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UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549


Form 10-K

|           |  |                                                                                             
|---------- |  | --------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                             
|þ          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|          
|           |  | For the fiscal year ended December 31,
    2002                                             
|          
|          
|or        
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|          
|           |  | For the transition period
    from           to           .                                 

Commission File
Number      -

Packeteer, Inc.

(Exact name of Registrant as specified in its
charter)


|                                 |  |                                                   
|-------------------------------- |  | --------------------------------------------------
|Delaware(State of incorporation) |  | 77-0420107(I.R.S. Employer Identification
    No.)

10201 North De Anza

Cupertino, California 95014


(Address of principal executive
offices)


Registrants telephone number, including
area code: (408) 873-4400

Securities registered pursuant to
Section 12(b) of the Act: None

Securities registered pursuant to
Section 12(g) of the Act:

Common Stock, $0.001 Par Value

(Title of Class)


Indicate by check mark whether the Registrant
(1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period
that the Registrant was required to file such reports), and
(2) has been subject to such filing requirements for the
past 90 days.
Yes þ         No o

Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of
the Registrants knowledge, in definitive proxy or
information statements incorporated by reference in Part III of
this Form 10-K or any amendment to this
Form 10-K. o

Indicate by checkmark whether the registrant is
an accelerated filer (as defined in Exchange Act
Rule 12b-2).
Yes þ         No o

Based on the closing sale price of the common
stock on the Nasdaq National Market System on June 28,
2002, the aggregate market value of the voting common stock held
by non-affiliates of the Registrant was $102,465,770. Shares of
common stock held by each officer and director and by each
person known by the Registrant to own 10% 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.

The number of shares outstanding of
Registrants common stock, $0.001 par value, was
31,016,186 at February 28, 2003.

DOCUMENTS INCORPORATED BY REFERENCE

Information required by Part III, Items 10,
11, 12 and 13, of this Form 10-K is incorporated by
reference from the Registrants definitive Proxy Statement
for the Registrants 2003 Annual Meeting of Stockholders to
be filed with the Securities and Exchange Commission pursuant to
Regulation 14A not later than 120 days after
December 31, 2002.



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TABLE OF CONTENTS



|              |                                                                                               |  |  |  |  |  |  | 
|------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I       
|              | Item 1. Business                                                                             
|              | Item 2. Properties                                                                           
|              | Item 3. Legal Proceedings                                                                    
|              | Item 4. Submission of Matters to a Vote of Security Holders                                  
|PART II      
|              | Item 5. Market for Registrants Common Stock and Related Stockholder Matters                 
|              | Item 6. Selected Financial Data                                                              
|              | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
|              | Item 7a. Quantitative and Qualitative Disclosures About Market Risk                          
|              | Item 8. Financial Statements and Supplementary Data                                          
|              | Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure 
|PART III     
|              | Item 14. Controls and Procedures                                                             
|              | Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K                     
|SIGNATURES   
|EXHIBIT INDEX
|EXHIBIT 10.24
|EXHIBIT 21.1 
|EXHIBIT 23.1 
|EXHIBIT 99.1 
|EXHIBIT 99.2 



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TABLE OF CONTENTS

|               |          |  |                                                                                           |  |  |    | 
|-------------- | -------- |  | ----------------------------------------------------------------------------------------- |  |  | -- | 
|Part I         |          |  |                                                                                           |  |  |   
|               | Item 1.  |  | Business                                                                                  |  |  | 1  | 
|               | Item 2.  |  | Properties                                                                                |  |  | 24 | 
|               | Item 3.  |  | Legal Proceedings                                                                         |  |  | 24 | 
|               | Item 4.  |  | Submission of Matters to a Vote of Security
    Holders                                   |  |  | 24 | 
|Part II        |          |  |                                                                                           |  |  |   
|               | Item 5.  |  | Market For Registrants Common Stock and
    Related Stockholder Matters                  |  |  | 25 | 
|               | Item 6.  |  | Selected Financial Data                                                                   |  |  | 26 | 
|               | Item 7.  |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations |  |  | 27 | 
|               | Item 7a. |  | Quantitative and Qualitative Disclosures about
    Market Risk                            |  |  | 36 | 
|               | Item 8.  |  | Financial Statements and Supplementary Data                                               |  |  | 37 | 
|               | Item 9.  |  | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosure  |  |  | 61 | 
|Part III       |          |  |                                                                                           |  |  |   
|               | Item 10. |  | Directors and Executive Officers of the Registrant                                        |  |  |    | 
|               | Item 11. |  | Executive Compensation                                                                    |  |  |    | 
|               | Item 12. |  | Security Ownership of Certain Beneficial Owners
    and Management                        |  |  |    | 
|               | Item 13. |  | Certain Relationships and Related Transactions                                            |  |  |    | 
|               | Item 14. |  | Controls and Procedures                                                                   |  |  | 61 | 
|               | Item 15. |  | Exhibits, Financial Statement Schedules and
    Reports on Form 8-K                       |  |  | 61 | 
|Signatures     |          |  | 62                                                                                        | 
|Certifications |          |  | 64                                                                                        | 



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PART I




Item 1.Business

In addition to historical information, this
Annual Report on Form 10-K contains forward-looking
statements regarding our strategy, financial performance and
revenue sources that involve a number of risks and
uncertainties, including those discussed below in Risk
Factors. Forward-looking statements in this report
include, but are not limited to, those relating to our ability
to develop multiple applications, our planned introduction of
new products and services, the possibility of acquiring
complementary businesses, products, services and technologies
and our development of relationships with providers of leading
Internet technologies. While this outlook represents our current
judgment on the future direction of the business, such risks and
uncertainties could cause actual results to differ materially
from any future performance suggested below. Readers are
cautioned not to place undue reliance on the forward-looking
statements, which speak only as of the date of this Annual
Report. Packeteer undertakes no obligation to publicly release
any revisions to forward-looking statements to reflect events or
circumstances arising after the date of this document. See
Risk Factors.

Overview

Packeteer is a leading provider of application
traffic management systems designed to enable enterprises to
gain visibility and control of networked applications, extend
network resources and align application performance with
business priorities. For service providers, Packeteer systems
provide a platform for delivering application-intelligent
network services that control quality of service, or QoS, expand
revenue opportunities and offer compelling differentiation from
other potential solutions. Our PacketShaper family of products,
including the PacketShaper®, PacketSeekerTM and
PacketShaper XpressTM, integrates application
discovery, analysis, control, acceleration and reporting
technologies that are required for proactive application
performance and bandwidth management. Our AppCeleraTM
family of Internet acceleration appliances employs secure socket
layer (SSL) offload and advanced content compression,
transformation and caching technologies to improve response
times of mission critical enterprise, eBusiness and eCommerce
web applications. Our ReportCenter and PolicyCenter software
products are designed to enable management of large deployments
of our PacketShaper systems.

Packeteers products are deployed by Global
2000 corporations and service providers, and are sold through an
established network of more than 100 resellers, distributors,
system-integrators and OEMs in more than 50 countries. Our
products are built on hardware platforms based on
Intel-compatible microprocessor technologies. In addition, our
PacketWise® software is licensed by several communications
industry partners who integrate the software into specific
strategic networking solutions. We primarily use indirect
channels to leverage the reach of our sales force to obtain
worldwide coverage. Our sales force and marketing efforts are
used to develop brand awareness and support our indirect
channels. We have subsidiaries or branch offices in Australia,
Caymans, Canada, Denmark, France, Germany, Hong Kong, Japan,
Singapore, Spain, South Korea, The Netherlands and the United
Kingdom. To date we have shipped more than 24,000 units.

We were incorporated in Delaware in January 1996
and began shipping our products in February 1997. In this
report, Company, Packeteer,
we, us, and our refer to
Packeteer, Inc. and its subsidiaries. Investors may access our
filings with the Securities and Exchange Commission on our
website, which is located on the Internet at www.packeteer.com,
but the information on our website does not constitute part of
this Annual Report.

Industry Background

The Emergence
of Internet Computing

Today, both the Internet and its underlying
protocol, TCP/IP, have grown to positions of prominence in
enterprise networking. Protocols are predefined mechanisms for
computers to communicate over networks. From its origins as a
network connecting academic and government institutions, the
Internet has evolved into an interactive communications and
commerce platform supporting businesses daily operations.
Originally

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intended to accommodate non-interactive traffic
such as file transfers and e-mail, the Internet and TCP/IP were
designed with the basic goals of connectivity, versatility and
bandwidth exploitation. With the evolution towards Internet
computing, TCP/IP has become the communications fabric, or as it
is commonly referred to in the technology industry, the
underlying protocol of mission-critical enterprise networks. The
Internet has enabled a new generation of interactive
applications to deliver core business functions, including
eCommerce, data access and information exchange, to a broad
range of users. Leveraging the fundamental attributes of the
Internet and TCP/IP, businesses, consumers and suppliers have
become better connected. This rapid development of a vast
connected economy has given rise to a new innovative business
model, the Internet computing model.


The rapid emergence of Internet computing has had
a significant effect on todays enterprise networks and has
created new challenges for information technology managers. As
more interactive business applications are developed using
web-enabled versions of enterprise software platforms, such as
SAP, Oracle, PeopleSoft and Siebel, the amount of network data
is increasing dramatically. eCommerce extends the confines of
the enterprise network across the Internet, making application
performance difficult to ensure. Enterprise users access
graphic-intensive web sites, download large files, view
streaming media presentations, monitor news and stock quotes and
access other non-critical information over the Internet. The
resulting traffic deluge impacts network resources that serve
point-of-sale, order processing, enterprise resource planning,
supply-chain management and other vital business functions.

Internet computing relies on TCP/ IP as the
underlying protocol to support distributed enterprise
applications and the delivery of electronic services. The
Internet Protocol, or IP, provides for routing of packets across
networks that utilize TCP/ IP as their underlying protocol. The
Transmission Control Protocol, or TCP, provides flow control
for, and reliable ordered delivery of, Internet Protocol
packets. Unlike early non-interactive applications that did not
require real-time responsiveness, todays enterprise and
eCommerce applications depend on timely access to data and
real-time transaction responses to ensure productivity and a
high quality of experience for end users. The shift toward
real-time, delay-sensitive data is accelerating as corporations
begin to converge database transactions and multimedia traffic
onto their enterprise networks. TCP/ IP is unable to
differentiate between traffic types and is designed so that each
transmission attempts to consume all available bandwidth. These
characteristics, which make TCP/ IP suitable for non-interactive
traffic, threaten the performance of todays
mission-critical applications.



| |                                                  
| | -------------------------------------------------
| | The Traffic Bottleneck at the WAN Access
    Link

In recent years, the adoption of Fast Ethernet
and Gigabit Ethernet technologies has reduced network congestion
on the local area network, or LAN. Simultaneously, the
deployment of fiber infrastructure in the service provider
backbone has also reduced bandwidth contention in that portion
of the network. However, the bridge between the two, the wide
area network, or WAN, access link, has remained the slow, weak
link in the chain, forming a bandwidth bottleneck. WAN access
link capacity is often constrained, expensive and difficult to
upgrade. When faced with bandwidth contention at the bottleneck,
TCP/ IP provides neither a means to give preferential treatment
to select applications nor a good mechanism to effectively
control data flows because TCP flow control is handled only by
end systems. TCP/ IP reacts to network congestion by discarding
data packets and sporadically reducing packet transmissions from
the host computer. In enterprise networks that are overwhelmed
by increasing amounts of both non-critical and mission-critical
traffic, unmanaged congestion at the WAN access link undermines
application performance and can result in impaired productivity
and lost revenues.

Todays enterprise networks require
solutions that ensure mission-critical application performance,
increase network efficiency, and enable the convergence of data,
voice and video traffic. Enterprises are seeking to align their
networks with their business priorities by making them adaptive
to the unique requirements of the growing mix of
mission-critical applications. At the same time, they seek to
leverage investments in application software and proactively
control recurring network costs by optimizing bandwidth
utilization.

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Many existing and newly emerging
telecommunications service providers are also seeking to address
the needs of enterprises that are adopting Internet computing.
Service providers have traditionally functioned as WAN bandwidth
suppliers, leasing data lines and selling Internet access to
businesses and consumers. In the face of heightened competition,
service providers are seeking to differentiate themselves by
offering tiered services in order to attract and retain
customers and increase profitability. These offerings include
web hosting, application outsourcing and managed network
services. To deliver these services, service providers must be
able to ensure network and application performance and better
manage and allocate network resources.



| |                                       
| | --------------------------------------
| | Limitations of Existing
    Approaches

Businesses and service providers currently employ
several approaches in an attempt to alleviate network congestion
at the WAN access link. These approaches include the following:

Adding bandwidth and infrastructure to
over-provision the network. This approach requires expensive
upgrades to WAN access links and associated network equipment.
Moreover, incremental increases in bandwidth only temporarily
alleviate network congestion, leaving the following problems
unresolved:



| |   |                                                                                                                                                                                   
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Increases in bandwidth tend to be consumed
    quickly by latent demand within LAN and backbone infrastructure,
    and often disproportionately by non-mission critical traffic; 
|
| |  | Deployment costs and increases in recurring
    service charges can be prohibitively expensive, especially for
    networks with many remote sites and for international networks;
|
| |  | There is no application performance visibility to
    enable effective capacity planning; and                                                                                     
|
| |  | Over-provisioning results in under-utilization of
    the network during non-peak periods.                                                                                        

Implementing queuing-based features. Queuing
technologies provide some degree of prioritization and are
frequently incorporated in routers, which are devices that
forward data packets from one LAN or WAN to another. These
implementations engage only after queues form, and attempt to
provide QoS by reordering packets and then discarding packets
when the queues overflow. Queuing-based approaches typically
identify and prioritize traffic based on rudimentary
characteristics such as port number, a simplistic mechanism to
coordinate the transmission of application data, IP address or
protocol type. While these approaches can alleviate some of the
bandwidth contention problems, they are inadequate to handle an
increasingly complex mix of interactive and real-time
mission-critical applications for the following reasons:



| |   |                                                                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Queuing-based approaches do not control inbound
    traffic flowing from the WAN to the LAN;                                                                                     
|
| |  | Queuing-based approaches are reactive in nature
    and can only address congestion after the fact, rather than
    preventing it from occurring;                                
|
| |  | Congested queues result in packet loss,
    retransmissions and delays that waste bandwidth and undermine
    application response times;                                        
|
| |  | Limited traffic classification capabilities
    inadequately distinguish between different types of
    applications, resulting in sub-optimal prioritization of
    traffic; and
|
| |  | Queuing does not directly control end-to-end
    application performance.                                                                                                        

Deploying traditional compression technologies.
Products are available which compress traffic. Although
compression can increase available bandwidth, which effectively
increases network capacity and avoids bandwidth upgrades, the
network and application performance problems are not necessarily
eliminated. As TCP/ IP protocol is inherently bursty,
non critical applications, even though compressed, may
still consume

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the available bandwidth. In addition, the
following problems are also introduced when deploying
traditional compression technologies:




| |   |                                                                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Latency, which can negatively affect performance;                                                                                                            
|
| |  | Non selective compression, which results in some
    already compressed application traffic being delayed with no
    discernable benefit to performance; and
|
| |  | Difficulty in configuring and maintaining
    compression tunnels.                                                                                           

Installing network-management tools. Several
vendors provide software that analyzes and monitors network
traffic. While these products enable network administrators to
determine how bandwidth is being utilized, thereby identifying
where bandwidth management is required, they do not comprise a
complete solution for the following reasons:



| |   |                                                                                                                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Traditional network-management tools only monitor
    and report network performance and bandwidth utilization,
    offering no means of fixing or resolving performance
    problems; and                           
|
| |  | As is the case with queuing-based approaches,
    traditional network management tools are reactive in nature in
    that they detect problems once they occur and do not prevent
    similar problems in the future.



| |                                         
| | ----------------------------------------
| | The Bandwidth Management
    Opportunity

As Internet computing is more widely adopted,
both businesses and service providers are seeking ways to
cost-effectively manage bandwidth, ensure application
performance and increase network efficiency. As mission-critical
applications compete with bandwidth-hungry non-critical traffic
for limited network resources, enterprises require a solution
that not only monitors and reports on network performance
problems, but also provides the means to fix such problems. As
the complexity of their network infrastructures increases,
enterprises seek solutions that integrate easily into the
existing network and are cost-effective to deploy and maintain.
In response to growing competition, service providers are
looking to create new revenue streams by offering differentiated
network and application-based services that meet the needs of
enterprise customers. Whether the solution is implemented by the
enterprise or purchased from a service provider, effectively
managing the performance of mission-critical applications is
essential to businesses relying on Internet computing.

