability, and accountability over network
      activity.





3





In
      this
      new complex network world, the old tried and true approaches of simply adding
      more bandwidth and/or inspecting packets won’t work. The dot-com boom led to an
      overbuilding and overcapacity of bandwidth. So following the dot-com bust,
      throwing more bandwidth to the problem was the cheap and expedient solution
      to
      growing congestion. Now, the demand for bandwidth is reported to have caught
      up
      with supply. Equally significant, there is growing awareness that the new breed
      of applications would cause network congestion even if additional bandwidth
      was
      still inexpensive.





There
      are
      several products that attempt to solve the problems set out above. These
      products are all based on packet inspection. These products, using technology
      called deep packet inspection (” ***DPI*** ”),
      have
      been popular in the past, but cope poorly with the new environment. This is
      because tracking only packets is similar to receiving only fragments of a
      telephone conversation. It is hard to figure out what is going on. A packet
      sampling based approach often leads to incorrect conclusions and identification
      especially now that applications commonly disguise, morph and encrypt themselves
      to avoid detection.




The
      Procera Solution





The
      growing crisis on the network in the form of increased congestion has led to
      the
      opportunity for our products which use a more accurate approach to network
      traffic analysis than competitors.





PacketLogic
      is designed for ISPs and broadband service networks as a flow-based
      intelligent network traffic and service management system. The core of the
      product suite functionality is a proprietary engine called Datastream
      Recognition Definition Language (“ ***DRDL*** ”)
      that
      provides network traffic identification and control availability based on
      the inspection of packet flows. The Company calls this approach Deep Flow
      Inspection (“ **DFI** ”).
      DFI
      looks at the flow of many packets in both directions to make decisions about
      network usage. DFI yields significantly more accurate identification of
      applications when compared to packet-based approaches *or
      DPI* .
      Because
      DFI examines flows and context, it is better at detecting disguised, morphed
      and
      encrypted traffic. Furthermore, PacketLogic's identification engine is
      identifying internet traffic at wire-line speed. And Accurate identification
      of
      the traffic in a network is of course the critical first step to achieving
      control.





Applications





Our
      core
      market is the commercial broadband service providers. This includes ISP's,
      telephone companies, wireless ISP **(WiSP's)** ,
      FTTx
      (Fiber-to-the-Home, Fiber-to-the-Premise), and cable companies.





Additionally,
      we have customer installations concentrated in certain vertical markets where
      broadband service deployments are accelerating, particularly utilizing wireless
      technologies or where compliance mandates value our highly accurate
      identification methodology. These segments include:


·
            Hospitality;


·
            Multi-tenant
                units;


·
            Municipalities;


·
            Universities
                and Colleges; and


·
            Lawful
                Intercept Compliance (CALEA)




Distribution





We
      utilize our own direct sales force to target the largest broadband service
      providers, telcos, carriers and enterprises. Procera also engages a worldwide
      network of value added resellers (“VAR”) to penetrate particular geographic
      regions and market segments. The direct and indirect sales mix varies by
      geography and target industry.





4





Competition





Our
      primary competitors are Allot, Sandvine, Cisco/P-cube and Ellocoya. These
      companies generally employ some form of single packet inspection methodology,
      implemented to some degree in custom hardware. We
      compete effectively in our market sub-segments. This is because PacketLogic's
      DFI approach yields higher identification accuracy and more timely response
      to
      newly released internet applications. We believe our current products provide
      our customers with superior performance, quality, and cost.




Intellectual
      Property




Our
      intellectual property(“IP”) includes several years of software development by an
      exceptionally highly trained team of programmers in Sweden. The core IP is
      protected by trade secret law and contractual rights. We have also filed patent
      applications with broad claims that if allowed may cover a rich combination
      of
      design and algorithms that may be fundamental to future solutions in the areas
      of our core markets We currently require all employees to sign confidentiality
      agreements as well as invention assignment agreements. All our design and
      architecture work is done at our Research and Development center in Varberg,
      Sweden.





Employees





As
      of
      December 31, 2006, we employed 41 people, of which 16 were employed in
      engineering, 3 in operations, 15 in sales and marketing, and 7 in management
      and
      administration. Of this, 14 are employees of Netintact AB and 2 of Netintact
      PTY. None of our employees are members of a labor union. Management believes
      that relations with our employees are good.








**RISK
      FACTORS**





Any
      of
      the following risks could materially adversely affect our business, financial
      condition, or operating results.





**WE
      HAVE A LIMITED OPERATING HISTORY ON WHICH TO EVALUATE OUR POTENTIAL FOR FUTURE
      SUCCESS.**





We
      completed the merger of Netintact on August 18, 2006 and Netintact, PTY on
      September 29, 2006. The products we sell are exclusively from the merged
      company. While we have the experience of Netintact operations on a stand alone
      basis, we have had limited operating history on a combined basis upon which
      we
      can evaluate our business and prospects. We have yet to develop sufficient
      experience regarding actual revenues to be achieved from our combined
      operations.





We
      have
      only recently launched many of the products and services on a worldwide basis.
      You must consider the risks and uncertainties frequently encountered by
      companies in new and rapidly evolving markets. If we are unsuccessful in
      addressing these risks and uncertainties, our business, results of operations
      and financial condition could be materially and adversely affected.





**WE
      EXPECT LOSSES FOR THE FORSEEABLE FUTURE.**





For
      the
      twelve months ended December 31, 2006 we had losses from operations of
      $(7,503,479). We will continue to incur losses from operations for the
      foreseeable future. These losses will result primarily from costs related to
      investment in sales and marketing, product development and administrative
      expenses. Our management believes these expenditures are necessary to build
      and
      maintain hardware and software technology and to further penetrate the markets
      for our products. If our revenue growth is slower than anticipated or our
      operating expenses exceed expectations, our losses will be greater. We may
      never
      achieve profitability.




**WE
      WILL NEED FURTHER CAPITAL.**





Based
      on
      curent reserves and anticipated cash flow from operations, our working capital
      will be insufficient to meet the needs of our business in the second half of
      2007. As a result, we anticipate raising additional capital in the near term.
      If
      additional funds are raised through the issuance of equity or convertible debt
      securities, the percentage ownership of our stockholders will be reduced,
      stockholders may experience additional dilution and such securities may have
      rights, preferences and privileges senior to those of our common stock. There
      can be no assurance that additional financing will be available on terms
      favorable to us or at all. If adequate funds are not available on acceptable
      terms, we may not be able to fund expansion, take advantage of unanticipated
      growth or acquisition opportunities, develop or enhance services or products
      or
      respond to competitive pressures. In addition, we may be required to cancel
      product development programs and/or lay-off employees. Such inability could
      have
      a material adverse effect on our business, results of operations and financial
      condition.





5





**HOLDERS
      OF OUR COMMON STOCK MAY BE DILUTED IN THE FUTURE.**





We
      are
      authorized to issue up to 100,000,000 shares of common stock and 15,000,000
      shares of preferred stock and to the extent of such authorization, our Board
      of
      Directors will have the ability, without seeking stockholder approval, to issue
      additional shares of common stock and/or preferred stock in the future for
      such
      consideration as our Board of Directors may consider sufficient. The issuance
      of
      additional common stock and/or preferred stock in the future will reduce the
      proportionate ownership and voting power of our common stock held by existing
      stockholders. At December 31, 2006 there were 67,663,855 shares of common stock
      outstanding, warrants to purchase 8,901,344 shares of common stock, stock
      options to purchase 5,483,784 shares of common stock. In addition, there are
      ungranted stock options to purchase 2,016,216 shares of common stock pursuant
      to
      our stock option plans, 166,250 shares for warrants paid for in December 2006,
      and 5,462,758 shares of common stock reserved but not issued for incentive
      shares resulting from Procera's acquisition of Netintact and Netintact
      PTY.




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




Our
      performance is substantially dependent on the continued services and on the
      performance of our executive officers and other key employees, particularly
      Douglas J. Glader (Chief Executive Officer), Gary J. Johnson (Senior Vice
      President of Sales and Marketing), Sven-Eric Nowicki (President of Netintact),
      Alexander Havang (Chief Technical Officer), Thomas Williams (Chief Financial
      Oficer), Jon Linden (Vice President, European Sales) Albert Lopez (Vice
      President Product Management) and Paul Eovino (Controller) . The loss of the
      services of any of our executive officers or other key employees could
      materially and adversely affect our business. We believe we will need to
      attract, retain and motivate talented management and other highly skilled
      employees to be successful. We may be unable to retain our key employees or
      attract, assimilate and retain other highly qualified employees in the future.
      Competitors and others have in the past, and may in the future, attempt to
      recruit our employees. We currently do not have key person insurance in place.
      If we lose one of the key officers, we must attract, hire, and retain an equally
      competent person to take his place. There is no assurance that we would be
      able
      to find such an employee. If we fail to recruit an equally qualified replacement
      or incur a significant delay, our business plans may slow down or stop. We
      could
      fail to implement our strategy or lose the sales and marketing and development
      momentum.




**WE
      MAY BE UNABLE TO COMPETE EFFECTIVELY WITH OTHER COMPANIES IN OUR MARKET SECTOR
      WHO ARE SUBSTANTIALLY LARGER AND MORE ESTABLISHED AND HAVE SIGNIFICANTLY GREATER
      RESOURCES.**





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 it on research and development, sales and marketing and customer
      support, any of which could have a negative financial impact on our business.
      We
      compete with Cisco Systems/P-Cube, Allot, Ellocoya, and Sandvine, as well as
      other companies which sell products incorporating competing technologies. In
      addition, our products and technology compete for information technology budget
      allocations with products that offer monitoring capabilities, such as probes
      and
      related software. Lastly, we face indirect competition from companies that
      offer
      service providers increased bandwidth and infrastructure upgrades that increase
      the capacity of their networks, which may lessen or delay the need for bandwidth
      management solutions.





6





Many
      of
      our 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. These competitors may enter
      our existing or future markets with solutions that may be less expensive,
      provide higher performance or additional features or be introduced earlier
      than
      our solutions. Given the market opportunity in the bandwidth management
      solutions market, we also expect that other companies may 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.





**OUR
      FAMILY OF PRODUCTS IS CURRENTLY OUR ONLY SUITE OF PRODUCTS, AND ALL OF OUR
      CURRENT REVENUES AND A SIGNIFICANT PORTION OF OUR FUTURE GROWTH DEPENDS ON
      OUR
      COMMERCIAL SUCCESS.**





All
      of
      our current revenues and a significant portion of our future growth depend
      on
      the commercial success of our PacketLogic family of products. If we target
      customers that do not widely adopt, purchase and successfully deploy our
      PacketLogic products, our revenues will not grow significantly.





**THE
      MARKET IN WHICH WE COMPETE IS SUBJECT TO RAPID TECHNOLOGICAL PROGRESS AND TO
      COMPETE WE MUST CONTINUALLY INTRODUCE NEW PRODUCTS THAT ACHIEVE BROAD MARKET
      ACCEPTANCE.**





The
      network equipment market is characterized by rapid technological progress,
      frequent new product introductions, changes in customer requirements and
      evolving industry standards. If we do not regularly introduce new products
      in
      this dynamic environment, our product lines will become obsolete. Developments
      in routers and routing software could also significantly reduce demand for
      our
      products. Alternative technologies could achieve widespread market acceptance
      and displace the technology on which we have based our product architecture.
      We
      cannot assure you that our technological approach will achieve broad market
      acceptance or that other technology or devices will not supplant our products
      and technology.





**IF
      THE BANDWIDTH MANAGEMENT SOLUTIONS MARKET FAILS TO GROW, OUR BUSINESS WILL
      BE
      ADVERSELY AFFECTED.**





The
      market for bandwidth management solutions is in an early stage of development
      and our success is not guaranteed. Therefore, we cannot accurately predict
      the
      future size of the market, the products needed to address the market, the
      optimal distribution strategy, or the competitive environment that will develop.
      In order for us to 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. The growth of the bandwidth management solutions market also depends
      upon a number of factors, including the availability of inexpensive bandwidth,
      especially in international markets, and the growth of wide area networks.
      The
      failure of the market to rapidly grow would adversely affect our sales and
      sales
      prospects leading to sustained financial losses.




**FUTURE
      PERFORMANCE WILL DEPEND ON THE INTRODUCTION AND ACCEPTANCE OF NEW
      PRODUCTS.**





Our
      future performance will also depend on the successful development, introduction
      and market acceptance of new and enhanced products that address customer
      requirements in a timely and cost-effective manner. In the past, we have
      experienced delays in product development and such delays may occur in the
      future. The introduction of new and enhanced products may cause our customers
      to
      defer or cancel orders for existing products. Such actions would substantially
      hurt sales and negatively affect future profitability.





7





**INTRODUCTION
      OF 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 inventory levels of older products
      and exposing it to greater risk of product obsolescence.




**IF
      WE ARE UNABLE TO EFFECTIVELY MANAGE OUR GROWTH, WE MAY EXPERIENCE OPERATING
      INEFFICIENCIES AND HAVE DIFFICULTY MEETING DEMAND FOR OUR
      PRODUCTS.**





We
      have
      been careful to regulate our growth due to capital requirements. If our customer
      base and market grow rapidly, we would need to expand to meet this demand.
      This
      expansion could place a significant strain on our management, products and
      support operations, sales and marketing personnel and other resources, which
      could harm our business.





In
      the
      future, we may experience difficulties meeting the demand for our products
      and
      services. The installation and use of our products requires training. If we
      are
      unable to provide training and support for our products, the implementation
      process will be longer and customer satisfaction may be lower. In addition,
      our
      management team may not be able to achieve the rapid execution necessary to
      fully exploit the market for our products and services. We cannot assure you
      that our systems, procedures or controls will be adequate to support the
      anticipated growth in our operations. The failure to meet the challenges
      presented by rapid customer and market expansion would cause us to miss sales
      opportunities and otherwise have a negative impact on our sales and
      profitability.





We
      may
      not be able to install management information and control systems in an
      efficient and timely manner, and our current or planned personnel, systems,
      procedures and controls may not be adequate to support our future
      operations.





**WE
      HAVE LIMITED ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY AND DEFEND AGAINST
      CLAIMS MAY ADVERSELY AFFECT OUR ABILITY TO COMPETE.**





For
      our
      primary line of PacketLogic products, we rely on trade secret law, contractual
      rights and trademark law to protect our intellectual property rights and for
      the
      intellectual property we developed prior to the acquisition of Netintact, we
      rely on a combination of copyright, trademark and trade secret laws and
      restrictions on disclosure to protect our intellectual property rights. We
      cannot assure you that the actions we have taken will adequately protect our
      intellectual property rights or that other parties will not independently
      develop similar or competing products that do not infringe on our patents.
      We
      enter into confidentiality or license agreements with our employees, consultants
      and corporate partners, and control access to and distribution of the software,
      documentation and other proprietary information. Despite our efforts to protect
      our proprietary rights, unauthorized parties may attempt to copy or otherwise
      misappropriate or use our products or technology.





Our
      industry is characterized by the existence of a large number of patents and
      frequent claims and related litigation regarding patent and other intellectual
      property rights. If we are found to infringe the proprietary rights of others,
      or if we otherwise settle such claims, we could be compelled to pay damages
      or
      royalties and either obtain a license to those intellectual property rights
      or
      alter our products so that they no longer infringe upon such proprietary rights.
      Any license could be very expensive to obtain or may not be available at all.
      Similarly, changing our products or processes to avoid infringing the rights
      of
      others may be costly or impractical. Litigation resulting from claims that
      we
      are infringing the proprietary rights of others could result in substantial
      costs and a diversion of resources, and could have a material adverse effect
      on
      our business, financial condition and results of operations.





**WE
      EXPECT OUR PRODUCTION VOLUME TO INCREASE CAUSING DEPENDENCE ON CONTRACT
      MANUFACTURERS WHICH COULD HARM OUR OPERATING RESULTS.**





If
      the
      demand for our products grows, we will need to increase our capacity for
      material purchases, production, test and quality functions. Any disruptions
      in
      product flow could limit our revenue growth and adversely affect our competitive
      position and reputation, and result in additional costs or cancellation of
      orders under agreements with our customers.





8





If
      we
      rely on independent contractors to manufacture our products, we will be reliant
      on their performance to meet business demand. We may experience delays in
      product shipments from contract manufacturers. Contract manufacturer performance
      problems may arise in the future, such as inferior quality, insufficient
      quantity of products, or the interruption or discontinuance of operations of
      a
      manufacturer, any of which could have a material adverse effect on our business
      and operating results.





We
      do not
      know whether we will effectively manage our contract manufacturers or that
      these
      manufacturers will meet our future requirements for timely delivery of products
      of sufficient quality and quantity. We also intend to regularly introduce new
      products and product enhancements, which will require that we rapidly achieve
      volume production by coordinating our efforts with those of our suppliers and
      contract manufacturers. The inability of our contract manufacturers to provide
      us with adequate supplies of high-quality products or a reduction in the general
      capacity of the contract manufacturing industry may cause a delay in our ability
      to fulfill orders and may have a material adverse effect on our business,
      operating results and financial condition.





As
      part
      of our cost-reduction efforts, we will need to realize lower per unit product
      costs from our contract manufacturers by means of volume efficiencies and the
      utilization of manufacturing sites in lower-cost geographies. However, we cannot
      be certain when or if such price reductions will occur. The failure to obtain
      such price reductions would adversely affect our gross margins and operating
      results.





**IF
      OUR PRODUCTS CONTAIN UNDETECTED SOFTWARE OR HARDWARE ERRORS, WE COULD INCUR
      SIGNIFICANT UNEXPECTED EXPENSES AND LOSE SALES.**





Network
      products frequently contain undetected software or hardware errors when new
      products or new versions or updates of existing products are first released
      to
      the marketplace. In the past, we have experienced such errors in connection
      with
      new products and product upgrades. We expect that such errors or component
      failures will be found from time to time in the future in new or existing
      products, including the components incorporated therein, after the commencement
      of commercial shipments. These problems may have a material adverse effect
      on
      our business by causing us to incur significant warranty and repair costs,
      diverting the attention of our engineering personnel from new product
      development efforts, delaying the recognition of revenue and causing significant
      customer relations problems. Further, if our product is not accepted by
      customers due to defects, and such returns exceed the amount we accrued for
      defect returns based on our historical experience, our operating results would
      be adversely affected.





Our
      products must successfully interface with products from other vendors. As a
      result, when problems occur in a computer or communications network, it may
      be
      difficult to identify the sources of these problems. The occurrence of hardware
      and software errors, whether or not caused by our products, could result in
      the
      delay or loss of market acceptance of our products and any necessary revisions
      may cause us to incur significant expenses. The occurrence of any such problems
      would likely have a material adverse effect on our business, operating results
      and financial condition.





**WE
      EXPECT THE AVERAGE SELLING PRICES OF OUR PRODUCTS TO DECREASE, WHICH MAY REDUCE
      GROSS MARGIN OR REVENUE.**





The
      network equipment industry has traditionally experienced a rapid erosion of
      average selling prices due to a number of factors, including competitive pricing
      pressures, promotional pricing, technological progress and a slowdown in the
      economy that has resulted in excess inventory and lower prices as companies
      attempt to liquidate this inventory. We anticipate that the average selling
      prices of our products will decrease in the future in response to competitive
      pricing pressures, excess inventories, increased sales discounts and new product
      introductions by us or our competitors. We may experience substantial decreases
      in future operating results due to the erosion of our average selling
      prices.





**SOME
      OF OUR CUSTOMERS MAY NOT HAVE THE RESOURCES TO PAY FOR OUR PRODUCTS AS A RESULT
      OF THE CURRENT ECONOMIC ENVIRONMENT.**





Some
      of
      our customers may experience serious cash flow problems and, as a result, find
      it increasingly difficult to finance their operations. If some of these
      customers are not successful in generating sufficient revenue or securing
      alternate financing arrangements, they may not be able to pay, or may delay
      payment for, the amounts that they owe us. Furthermore, they may not order
      as
      many products from us as forecast, or cancel orders entirely. The inability
      of
      some of our potential customers to pay us for our products may adversely affect
      our cash flow, the timing of our revenue recognition and the amount of revenue,
      which may cause our stock price to decline.





9





**LEGISLATIVE
      ACTIONS, HIGHER INSURANCE COSTS AND POTENTIAL NEW ACCOUNTING PRONOUNCEMENTS
      ARE
      LIKELY TO IMPACT OUR FUTURE FINANCIAL POSITION AND RESULTS OF
      OPERATIONS.**





Recent
      regulatory changes, including the Sarbanes-Oxley Act of 2002, and future
      accounting pronouncements and regulatory changes, will have an impact on our
      future financial position and results of operations. These changes and proposed
      legislative initiatives are likely to affect our general and administrative
      costs. In addition, insurance costs, including health and workers' compensation
      insurance premiums, have been increasing on a historical basis and are likely
      to
      continue to increase in the future. Recent and future pronouncements associated
      with expensing executive compensation and employee stock option may also impact
      operating results. These and other potential changes could materially increase
      the expenses we report under generally accepted accounting principles, and
      adversely affect our operating results.





**OUR
      PRODUCTS MUST COMPLY WITH EVOLVING INDUSTRY STANDARDS AND COMPLEX GOVERNMENT
      REGULATIONS OR ELSE OUR PRODUCTS MAY NOT BE WIDELY ACCEPTED, WHICH MAY PREVENT
      US FROM GROWING OUR NET REVENUE OR ACHIEVING
      PROFITABILITY.**




The
      market for network equipment products is characterized by the need to support
      new standards as different standards emerge, evolve and achieve acceptance.
      We
      will not be competitive unless we continually introduce new products and product
      enhancements that meet these emerging standards. In the past, we have introduced
      new products that were not compatible with certain technological standards,
      and
      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. Our products must comply with various United States
      federal government requirements and regulations and standards defined by
      agencies such as the Federal Communications Commission, in addition to standards
      established by governmental authorities in various foreign countries and
      recommendations of the International Telecommunication Union. If we do not
      comply with existing or evolving industry standards or if we fail to obtain
      timely domestic or foreign regulatory approvals or certificates we will not
      be
      able to sell our products where these standards or regulations apply, which
      may
      prevent us from sustaining our net revenue or achieving
      profitability.





**FAILURE
      TO SUCCESSFULLY EXPAND OUR SALES AND SUPPORT TEAMS OR EDUCATE THEM ABOUT
      TECHNOLOGIES AND OUR PRODUCT FAMILIES MAY HARM OUR OPERATING
      RESULTS.**





The
      sale
      of our products and services requires a concerted effort that is frequently
      targeted at several levels within a prospective customer's organization. We
      may
      not be able to increase net revenue unless we expand our sales and support
      teams
      in order to address all of the customer requirements necessary to sell our
      products.





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





**WE
      MUST CONTINUE TO DEVELOP AND INCREASE THE PRODUCTIVITY OF OUR INDIRECT
      DISTRIBUTION CHANNELS TO INCREASE NET REVENUE AND IMPROVE OUR OPERATING
      RESULTS.**





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





10





**OUR
      HEADQUARTERS ARE LOCATED IN NORTHERN CALIFORNIA WHERE DISASTERS MAY OCCUR THAT
      COULD DISRUPT OUR OPERATIONS AND HARM OUR BUSINESS** .





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





**ACQUISITIONS
      MAY DISRUPT OR OTHERWISE HAVE A NEGATIVE IMPACT ON OUR
      BUSINESS.**





We
      may
      acquire or make investments in complementary businesses, products, services
      or
      technologies on an opportunistic basis when we believe they will assist us
      in
      carrying out our business strategy. Growth through acquisitions has been a
      successful strategy used by other network control and management technology
      companies. Recently, Procera has purchased Netintact and Netintact PTY. Procera
      could have difficulty in assimilating those companies' personnel and operations.
      In addition, the key personnel of the acquired companies may decide not to
      work
      for us. These acquisitions could distract our management and employees and
      increase our expenses. Furthermore, Procera had to issue equity securities
      to
      pay for these acquisitions which had a dilutive effect on its existing
      shareholders and it may have to incur debt or issue equity securities to pay
      for
      any future acquisitions, the issuance of which could be dilutive to Procera’s
      existing shareholders.





**ANTI-TAKEOVER
      PROVISIONS AND OUR RIGHT TO ISSUE PREFERRED STOCK COULD MAKE A THIRD-PARTY
      ACQUISITION OF PROCERA DIFFICULT.**





We
      are a
      Nevada corporation. Anti-takeover provisions of Nevada law could make it more
      difficult for a third party to acquire control of us, even if such change in
      control would be beneficial to stockholders. Our articles of incorporation
      provide that our Board of Directors may issue preferred stock without
      stockholder approval. The issuance of preferred stock could make it more
      difficult for a third party to acquire us. All of the foregoing could adversely
      affect prevailing market prices for our common stock.





**OUR
      COMMON STOCK PRICE IS LIKELY TO BE HIGHLY VOLATILE.**





The
      market price of our common stock is likely to be highly volatile as the stock
      market in general, and the market for small cap and micro cap technology
      companies in particular, has been highly volatile. Investors may not be able
      to
      resell their shares of our common stock following periods of volatility because
      of the market's adverse reaction to volatility. We cannot assure you that our
      stock will trade at the same levels of other stocks in our industry or that
      industry stocks, in general, will sustain their current market prices. Factors
      that could cause such volatility may include, among other things:




-
            actual
                or anticipated fluctuations in our quarterly operating
                results;


-
            announcements
                of technological innovations;


-
            changes
                in financial estimates by securities
                analysts;


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


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


-
            the
                acceptance of market makers and institutional investors of our
                stock.





In
      addition, our stock is currently traded on the NASD O-T-C Market and it is
      uncertain that we will be able to successfully apply for listing on the American
      Stock Exchange or the NASDAQ National Market or SmallCap market in the
      foreseeable future due to the trading price for our Common Stock, market
      capitalization, our working capital and revenue history. Failure to list our
      shares on the American Stock Exchange or the National or SmallCap Markets will
      impair the liquidity for our common stock.





11





**SHARES
      ELIGIBLE FOR FUTURE SALE BY OUR CURRENT STOCKHOLDERS MAY ADVERSELY AFFECT OUR
      STOCK PRICE.**





Sales
      of
      substantial amounts of common stock, including shares issued upon the exercise
      of outstanding options and warrants, under Securities and Exchange Commission
      Rule 144 or otherwise could adversely affect the prevailing market price of
      our
      common stock and could impair our ability to raise capital at that time through
      the sale of our securities. See "Market For Common Equity and Related
      Stockholder Matters".





**ADDITIONAL
      SHARES HELD BY EXISTING STOCKHOLDERS MAY BE SOLD INTO THE PUBLIC MARKET IN
      THE
      FUTURE, WHICH MAY CAUSE OUR STOCK PRICE TO DECLINE.**





Sales
      of
      a substantial number of shares of common stock after the date of this report
      could adversely affect the market price of our common stock and could impair
      our
      ability to raise capital through the sale of additional equity securities.
      As of
      December 31, 2006, we had 67,663,855 shares of common stock
      outstanding.





**ITEM
                2****.**
            **DESCRIPTION
                OF
                PROPERTIES.**




Our
      headquarters are located at 100 Cooper Court, Los Gatos, California, 95032.
      We
      have a 37-month lease starting from June 1, 2005 and the rent is $12,949 per
      month for the first year, $14,126 per month for the second year, and $15,304
      per
      month for the third year for 11,772 square feet. The Swedish headquarters of
      Netintact is located at Hardgatan 13C, 432 31, Varberg, Sweden. We have a 36
      month lease starting from May 31, 2005 and the rent is $2,165 per month for
      331
      square meters. In addition, Netintact PTY leases 55 square meters located at
      205
      566 St Kilda Road, Melbourne VIC 3004, Australia; the lease is for 12 months
      starting December 9, 2006 with a monthly payment of $1,156. We believe that
      our
      facilities are adequate for our needs and that additional suitable space will
      be
      available on acceptable terms as required.





**ITEM
                3****.**
            **LEGAL
                PROCEEDINGS.**





None.








**ITEM
                4****.**
            **SUBMISSION
                OF MATTERS TO A VOTE OF SECURITY
                HOLDERS****.**





None.





**PART
      II**





**ITEM
              5.**
            **MARKET
                FOR COMMON EQUITY AND RELATED STOCKHOLDER
                MATTERS.**





MARKET
      FOR COMMON EQUITY.





Procera’s
      common stock is quoted on the OTC Bulletin Board under the symbol "PRNW".
      Procera’s common stock has been traded on the OTC Bulletin Board since June 24,
      2003. Prior to that date, Procera’s common stock was not actively traded in the
      public market. For the periods indicated, the following table sets forth the
      high and low bid prices per share of common stock as stated in the Over the
      Counter Bulletin Board Quarterly Trade and Quote Summary Report for the year
      ended December 31, 2006.