The Packeteer Solution

Packeteer is a leading provider of application
traffic management systems that are designed to enable
enterprises, service providers, and other organizations to align
network resources with business priorities. Packeteer systems
monitor, control, and accelerate application performance over
WANs and the Internet. Our systematic, application-intelligent
approach is designed to ensure that mission-critical
applications perform efficiently and reliably and that existing
network resources are extended to support business needs.
Packeteers application traffic management system is based
on the following:



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | I.     Application
    Traffic Monitoring:Packeteers monitoring capabilities
    serve as the backbone for PacketSeeker, an
    application-intelligent traffic monitoring system, as well as
    PacketShaper, a traffic management system that incorporates both
    monitoring and policy control. Packeteers monitoring
    capabilities involve automatic identification and classification
    of traffic through Layer 7, the applications layer, which
    is the highest layer in the industry standard OSI (Open Systems
    Interconnection) model. This application-layer insight is
    designed to enable organizations to analyze application
    performance and network utilization accurately. Packeteers
    performance analysis determines response times, delays, link
    utilization, and many more crucial metrics. Depending on the
    size of the Packeteer deployment, performance analysis may be
    captured via onboard or centralized reporting.
|
| | II.     Application
    Traffic Shaping:Packeteers PacketShaper systems allow
    the user to set policy control that aligns application
    performance in support of business needs. PacketShaper systems
    allow mission-critical applications to perform efficiently and
    reliably by allocating varying amounts of bandwidth to
    applications depending on their relative importance. For
    instance, network managers can                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | tailor policy management and bandwidth allocation
    to suit the requirements of particular applications or traffic,
    such as Citrix, SAP, Siebel, Video over IP and Voice over IP.
    Meanwhile, peer-to-peer file sharing, casual web browsing, and
    other unsanctioned traffic can be eliminated or minimized,
    depending on an organizations available network resources
    and business priorities.                                                                                                                                                                                                                                                                                                                                         
|
| | III.     Application
    Traffic Acceleration:Packeteer also enhances application
    performance through its acceleration technologies. PacketShaper
    Xpress provides a software option that utilizes
    application-intelligent compression, latency management and
    tunnel management to accelerate policy-managed business traffic.
    Packeteer also offers AppCelera ICX, an intranet acceleration
    system that addresses the trend of application
    webification. Utilizing a combination of
    compression, conversion, and caching, AppCelera ICX optimizes
    content to suit each users connection speed and browser.
    Its content-intelligent approach overcomes inherent last-mile
    obstacles reducing potential latency.
|
| | IV.     Report
    Performance:PacketShaper systems provide reports describing
    current and historical network performance. Comprehensive
    reports, graphs and tables enable network managers to refine
    bandwidth management policies, evaluate efficiency and plan
    capacity. PacketShaper systems automatically measure
    per-transaction response times for each application. Managers
    can set, enforce and monitor service-level agreements, which
    quantify desired QoS for a particular application or customer.
    Packeteers ReportCenter is designed to provide centralized
    analysis and reporting for large PacketSeeker and PacketShaper
    system deployments.                                                       

Our application traffic management systems are
designed to enable businesses and service providers to realize
the following key benefits:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Gain Network Performance Visibility and Insight.
    PacketSeeker and PacketShaper provide valuable historical and
    real-time information about application performance and network
    utilization through an easy-to-use browser interface. Network
    managers gain a better understanding of the nature of traffic
    running on their networks and the problems and inefficiencies
    associated with that traffic.
|
| |  | Ensure Bandwidth to Mission-Critical
    Applications. Policy-based bandwidth allocation protects
    bandwidth for mission-critical applications such as SAP, Oracle,
    PeopleSoft and Siebel, preventing disruptions from
    bandwidth-hungry but less urgent applications such as file
    transfers, peer-to-peer file sharing or casual web browsing.                                                                 
|
| |  | Permit Easy Deployment. PacketShaper installs
    easily, and automatically starts to discover, classify and
    analyze network traffic and suggest policies to optimize
    performance. It complements the existing network infrastructure,
    requires no router reconfiguration or desktop changes and is
    designed not to disrupt network connectivity in the event of
    software or hardware failure.            
|
| |  | Increase Effective Bandwidth. PacketShaper Xpress
    intelligently increases effective bandwidth and, through
    integration with PacketShapers advanced monitoring and
    shaping capabilities, enables the additional bandwidth to be
    utilized by mission-critical applications.                                                                                                                                    
|
| |  | Enable Interactive Services. Voice over IP, or
    VoIP, videoconferencing and other streaming media require
    guaranteed bandwidth in order to achieve minimum quality
    requirements. By using PacketShaper to set minimum bandwidth
    guarantees and priority, enterprises and service providers can
    deliver smooth and predictable performance of these
    delay-sensitive multimedia services.                
|
| |  | Increase Network Efficiency. PacketShaper
    improves network efficiency and helps delay expensive capacity
    upgrades by managing non-critical traffic to reduce
    retransmission overhead and smooth the variability in bandwidth
    utilization.                                                                                                                                                                     
|
| |  | Accelerate Web Applications. AppCelera applies
    content compression and optimization technologies to reduce
    bandwidth utilization and improve response times for web-enabled
    applications.                                                                                                                                                                                                                         

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Strategy

Our objective is to be the leading provider of
application traffic management systems that give enterprises and
service providers a new layer of control for applications
delivered across intranets, extranets and the Internet. Key
elements of our strategy include:

Focus on Bandwidth Management Needs of
Enterprises. We are focused on providing high performance,
easy-to-use and cost-effective bandwidth management solutions to
enterprises whose businesses are based on Internet computing.
For these businesses, managing mission-critical application
performance and optimizing the value of the network will
continue to be competitive requirements. As the Internet
proliferates and new Internet-based applications and services
emerge, we believe businesses will continue to adopt Internet
computing business models at a rapid rate and that effective
bandwidth management will become an increasingly important
requirement for maintaining an efficient enterprise network. We
believe we have established a differentiated market position
based on our development of a comprehensive solution that
provides for effective bandwidth management and our early market
leadership and brand awareness. We intend to continue to direct
our development, sales and marketing efforts toward addressing
the bandwidth management needs of the Internet computing market.

Expand Presence in Telecommunications Service
Provider Market. We are actively pursuing opportunities in the
telecommunications service provider market and currently have
numerous telecommunications service provider customers,
including: AT&T, Equant, Fujitsu Cable, Hughes Network
Systems, NTT Communications and Singapore Cable. We believe
service providers are under increasing pressure to attract new
subscribers, reduce subscriber turnover, improve operating
margins and develop new revenue streams. Specifically, service
providers seek to differentiate themselves through value-added
service offerings, such as web hosting, application outsourcing
and application service-level management. We believe our
PacketShaper and PacketWise solutions enable service providers
to deliver these higher value services by enhancing network and
application performance and better managing and allocating
network resources. Our goal is to increase demand for our
solutions with service providers by leveraging our strong
enterprise presence.

Expand Presence in the Managed Application
Services Market. We are actively pursuing opportunities in the
managed application services market and currently have several
managed application service provider customers, including NTT
Communications, Equant and AT&T using our managed
application service features. Our softwares policy based
application subscriber management features are designed to
enable managed application service providers to quickly and
cost-effectively deliver secure, measured and
performance-assured application services tailored to the needs
of specific markets and customers. Such features deliver a
clearly defined service demarcation point between service
providers and their customers and delivery-chain partners;
provide and enforce QoS application-specific service level
agreements (SLAs); and enable application-specific billing.

Continue to Build Indirect Distribution Channels.
We currently have over 100 resellers, distributors, systems
integrators and OEMs, that sell our products in over 50
countries. These relationships include: Allasso, Alternative
Technology; Equant, Kanematsu USA, Lan Systems Pty. Ltd.,
Macnica, Inc, Net One Systems Co., Ltd., Nissho Electronics
Corporation, RBR Networks Pte. Ltd. and Westcon, Inc. We intend
to continue to develop and support new reseller and distribution
relationships, as well as to establish additional indirect
channels with service providers, systems integrators and OEMs.
We believe this strategy will enable us to increase the
worldwide deployment of our products.

Extend Bandwidth Management Technology
Leadership. Our technological leadership is based on our
sophisticated traffic classification, flexible policy setting
capabilities, precise rate control expertise, web content
acceleration and compression technologies and ability to measure
response time and network performance. We intend to invest our
research and development resources to increase performance by
handling higher speed WAN connections, increase functionality by
identifying and managing additional applications or traffic
types, and increase modularity by taking individual components
of PacketWise together or on a stand-alone basis with our
existing bandwidth management solutions. We also plan to invest
our research and development resources to develop new
leading-edge technologies for emerging markets. These
development plans include extending our bandwidth management
solutions to incorporate in-depth application-management
techniques

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that will improve performance over the Internet
and reduce bandwidth requirements. We plan to extend our current
portfolio by offering PacketWise-defined solutions that target
the specific needs of three primary market opportunities:
enterprise bandwidth management, application service-level
management and service provider bandwidth management.


Products

Packeteers family of products 
powered by our PacketWise software  enable
enterprises and service providers to measure, control,
accelerate and validate the performance of networked
applications and managed application services.

PacketSeeker System.PacketSeeker is an application traffic-monitoring system that
builds on the Companys industry-leading Layer-7 traffic
classification, analysis and reporting technology. It features a
new PacketCaptureTM capability that enables effective
remote problem diagnosis. PacketSeeker further distinguishes
itself from passive monitoring solutions currently
available by giving the user the ability to seamlessly upgrade
the software to become a PacketShaper when traffic shaping is
required to enforce quality of service.

PacketShaper System.PacketShaper is an application-based traffic and bandwidth
management system designed to deliver predictable, efficient
performance for applications running over the WAN and Internet.
The PacketShaper Enterprise Edition is designed to provide
effective application QoS using state-of-the-art bandwidth,
traffic, service-level and policy management technology. The
PacketShaper ISP Edition is designed to enable service providers
to create differentiated services through fast and efficient
bandwidth provisioning and management. With over 24,000 units
shipped worldwide to enterprises and service providers,
PacketShaper is a market leader in application traffic
management systems. The PacketShaper family currently includes
the 1500, 2500, 4500, 6500 and 8500 Enterprise Editions and
4500, 6500 and 8500 ISP Editions.

PacketShaper Xpress
System.The PacketShaper Xpress is a
product that provides application traffic acceleration. By
leveraging its expertise in advanced Web acceleration and
content compression technology, Packeteer has created a
universal traffic acceleration solution that is
highly efficient, scalable and simple to administer. Combining
Layer 7 classification, traffic shaping and
application-intelligent acceleration raises the level of control
customers have over the performance of their networked
applications and associated bandwidth costs.

AppCelera System.A
product designed to accelerate the performance of Internet
applications, AppCelera ICX (Internet Content Accelerator) is an
advanced content acceleration product that can reduce web
response-times by up to 50% by accelerating web content delivery
all the way to the users desktop. It combines content
compression, transformation and caching technologies to improve
web application performance across the bandwidth-constrained
last mile connections while reducing both server and bandwidth
resource consumption.

PolicyCenterTMSoftware. A directory-based policy management application
that enables Packeteers enterprise and service provider
customers to broadly deploy, scale and manage application QoS
throughout the network, PolicyCenter is an LDAP
directory-enabled application running under Windows 2000 or
Windows NT that enables customers to centrally administer and
update PacketShaper policies, software versions, and device
status for Packeteer-based networks.

ReportCenterTMSoftware. An application that aggregates metrics from
large deployments and creates organizationwide reports to
manage trends and provide support for capacity planning and
usage analysis, ReportCenter lowers the cost of ownership for
large deployments of PacketWise-enabled appliances, improves the
quality of information and eases administrative overhead.

Technology

We differentiate our solution by combining our
knowledge of enterprise applications with our expertise in
underlying network protocols. We have invested heavily in
developing valuable, proprietary software and

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related technologies. In particular, we have
developed expertise and technology in these major areas:
sophisticated traffic discovery and classification, flexible
policy definition and enforcement, precise rate control,
application-based response-time measurement, high-performance
packet engines and scaleable configuration. We have tied
together these technologies with an easy-to-use, web browser
interface in order to insulate the end user from the
sophistication of the underlying technology and to allow them to
derive the benefits of the technology with minimal effort.




| |                                                       
| | ------------------------------------------------------
| | Sophisticated Traffic Discovery and
    Classification

We believe the ability to automatically detect
and classify an extensive collection of applications and
protocols differentiates PacketSeeker and PacketShaper systems
from other bandwidth management technologies. Sophisticated
traffic classification is crucial to understanding network
congestion and to targeting appropriate bandwidth-allocation
policies. Network software or devices that claim QoS features
typically offer rudimentary solutions that can identify traffic
based only on protocol type or port numbers. This approach
limits application-specific QoS capabilities because these
products do not recognize the detailed information required to
make intelligent classification decisions. PacketSeeker and
PacketShaper systems discover and classify traffic by focusing
on content and applications where value to the end user lies.

Relying only on more basic traffic classification
prevents network managers from discovering important traffic
trends and limits policy setting. Sophisticated traffic types
such as voice calls over networks based on Internet Protocol, or
VoIP, Oracle 8i, TN3270, Citrix, and Microsoft DCOM cannot
be identified using rudimentary traffic classification schemes.
PacketSeeker and PacketShaper systems identify traffic markers,
detect changing or dynamic port assignments and track
transactions with changing port assignments. This sophisticated
traffic classification allows network managers with PacketShaper
systems to set policies and control the traffic related to an
individual application, session, client, server or traffic type.
PacketSeeker and PacketShaper systems permit a network manager
to isolate each published application running on a centralized
server and can also differentiate among various applications
using the same port. This ability to individually classify
applications is a highly valuable tool for network managers,
since both non-critical applications such as web browsing and
music downloading through peer-to-peer applications and
mission-critical applications such as Citrix, Oracle or SAP and
critical web sites may all be assigned to the same TCP port
number on a network but can be individually classified using a
PacketShaper system.

Packeteer systems need no assistance from network
managers to automatically detect and identify approximately 400
different traffic types. Without a sophisticated identification
and classification capability, managers are usually unaware of
the diversity of their own network traffic. In addition,
managers can use our technology to define proprietary
applications so that their traffic can be recognized and
reported. Our technology is differentiated by its ability to
recognize older enterprise protocols, such as AppleTalk, DECnet,
IPX and SNA. We frequently enhance our classification capability
to include new traffic types. Any traffic category can be made
even more specific by adding more detailed criteria 
for example, Oracle traffic to or from a particular database.
Some of the traffic types which Packeteers technology
automatically detects and classifies are listed below. The
traffic types are named either with their associated protocol or
application and are grouped according to the class of
application that generated that traffic. Each traffic type has
an associated protocol that allows it to be recognized on the
network.

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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |  |                                                                                                                                                                                                                                                                                                               
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Client/ ServerCORBA
    CVS
    Folding@Home
    FIX (Finance)
    Java Rmt Mthd
    MATIP (Airline)
    MeetingMaker
    NetIQ AppMngr
    OpenConnect JCP
    SunRPC (dyn port)Content DeliveryAOL
    Backweb
    Chaincast
    EntryPoint
    Kontiki
    Marimba
    PointCast
    NewsStand
    WebShotsERPBaan
    JavaClient
    JD Edwards
    Oracle (7,8,9i)
    SAPInternetActiveX
    FTP, Passive FTP
    Gopher
    HTTP Tunnel
    IP, IPIP, UDP, TCP
    IPv6
    IRC
    Mime type
    NNTP
    Socks2http
    SSHTCP
    SSL
    TFTP
    UUCP
    URL
    Web browserDatabaseFileMaker Pro
    MS SQL
    Oracle 7/8i
    Progress |  | Directory ServicesCRS
    DHCP
    DNS
    DPA
    Finger
    Ident
    Kerberos
    LDAP
    RADIUS
    SSDP
    TACACS
    WINS
    whoisE-mail and CollaborationBiff
    cc:MAIL
    IMAP
    LotusNotes
    MSSQ
    Microsoft DCOM (MS Exchange)
    Novell GroupWise
    POP3
    SMTPFile ServerAFS
    CVSup
    Lockd
    Microsoft-ds
    NetBIOS-IP
    NFS
    Novell NetWare5
    rsyncGamesAsherons Call
    Battle.net
    Diablo II
    Doom
    EverQuest
    Kali
    Half-Life
    LucasArts (Jedi*)
    MSN Zone
    Dark Age of Camelot
    Quake I, II, & III
    SonyOnline
    Tribes I,II
    Unreal
    Warcraft III
    Yahoo! Games |  | HealthcareDICOM
    HL7Host AccessATSTCP
    Attachmate SHARESUDP
    Persoft Persona
    SMTBF
    TN3270
    TN5250Legacy LAN and Non-IPAFP
    AppleTalk
    DECnet
    IPX
    FNA
    LAT
    NetBEUI
    MOP-DL/ RC
    PPPoE
    SNAMessagingAOL Instant Messenger
    ICQ
    IRC
    MSN Messenger
    Yahoo! MessengerMiscAOLMultiMediaMulti-cast NetShow
    NetMeeting
    QuickTime
    RTP
    Real Audio
    Streamworks
    RTSP
    MPEG
    ST2
    SHOUTcast
    WebEx
    WindowsMedia |  | Music P2PAimster
    AudioGalaxy Rhapsody
    Mac Satellite
    Blubster
    DirectConnect
    EDonkey Emule
    Overnet
    FileRogue
    Furthurnet
    Gnutella Acquisition
    Ares
    BearShare
    Furi
    Gnotella
    Gnucleus
    gtk-gnutella
    LimeWire
    MyNapster
    Mactella
    Morpheus
    Mutella
    Nap Share
    Phex
    Qtraxmax
    Qtella
    Shareaza
    toadnode
    XoloX
    Groove
    Hotline
    iMesh
    KaZaA
    KaZaA Lite
    Napster Amster
    audioGnome
    File Navigator
    Gnapster
    Grokster
    gtk napster
    jnapster
    MacStar
    Maxter
    My Napster
    Napigator
    NapMX
    Napster Fast
    Search
    Napster/2
    Napster, MacOSX
    OpenNap
    Rapster
    Snap
    Spotlight
    WebNap
    WinMX
    Scour
    Tripnosis |  | Network ManagementCisco Discovery
    Date-Time
    IPComp
    ICMP by packet
    type
    Microsoft SMS
    NTP
    RSVP
    SNMP
    SYSLOG
    Time ServerPrintLPR
    IPP
    TN5250p
    TN3287RoutingAURP
    BGP
    CBT
    DRP
    EGP
    EIGRP
    IGMP
    IGP
    MPLS (+tag, +app)
    OSPF
    PIM
    RARP
    RIP
    Spanning Tree
    VLAN (802.1p/q)Security ProtocolDLS
    DPA
    GRE
    IPSEC
    ISAKMP/ IKE key
    exch
    L2TP
    PPTP
    SOCKS ProxySessionREXEC
    rlogin
    rsh
    Telnet
    Timbuktu
    VNC
    Xwindows |  | Thin Client or Server BasedCitrix
    Published Apps,
    Nfuse, IMA
    RDP/ Terminal ServerVoice over IPCiscoCTI
    Clarent
    CUSeeMe
    Dialpad
    H.323
    I-Phone
    MCK Commun.
    Megaco
    Micom VIP
    MGCP
    Net2Phone
    RTP
    RTCP
    SIP
    Skinny (SCCP)
    T.120
    VDOPhone



| |                                               
| | ----------------------------------------------
| | Flexible Policy Definition and
    Enforcement

PacketShaper systems provide network managers
flexible tools to tailor solutions for different applications or
traffic types. Unlike queuing-based approaches, PacketShaper
systems allow network managers to do more than just prioritize
one traffic type over another. Our policy features offer the
flexibility required to tune bandwidth to specific applications
and dynamically utilize available bandwidth. These policy
features, which may be used individually or in conjunction with
each other, include:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Per-session Rate
    Policies.These policies enable
    network managers to limit or guarantee bandwidth to each
    individual session of an applications traffic. Per-session
    policies allocate each session an appropriate amount of
    bandwidth and prevent one large session from inappropriately
    impacting others. Network managers specify a minimum-guaranteed
    rate and allow the session scaled access to additional available
    bandwidth. For example, a bandwidth cap for traffic prevents web
    browsers from competing for bandwidth required by
    mission-critical applications. Likewise, a guaranteed rate for

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | audio or video streams ensures that they are not
    interrupted by traffic that tends to consume any available
    bandwidth.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| |  | Partitions.Partitions allow for the creation of a separate, exclusive
    channel within a WAN access link. Partitions represent aggregate
    bandwidth minimums or maximums governing how much of the network
    can be used by a single application or traffic category.
    Partitions can be fixed, creating dedicated virtual circuits, or
    burstable, creating virtual circuits whose unused bandwidth can
    be shared.                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  | Dynamic Subscriber Bandwidth
    Provisioning.Dynamic Subscriber
    Bandwidth Provisioning allocates bandwidth and enforces QoS
    policies automatically by mapping a subscribers traffic
    profile (e.g. source/ destination IP address, traffic type, URL,
    etc.) to a prescribed policy. This feature is a scaleable and
    easy-to-deploy solution that actively provisions minimum and
    maximum bandwidth to up to 20,000 subscribers accessing the
    network concurrently. Using a 5-to-1 over subscription model,
    not uncommon in todays service provider market, bandwidth
    for as many as 100,000 subscribers can be managed with a single
    PacketShaper. This feature also gives service providers
    additional revenue opportunities through multi-tiered Internet
    access services (e.g. bronze, silver, gold) for dial-up, DSL,
    cable and wireless subscribers.
|
| |  | Priority Policies.This policy feature enables network managers to assign one of
    eight possible priority levels to each application or traffic
    category. Priority policies are ideal for traffic that does not
    burst, non-IP traffic and traffic characterized by small,
    high-priority flows.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| |  | Admission-control
    Policies.Network managers can use
    admission-control policy features to determine the response if a
    bandwidth guarantee cannot be satisfied. Such responses may
    include denying access, accommodating an additional user with
    less than guaranteed performance, or, for web requests,
    redirecting the request to another server. For example, if an
    online streaming-video service suffers a high-demand period and
    all available bandwidth is consumed, an admission-control policy
    could present a web page explaining that resources are busy.
    This allows a maximum number of users to receive a targeted
    service quality without degradation as new users seek to access
    the service.                                                                                                                                                    
|
| |  | Discard and Never-admit
    Policies.These policies intentionally
    block traffic. Discard policies toss packets without sending
    feedback to the sender. Never-admit policies are similar to
    discard policies except that the policy informs the sender that
    service is blocked.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 



| |                     
| | --------------------
| | Precise Rate Control

One of TCP/ IPs primary weaknesses is an
inability to guarantee QoS. Unlike systems network architecture,
or SNA, and asynchronous transfer mode, or ATM, protocols, which
have an embedded concept of rate, TCP/ IPs attempt to
consume all available bandwidth conflicts with the goal of
predictable, consistent, mission-critical application
performance. PacketShapers standards-based TCP rate
control technology overcomes TCP/ IPs shortcomings by
proactively preventing congestion on both inbound and outbound
traffic flows and increasing overall network throughput. Rather
than discarding packets from a congested queue, TCP rate control
paces packet delivery to prevent congestion. Rate control uses
the remote users access speed and real-time network
latency to calculate the optimal transmission speed. Evenly
paced packet transmissions, instead of packet bursts which
consume all available bandwidth, yield significant efficiency
gains in the network. TCP rate control is a proactive and
precise way to increase network efficiency by avoiding
retransmissions and packet loss. TCP rate control also creates a
smooth and even flow rate that maximizes throughput. By
employing TCP rate control, PacketShaper systems manage the
majority of traffic at the WAN access link before network
congestion occurs.

For non-TCP-based traffic, such as UDP, or User
Datagram Protocol, alternative rate-based management techniques
must be implemented. Typically UDP does not rely on
acknowledgments to signal successful receipt of data, and it
therefore offers no means for flow control. By directly
controlling other TCP flows, however, PacketShaper systems are
designed to effectively make bandwidth available for UDP flows.
The combination of per flow rate scheduling and explicit delay
boundaries removes latency and variability, or jitter, for the
UDP flows traversing the WAN access link.

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For example, VoIP is a UDP-based application that
is particularly latency-sensitive, requiring packets to be
evenly spaced to eliminate jitter. PacketShaper enhances VoIP
performance in two ways. First, PacketShaper manages competing
traffic by using rate control to constrain bursty TCP traffic.
In addition, a rate policy for VoIP gives a minimum bandwidth
guarantee to each flow, ensuring that each voice stream gets the
bandwidth it needs for predictable performance. When there is a
lull in the conversation, any unused bandwidth is re-allocated
to other traffic.



| |                                                
| | -----------------------------------------------
| | Application-Based Response-Time
    Measurement

The PacketShaper systems position in the
enterprise network  monitoring and controlling all
the traffic that passes  gives it an opportunity to
provide accurate response-time measurements. Because it already
handles and classifies every packet, the PacketShaper system can
easily calculate the amount of time traffic spends traveling
between a client and a server and the amount of time used by the
server itself.

The PacketShaper system breaks each response-time
measurement into network delay, which is the amount of time
spent in transit, and server delay, which is the amount of time
the server is used to process the request. It can highlight
clients and servers with the slowest performance. The
PacketShaper system allows network managers to set acceptability
standards and then track whether performance adheres to the
standards.



| |                                    
| | -----------------------------------
| | High-Performance Packet
    Engines

Sophisticated classification and control of
high-speed traffic must be accomplished in an efficient manner.
Adding significant delay in the process of managing traffic
flows would negate the resulting performance improvements.
Packeteer has developed expertise in the development of
high-speed, software-based packet engines running on real-time
operating systems that can efficiently process thousands of
simultaneous high-speed connections with minimal delay. This
core-engine software technology scales to take advantage of
ever-increasing microprocessor performance to manage faster
access links.



| |                        
| | -----------------------
| | Scaleable Configuration

Large deployments require tools to ease the
process of updating tens or hundreds of PacketShapers that are
distributed throughout the network. To address these
requirements, Packeteer offers its own centralized management
tools, PolicyCenter and ReportCenter. In addition to working
with PacketShaper systems, PolicyCenter and ReportCenter were
designed to align with industry standards and therefore
integrate with third-party tools such as InfoVista, HP Open View
and Micromuse.



| |                                     
| | ------------------------------------
| | Application Traffic
    Acceleration

Traffic can be accelerated by compression.
Compression reduces traffic primarily by eliminating repeated
sequences. Although compression effectively increases network
capacity and avoids bandwidth upgrades, introducing compression
or bandwidth upgrades does not necessarily eliminate network and
application performance problems. As TCP/ IP is an inherently
bursty protocol, non-critical applications frequently consume
all available bandwidth. Therefore, applying compression may
increase the virtual size of a WAN connection, but
does not ensure that mission-critical application traffic takes
advantage of the newly created bandwidth. In addition, standard
compression adds latency to the compressed traffic. This
latency, which is caused by the act of compressing itself and by
trying to compress traffic that cannot be compressed further,
increases configuration and management complexity.

PacketShaper Xpress merges application traffic
management with acceleration using compression, active tunnel
management and latency management. The integration of
PacketShaper Xpress with the PacketShaper traffic management
technology is designed to ensure that increased WAN capacity is
utilized by mission-

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critical applications by allocating the newly
created virtual bandwidth to the important applications.
PacketShaper Xpress manages by:




| |   |                                                                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | making compression decisions based on application
    type;                                                                                                                      
|
| |  | utilizing application specific algorithms, and;                                                                                                                                  
|
| |  | working with TCP rate control and other traffic
    management technology to manage flows of data through the
    compression engine to ensure consistent, predictable responses.

PacketShaper Xpress also reduces configuration
and management complexity of compression through the use of the
active tunnel management feature. This feature uses dynamic
discovery and automatic establishment of tunnels to simplify
deployment and ongoing maintenance costs.

While traffic management prioritizes
mission-critical applications and smoothes bursty traffic,
PacketShaper Xpress enhances performance by fostering greater
throughput, faster performance, and increased network capacity.



| |                        
| | -----------------------
| | Web Server Acceleration

Our technology includes several network
appliances (hardware and software systems), represented by the
AppCelera ICX-55, ICX-75 and ICX-75s, ICX-95 and ICX-95s that
accelerate the transmission and rendering speed of Internet
applications by compressing traffic from end-to-end and
dynamically increasing the throughput of the low and medium
speed connections, and in the case of the ICX-75s and ICX-95s,
provide the ability to offload secure socket layer (SSL)
processing. The software embedded in these appliances achieves
these results by using dynamic, static and variant content
caching together with content-aware compression and
transformation techniques for an increase in performance. These
products also determine the type of content, speed of access,
and type of browser and automatically optimize the speed of
delivery and rendering of information. By combining caching with
compression, this technology accelerates delivery of business
content and Internet applications to the user. AppCelera ICX is
designed to accelerate content as it overcomes the worst sources
of performance impact  first mile SSL overload and
last-mile bandwidth constraints  that limit the
effectiveness of stand-alone caches and load balancers.

Customers

We sell all of our products primarily through
indirect channel partners. The following is a representative
list of our indirect channel partners by geographic region:

|                                                                                                                                                                                                            |  |                                                                                                                                                                                                                                              |  |                                                                                                                                                                                                                                                                                                          
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                            |  | Europe, The Middle East,                                                                                                                                                                                                                     |  |                                                                                                                                                                                                                                                                                                          
|North America                                                                                                                                                                                               |  | Africa and Rest of World                                                                                                                                                                                                                     |  | Asia Pacific                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                            |  |                                                                                                                                                                                                                                              |  |                                                                                                                                                                                                                                                                                                          
|Alternative Technology, Inc.
    Atrion Networking Corporation
    Combyte USA, Inc
    Compaq Computer Corporation/ HP
    Compunet Engineering, Inc.
    Equant
    OCD Network Systems
    Westcon, Inc. |  | ACAL Nederlands BV
    ADD Distribuciones Informat, SA
    ADN Distribution, GmbH
    Affina Systems, Inc.
    Allasso
    Centia Ltd.
    Computer Links AG
    Equant
    IB Solution
    Miel
    Network Alliance Ltd.
    Westcon, Inc. |  | AsiaSoft HK Ltd.
    Encom Information Systems Co., Ltd.
    Express Data
    Kanematsu Electronics Ltd.
    Lan Systems Pty Ltd.
    Macnica, Inc.
    Net One Systems Co., Ltd..
    Nissho Electronics Corporation
    RBR Networks Pte. Ltd.
    Sunrise Information Co. Ltd.
    Transitions Systems

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The following is a representative list of end
users that have deployed multiple PacketShapers:

|                                                                                                                                                                                                                                                                                                                                                                                                     |  |                                                                                                                                                                                                                                                                                                                                                                |  |                                                                           
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                     |  |                                                                                                                                                                                                                                                                                                                                                               
|Enterprises                                                                                                                                                                                                                                                                                                                                                                                          |  | Service Providers                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                     |  |                                                                                                                                                                                                                                                                                                                                                               
|Adventis-Behring
    Altria Group, Inc. (formerly Philip  Morris)
    Autodesk, Inc.
    Bank of Tokyo-Mitsubishi, Ltd.
    Beckman Coulter, Inc.
    Charter Communications, Inc.
    Cleveland Clinic
    Daewoo Securities Co., Ltd.
    Daito Trust Construction Co., Ltd.
    Edmonds School District
    E. I. du Pont Nemours and Company
    Fuji Photo Film Co., Ltd.
    Mizuho Bank, Ltd. |  | The Netherlands Agency for Energy  and
    Environment
    Raytheon Company
    RHB Bank
    RMC Aggregates
    Stanford University
    Synopsys, Inc.
    TAFE, New South Wales
    Takashimaya Company Limited
    Telekom Austria
    U. S. Filter
    U. S. Air Force Standards Systems  Group
    University of California Los Angeles
    VeriSign, Inc. |  | AT&T
    Equant
    Japan Telecom
    MCI/ WorldCom
    NTT Communications

In 2002, sales to Alternative Technology, Inc.,
Westcon, Inc., and Macnica, Inc. accounted for 21%, 13% and 11%
of net revenues respectively. In 2001 and 2000, one customer,
Alternative Technology, Inc., accounted for 22% and 12% of net
revenues, respectively. No other customer accounted for 10% or
more of revenues in 2001 or 2000. Sales to the top 10 indirect
channel partners accounted for 66%, 59%, and 46% of net revenues
for the years ended December 31, 2002, 2001 and 2000,
respectively.

Manufacturing

We outsource all of our manufacturing, including
warranty repair, to one contract manufacturer, SMTC
Manufacturing Corporation (SMTC) located in San Jose,
California. The manufacturing processes and procedures for this
manufacturer are ISO 9002 certified. Outsourcing our
manufacturing enables us to reduce fixed costs and to provide
flexibility in meeting market demand.

We design and develop a majority of the key
components of our products, including printed circuit boards and
software. In addition, we determine the components that are
incorporated into our products and select the appropriate
suppliers of these components. Product testing and burn-in is
performed by our contract manufacturer using tests and automated
testing equipment that we specify. We also use inspection
testing and statistical process controls to assure the quality
and reliability of our products.

We use a rolling six-month forecast based on
anticipated product orders to determine our material
requirements. Lead times for the materials and components we
order vary significantly and depend on factors such as specific
supplier, contract terms and demand for a component at a given
time. We submit purchase orders for quantities needed within the
next 90 days. SMTC or Packeteer may terminate the contract
without cause at any time. At that time the terminating party
must honor all open purchase orders.

Marketing and Sales

We target our marketing and sales efforts at
enterprises and service providers. Marketing and sales
activities focus on reaching the corporate information
technology organization managers responsible for the performance
of mission-critical applications and maintenance of network
performance in the enterprise. We also focus on reaching service
providers that provide valued-added service offerings, such as
application performance monitoring and management.

Our marketing programs support the sale and
distribution of our products and educate existing and potential
enterprise and service provider customers about the benefits of
our application traffic management systems. Our marketing
efforts include the following:



| |   |                                                                                               
| | - | ----------------------------------------------------------------------------------------------
| |  | publication of technical, educational and
    business articles in industry magazines;        
|
| |  | public speaking opportunities at international
    tradeshows, conferences and analyst events;

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| |   |                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------
| |  | electronic marketing including web site-based
    communication programs, electronic newsletters and on-line
    end-user seminars;
|
| |  | industry tradeshows, technical conferences and
    technology seminars; and                                                        
|
| |  | focused advertising, direct mail, public
    relations and analyst outreach.                                                       

We classify our distribution channels in the
following categories:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Channel Partners.Packeteer has teamed with value-added resellers and distributors
    in the industry that are distinguished by their ability to
    deliver comprehensive QoS solutions, their industry expertise,
    and their commitment to customer satisfaction. We have
    established an indirect distribution channel, which is comprised
    of a network of over 100 resellers, distributors and system
    integrators that sell our solutions in over 50 countries. These
    partners sell our systems and software products as well as other
    third-party products that are complementary to our application
    traffic management systems.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| |  | Alliance Partners.Our Alliance Partners Program (APP) unites Packeteer with
    organizations whose product offerings enhance, extend and
    advance Packeteer technology in the marketplace. In exchange,
    Packeteer presents APP partners with the opportunity to extend
    to its customers our industry-leading application performance
    and quality of service solutions. The APP has three
    designations, differentiated by the partners customer
    focus: Technology Alliance Partner, Solutions Alliance Partner,
    and Strategic Integration Partner. Technology Alliance Partners
    include partnerships that provide customers with more
    sophisticated classification, control, reporting and management
    of their applications. Solutions Alliance Partners include
    companies whose product/ solution offerings require performance
    enhancing technologies, such as QoS or content acceleration.
    Strategic Alliance Partners include integration and consulting
    organizations that seek to offer Packeteer products as part of a
    whole solution offering. Some of these Alliance Partners include
    Citrix, Compaq Computer Corporation/ Hewlett Packard, Concord
    and InfoVista.