HIGH
                BID
            
            LOW
                BIDFirst
                Quarter 2005
            
            $
            2.47
            
            $
            1.22Second
                Quarter 2005
            
            $
            2.16
            
            $
            0.88Third
                Quarter 2005
            
            $
            1.19
            
            $
            0.42Fourth
                Quarter 2005
            
            $
            0.66
            
            $
            0.35First
                Quarter 2006
            
            $
            0.88
            
            $
            0.45Second
                Quarter 2006
            
            $
            0.75
            
            $
            0.46Third
                Quarter 2006
            
            $
            0.85
            
            $
            0.43Fourth
                Quarter 2006
            
            $
            2.28
            
            $
            0.77








These
      bid
      prices represent prices quoted by broker-dealers on the OTC Bulletin Board.
      The
      quotations reflect inter-dealer prices, without retail mark-up, mark-down or
      commissions, and may not represent actual transactions.  On
      December 31, 2006, the closing price of our common stock on the OTCBB was
      $2.19.





12





HOLDERS.





As
      of
      December 31, 2006, Procera had approximately 1,647 holders of its common stock.
      The number of record holders was determined from the records of Procera’s
      transfer agent and does not include beneficial owners of common stock whose
      shares are held in the names of various security brokers, dealers, and
      registered clearing agencies. The transfer agent of Procera’s common stock is
      Pacific Stock Transfer Company, 500 East Warm Springs Road, Suite 240, Las
      Vegas, Nevada 89119.





DIVIDEND
      POLICY.





Procera
      has not declared or paid any cash dividends on its common stock or other
      securities and does not anticipate paying any cash dividends in the foreseeable
      future. Any future determination to pay cash dividends will be at the discretion
      of the Board of Directors and will be dependent upon Procera’s financial
      condition, results of operations, capital requirements, and such other factors
      as the Board of Directors deem relevant.





DESCRIPTION
      OF SECURITIES.





The
      descriptions in this section and in other sections of this annual report of
      Procera’s securities and various provisions of the Company’s articles of
      incorporation and its bylaws are limited solely to descriptions of the material
      terms of its securities, articles of incorporation and bylaws. Procera’s
      articles of incorporation and bylaws have been filed with the SEC as exhibits
      to
      this annual report





Procera’s
      authorized capital stock consists of 100,000,000 shares of common stock, par
      value $0.001 per share, and 15,000,000 shares of preferred stock, par value
      $0.001 per share. As of December 31, 2006, 67,663,855 shares of Procera’s common
      stock and no shares of its preferred stock were issued and outstanding. This
      excludes an aggregate of 23,196,602 shares of common stock reserved for issuance
      upon achievement of milestone incentives and the exercise of stock options
      and
      warrants.





COMMON
      STOCK.





The
      holders of Procera’s common stock are entitled to equal dividends and
      distributions per share with respect to the common stock when, and if declared
      by the Board of Directors from funds legally available therefore. No holder
      of
      any shares of Procera’s common stock has a pre-emptive right to subscribe for
      any of the Company’s securities, nor are any common stock subject to redemption
      or convertible into other of its securities. Upon liquidation, dissolution
      or
      winding up of the Company, and after payment of creditors and preferred
      stockholders the assets will be divided pro-rata on a share-for-share basis
      among the holders of the shares of common stock. All shares of common stock
      now
      outstanding are fully paid, validly issued and non-assessable.





Each
      share of common stock is entitled to one vote with respect to the election
      of
      any Director or any other matter upon which stockholders are required or
      permitted to vote. Holders of the common stock do not have cumulative voting
      rights, so the holders of more than 50% of the combined shares voting for the
      election of Directors may elect all of the Directors if they choose to do so,
      and, in that event, the holders of the remaining shares will not be able to
      elect any members to the Board of Directors.





PREFERRED
      STOCK.





Procera
      may issue shares of preferred stock in one or more classes or series within
      a
      class as may be determined by its Board of Directors, who may establish, from
      time to time, the number of shares to be included in each class or series,
      may
      fix the designation, powers, preferences and rights of the shares of each such
      class or series and any qualifications, limitations or restrictions thereof,
      and
      may increase or decrease the number of shares of any such class or series
      without any further vote or action by the stockholders. Any preferred stock
      so
      issued by the Board of Directors may rank senior to the common stock with
      respect to the payment of dividends or amounts upon liquidation, dissolution
      or
      winding up of Procera, or both. In addition, any such shares of preferred stock
      may have class or series voting rights. Moreover, under certain circumstances,
      the issuance of preferred stock or the existence of the unissued preferred
      stock
      might tend to discourage or render more difficult a merger or other change
      in
      control of Procera.





13





No
      shares
      of preferred stock are currently outstanding. The issuance of preferred stock,
      while providing desirable flexibility in connection with possible acquisitions
      and other corporate purposes, could have the effect of making it more difficult
      for a third party to acquire, or of discouraging a third party from acquiring,
      a
      majority of Procera’s outstanding voting stock.




**ITEM
                6****.**
            **MANAGEMENT'S
                DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                RESULTS OF OPERATIONS**





*The
      following discussion and analysis of our financial condition and results of
      operations should be read in conjunction with our consolidated financial
      statements and related notes that appear elsewhere in this report. In addition
      to historical consolidated financial information, the following discussion
      contains forward-looking statements that reflect our plans, estimates and
      beliefs. Our actual results could differ materially from those discussed in
      the
      forward-looking statements. Factors that could cause or contribute to these
      differences include those discussed below and elsewhere in this report,
      particularly in the section entitled “Risk Factors” set forth later in this Item
      6* *.*




OVERVIEW .





Headquartered
      in Los Gatos, CA, Procera Networks, Inc. (" ***Procera*** "
      or the
      " ***Company*** ")
      is a
      global provider of intelligent network traffic identification, control and
      service management infrastructure equipment. Procera’s core product suite, the
      PacketLogic line of appliances, provides the most accurate application
      identification engine available today. PacketLogic is deployed at more than
      300
      broadband service providers (“SP’s”), telephone companies, colleges and
      universities worldwide.





Procera
      was formed as a result of a merger and plan of reorganization (the ***"Merger"*** )
      between
      Zowcom, Inc. ( ***"Zowcom"*** ),
      a
      Nevada corporation incorporated on July 11, 2001, and Procera Networks, Inc. ***("PNI"*** ),
      a
      Delaware corporation incorporated on May 1, 2002. On October 16, 2003, PNI
      merged into Zowcom in a stock-for-stock transaction. As a result of the Merger,
      Zowcom continued as the surviving corporation, assumed the operations and
      business plan of PNI, the stockholders of PNI became stockholders of Zowcom,
      and
      Zowcom changed its name to Procera Networks, Inc. ("Procera" or the
      "Company")(trading symbol OTC: BB: PRNW.OB).





On
      August
      18, 2006, Procera and all shareholders of Netintact AB, a Swedish corporation
      (" ***Netintact*** ")
      entered into a First Amended and Restated Stock Exchange Agreement and Plan
      of
      Reorganization (the " ***Agreement*** "), and
      closed the transaction effective as of August 18, 2006, making Netintact a
      wholly owned subsidiary of Procera. The Agreement was amended on January 24,
      2007 to, among other things, amend several of the terms and conditions of the
      incentive warrants, closing date warrants and incentive share plan. A copy
      of
      the amendment is attached hereto to this Report.





On
      September 29, 2006, Procera and two of the three shareholders of Netintact
      PTY,
      an Australian company (“ ***Netintact
      PTY*** ”)
      entered into a certain Stock Exchange Agreement and Plan of Reorganization
      and
      closed the transaction effective as of September 29, 2006. Netintact, the
      remaining shareholder of Netintact PTY, owns 51 shares of Common Stock of
      Netintact PTY, constituting fifty-one (51%) of the issued and outstanding
      securities of Netintact PTY.





Consolidated
      financial information for the year ended December 31, 2006 includes historical
      financial information of Procera from January 2, 2006, historical financial
      information of Netintact AB from August 19, 2006, and financial information
      of
      Netintact PTY from September 30, 2006.








PLAN
      OF OPERATION





Since
      our
      inception, Procera has funded its operations primarily through proceeds from
      the
      private placement of equity. Procera received aggregate proceeds of
      approximately $5.5 and $4.8 million from private placements of common stock
      in
      February and November 2006 respectively and $0.3 million from warrants exercised
      in 2006





14





RECENT
      DEVELOPMENTS





On
      November 30, 2006, Procera completed the sale of 5,100,000 shares of its
      restricted common stock for $1.00 per share for a total of $5,100,000 to fifteen
      accredited investors (the ***“November
      2006***  ***Investors”*** ).
      Chadbourn Securities served as the lead placement agent for the transaction.
      The
      November 2006 Investors purchased the shares pursuant to subscription agreements
      (each a ***“Subscription
      Agreement”*** ).
      In
      conjunction with the transaction, Procera also issued warrants to the November
      2006 Investors to purchase an aggregate of 1,020,000 shares of its common stock
      at per share price of $1.50 and to Chadbourn Securities and other placement
      agents to purchase an aggregate of 360,000 shares of its common stock at a
      per
      share price of $1.00. The warrants are exercisable, in whole or in part, for
      three years following the effectiveness of the registration statement. Procera’s
      Board of Directors accepted the terms for the sale of the shares after pursuing
      all financing alternatives and based upon advice from its lead placement agent.
      Each Investor completed a Subscription Agreement and a Registration Rights
      agreement. The Investors and the placement agents also received registration
      rights with respect to the shares of common stock issued and to the shares
      of
      common stock underlying the warrants.





Those
      investors who participated in Procera’s private placement of restricted common
      stock for $0.40 per share for a total of $6,000,000 in February 2006 (the
“ ***February
      2006 Investors*** ”),
      the
      November 2006 Investors and certain other entities, entered into a registration
      rights agreement with Procera. As of the filing of this Report, Procera has
      not
      filed a registration statement for the registration of those shares of common
      stock and the shares of common stock underlying the warrants. In
      April
      2007, we obtained an amendment to the registration rights agreements from
      November 2006 Investors holding a majority of the shares issued in the November
      2006 private placement and from 100% of the February 2006 Investors who
      cannot currently sell all of their stock under Rule 144 in one quarter to
      extend the required filing date of the initial registration statement to June
      30, 2007, a deadline that we believe we will be able to meet.





On
      January 24, 2007, Netintact and Procera entered into a First Amendment to the
      First Amended and Restated Stock Exchange Agreement and Plan of Reorganization
      (the “ ***Amendment*** ”)
      copy
      of which is attached to this Report. The Amendment amended several of the terms
      and conditions of the incentive warrants and closing date warrants by, among
      other things, (i) obligating Procera to pay all social fees which Netintact
      and
      Holders are obligated to pay pursuant to Swedish Law, and (ii) making all
      warrants immediately exerciseable if certain conditions are met. In addition,
      the incentive shares plan was amended by clarifying that all employees of
      Netintact, or any subsidiary of Netintact, can receive distributions of shares
      and that, in the event an employee who is entitled to incentive shares is no
      longer employed on such distribution date, the remaining employees, who are
      entitled to participate, shall be eligible to receive be such shares on a pro
      rated basis.




Procera
      has only recently generated significant revenues, since its acquisition of
      Netintact AB and Netintact PTY., and therefore Procera can draw no conclusions
      regarding the seasonality of its business.





In
      2006,
      Procera emerged from being a development-stage enterprise and future liquidity
      may be dependent upon debt and equity financing from outside investors. We
      have
      yet to generate a positive internal cash flow and until revenues increase from
      the sale of our products, we may be dependent upon future debt and equity
      funding.




**RESULTS
      OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2006 AND THE YEAR ENDED JANUARY
      1,
      2006**





**Revenues,
      Costs of Sales and Gross Profit** ***.***





Fiscal
                Year Ended December 31,Revenue
            
            2006
            
            2005
            
            Change
            
            %
                ChangeSales
            
            
            1,914,430
            
            
            254,809
            
            
            1,660,9510
            
            
            651
            %Costs
                of Sales
            
            
            630,788
            
            
            307,799
            
            
            224,217
            
            
            105
            %Gross
                Profit (Loss)
            
            
            1,283,642
            
            
            (52,990
            )
            
            1,436,734
            
            
            NC




15





**Revenues**





From
      the
      date of its inception on May 1, 2002 through July 2, 2006, Procera was a
      development stage company, devoting all of its efforts and resources to
      developing and testing new products and preparing for introduction of its
      products into the market place. During this period, Procera generated
      insignificant revenues from actual sales of its products.





During
      the fiscal year ended January 1, 2006, Procera recognized revenues of $254,809
      from sales of its OptimIP product offerings.





Beginning
      with the three months which ended October 1, 2006, Procera emerged from its
      development stage and began to recognize increased revenues from sales of
      PacketLogic software products. Due to Procera having an increased revenue stream
      from its products, it has emerged from development stage status.




During
      the fiscal year ended December 31, 2006, Procera recognized consolidated
      revenues of $1,914,430, primarily from sales of PacketLogic products, of which
      revenues of $1,398,917 were recognized by Netintact AB and Netintact PTY from
      their respective dates of acquisition through December 31, 2006. During the
      fiscal year ended January 1, 2006, Procera recognized revenues of $254,809.
      The
      substantial increase of 2006 over 2005 was due to the merger with Netintact,
      AB.





**Cost
      of Sales**





Cost
      of
      sales of $630,788 and $307,799 reported for the fiscal years ended December
      31,
      2006 and January 1, 2006, respectively, include: (a) the direct cost of
      materials for products sold; (b) charges to write-down the value of Procera's
      inventories;(c) transportation in costs; and (d) cost of warranty allowance
      for
      products sold. Procera follows the accounting policy of valuing inventories
      at
      the lower of cost or market, with standard FIFO cost used to determine inventory
      cost. Standard costs are evaluated at the end of each fiscal quarter and are
      adjusted, if necessary, to equate to actual costs. As a result of adjusting
      standard costs to equate with actual costs, cost of sales was charged $173,343
      and $19,129 during the fiscal years ended December 31, 2006, and January 1,
      2006, respectively.





Procera
      follows the accounting policy of charging cost of goods sold for an estimated
      inventory reserve against consigned inventory for products shipped to end users
      for evaluation purposes. For evaluation shipments, the end user has 30 days
      in
      which to decide to keep the consigned products and pay billed price for them
      or
      return them to Procera. If such products are returned to Procera, they are
      recorded as used inventory and are placed in the pool of products which may
      be
      used for future evaluation trials. Inventory reserve amounts of $77,273 and
      $59,229 where charged to cost of sales during the fiscal years ended December
      31, 2006 and January 1, 2006, respectively.




Because
      volume sales were not achieved during 2006, the majority of fixed and variable
      overhead costs have been expensed and reported as engineering operating
      expenses. During the fiscal years ended December 31, 2006 and January 1, 2006,
      one-half of labor charges for receiving and storekeeping, as well as facilities
      expenses related to square footage occupied by receiving and storekeeping
      totaling $78,056 and $36,531, respectively, were charged to cost of sales.
      Beginning in fiscal 2007, reported cost of sales will include 100% of fixed
      and
      variable manufacturing overhead costs.





**Gross
      Profit or Loss and Margins**





Gross
      profit reported for the fiscal year ended January 1,2006 was ($52,990) and
      consolidated gross profit reported for the fiscal year ended December 31, 2006
      was $1,283,642. The increase in gross profit of approximately $1,337,000 is
      attributable to the fact that 73% of our consolidated revenues came from sales
      of PacketLogic products following the acquisitions of Netintact AB and Netintact
      PTY during our third fiscal quarter of 2006. Because PacketLogic software
      products were completely developed and field tested by customers of the
      Netintact companies, gross margins on these products are significantly higher
      than any other products we have sold to date.





Excluding
      inventory write-downs and reserves, which are not expected to occur on a regular
      basis, margins for the fiscal years ended December 31, 2006 and January 1,
      2006
      were 80% and 10%, respectively.





16




Fiscal
                Year EndedDecember
                31,
              2006
            
            January
                1,
              2006Revenues
            
            $
            1,914,430
            
            $
            254,809Cost
                of sales:Direct
                material cost
            
            
            295,403
            
            
            184,878Inventory
                write-downs
            
            
            173,343
            
            
            19,129Inventory
                reserves
            
            
            77,273
            
            
            59,229Applied
                manufacturing overhead
            
            
            78,056
            
            
            36,531Warranty
                allowances
            
            
            6,713
            
            
            8,032Total
                cost of sales
            
            
            630,788
            
            
            307,799Gross
                Profit
            
            $
            1,283,642
            
            $
            (52,990
            )Gross
                margin
            
            
            67
            %
            
            (21
            %)Gross
                margin (excluding inventory write-downs and reserves)
            
            
            80
            %
            
            10
            %




**Operating
      Expenses**





Operating
      expenses for the fiscal year ended December 31, 2006 totaled $9,046,598 as
      compared to $6,696,503 incurred during the fiscal year ended January 1, 2006.
      These expenses increased by approximately $2,350,000 during 2006 as a result
      of
      the following:




(a)
            
            
            Operating
                expenses of Netintact AB and Netintact PTY
            
            $
            890,000(b)
            
            
            Increase
                in employee stock based compensation
            
            
            1,228,000(c)
            
            
            Increase
                in amortization expenses (net)
            
            
            960,000(d)
            
            
            Increase
                in audit, legal expenses
            
            
            297,000(e)
            
            
            Increase
                in investor relations expense
            
            
            371,000(f)
            
            
            Decrease
                in outside consulting expenses
            
            
            (526,000
            )(g)
            
            
            Decrease
                in salaries, taxes, and benefits
            
            
            (272,000
            )(h)
            
            
            Decrease
                in bad debt expense
            
            
            (107,000
            )(i)
            
            
            Decrease
                in software license & maintenance expense
            
            
            (
                63,000
            )(j)
            
            
            Decrease
                in sales and marketing expenses
            
            
            (
                59,000
            )(k)
            
            
            Decrease
                in travel & entertainment
            
            
            (
                33,000
            )(l)
            
            
            Decrease
                in development materials used
            
            
            (
                44,000
            )(m)
            
            
            Decrease
                in insurance expense
            
            
            (
                42,000
            )(n)
            
            
            Decrease
                in expendable equipment & equipment rental
            
            
            (
                19,000
            )Net
                increase in operating expenses
            
            $
            2,350,000





(a) On
      August 18,
      2006, Procera acquired all of the issued and outstanding stock of Netintact
      AB,
      a Swedish corporation. At that time, Netintact AB owned 51% of issued and
      outstanding stock of Netintact PTY, an Australian corporation. On September
      29,
      2006, Procera acquired the remaining 49% of issued and outstanding stock of
      Netintact PTY. The consolidated operating results reported by Procera for the
      fiscal year ended December 31, 2006 include operating results of Netintact
      AB
      from August 18, 2006 through December 31, 2006 and operating results of
      Netintact PTY from September 30, 2006 through December 31, 2006. As a result,
      Procera included in its operating expenses reported for the year ended December
      31, 2006 approximately $890,000 of operating expenses incurred by Netintact
      AB
      and Netintact PTY since their respective dates of acquisition by
      Procera.





(b) Effective
      January 2, 2006, Procera adopted the provisions of SFAS No. 123(R), “Share-Based
      Payment.” Accordingly, employee stock based non-cash compensation expense
      increased by approximately $729,000 during the fiscal year ended December 31,
      2006 as a result of implementing the provisions of SFAS 123 (R).





(c) Procera’s
      acquisition of Netintact AB and Netintact PTY in exchange for shares of
      Procera’s restricted common stock resulted in the recognition and reporting of
      the following intangible assets: Customer Base ($4,317,000); Product Software
      ($4,578,000); and Management Information &
      Related Software ($2,224,000). These asset values were determined for Procera
      by
      an independent consulting organization. These intangible assets are being
      amortized on a straight-line basis over 36 calendar months. Accordingly,
      amortization for these intangible assets during the fiscal year ended December
      31, 2006 amounted to $1,228,000.




17





(d) In
      relation
      to the acquisitions of Netintact AB and Netintact PTY, Procera incurred an
      increase in audit, legal, and consulting expenses, amounting to $297,260 during
      the fiscal year ended December 31, 2006.





(e) An
      investor relations firm was retained during 2006 to provide monthly investor
      relations services to the Company in exchange for 45,833 shares of common stock
      per month, valued at a market value of $0.70 per share, which represents the
      market value of the company’s common shares on the date the firm was
      retained.





(f) During
      fiscal 2005, several investment financing firms were issued warrants to purchase
      the Company’s common stock as compensation to search for investors to
      participate in private placement sales of the Company’s common stock. Because
      the efforts of these firms on behalf of the Company was largely unsuccessful,
      the market value of the warrants issued was recognized and reported as
      consulting expenses for that year in the amount of approximately
      $526,000.





(g) The
      Company’s employee headcount was reduced by 3 employees during 2006, resulting
      in a reduction in salaries and related taxes and insurance expenses of
      approximately $272,000.





(h) During
      the
      fiscal year which ended December 31, 2006, a bad debt reserve for uncollectible
      accounts in the amount of $11,000 was expensed, compared with a bad debt expense
      of $118,000 during the fiscal year ended January 1, 2006.





(i) Software
      licenses and software maintenance relating to Procera’s OPT2402 and OPT12012
      products expired and were not renewed during the fiscal year ended December
      31,
      2006 because Procera has diverted all of its sales efforts to selling
      PacketLogic software which was acquired from Netintact AB.





(j) During
      the
      fiscal year which ended December 31, 2006: (a) marketing consulting expenses
      decreased ($54,000); (b) website development expenses decreased ($18,000);
      (c)
      marketing literature expenses decreased ($20,000); offset by (d) an increase
      in
      independent sales representative expenses of $24,000; and (e) an increase in
      trade show and conference expenses of $9,000.




**Interest
      and Other Income**




During
      the fiscal year which ended December 31, 2006, Procera earned interest income
      of
      $11,880 on cash balances deposited in a money market account, compared to
      interest income of $6,176 earned on similar deposits during the fiscal year
      which ended January 1, 2006. In addition, Procera recognized a currency
      conversion rate gain of $8,900 during the fiscal year which ended December
      31,
      2006.




**Net
      Loss**





Procera
      incurred a consolidated comprehensive loss of $7,503,479 for the fiscal year
      ended December 31, 2006, compared to a net loss of $6,738,915 for the fiscal
      year ended January 1, 2006. From its inception through December 31, 2006 Procera
      has sustained operating losses and it expects such losses to continue.





**Liquidity
      and Capital Resources**





Procera's
      balance of cash and cash equivalents of $5,214,177 at December 31, 2006
      represents primarily net proceeds of approximately $4,840,000 from the private
      placement sales of common stock to thirty-three accredited investors which
      closed on November 30, 2006, and cash and cash equivalents of approximately
      $600,000 held by Netintact AB and Netintact PTY. Chadbourn Securities served
      as
      lead placement agent, along with several other participating agents, for the
      private placement transactions which resulted in net proceeds of approximately
      $4,840,000 to the Company. The placement agents received a total of $259,641
      in
      cash and warrants to purchase 360,000 shares of Procera’s common stock at $1.00
      per share as compensation for their services.





We
      project that cash and cash equivalents on hand at December 31, 2006 will be
      insufficient to meet the needs of our business in the second half of 2007. 
Procera expects that additional funds from the sale of equity will be needed
      in
      order to support its business plan.




18





In
      2006,
      our cash outflow from operating activities was primarily the result of costs
      incurred in operating our business, our cash outflow from investing activities
      was primarily the result of fixed asset purchases, and our cash inflow from
      financing activities was from private placements and warrants exercised, during
      2006.




In
      2005,
      our cash outflow from operating activities was primarily the result of costs
      incurred in operating our business, our cash outflow from investing activities
      was primarily the result of fixed asset purchases, and our cash inflow from
      financing activities was from private placements that occurred during
      2005





**Debt
      and Lease Obligations**




At
      December 31, 2006, Procera had obligations for leased equipment from various
      sources as shown below. Interest rates on such debt range from 9% to 10%.
      Procera also leases office space and equipment under non-cancelable operating
      and capital leases with various expiration dates through 2010.




As
      of
      December 31, 2006, future minimum lease payments that come due in the current
      and following fiscal years ending December 31 are as follows:




Capital
                Leases
            
            Operating
                Leases2007
            
            $
            24,861
            
            $
            225,1102008
            
            
            22,982
            
            
            88,3052009
            
            
            2,5392010
                and thereafterTotal
                minimum lease payments
            
            
            50,382
            
            $
            313,415Less:
                Amount representing interest
            
            
            4,248Present
                value of minimum lease payments
            
            
            46,134Less:
                Current portion
            
            
            20,982Obligations
                under capital lease, net of current portion
            
            $
            25,152





**Deferred
      Revenue Items**




Procera
      has $346,346 of deferred revenue as of December 31, 2006, compared to $7,319
      as
      of January 1, 2006.




**Material
      Commitments of Capital**





Procera
      uses third-party contract manufacturers to assemble and test its products.
      In
      order to reduce manufacturing lead-times and ensure an adequate supply of
      inventories, Procera's agreements with some of these manufacturers allow them
      to
      procure long lead-time component inventory on its behalf based on a rolling
      production forecast provided by Procera. Procera may be contractually obligated
      to purchase long lead-time component inventory procured by certain manufacturers
      in accordance with its forecasts. In addition, Procera issues purchase orders
      to
      its third-party manufacturers that may not be cancelable at any time. As of
      December 31, 2006, Procera had no open non-cancelable purchase orders with
      its
      third-party manufacturers.





**Off-Balance
      Sheet Arrangements**





As
      of
      December 31, 2006, the Company had no off-balance sheet items as described
      by
      Item 303(a)(4)(ii) of Securities and Exchange Commission Regulation S-K. Procera
      has not entered into any transactions with unconsolidated entities whereby
      it
      has financial guarantees, subordinated retained interests, derivative
      instruments or other contingent arrangements that expose it to material
      continuing risks, contingent liabilities, or any other obligations under a
      variable interest in an unconsolidated entity that provides it with financing,
      liquidity, market risk or credit risk support





19





**CRITICAL
      ACCOUNTING POLICIES AND ESTIMATES**





Procera's
      financial statements have been prepared in accordance with accounting principles
      generally accepted in the United States of America. The preparation of these
      financial statements requires Procera to make significant estimates and
      judgments that affect the reported amounts of assets, liabilities, revenues
      and
      expenses and related disclosure of contingent assets and liabilities. Procera
      evaluates estimates, including those related to bad debts, inventories and
      income taxes, on an ongoing basis. Procera bases its estimates on historical
      experience and on various other assumptions that are believed to be reasonable
      under the circumstances, the results of which form the basis for making
      judgments about the carrying values of assets and liabilities that are not
      readily apparent from other sources. Actual results may differ from these
      estimates under different assumptions or conditions.





An
      accounting policy is deemed to be critical if it requires an accounting estimate
      to be made based on assumptions about matters that are highly uncertain at
      the
      time the estimate is made, and if different estimates that reasonably could
      have
      been used, or changes in the accounting estimates that are reasonably likely
      to
      occur periodically, could materially impact the financial
      statements.  Procera
      believes the following critical accounting policies, among others, involve
      the
      more significant judgments and estimates used in the preparation of its
      financial statements:





**REVENUE**





Procera
      recognizes revenue in accordance with SEC Staff Accounting Bulletin No. 104,
      "Revenue Recognition in Financial Statements" (SAB 104). Under SAB 104, revenue
      is recognized when the title and risk of loss have passed to the customer,
      there
      is persuasive evidence of an arrangement, delivery has occurred or services
      have
      been rendered, the sales price is fixed or determinable and collectibility
      is
      reasonably assured. Procera recognizes revenue from product sales upon shipment
      to the customer provided no significant obligations remain and collection of
      the
      receivable is probable. Upon shipment, Procera provides for estimated product
      returns and discounts.





Procera
      also provides a provision for estimated customer returns at the time product
      revenue is recognized. Its provision is based on best estimate at the time
      of
      sale and its return policies. Procera's resellers generally do not have a right
      of return, except for approved stock rotations of excess inventory which must
      be
      accompanied by a new order for products which is equivalent in amount to the
      products being returned. Procera’s contracts with original equipment
      manufacturers only provide for rights of return in the event Procera's products
      do not meet specifications or there is an epidemic failure, as defined in the
      contracts. If historical data used by Procera to calculate estimated sales
      returns do not reasonably approximate future returns, revenue in future periods
      could be affected. For accounting arrangements that have multiple revenue
      generating activities, the Company recognized revenue from product shipments
      at
      the time of shipment under the terms of SAB 104.





**ALLOWANCE
      FOR DOUBTFUL ACCOUNTS**





Procera
      maintains an allowance for doubtful accounts for estimated bad debts. If the
      financial condition of its customers were to deteriorate, resulting in an
      impairment of their ability to make payments, additional allowances might be
      required.





**INVENTORIES**





Inventories
      are recorded at the lower of cost or market on a first-in, first-out basis.
      On
      an ongoing basis, Procera reviews for estimated obsolete or excess inventories
      and writes down its inventories to their estimated net realizable value based
      upon its projections of future product demand and product lifecycle and product
      development plans. These write downs are reflected in Procera's cost of revenue.
      Actual product demand may differ from Procera's projections, in which case
      it
      may have understated or overstated the provision for excess and obsolete
      inventory, which would have an impact on its operating results.