As of December 31, 2002, our worldwide sales
and marketing organization consisted of 83 individuals,
including managers, sales representatives and technical and
administrative support personnel. We have domestic sales offices
located in California, Illinois, Massachusetts, New Jersey and
Texas. In addition, we have international sales offices located
in Australia, Denmark, England, France, Germany, Hong Kong,
Japan, Singapore, South Korea, Spain and The Netherlands.

We believe there is a strong international market
for our application traffic management solutions. Our
international sales are conducted primarily through our overseas
offices. Sales to customers outside of North America accounted
for 58%, 55% and 54% of our net revenues in 2002, 2001 and 2000,
respectively.

Research and Development

As of December 31, 2002, our research and
development organization consisted of 63 employees
providing expertise in different areas of our software: core
functionality, classification, central management, user
interface and platform engineering. Since inception, we have
focused our research and development efforts on developing and
enhancing our application performance solutions.

Customer Service and Technical
Support

Our customer service and support organization
provides technical support services. Our technical support staff
is strategically located in five regional service centers:
California, Hong Kong, Japan, Australia and The Netherlands.
These services, which may include telephone/ web support, next
business day advance replacement and access to all software
updates and upgrades, are typically sold as single or multi-year
contracts to our resellers and end users. In addition, Packeteer
has formal agreements with two third party service providers to
facilitate next business day replacement for end-user customers
outside the United States covered by maintenance agreements
providing this service level. We believe that these programs
will improve service levels and lead to increased customer
satisfaction.

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Competition

We compete in a rapidly evolving and highly
competitive sector of the Internet application infrastructure
system market. We expect competition to persist and intensify in
the future from a number of different sources. Increased
competition could result in reduced prices and gross margins for
our products and could require increased spending by us on
research and development, any of which could harm our business.
We compete with Cisco, CheckPoint and several small private
companies that sell products that utilize competing technologies
to provide bandwidth management. In addition, our products and
technology compete for information technology budget allocations
with products that offer monitoring technologies, such as probes
and related software. Lastly, we face indirect competition from
companies that offer enterprises and service providers
increased bandwidth and infrastructure upgrades that increase
the capacity of their networks, and thereby may lessen or delay
the need for bandwidth management.

We believe the principal competitive factors in
the traffic management market are:



| |   |                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------
| |  | expertise and in-depth knowledge of applications;                                                                               
|
| |  | timeliness of new product introductions;                                                                                        
|
| |  | ability to integrate in the existing network
    architecture without requiring network reconfigurations or
    desktop changes;
|
| |  | ability to ensure end-user performance in
    addition to aggregate performance of the WAN access link;                         
|
| |  | ability to compress traffic without decreasing
    throughput, performance or network capacity;                                 
|
| |  | ability to integrate traffic classification,
    management, reporting and acceleration into a single platform;                 
|
| |  | compatibility with industry standards;                                                                                          
|
| |  | products that do not increase latency and packet
    loss;                                                                      
|
| |  | size and scope of distribution network;                                                                                         
|
| |  | brand name; and                                                                                                                 
|
| |  | access to customers and size of installed
    customer base.                                                                    

Intellectual Property

We rely on a combination of patent, copyright and
trademark laws, and on trade secrets, confidentiality provisions
and other contractual provisions to protect our proprietary
rights. These measures afford only limited protection. As of
December 31, 2002 we have 11 issued U.S. patents
and 34 pending U.S. patent applications. We cannot assure
you that our means of protecting our proprietary rights in the
U.S. or abroad will be adequate or that competitors will
not independently develop similar technologies. Our future
success depends in part on our ability to protect our
proprietary rights to the technologies used in our principal
products. Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy aspects of our products
or to obtain and use trade secrets or other information that we
regard as proprietary. In addition, the laws of some foreign
countries do not protect our proprietary rights as fully as do
the laws of the U.S. We cannot assure you that any issued
patent will preserve our proprietary position, or that
competitors or others will not develop technologies similar to
or superior to our technology. Our failure to enforce and
protect our intellectual property rights could harm our
business, operating results and financial condition.

From time to time, third parties, including our
competitors, have asserted patent, copyright and other
intellectual property rights to technologies that are important
to us. We expect that we will increasingly be subject to
infringement claims as the number of products and competitors in
the application-adaptive bandwidth management market grows and
the functionality of products overlaps. The results of any
litigation matter are inherently uncertain. In the event of an
adverse result in any litigation with third parties that could
arise in the future, we could be required to pay substantial
damages, including treble damages if we are held to have
willfully infringed, to cease the manufacture, use and sale of
infringing products, to expend significant

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resources to develop non-infringing technology,
or to obtain licenses to the third-party technology. Licenses
may not be available from any third party that asserts
intellectual property claims against us on commercially
reasonable terms, or at all. In addition, litigation frequently
involves substantial expenditures and can require significant
management attention, even if we ultimately prevail.


Employees

As of December 31, 2002, Packeteer employed
a total of 203 full-time employees. Of the total number of
employees, 63 were in research and development, 67 in
sales and system engineering, 16 in marketing, 30 in
operations and 27 in administration. Our employees are not
represented by any collective bargaining agreement with respect
to their employment by Packeteer.

RISK FACTORS

You should carefully consider the risks described
below before making an investment decision. If any of the
following risks actually occur, our business, financial
condition or results of operations could be materially and
adversely affected. In such case, the trading price of our
common stock could decline, and you may lose all or part of your
investment.

Our limited operating history and the
rapidly evolving market we serve makes evaluating our business
prospects difficult

We were incorporated in January 1996 and began
shipping our products commercially in February 1997. Because of
our limited operating history and the uncertain nature of the
rapidly changing market that we serve, we believe the prediction
of future results of operations is difficult. As an investor in
our common stock, you should consider the risks and difficulties
that we face as an early stage company in a new and rapidly
evolving market. Some of the specific risks we face include our
ability to:



| |   |                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | execute our sales and marketing strategy;                                                                                                                      
|
| |  | maintain current and develop new relationships
    with key resellers, distributors, systems integrators and
    original equipment manufacturers, or OEMs; and
|
| |  | expand our domestic and international sales
    efforts.                                                                                                       

We have a history of losses and
profitability will be difficult to sustain

Although we earned a net income of
$3.7 million in 2002, we incurred net losses of $71.0 and
$9.4 million in 2001 and 2000 respectively. As of December
31, 2002, we had an accumulated deficit of $103.4 million.
Our recent profitability could be difficult to sustain. If
revenues grow slower than we anticipate or if operating
expenditures exceed our expectations or cannot be adjusted
accordingly, we may experience additional losses on a quarterly
and annual basis.

If the application traffic management
solutions market fails to grow, our business will
fail

The market for application traffic management
solutions is in an early stage of development and its success is
not guaranteed. Therefore, we cannot accurately assess the size
of the market, the products needed to address the market, the
optimal distribution strategy, or the competitive environment
that will develop. In order for us to be successful, our
potential customers must recognize the value of more
sophisticated bandwidth management solutions, decide to invest
in the management of their networks and the performance of
important business software applications and, in particular,
adopt our bandwidth management solutions.

Our future operating results may not meet
analysts expectations and may fluctuate significantly,
which could adversely affect our stock price

We believe that period-to-period comparisons of
our operating results cannot be relied upon as an indicator of
our future performance. Our operating results may be below the
expectations of public market

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analysts or investors in some future quarter. If
this occurs, the price of our common stock would likely
decrease. Our operating results are likely to fluctuate in the
future on both a quarterly and an annual basis due to a number
of factors, many of which are outside our control. Factors that
could cause our operating results to fluctuate include
variations in:




| |   |                                                                 
| | - | ----------------------------------------------------------------
| |  | the timing and size of orders and shipments of
    our products;
|
| |  | the mix of products we sell;                                    
|
| |  | the mix of channels through which those products
    are sold;  
|
| |  | the average selling prices of our products; and                 
|
| |  | the amount and timing of our operating expenses.                

In the past, we have experienced fluctuations in
operating results. These fluctuations resulted primarily from
variations in the mix of products sold and variations in
channels through which products were sold. Research and
development expenses, specifically prototype expenses,
consulting fees and other program costs, have fluctuated
relative to the specific stage of product development of the
various projects underway. Sales and marketing expenses have
fluctuated due to increased personnel expenses, expenditures
related to trade shows and the launch of new products. See
Managements Discussion and Analysis of Financial
Condition and Results of Operations for detailed
information on our operating results.

The average selling prices of our products
could decrease rapidly which may negatively impact gross margins
and revenues

We may experience substantial period-to-period
fluctuations in future operating results due to the erosion of
our average selling prices. The average selling prices of our
products could decrease in the future in response to competitive
pricing pressures, increased sales discounts, new product
introductions by us or our competitors or other factors.
Therefore, to maintain our gross margins, we must develop and
introduce on a timely basis new products and product
enhancements and continually reduce our product costs. Our
failure to do so would cause our revenue and gross margins to
decline.

If our international sales efforts are
unsuccessful, our business will fail to grow

The failure of our indirect partners to sell our
products internationally will harm our business. Sales to
customers outside of North America accounted for 58%, 55% and
54% of our total net revenues in fiscal 2002, 2001 and 2000,
respectively. Our ability to grow will depend in part on the
expansion of international sales, which will require success on
the part of our resellers, distributors and systems integrators
in marketing our products.

We intend to expand operations in our existing
international markets and to enter new international markets,
which will demand management attention and financial commitment.
We may not be able to successfully sustain and expand our
international operations. In addition, a successful expansion of
our international operations and sales in foreign markets will
require us to develop relationships with suitable indirect
channel partners operating abroad. We may not be able to
identify, attract or retain these indirect channel partners.

Furthermore, to increase revenues in
international markets, we will need to continue to establish
foreign operations, to hire additional personnel to run these
operations and to maintain good relations with our foreign
indirect channel partners. To the extent that we are unable to
successfully do so, our growth in international sales will be
limited.

Our international sales are currently all U.S.
dollar-denominated. As a result, an increase in the value of the
U.S. dollar relative to foreign currencies could make our
products less competitive in international markets. In the
future, we may elect to invoice some of our international
customers in local currency. Doing so will subject us to
fluctuations in exchange rates between the U.S. dollar and the
particular local currency and could negatively affect our
financial performance.

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If we are unable to develop and maintain
strong partnering relationships with our indirect channel
partners, or if their sales efforts on our behalf are not
successful, or if they fail to provide adequate services to our
end-user customers, our sales may suffer and our revenues may
not increase

We rely primarily on an indirect distribution
channel consisting of resellers, distributors and systems
integrators for our revenues. Because many of our indirect
channel partners also sell competitive products, our success and
revenue growth will depend on our ability to develop and
maintain strong cooperative relationships with significant
indirect channel partners, as well as on the sales efforts and
success of those indirect channel partners.

We cannot assure you that our indirect channel
partners will market our products effectively or continue to
devote the resources necessary to provide us with effective
sales, marketing and technical support. In order to support and
develop leads for our indirect distribution channels, we plan to
continue to expand our field sales and support staff as needed.
We cannot assure you that this internal expansion will be
successfully completed, that the cost of this expansion will not
exceed the revenues generated or that our expanded sales and
support staff will be able to compete successfully against the
significantly more extensive and well-funded sales and marketing
operations of many of our current or potential competitors. In
addition, our indirect channel agreements are generally not
exclusive and one or more of our channel partners may compete
directly with another channel partner for the sale of our
products in a particular region or market. This may cause such
channel partners to stop or reduce their efforts in marketing
our products. Our inability to effectively establish or manage
our distribution channels would harm our sales.

In addition, our indirect channel partners may
provide services to our end-user customers that are inadequate
or do not meet expectations. Such failures to provide adequate
services could result in customer dissatisfaction with us or our
products and services due to delays in maintenance and
replacement, decreases in our customers network
availability and other losses. These occurrences could result in
the loss of customers and repeat orders and could delay or limit
market acceptance of our products, which would negatively affect
our sales and results of operations.

Sales to large customers would be difficult
to replace if lost

A limited number of indirect channel partners
have accounted for a large part of our revenues to date and we
expect that this trend will continue. Because our expense levels
are based on our expectations as to future revenue and to a
large extent are fixed in the short term, any significant
reduction or delay in sales of our products to any significant
indirect channel partner or unexpected returns from these
indirect channel partners could harm our business. In 2002,
sales to Alternative Technology, Inc., Westcon, Inc., and
Macnica, Inc. accounted for 21%, 13% and 11% of net revenues
respectively. In 2001 and 2000, one customer, Alternative
Technology, Inc., accounted for 22% and 12% of net revenues,
respectively. No other customer accounted for 10% or more of
revenues in 2001 or 2000. We expect that our largest customers
in the future could be different from our largest customers
today. End users can stop purchasing and indirect channel
partners can stop marketing our products at any time. We cannot
assure you that we will retain these indirect channel partners
or that we will be able to obtain additional or replacement
partners. The loss of one or more of our key indirect channel
partners or the failure to obtain and ship a number of large
orders each quarter could harm our operating results and
liquidity.

Our reliance on sales of our products by
others makes it difficult to predict our revenues and results of
operations

The timing of our revenues is difficult to
predict because of our reliance on indirect sales channels and
the variability of our sales cycle. The length of our sales
cycle for sales through our indirect channel partners to our end
users may vary substantially depending upon the size of the
order and the distribution channel through which our products
are sold.

If revenues forecasted in a particular quarter do
not occur in that quarter, our operating results for that
quarter could be adversely affected. Furthermore, because our
expense levels are based on our expectations as

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to future revenue and to a large extent are fixed
in the short term, a substantial reduction or delay in sales of
our products or the loss of any significant indirect channel
partner could harm our business.


We face risks related to inventories of our
products held by our distributors

Many of our distributors maintain inventories of
our products. We work closely with these distributors to monitor
channel inventory levels so that appropriate levels of products
are available to resellers and end users. However, if
distributors reduce their levels of inventory or if they do not
maintain sufficient levels to meet customer demand, our sales
could be negatively impacted.

Additionally, although we monitor and track
channel inventory with our distributors, overstocking could
occur if the demand for our products were to rapidly decline due
to economic downturns, increased competition, underperformance
of distributors or the introduction of new products by our
competitors or ourselves. This could cause sales and cost of
sales to fluctuate from quarter to quarter.

We have relied and expect to continue to
rely on a limited number of products for a significant portion
of our revenues

Most of our revenues have been derived from sales
of our PacketShaper family of products and related maintenance
and training services. We currently expect that
PacketShaper-related revenues will continue to account for a
substantial percentage of our revenues in fiscal 2003 and for
the foreseeable future thereafter. Our future operating results
are significantly dependent upon the continued market acceptance
of our PacketShaper family of products and enhanced PacketShaper
applications. Our business will be harmed if our PacketShaper
products do not continue to achieve market acceptance or if we
fail to develop and market improvements to our PacketShaper
products or new and enhanced products. A decline in demand for
our PacketShaper family of products as a result of competition,
technological change or other factors would harm our business.

Introduction of our new products may cause
customers to defer purchases of our existing products which
could harm our operating results

When we announce new products or product
enhancements that have the potential to replace or shorten the
life cycle of our existing products, customers may defer
purchasing our existing products. These actions could harm our
operating results by unexpectedly decreasing sales, increasing
our inventory levels of older products and exposing us to
greater risk of product obsolescence.

Our reliance on SMTC for all of our
manufacturing requirements could cause us to lose orders if this
third party manufacturer fails to satisfy our cost, quality and
delivery requirements

We currently contract with SMTC for all of our
manufacturing requirements. Any manufacturing disruption could
impair our ability to fulfill orders. Our future success will
depend, in significant part, on our ability to have SMTC or
others manufacture our products cost-effectively and in
sufficient volumes. We face a number of risks associated with
our dependence on third-party manufacturers including:



| |   |                                                                             
| | - | ----------------------------------------------------------------------------
| |  | reduced control over delivery schedules;                                    
|
| |  | the potential lack of adequate capacity during
    periods of excess demand;
|
| |  | manufacturing yields and costs;                                             
|
| |  | quality assurance                                                           
|
| |  | increases in prices; and                                                    
|
| |  | the potential misappropriation of our
    intellectual property.            

We have no long-term contracts or arrangements
with any of our vendors that guarantee product availability, the
continuation of particular payment terms or the extension of
credit limits. We have

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experienced in the past, and may experience in
the future, problems with our contract manufacturers, such as
inferior quality, insufficient quantities and late delivery of
product. To date, these problems have not materially adversely
affected us. We may not be able to obtain additional volume
purchase or manufacturing arrangements on terms that we consider
acceptable, if at all. If we enter into a high-volume or
long-term supply arrangement and subsequently decide that we
cannot use the products or services provided for in the
agreement, our business will be harmed. We cannot assure you
that we can effectively manage our contract manufacturer or that
this manufacturer will meet our future requirements for timely
delivery of products of sufficient quality or quantity. Any of
these difficulties could harm our relationships with customers
and cause us to lose orders.


In the future, we may seek to use additional
contract manufacturers. We may experience difficulty in locating
and qualifying suitable manufacturing candidates capable of
satisfying our product specifications or quantity requirements.
Further, new third-party manufacturers may encounter
difficulties in the manufacture of our products resulting in
product delivery delays.

Most of the components for our products
come from single or limited sources, and we could lose sales if
these sources fail to satisfy our supply
requirements

Almost all of the components used in our products
are obtained from single or limited sources. Our products have
been designed to incorporate a particular set of components. As
a result, our desire to change the components of our products or
our inability to obtain suitable components on a timely basis
would require engineering changes to our products before we
could incorporate substitute components. Any such changes could
be costly and result in lost sales.

We do not have any long-term supply contracts to
ensure sources of supply. If our contract manufacturer fails to
obtain components in sufficient quantities when required, our
business could be harmed. Our suppliers also sell products to
our competitors. Our suppliers may enter into exclusive
arrangements with our competitors, stop selling their products
or components to us at commercially reasonable prices or refuse
to sell their products or components to us at any price. Our
inability to obtain sufficient quantities of single-sourced or
limited-sourced components, or to develop alternative sources
for components or products would harm our ability to maintain
and expand our business.

Potential new accounting pronouncements are
likely to impact our future financial position and results of
operations

Proposed initiatives could result in changes in
accounting rules, including legislative and other proposals to
account for employee stock options as compensation expense.
These and other potential changes could materially increase the
expenses we report under generally accepted accounting
principles, and adversely affect our operating results.

Any acquisitions we make could result in
dilution to our existing shareholders and difficulties in
successfully managing our business

We continually evaluate strategic acquisitions of
other businesses. Our consummation of the acquisition of other
businesses would subject us to a number of risks, including the
following:



| |   |                                                                                                                                                                                                             
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | difficulty in integrating the acquired operations
    and retaining acquired personnel;                                                                                                                     
|
| |  | limitations on our ability to retain acquired
    distribution channels and customers;                                                                                                                      
|
| |  | diversion of managements attention and
    disruption of our ongoing business; and                                                                                                                         
|
| |  | limitations on our ability to successfully
    incorporate acquired technology and rights into our product and
    service offerings and maintain uniform standards, controls,
    procedures, and policies.

Furthermore, we may incur indebtedness or issue
equity securities to pay for future acquisitions. The issuance
of equity or convertible debt securities could be dilutive to
our existing shareholders.

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Our inability to attract and retain
qualified personnel could significantly interrupt our business
operations

Our future success will depend, to a significant
extent, on the ability of our management to operate effectively,
both individually and as a group. We are dependent on our
ability to attract, retain and motivate high caliber key
personnel. Competition for qualified personnel and management in
the networking industry, including engineers, sales and service
and support personnel, is intense, and we may not be successful
in attracting and retaining such personnel. There may be only a
limited number of persons with the requisite skills to serve in
these key positions and it may become increasingly difficult to
hire such persons. Competitors and others have in the past and
may in the future attempt to recruit our employees. We do not
have employment contracts with any of our personnel. Our
business will suffer if we encounter delays in hiring these
additional personnel.

We may be unable to compete effectively
with other companies in our market sector who are substantially
larger and more established and who have significantly greater
resources than our company

We compete in a rapidly evolving and highly
competitive sector of the networking technology market. We
expect competition to persist and intensify in the future from a
number of different sources. Increased competition could result
in reduced prices and gross margins for our products and could
require increased spending by us on research and development,
sales and marketing and customer support, any of which could
harm our business. We compete with Cisco Systems, Inc. and
CheckPoint Software Technologies Ltd., which sell products
incorporating competing technologies. We also compete with
several small private companies that utilize competing
technologies to provide bandwidth management and compression. In
addition, our products and technology compete for information
technology budget allocations with products that offer
monitoring capabilities, such as probes and related software.
Lastly, we face indirect competition from companies that offer
enterprises and service providers increased bandwidth and
infrastructure upgrades that increase the capacity of their
networks, which may lessen or delay the need for traffic
management solutions.

Some 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 traffic
management solutions market, we also expect that other companies
may enter or announce an intention to enter our market with
alternative products and technologies, which could reduce the
sales or market acceptance of our products and services,
perpetuate intense price competition or make our products
obsolete. If any technology that is competing with ours is or
becomes more reliable, higher performing, less expensive or has
other advantages over our technology, then the demand for our
products and services would decrease, which would harm our
business.

If we do not expand or enhance our product
offerings or respond effectively to technological change, our
business may not grow

Our future performance will depend on the
successful development, introduction and market acceptance of
new and enhanced products that address customer requirements in
a cost-effective manner. We cannot assure you that our
technological approach will achieve broad market acceptance or
that other technologies or solutions will not supplant our
approach. The traffic management solutions market is
characterized by rapid technological change, frequent new
product introductions, changes in customer requirements and
evolving industry standards. The introduction of new products,
market acceptance of products based on new or

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alternative technologies, or the emergence of new
industry standards, could render our existing products obsolete
or make it easier for other products to compete with our
products. Developments in router-based queuing schemes could
also significantly reduce demand for our product. Alternative
technologies, including packet-queuing and compression
technologies, could achieve widespread market acceptance. Our
future success will depend in large part upon our
ability to:




| |   |                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------
| |  | develop and maintain competitive products;                                                                               
|
| |  | enhance our products by adding innovative
    features that differentiate our products from those of our
    competitors;
|
| |  | bring products to market on a timely basis at
    competitive prices;                                                    
|
| |  | identify and respond to emerging technological
    trends in the market; and                                             
|
| |  | respond effectively to new technological changes
    or new product announcements by others.                             

We have in the past experienced delays in product
development which to date have not materially adversely affected
us. However, these delays may occur in the future and could
result in a loss of customers and market share.

If we are unable to effectively manage our
growth, we may experience operating inefficiencies and have
difficulty meeting demand for our products

In the past, we have experienced rapid and
significant expansion of our operations. If further rapid and
significant expansion is required to address potential growth in
our customer base and market opportunities, this expansion could
place a significant strain on our management, products and
support operations, sales and marketing personnel and other
resources, which could harm our business.

In the future, we may experience difficulties
meeting the demand for our products and services. The use of our
products requires training, which is provided by our channel
partners, as well as ourselves. If we are unable to provide
training and support for our products in a timely manner, the
implementation process will be longer and customer satisfaction
may be lower. In addition, our management team may not be able
to achieve the rapid execution necessary to fully exploit the
market for our products and services. We cannot assure you that
our systems, procedures or controls will be adequate to support
the anticipated growth in our operations.

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

Our products may have errors or defects
that we find after the products have been sold, which could
negatively affect our revenues and the market acceptance of our
products and increase our costs

Our products are complex and may contain
undetected defects, errors or failures in either the hardware or
software. In addition, because our products plug into our end
users existing networks, they can directly affect the
functionality of the network. Furthermore, end users rely on our
products to maintain acceptable service levels. We have in the
past encountered errors in our products, which in a few
instances resulted in network failures and in a number of
instances resulted in degraded service. To date, these errors
have not materially adversely affected us. Additional errors may
occur in our products in the future. The occurrence of defects,
errors or failures could result in the failure of our
customers network or mission-critical applications, delays
in installation, product returns and other losses to us or to
our customers or end users. In addition, we would have limited
experience responding to new problems that could arise with any
new products that we introduce. These occurrences could also
result in the loss of or delay in market acceptance of our
products, which could harm our business.

We may also be subject to liability claims for
damages related to product errors. While we carry insurance
policies covering this type of liability, these policies may not
provide sufficient protection should a claim be asserted. A
material product liability claim may harm our business.

22



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##### Table of Contents



Failure to adequately protect our
intellectual property would result in significant harm to our
business

Our success depends significantly upon our
proprietary technology and our failure or inability to protect
our proprietary technology would result in significant harm to
our business. We rely on a combination of patent, copyright and
trademark laws, and on trade secrets, confidentiality provisions
and other contractual provisions to protect our proprietary
rights. These measures afford only limited protection. As of
December 31, 2002 we have eleven issued U.S. patents and
thirty-four pending U.S. patent applications. Currently,
none of our technology is patented outside of the United States.
Our means of protecting our proprietary rights in the
U.S. or abroad may not be adequate and competitors may
independently develop similar technologies. Our future success
will depend in part on our ability to protect our proprietary
rights and the technologies used in our principal products.
Despite our efforts to protect our proprietary rights and
technologies unauthorized parties may attempt to copy aspects of
our products or to obtain and use trade secrets or other
information that we regard as proprietary. Legal proceedings to
enforce our intellectual property rights could be burdensome and
expensive and could involve a high degree of uncertainty. These
legal proceedings may also divert managements attention
from growing our business. In addition, the laws of some foreign
countries do not protect our proprietary rights as fully as do
the laws of the U.S. Issued patents may not preserve our
proprietary position. If we do not enforce and protect our
intellectual property, our business will suffer substantial harm.

Claims by others that we infringe on their
intellectual property rights could be costly to defend and could
harm our business

We may be subject to claims by others that our
products infringe on their intellectual property rights. These
claims, whether or not valid, could require us to spend
significant sums in litigation, pay damages, delay product
shipments, reengineer our products or acquire licenses to such
third-party intellectual property. We may not be able to secure
any required licenses on commercially reasonable terms, or at
all. We expect that we will increasingly be subject to
infringement claims as the number of products and competitors in
the traffic management solutions market grows and the
functionality of products overlaps. Any of these claims or
resulting events could harm our business.

If our products do not comply with evolving
industry standards and government regulations, our business
could be harmed

The market for traffic management solutions is
characterized by the need to support industry standards as these
different standards emerge, evolve and achieve acceptance. In
the United States, our products must comply with various
regulations and standards defined by the Federal Communications
Commission and Underwriters Laboratories. Internationally,
products that we develop must comply with standards established
by the International Electrotechnical Commission as well as with
recommendations of the International Telecommunication Union. To
remain competitive we must continue to introduce new products
and product enhancements that meet these emerging U.S. and
international standards. However, in the future we may not be
able to effectively address the compatibility and
interoperability issues that arise as a result of technological
changes and evolving industry standards. Failure to comply with
existing or evolving industry standards or to obtain timely
domestic or foreign regulatory approvals or certificates could
harm our business.

Our growth and operating results would be
impaired if we are unable to meet our future capital
requirements

We currently anticipate that our existing cash
and investment balances and available line of credit will be
sufficient to meet our liquidity needs for the foreseeable
future. However, we may need to raise additional funds if our
estimates of revenues, working capital or capital expenditure
requirements change or prove inaccurate or in order for us to
respond to unforeseen technological or marketing hurdles or to
take advantage of unanticipated opportunities.

In addition, we expect to review potential
acquisitions that would complement our existing product
offerings or enhance our technical capabilities. While we have
no current agreements or negotiations underway

23



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##### Table of Contents



with respect to any such acquisition, any future
transaction of this nature could require potentially significant
amounts of capital. These funds may not be available at the time
or times needed, or available on terms acceptable to us. If
adequate funds are not available, or are not available on
acceptable terms, we may not be able to take advantage of market
opportunities to develop new products or to otherwise respond to
competitive pressures.


Certain provisions of our charter and of
Delaware law make a takeover of Packeteer more difficult, which
could lower the market price of the common stock

Our corporate documents and Section 203 of
the Delaware General Corporation Law could discourage, delay or
prevent a third party or a significant stockholder from
acquiring control of Packeteer. In addition, provisions of our
certificate of incorporation may have the effect of
discouraging, delaying or preventing a merger, tender offer or
proxy contest involving Packeteer. Any of these anti-takeover
provisions could lower the market price of the common stock and
could deprive our stockholders of the opportunity to receive a
premium for their common stock that they might otherwise receive
from the sale of Packeteer.






|        |           
|------- | ----------
|Item 2. | Properties

We lease approximately 69,000 square feet of
administrative and research and development facilities in
Cupertino, California under a lease that expires November 2007.
We also lease sales offices in the following domestic locations:
Bedminster, New Jersey; Dallas, Texas; Fall River,
Massachusetts; Irvine, California; Schaumburg, Illinois; and
Westlake Village, California. Our international leased offices
include a research and development facility located in Canada,
and sales and marketing offices in Australia, France, Germany,
Hong Kong, Singapore, South Korea, Spain and The Netherlands. We
believe that our future growth can be accommodated by current
facilities or by leasing the necessary additional space.






|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

In November 2001, Packeteer, certain company
officers and directors, and underwriters of our initial public
offering were named as defendants in a securities class-action
lawsuit filed in the United States District Court for the
Southern District of New York. The complaint, captioned
Antoniono v. Packeteer, Inc. et. al., alleges violations of
Sections 11, 12(a)2 and 15 of the Securities Act of 1933,
as amended, Section 10(b) of the Securities Exchange Act of
1934 and Rule 10b-5 promulgated thereunder on behalf of a
purported class of purchasers of Packeteer common stock between
July 27, 1999 and December 6, 2000. The plaintiffs
seek unspecified damages. Various plaintiffs have filed similar
actions asserting virtually identical allegations against more
than 300 other issuers. These cases have all been assigned to
the Hon. Shira A. Scheindlin.

In October 2002, the plaintiffs agreed to dismiss
the companys officers and directors from the litigation
without prejudice, in return for a tolling agreement. The
Company moved to dismiss the claims against it. The Court
recently denied the motion. As a result, the case may proceed to
the discovery phase. We believe that we have meritorious
defenses to the lawsuit and will defend ourselves vigorously in
the litigation. We are not presently able to estimate the
losses, if any, related to this lawsuit, and accordingly, as of
December 31, 2002, no accrual for this contingency has been
recorded.

We are routinely involved in legal and
administrative proceedings incidental to our normal business
activities and believe that these matters will not have a
material adverse effect on our financial position, results of
operations or cash flows.






|        |                                                        
|------- | -------------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security
    Holders

Not applicable.

24



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##### Table of Contents






PART II






|        |                                                                         
|------- | ------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Stock
    and Related Stockholder Matters

Our common stock has been quoted on the Nasdaq
National Market under the symbol PKTRsince
our initial public offering on July 28, 1999. Prior to this
time, there was no public market for our common stock. The
following table shows the high and low closing prices per share
of our common stock as reported on the Nasdaq National Market
for the periods indicated:

|             |                |      |   |       |  |  |   |      | 
|------------ | -------------- | ---- | - | ----- |  |  | - | ---- | 
|             |                | High |   | Low  
|             |                |      |   |      
|Fiscal 2002: |                |      |   |       |  |  |   |     
|             | Fourth Quarter |      | $ | 8.28  |  |  | $ | 3.35 | 
|             | Third Quarter  |      |   | 5.35  |  |  |   | 2.66 | 
|             | Second Quarter |      |   | 7.50  |  |  |   | 4.13 | 
|             | First Quarter  |      |   | 7.93  |  |  |   | 5.47 | 
|Fiscal 2001: |                |      |   |       |  |  |   |     
|             | Fourth Quarter |      |   | 8.71  |  |  |   | 2.83 | 
|             | Third Quarter  |      |   | 11.92 |  |  |   | 3.03 | 
|             | Second Quarter |      |   | 12.53 |  |  |   | 2.13 | 
|             | First Quarter  |      |   | 20.13 |  |  |   | 3.03 | 

As of February 28, 2003, there were
approximately 400 registered holders of our common stock. We
have never declared or paid any dividends on our capital stock.
We currently expect to retain future earnings, if any, for use
in the operation and expansion of our business and do not
anticipate paying any cash dividends in the foreseeable future.
The covenants under our Loan and Security Agreement with Silicon
Valley Bank prohibit us from paying cash dividends.

Craig W. Elliott, a director and our former
President and CEO, and Brett D. Galloway, a director and our
former Vice President of Corporate Development, have informed us
that, in order to diversify their investment portfolios while
avoiding conflicts of interest or the appearance of any such
conflict that might arise from their position with the Company,
they have established written plans in accordance with SEC
Rule 10b5-1 for gradually liquidating a portion of their
holdings of our common stock. Such plans call for sales of a
specific number of shares of stock per month, subject to certain
contingencies relating to prevailing stock price.