**WARRANTY
      RESERVE**





Procera
      generally warrants its products for a specific period of time, usually three
      months for software and twelve months for hardware, against material defects.
      Procera provides for the estimated future costs of warranty obligations in
      costs
      of goods sold when the related revenue is recognized. The accrued warranty
      costs
      represent Procera's best estimate at the time of sale of the total costs that
      it
      will incur to repair or replace product parts, which fail while still under
      warranty. Actual warranty costs could differ from the estimate amounts. On
      a
      quarterly basis, Procera reviews the accrued balances and updates the historical
      warranty cost trends. If Procera were required to accrue additional warranty
      cost in the future, it would negatively affect operating results.





20





**DEFERRED
      TAX VALUATION ALLOWANCE**





The
      carrying value of Procera's deferred tax assets are dependent upon its ability
      to generate sufficient future taxable income in certain tax jurisdictions.
      Should Procera determines that it would not be able to realize all or part
      of
      our deferred tax assets in the future, an adjustment to the deferred tax assets
      would be charged to income in the period such determination was made. Currently,
      Procera's deferred tax assets are fully reserved.




**STOCK-BASED
      COMPENSATION** **




Stock-based
      compensation to outside consultants is recorded at fair market value in
      accordance with SFAS 123(R) and EITF 98-16, and these costs are a component
      of
      general and administrative expense. Prior to the adoption of Statement of
      Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,”
(“SFAS 123(R)”), Procera accounted for stock-based awards to employees and
      directors using the intrinsic value method in accordance with Accounting
      Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”
(“APB 25”). Under the intrinsic value method that was used to account for
      stock-based awards prior to January 2, 2006, which had been allowed under the
      original provisions of Statement 123, no stock compensation expense had been
      recognized in Procera’s statement of operations as the exercise price of
      Procera’s stock options granted to employees and directors equaled the fair
      market value of the underlying stock at the date of grant.




On
      January 2, 2006, Procera adopted SFAS 123(R) which requires the measurement
      and
      recognition of compensation expense for all share-based awards made to employees
      and directors, including employee stock options and employee stock purchases,
      based on estimated fair values. SFAS 123(R) supersedes Procera’s previous
      accounting for share-based awards under APB 25 for periods beginning in 2006.
      In
      March 2005, the Securities and Exchange Commission issued Staff Accounting
      Bulletin No. 107 (“SAB 107”) relating to SFAS 123(R). Procera have applied the
      provisions of SAB 107 in its adoption of SFAS 123(R). Procera adopted SFAS
      123(R) using the modified prospective transition method, which requires the
      application of the accounting standard as of the beginning of Procera’s current
      year. Procera’s financial statements as of and for the year ended December 31,
      2006 reflect the impact of SFAS 123(R). In accordance with the modified
      prospective transition method, Procera’s financial statements for prior periods
      have not been restated to reflect, and do not include, the impact of SFAS
      123(R).




Stock
      compensation expense recognized during the period is based on the value of
      share-based awards that are expected to vest during the period. Stock
      compensation expense recognized in Procera’s statement of operations for 2006
      includes compensation expense related to share-based awards granted prior to
      January 2, 2006 that vested during the current period based on the grant date
      fair value estimated in accordance with the pro forma provisions of SFAS 123.
      Stock compensation expense during the current period also includes compensation
      expense for the share-based awards granted subsequent to January 1, 2006 based
      on the grant date fair value estimated in accordance with the provisions of
      SFAS
      123(R). As stock compensation expense recognized in the statement of operations
      is based on awards ultimately expected to vest, it has been reduced for
      estimated forfeitures (which are currently estimated to be minimal). SFAS 123(R)
      requires forfeitures to be estimated at the time of grant and revised, if
      necessary, in subsequent periods if actual forfeitures differ from those *estimates.* In the
      Procera’s pro forma information required under SFAS 123 for the periods prior to
      2006, forfeitures were estimated and factored into the expected term of the
      options.




Procera’s
      determination of estimated fair value of share-based awards utilizes the
      Black-Scholes option-pricing model. The Black-Scholes model is affected by
      Procera’s stock price as our assumptions regarding a number of highly complex
      and subjective variables. These variables include, but are not limited to,
      Procera’s expected stock price volatility over the term of the awards, and
      actual and projected employee stock option exercise behaviors.





**COMMITMENTS
      AND CONTINGENCIES** ***.*** **





Commitments
      and Contingencies are disclosed in the footnotes of the financial statements
      according to generally accepted accounting principles. If a contingency becomes
      probable, and is estimatable by management, a liability is recorded per SFAS
      No.
      5.





21





**RECENT
      ACCOUNTING PRONOUNCEMENTS**




In
      May
      2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections—a
      replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS
      154”). SFAS 154 changes the requirements for the accounting for and reporting of
      a change in accounting principle, and applies to all voluntary changes in
      accounting principle. It also applies to changes required by an accounting
      pronouncement in the unusual instance that the pronouncement does not include
      specific transition provisions. This statement requires retrospective
      application to prior periods’ financial statements of changes in accounting
      principle, unless it is impracticable to determine either the period-specific
      effects or the cumulative effect of the change. SFAS 154 is effective for
      accounting changes made in fiscal years beginning after December 15, 2005.
      The adoption of this statement did not have any material impact on our results
      of operations or financial condition.





In
      November 2005, the FASB issued FASB Staff Posistion FAS 115-1 and
      FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its
      Application to Certain Investments” (“FSP FAS 115-1”), which provides
      guidance on determining when investments in certain debt and equity securities
      are considered impaired, whether that impairment is other-than-temporary, and
      on
      measuring such impairment loss. FSP FAS 115-1 also includes accounting
      considerations subsequent to the recognition of an other-than temporary
      impairment and requires certain disclosures about unrealized losses that have
      not been recognized as other-than-temporary impairments. FSP FAS 115-1 is
      required to be applied to reporting periods beginning after December 15,
      2005. The Company is required to adopt FSP FAS 115-1 in the first quarter of
      fiscal 2006. The adoption of this statement did not have any material impact
      on
      our results of operations or financial condition.




In
      February 2006, the Financial Accounting Standards Board (“FASB”) issued
      Statement of Financial Accounting Standards (“SFAS”) No. 155, “Accounting for
      Certain Hybrid Financial Instruments”.  SFAS No. 155 amends SFAS No 133,
“Accounting for Derivative Instruments and Hedging Activities”, and SFAS No.
      140, “Accounting for Transfers and Servicing of Financial Assets and
      Extinguishments of Liabilities”.  SFAS No. 155, permits fair value
      remeasurement for any hybrid financial instrument that contains an embedded
      derivative that otherwise would require bifurcation, clarifies which
      interest-only strips and principal-only strips are not subject to the
      requirements of SFAS No. 133, establishes a requirement to evaluate interest
      in
      securitized financial assets to identify interests that are freestanding
      derivatives or that are hybrid financial instruments that contain an embedded
      derivative requiring bifurcation, clarifies that concentrations of credit risk
      in the form of subordination are not embedded derivatives, and amends SFAS
      No.
      140 to eliminate the prohibition on the qualifying special-purpose entity from
      holding a derivative financial instrument that pertains to a beneficial interest
      other than another derivative financial instrument.  This statement is
      effective for all financial instruments acquired or issued after the beginning
      of the Company’s first fiscal year that begins after September 15, 2006. The
      Company has not yet determined the effect, if any, of SFAS No. 155 on its
      financial position, operations or cash flows.




In
      June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for
      Uncertainty in Income Taxes” (“FIN 48”), an interpretation of SFAS No. 109,
“Accounting for Income Taxes”.  FIN 48 clarifies the accounting for
      uncertainty in income taxes recognized in a company’s financial statements and
      prescribes a recognition threshold and measurement process for financial
      statement recognition and measurement of a tax position taken or expected to
      be
      taken in a tax return.  FIN 48 also provides guidance on derecognition,
      classification, interest and penalties, accounting in interim periods,
      disclosure and transition and will become effective for the Company for fiscal
      years beginning after December 15, 2006.  The Company has not yet
      determined the effect of FIN No. 48 on its financial position, operations or
      cash flows.




In
      September 2006, FASB issued SFAS No. 157, “Fair Value Measurements”.  SFAS
      No. 157 defines fair value, establishes a framework for measuring fair value
      in
      generally accepted accounting principles, and expands disclosures about fair
      value measurements.  It applies under other accounting pronouncements that
      require or permit fair value measurements, the board having previously concluded
      in those accounting pronouncements that fair value is the relevant measurement
      attribute.  Accordingly, this statement does not require any new fair value
      measurements.  This statement is effective for all financial instruments
      issued for fiscal years beginning after November 15, 2007, and interim periods
      within those fiscal years. The
      Company has not yet determined the effect, if any, of SFAS No. 157 on its
      financial position, operations or cash flows.




22




In
      September 2006, the Securities and Exchange Commission issued Staff Accounting
      Bulletin (SAB) No. 108 to address diversity in practice in quantifying financial
      statement misstatements. SAB 108 requires that registrants quantify the impact
      on the current year’s financial statements of correcting all misstatements,
      including the carryover and reversing effects of prior years’ misstatements, as
      well as the effects of errors arising in the current year. SAB 108 is effective
      as of the first fiscal year ending after November 15, 2006, allowing a one-time
      transitional cumulative effect adjustment to retained earnings as of January
      1,
      2006, for errors that were not previously deemed material, but are material
      under the guidance in SAB No. 108. There was no impact on our consolidated
      financial statements with respect to the adoption of SAB No. 108.




In
      February 2007, FASB issued SFAS 159, “The Fair Value Option for Financial Assets
      and Financial Liabilities”.  SFAS No. 159 amends SFAS No. 115, “Accounting
      for Certain Investments in Debt and Equity Securities”.  SFAS No. 159
      permits entities to choose to measure many financial instruments and certain
      other items at fair value. The objective of SFAS No. 159 is to improve financial
      reporting by providing entities with the opportunity to mitigate volatility
      in
      reported earnings caused by measuring related assets and liabilities differently
      without having to apply complex hedge accounting provisions. SFAS No. 159 is
      expected to expand the use of fair value measurement, which is consistent with
      the Board's long-term measurement objectives for accounting for financial
      instruments. SFAS No. 159 applies to all entities, including not-for-profit
      organizations. Most of the provisions of SFAS No. 159 apply only to entities
      that elect the fair value option. However, the amendment to SFAS No. 115 applies
      to all entities with available-for-sale and trading securities. Some
      requirements apply differently to entities that do not report net income. This
      statement is effective as of the beginning of each reporting entity’s first
      fiscal year that begins after November 15, 2007. The
      Company has not yet determined the effect of SFAS No. 159 on its financial
      position, operations or cash flows. ****




**ITEM
              7.**
            **FINANCIAL
                STATEMENTS**






**Procera
        Networks, Inc.**
 **Consolidated
        Financial Statements**
 **December
        31, 2006**
 
 
 
 **C
        O N T E N T S**
 
  PageReport
                  of PMB Helin Donovan, LLP, Independent Registered Public Accounting
                  Firm
              24Report
                  of Burr, Pilger & Mayer LLP, Independent Registered Public Accounting
                  Firm
              25Audited
                  Consolidated Financial Statements:Consolidated
                  Balance Sheet
              26Consolidated
                  Statements of Operations and Comprehensive Income
              27Consolidated
                  Statements of Stockholders’ Equity (Deficit)
              28-30Consolidated
                  Statements of Cash Flows
              31-32Notes
                  to Consolidated Financial Statements
              33
 
 
 
 
 23
 
  
 **Report
        of Independent Registered Public Accounting Firm**
 
 To
        the
        Board of Directors and Stockholders
 Procera
        Networks, Inc.
 Los
        Gatos, California
 
 We
        have
        audited the accompanying consolidated balance sheet of Procera Networks,
        Inc.
        (“Procera”) as of December 31, 2006, and the related consolidated statements of
        operations and comprehensive income, stockholders’ equity and cash flows for the
        year ended December 31, 2006. These consolidated financial statements are
        the
        responsibility of the Company’s management. Our responsibility is to express an
        opinion on these consolidated financial statements based on our audit.
  We
        conducted our audit in accordance with the standards of the Public Company
        Accounting Oversight Board (United States). Those standards require that
        we plan
        and perform the audit to obtain reasonable assurance about whether the financial
        statement is free of material misstatement. The Company is not required to
        have,
        nor were we engaged to perform, an audit of its internal control over financial
        reporting. Our audit includes consideration of internal control over financial
        reporting as a basis for designing audit procedures that are appropriate
        in the
        circumstances, but not for expressing an opinion on the effectiveness of
        the
        Company’s internal control over financial reporting. Accordingly, we express no
        such opinion. An audit includes examining, on a test basis, evidence supporting
        the amounts and disclosures in the financial statements. An audit also includes
        assessing the accounting principles used and significant estimates made by
        management, as well as evaluating the overall financial statement presentation.
        We believe that our audit provides a reasonable basis for our
        opinion.
 
 In
        our
        opinion, the consolidated financial statements referred to above present
        fairly,
        in all material respects, the consolidated financial position of Procera
        Networks, Inc. as of December 31, 2006 and the consolidated results of their
        operations and their consolidated cash flows for the years ended December
        31,2006, in conformity with accounting principles generally accepted in the
        United States of America.
 
 As
        discussed in Note 1 to the consolidated financials statements, the Company
        changed its method of accounting for stock-based compensation upon adoption
        of
        Financial Accounting Standards No. 123(R), “Share-Based
        Payment.”
 
 
 
 
 **PMB
        Helin Donovan, LLP**
 San
        Francisco, California
 March
        27,
        2006
 
 24
 
 
 **REPORT
        OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
 
 
 
 The
        Board
        of Directors and Stockholders
 of
        Procera Networks, Inc.
 
 We
        have
        audited the accompanying statements of operations, stockholders’ equity
        (deficit), and cash flows of Procera Networks, Inc. for the year ended January
        1, 2006. These financial statements are the responsibility of the Company’s
        management. Our responsibility is to express an opinion on these financial
        statements based on our audits.
 
 We
        conducted our audit in accordance with the standards of the Public Company
        Oversight Board (United States). Those standards require that we plan and
        perform the audit to obtain reasonable assurance about whether the financial
        statements are free of material misstatement. An audit includes examining,
        on a
        test basis, evidence supporting the amounts and disclosures in the financial
        statements. An audit also includes assessing the accounting principles used
        and
        significant estimates made by management, as well as evaluating the overall
        financial statement presentation. We believe that our audit provides a
        reasonable basis for our opinion.
 
 In
        our
        opinion, the financial statements referred to above present fairly, in all
        material respects, the results of its operations and its cash flows of Procera
        Networks, Inc. for the year ended January 1, 2006, in conformity with accounting
        principles generally accepted in the United States of America.
 
 The
        accompanying financial statements have been prepared assuming Procera Networks,
        Inc. will continue as a going concern. As more fully described in Note 2,
        the
        Company has incurred net losses since its inception and has experienced severe
        liquidity problems. These conditions raise substantial doubt about the Company’s
        ability to continue as a going concern. Management’s plans in regard to these
        matters are also described in Note 2. The financial statements do not include
        any adjustments that might result from the outcome of this
        uncertainty.
 
 
 /s/
        Burr,
        Pilger & Mayer LLP
 
 Palo
        Alto, California
 February
        13, 2006
 
 25
  **Procera
          Networks, Inc.**
 **Consolidated
          Balance Sheet**
 **December
          31, 2006**
 **ASSETS**Current
                  Assets:Cash
                  and cash equivalents
              
              $
              5,214,177Accounts
                  receivable, net
              
              
              1,161,170Inventories,
                  net
              
              
              259,207Prepaid
                  expenses and other current assets
              
              
              123,805Total
                  Current Assets
              
              
              6,758,359Property
                  and Equipment, net
              
              
              6,330,948Other
                  Assets
              
              
              4,414,114Total
                  Assets
              
              $
              17,503,421**LIABILITIES
                  AND STOCKHOLDERS’ EQUITY**Current
                  Liabilities:Accounts
                  payable
              
              $
              286,232Deferred
                  revenue
              
              
              383,231Accrued
                  liabilities
              
              
              656,943Leases
                  payable—current portion
              
              
              20,982Total
                  Current Liabilities
              
              
              1,347,388Long
                  Term LiabilitiesDeferred
                  rent
              
              
              20,621Deferred
                  tax liability
              
              
              2,820,600Leases
                  payable—non-current portion
              
              
              25,152Commitments
                  and Contingencies
              
              
              -Total
                  Liabilities
              
              
              4,213,761Stockholders’
                  Equity:Preferred
                  stock, $0.001 par value; 15,000,000 shares authorized;none
                  issued and outstanding at January 1, 2006
              
              
              -Common
                  stock, $0.001 par value, 100,000,000 shares authorized;
                  67,663,855shares
                  issued and outstanding at December 31, 2006
              
              
              67,664Additional
                  paid-in-capital
              
              
              38,564,450Accumulated
                  deficit
              
              
              (25,356,835
              )Foreign
                  currency translation adjustment
              
              
              14,381Total
                  Stockholders’ Equity
              
              
              13,289,660Total
                  Liabilities and Stockholders’ Equity
              
              $
              17,503,421
 
  The
          accompanying notes are an integral part of these financial
          statements
 
 26
  **Procera
          Networks, Inc.**
 **Consolidated
          Statements of Operations and Comprehensive Income**
 **For
          the Twelve Months Ended December 31, 2006 and January 1,
          2006**
 Twelve
                  Months EndedDecember
                  31,
              
              January
                  1,2006
              
              2006Sales
              
              $
              1,914,430
              
              $
              254,809Cost
                  of sales
              
              
              630,788
              
              
              307,799Gross
                  Profit
              
              
              1,283,642
              
              
              (52,990
              )Operating
                  Expenses:Engineering
              
              
              3,065,266
              
              
              2,604,897Sales
                  and marketing
              
              
              2,274,429
              
              
              1,752,886General
                  and administrative
              
              
              3,706,903
              
              
              2,338,720Total
                  Operating Expenses
              
              
              9,046,598
              
              
              6,696,503Loss
                  from operations
              
              
              (7,762,956
              )
              
              (6,749,493
              )Other
                  Income (Expense)Interest
                  and other income
              
              
              16,822
              
              
              11,724Interest
                  and other expense
              
              
              (8,918
              )
              
              (1,146
              )Total
                  Other Income (Expense)
              
              
              7,904
              
              
              10,578Net
                  loss before taxes
              
              
              (7,755,052
              )
              
              (6,738,915
              )Provision
                  for Income Taxes
              
              
              251,573
              
              
              -Net
                  loss after taxes
              
              
              (7,503,479
              )
              
              (6,738,915
              )Other
                  comprehensive income, net
              
              
              -
              
              
              -Comprehensive
                  Loss
              
              $
              (7,503,479
              )
              $
              (6,738,915
              )Net
                  loss per share - basic and diluted
              
              $
              (0.15
              )
              $
              (0.22
              )Shares
                  used in computing net loss per share-basic and diluted
              
              
              50,443,688
              
              
              30,445,423
 
  The
          accompanying notes are an integral part of these financial
          statements
  27
   **Procera
          Networks, Inc.**
 **Statements
          of Stockholders' Equity (Deficit)**
 **For
          the Twelve Months Ended December 31, 2006 and January 1,
          2006**
 **Common
                      Stock**
                  
                  **Stock
                      Issuance**
                  
                  **Add.
                      Paid-In**
                  
                  **Subscribed
                      Com. Stock**
                  
                  **Receivable**
                  
                  **Foreign
                      Currency**
                  ****
                  **Accum.**
                  ****
                  **Total
                      Stockholders'**
                  ******Description**
                  ****
                  **Shares**
                  ****
                  **Amount**
                  ****
                  **Costs**
                  ****
                  **Capital**
                  ****
                  **Shares**
                  ****
                  **Amount**
                  ****
                  **For
                      Stock**
                  ****
                  **Translation**
                  
                  **Deficit**
                  
                  **Equity****Balances,
                      January 2, 2005**
                  
                  
                  **24,115,406**
                  
                  
                  **24,115**
                  
                  
                  **(771,892**
                  **)**
                  
                  **11,645,247**
                  
                  
                  **5,762,500**
                  
                  
                  **4,324,375**
                  
                  
                  **-**
                  
                  
                  **-**
                  
                  
                  **(11,114,441**
                  **)**
                  
                  **4,107,404**Issuance
                      of common stock in connection with private placement of common
                      stock at
                      $0.80 per share in December 2004, less issuance costs of
                      $285,625
                  
                  
                  5,762,500
                  
                  
                  5,763
                  
                  
                  
                  
                  
                  4,318,612
                  
                  
                  (5,762,500
                  )
                  
                  (4,324,375
                  )
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  -Issuance
                      of common stock at $1.86 per share to charity organization
                      in connection
                      with private placement in December 2004
                  
                  
                  17,473
                  
                  
                  17
                  
                  
                  
                  
                  
                  32,483
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  32,500Issuance
                      of common stock for cash at $0.075 per share upon exercise
                      of warrants in
                      March 2005
                  
                  
                  100,000
                  
                  
                  100
                  
                  
                  
                  
                  
                  7,400
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  7,500Issuance
                      of common stock for cash at $2.00 per share upon exercise of
                      warrants in
                      March 2005, less issuance cost of $5,000
                  
                  
                  50,000
                  
                  
                  50
                  
                  
                  (5,000
                  )
                  
                  99,950
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  95,000Issuance
                      of common stock for cash at $0.075 per share upon exercise
                      of warrants in
                      April 2005
                  
                  
                  75,000
                  
                  
                  75
                  
                  
                  
                  
                  
                  5,550
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  5,625Issuance
                      of common stock for cash at $1.50 per share upon exercise of
                      warrants in
                      April 2005, less issuance cost of $4,898
                  
                  
                  557,438
                  
                  
                  557
                  
                  
                  (4,898
                  )
                  
                  835,600
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  831,259Issuance
                      of common stock for cash at $1.40 per share upon exercise of
                      warrants in
                      April 2005
                  
                  
                  102,500
                  
                  
                  103
                  
                  
                  
                  
                  
                  143,397
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  143,500Issuance
                      of common stock for services provided at $0.51 per share in
                      November
                      2005
                  
                  
                  165,000
                  
                  
                  165
                  
                  
                  
                  
                  
                  83,985
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  84,150Fair
                      value of common stock warrants issued to non-employees
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  542,648
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  542,648Stock
                      based employee compensation
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  429,386
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  429,386Common
                      stock subscribed, net of issuance costs of $112,000
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3,500,000
                  
                  
                  1,288,000
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  1,288,000Common
                      stock subscribed for services to be rendered
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  45,833
                  
                  
                  22,917
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  22,917Net
                      loss
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (6,738,915
                  )
                  
                  (6,738,915
                  )**Balances,
                      January 1, 2006**
                  
                  
                  **30,945,317**
                  
                  
                  **30,945**
                  
                  
                  **(781,790**
                  **)**
                  
                  **18,144,258**
                  
                  
                  **3,545,833**
                  
                  
                  **1,310,917**
                  
                  
                  **-**
                  
                  
                  **-**
                  
                  
                  **(17,853,356**
                  **)**
                  
                  **850,974**
  28
 
 **Procera
              Networks, Inc.**
 **Statements
              of Stockholders' Equity (Deficit)**
 **For
              the Twelve Months Ended December 31, 2006 and January 1,
              2006**
 **Common
                      Stock**
                  
                  **Stock
                      Issuance**
                  
                  **Add.
                      Paid-In**
                  
                  **Subscribed
                      Com. Stock**
                  
                  **Receivable**
                  
                  
                  **Foreign
                      Currency**
                  
                  **Accum.**
                  
                  **Total
                      Stockholders****Description**
                  
                  **Shares**
                  
                  **Amount**
                  
                  **Costs**
                  
                  **Capital**
                  
                  **Shares**
                  
                  **Amount**
                  
                  **For
                      Stock**
                  
                  
                  **Translation**
                  
                  **Deficit**
                  
                  **Equity****Balances,
                      January 1, 2006**
                  
                  
                  **30,945,317**
                  
                  **$**
                  **30,945**
                  
                  **$**
                  **(781,790**
                  **)**
                  **$**
                  **18,144,258**
                  
                  
                  **3,545,833**
                  
                  **$**
                  **1,310,917**
                  
                  **$**
                  **-**
                  
                  **$**
                  
                  
                  **$**
                  **(17,853,356.00**
                  **)**
                  **$**
                  **850,974**Issuance
                      of common stock for cash at $0.10 per share upon exercise of
                      stock
                      purchase rights
                  
                  
                  20,000
                  
                  
                  20
                  
                  
                  
                  
                  
                  1,980
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  2,000Issuance
                      of common stock in connection with private placement of common
                      stock at
                      $0.40 per share in February 2006, less issuance costs of
                      $482,541
                  
                  
                  11,500,025
                  
                  
                  11,500
                  
                  
                  (482,541
                  )
                  
                  4,588,510
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  4,117,469Issuance
                      of common stock in connection with private placement of common
                      stock at
                      $0.40 per share in February 2006, which had been subscribed
                      and paid for
                      in December 2005
                  
                  
                  3,500,000
                  
                  
                  3,500
                  
                  
                  
                  
                  
                  1,396,500
                  
                  
                  (3,500,000
                  )
                  
                  (1,288,000
                  )
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  112,000Issuance
                      of warrants to placement agents to purchase 1,500,000 common
                      shares at
                      $0.40 per share, as compensation for services provided in connection
                      with
                      the private placement in February 2006
                  
                  
                  
                  
                  
                  
                  
                  
                  (712,828
                  )
                  
                  712,828Issuance
                      of common stock in connection with private placement of common
                      stock at
                      $1.00 per share in November 2006, less issuance costs of
                      $259,641
                  
                  
                  5,100,000
                  
                  
                  5,100
                  
                  
                  (259,641
                  )
                  
                  5,094,900
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  4,840,359Issuance
                      of common stock with a market value of $0.60 per share in exchange
                      for
                      100% of the outstanding stock of Netintact AB (a Swedish corporation)
                      in
                      August 2006
                  
                  
                  15,713,513
                  
                  
                  15,714
                  
                  
                  
                  
                  
                  8,670,950
                  
                  
                  1,826,000
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  8,686,664Issuance
                      of common stock with a market value of $0.82 per share in exchange
                      for 49%
                      of the outstanding stock of Netintanct PTY (an Australian corporation)
                      in
                      September 2006
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  273,693
                  
                  
                  760,000
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  273,693Issuance
                      of common stock for cash at $1.25 per share, upon exercise
                      of stock
                      warrants
                  
                  
                  60,000
                  
                  
                  60
                  
                  
                  
                  
                  
                  145,252
                  
                  
                  56,250
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  145,312Issuance
                      of common stock for cash at $1.37 per share, upon exercise
                      of stock
                      warrants
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  82,200
                  
                  
                  60,000
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  82,200Issuance
                      of common stock for cash at $0.75 per share, upon exercise
                      of stock
                      warrants
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  37,500
                  
                  
                  50,000
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  37,500Stock
                      based employee compensation
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  1,168,611
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  1,168,611Issuance
                      of 825,000 shares of common stock, having a market value of
                      $0.70 per
                      share, in exchange for 18 months of investor relations services
                      beginning
                      with the month of December 2005
                  
                  
                  825.000
                  
                  
                  825
                  
                  
                  ****
                  
                  
                  570,718
                  
                  
                  (45,833
                  )
                  
                  (22,917
                  )
                  
                  (160,420
                  )
                  
                  
                  
                  
                  
                  
                  
                  388,206
  29
 
 **Procera
              Networks, Inc.**
 **Statements
              of Stockholders' Equity (Deficit)**
 **For
              the Twelve Months Ended December 31, 2006 and January 1,
              2006**
 **Common
                      Stock**
                  
                  **Stock
                      Issuance**
                  
                  **Add.
                      Paid-In**
                  
                  **Subscribed
                      Com. Stock**
                  
                  **Receivable**
                  
                  
                  **Foreign
                      Currency**
                  
                  **Accum.**
                  
                  **Total
                      Stockholders'****Description**
                  
                  **Shares**
                  
                  **Amount**
                  
                  **Costs**
                  
                  **Capital**
                  
                  **Shares**
                  
                  **Amount**
                  
                  **For
                      Stock**
                  
                  
                  **Translation**
                  
                  **Deficit**
                  
                  **Equity**Issuance
                      of warrants to placement agents to purchase 1,550,000 shares
                      of common
                      stock at $1.50 per share as compensation for private placement
                      financial
                      services in February 2006
                  
                  
                  
                  
                  
                  
                  
                  
                  (1,552,423
                  )
                  
                  1,552,423Issuance
                      of warrants to purchase 1,020,000 shares of common stock at
                      $1.50 per
                      share to investors who participated in the private placement
                      financing in
                      November 2006
                  
                  
                  
                  
                  
                  
                  
                  
                  (1,034,948
                  )
                  
                  1,034,948Fair
                      value of warrants issued to service providers
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  73,770
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  73,770Foreign
                      currency translation adjustment
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  14,381
                  
                  
                  
                  
                  
                  14,381Net
                      Loss for 2006
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (7,503,479
                  )
                  