25



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##### Table of Contents








|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data

The selected consolidated financial data set
forth below should be read in conjunction with
Managements Discussion and Analysis of Financial
Condition and Results of Operations and the Consolidated
Financial Statements of Packeteer, Inc. and the notes thereto
included elsewhere in this report. The historical results are
not necessarily indicative of the operating results to be
expected in the future.

|                                                                                   |                                          |                                       |        |        |        |      |         |        |         |      |         |        |        |   |         |        |        |   |        |       |        | 
|---------------------------------------------------------------------------------- | ---------------------------------------- | ------------------------------------- | ------ | ------ | ------ | ---- | ------- | ------ | ------- | ---- | ------- | ------ | ------ | - | ------- | ------ | ------ | - | ------ | ----- | ------ | 
|                                                                                   |                                          |                                      
|                                                                                   |                                          | Years Ended December 31,             
|                                                                                   |                                          |                                      
|                                                                                   |                                          | 2002                                  |        | 2001   |        | 2000 |         | 1999   |         | 1998
|                                                                                   |                                          |                                       |        |        |        |      |         |        |         |     
|                                                                                   |                                          |                                      
|                                                                                   |                                          | (In thousands, except per share data)
|Consolidated Statements of Operations
    Data:                                    |                                          |                                       |        |        |        |      |         |        |         |      |         |        |        |   |         |        |        |   |        |      
|Net revenues                                                                       |                                          | $                                     | 55,014 |        |        | $    | 46,661  |        |         | $    | 41,097  |        |        | $ | 18,441  |        |        | $ | 7,230  |      
|Product and service costs                                                          |                                          |                                       | 12,852 |        |        |      | 13,867  |        |         |      | 12,585  |        |        |   | 5,286   |        |        |   | 2,386  |      
|Amortization of acquired technology                                                |                                          |                                       |       |        |        |      | 1,199   |        |         |      | 678     |        |        |   |        |        |        |   |       |      
|                                                                                   |                                          |                                       |        |        |        |      |         |        |         |      |         |        |        |   |         |        |        |   |        |      
|Gross profit                                                                       |                                          |                                       | 42,162 |        |        |      | 31,595  |        |         |      | 27,834  |        |        |   | 13,155  |        |        |   | 4,844  |      
|Operating expenses:                                                                |                                          |                                       |        |        |        |      |         |        |         |      |         |        |        |   |         |        |        |   |        |      
|                                                                                   | Research and development*                |                                       |        | 10,694 |        |      |         | 11,697 |         |      |         | 8,760  |        |   |         | 5,164  |        |   |        | 2,779 |       
|                                                                                   | Sales and marketing*                     |                                       |        | 23,269 |        |      |         | 22,417 |         |      |         | 18,614 |        |   |         | 13,737 |        |   |        | 8,866 |       
|                                                                                   | General and administrative*              |                                       |        | 4,585  |        |      |         | 5,704  |         |      |         | 4,824  |        |   |         | 2,936  |        |   |        | 1,750 |       
|                                                                                   | Amortization of goodwill                 |                                       |        |       |        |      |         | 11,017 |         |      |         | 6,424  |        |   |         |       |        |   |        |      |       
|                                                                                   | Impairment of goodwill and intangibles   |                                       |        |       |        |      |         | 52,552 |         |      |         |       |        |   |         |       |        |   |        |      |       
|                                                                                   | Amortization of stock-based compensation |                                       |        | 385    |        |      |         | 1,233  |         |      |         | 1,683  |        |   |         | 3,088  |        |   |        | 537   |       
|                                                                                   |                                          |                                       |        |        |        |      |         |        |         |      |         |        |        |   |         |        |        |   |        |      
|                                                                                   |                                          | Total operating expenses              |        |        | 38,933 |      |         |        | 104,620 |      |         |        | 40,305 |   |         |        | 24,925 |   |        |       | 13,932 | 
|                                                                                   |                                          |                                       |        |        |        |      |         |        |         |      |         |        |        |   |         |        |        |   |        |      
|Net income (loss) from operations                                                  |                                          |                                       | 3,229  |        |        |      | (73,025 | )      |         |      | (12,471 | )      |        |   | (11,770 | )      |        |   | (9,088 | )    
|Interest and other income                                                          |                                          |                                       | 1,392  |        |        |      | 3,170   |        |         |      | 4,020   |        |        |   | 1,757   |        |        |   | 367    |      
|Interest and other expense                                                         |                                          |                                       | (477   | )      |        |      | (1,133  | )      |         |      | (618    | )      |        |   | (863    | )      |        |   | (78    | )    
|                                                                                   |                                          |                                       |        |        |        |      |         |        |         |      |         |        |        |   |         |        |        |   |        |      
|Net income (loss) before income taxes                                              |                                          |                                       | 4,144  |        |        |      | (70,988 | )      |         |      | (9,069  | )      |        |   | (10,876 | )      |        |   | (8,799 | )    
|Provision for income taxes                                                         |                                          |                                       | 415    |        |        |      |        |        |         |      | 300     |        |        |   |        |        |        |   |       |      
|                                                                                   |                                          |                                       |        |        |        |      |         |        |         |      |         |        |        |   |         |        |        |   |        |      
|Net income (loss)                                                                  |                                          | $                                     | 3,729  |        |        | $    | (70,988 | )      |         | $    | (9,369  | )      |        | $ | (10,876 | )      |        | $ | (8,799 | )    
|                                                                                   |                                          |                                       |        |        |        |      |         |        |         |      |         |        |        |   |         |        |        |   |        |      
|Basic and diluted net income (loss) per share                                      |                                          | $                                     | 0.12   |        |        | $    | (2.40   | )      |         | $    | (0.35   | )      |        | $ | (0.71   | )      |        | $ | (1.54  | )    
|                                                                                   |                                          |                                       |        |        |        |      |         |        |         |      |         |        |        |   |         |        |        |   |        |      
|Shares used in computing basic net income (loss)
    per share                     |                                          |                                       | 30,205 |        |        |      | 29,559  |        |         |      | 27,152  |        |        |   | 15,343  |        |        |   | 5,709  |      
|                                                                                   |                                          |                                       |        |        |        |      |         |        |         |      |         |        |        |   |         |        |        |   |        |      
|Shares used in computing diluted net income
    (loss) per share                   |                                          |                                       | 30,718 |        |        |      | 29,559  |        |         |      | 27,152  |        |        |   | 15,343  |        |        |   | 5,709  |      
|                                                                                   |                                          |                                       |        |        |        |      |         |        |         |      |         |        |        |   |         |        |        |   |        |      
|                                                                                   |                                          |                                       |        |        |        |      |         |        |         |      |         |        |        |   |         |        |        |   |        |      
|* Excludes amortization of deferred
    stock-based compensation of the following: |                                          |                                       |        |        |        |      |         |        |         |      |         |        |        |   |         |        |        |   |        |      
|                                                                                   | Research and development                 |                                       | $      | 183    |        |      | $       | 663    |         |      | $       | 558    |        |   | $       | 459    |        |   | $      | 86    |       
|                                                                                   | Sales and marketing                      |                                       |        | 151    |        |      |         | 442    |         |      |         | 892    |        |   |         | 2,184  |        |   |        | 436   |       
|                                                                                   | General and administrative               |                                       |        | 51     |        |      |         | 128    |         |      |         | 233    |        |   |         | 445    |        |   |        | 15    |       

|                                       |  |                |        |      |  |      |        |      |  |      |         |  |  |   |        |  |  |   |       | 
|-------------------------------------- |  | -------------- | ------ | ---- |  | ---- | ------ | ---- |  | ---- | ------- |  |  | - | ------ |  |  | - | ----- | 
|                                       |  |               
|                                       |  | December 31,  
|                                       |  |               
|                                       |  | 2002           |        | 2001 |  | 2000 |        | 1999 |  | 1998
|                                       |  |                |        |      |  |      |        |      |  |     
|                                       |  |               
|                                       |  | (In thousands)
|Consolidated Balance Sheet Data:       |  |                |        |      |  |      |        |      |  |      |         |  |  |   |        |  |  |   |       | 
|Cash, cash equivalents and investments |  | $              | 65,474 |      |  | $    | 62,221 |      |  | $    | 62,206  |  |  | $ | 65,158 |  |  | $ | 4,477 | 
|Working capital                        |  |                | 52,665 |      |  |      | 52,723 |      |  |      | 51,958  |  |  |   | 51,285 |  |  |   | 3,501 | 
|Total assets                           |  |                | 79,912 |      |  |      | 73,005 |      |  |      | 144,281 |  |  |   | 70,821 |  |  |   | 8,570 | 
|Long-term obligations                  |  |                | 545    |      |  |      | 1,289  |      |  |      | 3,215   |  |  |   | 839    |  |  |   | 739   | 
|Total stockholders equity             |  |                | 63,401 |      |  |      | 56,624 |      |  |      | 124,133 |  |  |   | 59,120 |  |  |   | 3,759 | 

26



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|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

The following discussion should be read in
conjunction with our consolidated financial statements and the
related notes included elsewhere in this report. Except for
historical information, the discussion in this report contains
forward-looking statements that involve risks and uncertainties.
Our actual results could differ materially from those
anticipated in the forward-looking statements as a result of a
number of factors, including the risks described in the section
titled RISK FACTORS beginning on page 16.

Overview

Packeteer is a leading provider of application
traffic management systems designed to enable enterprises to
gain visibility and control for networked applications, extend
network resources and align application performance with
business priorities. For service providers, Packeteer systems
provide a platform for delivering application-intelligent
network services that control quality of service, expand revenue
opportunities and offer compelling differentiation.
Packeteers products  powered by PacketWise
software  are designed to ensure end-to-end QoS for
networked applications and managed services, enhancing
users quality of experience through comprehensive
bandwidth, traffic, content, service-level and policy
management. Packeteers PacketShaper family of products,
the PacketSeeker, PacketShaper and PacketShaper Xpress systems,
integrates application discovery, analysis, control and
reporting technologies that are required for proactive
application performance and bandwidth management. The AppCelera
family of Internet acceleration appliances employs SSL offload
and advanced content compression, transformation and caching
technologies to improve response times of mission critical
enterprise, eBusiness and eCommerce web applications.

Packeteers products are deployed by Global
2000 corporations and service providers, and sold through an
established network of more than 100 resellers, distributors,
system-integrators and OEMs in more than 50 countries. Our
products are built on hardware platforms based on
Intel-compatible microprocessor technologies. In addition,
PacketWise software is licensed by major communications industry
partners who integrate the software into specific strategic
networking solutions. We primarily use indirect channels,
resellers, distributors and system integrators, to leverage the
reach of our sales force and to obtain worldwide coverage. Our
sales and marketing efforts are used to develop brand awareness
and support our indirect channels. We have subsidiaries or
branch offices in Australia, Canada, Caymans, Denmark, France,
Germany, Hong Kong, Japan, Singapore, South Korea, The
Netherlands, and the United Kingdom. To date, we have shipped
more than 24,000 units.

We were incorporated in January 1996. From our
inception through January 1997, our operating activities related
primarily to establishing a research and development
organization, developing and testing prototype designs,
establishing a sales and marketing organization and developing
customer, vendor and manufacturing relationships. We shipped our
first product in February 1997. Since then, we have focused on
developing additional products and product enhancements,
building our worldwide indirect sales channel and establishing
our sales, marketing and customer support organizations.

In order to further the growth of our business,
we sold 4,600,000 shares of common stock in our initial public
offering on July 28, 1999, which raised approximately
$62.6 million net of fees and expenses.

We have a limited operating history. As of
December 31, 2002, we had an accumulated deficit of
$103.4 million. We achieved profitability throughout fiscal
2002. However, as we incurred losses since we commenced
operations in 1996 until 2002, continued profitability could be
difficult to sustain. We expect to continue to incur significant
sales and marketing, product development and administrative
expenses and, as a result, will need to generate significant
quarterly revenues to maintain profitability.

Critical Accounting Policies

Our discussion and analysis of our financial
condition and results of operations are based upon our
consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements
requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses
and

27



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related disclosures of contingent assets and
liabilities. On an ongoing basis, we evaluate our estimates,
including those related to inventory valuation, valuation of
long-lived assets, valuation allowances including sales return
reserves and allowance for doubtful accounts, and other
liabilities, specifically warranty reserves. We base our
estimates on historical experience and on various other
assumptions that are believed to be reasonable under the
circumstances. Actual results may differ from these estimates
under different assumptions or conditions.


The items in our financial statements requiring
the most significant estimates and judgment are as follows:



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Revenue Recognition.Product revenue consists primarily of sales of our PacketShaper
    and AppCelera products, which include hardware, as well as
    software licenses. Service revenue consists primarily of
    maintenance revenue and, to a lesser extent, training revenue.                                                                                                                                                                                       
|
| | The Company applies the provisions of Statement
    of Position 97-2, Software Revenue Recognition,
    as amended by Statement of Position 98-9,
    Modification of SOP 97-2, Software Revenue
    Recognition, With Respect to Certain Transactions, to all
    transactions involving the sale of hardware and software
    products. Revenue is generally recognized when all of the
    following criteria are met as set forth in paragraph 8 of
    SOP 97-2:



| |   |                                              
| | - | ---------------------------------------------
| |  | persuasive evidence of an arrangement exists,
|
| |  | delivery has occurred,                       
|
| |  | the fee is fixed or determinable, and        
|
| |  | collectibility is reasonably assured.        



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Receipt of a customer purchase order is
    persuasive evidence of an arrangement. Sales through our
    distribution channel are evidenced by an agreement governing the
    relationship together with purchase orders on a
    transaction-by-transaction basis.                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| | Delivery generally occurs when product is
    delivered to a common carrier from Packeteer or its designated
    fulfillment house. For maintenance contracts, delivery is deemed
    to occur ratably over the contract period.                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| | The Companys fees are typically considered
    to be fixed or determinable at the inception of the arrangements
    and are negotiated at the outset of an arrangement, generally
    based on specific products and quantities to be delivered. In
    the event payment terms are provided that differ significantly
    from our standard business practices, the fees are deemed to not
    be fixed or determinable and revenue is recognized as the fees
    become due and payable.                                                                                                                                                                                                       
|
| | We assess collectibility based on a number of
    factors, including credit worthiness of the customer and past
    transaction history of the customer.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| | Our standard revenue recognition policy includes
    modifications under certain circumstances as follows: Product
    revenue on sales to major new distributors is recorded based on
    sell-through to the end user customers until such time as the
    Company has established significant experience with the
    distributors product exchange activity. Additionally, when
    the Company introduces a new product into its distribution
    channel for which there is no historical customer demand or
    acceptance history, revenue is recognized on the basis of
    sell-through to end user customers until such time as demand or
    acceptance history has been established.
|
| | The Company has analyzed all of the elements
    included in its multiple element arrangements and has determined
    that it has sufficient vendor specific objective evidence
    (VSOE) of fair value to allocate revenue to the maintenance
    component of its product and to training. VSOE is based upon
    separate sales of maintenance renewals and training to
    customers. Accordingly, assuming other revenue recognition
    criteria are met, revenue from product sales is recognized upon
    delivery using the residual method in accordance with SOP 98-9.
    Revenue from maintenance is recognized ratably over the
    maintenance term                               

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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | and revenue from training is recognized when the
    training has taken place. To date, training revenues have not
    been material.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| | Inventory Valuation.Inventories consist primarily of finished goods and are stated
    at the lower of cost (on a first-in, first-out basis) or market.
    We currently contract with SMTC for the manufacture of all of
    our products. We record inventory reserves for excess and
    obsolete inventories based on historical usage and forecasted
    demand. Factors which could cause our forecasted demand to prove
    inaccurate include our reliance on indirect sales channels and
    the variability of our sales cycle; the potential of
    announcements of our new products or enhancements to replace or
    shorten the life cycle of our current products, or cause
    customers to defer their purchases; loss of sales due to product
    shortages; and the potential of new or alternative technologies
    achieving widespread market acceptance and thereby rendering our
    existing products obsolete. If future demand or market
    conditions are less favorable than our projections, additional
    inventory write-downs may be required and would be reflected in
    cost of sales in the period the revision is made.                                                                                              
|
| | Valuation of Long-Lived and Intangible Assets
    and Goodwill.As required by
    SFAS 144, Accounting for Impairment or Disposal of
    Long-lived Assets, the Company regularly performs reviews
    to determine if the carrying value of its long-lived assets is
    impaired. The purpose for the review is to identify any facts or
    circumstances, either internal or external, which indicate that
    the carrying value of the assets cannot be recovered. Such facts
    or circumstances might include significant underperformance
    relative to expected historical or projected future operating
    results or significant negative industry or economic trends. If
    such indicators are present, we determine whether the sum of the
    estimated undiscounted cash flows attributable to the assets in
    question is less than their carrying value. If less, we
    recognize an impairment loss based on the excess carrying amount
    of the assets over their respective fair values. If quoted
    market prices for assets are not available, the fair value is
    estimated based on the present value of expected future cash
    flows. The fair value of the asset then becomes the assets
    new carrying value.
|
| | During the third quarter of 2001, the Company
    performed an assessment of the carrying value of the goodwill
    and other intangible assets related to its acquisition of
    Workfire Technologies International, Inc. pursuant to the
    Companys stated policy as described in Note 1 to the
    Financial Statements. Managements determination of the
    existence of impairment indicators included continued general
    economic slowing, broad based declines in the values of
    networking technologies and a review of current, historical and
    future projections of cash flows related to these assets. The
    conclusion of the assessment was a determination that the
    carrying value of the goodwill and other intangible assets
    exceeded its fair value. The fair value was determined based on
    Company projections of the present value of future net cash
    flows to be generated over the expected lives of these assets.
    Accordingly, the Company recorded an impairment charge of
    $52.6 million during the third quarter of 2001 for the
    entire unamortized balance.                                                                                                                             
|
| | In July 2001, the FASB issued SFAS No. 142,
    Goodwill and Other Intangible Assets. SFAS
    No. 142 changes the accounting for goodwill from an
    amortization method to an impairment-only approach. Any goodwill
    or other intangible assets recorded in the future will be tested
    for impairment on an annual basis according to the specific
    guidance in the statement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| | Sales Return Reserve and Allowance for
    Doubtful Accounts.In accordance with
    SFAS 48, Revenue Recognition When Right of Return
    Exists, management must use judgment and make estimates of
    potential future product returns related to current period
    product revenue. When providing for sales return reserves, we
    analyze historical return rates as they are the primary
    indicator for estimating future returns. Material differences
    may result in the amount and timing of our revenue if for any
    period actual returns differ from our judgments or estimates.
    The sales return reserve balances at December 31, 2002 and
    2001 were $875,000 and $331,000, respectively. We must also make
    estimates of the uncollectibility of accounts receivable. When
    evaluating the adequacy of the allowance for doubtful accounts,
    we review the aged receivables on an account-by-account basis,
    taking into consideration such factors as age of the
    receivables, customer history and estimated continued
    credit-worthiness, as well as general economic and industry
    trends. If the financial condition of our customers were to
    deteriorate,                                    

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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | resulting in an impairment of their ability to
    make payments, additional allowances could be required. The
    allowance for doubtful accounts was $145,000 and $132,000 at
    December 31, 2002 and 2001, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| | Warranty Reserves.Upon shipment of products to our customers, we provide for the
    estimated cost to repair or replace products that may be
    returned under warranty. Our warranty period is typically
    12 months from the date of shipment to the end user
    customer. For existing products, the reserve is estimated based
    on actual historical experience. For new products, the warranty
    reserve is based on historical experience of similar products
    until such time as sufficient historical data has been collected
    on the new product. Factors that may impact our warranty costs
    in the future include our reliance on our contract manufacturer
    to provide quality products and the fact that our products are
    complex and may contain undetected defects, errors or failures
    in either the hardware or the software. To date, these problems
    have not materially adversely affected us. Warranty reserves
    amounted to $284,000 and $552,000 at December 31, 2002 and
    2001, respectively.