                  (7,503,479
                  )Balances,
                      December 31, 2006
                  
                  $
                  67,663,855
                  
                  $
                  67,664
                  
                  
                  ($4,824,171
                  )
                  $
                  43,549,041
                  
                  
                  2,752,250
                  
                  $
                  
                  
                  
                  ($160,420
                  )
                  
                  14,381
                  
                  
                  ($25,356,835
                  )
                  $
                  13,289,660
 
 The
          accompanying notes are an integral part of these financial
          statements
 30
 **Procera
          Networks, Inc.**
 **Consolidated
          Statements of Cash Flows**
 **For
          the Twelve Months Ended December 31, 2006 and January 1,
          2006**
 Fiscal
                    Year EndedDecember
                    31, 2006
                
                January
                    1, 2006Cash
                    flows from operating activities:Net
                    loss
                
                $
                (7,503,479
                )
                $
                (6,738,915
                )Adjustments
                    to reconcile net loss to net cash used in operating activities:Common
                    stock issued for service rendered
                
                
                388,206
                
                
                84,150Common
                    stock subscribed for services
                
                
                -
                
                
                22,917Stock
                    based compensation
                
                
                1,168,611
                
                
                429,387Fair
                    value of warrants issued to non-employee
                
                
                73,770
                
                
                542,647Depreciation
                
                
                44,520
                
                
                32,214Amortization
                    of intangibles
                
                
                1,227,761
                
                
                -Deferred
                    income taxes
                
                
                (298,252
                )
                
                -Other
                
                
                158
                
                
                -Changes
                    in assets and liabilities:Accounts
                    receivable
                
                
                (684,003
                )
                
                22,872Inventory
                
                
                (7,632
                )
                
                (13,403
                )Prepaid
                    expenses and other assets
                
                
                72,041
                
                
                45,793Accounts
                    payable
                
                
                (142,774
                )
                
                221,910Accrued
                    liabilities, deferred rent
                
                
                76.333
                
                
                (128,220
                )Deferred
                    revenue
                
                
                180,960
                
                
                -Net
                    cash used in operating activities
                
                
                (5,403,780
                )
                
                (5,478,648
                )Cash
                    flows from investing activities:Purchase
                    of property and equipment
                
                
                (178,313
                )
                
                (25,335
                )Cash
                    acquired in acquisition of business
                
                
                452,669
                
                
                -Net
                    cash used in investing activities
                
                
                274,356
                
                
                (25,335
                )Cash
                    flows from financing activities:Proceeds
                    from issuance of common stock to investors, net
                
                
                8,939,828
                
                
                -Proceeds
                    from common stock subscription, net
                
                
                -
                
                
                1,288,000Proceeds
                    from exercise of warrants
                
                
                265,012
                
                
                1,082,884Lease
                    payments
                
                
                (8,070
                )Payment
                    on loan payable
                
                
                (110,000
                )
                
                -Proceeds
                    from notes payable-related party
                
                
                -
                
                
                240,000Other
                
                
                2,000
                
                
                -Net
                    cash provided by financing activities
                
                
                9,088,770
                
                
                2,610,884Effect
                    of exchange rates on cash and cash equivalents
                
                
                
                
                
                -Net
                    increase in cash and cash equivalents
                
                
                3,959,346
                
                
                (2,893,099
                )Cash
                    and cash equivalents, beginning of period
                
                
                1,254,831
                
                
                4,147,930Cash
                    and cash equivalents, end of period
                
                $
                5,214,177
                
                $
                1,254,831
 
  (continued)
  The
          accompanying notes are an integral part of these financial
          statements
 31
 **Procera
            Networks, Inc.**
 **Consolidated
            Statements of Cash Flows**
 **For
            the Twelve Months Ended December 31, 2006 and January 1,
            2006**
 Supplemental
                  cash flow information:Cash
                  paid for income taxes
              
              $
              7,894
              
              $
              830Cash
                  paid for interest
              
              $
              5,072
              
              $
              1,076Non
                  cash investing and financing activities:Issuance
                  of common stock in connection withacquisition
                  of Netintact AB and Netintact PTY
              
              $
              9,444,776
              
              $
              -Issuance
                  of common stock to charity organization inconnection
                  with the private placement in December 2004
              
              $
              -
              
              $
              32,500Conversion
                  of notes payable
              
              $
              130,000Supplemental
                  cash flow information regarding the Company’s acquisition of Netintact AB
                  and Netintact PTY in 2006 is as follows:Fair
                  value of assets acquired
              
              $
              13,304,434Less
                  liabilities assumed
              
              
              (3,859,658
              )Net
                  assets acquired
              
              
              9,444,776Fair
                  value of common shares issued
              
              
              (9,444,776
              )Cash
                  acquired
              
              
              (452,669
              )
 
  The
          accompanying notes are an integral part of these financial
          statements
 32
 **Procera
          Networks, Inc.**
 **Notes
          to Consolidated Financial Statements**
 **December
          31, 2006**
 **1.**  **Formation
        and Business of the Company**
 
 Procera
        Networks, Inc. (“Procera” or “the Company”) is a Nevada corporation and is
        headquartered in Los Gatos, California. Procera was spun out from Digi
        International of Eden Prairie, Minnesota by Douglas Glader on May 1, 2002.
        Procera’s mission was to develop and market intelligent network products to
        protect, control and optimize IP-based traffic. On October 16, 2003, Procera
        merged with Zowcom, Inc, a publicly-traded Nevada corporation. The merged
        company started trading under the symbol OTC: BB:PRNW.OB.
 
 On
        June
        28, 2006, Procera and all shareholders of Netintact AB, a Swedish corporation
        (“ *Netintact* ”)
        entered into a First Amended and Restated Stock Exchange Agreement and Plan
        of
        Reorganization (the “ *Agreement* ”),
        and
        closed the transaction effective as of August 18, 2006, making Netintact
        a
        wholly owned subsidiary of Procera. The Agreement was amended on January
        24,
        2007 to, among other things, amend several of the terms and conditions of
        the
        incentive warrants, closing date warrants and incentive share plan. A copy
        of
        the amendment is attached hereto to this Report
 
 On
        September 29 ,
        2006,
        Procera and two of the three shareholders of Netintact PTY, an Australian
        company (“ *Netintact
        PTY* ”)
        entered into a certain Stock Exchange Agreement and Plan of Reorganization
        and
        closed the transaction effective as of September 29, 2006. Netintact, the
        remaining shareholder of Netintact PTY, owns 51 shares of Common Stock of
        Netintact PTY, constituting fifty-one (51%) of the issued and outstanding
        securities of Netintact PTY.
 
 As
        a
        result of the Netintact and Netintact PTY transactions, the core products
        and
        business of Procera have changed dramatically. Today, Procera is looking
        to
        become one of the prominent next generation traffic management solutions
        for
        broadband service networks. Netintact’s flagship product and technology,
        PacketLogic, now form the core of Procera’s product offering. There are over 600
        PacketLogic installations at more than 200 service providers, telephone
        companies, enterprises, colleges and universities around the world.
  Fiscal
        Year
 
 Prior
        to
        the Fiscal year which ended December 31, 2006, the Company maintained its
        accounting records on a 52-53 week fiscal year, with the fiscal year ending
        on
        the Sunday nearest to December 31. Fiscal year 2005 ended January 1, 2006.
        Beginning with the current Fiscal year which ended December 31, 2006, the
        Company’s Board of Directors will discuss maintaining its accounting records on
        a Fiscal year which ends on December 31.
  **2.**  **Summary
        of Significant Accounting Policies**
 
 Basis
        of Presentation
 
 The
        accompanying financial statements have been prepared in conformity with
        accounting principles generally accepted in the United States of America,
        which
        contemplate continuation of the Company as a going concern. However, at December
        31, 2006, the Company has an accumulated deficit of $25,356,835and has sustained
        an operating cash flow deficiency of $19,340,047 since inception. In addition,
        the Company had insufficient cash at December 31, 2006 to fund its operations
        for the next fiscal year. The Company’s activities have been financed
        principally through borrowings and the issuance of equity.
 33
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **2.**  **Summary
        of Significant Accounting Policies (continued)**
 
 Basis
        of Presentation (continued)
 
 The
        Company will require additional financing to fund ongoing operations. There
        can
        be no assurance that any new debt or equity financing could be successfully
        consummated. These factors raise substantial doubt about the Company’s ability
        to continue as a going concern. The financial statements do not include any
        adjustments relating to the recoverability and classification of the recorded
        asset amounts or amounts and classification of liabilities that might result
        from the outcome of this uncertainty.
  Use
        of
        Estimates
 
 The
        preparation of financial statements in conformity with accounting principles
        generally accepted in the United States of America requires management to
        make
        estimates and assumptions that affects certain report amounts and disclosures.
        Accordingly, actual results could differ from those estimates.
  Liquidity
 
 The
        Company has sustained recurring losses and negative cash flows from operations.
        Over the past year, the Company’s growth has been funded through a combination
        of private equity, and lease financing. As of December 31, 2006, the Company
        had
        $5,214,177 of unrestricted cash and cash equivalents. During 2006, the Company
        obtained equity financing through private placements. The Company has
        experienced and continues to experience negative cash flows from operations,
        as
        well as an ongoing requirement for additional investment in operations. The
        Company expects that it will need to raise additional capital to accomplish
        its
        business plan. There can be no assurance as to the availability or terms
        upon
        which such financing and capital might be available.
  Fair
        Value of Financial Instruments
 
 The
        carrying amounts of certain of the Company’s financial instruments including
        cash and cash equivalents, accounts receivable, prepaid expenses, accounts
        payable and accrued liabilities approximate fair value due to their short
        maturities.
  Concentration
        of Credit Risk
 
 Financial
        instruments that potentially subject the Company to a concentration of credit
        risk consist of cash and cash equivalents and accounts receivable. Cash and
        cash
        equivalents are deposited in demand and money market accounts in one financial
        institution in the United States. Deposits held with financial institutions
        may
        exceed the amount of insurance provided on such deposits. The Company has
        not
        experienced any material losses on its deposits of cash and cash
        equivalents.
 34
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **2.**  **Summary
        of Significant Accounting Policies (continued)**
 
 Concentration
        of Credit Risk (continued)
 
 The
        Company’s accounts receivable are derived from revenue earned from customers
        located in the United States, Australia, Europe, Asia, Canada and the Middle
        East. There are a limited number of customers accounting for the majority
        of
        purchases in the industry worldwide. The Company maintains an allowance for
        doubtful accounts based upon the expected collection of its outstanding
        receivable balances.
 
 On
        December 31, 2006, accounts receivable are owing from fifty customers and
        no one
        customer represents more than 12% of total accounts receivable.
  Advertising
        Costs
 
 Advertising
        costs are expenses as incurred. Advertising expenses were not significant
        for
        the periods ended December 31, 2006 and January 1, 2006.
  Cash
        and Cash Equivalents and Restricted Cash
 
 The
        Company considers all highly liquid investments to mature within three months
        or
        less to be cash equivalents. Restricted cash consists of a certificate of
        deposit in the amount of $30,000 held with a financial institution as a sales
        tax security deposit.
  Accounts
        Receivable
 
 Accounts
        receivable are stated at net realizable value. Customers are on cash on delivery
        until credit approval. Uncollectible receivables are recorded as bad debt
        expense when all efforts to collect have been exhausted and recoveries are
        posted as they are received.
  Inventory
 
 Inventory
        is stated at the lower of cost or market. Cost is determined on a standard
        cost
        basis which approximates actual cost on the first-in, first-out (“FIFO”) method.
        Lower of cost or market is evaluated by considering obsolescence, excessive
        levels of inventory, deterioration and other factors.
 35
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **2.**  **Summary
        of Significant Accounting Policies (continued)**
 
 Property
        and Equipment
 
 Property
        and equipment are stated at cost. Depreciation is calculated using the
        straight-line method over the estimated useful lives of the assets, which
        is
        three years for computer, tooling, test and office equipment and two years
        for
        software. Leasehold improvements are amortized using the straight-line method
        over the estimated useful lives of the assets or the term of the lease,
        whichever is shorter. Whenever assets are retired or otherwise disposed of,
        the
        cost and related accumulated depreciation are removed from the accounts,
        and any
        resulting gain or loss is recognized in income for the period. The cost of
        maintenance and repairs is expensed as incurred; significant improvements
        are
        capitalized.
  Assets
        Held under Capital Leases:
 
 Assets
        held under capital leases are recorded at the lower of the net present value
        of
        the minimum lease payments or the fair value of the leased asset at the
        inception of the lease. Amortization expense is computed using the straight-line
        method over the shorter of the estimated useful lives of the assets or the
        period of the related lease.
  Impairment
        of Long-Lived Assets
 
 The
        Company evaluates its long-lived assets for indicators of possible impairment
        by
        comparison of the carrying amounts to future net undiscounted cash flows
        expected to be generated by such assets when events or changes in circumstances
        indicate the carrying amount of an asset may not be recoverable. Should an
        impairment exist, the impairment loss would be measured based on the excess
        carrying value of the asset over the asset’s fair value or discounted estimates
        of future cash flows. The Company has not identified any such impairment
        losses
        to date.
  Intangible
        Assets
 
 Effective
        September 29, 2006, the Company completed the purchase of Netintact AB and
        Netintact PTY, a privately held software company. The assets acquired included
        approximately $11.1 million of intangible assets, other than goodwill. Of
        the
        $11 million of acquired intangible assets, $4.3 million was assigned to customer
        lists, $2.2 million to management information and software, and $4.6 million
        to
        product software, these intangible assets are subject to amortization. The
        $11
        million of acquired intangible assets have an average useful life of
        approximately 3 years.
  36
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **2.**  **Summary
        of Significant Accounting Policies (continued)**
 
 Goodwill
 
 Effective
        September 29, 2006, the Company acquired Netintact AB and Netintact PTY,
        a
        privately held software company. The Company issued 18,299,514 shares of
        common
        stock with a total fair value of $9.4 million, in exchange for all outstanding
        shares of Netintact AB and Netintact PTY. The Company accounted for the
        acquisition using the purchase method of accounting for business combinations.
        The purchase price and costs associated with the acquisition did not exceed
        the
        preliminary estimated fair value of net worth of $.5million and intangible
        assets acquired by $8.9 million.
 
 Subsequent
        to September 30, 2006, the Company completed the valuation of the intangible
        assets and analysis of deferred tax liabilities (pursuant to SFAS No. 109,
        paragraphs 30 and 258-260) it acquired in the Netintact transaction. Based
        on
        this analysis, the remaining an additional portion of the purchase price
        of $3.1
        million was assigned to amortizable intangible assets of $2 million and $1
        million to goodwill.
  Impairment
        of Finite Life Intangible Assets
 
 The
        Company evaluates its operations to ascertain if a triggering event has occurred
        which would impact the value of finite-lived intangible assets (e.g., customer
        lists). Examples of such triggering events include a significant disposal
        of a
        portion of such assets, an adverse change in the market involving the business
        employing the related asset, a significant decrease in the benefits realized
        from an acquired business, difficulties or delays in integrating the business,
        and a significant change in the operations of an acquired business.
 
 As
        of
        December 31, 2006, no such triggering event has occurred, and, no impairment
        test was needed. An impairment test involves a comparison of undiscounted
        cash
        flows against the carrying value of the asset as an initial test. If the
        carrying value of such asset exceeds the undiscounted cash flow, the asset
        would
        be deemed to be impaired. Impairment would then be measured as the difference
        between the fair value of the fixed or amortizing intangible asset and the
        carrying value to determine the amount of the impairment. The Company determines
        fair value generally by using the discounted cash flow method. To the extent
        that the carrying value is greater than the asset’s fair value, an impairment
        loss is recognized for the difference.
  Impairment
        of Goodwill
 
 The
        Company periodically reviews the carrying value of intangible assets not
        subject
        to amortization, including goodwill, to determine whether impairment may
        exist.
        FASB Statement of Financial Accounting Standards No. 142, *Goodwill
        and Other Intangible Assets* ,
        requires that goodwill and certain intangible assets be assessed annually
        for
        impairment using fair value measurement techniques. Specifically, goodwill
        impairment is determined using a two-step process. The first step of the
        goodwill impairment test is used to identify potential impairment by comparing
        the fair value of a reporting unit with its carrying amount, including goodwill.
        The estimates of fair value of a reporting unit, generally the Company’s
        operating segments, are determined using various valuation
        techniques
  37
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **2.**  **Summary
        of Significant Accounting Policies (continued)**
 
 Impairment
        of Goodwill (continued)
 
 with
        the
        primary technique being a discounted cash flow analysis. A discounted cash
        flow
        analysis requires one to make various judgmental assumptions including
        assumptions about future cash flows, growth rates, and discount rates. The
        assumptions about future cash flows and growth rates are based on the Company’s
        budget and long-term plans. Discount rate assumptions are based on an assessment
        of the risk inherent in the respective reporting units. If the fair value
        of a
        reporting unit exceeds its carrying amount, goodwill of the reporting unit
        is
        considered not impaired and the second step of the impairment test is
        unnecessary. If the carrying amount of a reporting unit exceeds its fair
        value,
        the second step of the goodwill impairment test is performed to measure the
        amount of impairment loss, if any. The second step of the goodwill impairment
        test compares the implied fair value of the reporting unit’s goodwill with the
        carrying amount of that goodwill. If the carrying amount of the reporting
        unit’s
        goodwill exceeds the implied fair value of that goodwill, an impairment loss
        is
        recognized in an amount equal to that excess. The implied fair value of goodwill
        is determined in the same manner as the amount of goodwill recognized in
        a
        business combination. That is, the fair value of the reporting unit is allocated
        to all of the assets and liabilities of that unit (including any unrecognized
        intangible assets) as if the reporting unit had been acquired in a business
        combination and the fair value of the reporting unit was the purchase price
        paid
        to acquire the reporting unit.
 
 As
        of
        December 31, 2006, the Company concluded that there was no impairment to
        the
        carrying value of goodwill.
  Stock
        and Warrants Issued to Third Parties
  The
        Company accounts for stock and stock warrants issued to third parties, including
        customers, in accordance with the provisions of the Emerging Issues Task
        Force
        (EITF) Issue No. 96-18, *Accounting
        for Equity Instruments That Are Issued to Other Than Employees for Acquiring,
        or
        in Conjunction with Selling Goods or Services* ,
        and
        EITF 01-9, *Accounting
        for Consideration Given by a Vendor to a Customer (Including a Reseller of
        the
        Vendor’s Products)* .
        Under
        the provisions of EITF 96-18, if none of the Company’s agreements have a
        disincentive for nonperformance, the Company records a charge for the fair
        value
        of the stock and the portion of the warrants earned from the point in time
        when
        vesting of the stock or warrants becomes probable. EITF 01-9 requires that
        the
        fair value of certain types of warrants issued to customers be recorded as
        a
        reduction of revenue to the extent of cumulative revenue recorded from that
        customer. The Company has not given any stock based consideration to a
        customer.
 38
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **2.**  **Summary
        of Significant Accounting Policies (continued)**
 
 Stock-Based
        Compensation
 
 Effective
        January 2, 2006, the Company adopted the provisions of SFAS No. 123 (R),
        “Share-Based Payment.” SFAS No. 123(R) establishes accounting for stock-based
        awards exchanged for employee services. Accordingly, stock-based compensation
        cost is measured at grant date, based on the fair value of the award, and
        is
        recognized as expense over the employee requisite service period. All of
        the
        Company’s stock compensation is accounted for as an equity instrument. The
        Company previously applied Accounting Principles Board (“APB”) Opinion No. 25,
“Accounting for Stock Issued to Employees,” and related interpretations and
        provided the required pro forma disclosures of SFAS No. 123, “Accounting for
        Stock-Based Compensation.”
  *Prior
        to the Adoption of SFAS No. 123(R)*
 
 Prior
        to
        the adoption of SFAS No. 123 (R), the Company provided the disclosures required
        under SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by
        SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and
        Disclosures.” The Company recorded employee stock-based compensation for the
        twelve months ended December 31, 2006 for options granted to employees with
        a
        market value of the underlying common stock greater than exercise price on
        the
        date of grant.
 
 The
        pro-forma information for the fiscal years ended January 1, 2006 and January
        2,
        2005 was as follows:
 
 January
                    1, 2006
                
                January
                    2, 2005Net
                    loss as reported
                
                $
                (6,738,915
                )
                $
                (6,363,169
                )Add:
                    Stock-based employee compensation expense included in reported
                    net loss,
                    net of related tax effects
                
                
                429,386
                
                
                1,068,615Deduct;
                    Total stock-based employee compensation expense determined under
                    fair
                    value based method for all awards, net of related tax
                    effects
                
                
                (1,412,246
                )
                
                (969,854
                )Pro
                    forma net loss
                
                $
                (7,721,775
                )
                $
                (6,264,408
                )Earnings
                    per share basic and diluted:
                
                $
                (0.22
                )
                $
                (0.27
                )Pro
                    Forma
                
                $
                (0.25
                )
                $
                (0.27
                )
 39
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **2.**  **Summary
        of Significant Accounting Policies (continued)**
 
 Stock-Based
        Compensation (continued)
 
 *Prior
        to the Adoption of SFAS No. 123(R) (continued)*
 
 The
        Company elected to adopt the modified-prospective application method as provided
        by SFAS No. 123 (R). The effect of recording stock-based compensation for
        the
        fiscal year ended December 31, 2006 and the allocation to expense under SFAS
        No.
        123(R) was as follows:
 
 Year
                  EndedDecember
                  31,2006Stock-based
                  compensation expensefrom
                  employee stock options
              
              $
              1,168,611Tax
                  effect on stock-based compensation
              
              
              -Net
                  effect on net loss
              
              $
              1,168,611Effect
                  on basic and diluted net loss per share
              
              $
              0.02
 
 
 Year
                  EndedDecember
                  31,2006Cost
                  of sales
              
              $
              -Engineering
              
              
              787,859Selling,
                  general and administrative
              
              
              380,752Stock
                  based compensation before income taxes
              
              
              1,168,611Income
                  tax benefit
              
              
              -Total
                  stock-based compensation expensesAfter
                  income taxes
              
              $
              1,168,611
 
 
 No
        stock-based compensation has been capitalized in inventory due to the
        immateriality of such amounts.
  The
        Company estimates the fair value of stock options using a Black-Scholes
        valuation model, consistent with the provisions of SFAS No. 123 (R), SEC
        SAB No.
        107 and the Company’s prior period pro forma disclosures of net loss, including
        stock-based compensation (determined under a fair value method as prescribed
        by
        SFAS No. 123). The fair value of each option grant is estimated on the date
        of
        grant using the Black-Scholes option valuation model and the straight-line
        attribution approach.
 
 40
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **2.**  **Summary
        of Significant Accounting Policies (continued)**
 
 Stock-Based
        Compensation (continued)
 
 *Prior
        to the Adoption of SFAS No. 123(R) (continued)*
 
 The
        weighted average assumptions used for 2006 and 2005 are as follows:
 
 Year
                  EndedDecember
                  31,
              
              January
                  1,2006
              
              2006Risk
                  free interest rate
              
              
              4.79
              %
              
              3.88
              %Expected
                  life of option
              
              
              6.2
                  years
              
              
              3.9
                  yearsExpected
                  dividends
              
              
              0
              %
              
              0
              %Volatility
              
              
              110
              %
              
              114
              %
  The
        dividend yield of zero is based on the fact that the Company has never paid
        cash
        dividends and has no present intention to pay cash dividends. Expected
        volatility is based on historical volatility of the Company’s common stock. The
        risk-free interest rates are taken from the 3-year and 7-year daily constant
        maturity rate as of the grant dates as published by the Federal Reserve Bank
        of
        St. Louis and represent the yields on actively traded Treasury securities
        for
        comparable to the expected term of the options. The expected life of the
        options
        granted in 2006 is calculated using the simplified method which uses the
        midpoint between the vesting period and the contractual grant date.
  Income
        Taxes
 
 The
        Company accounts for its income taxes using the Financial Accounting Standards
        Board Statements of Financial Accounting Standards No. 109, “Accounting for
        Income Taxes,” which requires the establishment of a deferred tax asset or
        liability for the recognition of future deductible or taxable amounts and
        operating loss and tax credit carryforwards. Deferred tax expense or benefit
        is
        recognized as a result of timing differences between the recognition of assets
        and liabilities for book and tax purposes during the year.
 
 Deferred
        tax assets and liabilities are measured using enacted tax rates expected
        to
        apply to taxable income in the years in which those temporary differences
        are
        expected to be recovered or settled. Deferred tax assets are recognized for
        deductible temporary differences and operating loss, and tax credit
        carryforwards. A valuation allowance is established, when necessary, to reduce
        that deferred tax asset if it is “more likely than not” that the related tax
        benefits will not be realized
  Revenue
        Recognition
 
 PROCERA
        recognizes revenue when persuasive evidence of a sale arrangement exists,
        delivery has occurred or services have been rendered, the sales price is
        fixed
        or determinable, and collectibility is reasonably assured in accordance with
        SEC
        Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial
        Statements” (“SAB 104”).
 41
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **2.**  **Summary
        of Significant Accounting Policies (continued)**
 
 Revenue
        Recognition (continued)
 
 When
        a
        customer order contains multiple items such as hardware, software, and services
        which are delivered at varying times, the Company determines whether the
        delivered items can be considered separate units of accounting as prescribed
        under Emerging Issues Task Force (“EITF”) Issue No. 00-21, “Revenue
        Arrangements with Multiple Deliverables” (“EITF 00-21”). EITF 00-21 states that
        delivered items should be considered separate units of accounting if delivered
        items have value to the customer on a standalone basis, there is objective
        and
        reliable evidence of the fair value of undelivered items, and if delivery
        of
        undelivered items is probable and substantially in Procera’s control.
 
 In
        these
        circumstances, PROCERA allocates revenue to each element based on its relative
        vendor specific objective evidence of fair value (“VSOE”). VSOE for products and
        software is established based on the Company’s approved pricing schedules. To
        establish VSOE for services, the Company uses standard billing rates based
        on
        said services. Generally, the Company is able to establish VSOE for all elements
        of the sales order and bifurcate the customer order or contract accordingly.
        In
        these instances, sales are recognized on each element separately. However,
        if
        VSOE cannot be established or if the delivered items do not have stand alone
        value to the customer without additional services provided, the Company
        recognizes revenue on the contract as a whole based on either the
        completed-performance or proportional-performance methods as described below.
 
 In
        most
        cases, revenue from hardware and software product sales is recognized when
        title
        passes to the customer. Based upon the Company’s standard shipping terms, FCA
        Procera, title passes upon shipment to the customer.
 
 Revenue
        is recognized on service contracts using either the completed-performance
        or
        proportional-performance method depending on the terms of the service agreement.
        When the amount of services to be performed in the last series of acts is
        so
        significant in relation to the entire service contract that performance is
        deemed not to have occurred until the final act is completed or when there
        are
        acceptance provisions based on customer-specified subjective criteria, the
        completed-performance method is used. Once the last significant act has been
        performed, revenue is recognized. The Company uses the proportional-performance
        method when a service contract specifies a number of acts to be performed
        and
        the Company has the ability to produce reasonable estimates. The estimates
        used
        on these contracts are periodically updated during the term of the contract
        and
        may result in the Company’s revision of recognized sales in the period in which
        they are identified.
 
 In
        many
        contracts, billing terms are agreed upon based on performance milestones
        such as
        the execution of a contract, the customer’s acceptance of a list detailing the
        equipment and/or vendor for products, the partial or complete delivery of
        products and/or the completion of specified services. Payments received before
        delivery has occurred or services have been rendered are recorded as deferred
        revenue until the revenue recognition criteria are met. Deferred revenue
        from
        maintenance or warranty contracts is recognized over the terms of the underlying
        contract.
 42
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **2.**  **Summary
        of Significant Accounting Policies (continued)**
 
 Revenue
        Recognition (continued)
 
 The
        Company offers rights of return to certain end-user customers on the products
        it
        sells. In accordance with SFAS No. 48, “Revenue Recognition When Right of
        Return Exists,” the Company records a sales return allowance based on historical
        trends in product return rates, when such returns became material. The allowance
        for future sales returns as of December 31, 2006 was $20,950.
 
 The
        Company provides products to direct customers under payment terms of net
        30
        days, with no price protection provisions. Under standard terms, we provide
        initial products to indirect channel customers (value-added resellers) under
        payment terms of net 45 days. Thereafter, under follow-on orders from
        value-added resellers the Company provides products under payment terms of
        net
        30 days. Any terms other than those just described would be considered
        non-standard.
  Deferred
        Revenue
 
 Revenue
        under maintenance agreements is deferred and recognized over the term of
        the
        agreements (typically one year) on a straight-line basis. At December 31,
        2006,
        deferred revenue totaled $ 383,231 and is included under “Deferred revenue” in
        the accompanying Balance Sheet.
  Research
        and Development
 
 Research
        and development expenses include internal and external costs. Internal costs
        include salaries and employment related expenses and allocated facility costs.
        External expenses consist of costs associated with outsourced software
        development activities. In accordance with SFAS No. 2, “Accounting for Research
        Development Costs”, all such costs are charged to expense as
        incurred.
  Shipping
        and Handling Costs
 
 The
        Company includes shipping and handling costs associated with inbound and
        outbound freight in costs of goods sold.
  Product
        Development Costs
 
 The
        Company accounts for internally-generated software development costs in
        accordance with SFAS No. 86, “Accounting for the Costs of Computer Software to
        be Sold, Leased or Otherwise Marketed.” Capitalization of eligible product
        development costs begins upon the establishment of technological feasibility,
        which we have defined as completion of a working model. Internally-generated
        software related costs that were eligible for capitalization was approximately
        $75,000 of which approximately $11,500 and $37,500 has been amortized and
        charged to “Engineering” in the statements of operations for the years ended
        December 31, 2006 and January 1, 2006, respectively.
 43
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **2.**  **Summary
        of Significant Accounting Policies (continued)**
 
 Comprehensive
        Income
 
 The
        Company has adopted Statement of Financial Accounting Standards No. 130,
        “Reporting Comprehensive Income,” which establishes standards for reporting
        comprehensive income and its components in the financial statements.
        Comprehensive income consists of net income and other gains and losses affecting
        shareholders’ equity that, under generally accepted accounting principles, are
        excluded from net income. For the Company, such items consist primarily of
        foreign currency translation gains and losses. For the fiscal year ended
        December 31, 2006 the changes in the components of other comprehensive income
        (loss) related to foreign currency adjustments were de minimis. For the fiscal
        years ended December 31, 2006 and January 1, 2006, the Company’s comprehensive
        income (loss) equaled its net loss.
  Net
        Loss per Share
 
 Basic
        earnings per share (“EPS”) is computed by dividing net loss by the weighted
        average number of common shares outstanding for the period. Diluted EPS reflects
        the potential dilution that could occur from common shares issuable through
        stock options, warrants and other convertible securities, if
        dilutive.
 
 The
        following table is a reconciliation of the numerator (net loss) and the
        denominator (number of shares) used in the basic and diluted EPS calculations
        and sets forth potential shares of common stock that are not included in
        the
        diluted net loss per share calculation as the effect is
        antidilutive:
  Fiscal
                  Year EndedDecember
                  31,
              
              January
                  1,2006
              
              2006Numerator
                  - Basic and diluted
              
              $
              (7,503,479
              )
              $
              (6,768,915
              )Denominator
                  - basic and dilutedWeighted
                  average common sharesoutstanding
              
              
              50,443,688
              
              
              30,445,423Weighted
                  average unvested commonshares
                  subject to repurchase
              
              
              -
              
              
              -Total
              
              $
              50,443,688
              
              $
              30,445,423Net
                  loss per share - basic and diluted
              
              $
              (0.15
              )
              $
              (0.22
              )Antidilutive
                  securities:Common
                  stock subscriptions
              
              
              166,250
              
              
              3,545,833Common
                  stock reserved for incentives
              
              
              5,462,758
              
              
              -Options
              
              
              5,483,784
              
              
              3,916,970Warrants
              
              
              8,901,344
              
              
              7,213,178Rights
                  to purchase common stock
              
              
              -
              
              
              292,100
 
 44
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **2.**  **Summary
        of Significant Accounting Policies (continued)**
 
 Commitments
        and Contingencies:
 
 Certain
        conditions may exist as of the date the financial statements are issued,
        which
        may result in a loss to the Company but which will only be resolved when
        one or
        more future events occur or fail to occur. The Company’s management and its
        legal counsel assess such contingent liabilities, and such assessment inherently
        involves an exercise of judgment. In assessing loss contingencies related
        to
        legal proceedings that are pending against the Company or unasserted claims
        that
        may result in such proceedings, the Company’s legal counsel evaluates the
        perceived merits of any legal proceedings or unasserted claims as well as
        the
        perceived merits of the amount of relief sought or expected to be sought
        therein.
 
 If
        the
        assessment of a contingency indicates that it is probable that a material
        loss
        has been incurred and the amount of the liability can be estimated, then
        the
        estimated liability would be accrued in the Company’s financial statements. If
        the assessment indicates that a potentially material loss contingency is
        not
        probable, but is reasonably possible, or is probable but cannot be estimated,
        then the nature of the contingent liability, together with an estimate of
        the
        range of possible loss if determinable and material, would be
        disclosed.
 
 Loss
        contingencies considered remote are generally not disclosed unless they involve
        guarantees, in which case the nature of the guarantee would be disclosed.
 
 Foreign
        Currency Translation
 
 Financial
        statements of foreign subsidiaries, located in Sweden and Australia, where
        the
        local currency, Swedish Krona and Australian Dollar, is the functional currency
        are translated into U.S. dollars using period-end exchange rates for assets
        and
        liabilities and average exchange rates during the period for revenues and
        expenses.  Cumulative translation adjustments associated with net assets or
        liabilities are reported in non-owner changes in equity.  Any exchange rate
        gains or losses related to foreign currency transactions are recognized in
        the
        income statement as incurred, in the same financial statement caption as
        the
        underlying transaction, and are not material for any year shown.
 
 Cash
        at
        Netintact AB, was translated at exchange rates in effect at December 31,
        2006,
        and its cash flows were translated at the average exchange rates for the
        years
        then ended.  Changes in cash resulting from the translations are presented
        as a separate item in the statements of cash flows.
  Registration
        Rights Agreements
 
 The
        Company’s management reviewed the Securities and Exchange Commission’s release
        on December 1, 2005 entitled “Current Accounting and Disclosure Issues in the
        Division of Corporation Finance” as Prepared by Accounting Staff Members in the
        Division of Corporation Finance, U.S. Securities and Exchange Commission
        Washington, D.C. Furthermore, the Company evaluated the terms of the warrants
        and registration rights agreement in accordance with EITF Issue Nos., 00-19,
        05-04, 05-07, and 06-06, and with FSP 00-19-2. The Company determined that
        it
        does not have a contingent liability in regards to the registration rights
        agreements.
 
 45
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **2.**  **Summary
        of Significant Accounting Policies (continued)**
 
 Recent
        Accounting Pronouncements
 
 In
        February 2006, the Financial Accounting Standards Board (“FASB”) issued
        Statement of Financial Accounting Standards (“SFAS”) No. 155, “Accounting for
        Certain Hybrid Financial Instruments”.  SFAS No. 155 amends SFAS No 133,
“Accounting for Derivative Instruments and Hedging Activities”, and SFAS No.
        140, “Accounting for Transfers and Servicing of Financial Assets and
        Extinguishments of Liabilities”.  SFAS No. 155, permits fair value
        remeasurement for any hybrid financial instrument that contains an embedded
        derivative that otherwise would require bifurcation, clarifies which
        interest-only strips and principal-only strips are not subject to the
        requirements of SFAS No. 133, establishes a requirement to evaluate interest
        in
        securitized financial assets to identify interests that are freestanding
        derivatives or that are hybrid financial instruments that contain an embedded
        derivative requiring bifurcation, clarifies that concentrations of credit
        risk
        in the form of subordination are not embedded derivatives, and amends SFAS
        No.
        140 to eliminate the prohibition on the qualifying special-purpose entity
        from
        holding a derivative financial instrument that pertains to a beneficial interest
        other than another derivative financial instrument.  This statement is
        effective for all financial instruments acquired or issued after the beginning
        of the Company’s first fiscal year that begins after September 15, 2006. The
        Company has not yet determined the effect, if any, of SFAS No. 155 on its
        financial position, operations or cash flows.
 
 In
        June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for
        Uncertainty in Income Taxes” (“FIN 48”), an interpretation of SFAS No. 109,
“Accounting for Income Taxes”.  FIN 48 clarifies the accounting for
        uncertainty in income taxes recognized in a company’s financial statements and
        prescribes a recognition threshold and measurement process for financial
        statement recognition and measurement of a tax position taken or expected
        to be
        taken in a tax return.  FIN 48 also provides guidance on derecognition,
        classification, interest and penalties, accounting in interim periods,
        disclosure and transition and will become effective for the Company for fiscal
        years beginning after December 15, 2006.  The Company has not yet
        determined the effect of FIN No. 48 on its financial position, operations
        or
        cash flows.
 
 In
        September 2006, FASB issued SFAS No. 157, “Fair Value Measurements”.  SFAS
        No. 157 defines fair value, establishes a framework for measuring fair value
        in
        generally accepted accounting principles, and expands disclosures about fair
        value measurements.  It applies under other accounting pronouncements that
        require or permit fair value measurements, the board having previously concluded
        in those accounting pronouncements that fair value is the relevant measurement
        attribute.  Accordingly, this statement does not require any new fair value
        measurements.  This statement is effective for all financial instruments
        issued for fiscal years beginning after November 15, 2007, and interim periods
        within those fiscal years. The
        Company has not yet determined the effect, if any, of SFAS No. 157 on its
        financial position, operations or cash flows.
 
 In
        September 2006, the Securities and Exchange Commission issued Staff Accounting
        Bulletin (SAB) No. 108 to address diversity in practice in quantifying financial
        statement misstatements. SAB 108 requires that registrants quantify the impact
        on the current year’s financial statements of correcting all misstatements,
        including the carryover and reversing effects of prior years’ misstatements, as
        well as the effects of errors arising in the current year. SAB 108 is effective
        as of the first fiscal year ending after November 15, 2006, allowing a one-time
        transitional cumulative effect adjustment to retained earnings as of January
        1,
        2006, for errors that were not previously deemed material, but are material
        under the guidance in SAB No. 108. There was no impact on our consolidated
        financial statements with respect to the adoption of SAB No. 108.
 46
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 2  **Summary
        of Significant Accounting Policies (continued)**
 
 Recent
        Accounting Pronouncements (continued)
 
 In
        February 2007, FASB issued SFAS 159, “The Fair Value Option for Financial Assets
        and Financial Liabilities”.  SFAS No. 159 amends SFAS No. 115, “Accounting
        for Certain Investments in Debt and Equity Securities”.  SFAS No. 159
        permits entities to choose to measure many financial instruments and certain
        other items at fair value. The objective of SFAS No. 159 is to improve financial
        reporting by providing entities with the opportunity to mitigate volatility
        in
        reported earnings caused by measuring related assets and liabilities differently
        without having to apply complex hedge accounting provisions. SFAS No. 159
        is
        expected to expand the use of fair value measurement, which is consistent
        with
        the Board’s long-term measurement objectives for accounting for financial
        instruments. SFAS No. 159 applies to all entities, including not-for-profit
        organizations. Most of the provisions of SFAS No. 159 apply only to entities
        that elect the fair value option. However, the amendment to SFAS No. 115
        applies
        to all entities with available-for-sale and trading securities. Some
        requirements apply differently to entities that do not report net income. This
        statement is effective as of the beginning of each reporting entity’s first
        fiscal year that begins after November 15, 2007. The
        Company has not yet determined the effect of SFAS No. 159 on its financial
        position, operations or cash flows.
  **3.**  **Merger
        with Netintact**
 
 On
        August
        18, 2006, Procera acquired 100% of the outstanding stock of Netintact, AB.,
        (“Netintact AB”), a Swedish software company. The purchase agreement was amended
        on January 24, 2007. At the time of its acquisition by Procera, Netintact
        AB
        owned 51% of the outstanding shares of Netintact PTY (“Netintact PTY”), an
        Australian company that distributed Netintact AB’s products in Australia and
        Asia. On September 29, 2006, Procera acquired the remaining 49% of the
        outstanding shares of Netintact PTY. The total purchase price of $14.0 million.
        Netintact, AB’s and Netintact PTY’s results of operations have been included in
        the consolidated financial statements since the date of acquisition. Procera
        believes the Netintact companies are desirable and valuable partners due
        to
        their strategic customer base, the technology is incorporated into their
        software products, and their success in penetrating their markets (Europe,
        Australia and Asia).
 
 Pursuant
        to the terms of the Stock Exchange Agreement, Procera has committed up to
        22,002,000 shares of common stock including 18,299,514 shares at the close
        of
        the acquisitions, 2,876,757 shares upon the attainment of future milestones,
        incentive warrants convertible into 123,243 shares and warrants convertible
        into
        702,486 shares. The fair value of common stock issued for the acquisitions,
        excluding future shares (incentive and milestone related) was $9,444,776.
        The
        value of the common shares issued was determined based on the market price
        of
        the Company’s common shares on the effective date of the
        acquisition.
 
 47
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **3.**  **Merger
        with Netintact (continued)**
 
 The
        following table presents the allocation of the acquisition cost, including
        professional fees and other related acquisition costs, to the assets acquired
        and liabilities assumed, based on their fair values:
 
 Cash
                  and cash equivalents
              
              $
              452,669Accounts
                  receivable
              
              
              391,826Inventories
              
              
              129,041Other
                  current assets
              
              
              71,235Property,
                  plant, and equipment
              
              
              180,454Intangible
                  assets
              
              
              11,119,000Goodwill
              
              
              960,209Total
                  assets acquired
              
              
              13,304,434Accounts
                  payable
              
              
              215,775Other
                  current liabilities
              
              
              330,079Deferred
                  revenue
              
              
              194,952Deferred
                  tax liability related to amortizable intangible assets
              
              
              3,118,852Total
                  liabilities assumed
              
              
              3,859,658Net
                  assets acquired
              
              $
              9,444,776
 
 
 Following
        the closing of the Netintact AB and Netintact PTY acquisition transactions,
        Procera obtained an independent third-party valuation of the intangible assets
        contained therein. The independent third-party valuation allocated the total
        fair value of common stock for the two acquisitions to intangible assets
        and net
        tangible assets. Of the $12.1 million of acquired intangible assets, $1.0
        million was assigned to goodwill that is not subject to amortization and
        the
        remaining $11.1 million of acquired intangible assets have a weighted-average
        useful life of approximately 3 years. The intangible assets that make up
        that
        amount include: product software of $4.6 million (3-year weighted-average
        useful
        life), management information and related software of $2.2 million (3-year
        weighted-average useful life), and customer base of $4.3 million (3-year
        weighted-average useful life). The amounts allocated to the intangible assets
        are not expected to be deductible for tax purposes.
 
 The
        following (unaudited) pro forma consolidated results of operations have been
        prepared as if the acquisition of Netintact had occurred at January 1,
        2005:
 
 December
                31,
                  2006
              
              December
                31,
                  2005Sales
              
              $
              3,557,175
              
              $
              2,672,096Net
                  income
              
              $
              (7,885,298
              )
              $
              (7,581,147
              )Net
                  income per share—Basic and diluted
              
              $
              (0.13
              )
              $
              (0.17
              )Weighted
                  average shares—Basic and diluted
              
              
              62,268,887
              
              
              45,829,876
 
 
 The
        pro
        forma information is presented for informational purposes only and is not
        necessarily indicative of the results of operations that actually would have
        been achieved had the acquisition been consummated as of that time, nor is
        it
        intended to be a projection of future results.
 48
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **3.**  **Merger
        with Netintact (continued)**
 
 Because
        the Netintact acquisition was a complex operation, it required a comprehensive
        review of asset values and liabilities and a significant part of the evaluation
        had to take into consideration the valuation of the intangible assets and
        the
        deferred tax liability associated with the difference in book versus tax
        basis
        of intangible assets. The final assessment of asset values, and making other
        necessary changes for the deferred tax liability was not completed until
        the end
        of the fourth quarter of 2006. The determination of the final fair values
        resulted in adjustments, made to the initially determined values as of September
        29, 2006, as follows:
 
 Increase
                  in goodwill
              
              $
              960,209Increase
                  in intangible assets - customer base
              
              
              838,101Increase
                  in intangible assets - management information systems and related
                  software
              
              
              431,770Increase
                  in intangible assets - product software
              
              
              888,772Total
              
              $
              3,118,852
 
 In
        connection with the above acquisitions, the Company has agreed to pay additional
        consideration in future periods, based upon the attainment by the acquired
        entity of defined operating objectives. In accordance with Statement of
        Financial Accounting Standards No. 141, *Business
        Combinations* ,
        the
        Company does not accrue contingent consideration obligations prior to the
        attainment of the objectives. At December 31, 2006, maximum potential future
        consideration pursuant to such arrangements, to be resolved during 2007,
        is
        approximately $1.5 million. Any such payments would result in increases in
        goodwill.
 
 The
        following unaudited pro forma summary is provided for illustrative purposes
        only
        and is not necessarily indicative of the consolidated results of operations
        for
        future periods or that actually would have been realized had Zowcom and PNI
        been
        a consolidated entity during the periods presented. The summary combines
        the
        results of operations as if the merger between Netintact and PNI had taken
        place
        as of the beginning of the periods presented.
  **4.**  **Balance
        Sheet Details**
 
 Accounts
        receivable consist of the following at December 31, 2006:
 
 Accounts
                  receivable
              
              $
              1,172,842Less:
                  Allowance for bad debts
              
              
              (11,672
              )Accounts
                  receivable, net
              
              $
              1,161,170
 
 
 Inventory
        consists of the following at December 31, 2006:
 
 Raw
                  Material
              
              $
              37,871WIP
                  inventory
              
              
              -Finished
                  goods inventory
              
              
              340,300Less:
                  inventory reserve for obsolescence
              
              
              (118,964
              )Inventories,
                  net
              
              $
              259,207
 49
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 4.  **Balance
        Sheet Details (continued)**
 
 Prepaid
        expenses and other current assets consist of the following at December 31,
        2006:
 
 Prepaid
                  insurance premiums
              
              $
              32,244Prepaid
                  software licenses
              
              
              27,085Prepaid
                  rent
              
              
              12,562Prepaid
                  vehicle lease
              
              
              6,723Prepaid
                  equipment lease
              
              
              3,676Prepaid
                  maintenance
              
              
              2,162Other
                  prepaid expenses
              
              
              39,353Total
                  prepaid expenses and other current assets
              
              $
              123,805
  Property
        and equipment consists of the following at December 31, 2006:
 
 Tooling
                  and test equipment
              
              $
              236,160Office
                  equipment
              
              
              44,388Computer
                  equipment
              
              
              258,030Software
              
              
              6,842,368Furniture
                  and fixtures
              
              
              23,317Total
              
              
              7,404,263Less:
                  accumulated depreciation & amortization
              
              
              (1,073,315
              )Property
                  and equipment, net
              
              $
              6,330,948
 
 Other
        assets consist of the following at December 31, 2006:
 
 Netintact
                  customer base
              
              $
              3,832,581Goodwill
              
              
              960,209Security
                  deposit - HR and payroll services
              
              
              50,615Security
                  deposit - Sales taxes collateral
              
              
              30,000Security
                  deposit - Facility lease
              
              
              15,304Total
                  other assets
              
              
              4,888,709Less:
                  Accumulated amortization
              
              
              (474,595
              )Total
                  other assets
              
              $
              4,414,114
  Accrued
        liabilities consist of the following at December 31, 2006:
 
 Payroll
                  and related expenses
              
              $
              364,527Accrued
                  audit, tax & legal fees
              
              
              152,864Contingent
                  warranty liability
              
              
              20,950VAT
                  taxes accrued
              
              
              44,154Income
                  taxes accrued
              
              
              34,065Other
                  accrued expenses
              
              
              40,383Total
                  accrued liabilities
              
              $
              656,943
  50
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **5.**  **Intangible
        Assets**
 
 Intangible
        assets consist of the following at December 31, 2006:
 
 Gross
              
              
              
              NetIntangible
              
              Accumulated
              
              IntangibleAssets
              
              Amortization
              
              AssetsNetintact
                  customer base
              
              $
              4,317,000
              
              $
              (474,595
              )
              $
              3,842,405Netintact
                  product software
              
              
              4,578,000
              
              
              (508,667
              )
              
              4,069,333Netintact
                  MI & related software
              
              
              2,224,000
              
              
              (244,499
              )
              
              1,979,501Goodwill
              
              
              960,209
              
              
              -
              
              
              960,209Total
                  intangible assets
              
              $
              12,079,209
              
              $
              (1,227,761
              )
              $
              10,851,448
 
 
 Amortization
        expense for those intangible assets still required to be amortized under
        Statement of Financial Accounting Standards No. 142, Goodwill and Other
        Intangible Assets, was $985,643 for fiscal year ended December 31, 2006 and
        zero
        for the fiscal year ended January 1, 2006.
  **6.**  **Notes
        Payable**
 
 On
        November 29, 2005, the Company received loan proceeds of $90,000 from Cagan
        McAfee Capital Partners, a related party, and issued a promissory note in
        that
        amount, bearing interest of 6% per annum, and maturing on April 1, 2006.
        This
        loan, together with accrued interest of $562, was paid in full on January
        6,
        2006.
 
 On
        December 13, 2005, the Company received loan proceeds of $150,000 from Laird
        Cagan, a related party who is a partner with Chadbourn Securities, Inc.,
        and
        issued a promissory note in that amount, bearing interest of 6% per annum,
        and
        maturing on April 1, 2006. On February 28, 2006, Mr. Cagan requested that
        $130,000 of the loan principal owed to him by the Company be converted to
        a
        purchase of 325,000 shares of the Company’s common stock in conjunction with the
        private placement sales of the Company’s common stock that closed on that date.
        The remaining loan principal of $20,000, together with accrued interest of
        $1,971, was paid in full by the Company on March 22, 2006.
 
 At
        December 31, 2006, the Company has no long-term or convertible debt
        outstanding.
 
 51
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **7.**  **Commitments
        and Contingencies**
 
 Leases
 
 On
        June
        1, 2005, the Company entered into a 37-month lease for 11,772 square feet
        of
        space in Los Gatos, California at a rent expense of $12,949 per month for
        the
        first 12 months, $14,126 per month for the second 12 months, and $15,304
        per
        month for the third 12 months, with the first month’s rent under the lease at no
        charge. The Swedish
        headquarters of Netintact is located at Hardgatan 13C, 432 31, Varberg, Sweden.
        We have a 36 month lease starting from May 31, 2005 and the rent is $2,165
        per
        month for 331 square meters. In addition, Netintact PTY leases 55 square
        meters
        located at 205 566 St Kilda Road, Melbourne VIC 3004, Australia; the lease
        is
        for 12 months starting December 9, 2007 with a monthly payment of $1,156. Rent
        expense for the year ended December 31, 2006 and the year ended January 1,
        2006
        was $166,523, and $127,521, respectively.
 
 At
        December 31, 2006, Procera had obligations for leased equipment from various
        sources as shown below. Interest rates on such debt range from 9% to 10%.
        Procera also leases office space and equipment under non-cancelable operating
        and capital leases with various expiration dates through 2010.
  As
        of
        December 31, 2006, future minimum lease payments that come due in the current
        and following fiscal years ending December 31:
 
 Period
                  Ended December 31, 2006
              
              Capital
                  Leases
              
              Operating
                  Leases2007
              
              $
              24,861
              
              $
              225,1102008
              
              
              22,982
              
              
              88,3052009
              
              
              2,539
              
              
              -2010
              
              
              -
              
              
              -2011
              
              
              -
              
              
              -2012
                  and thereafter
              
              
              -
              
              
              -Total
                  minimum lease payments
              
              
              50,382
              
              $
              313,415Less:
                  Amount representing interest
              
              
              (4,248
              )Present
                  value of minimum lease payments
              
              
              46,134Less:
                  Current portion
              
              
              (20,982
              )Obligations
                  under capital lease, net of current portion
              
              $
              25,152
 
 52
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **7.**  **Commitments
        and Contingencies (continued)**
 
 Registration
        Rights Agreement
 
 The
        Company closed an offering of its common stock and warrants on February 28,
        2006
        (the “February Offering”) and a second offering on November 30, 2006 (the
“November Offering”). The registration rights agreements for both Offerings
        contained a covenant that called for the Company to “.... use commercially
        reasonable efforts to file a registration statement, on the appropriate form,
        with the SEC, within ninety (90) days of the final closing of the entire
        Offering....” The Company filed a registration statement of form SB2 in May 2006
        which contained the shares of the February Offering. In June, 2006, the Company
        signed definitive agreements to enter into a merger with Netintact, AB, a
        Swedish Corporation. The SEC advised the Company that its registration statement
        on Form SB2 would not be permitted to become effective until the Company
        had
        filed financial statements performed according to US GAAP covering the previous
        two fiscal years of Netintact, AB (the “Foreign Financial Statements). On
        October 30, 2006, the company withdrew its registration statement on Form
        SB2.
        On November 30, 2006 the company completed its November Offering. The historical
        audited Financial Statements of Netintact AB were filed with the SEC on March
        8,
        2007. The Company will file its Form 10K on or about March 8, 2007.
 
 As
        of
        December 31, 2006, the obligation to file a registration statement for the
        November 30 Offering had not run its term. The obligation to file the
        registration statement for the February Offering within 90 days was
        accomplished. The Company believes that because of the rules and regulations
        governing the filing of registration statements, the SB2 filing will occur
        subsequent to the Company’s filing of its annual report on Form 10KSB for 2006.
        The Company believes it has and is taking commercially reasonable efforts
        in
        regards to filing of the registration statements accordingly, it was in
        compliance with its obligation under the registration rights agreements for
        the
        February 2006 and November 2006 financings.
  *Common
        Stock Issued with Stock Purchase Warrants*
 
 On
        February 28, 2006, the Company completed a private placement of 15,000,025
        million shares (“Restricted Shares”) of its restricted Common Stock and
        received proceeds of $6,000,010 before expenses of $482,541 and recorded
        an
        increase in stockholders’ equity of $5,517,469 (the “February 2006 Placement”).
        The Company issued warrants to the placement agents to acquire up to 1,500,000
        shares at an exercise price of $.40 per share (“Restricted Warrants”, together
        with the Restricted Shares, the “Restricted Securities”). The proceeds of the
        equity fund raisings assigned to the common stock and warrants are reflected
        in
        total within the consolidated statements of stockholders’ equity. The
        net
        proceeds of the sale will be used primarily to continue to expand the Company’s
        product base and for general working capital purposes.
 
 Pursuant
        to the registration rights agreements executed with the holders of the
        Restricted Securities the Company is obligated to use commercially reasonable
        efforts to file a registration statement covering the resale of the Restricted
        Securities with the SEC within 90 days. The registration rights agreement
        further requires the Company to use its best efforts to cause such registration
        statement to become effective. Finally, the registration rights agreements
        specifies that it agreement does not apply to any holder who can sell all
        of its
        shares in a three month period under Rule 144 of the Securities Act
 53
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **7.**  **Commitments
        and Contingencies (continued)**
 
 Registration
        Rights Agreement (continued)
 
 *Common
        Stock Issued with Stock Purchase Warrants (continued)*
 
 Such
        a
        registration statement was timely filed .
        In
        response to such filing, the SEC in its comments in May 2006 required the
        Company to obtain audited financial reports covering the last two fiscal
        years
        of Netintact AB, a Swedish corporation (“Netintact”) with which the Company
        merged in August, 2006 (the “Audited Financials”). The Company inquired to the
        SEC for relief from the Audited Financials requirement arguing that it had
        only
        signed a letter of intent. The SEC did not change its position. In October
        2006,
        the Company withdrew its registration statement for the February 2006 Placement
        in anticipation of receiving the Audited Financial and making a separate
        offering of its securities (the “November 2006 Offering”). The Company has not
        yet re-filed a registration statement for the Restricted Securities. The
        Audited
        Financial statements of Netintact AB were filed with the SEC on March 8,
        2007.
        On that date, s even
        million six hundred and twenty-five thousand (7,625,000) shares of the offering
        became eligible for sale under Rule 144.
 
 The
        registration rights agreement does not require the Company to pay a penalty
        or
        liquidated damages of any sort in connection with a failure to use commercially
        reasonable efforts file a timely registration statement or a failure to use
        best
        efforts to pursue effectiveness of such a filed registration statement.
 
 The
        Company evaluated the terms of the registration rights agreements in accordance
        with Statement of Financial Accounting Standards No. 133, “Accounting for
        Derivative Instruments and Hedging Activities,” as amended (“SFAS 133”). In
        considering the appropriate treatment of these instruments, the Company observed
        that t here
        is
        no required payment of liquidated damages or any other penalties under the
        registration rights agreement. Any potential damages under the registration
        rights agreements relate to the risk of actual loss that a holder of Restricted
        Shares of the Company would be exposed to as a result of the passage of time
        due
        to the Company’s failure to cause effective registration of the Restricted
        Securities at the earliest possible date and not use commercially reasonable
        efforts. The Company filed the required registration statement in a timely
        way
        within 90 days from the close of the Offering, and the Company believes that
        it
        used best efforts to cause such statements to become effective. All
        circumstances causing the delay in registration were beyond the control of
        the
        Company.
 
 At
        issuance of the common stock on February 28, 2006, the Company assigned an
        initial fair value to the registration rights agreements of zero. In subsequent
        periods, the carrying value of the derivative financial instrument related
        to
        the registration rights agreements will be adjusted to their fair value at
        each
        balance sheet date and any change since the prior balance sheet date will
        be
        recognized as a component of other income/ (expense).
 