Results of Operations

The following table sets forth certain financial
data as a percentage of net revenues for the periods indicated.
These historical operating results are not necessarily
indicative of the results for any future period.

|                                      |                                          |                          |     |      |    |      |      |     |     |  |      |    |    | 
|------------------------------------- | ---------------------------------------- | ------------------------ | --- | ---- | -- | ---- | ---- | --- | --- |  | ---- | -- | -- | 
|                                      |                                          | 2002                     |     | 2001 |    | 2000
|                                      |                                          |                          |     |      |    |     
|Net revenues                          |                                          |                          | 100 | %    |    |      | 100% |     |     |  | 100% |   
|Product and service costs             |                                          |                          | 23  |      |    |      | 30   |     |     |  | 31   |   
|Amortization of acquired technology   |                                          |                          |    |      |    |      | 2    |     |     |  | 1    |   
|                                      |                                          |                          |     |      |    |      |      |     |     |  |      |   
|Gross margin                          |                                          |                          | 77  |      |    |      | 68   |     |     |  | 68   |   
|Operating expenses:                   |                                          |                          |     |      |    |      |      |     |     |  |      |   
|                                      | Research and development                 |                          |     | 20   |    |      |      | 25  |     |  |      | 21 |   
|                                      | Sales and marketing                      |                          |     | 42   |    |      |      | 48  |     |  |      | 45 |   
|                                      | General and administrative               |                          |     | 8    |    |      |      | 12  |     |  |      | 12 |   
|                                      | Amortization of goodwill                 |                          |     |     |    |      |      | 24  |     |  |      | 16 |   
|                                      | Impairment of goodwill and intangibles   |                          |     |     |    |      |      | 113 |     |  |      |   |   
|                                      | Amortization of stock-based compensation |                          |     | 1    |    |      |      | 3   |     |  |      | 4  |   
|                                      |                                          |                          |     |      |    |      |      |     |     |  |      |   
|                                      |                                          | Total operating expenses |     |      | 71 |      |      |     | 225 |  |      |    | 98 | 
|                                      |                                          |                          |     |      |    |      |      |     |     |  |      |   
|Net income (loss) from operations     |                                          |                          | 6   |      |    |      | (157 | )   |     |  | (30  | ) 
|Interest and other income             |                                          |                          | 3   |      |    |      | 7    |     |     |  | 10   |   
|Interest and other expense            |                                          |                          | (1  | )    |    |      | (2   | )   |     |  | (2   | ) 
|                                      |                                          |                          |     |      |    |      |      |     |     |  |      |   
|Net income (loss) before income taxes |                                          |                          | 8   |      |    |      | (152 | )   |     |  | (22  | ) 
|Provision for income taxes            |                                          |                          | 1   |      |    |      |     |     |     |  | (1   | ) 
|                                      |                                          |                          |     |      |    |      |      |     |     |  |      |   
|Net income (loss)                     |                                          |                          | 7   | %    |    |      | (152 | )%  |     |  | (23  | )%
|                                      |                                          |                          |     |      |    |      |      |     |     |  |      |   

Net Revenues

Product revenues consist primarily of sales of
our PacketShaper family of products. Service revenues consist
primarily of maintenance revenues and, to a lesser extent,
training revenues.

Total net revenues increased to
$55.0 million in fiscal 2002 from $46.7 million in
fiscal 2001 and from $41.1 million in fiscal 2000. Product
revenues increased to $47.2 million in fiscal 2002 from
$41.1 million in fiscal 2001 and from $38.1 million in
fiscal 2000. The increase in product revenues from 2001 to 2002
was primarily due to a favorable product mix, as sales of our
higher end products continue to represent a higher percentage of
our reported revenues. To a lesser extent, an overall increase
in the number of units shipped also

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contributed to the increase in product revenues.
The increase from 2000 to 2001 was due to a more favorable
product mix, with sales of our PacketShaper 6500 models,
introduced in the fourth quarter of fiscal 2000, showing the
largest growth in 2001. There were no significant changes in
selling prices during any of the periods presented. Service
revenues increased to $7.8 million in fiscal 2002 from
$5.6 million in fiscal 2001 and from $3.0 million in
2000 due mainly to increases in the number of units on
maintenance contracts.


For fiscal 2002, total net revenues in North
America increased to $23.1 million, from $20.8 million
in fiscal 2001 and $18.8 million in fiscal 2000. Sales in
North America accounted for 42%, 45% and 46% of net revenues for
2002, 2001 and 2000, respectively. Net revenues in Asia Pacific
were $18.0 million, $12.1 million and
$11.6 million, or 33%, 26% and 28% of net revenues in 2002,
2001 and 2000, respectively. The increase in 2002 was due to
strong sales in Japan. Net revenues in Europe, the Middle East
and Africa, EMEA, of $13.9 million,
$13.8 million and $10.7 million, represented 25%, 29%
and 26% of net revenues in fiscal 2002, 2001 and 2000,
respectively.

In 2002, sales to three customers, Alternative
Technology, Inc., Westcon, Inc., and Macnica, Inc. accounted for
21%, 13% and 11% of net revenues respectively. In 2001 and 2000,
one customer, Alternative Technology, Inc., accounted for 22%
and 12% of net revenues, respectively. No other customer
accounted for 10% or more of revenues in 2001 or 2000. Sales to
the top 10 indirect channel partners accounted for 66%,
59%, and 46% of net revenues for the years ended
December 31, 2002, 2001 and 2000, respectively. At
December 31, 2002, three customers accounted for 38% of
accounts receivable.

Despite our belief that world-wide economic
growth and IT spending will remain relatively flat for at least
2003, we believe that our current value proposition, which
enables our enterprise customers to get more value out of
existing network resources and improved performance of their
critical applications should continue to allow us to grow our
business again in 2003. Our growth rate and net revenue depend
significantly on continued growth in the application traffic
solutions market, our ability to develop and maintain strong
partnering relationships with our indirect channel partners and
our ability to expand or enhance our product offerings or
respond to technological change. Our growth in service revenues
is dependent upon increasing the number of products on
maintenance, which is dependent on both growing our installed
base and renewing existing maintenance contracts. Our future
profitability and rate of growth, if any, will be directly
affected by the continued acceptance of our product in the
marketplace, as well as the timing and size of orders and
shipments, product mix, average selling price of our products
and general economic conditions. Our failure to successfully
convince the market of our value proposition and maintain strong
relationships with our indirect channel partners to ensure the
success of their selling efforts on our behalf, would adversely
impact our net revenues and operating results.

Cost of Revenues

Our cost of revenues (excluding amortization of
acquired technology) consists of the cost of finished products
purchased from our turnkey contract manufacturer, overhead costs
and service support costs. Our cost of revenues decreased to
$12.9 million in fiscal 2002 from $13.9 million in
fiscal 2001 and increased from $12.6 million in fiscal
2000. The cost of revenues represented 23%, 30% and 31% of net
revenues in fiscal 2002, 2001, and 2000, respectively.

Product costs decreased to $9.8 million in
fiscal 2002 from $10.9 million in fiscal 2001 and
$10.7 million in fiscal 2000. Overhead costs, specifically
warranty costs and parts costs, decreased $1.3 million in
fiscal 2002 compared to fiscal 2001. This was partially offset
by an increase in manufacturing costs, due to increased products
shipped. Per unit manufacturing costs decreased in 2002,
compared to 2001, due to lower component prices. The increase
from 2000 to 2001 was due to increases in overhead costs,
partially offset by reductions in manufacturing and other
product costs. To maintain our gross margins we must continue to
develop and introduce on a timely basis new products and
enhancements and reduce product costs as we did in 2002.
Although we expect our overhead costs to increase in absolute
dollars in future quarters, as a percent of revenues we do not
expect them to return to fiscal 2001 levels.

Service costs remained unchanged at
$3.0 million in fiscal 2002 compared to $3.0 million
in fiscal 2001 and increased from $1.9 million in fiscal
2000. Decreased consulting costs in 2002 were offset by increased

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service fees and supplies related to an agreement
entered into in the third quarter of 2002 for the outsourcing of
certain maintenance and support services. The increases from
2000 to 2001 are due to the costs of developing the service
support organization to support the increased installed base.
Prior to fiscal 2000, support activities were handled primarily
by the sales organization. We expect service costs to increase
in absolute dollars in future quarters primarily as a result of
increased service fees related to the outsourcing of certain
maintenance and support services.


Amortization of Acquired Technology

Amortization of acquired technology relates to
the acquired developed technologies of Workfire Technologies
International, Inc. (Workfire). The acquisition occurred in
September 2000. Due to the impairment write-off in the third
quarter of fiscal 2001, there was no amortization during the
current fiscal year. The amortization of acquired technology was
$1.2 million during 2001 and $678,000 in 2000.

Research and Development

Research and development expenses consist
primarily of salaries and related personnel expenses, consultant
fees and prototype expenses related to the design, development,
testing and enhancement of our products and software. Excluding
the effects of stock-based compensation of $183,000, $663,000
and $558,000 for the years 2002, 2001 and 2000, respectively,
research and development expenses decreased to
$10.7 million in fiscal 2002 from $11.7 million in fiscal
2001 and increased from $8.8 million in fiscal 2000. The
decreased expenses in 2002 were primarily due to a decrease in
program related charges, mainly project materials, and to a
lesser extent, a reduction in depreciation expense, partially
offset by an increase in distributed costs. Distributed costs
include expenses related to facilities, communications and
technology, which are allocable to all functional areas of the
Company. The increase in distributed expenses is discussed below
under the heading GENERAL AND ADMINISTRATIVE. The
increase in research and development expenses from fiscal 2000
to fiscal 2001 was due to increases in staffing and related
personnel costs, as well as increases in project related
materials. The increase in personnel related expenses was due to
the inclusion of Workfire for all of fiscal 2001, compared to
only three and one half months in fiscal 2000. Research and
development expenses represented 20%, 25% and 21% of net
revenues in fiscal 2002, 2001 and 2000, respectively. As of
December 31, 2002, all research and development costs have
been expensed as incurred. We believe that continued investment
in research and development is critical to attaining our
strategic product and cost control objectives. We currently
expect to experience somewhat higher spending levels in the
upcoming quarters, but continue to target our spending to
approximate our current long-term business model target of 18%
to 20% of revenues going forward.

Sales and Marketing

Sales and marketing expenses consist primarily of
salaries, commissions and related personnel expenses for those
engaged in the sales, marketing and support of the product as
well as related trade show, promotional and public relations
expenses. Excluding the effects of stock-based compensation of
$151,000, $442,000 and $892,000 in 2002, 2001 and 2000
respectively, sales and marketing expenses increased to
$23.3 million in fiscal 2002, from $22.4 million in
fiscal 2001, and from $18.6 million in fiscal 2000. In
2002, increases in personnel costs, specifically commissions and
recruiting, and distributed costs, were partially offset by
decreases in depreciation expense, supplies costs and marketing
activities. The increase in distributed costs is discussed below
under the heading GENERAL AND ADMINISTRATIVE. The
increases in fiscal 2001 compared to fiscal 2000 reflected the
hiring of additional personnel in connection with building our
sales force and distribution channels. Sales and marketing
expenses represented 42%, 48% and 45% of net revenues for fiscal
2002, 2001, and 2000, respectively. We intend to continue to
invest in appropriate sales and marketing campaigns and
therefore expect sales and marketing expenses in absolute dollar
expenses to increase in the future. We continue to work towards
our long-term business model target of sales and marketing
expenses in the range of 26 to 28% of revenues, but do not
expect to achieve this on a quarterly basis for at least the
next one to two years.

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General and Administrative

General and administrative expenses consist
primarily of salaries and related personnel expenses for
administrative personnel, professional fees and other general
corporate expenses. Excluding the effects of stock-based
compensation of $51,000, $128,000 and $233,000 in 2002, 2001 and
2000 respectively, general and administrative expenses decreased
to $4.6 million in fiscal 2002 from $5.7 million in
fiscal 2001 and from $4.8 million in fiscal 2000. For
fiscal 2002, decreases in professional services and distributed
costs were partially offset by increased personnel costs,
primarily related to the CEO transition and search occurring
during the second and third quarters of 2002. Decreases in
distributed costs are due to a change in the allocation of the
expenses associated with our Information Technology group (IT).
Prior to fiscal 2002, only a small portion of IT costs were
allocated out of general and administrative expenses. Beginning
in fiscal 2002, based on improved tracking and reporting of IT
services, a greater portion of IT costs were allocated to other
departments to better reflect the services performed by this
group. During 2002, approximately $640,000 of additional IT
costs were allocated from general and administrative expenses
into cost of revenues, research and development and sales and
marketing. Comparable figures for the prior year are not
available. The increase in expenses from 2000 to 2001 included
additional personnel costs and depreciation expenses.

General and administrative expenses represented
8% of net revenues in 2002, and 12% of net revenues for fiscal
2001 and 2000. This percentage decrease was due to lower
expenses as well as increased revenues. Without the change in
allocation of IT costs, general and administrative expenses
would have been 10% of total net revenues in fiscal 2002. We
expect to see general and administrative expenses continue to
decline as a percentage of revenue and expect to reach our
long-term business model target of 6% to 7% of revenue within
the next twelve to eighteen months.

Amortization of Goodwill

In connection with the Workfire acquisition
completed in September 2000, we recorded goodwill and other
intangible assets of approximately $66.1 million, which was
being amortized on a straight-line basis over a three-year
period. Amortization of this goodwill and other intangibles
totaled an aggregate of $11.0 million in 2001 and
$6.4 million in 2000. There was no amortization during
fiscal 2002, due to an impairment charge discussed below.

We may have additional acquisitions in future
periods that could give rise to the acquisition of additional
goodwill. Under the provisions of SFAS No. 142,
Goodwill and Other Intangible Assets, any future
goodwill will be accounted for using an impairment-only approach.

Impairment of Goodwill and Other
Intangibles

In September 2000, the Company purchased Workfire
for approximately $72.8 million, mostly in Packeteer stock.
Substantially all the purchase price was allocated to goodwill
and other intangibles.

During the third quarter of 2001, the Company
performed an assessment of the carrying value of the goodwill
and other intangible assets related to its acquisition of
Workfire pursuant to the Companys stated policy as
described in Note 1 to the Financial Statements.
Managements determination of the existence of impairment
indicators included continued general economic slowing, broad
based declines in the values of networking technologies and a
review of current, historical and future projections of cash
flows related to these assets. The conclusion of the assessment
was a determination that the carrying value of the goodwill and
other intangible assets exceeded its fair value. The fair value
was determined based on Company projections of the present value
of future net cash flows to be generated over the expected lives
of these assets. Accordingly, the Company recorded an impairment
charge of $52.6 million during the third quarter of 2001
for the entire unamortized balance.

Stock-Based Compensation

Amortization of stock-based compensation resulted
primarily from stock options grants to employees and options
assumed in the Workfire acquisition. Stock-based compensation is
being amortized to expense in

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accordance with FASB Interpretation No. 28,
Accounting for Stock Appreciation Rights and Other
Variable Stock Option Award Plans, over the vesting period
of the individual options, generally four years. We recorded
stock-based compensation expense of $385,000, $1.2 million
and $1.7 million in fiscal 2002, 2001 and 2000,
respectively, leaving $19,000 to be amortized in future periods.


Interest and Other Income

Interest and other income consists primarily of
interest income from our cash and investments and totaled
$1.4 million, $3.2 million and $4.0 million for
fiscal 2002, 2001 and 2000, respectively. The decrease in
interest income from 2001 to 2002 and from 2000 to 2001 is the
result of lower yields on invested funds.

Interest and Other Expense

Interest and other expense consists primarily of
interest expense related to our line of credit, debt and capital
lease obligations. Interest and other expense totaled $477,000
in 2002, $1.1 million in 2001 and $618,000 in 2000. The
decrease in interest and other expenses from 2001 to 2002 was
attributable to lower interest expense due to decreased levels
of debt. Additionally, 2001 expenses included $545,000 loss on
the disposition of $3.0 million of defaulted California
Edison notes. The increase from 2000 to 2001 was due primarily
to the $545,000 loss on the disposition of defaulted California
Edison notes.

Income Tax Provision

Our income tax provision for 2002 is primarily
attributable to income taxes payable in foreign jurisdictions.
The effective rate for 2002 is approximately ten percent. There
was no corresponding provision in 2001 due to the Companys
consolidated net loss. In fiscal 2000, we recognized a $300,000
tax provision related to charges in lieu of income taxes
associated with alternative minimum income tax. A corresponding
credit was made to paid-in-capital. As of December 31,
2002, we had net operating loss carryforwards of approximately
$52.3 million and $23.4 million for federal and state
income tax purposes, respectively. These carryforwards, if not
utilized, expire 2004 through 2022. See Note 11 of Notes to
Consolidated Financial Statements.