 54
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **7.**  **Commitments
        and Contingencies (continued)**
 
 Registration
        Rights Agreement (continued)
 
 *Common
        Stock Issued with Stock Purchase Warrants (continued)*
 
 The
        estimated fair value of the registration rights agreements was determined
        using
        the discounted value of the expected future cash flows. As of March 2, 2007,
        the
        Company was not able to have a registration statement filed with the SEC
        as
        required by the registration rights agreements. However, the Company obtained
        an
        amendment to the registration rights agreements to extend the required filing
        date of the Company’s initial registration statement to June 30, 2007, a
        deadline that the Company believes it will be able to meet. Furthermore,
        the
        Company believes that, it would not be subject to any cash damages if it
        failed
        to meet the June 30, 2007 deadline provided that it had used commercially
        reasonable efforts to do so. As a result, at December 31, 2006, the Company
        in
        accordance with SFAS No. 5 and the terms of the registration rights agreement,
        determined that it had no loss in regards to this contingency.
  On
        November 30, 2006, the Company completed a private placement of 5.1
        million shares of its restricted common stock and received proceeds of $5.1
        million before expenses of $259,641 and recorded an increase in stockholders’
equity of $4,840,359. The Company also issued to the same investors warrants
        to
        acquire 1,020,000 shares of its restricted common stock at an exercise
        price of $1.50 per share. These warrants are exercisable immediately after
        the closing date and expire three years from the date of issuance. The Company
        also issued warrants to the placement agents to acquire up to 360,000 shares
        at
        an exercise price of $1.00 per share (all transaction shares and shares
        underlying warrants together the “Restricted Securities”). The proceeds of the
        equity fundraising assigned to the common stock and warrants are reflected
        in
        total within the consolidated statements of stockholders’ equity. The
        net
        proceeds of the sale will be used primarily to continue to expand the Company’s
        market penetration and for general working capital purposes.
 
 Pursuant
        to the registration rights agreements executed with the holders of the
        Restricted Securities the Company is obligated to use commercially reasonable
        efforts to file a registration statement covering the resale of the Restricted
        Securities with the SEC within 90 days. The registration rights agreement
        further requires the Company to use its best efforts to cause such registration
        statement to become effective.
 
 The
        registration rights agreement does not require the Company to pay a penalty
        or
        liquidated damages of any sort in connection with a failure to use commercially
        reasonable efforts file a timely registration statement or a failure to use
        best
        efforts to pursue effectiveness of such a filed registration statement.
 55
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **7.**  **Commitments
        and Contingencies (continued)**
 
 Registration
        Rights Agreement (continued)
 
 *Common
        Stock Issued with Stock Purchase Warrants (continued)*
 
 The
        Company evaluated the terms of the registration rights agreements in accordance
        with Statement of Financial Accounting Standards No. 133, “Accounting for
        Derivative Instruments and Hedging Activities,” as amended (“SFAS 133”) and EITF
        00-19. In considering the appropriate treatment of these instruments, the
        Company observed that:
 
 ·
              Although
                  entered into contemporaneously, the common stock, the warrants
                  and
                  registration rights agreements are separate legal agreements. The
                  registration rights agreement does not alter the investors’ rights under
                  either the warrant or as holders of common stock. Further, the
                  various
                  agreements do not relate to the same risk. The common stock and
                  warrants
                  have values which are based on the quoted market price of the common
                  stock
                  and the relation between the exercise price and the value of the
                  Company’s
                  common stock. This value is thus independent of any value attributed
                  to
                  the registration rights agreement. The risk inherent in the common
                  stock
                  relates to the purchasers of common stock ability to be able to
                  sell their
                  shares at the price of the Company’s common stock as traded daily. The
                  warrants similarly bear risk related to the value of the Company
                  common
                  stock. Any potential damages under the registration rights agreements
                  relate to the risk of actual loss that a holder of Restricted Shares
                  of
                  the Company would be exposed to as a result of the passage of time
                  due to
                  the Company’s failure to cause effective registration of the Restricted
                  Securities at the earliest possible date.Thus,
                  in light of the above facts and, the Company evaluated and treated
                  the
                  registration rights agreements, common stock and associated warrants
                  as
                  separate free standing agreements.
 
 ·
              There
                  is no required payment of liquidated damages penalties under the
                  registration rights agreements, or any other agreement associated
                  with the
                  offering.
  ·
              The
                  Company is also advised by the SEC staff that the filing of the
                  annual
                  report on Form 10KSB for the fiscal year ended December 31, 2006
                  will be
                  required for any registration statement to become
                  effective.
 
 ·
              Thus
                  the Company believes that it has and will continue to use commercially
                  reasonable efforts to file a registration statement.
 
 At
        issuance of the common stock on November 30, 2006, the Company assigned no
        initial fair value to the registration rights agreements.
 56
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **7.**  **Commitments
        and Contingencies (continued)**
 
 Registration
        Rights Agreement (continued)
 
 *Common
        Stock Issued with Stock Purchase Warrants (continued)*
 
 The
        estimated fair value of the registration rights agreements was determined
        using
        the discounted value of the expected future cash flows. As of April 8, 2007,
        the
        Company was not able to have a registration statement filed with the SEC
        as
        required by the registration rights agreements. However, the Company obtained
        an
        amendment to the registration rights agreements to extend the required filing
        date of the Company’s initial registration statement to June 30, 2007, a
        deadline that the Company believes it will be able to meet. Furthermore,
        the
        Company believes that, it would not be subject to any cash damages if it
        failed
        to meet the June 30, 2007 deadline provided that it had used commercially
        reasonable efforts to do so. As a result, at December 31, 2006, the Company
        assigned no value to damages associated with the registration rights
        agreement.
  **8.**  **Guarantees**
 
 Indemnification
        Agreements
 
 The
        Company enters into standard indemnification arrangements in our ordinary
        course
        of business. Pursuant to these arrangements, the Company indemnifies, holds
        harmless, and agrees to reimburse the indemnified parties for losses suffered
        or
        incurred by the indemnified party, generally our business partners or customers,
        in connection with any U.S. patent, or any copyright or other intellectual
        property infringement claim by any third party with respect to our products.
        The
        term of these indemnification agreements is generally perpetual anytime after
        the execution of the agreement. The maximum potential amount of future payments
        the Company could be required to make under these agreements is unlimited.
        The
        Company has never incurred costs to defend lawsuits or settle claims related
        to
        these indemnification agreements. As a result, the Company believes the
        estimated fair value of these agreements is minimal.
 
 The
        Company has entered into indemnification agreements with its directors and
        officers that may require the Company: to indemnify its directors and officers
        against liabilities that may arise by reason of their status or service as
        directors or officers, other than liabilities arising from willful misconduct
        of
        a culpable nature; to advance their expenses incurred as a result of any
        proceeding against them as to which they could be indemnified; and to obtain
        directors’ and officers’ insurance if available on reasonable terms, which the
        Company currently has in place.
  57
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **8.**  **Guarantees
        (continued)**
 
 Product
        Warranty
 
 The
        Company warrants its products for a specific period of time, generally twelve
        months, against material defects. The Company provides for the estimated
        future
        costs of warranty obligations in cost of sales when the related revenue is
        recognized. The accrued warranty costs represent the best estimate at the
        time
        of sale of the total costs that the Company expects to incur to repair or
        replace product parts, which fail while still under warranty. The amount
        of
        accrued estimated warranty costs are primarily based on current information
        on
        repair costs. The Company periodically reviews the accrued balances and updates
        the historical warranty cost trends. The following table reflects the change
        in
        the Company’s warranty accrual during the year ended December 31,
        2006:
 
 Warranty
                  accrual, January 1, 2006
              
              $
              14,237Charged
                  to cost of sales
              
              
              6,713Actual
                  warranty expenditures
              
              
              -Warranty
                  accrual, December 31, 2006
              
              $
              20,950
 
 **9.**  **Stockholders’
        Equity (Deficit)**
 Common
          Stock
 
 On
          February 28, 2006, the Company closed private placement sales of 15,000,025
          shares of its common stock at $0.40 per share to thirty-three institutional
          and
          other accredited investors, and received cash proceeds of 5,517,469, net
          of
          financing expenses of $482,541. In addition, warrants to purchase 1,500,000
          shares of the Company’s common stock at $0.40 per share was issued to placement
          agents as compensation for their services in completing the private placement.
 
 On
          August
          18, 2006, the Company agreed to exchange 17,539,513 shares of its common
          stock,
          plus 2,756,757 shares of its common stock to be issued upon successful
          completion of operating milestones, for all of the outstanding shares of
          Netintact AB (a Swedish corporation).
 
 On
          September 29, 2006, the Company agreed to exchange 760,000 shares of its
          common
          stock, plus 120,000 shares of its common stock to be issued upon successful
          completion of operating milestones, for 49% of the outstanding shares of
          Netintact PTY Ltd. (an Australian corporation). Because 51% of the outstanding
          shares of Netintact PTY were previously owned by Netintact AB, the Company
          now
          owns all of the outstanding shares of Netintact PTY.
 
 On
          November 30, 2006, the Company completed private placement sales of 5,100,000
          shares of its common stock at $1.00 per share to fifteen institutional
          and
          accredited investors, and received cash proceeds of $4,840,359, net of
          financing
          expenses of $259,641. In addition, investors were issued warrants to purchase
          1,020,000 shares of the Company’s common stock (representing 20% of shares
          purchased in the private placement) at $1.50 per share and warrants to
          purchase
          1,530,000 shares of the Company’s common stock at $1.50 per share were issued to
          private placement agents as compensation for their services in completing
          the
          private placement.
  58
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 9.  **Stockholders’
            Equity (Deficit) (continued)**
  In
            March
            2005, Procera issued 17,473 shares of the Company’s stock to a charity
            organization in connection with the private placement of December
            2004.
  In
            November, 2005, Procera issued 165,000 shares of its restricted common
            stock for
            services provided for $0.51 per share
 
 Common
            Stock Subscriptions
 
 In
            April
            2006, the Company issued 825,000 share of its common stock to an investor
            relations firm as compensation to perform investor relations services
            on behalf
            of the Company for a period of eighteen months, beginning with the month
            of
            December 2005. As of December 31, 2006, 595,829 of the share issued have
            been
            earned through the performance of investor relations services and 229,171
            shares
            are considered to be subscribed stock, pending completion of five additional
            months of investor relations services.
 
 In
            December 2004, 23 institutional and accredited investors (the “December 2004
            Investors”), each signed a Subscription Agreement, applied to purchase a total
            of 5,762,500 shares of the Company’s restricted common stock for $0.80 per share
            for a total of $4,324,375, net of issuance costs of $285,625. Under the
            Subscription Agreements, the Company granted warrants to purchase common
            stock.
 
 In
            January 2005, the Company issued 5,762,500 shares of common stock in
            satisfaction of the common stock subscriptions.
 
 In
            December 2005, five accredited investors each signed a Subscription Agreement,
            applied to purchase a total of 3,500,000 shares of the Company’s restricted
            common stock for $0.40 per share for a total of $1,288,000, net of issuance
            costs of $112,000.
 
 In
            November 2005, the Company agreed to issue 825,000 shares of its restricted
            common stock to a financial adviser as compensation for services to be
            provided
            over 18 months, beginning in December 2005 and vests ratably over the
            service
            term. At January 1, 2006, the Company recognized and reported as common
            stock
            subscriptions 45,833 shares of its restricted common stock as compensation
            for
            financial services for the month of December 2005.
 
 Warrants
 
 During
            the fiscal year ended December 31, 2006, 226,250 warrants were exercised
            at a
            weighted average price of $1.17 per share, for proceeds to the Company
            of
            $265,013. Shares for 106,250 of these warrants were not issued until
            January
            2006.
 
 In
            April
            2005, warrants to purchase 102,500 shares of common stock were exercised
            and
            said shares were purchased for a reduced price of $1.40 per share.
 
 During
            the year ended January 1, 2006, warrants to purchase 100,000 shares and
            75,000
            shares were exercised and the shares were purchased for a price of $0.075
            per
            share.
 
 In
            April
            2005, warrants to purchase 47,438 shares of common stock were exercised
            and said
            shares were purchased at a reduced price of $1.50 per share and warrants
            to
            purchase 62,750 of common stock expired.
 
 In
            April
            2005, warrants to purchase 560,000 shares of common stock were exerc9ised
            and
            said shares were purchased at a reduced price of $1.50 per share and
            warrants to
            purchase 526,250 of common stock expired
 
 In
            February 2005, the Company issued warrants to purchase 100,000 shares
            of common
            stock with an exercise price of $1.78 per share to independent sales
            representative number one as an incentive to secure orders from prospective
            customers to purchase Company products. The warrants are exercisable
            in relation
            to cash payments received by the Company from customers who have purchased
            Company products under orders secured by the independent representative.
            The
            warrants expire on February 23, 2010. Since there were no cash collections
            relating to these warrants during 2005, there was no charge recorded
            in the
            financial statements for these warrants.
 
 In
            February 2005, the Company issued warrants to purchase 100,000 shares
            of common
            stock with an exercise price of $1.78 per share to independent sales
            representative number two as an incentive to secure orders from prospective
            customers to purchase Company products. The warrants are exercisable
            in relation
            to cash payments received by the Company from customers who have purchased
            Company products under orders secured by the independent representative.
            The
            warrants expire on February 23, 2010. The fair value of warrants calculated
            using the Black-Scholes option pricing model was $42 and has been recorded
            as
            marketing consulting expenses for the year ended January 1, 2006.
 
 59
 **Procera
              Networks, Inc.**
 **Notes
              to Consolidated Financial Statements**
 **December
              31, 2006**
 9.  **Stockholders’
              Equity (Deficit) (continued)**
 In
            February 2005, the Company issued warrants to purchase 50,000 shares
            of common
            stock with an exercise price of $1.78 per share to independent sales
            representative number three as an incentive to secure orders from prospective
            customers to purchase Company products. The warrants are exercisable
            in relation
            to cash payments received by the Company from customers who have purchased
            Company products under orders secured by the independent representative.
            The
            warrants expire on February 23, 2010. Since there were no cash collections
            relating to these warrants during 2005, there was no charge recorded
            in the
            financial statements for these warrants.
 
 In
            February 2005, the Company issued warrants to purchase 50,000 shares
            of common
            stock with an exercise price of $1.78 per share to independent sales
            representative number four as an incentive to secure orders from prospective
            customers to purchase Company products. The warrants are exercisable
            in relation
            to cash payments received by the Company from customers who have purchased
            Company products under orders secured by the independent representative.
            In
            April 2005, the Company terminated its agreement with independent sales
            representative four and the warrants to purchase 50,000 shares of common
            stock
            were cancelled. Since there were no cash collections relating to these
            warrants
            during 2005, there was no charge recorded in the financial statements
            for these
            warrants.
 
 In
            April
            2005, the Company issued warrants to purchase 10,000 shares of common
            stock with
            an exercise price of $1.86 per share to one of the Company’s directors for
            successfully directing and completing an equity raising initiative on
            behalf of
            the Company. The warrants are exercisable immediately and expire on April
            13,
            2008. The fair value of warrants calculated using the Black-Scholes option
            pricing model was $14,854 and has been recorded as administrative consulting
            expenses for the year ended January 1, 2006.
 
 In
            May
            2005, the Company issued warrants to purchase 25,000 shares of common
            stock at a
            price of $1.22 per share to its landlord as compensation for assisting
            the
            Company in securing a facility lease that satisfies the Company’s current
            requirements at a reasonably competitive cost. The warrants vested immediately
            and expire 36 months from the date that the shares supporting these warrants
            are
            declared effectively registered by the Securities and Exchange Commission.
            The
            fair value of warrants calculated using the Black-Scholes option pricing
            model
            was $22,569. The Company will record quarterly charges over the 37-month
            term of
            the lease and $4,595 has been recorded as an addition to rent expenses
            for the
            year ended January 1, 2006.
 
 In
            June
            2005, the Company issued warrants to purchase 75,000 shares of common
            stock with
            an exercise price of $1.42 per share to one of the Company’s directors as
            partial compensation for successfully directing and coordinating activities
            to
            complete a strategic business relationship with a high profile partner(s)
            and/or
            investors. Fifty percent of the warrants became exercisable on October
            14, 2005
            and the remainder will vest upon completion of a PIPE or strategic investment
            with a minimum value of five million dollars. The warrants expire on
            June 14,
            2008. The fair value of warrants calculated using the Black-Scholes option
            pricing model was $8,102 and has been recorded as administrative consulting
            expenses for the year ended January 1, 2006.
  In
            September 2005, the Company issued warrants to purchase 15,000 shares
            of common
            stock with an exercise price of $0.68 per share to independent sales
            representative number five as compensation for assisting the Company
            in
            finalizing the specification and definition of a new Company product
            and other
            services. The warrants vest upon completion of mutually agreed upon milestones.
            As of January 1, 2006, milestones have not been completed and no warrant
            shares
            have vested. The warrants expire 36 months from the date that the shares
            supporting these warrants are declared effectively registered by the
            Securities
            and Exchange Commission.
 
 In
            December 2005, the Company received subscriptions from five accredited
            investors
            to purchase 3,500,000 shares of the Company’s common stock at a price of $0.40
            per share as part of the Company’s private placement sale of common shares which
            closed on February 28, 2006. As partial compensation to placement agents
            for
            obtaining these December subscriptions, as of January 1, 2006 the Company
            is
            obligated to issue warrants to said agents to purchase 350,000 shares
            of the
            Company’s common stock at a price of $0.40 per share. These warrants vest
            immediately upon issuance and expire on February 28, 2011.
 
 At
        December 31, 2006, warrants to purchase 8,901,344 shares of common stock
        are
        outstanding.
 
 The
        following table sets forth the key terms of these outstanding
        warrants:
  WeightedAverage
              
              Reasons
                  forDate
                  of
              
              Underlying
              
              Shares
              
              Vesting
                  of
              
              Expiration
              
              Exercise
              
              Grant
                  ofGrant
              
              Security
              
              Outstanding
              
              Grant
              
              Date
              
              Price
              
              Warrants11/2002
              
              Common
                  stock
              
              20,000
              
              Immediate
              
              11/2007
              
              $
              0.08
              
              Raising
                  capital12/2002
              
              Common
                  stock
              
              301,268
              
              Milestones
              
              06/2007
              
              $
              0.01
              
              Customer
                  base06/2003
              
              Common
                  stock
              
              354,000
              
              Immediate
              
              06/2008
              
              $
              0.75
              
              Raising
                  capital06/2003
              
              Common
                  stock
              
              50,000
              
              Immediate
              
              06/2008
              
              $
              0.50
              
              Legal
                  services04/2004
              
              Common
                  stock
              
              15,000
              
              Over
                  9 months period
              
              01/2007
              
              $
              2.05
              
              Consulting
                  services08/2004
              
              Common
                  stock
              
              100,000
              
              Immediate
              
              08/2007
              
              $
              1.56
              
              Investor/Public
                  Relations services12/2004
              
              Common
                  stock
              
              1,844,297
              
              Immediate
              
              07/2008
              
              $
              1.25
              
              Raising
                  capital12/2004
              
              Common
                  stock
              
              1,787,050
              
              Immediate
              
              07/2008
              
              $
              1.37
              
              Raising
                  capital02/2005
              
              Common
                  stock
              
              100,000
              
              Based
                  on sales performance
              
              02/2010
              
              $
              1.78
              
              Sales
                  services02/2005
              
              Common
                  stock
              
              100,000
              
              Based
                  on sales performance
              
              02/2010
              
              $
              1.78
              
              Sales
                  servicesBased
                  on sales performance
              
              02/2010
              
              $
              1.78
              
              Sales
                  services04/2005
              
              Common
                  stock
              
              10,000
              
              Immediate
              
              04/2008
              
              $
              1.86
              
              Raising
                  capital05/2005
              
              Common
                  stock
              
              25,000
              
              Immediate
              
              3
                  years after effective date of SB-2
              
              $
              1.42
              
              Real
                  estate services06/2005
              
              Common
                  stock
              
              75,000
              
              Milestones
              
              06/2008
              
              $
              1.42
              
              Strategic
                  investment09/2005
              
              Common
                  stock
              
              15,000
              
              Milestones
              
              3
                  years after effective date of SB-2
              
              $
              0.68
              
              Sales
                  services02/2006
              
              Common
                  stock
              
              1,500,000
              (1)
              Immediate
              
              3
                  years after effective date of SB-2
              
              $
              0.40
              
              Raising
                  capital08/2006
              
              Common
                  stock
              
              400,000
              (2)
              Immediate
              
              08/2008
              
              $
              1.40
              
              Investor
                  relations08/2006
              
              Common
                  stock
              
              825,729
              (3)
              Immediate
              
              08/2011
              
              $
              0.60
              
              Acquisition
                  of subsidiary company11/2006
              
              Common
                  stock
              
              1,380,000
              (4)
              Immediate
              
              3years
                  after effective date of SB-2
              
              $
              1.50
              
              Raising
                  capital8,901,344
 
 
 (1)
              In
                  conjunction with the closing of private placement sales of common
                  stock on
                  February 28, 2006, warrants to purchase 1,500,000 shares of the
                  Company’s
                  common stock at $0.40 per share were issued to placement agents
                  as
                  compensation for their services in completing the private
                  placement.
  60
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **9.**  **Stockholders’
        Equity (Deficit) (continued)**
 
 Warrants
        (continued)
 
 (2)
              On
                  August 2, 2004, warrants to purchase 400,000 shares of the Company’s
                  common stock at $1.40 per share were issued to an investor relations
                  firm
                  as compensation to perform investor relations services on behalf
                  of the
                  Company during 2004. On August 2, 2006, the subject warrants were
                  cancelled and replacement warrants to purchase a total of 400,000
                  shares
                  of the Company’s common stock at $1.40 per share were issued to said
                  investor relations firm and one of its
                  employees.
 
 (3)
              In
                  conjunction with the its agreement to acquire all of the outstanding
                  shares of Netintact AB (a Swedish corporation), the Company agreed
                  to
                  issue warrants as of the August 18, 2006 acquisition date to purchase
                  702,486 shares of the Company’s common stock at a price of $0.60 per share
                  and to issue warrants upon successful completion of operating milestones
                  to purchase 123,243 shares of the Company’s common stock at a price of
                  $0.60 per share. Said warrants are not exercisable until the Company’s
                  common stock has reached a market value of $2.00 or more and sustains
                  that
                  value for 90 consecutive trading days. On December 12, 2006, the
                  Company’s
                  stock closed with a market value of $2.06 per share and has remained
                  above
                  $2.00 per share since that date.
 
 (4)
              On
                  November 30, 2006, the Company completed private placement sales
                  of
                  5,100,000 shares of its common stock at $1.00 per share to fifteen
                  institutional and accredited investors, and received cash proceeds
                  of
                  $4,840,359, net of financing expenses of $259,641. In addition,
                  investors
                  were issued warrants to purchase 1,020,000 shares of the Company’s common
                  stock (representing 20% of shares purchased in the private placement)
                  at
                  $1.50 per share and warrants to purchase 360,000 shares of the
                  Company’s
                  common stock at $1.00 per share were issued to private placement
                  agents as
                  compensation for their services in completing the private placement.
  On
          March
          30, 2005, the Board of Directors approved an offer by the Company to amend
          the
          1,177,688 shares of investor warrants issued on December 9, 2003, to reduce
          the
          exercise price of such warrants from $2.00 to $1.50 per share, and to change
          the
          expiration date of such warrants from April 26, 2005 to April 13, 2005.
          In
          addition, the Company offered to amend 1,446,438 investor warrants issued
          on
          June 27, 2004, to reduce the exercise price of such warrants from $2.00
          to $1.40
          per share and to change the expiration date of such warrants from June
          30, 2006
          to April 13, 2005. On or about April 13, 2005, certain holders of the Company’s
          December 2003 Warrants and June 2004 Warrants exercised warrants to purchase
          557,438 and 102,500 shares of its common stock at $1.50 and $1.40 per share,
          respectively, and the Company received net proceeds of $974,759 from the
          exercise of such exchange warrants. The Black-Scholes fair value of the
          warrant
          re-pricing is estimated to be $1,926,330.
 61
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **9.**  **Stockholders’
        Equity (Deficit) (continued)**
 
 Warrants
        (continued)
 
 Warrants
                  OutstandingWeighted
                  AverageRemainingExercise
              
              Number
              
              Contractual
                  Life
              
              NumberPrice
              
              Outstanding
              
              (Years)
              
              Exercisable$0.01
              
              301,268
              
              0.5
              
              301,268$0.08
              
              20,000
              
              0.9
              
              20,000$0.40
              
              1,500,000
              
              3
              
              1,500,000$0.50
              
              50,000
              
              0.5
              
              50,000$0.60
              
              825,729
              
              4.7
              
              825,729$0.68
              
              15,000
              
              3
              
              15,000$0.75
              
              354,000
              
              1.5
              
              354,000$1.00
              
              360,000
              
              1.5
              
              360,000$1.25
              
              1,787,050
              
              1.5
              
              1,787,050$1.37
              
              1,843.297
              
              1.5
              
              1,843,297$1.40
              
              400,000
              
              1.6
              
              400,000$1.42
              
              100,000
              
              1.8
              
              100,000$1.50
              
              1,020,000
              
              3
              
              1,020,000$1.56
              
              100,000
              
              0.7
              
              100,000$1.78
              
              200,000
              
              3.2
              
              200,000$1.86
              
              10,000
              
              1.3
              
              10,000$2.05
              
              15,000
              
              0
              
              15,000$1.12
              
              8,901,344
              
              2.4
              
              8,901,344
  Rights
          to Purchase Common Stock
 
 In
          July,
          August and September 2003, the Company granted the right to purchase 250,000
          shares, 175,000 shares and 150,000 shares with exercise prices of $0.075,
          $0.10
          and $0.25 per share, respectively, to employees in connection with employment
          agreements. The rights vest over a three year period and expire in July,
          August
          and September 2006. The Company will record stock compensation expense
          for the
          excess of the deemed fair market value over the exercise price at the date
          of
          issuance. The compensation expense is being recognized over the vesting
          period
          of three years using the straight line method. For the years ended January
          1,
          2006, the Company recorded stock compensation expense of $429,387.
 
 In
          November 2005, an employee terminated his employment with the Company and
          32,900
          additional shares of unvested rights to purchase common stock expired.
          At
          January 1, 2006, this employee had vested the right to purchase 142,100
          shares
          of the Company’s common stock at a price of $0.10 per share, provided such
          purchase be made on or before January 17, 2006. On January 13, 2006 the
          employee
          purchased 20,000 shares of the Company’s common stock at $0.10 per share and on
          January 17, 2006 rights to purchase 122,100 shares expired.
 
 Stock
          compensation to be recorded in future periods will be $18,750 in 2006.
          The
          amount of stock compensation expense to be recorded in future periods could
          decrease if the stock purchase rights do not fully vest.
 
 At
          January 1, 2006, there are 292,100 shares of the above rights to purchase
          common
          stock outstanding .
 Stock
        Option Plans
 
 In
        August
        2003 and October 2004 our board of directors and stockholders adopted the
        2003
        Stock Option Plan and 2004 Stock Option Plan, respectively (collectively
        referred to as the “Plan”). The number of shares available for options under the
        2003 Plan and 2004 Plan, as amended, is 2,500,000 and 5,000,000, respectively.
        The following description of our Plan is a summary and qualified in our entirety
        by the text of the Plan. The purpose of the Plan is to enhance our profitability
        and stockholder value by enabling us to offer stock based incentives to
        employees, directors and consultants. The Plan authorizes the grant of options
        to purchase shares of our common stock to employees, directors and consultants.
        Under the Plan, we may grant incentive stock options within the meaning of
        Section 422 of the Internal Revenue Code of 1986 and non-qualified stock
        options. Incentive stock options may only be granted to our
        employees.
  62
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **9.**  **Stockholders’
        Equity (Deficit) (continued)**
 
 Stock
        Option Plans (continued)
 
 The
        number of shares available for options under the Plan is 7,500,000. As of
        December 31, 2006, 2,016,216 shares were available for future grants. The
        options under the Plan vest over varying lengths of time pursuant to various
        option agreements that we have entered into with the grantees of such options.
        The Plan is administered by the board of directors. Subject to the provisions
        of
        the Plan, the board of directors has authority to determine the employees,
        directors and consultants who are to be awarded options and the terms of
        such
        awards, including the number of shares subject to such option, the fair market
        value of the common stock subject to options, the exercise price per share
        and
        other terms.
 
 Incentive
        stock options must have an exercise price equal to at least 100% of the fair
        market value of a share on the date of the award and generally cannot have
        a
        duration of more than 10 years. If the grant is to a stockholder holding
        more
        than 10% of our voting stock, the exercise price must be at least 110% of
        the
        fair market value on the date of grant. Terms and conditions of awards are
        set
        forth in written agreements between us and the respective option holders.
        Awards
        under the Plan may not be made after the tenth anniversary of the date of
        our
        adoption but awards granted before that date may extend beyond that
        date.
 
 Optionees
        have no rights as stockholders with respect to shares subject to option prior
        to
        the issuance of shares pursuant to the exercise thereof. An option becomes
        exercisable at such time and for such amounts as determined by the board
        of
        directors. An optionee may exercise a part of the option from the date that
        part
        first becomes exercisable until the option expires. The purchase price for
        shares to be issued to an employee upon his exercise of an option is determined
        by the board of directors on the date the option is granted. The Plan provides
        for adjustment as to the number and kinds of shares covered by the outstanding
        options and the option price therefore to give effect to any stock dividend,
        stock split, stock combination or other reorganization.
 
 Under
        our
        2003 Stock Plan and our 2004 Stock Option Plan (the “Option Plans”), 7,500,000
        shares of Common Stock are authorized for issuance to our employees, officers,
        consultants, and directors. Stock options are granted at fair market value
        as
        determined by the board of directors on the date of grant with terms up to
        ten
        years. Under the terms of the Option Plans, generally 25% of the stock options
        granted to employees will vest one year after the date of employment or the
        date
        of grant, whichever is appropriate, and the remaining stock options will
        continue to vest ratably over the remainder of the four-year vesting period.
        Certain grants of options to employees after the initial grant of options
        to
        employees vest over three years. Stock option grants to members of our Board
        of
        Directors in compensation for their services vest over four calendar
        quarters
  In
            July,
            August and September 2003, the Company granted the right to purchase
            250,000
            shares, 175,000 shares and 150,000 shares with exercise prices of $0.075,
            $0.10
            and $0.25 per share, respectively, to employees in connection with employment
            agreements. The rights vest over a three year period and expire in July,
            August
            and September 2006. The Company will record stock compensation expense
            for the
            excess of the deemed fair market value over the exercise price at the
            date of
            issuance. The compensation expense is being recognized over the vesting
            period
            of three years using the straight line method. For the years ended January
            1,
            2006, January 2, 2005 and December 28, 2003, the Company recorded stock
            compensation expense of $429,387, $1,068,615 and $84,688, respectively. In
            November 2005, an employee terminated his employment with the Company
            and 32,900
            additional shares of unvested rights to purchase common stock expired.
            At
            January 1, 2006, this employee had vested the right to purchase 142,100
            shares
            of the Company’s common stock at a price of $0.10 per share, provided such
            purchase be made on or before January 17, 2006. On January 13, 2006 the
            employee
            purchased 20,000 shares of the Company’s common stock at $0.10 per share and on
            January 17, 2006 rights to purchase 122,100 shares expired.
 63
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 The
        following table summarizes activity under the equity incentive plans for
        the
        three years ended December 31, 2006:
 
 Weighted
              
              WeightedNumber
                  of
              
              Average
              
              Remaining
              
              AggregateShares
                  Available
              
              Options
              
              Exercise
              
              Contractual
              
              IntrinsicFor
                  Grant
              
              Outstanding
              
              Price
              
              Life
                  (in years)
              
              ValueBalance
                  at December 28, 2003
              
              
              2,500,000
              
              
              -
              
              
              -Authorized
              
              
              2,500,000
              
              
              -
              
              
              -Granted
              
              
              (3,173,000
              )
              
              3,173,000
              
              
              1.41Exercised
              
              
              -
              
              
              -
              
              
              -Cancelled
              
              
              -
              
              
              -
              
              
              -Balance
                  at January 2, 2005
              
              
              1,827,000
              
              
              3,173,000
              
              $
              1.41Authorized
              
              
              2,500,000
              
              
              -
              
              
              -Granted
              
              
              (1,263,000
              )
              
              1,263,000
              
              
              1.27Exercised
              
              
              -
              
              
              -
              
              
              -Cancelled
              
              
              519,030
              
              
              (519,030
              )
              
              1.36Balance
                  at January 1, 2006
              
              
              3,583,030
              
              
              3,916,970
              
              $
              1.38Authorized
              
              
              -
              
              
              -
              
              
              -Granted
              
              
              (4,185,000
              )
              
              4,185,000
              
              
              0.86Exercised
              
              
              -
              
              
              -
              
              
              -Cancelled
              
              
              2,618,186
              
              
              (2,618,186
              )
              
              1.44Balance
                  at December 31, 2006
              
              
              2,016,216
              
              
              5,483,784
              
              $
              0.96
              
              
              9.2
              
              $
              6,839,716Options
                  vested and expected tovest
                  at December 31, 2006
              
              
              
              
              
              3,939,492
              
              $
              0.97
              
              
              9.0
              
              $
              4,805,454Options
                  vested and exercisable at
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              1,188,927December
                  31, 2006
              
              
              
              
              
              1,116,968
              
              $
              1.19
              
              
              8.2
              
              $
 
 The
        weighted average grant date fair value of options granted during the fiscal
        year
        ended December 31, 2006 and January 1, 2006 was $0.74 and $0.82, respectively.
        The total fair value of shares vested during the year ended December 31,
        2006
        and January 1, 2006 was $1,374,836 and $1,412,246, respectively. The total
        fair
        value of shares forfeited and cancelled for the fiscal year ended December
        31,
        2006 was $3,831,217.
 
 The
        number of unvested shares as of December 31, 2006 and January 1, 2006 was
        4,366,782 and 1,667,226 respectively and the weighted average grant date
        fair
        value of nonvested shares as of December 31, 2006 and January 1, 2006 was
        $0.73
        and $1.35 respectively. The total compensation cost for nonvested shares
        is
        expected to be recognized over the next 3.1 years on a weighted average
        basis.
 
 The
        options outstanding and exercisable at December 31, 2006 were in the following
        exercise price ranges:
 
 Options
                  Outstanding
              
              Options
                  Vested and ExercisableAt
                  December 31, 2006
              
              At
                  December 31, 2006Weighted
              
              
              
              
              
              
              WeightedAverage
              
              Weighted
              
              
              
              Average
              
              WeightedRemaining
              
              Average
              
              
              
              Remaining
              
              AverageNumber
              
              Contractual
              
              Exercise
              
              Number
              
              Contractual
              
              ExerciseOutstanding
              
              Life
                  (Years)
              
              Price
              
              Outstanding
              
              Life
                  (Years)
              
              Price$0.45
                  - $0.69
              2,025,000
              
              9.5
              
              $
              0.56
              
              205,554
              
              9.3
              
              $
              0.50$0.70
                  - $1.19
              2,442,784
              
              9.0
              
              $
              0.96
              
              563,473
              
              8.0
              
              $
              0.89$1.20
                  - $3.35
              1,016,000
              
              9.0
              
              $
              1.74
              
              347,941
              
              7.9
              
              $
              2.085,483,784
              
              9.2
              
              $
              0.96
              
              1,116,968
              
              8.2
              
              $
              1.19
 
 64
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **10.** **Income
        Taxes**
 
 The
        components of income and loss before income taxes are as follows:
 
 December
                  31,
              
              January
                  1,2006
              
              2006Domestic
              
              $
              (7,683,849
              )
              $
              (6,738,911
              )Foreign
              
              
              (42,357
              )
              
              -Loss
                  before income taxes
              
              $
              (7,726,206
              )
              $
              (6,738,911
              )
 
 The
        Company’s provision for income taxes consists of the following:
 
 December
                  31,
              
              January
                  1,2006
              
              2006Current
                  income taxesFederal/state
              
              $
              -
              
              $
              -Foreign
              
              
              46,679
              
              
              -Total
                  current income taxes
              
              
              46,679
              
              
              -Deferred
                  income taxesFederal/state
              
              
              -
              
              
              -Foreign
              
              
              (298,252
              )
              
              -Total
                  deferred income taxes
              
              
              (298,252
              )
              
              -Provision
                  for income taxes
              
              $
              (251,573
              )
              $
              -
 
 
 Deferred
        income taxes reflect the net tax effects of net operating loss and tax credit
        carryovers and temporary differences between the carrying amounts of assets
        and
        liabilities for financial reporting purposes and the amounts used for income
        tax
        purposes. Significant components of the Company’s deferred tax assets are as
        follows:
 
 Fiscal
                  Year EndedDecember
                  31, 2006
              
              
              January
                  1, 2006Deferred
                  tax assets:Federal
                  and state net operating losses
              
              $
              7,582,244
              
              $
              5,468,362Research
                  credits
              
              
              487,523
              
              
              529,974Non-deductible
                  accrued expenses
              
              
              1,248,740
              
              
              1,209,378Valuation
                  allowance
              
              
              (9,318,507
              )
              
              (7,207,714
              )Total
                  deferred tax assets
              
              
              -
              
              
              -Deferred
                  tax liability:Foreign
                  intangibles
              
              
              (2,774,471
              )
              
              -Net
                  deferred tax liabilities
              
              $
              (2,774,471
              )
              $
              -
 
 65
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **10.** **Income
        Taxes (continued)**
 
 Reconciliation
        between the tax provision computed at the statutory income tax rate of 35%
        and
        the Company’s actual effective income tax provision is as follows:
 
 Fiscal
                  Year EndedDecember
                  31,
              
              January
                  1,2006
              
              2006Computed
                  at statutory rate
              
              $
              (2,642,376
              )
              $
              (2,291,230
              )Research
                  & development credits
              
              
              42,451
              
              
              (147,171
              )State
                  income taxes
              
              
              (288,260
              )
              
              (118,709
              )Stock
                  compensation - ISO
              
              
              393,175
              
              
              -Loss
                  not benefited
              
              
              2,146,098
              
              
              2,398,896Foreign
                  tax
              
              
              46,129
              
              
              -Other
              
              
              4,531
              
              
              158,214Total
              
              $
              (298,252
              )
              $
              -
 
 
 Realization
        of deferred tax assets is dependent upon future earnings, if any, the timing
        and
        amount of which are uncertain. Accordingly, the net deferred tax assets have
        been fully offset by a valuation allowance. The Valuation Allowance increased
        by
        $2,066,381 and by $2,398,896 for the fiscal years ended December 31, 2006
        and
        January 1, 2006, respectively.
 
 As
        of
        December 31, 2006, the Company had net operating loss carryforwards for federal
        income tax purposes of approximately $19,450,980 which expire beginning after
        the year 2020. The Company also has California net operating loss carryforwards
        of approximately $16,619,398 which expire beginning after the year 2012.
        The
        Company also has federal and California research and development tax credits
        of
        $230,748 and $256,776. The federal research credits will begin to expire
        in the
        year 2021 and the California research credits have no expiration date. The
        Company also has California Manufacturer’s Investment Credit of $4,382 which
        begins to expire after the year 2012.
  Utilization
        of the Company’s net operating loss may be subject to substantial annual
        limitation due to the ownership change limitations provided by the Internal
        Revenue Code and similar state provisions. Such an annual limitation could
        result in the expiration of the net operating loss before
        utilization.
 
 Undistributed
        earnings of our foreign subsidiaries of approximately $43,000 at December
        31,
        2006 are considered to be indefinitely reinvested and, accordingly, no
        provisions for federal and state income taxes have been provided thereon.
        Upon
        distribution of those earnings in the form of dividends or otherwise, we
        would
        be subject to both U.S. income taxes (subject to an adjustment for foreign
        tax
        credits) and withholding taxes payable to various foreign
        countries.
 
 In
        July
        2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in
        Income Taxes—an interpretation of FASB Statement No. 109. This interpretation
        clarifies the accounting for uncertainty in income taxes recognized in an
        enterprise’s financial statements in accordance with SFAS 109. This
        interpretation is effective for the Company in the first quarter of fiscal
        year
        2008. The Company is in the process of evaluating the impact of the adoption
        of
        this statement on the Company’s consolidated financial position, results of
        operations and cash flows.
 
 **11.** **Related
        Party Transactions**
 
 On
        November 29, 2005, the Company received loan proceeds of $90,000 from Cagan
        McAfee Capital Partners, a related party, and issued a promissory note in
        that
        amount, bearing interest of 6% per annum, and maturing on April 1, 2006.
        This
        loan, together with accrued interest of $562, was paid in full on January
        6,
        2006.
 
 On
        December 13, 2005, the Company received loan proceeds of $150,000 from Laird
        Cagan, a related party who is a partner with Chadbourn Securities, Inc.,
        and
        issued a promissory note in that amount, bearing interest of 6% per annum,
        and
        maturing on April 1, 2006. On February 28, 2006, Mr. Cagan requested that
        $130,000 of the loan principal owed to him by the Company be converted to
        a
        purchase of 325,000 shares of the Company’s common stock in conjunction with the
        private placement sales ofthe company’s common stock that closed on this date.
        The remaining loan principal of $20,000, together with accrued interest of
        $1,971, was paid in full by the Company on March 22, 2006.
 
 Related
        party transactions occurring from the issuance options were as
        follows:
 
 Number
                  of
              
              Number
                  ofSecurities
              
              SecuritiesUnderlying
              
              UnderlyingUnexercised
              
              Unexercised
              
              OptionOptions
              
              Options
              
              Exercise(#)
              
              (#)
              
              Price
              
              ExpirationName
              
              Exercisable
              
              Unexercisable
              
              ($)
              
              DateDouglas
                  J. Glader
              
              -
              
              -
              
              $
              -
              
              -Thomas
                  Williams
              
              16,000
              
              -
              
              $
              3.35
              
              3/9/201416,000
              
              -
              
              $
              1.67
              
              4/20/2015450,000
              
              -
              
              $
              0.69
              
              3/20/2016750,000
              
              -
              
              $
              0.52
              
              8/11/201675,000
              
              
              
              $
              1.42
              
              6/14/200810,000
              
              
              
              $
              1.86
              
              4/13/2008Gary
                  Johnson
              
              500,000
              
              138,889
              
              $
              0.92
              
              10/12/2014500,000
              
              -
              
              $
              0.52
              
              8/11/2016Albert
                  Lopez
              
              900,000
              
              -
              
              $
              1.19
              
              10/24/2016Jay
                  Zerfoss
              
              50,000
              
              -
              
              $
              0.72
              
              3/22/2016Sven
                  Nowicki
              
              -
              
              -
              
              $
              -
              
              -Tom
                  Saponas
              
              28,000
              
              -
              
              $
              1.70
              
              4/1/201516,000
              
              -
              
              $
              1.67
              
              4/20/2015Scott
                  McClendon
              
              28,000
              
              -
              
              $
              3.35
              
              3/9/201416,000
              
              -
              
              $
              1.67
              
              4/20/2015
 
  66
 **Procera
            Networks, Inc.**
 **Notes
            to Consolidated Financial Statements**
 **December
            31, 2006**
 **12.** **Segment
        Information**
 
 The
        Company operates in one segment, using one measure of profitability to manage
        its business. Revenues for geographic regions are based upon the customer’s
        location. The following are summaries of revenue and long lived assets by
        geographical region:
 
 Year
                  EndedDecember
                  31,
              
              January
                  1,REVENUES
              
              2006
              
              2006United
                  States
              
              $
              469,419
              
              $
              208,786Australia
              
              
              195,252
              
              
              -Asia
              
              
              84,545
              
              
              36,466Europe
              
              
              252,113
              
              
              9,557South
                  America
              
              
              60,702
              
              
              -Scandinavia
              
              
              830,898
              
              
              -West
                  Indies
              
              
              21,501
              
              
              -Total
              
              $
              1,914,430
              
              $
              254,809
 
 
  *FYE
                  12-31- 2006*
              
              *FYE
                  1-1- 2006*Long-lived
                  assets:United
                  States
              
              $
              1,437,549
              
              $
              133,210Sweden
              
              
              9,263,358
              
              
              -Australia
              
              
              44,355
              
              
              -Total
              
              $
              10,745,262
              
              $
              133,210
 
 Foreign
        sales as a percentage of revenues were 75% and 18% for the year ended December
        31, 2006, and January 1, 2006, respectively.
 
 The
        Company’s accounts receivable are derived from revenue earned from customers
        located in the United States, Australia, Asia, Europe, and the Middle East.
        The
        Company performs ongoing credit evaluations of certain customers’ financial
        condition and, generally, requires no collateral from its customers. For
        the
        year ended December 31, 2006, three customers accounted for 24%, 13% and
        7% of
        revenues, respectively, and no other customer accounted for more than 5%
        of
        total sales for the year. For the year ended January 1, 2006, two customers
        accounted for 46% and 15% of revenues, respectively.
  **13.** **Subsequent
        Events**
 
 None


**ITEM
                8**.
            **CHANGES
                IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
                FINANCIAL STATEMENTS**




On
      June
      7, 2006, our auditors, Burr, Pilger & Mayer LLP ***(“BPM”)*** stated
      that we no longer fit the BPM client profile and resigned. The independent
      auditor’s reports of BPM on our financial statements for the year ended January
      1, 2006 and January 2, 2005, or any later interim period through the date of
      resignation, did not contain an adverse opinion or a disclaimer of opinion,
      and
      were not modified as to uncertainty, audit scope or accounting principles.
      During our two most recent fiscal years through the date of resignation, we
      did
      not have any disagreements with BPM on any matter of accounting principles
      or
      practice, financial statement disclosure, or auditing scope or procedure, which
      if not resolved to the satisfaction of BPM would have caused BPM to make
      reference to the subject matter thereof in connection with BPM’s independent
      auditor’s report.





With
      the
      approval of our board of directors, our Audit committee engaged PMBPMB Helin
      Donovan, LLP (“PMB”) as our independent registered public accounting firm for
      the fiscal year ended December 31, 2006. PMB accepted such appointment on July
      26, 2006. Prior to the appointment of PMB, we did not consult with PMB on any
      matters relating to accounting opinions or any other matter related to us which
      would require disclosure pursuant to Item 304(a)(2) of Regulation
      S-B.





**ITEM
                8A****.**
            **CONTROLS
                AND
                PROCEDURES**





***Evaluation
      of Disclosure Controls and Procedures*** *.* The
      Securities and Exchange Commission defines the term “disclosure controls and
      procedures” to mean a company’s controls and other procedures that are designed
      to ensure that information required to be disclosed in the reports that it
      files
      or submits under the Securities Exchange Act of 1934 is recorded, processed,
      summarized and reported, within the time periods specified in the Commission’s
      rules and forms. We
      carried out an evaluation, under the supervision and with the participation
      of
      our Chief Executive Officer and Chief Financial Officer, of the effectiveness
      of
      the design and operation of our disclosure controls and procedures, as defined
      in Exchange Act Rule 13a 14(c) as of the end of the period covered by this
      Annual Report on Form 10-KSB. However, as previously reported in our Quarterly
      Report on Form 10-QSB for the quarter ended October 1, 2006, the Company
      recently failed to timely file certain Current Report on Form 8-K. In addition,
      we have filed a Notification of Late Filing on Form 12b-25 in connection
      with our Annual Report on Form 10-KSB for the year ended December 31, 2006.
      As a result of the foregoing, as of the date of this filing, based on that
      evaluation, they concluded that there are weaknesses in our disclosure controls
      and our procedures are not effective to ensure that information required to
      be
      disclosed in our Exchange Act reports is recorded, processed, summarized and
      reported within the time periods specified in the Securities and Exchange
      Commission's rules and forms, and that such information is accumulated and
      communicated to them to allow timely decisions regarding required disclosure.
      Specifically, we were late in filing the audited historical consolidated
      financial statements of Netintact AB., on Form 8KA. The audited historical
      consolidated financial statements of Netintact AB., were filed with the SEC
      on
      Form 8KA in March 2007. To ensure that this does not occur in the future, the
      Company has hired a new corporate controller to assist the Chief Financial
      Officer and the Vice President of Finance.





***Limitations
      on Effectiveness of Controls and Procedures*** *.* Our
      management, including our chief executive officer and chief financial officer,
      does not expect that our disclosure controls and procedures or our internal
      controls will prevent all errors and all fraud. A control system, no matter
      how
      well conceived and operated, can provide only reasonable, not absolute,
      assurance that the objectives of the control system are met. Further, the design
      of a control system must reflect the fact that there are resource constraints
      and the benefits of controls must be considered relative to their costs. Because
      of the inherent limitations in all control systems, no evaluation of controls
      can provide absolute assurance that all control issues and instances of fraud,
      if any, within the Company have been detected. These inherent limitations
      include, but are not limited to, the realities that judgments in decision-making
      can be faulty and that breakdowns can occur because of simple error or mistake.
      Additionally, controls can be circumvented by the individual acts of some
      persons, by collusion of two or more people, or by management override of the
      control. The design of any system of controls also is based in part upon certain
      assumptions about the likelihood of future events and there can be no assurance
      that any design will succeed in achieving its stated goals under all potential
      future conditions. Over time, controls may become inadequate because of changes
      in conditions, or the degree of compliance with the policies or procedures
      may
      deteriorate. Because of the inherent limitations in a cost-effective control
      system, misstatements due to error or fraud may occur and not be detected.





67





**ITEM
                8B****.**
            **OTHER
                INFORMATION**





We
      did
      not recognize the effect of deferred tax liabilities resulting from the
      differences between assigned values in the purchase price allocation and tax
      basis of assets acquired and liabilities assumed in the purchase business
      combination of Netintact as required under FAS109.30. The resulting effect
      to
      the Statements of Operations and Cash Flows through the third quarter which
      ended October 1, 2006 were minimal and the associated adjustments have been
      made
      to the Balance Sheet in Form 10-KSB for the fiscal year ended December 31,
      2006.





To
      avoid
      a recurrence of this issue, we will engage a tax professional prior to
      completing fair market valuation adjustments associated with future purchase
      business combinations.





**ITEM
                9****.**
            **DIRECTORS
                AND EXECUTIVE OFFICERS OF THE
                REGISTRANT.**





The
      following table sets forth certain information regarding Procera’s directors,
      executive officers and certain key employees as of December 31,
      2006:





NAME
            AGE
            POSITIONDouglas
                J. Glader
            64
            President,
                Chief Executive Officer and a DirectorThomas
                Williams
            68
            Chief
                Financial Officer and Secretary and a DirectorGary
                J. Johnson
            63
            Senior
                Vice President of Sales and MarketingAlbert
                Lopez
            40
            Vice-President
                and Chief Technical OfficerSven
                Nowicki
            45
            President
                of Netintact AB and a DirectorScott
                McClendon
            67
            DirectorThomas
                Saponas
            57
            Director





**DOUGLAS
      J. GLADER** has
      served as President and Chief Executive Officer and as a member of Board of
      Directors since the October 2003 merger. He served as President and Chief
      Executive Officer of PNI since founding PNI in May 2002. Prior to founding
      PNI,
      Mr. Glader served from 1996 to 2002 in key senior executive positions at Digi
      International, Inc., including Executive Vice President, Chief Operating
      Officer, Senior Vice President of Worldwide Manufacturing and Operations, and
      General Manager of Milan Technology, Digi's LAN products division. Mr. Glader
      has more than 27 years of experience in general management with firms such
      as
      Memorex, Measurex Corporation, Altus Corporation and Direct Incorporated, all
      located in the San Francisco Bay Area. In addition to co-founding Greyhawk
      Systems, Inc., a manufacturer of electronic imaging hardware and software,
      Mr.
      Glader has managed manufacturing operations in Belgium, Ireland, Mexico and
      the
      Pacific Rim. Mr. Glader serves on the board of directors of Uromedica, a
      privately held company in Plymouth, Minnesota.




**SVEN
      NOWICKI** has
      worked within the IT industry for over 15 years. He is the former CEO of
      Netintact, which he founded in 2000, together with four colleagues. Mr. Nowicki
      executed and closed the merger of Netintact AB with Procera Networks, Inc.
      in
      August 2006. Prior to Netintact, Mr. Nowicki started his first company in 1990
      building computers and networks for small business and private customers, and
      in
      1996 he started a web hosting company, together with two of the cofounders
      of
      Netintact. Mr. Nowicki is the IT manager for The Federation of Private
      Enterprises, a non-government organization for entrepreneurs and business
      owners. He is also an active member of SIB (Swedish IT Security Industry
      council), an association for the Swedish IT and information security companies,
      and an active member of SIG Security in Sweden.





**ALBERT
      LOPEZ** has
      served as our Vice President of Business Development and Products since November
      2006. Since February 2003, Mr. Lopez was the Chief Operating Officer at
      Brightidea, Inc., a provider of on-demand software for innovation and idea
      management until his departure in August, 2006. At Brightidea, he was
      responsible for Worldwide Sales, Marketing, Business Development, and Market
      Strategy. From September 2003 to February 2006, Mr. Lopez was a Senior Director
      of the Solutions Group and Global Alliances at Taleo Inc, a leading provider
      of
      on-demand talent management software that enables organizations of all sizes
      to
      assess, acquire, develop and align their workforce for improved business
      performance. At Taleo, Inc., he helped lead the company through a successful
      IPO, and was responsible for corporate development, product and market strategy,
      industry product marketing, solution consulting, and worldwide partnerships
      and
      strategic alliances. From February, 2002 to May 2003, Mr. Lopez was Senior
      Director of Business Development of MS2, Inc. From December 1998 to July 2001,
      Mr Lopez was CEO and President of Adflight, a performance-based internet
      advertising company. He grew the Adflight from concept to over 100 employees
      and
      raised over $28 Million in venture financing. Mr. Lopez received his Masters
      of
      Science in Manufacturing Systems Engineering from Stanford University, and
      a
      Bachelors of Science in Engineering from Harvey Mudd College.





68





**GARY
      J. JOHNSON** has
      served as Senior Vice President of Sales & Marketing
      since October 2004.  Mr. Johnson has more than 25 years
      experience as an executive in the Silicon Valley high technology industry. 
He is a highly respected senior executive, who has held positions as CEO
      and president, executive vice president of sales and marketing, vice president
      of operations and numerous other senior management roles. Prior to joing
      Procera, Mr. Johnson was CEO at Force Field, Inc. From November 1999 until
      June
      2001, he served as president and CEO of Berkeley Software Design, Inc. (BSDi),
      where he pioneered the Internet server category, built the company with 1000
      percent revenue growth, orchestrated the acquisition of two companies
      leading to the acquisition of BSDi by Wind River Systems Inc. From December
      1996
      to November 1999, he served as President of Click Software Inc. an enterprise
      service scheduling software provider, where he developed their presence in
      North America, developed relationships with numerous OEM and channel
      partners, grew the customer base with dozens of significant enterprise accounts
      and positioned the firm to raise over $50 million in its NASDAQ IPO. 
Mr. Johnson also held various senior sales management positions at SCO (The
      Santa Cruz Operation, Inc.) now (Caldera/SCO), Convergent Technologies,
      now (Unisys), and Tandem Computers, now (Compaq/HP). He was also
      employed by Fairchild Semiconductor, and Measurex Corporation early in his
      career. Mr. Johnson holds a Bachelor's Degree in Business Administration from
      Michigan State University.





**SCOTT
      MCCLENDON** has
      served as a member of Board of Directors since March 1, 2004. He is currently
      a
      member of the Audit Committee. Mr. McClendon served as the President and Chief
      Executive Officer of Overland Storage, Inc. (NASDAQ: OVRL) from October 1991
      to
      March 2001, when he was named Chairman, and was an officer and employee until
      June 2001. He was employed by Hewlett-Packard Company, a global manufacturer
      of
      computing, communications and measurement products and services, for over 32
      years in various positions in engineering, manufacturing, sales and marketing.
      He last served as the General Manager of the San Diego Technical Graphics
      Division and Site Manager of Hewlett-Packard in San Diego, California. Mr.
      McClendon is a director of SpaceDev, Inc., an aerospace development company.
      Mr.
      McClendon has a BSEE and MSEE from Stanford University.





**THOMAS
      SAPONAS** has
      served as a member of Board of Directors since April 1, 2004. Mr. Saponas served
      as the Senior Vice President and Chief Technology Officer of Agilent
      Technologies, Inc. (NYSE: A) from August 1999 until he retired in October 2003.
      Prior to being named Chief Technology Officer, from June 1998 to April 1999,
      Mr.
      Saponas was Vice President and General Manager of Hewlett-Packard's Electronic
      Instruments Group. Mr. Saponas has held a number of positions since the time
      he
      joined Hewlett-Packard. Mr. Saponas served as General Manager of the Lake
      Stevens Division from August 1997 to June 1998 and General Manager of the
      Colorado Springs Division from August 1989 to August 1997. In 1986, he was
      a
      White House Fellow in Washington, D.C. Mr. Saponas has a BSEE/CS (Electrical
      Engineering and Computer Science) and an MSEE from the University of Colorado.
      Mr. Saponas is a director of nGimat, a nanotechnology company. He also serves
      on
      the Visiting Committee on Advanced Technology at the National Institute of
      Standards and Technology. On March 23, 2006, Mr. Saponas filled the vacancy
      left
      by Tom Williams as a member of the Company’s Audit Committee.





**THOMAS
      H. WILLIAMS** has
      served as a member of Board of Directors since the October 2003 merger. On
      March
      23, 2006, the Company appointed Thomas H. Williams as its Chief financial
      Officer, effective March 20, 2006. He is currently a member of the Compensation
      Committee. He served as a Director of PNI from May 2002 to October 2003. Mr.
      Williams has 20 years' experience as CFO and General Counsel in start-up and
      medium-sized venture capital-backed technology companies. Mr. Williams' early
      years were spent with IBM and Shell Oil Company in engineering and legal
      positions. In 1971, Mr. Williams joined the management team of Measurex Corp.,
      a
      process control start-up, responsible for engineering project budgeting and
      patent matters as the company grew from $4 million to $50 million in revenues.
      In 1976, Mr. Williams and two partners took over management of Altus
      Corporation, guided the company through bankruptcy and raised venture capital.
      From 1984 though 1993, Mr. Williams was CFO and General Counsel for Greyhawk
      Systems, an innovator in high-resolution electronic imaging, which was sold
      in
      1993. From 1993 to 1997, Mr. Williams was in the private practice of law. In
      1997 he was appointed as CFO of IC WORKS, Inc., a venture capital-backed
      semiconductor company, on an interim basis to guide a financial turnaround.
      Within six months, the company was brought from near bankruptcy to a cash
      positive position, which allowed the company to be sold in 1998 for more than
      $100 million. From 1999 to 2003, Mr. Williams was CFO at Bandwidth9, a
      company developing tunable lasers for the fiber optics industry. Mr. Williams
      served as CEO of Banwidth9, in 2003 and 2004.  Mr. Williams served as
      interim CEO for TeleCIS Wireless a venture capital backed WIMAX startup from
      November 2004 to March 2005. Mr.
      Williams holds a B.S. degree in electrical engineering, and a law degree from
      the University of Minnesota and a M.B.A. from the University of California
      at
      Berkeley. He is a member of the California, New York (inactive), Federal and
      Patent bars. On March 23, 2006, Mr. Williams joined the Company’s management
      team as Chief Financial Officer and Secretary. Early in fiscal 2006, Mr.
      Williams resigned his position on the Audit Committee but will continue to
      perform as a Director of the Company.





69





Procera’s
      executive officers are elected by the Board of Directors on an annual basis
      and
      serve at the discretion of the Board of Directors, subject to the terms of
      any
      employment agreements with us, until their successors have been duly elected
      and
      qualified or until their earlier resignation or removal. There are no family
      relationships between any directors and executive officers.





**BOARD
      COMMITTEES**





Procera
      currently has two committees of its Board of Directors: the Audit Committee
      and
      the Compensation Committee.





The
      Audit
      Committee reviews, acts on and reports to the Board of Directors regarding
      various auditing and accounting matters, including the selection of our
      independent auditors, the monitoring of the rotation of the partners of the
      independent auditors, the review of our financial statements, the scope of
      the
      annual audits, fees to be paid to the auditors, the performance of our
      independent auditors and our accounting practices. There are currently two members
      of the Audit Committee, Mr. McClendon and Mr. Saponas.





The
      Compensation Committee determines the salaries and incentive compensation of
      our
      officers and provides recommendations for the salaries and incentive
      compensation of our other employees. The Compensation Committee also administers
      our stock option plan. There is currently one member of the Compensation
      Committee, Mr. Williams. Mr. Glader, our Chief Executive Officer, participated
      in deliberations of the Board of Directors relating to his compensation.





**AUDIT
      COMMITTEE FINANCIAL EXPERT**





Procera’s
      Board of Directors has determined that it does not have an audit committee
      financial expert serving on its audit committee. Under the applicable Securities
      and Exchange Commission standard, an audit committee financial expert means
      a
      person who has the following attributes:





-
            An
                understanding of generally accepted accounting principles and financial
                statements;


-
            The
                ability to assess the general application of such principles in connection
                with the accounting for estimates, accruals and
                reserves;


-
            Experience
                preparing, auditing, analyzing or evaluating financial statements
                that
                present a breadth and level of complexity of accounting issues that
                are
                generally comparable to the breadth and complexity of issues that
                can
                reasonably be expected to be raised by the registrant's financial
                statements, or experience actively supervising one or more persons
                engaged
                in such activities;


-
            An
                understanding of internal controls and procedures for financial reporting;
                and


-
            An
                understanding of audit committee
                functions.





**COMPLIANCE
      WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934**





Section
      169a) of the Exchange Act requires Procera’ officers and directors, and persons
      who own more than 10% of its common stock to file reports of ownership and
      changes of ownership of such securities with the Securities and Exchange
      Commission. Based on a review of its records, Procera’s management believes that
      its officers, directors and holders of more than 10% of its common stock have
      not complied with all applicable requirements during the 2006 fiscal year.
      The
      following officers were not in compliance as of December 31, 2006: Albert Lopez
      had not reported an option to purchase 900,000 shares of common stock; Paul
      Eovino had not reported an option to purchase 500,000 shares of common stock;
      Thomas Williams had not reported option for the purchase of 1,216,000 shares
      of
      common stock and warrants for the purchase of 85,000 shares; Gary Johnson had
      not reported an option for the purchase of 1,000,000 shares. The following
      Directors were not compliant as of December 31, 2006: Tom Saponas had not
      reported an option to purchase 50,000 shares of common stock; Scott McClendon
      had not reported an option to purchase 50,000 shares of common stock; Thomas
      Williams had not reported an option to purchase 16,000 shares of common
      stock.





70





**CODE
      OF ETHICS**





Procera
      does not have a code of ethics. The Board of Directors has decided to postpone
      the adoption of a code of ethics until the Company is able to develop a greater
      infrastructure. Once Procera has adopted a code of ethics a copy may be obtained
      by sending a written request to the Company.





**DIRECTORS'
      COMPENSATION**





Directors
      who are also Procera’s employees receive no additional compensation for serving
      on the Board. Procera reimburses non-employee Directors for all travel and
      other
      expenses incurred in connection with attending meetings of the Board of
      Directors. Procera’s Directors who are also employees may participate in other
      incentive plans described under "Item 10. Executive Compensation."





**ITEM
                10****.**
            **EXECUTIVE
                COMPENSATION**





The
      following table sets forth, as to our named executive officers, information
      concerning all compensation paid to our named executive officers for services
      rendered during our fiscal year ended December 31, 2006. No other executive
      officers received total compensation in excess of $100,000 for the fiscal year
      ended December 31, 2006.




ANNUAL
                COMPENSATIONNAME
                AND PRINCIPAL POSITION
            
            YEAR
            
            SALARY
                ($)
            
            BONUS
                ($)
            
            Options
                AwardsDouglas
                J. Glader,
            
            
            2006
            
            $
            245,000
            
            
            0
            
            
            0CEO
            
            
            2005
            
            $
            245,000
            
            
            0
            
            
            0Thomas
                Williams
            
            
            2006
            
            $
            126,154
            
            
            0
            
            
            595,335CFO
            
            
            2005
            
            $
            0
            
            
            0
            
            
            73,770Sven
                Nowicki
            
            
            2006
            
            $
            33,710
            
            
            0
            
            
            0CEO
                & VP Sales, Netintact AB
            
            
            2005
            
            $
            0
            
            
            0
            
            
            0Albert
                Lopez
            
            
            2006
            
            $
            33,846
            
            
            0
            
            
            914,940V.P.
                and CTO
            
            
            2005
            
            $
            0
            
            
            0
            
            
            0Jay
                Zerfoss
            
            
            2006
            
            $
            140,000
            
            
            0
            
            
            30,745V.P.
                Finance
            
            
            2005
            
            $
            140,000
            
            
            0
            
            
            0Gary
                Johnson
            
            
            2006
            
            $
            126,655
            
            
            59,500
            
            
            220,100Sr.
                V.P. of Sales and Marketing
            
            
            2005
            
            $
            120,000
            
            
            0
            
            
            0




**EMPLOYMENT
      AGREEMENTS; TERMINATION OF EMPLOYMENT AND CHANGE OF CONTROL
      ARRANGEMENTS**





In
      September 2003, Procera entered into an offer letter with Mr. Douglas Glader
      employing him as its Chief Executive Officer for a minimum term of one year.
      The
      agreement provides for a base salary of $245,000 per year. In addition, Procera
      granted to Mr. Glader the right to purchase 4,000,000 shares of our common
      stock
      at a price of $0.001 per share. In addition, Mr. Glader is entitled to the
      employee benefits available to all Company employees and is eligible for
      participation in any executive bonus program adopted by the Company’s board of
      directors. Mr Glader’s offer letter provides that he will receive his then
      current base salary for an additional 18 months in the event that he is
      terminated without cause. There are no other severance provisions.





71





In
      October 2004, Procera entered into an offer letter with Mr. Gary J. Johnson
      employing his as its Sr. Vice-President of Sales and Marketing on an at-will
      basis. The agreement provides for a base salary of $120,000 per year and an
      incentive to earn an additional $80,000 annually in commissions based on
      performance. In addition, Procera granted to Mr. Johnson an incentive stock
      option to purchase 500,000 shares of our common stock at a price of $0.92 per
      share. In addition, Mr. Johnson is entitled to the employee benefits available
      to all Company employees and is eligible for participation in any executive
      bonus program adopted by the Company’s board of directors. There are no
      severance provisions.,





In
      March
      2006, Procera entered into an offer letter with Mr. Thomas H. Williams employing
      him as Chief Financial Officer. The agreement provides for a base salary of
      $160,000 per annum. In addition, Procera granted to Mr. Williams an option
      to
      purchase 450,000 shares of Procera common stock at a price of $.69 per share.
      In
      August Mr. Williams was granted an option to purchase an additional 750,000
      shares at an option price of $.52 per share. Mr. Williams is eligible to
      participate in any executive bonus programs adopted by the Company’s board of
      directors. There are no severance provisions.




On
      August
      18, 2006, the merger between Procera Networks, Inc. and Netintact, AB closed.
      At
      that time all shares of Netintact, AB were owned by Procera. Mr. Sven Nowicki,
      is the President of Netinact, AB and has an employment contract with Netintact,
      AB. This agreement is a customary Swedish employment agreement that conforms
      to
      Swedish law. No severance provisions beyond those mandated by Swedish law are
      included. Procera does not have an employment contract with Mr.
      Nowicki.




In
      September 2006, Procera entered into an offer letter with Mr. Albert Lopez
      employing him as Vice President of Product Management and Business Development.
      The agreement provides for a base salary of $160,000 per annum. In addition,
      Procera granted to Mr. Lopez an option to purchase 900,000 shares of Procera
      common stock at a price of $1.19 per share. Mr. Lopez is eligible to participate
      in any executive bonus programs adopted by the Company’s board of directors.
      There are no severance provisions.





**STOCK
      OPTION PLANS**





In
      August
      2003 and October 2004 Procera’s board of directors and stockholders adopted the
      2003 Stock Option Plan and 2004 Stock Option Plan, respectively (collectively
      referred to as the “Plan”). The number of shares available for options under the
      2003 Plan and 2004 Plan, as amended, is 2,500,000 and 5,000,000, respectively.
      The following description of our Plan is a summary and qualified in its entirety
      by the text of the Plan. The purpose of the Plan is to enhance our profitability
      and stockholder value by enabling us to offer stock based incentives to
      employees, directors and consultants. The Plan authorizes the grant of options
      to purchase shares of Procera’s common stock to employees, directors and
      consultants. Under the Plan, Procera may grant incentive stock options within
      the meaning of Section 422 of the Internal Revenue Code of 1986 and
      non-qualified stock options. Incentive stock options may only be granted to
      Procera employees.





The
      number of shares available for options under the Plan is 7,500,000. As of
      December 31, 2006, 2,016,216 shares were available for future grants. The
      options under the Plan vest over varying lengths of time pursuant to various
      option agreements that Procera has entered into with the grantees of such
      options. The Plan is administered by the board of directors. Subject to the
      provisions of the Plan, the board of directors has authority to determine the
      employees, directors and consultants who are to be awarded options and the
      terms
      of such award, including the number of shares subject to such option, the fair
      market value of the common stock subject to options, the exercise price per
      share and other and other terms.





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





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




72




**OUTSTANDING
      EQUITY AWARDS AT DECEMBER 31, 2006**





The
      following table presents information regarding outstanding options and warrants
      held by our named executive officers as of the end of our fiscal year ending
      December 31, 2006.





Name
            
            Number
                of Securities Underlying Unexercised Options
              (#)
              Exercisable
            
            Number
                of Securities Underlying Unexercised Options
              (#)
              Unexercisable
            
            Option
                Exercise Price
              ($)
            
            Option
                Expiration DateDouglas
                J. Glader
            
            
            -
            
            
            -
            
            
            -
            
            
            -Thomas
                Williams
            
            
            16,000
            
            
            -
            
            $
            3.35
            
            
            03/09/1416,000
            
            
            -
            
            $
            1.67
            
            
            04/20/15450,000
            
            
            -
            
            $
            0.69
            
            
            03/20/16750,000
            
            
            -
            
            $
            0.52
            
            
            08/11/1675,000
            
            
            -
            
            $
            1.42
            
            
            06/14/0810,000
            
            
            -
            
            $
            1.86
            
            
            04/13/08Gary
                Johnson
            
            
            500,000
            
            
            -
            
            $
            0.92
            
            
            10/12/14500,000
            
            
            -
            
            $
            0.52
            
            
            08/11/16Albert
                Lopez
            
            
            900,000
            
            
            -
            
            $
            1.19
            
            
            10/24/16Jay
                Zerfoss
            
            
            50,000
            
            
            -
            
            $
            0.72
            
            
            03/22/16Sven
                Nowicki
            
            
            -
            
            
            -
            
            
            -
            
            
            -




Equity
      Compensation Plan Information




The
      following table sets forth information concerning our equity compensation plan
      as of December 31, 2006.




Plan
                Category
            
            Number
                of securities to be issued upon exercise of outstanding options,
                warrants
                and rights
              (a)
            
            Weighted-average
                exercise price of outstanding options, warrants and rights
              (b)
            
            Number
                of securities remaining available for future issuance under equity
                compensation plans (excluding securities reflected in column
              (a))
                (c)Equity
                compensation plans approved by security holders
            
            
            5,483,784
            
            $
            0.96
            
            
            2,016,216Equity
                compensation plans not approved by security holders
            
            
            0
            
            $
            0.00Total
            
            
            5,483,784
            
            $
            0.96
            
            
            2,016,216








**ITEM
                11****.**
            **SECURITY
                OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
                AND RELATED********STOCKHOLDER
                MATTERS.**





The
      following table sets forth certain information known to us with respect to
      the
      beneficial ownership of our common stock as of December 31, 2006 and: (i) all
      persons who are known to us to be beneficial owners of five percent or more
      of
      the common shares; (ii) each of our Directors; (iii) the Named Executive
      Officers; and (iv) all current Directors and executive officers as a
      group.





NAME
                OF BENEFICIAL OWNER
            
            SHARES
                BENEFICIALLY OWNED
            
            PERCENT
                OF CLASS BENEFICIALLY OWNEDDouglas
                Glader (1)
            
            
            4,148,970
            
            
            6.0
            %Linden
                Growth Partners
            
            
            3,252,959
            
            
            4.7
            %Sven
                Nowicki
            
            
            2,906,998
            
            
            4.2
            %Thomas
                Williams (2)
            
            
            1,417,000
            
            
            2.1
            %Gary
                Johnson (3)
            
            
            1,000,000
            
            
            1.5
            %Albert
                Lopez (4)
            
            
            900,000
            
            
            1.3
            %Scott
                McClendon (5)
            
            
            94,000
            
            
            *Thomas
                Saponas (6)
            
            
            94,000
            
            
            *All
                officers and directors as a group (seven persons)
            
            
            10,460,968
            
            
            15.2
            %




73





*
      Indicates less than 1%


(1)
      Shares beneficially owned by Douglas Glader include 11,000 shares owned by
      Scott
      Glader, the son of Douglas Glader and 11,000 shares owned by Christine Glader,
      the daughter-in-law of Douglas Glader.





(2)
      Shares beneficially owned by Thomas Williams include 100,000 shares of Procera’s
      common stock purchased at $0.001 per share, warrants to purchase 75,000 shares
      of Procera’s common stock at $1.42 per share, warrants to purchase 10,000 shares
      of Procera’s common stock at $1.86 per share, options to purchase 450,000 shares
      of Procera’s common stock at $0.69 per share, options to purchase 750,000 shares
      of Procera’s common stock at $0.52 per share, options to purchase 16,000 shares
      of Procera’s common stock at $1.67 per share, and options to purchase 16,000
      shares of Procera’s common stock at $3.35 per share that are exercisable in
      whole or in part within 60 days of March 31, 2007.




(3)
      Shares beneficially owned by Gary Johnson include options to purchase 500,000
      shares of Procera's common stock at $0.52 per share and options to purchase
      15,000 shares of Procera’s common stock at $0.92 per share that are exercisable
      in whole or in part within 60 days of March 31, 2007.


(4)
      Shares beneficially owned by Albert Lopez include options to purchase 900,000
      shares of Procera's common stock at $1.19 per share that are exercisable in
      whole or in part within 60 days of March 31, 2007.





(5)
      Shares beneficially owned by Scott McClendon include options to purchase 28,000
      shares of Procera's common stock at $3.35 per share and options to purchase
      16,000 shares of Procera’s common stock at $1.67 per share that are exercisable
      in whole or in part within 60 days of March 31, 2007.





(6)
      Shares beneficially owned by Thomas Saponas include options to purchase 28,000
      shares of Procera's common stock at $1.70 per share and options to purchase
      16,000 shares of Procera’s common stock at $1.67 per share that are exercisable
      in whole or in part within 60 days of March 31, 2007.





Beneficial
      ownership is determined in accordance with the rules of the Securities and
      Exchange Commission and includes voting or investment power with respect to
      the
      securities. Common shares subject to options that are currently exercisable
      or
      exercisable within 60 days of March 31, 2007 are deemed to be outstanding and
      to
      be beneficially owned by the person or group holding such options or warrants
      for the purpose of computing the percentage ownership of such person or group
      but are not treated as outstanding for the purpose of computing the percentage
      ownership of any other person or group. Unless otherwise indicated, the address
      for each of the individuals listed in the table is care of Procera Networks,
      Inc., 100C Cooper Court, Los Gatos, California 95032. Unless otherwise indicated
      by footnote, the persons named in the table have sole voting and sole investment
      power with respect to all common shares shown as beneficially owned by them,
      subject to applicable community property laws. Percentage of beneficial
      ownership is based on 68,614,105 shares of our common stock outstanding as
      of
      March 31, 2007.





**ITEM
                12****.**
            **CERTAIN
                RELATIONSHIPS AND RELATED
                TRANSACTIONS**


Executive
        officers have an employment agreement with the Company discussed elsewhere
        in
        this Annual Report.
 
 In
        November 2005, Procera entered into an engagement letter with Chadbourn
        Securities pursuant to which Chadbourn agreed to raise equity money for Procera
        in exchange for a fee of 8% in cash and 10% warrant coverage as reported
        elsewhere in this report. A principal in Chadbourn Securities is Laird Cagan,
        a
        shareholder in Procera.
 
 On
        November 29, 2005, the Company received loan proceeds of $90,000 from Cagan
        McAfee Capital Partners, a related party, and issued a promissory note in
        that
        amount baring interest of 6% per annum and maturing on April 1, 2006. This
        loan
        together with interest of $562 was paid in full on January 6, 2006.
 
 On
        December 13, 2005, the Company received loan proceeds of $150,000 form Laird
        Cagan, a related party who is a partner in Chadbourn Securities, Inc., and
        issued a promissory note in tat amount, bearing interest of 6% per annum,
        and
        maturing on April 1, 2006. On February 28, 2006, Mr. Cagan requested that
        $130,000 of the loan principal owed to him by the Company be converted to
        a
        purchase of 325,000 shares of the Company’s common stock as part of a private
        offering of the Company’s common stock which closed on that date. The remaining
        loan principal of $20,000 together with interest of $1,971 was paid in full
        on
        March 22, 2006.
  In
        March
        2006, an option award of 450,000 was issued to Thomas H. Williams having
        an
        exercise price of $.69 per share, which was the closing price on the over
        the
        counter exchange on the date that he commenced employment as the Chief Financial
        Officer. One quarter of the options vest after 12 months and the remainder
        at
        one-thirty sixth per month.
 In
          August
          2006, an option award of 750,000 was issued to Thomas H. Williams, Chief
          Financial Officer, having an exercise price of $.52 per share, which was
          the
          closing price on the over the counter exchange on the date of grant. One
          sixth
          of the options vest after 6 months and the remainder at one-thirtieth per
          month.
 
 In
          August
          2006, an option award of 500,000 was issued to Gary J. Johnson, Senior
          Vice
          President, having an exercise price of $.52 per share, which was the closing
          price on the over the counter exchange on the date of grant. One sixth
          of the
          options vest after 6 months and the remainder at one-thirtieth per
          month.
 
 In
          September 2006, an option award of 900,000 was issued to Albert Lopez,
          Vice
          President, having an exercise price of $1.18 per share, which was the closing
          price on the over the counter exchange on the date that he commenced employment
          as the Vice President of Business Development. One quarter of the options
          vest
          after 12 months and the remainder at one-thirty sixth per month.
  Procera
          believes that all of the transactions set forth above were made on terms
          no less
          favorable to the Company than could have been obtained from unaffiliated
          third
          parties. Procera intends that all future transactions with affiliated persons
          be
          approved by a majority of the Board of Directors, including a majority
          of the
          independent and disinterested outside directors on the Board of Directors,
          and
          be on terms no less favorable to it than could be obtained from unaffiliated
          third parties.


**ITEM
                13.**
            **EXHIBITS**


2.1*
                Agreement and Plan of Merger included in our Preliminary Proxy Statement
                on Schedule 14A filed on August 25, 2003 and incorporated herein
                by
                reference.2.2*
                First Amended and Restated Stock Exchange Agreement and Plan of
                Reorganization by and between Procera and the Sellers of Netintact
                dated
                August 18, 2006.2.3*
                Form of Closing Date Warrant Agreement dated August 18,
                2006.




74




2.4*
                Form of Incentive Warrant Agreement dated August 18,
                2006.2.5*
                Lockup Agreement dated August 18, 2006.2.6*
                Voting Agreement dated August 18, 2006.2.7*
                Escrow Agreement dated August 18, 20062.8
                First Amendment to First Amended and Restated Stock Exchange Agreement
                and
                Plan of Reorganization by and between Procera and the Sellers of
                Netintact
                Dated January 24, 2007.3.1*
                Articles of Incorporation included as Exhibit 3.1 to our form SB-2
                filed
                on February 11, 2002 and incorporated herein by
                reference.3.2*
                Amendment to Articles of Incorporation includes as Exhibit 99.1 to
                our
                form 8K filed on October 12, 2005 and incorporated herein by
                reference.3.2*
                Bylaws included as Exhibit 3.2 to our form SB-2 filed on February
                11, 2002
                and incorporated herein by reference.4.1*
                Form of Subscription Agreement for February 28, 2006 offering included
                as
                Exhibit 10.1 to our current report on form 8-K filed on March 1,
                2006 and
                incorporated herein by reference.4.2*
                Form of Registration Rights Agreement for February 2006 offering
                included
                as Exhibit 10.2 to our current report on Form 8-K filed on March
                1, 2006
                and incorporated herein by reference.4.3*
                Form of Subscription Agreement for November 30, 2006 offering included
                as
                Exhibit 10.1 to our current report form 8-K filed on November 30,
                2006 and
                incorporated herein by reference4.4*
                Form of Registration Rights Agreement for November 30, 2006 offering
                included as Exhibit 10.2 to our current report on Form 8-K filed
                on
                November 30, 2006 and incorporated herein by reference.10.1*
                2003 Stock Option Plan10.2*
                Sublease Agreement10.3*
                Employee Offer Letter for Douglas J. Glader10.4*
                2004 Stock Option Plan10.5*
                Employee Offer Letter for Thomas H. Williams10.6*
                Employee Offer Letter for Jay Zerfoss10.7*
                Employee Offer Letter for Albert Lopez10.8*
                Employee Offer Letter for Gary Johnson31.1
                Certification of Chairman and Chief Executive Officer Pursuant to
                Section
                302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Sec. 1350) (transmitted
                herewith).31.2
                Certification of Chief Accounting Officer Pursuant to Section 302
                of the
                Sarbanes-Oxley Act of 2002 (18 U.S.C. Sec. 1350) (transmitted
                herewith).32.1
                Written Statement of Chairman and Chief Executive Officer Pursuant
                to
                Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section
                1350)
                (transmitted herewith).32.2
                Written Statement of Chief Financial Officer Pursuant to Section
                906 of
                the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350) (transmitted
                herewith).





*
            Previously
                filed.





**ITEM
                14****.**
            **PRINCIPAL
                ACCOUNTING FEES AND
                SERVICES**





Below
      is
      the aggregate amount of fees billed for professional services rendered by
      Procera’s principal accountants with respect to the Company’s last two fiscal
      years:





75




Year
                Ended
              December
                31, 2006
            
            Year
                Ended
              January
                1, 2006Audit
                fees
            
            $
            67,420
            
            $
            71,500Audit-related
                fees
            
            
            39,140
            
            
            49,839Tax
                fees
            
            
            26,015
            
            
            -All
                other fees
            
            
            -
            
            
            -Total
            
            $
            132,575
            
            $
            121,339





All
      of
      the professional services rendered by Procera’s principal accountants for the
      audit of the Company’s annual financial statements and review of financial
      statements included in its Form 10-QSB or services that are normally provided
      by
      the accountant in connection with statutory and regulatory filings or
      engagements for last two fiscal years were approved by the Audit
      Committee.





76





**SIGNATURES**





In
      accordance with section 13 and 15 (d) of the Securities Exchange Act of 1934,
      the registrant has duly caused this report to be signed on its behalf by the
      undersigned, thereunto duly authorized.








Procera
      Networks, Inc.





/s/
      Douglas J. Glader


Douglas
      J. Glader


President
      and CEO/Director





77





In
      accordance with the Securities Exchange Act of 1934, this Annual Report on
      Form
      10-KSB has been signed below by the following persons on behalf of the registrant
      and in the capacities and on the dates indicated.





SIGNATURE
            
            TITLE
            
            DATE/s/
                Douglas J. Glader
            
            President,
                Chief Executive Officer
            
            April
                15, 2007Douglas
                J. Glader
            
            and
                Director/s/
                Thomas Saponas
            
            Director
            
            April
                15, 2007Thomas
                Saponas/s/
                Thomas Williams
            
            Chief
                Financial Officer
            
            April
                15, 2007Thomas
                Williams/s/
                Scott McClendon
            
            Director
            
            April
                15, 2007Scott
                McClendon/s/
              Sven Nowicki
            
            President
              of Netintact, AB and Director
            
            April
                15, 2007Sven
              Nowicki





EXHIBIT
      INDEX


2.1*
                  Agreement and Plan of Merger included in our Preliminary Proxy
                  Statement
                  on Schedule 14A filed on August 25, 2003 and incorporated herein
                  by
                  reference.2.2*
                  First Amended and Restated Stock Exchange Agreement and Plan of
                  Reorganization by and between Procera and the Sellers of Netintact
                  dated
                  August 18, 2006.2.3*
                  Form of Closing Date Warrant Agreement dated August 18,
                  2006.
 2.4*
                  Form of Incentive Warrant Agreement dated August 18,
                  2006.2.5*
                  Lockup Agreement dated August 18, 2006.2.6*
                  Voting Agreement dated August 18, 2006.2.7*
                  Escrow Agreement dated August 18, 20062.8
                  First Amendment to First Amended and Restated
                  Stock Exchange Agreement and Plan of Reorganization by and between
                  Procera
                  and the Sellers of Netintact Dated January 24, 2007.3.1*
                  Articles of Incorporation included as Exhibit 3.1 to our form SB-2
                  filed
                  on February 11, 2002 and incorporated herein by
                  reference.3.2*
                  Amendment to Articles of Incorporation includes as Exhibit 99.1
                  to our
                  form 8K filed on October 12, 2005 and incorporated herein by
                  reference.3.2*
                  Bylaws included as Exhibit 3.2 to our form SB-2 filed on February
                  11, 2002
                  and incorporated herein by reference.4.1*
                  Form of Subscription Agreement for February 28, 2006 offering included
                  as
                  Exhibit 10.1 to our current report on form 8-K filed on March 1,
                  2006 and
                  incorporated herein by reference.4.2*
                  Form of Registration Rights Agreement for February 2006 offering
                  included
                  as Exhibit 10.2 to our current report on Form 8-K filed on March
                  1, 2006
                  and incorporated herein by reference.4.3*
                  Form of Subscription Agreement for November 30, 2006 offering included
                  as
                  Exhibit 10.1 to our current report form 8-K filed on November 30,
                  2006 and
                  incorporated herein by reference4.4*
                  Form of Registration Rights Agreement for November 30, 2006 offering
                  included as Exhibit 10.2 to our current report on Form 8-K filed
                  on
                  November 30, 2006 and incorporated herein by reference.10.1*
                  2003 Stock Option Plan10.2*
                  Sublease Agreement10.3*
                  Employee Offer Letter for Douglas J. Glader10.4*
                  2004 Stock Option Plan10.5*
                  Employee Offer Letter for Thomas H. Williams10.6*
                  Employee Offer Letter for Jay Zerfoss10.7*
                  Employee Offer Letter for Albert Lopez10.8*
                  Employee Offer Letter for Gary Johnson31.1
                  Certification of Chairman and Chief Executive
                  Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
                  (18
                  U.S.C. Sec. 1350) (transmitted herewith).31.2
                  Certification of Chief Accounting Officer
                  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C.
                  Sec.
                  1350) (transmitted herewith).32.1
                  Written Statement of Chairman and Chief
                  Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley
                  Act of
                  2002 (18 U.S.C. Section 1350) (transmitted herewith).32.2
                  Written Statement of Chief Financial Officer
                  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C.
                  Section 1350) (transmitted
                  herewith).


*
            Previously
                filed.






78