Liquidity and Capital Resources

Since inception, we have financed our operations
primarily from the sale of preferred and common stock and other
financing activities such as bank credit against accounts
receivable, subordinated debt offerings and equipment leasing
and loans. Cash, cash equivalents and investments totaled
$65.5 million at December 31, 2002, up from the
$62.2 million reported at December 31, 2001.

Net cash provided by operating activities was
$5.4 million in fiscal 2002, up from $416,000 net cash
provided in fiscal 2001 and net cash used in operations of
$1.1 million in fiscal 2000. The increase in operating cash
flows was primarily due to net income reported in fiscal 2002,
compared to net losses in 2001 and 2000.

Net cash provided by (used in) investing
activities was $(10.0) million, $25.2 million and
$1.4 million in 2002, 2001, and 2000, respectively
primarily reflecting transactions in marketable securities. In
2002, the purchase of investments exceeded proceeds by
$7.0 million. An additional $2.9 million was used to
purchase fixed assets, including $2.0 related to our
headquarters move in December 2002. In 2001, the activity in our
portfolio generated net cash proceeds of $25.7 million,
which was reinvested in short-term securities. In 2000, the net
cash proceeds of $7.8 from portfolio activity were offset by
disbursements related to purchases of fixed assets totaling
$2.6 million and cash outlays related to our acquisition of
Workfire totaling $3.3 million.

Net cash provided by financing activities was
$754,000, $225,000 and $4.3 million in 2002, 2001, and
2000, respectively. In 2002, proceeds from issuance of stock
totaled $2.5 million, which was partially offset by
disbursements repaying lease obligations, notes payable and our
line of credit. In 2001, proceeds from issuance of stock totaled
$2.3 million, which was offset by disbursements repaying
lease obligations, notes payable and the line of credit. In
2000, proceeds were generated by issuance of common stock, lease
financing and increased borrowing under the line of credit.

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We have entered into capital leases and notes
payable to finance the acquisition of computer software,
hardware and furniture. As of December 31, 2002,
approximately $1.0 million was outstanding under capital
lease obligations and $328,000 was outstanding on a note
payable. We also have a revolving credit facility against
accounts receivable, which provides for borrowings of up to
$10.0 million. As of December 31, 2002, the
outstanding balance on the line was $1.0 million. This
facility expires in May 2003. Borrowings under this facility
bear interest at the prime rate, which was 4.25% as of
December 31, 2002, and are secured by substantially all the
assets of the Company. The Company is required to maintain
certain financial covenants related to working capital and
quarterly profit and loss amounts. At December 31, 2002,
the Company was in compliance with these covenants.

A summary of future cash payments, including
interest where applicable, due under debt and lease obligations
as of December 31, 2002 (in thousands) is shown below.
Capital lease obligations are equipment leases entered into in
prior years. Operating leases relate to facilities and the note
payable is an equipment loan entered into in August 2001.

|           |  |                |       |                  |  |              |       |       |  |   |     |  |  |   |       | 
|---------- |  | -------------- | ----- | ---------------- |  | ------------ | ----- | ----- |  | - | --- |  |  | - | ----- | 
|           |  | Capital Leases |       | Operating Leases |  | Note Payable |       | Total
|           |  |                |       |                  |  |              |       |      
|2003       |  | $              | 643   |                  |  | $            | 1,365 |       |  | $ | 217 |  |  | $ | 2,225 | 
|2004       |  |                | 490   |                  |  |              | 1,205 |       |  |   | 145 |  |  |   | 1,840 | 
|2005       |  |                |      |                  |  |              | 1,211 |       |  |   |    |  |  |   | 1,211 | 
|2006       |  |                |      |                  |  |              | 1,425 |       |  |   |    |  |  |   | 1,425 | 
|2007       |  |                |      |                  |  |              | 1,195 |       |  |   |    |  |  |   | 1,195 | 
|Thereafter |  |                |      |                  |  |              | 201   |       |  |   |    |  |  |   | 201   | 
|           |  |                |       |                  |  |              |       |       |  |   |     |  |  |   |       | 
|           |  | $              | 1,133 |                  |  | $            | 6,602 |       |  | $ | 362 |  |  | $ | 8,097 | 
|           |  |                |       |                  |  |              |       |       |  |   |     |  |  |   |       | 

Additionally, we had outstanding purchase order
commitments with our contract manufacturer for completed
products of approximately $1.2 million as of
December 31, 2002. Packeteer expects these purchase orders
to be fulfilled in the first quarter of 2003.

We have used a portion of the net initial public
offering proceeds of $62.6 million to repay subordinated
loans of $5.0 million in 1999 and to fund operations in
1999 and 2000, including expanding and enhancing our sales and
marketing operations and product offerings. The balance remains
invested as described in Note 4 of the notes to consolidated
financial statements.

We expect to experience growth in our working
capital needs for the foreseeable future in order to execute our
business plan. We anticipate that operating activities, as well
as planned capital expenditures, will constitute a partial use
of our cash resources. In addition, we may utilize cash
resources to fund acquisitions or investments in complementary
businesses, technologies or products. We believe that our
current cash, cash equivalents and investments of
$65.5 million at December 31, 2002 and available
borrowings under our credit facilities will be sufficient to
meet our anticipated cash requirements for working capital and
capital expenditures for at least the foreseeable future.
However, we may need to raise additional funds if our estimates
of revenues, working capital or capital expenditure requirements
change or prove inaccurate or in order for us to respond to
unforeseen technological or marketing hurdles or to take
advantage of unanticipated opportunities. These funds may not be
available at the time or times needed, or available on terms
acceptable to us. If adequate funds are not available, or are
not available on acceptable terms, we may not be able to take
advantage of market opportunities to develop new products or to
otherwise respond to competitive pressures.

Recent Accounting Pronouncements

The impact of recent accounting pronouncements is
discussed in Note 1 of the notes to consolidated financial
statements.

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|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7a. | Quantitative and Qualitative Disclosures
    About Market Risk

Fixed Income Investments

Our exposure to market risks for changes in
interest rates and principal relates primarily to investments in
debt securities issued by U.S. government agencies and
corporate debt securities. We place our investments with high
credit quality issuers and, by policy, limit the amount of the
credit exposure to any one issuer. Our investment securities are
classified as available-for-sale and consequently are recorded
on the balance sheet at fair value with unrealized gains and
losses reported as a separate component of accumulated other
comprehensive income (loss).

We do not use derivative financial instruments.
In general our policy is to limit the risk of principal loss and
ensure the safety of invested funds by limiting market and
credit risk. All highly liquid investments with less than three
months to maturity from date of purchase are considered to be
cash equivalents; investments with maturities between three and
twelve months are considered to be short-term investments; and
investments with maturities in excess of twelve months are
considered to be long-term investments. The following table
presents the amortized cost, fair value and related
weighted-average interest rates by year of maturity for our
investment portfolio as of December 31, 2002 and comparable
fair values as of December 31, 2001.

|                           |                       |                |        |           |  |       |       |            |  |       |        |  |  |   |        |  |  |   |        |  | 
|-------------------------- | --------------------- | -------------- | ------ | --------- |  | ----- | ----- | ---------- |  | ----- | ------ |  |  | - | ------ |  |  | - | ------ |  | 
|                           |                       |                |        |          
|                           |                       | 2002           |        |          
|                           |                       |                |        | 2001 Fair
|                           |                       | 2003           |        | 2004      |  | Total |       | Fair Value |  | Value
|                           |                       |                |        |           |  |       |       |            |  |      
|                           |                       |               
|                           |                       | (In thousands)
|Cash equivalents           |                       | $              | 44,518 |           |  |       |      |            |  | $     | 44,518 |  |  | $ | 44,519 |  |  | $ | 48,286 | 
|                           | Weighted-average rate |                |        | 1.25%     |  |       |       |           |  |       |        |  |  |   |        |  |  |   |        |  | 
|Short-term investments     |                       |                | 11,245 |           |  |       |      |            |  |       | 11,245 |  |  |   | 11,339 |  |  |   | 8,624  | 
|                           | Weighted-average rate |                |        | 2.10%     |  |       |       |           |  |       |        |  |  |   |        |  |  |   |        |  | 
|Long-term investments      |                       |                |       |           |  | $     | 7,922 |            |  |       | 7,922  |  |  |   | 7,991  |  |  |   | 3,588  | 
|                           | Weighted-average rate |                |        |          |  |       |       | 2.55%      |  |       |        |  |  |   |        |  |  |   |        |  | 
|                           |                       |                |        |           |  |       |       |            |  |       |        |  |  |   |        |  |  |   |        | 
|Total investment portfolio |                       | $              | 55,763 |           |  | $     | 7,922 |            |  | $     | 63,685 |  |  | $ | 63,849 |  |  | $ | 60,498 | 
|                           |                       |                |        |           |  |       |       |            |  |       |        |  |  |   |        |  |  |   |        | 

Foreign Exchange

We develop products in the United States and sell
in North America, Asia, Europe and the rest of the world. As a
result, our financial results could be affected by factors such
as changes in foreign currency exchange rates or weak economic
conditions in worldwide markets. All sales are currently made in
U.S. dollars; however, a strengthening of the dollar could
make our products less competitive in foreign markets. We have
no foreign exchange contracts, option contracts or other foreign
currency hedging arrangements.

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|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

The following consolidated financial statements,
and the related notes thereto, of Packeteer and the Report of
Independent Auditors are filed as a part of this Form 10-K.

|                                                                                                                                             |  |        |    | 
|-------------------------------------------------------------------------------------------------------------------------------------------- |  | ------ | -- | 
|                                                                                                                                             |  | Page  
|                                                                                                                                             |  | Number
|                                                                                                                                             |  |       
|Independent Auditors Report                                                                                                                 |  |        | 37 | 
|Consolidated Balance Sheets as of
    December 31, 2002 and 2001                                                                             |  |        | 38 | 
|Consolidated Statements of Operations for the
    years ended December 31, 2002, 2001 and 2000                                               |  |        | 39 | 
|Consolidated Statements of Stockholders
    Equity and Comprehensive (Loss) Income for the years ended
    December 31, 2002, 2001 and 2000 |  |        | 40 | 
|Consolidated Statements of Cash Flows for the
    years ended December 31, 2002, 2001 and 2000                                               |  |        | 41 | 
|Notes to Consolidated Financial Statements                                                                                                   |  |        | 42 | 

INDEPENDENT AUDITORS REPORT

To the Board of Directors and Stockholders of
Packeteer, Inc.:

We have audited the accompanying consolidated
balance sheets of Packeteer, Inc. and subsidiaries as of
December 31, 2002 and 2001, and the related consolidated
statements of operations, stockholders equity and
comprehensive (loss) income, and cash flows for each of the
years in the three-year period ended December 31, 2002.
These consolidated financial statements are the responsibility
of the Companys management. Our responsibility is to
express an opinion on these consolidated financial statements
and the financial statement schedule based on our audits.

We conducted our audits in accordance with
auditing standards generally accepted in the United States of
America. 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 audits
provide a reasonable basis for our opinion.

In our opinion, the consolidated financial
statements referred to above present fairly, in all material
respects, the financial position of Packeteer, Inc. and
subsidiaries as of December 31, 2002 and 2001, and the
results of their operations and their cash flows for each of the
years in the three-year period ended December 31, 2002, in
conformity with accounting principles generally accepted in the
United States of America.



| |             
| | ------------
| | /s/ KPMG LLP

Mountain View, California

January 16, 2003


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PACKETEER, INC.

CONSOLIDATED BALANCE SHEETS

|                                                |                                                                                                                                                               |                                            |       |          |        |  |       |          |        | 
|----------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ----- | -------- | ------ |  | ----- | -------- | ------ | 
|                                                |                                                                                                                                                               |                                           
|                                                |                                                                                                                                                               | December 31,                              
|                                                |                                                                                                                                                               |                                           
|                                                |                                                                                                                                                               | 2002                                       |       | 2001    
|                                                |                                                                                                                                                               |                                            |       |         
|                                                |                                                                                                                                                               |                                           
|                                                |                                                                                                                                                               | (In thousands, except per                 
|                                                |                                                                                                                                                               | share data)                               
|ASSETS                                         
|Current assets:                                 |                                                                                                                                                               |                                            |       |          |        |  |       |         
|                                                | Cash and cash equivalents                                                                                                                                     |                                            | $     | 46,144   |        |  | $     | 50,009   |       
|                                                | Short-term investments                                                                                                                                        |                                            |       | 11,339   |        |  |       | 8,624    |       
|                                                | Accounts receivable, less allowance for doubtful
    accounts of $145, and $132, as of December 31, 2002 and
    2001, respectively                           |                                            |       | 7,145    |        |  |       | 5,772    |       
|                                                | Other receivables                                                                                                                                             |                                            |       | 410      |        |  |       | 183      |       
|                                                | Inventories                                                                                                                                                   |                                            |       | 2,291    |        |  |       | 2,189    |       
|                                                | Prepaids and other current assets                                                                                                                             |                                            |       | 1,302    |        |  |       | 1,038    |       
|                                                |                                                                                                                                                               |                                            |       |          |        |  |       |         
|                                                |                                                                                                                                                               | Total current assets                       |       |          | 68,631 |  |       |          | 67,815 | 
|Property and equipment, net                     |                                                                                                                                                               |                                            | 3,027 |          |        |  | 1,377 |         
|Long-term investments                           |                                                                                                                                                               |                                            | 7,991 |          |        |  | 3,588 |         
|Other assets                                    |                                                                                                                                                               |                                            | 263   |          |        |  | 225   |         
|                                                |                                                                                                                                                               |                                            |       |          |        |  |       |         
|                                                |                                                                                                                                                               | Total assets                               |       | $        | 79,912 |  |       | $        | 73,005 | 
|                                                |                                                                                                                                                               |                                            |       |          |        |  |       |         
|LIABILITIES AND STOCKHOLDERS
    EQUITY       
|Current liabilities:                            |                                                                                                                                                               |                                            |       |          |        |  |       |         
|                                                | Line of credit                                                                                                                                                |                                            | $     | 1,000    |        |  | $     | 1,851    |       
|                                                | Current portion of capital lease obligations                                                                                                                  |                                            |       | 598      |        |  |       | 748      |       
|                                                | Current portion of note payable                                                                                                                               |                                            |       | 188      |        |  |       | 169      |       
|                                                | Accounts payable                                                                                                                                              |                                            |       | 1,352    |        |  |       | 2,282    |       
|                                                | Accrued compensation                                                                                                                                          |                                            |       | 3,452    |        |  |       | 2,082    |       
|                                                | Other accrued liabilities                                                                                                                                     |                                            |       | 3,408    |        |  |       | 3,854    |       
|                                                | Deferred revenue                                                                                                                                              |                                            |       | 5,968    |        |  |       | 4,106    |       
|                                                |                                                                                                                                                               |                                            |       |          |        |  |       |         
|                                                |                                                                                                                                                               | Total current liabilities                  |       |          | 15,966 |  |       |          | 15,092 | 
|Capital lease obligations, less current portion |                                                                                                                                                               |                                            | 405   |          |        |  | 958   |         
|Note payable, less current portion              |                                                                                                                                                               |                                            | 140   |          |        |  | 331   |         
|                                                |                                                                                                                                                               |                                            |       |          |        |  |       |         
|                                                |                                                                                                                                                               | Total liabilities                          |       |          | 16,511 |  |       |          | 16,381 | 
|Commitments and contingencies (Notes 9 and 10)  |                                                                                                                                                               |                                            |       |          |        |  |       |         
|Stockholders equity:                           |                                                                                                                                                               |                                            |       |          |        |  |       |         
|                                                | Preferred stock, $0.001 par value; 5,000 shares
    authorized; no shares issued and outstanding as of
    December 31, 2002 and 2001, respectively           |                                            |       |         |        |  |       |         |       
|                                                | Common stock, $0.001 par value; 85,000 shares
    authorized; 30,599 and 29,951 shares issued and outstanding at
    December 31, 2002 and 2001, respectively |                                            |       | 31       |        |  |       | 30       |       
|                                                | Additional paid-in capital                                                                                                                                    |                                            |       | 166,727  |        |  |       | 164,273  |       
|                                                | Deferred stock-based compensation                                                                                                                             |                                            |       | (19      | )      |  |       | (400     | )     
|                                                | Accumulated other comprehensive income (loss)                                                                                                                 |                                            |       | 165      |        |  |       | (18      | )     
|                                                | Notes receivable from stockholders                                                                                                                            |                                            |       | (54      | )      |  |       | (83      | )     
|                                                | Accumulated deficit                                                                                                                                           |                                            |       | (103,449 | )      |  |       | (107,178 | )     
|                                                |                                                                                                                                                               |                                            |       |          |        |  |       |         
|                                                |                                                                                                                                                               | Total stockholders equity                 |       |          | 63,401 |  |       |          | 56,624 | 
|                                                |                                                                                                                                                               |                                            |       |          |        |  |       |         
|                                                |                                                                                                                                                               | Total liabilities and stockholders equity |       | $        | 79,912 |  |       | $        | 73,005 | 
|                                                |                                                                                                                                                               |                                            |       |          |        |  |       |         

See accompanying notes to consolidated financial
statements.

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PACKETEER, INC.

CONSOLIDATED STATEMENTS OF
OPERATIONS

|                                                                 |                                                                                                                                                     |                                       |        |        |        |      |         |        |         |   |         |        |        | 
|---------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------- | ------ | ------ | ------ | ---- | ------- | ------ | ------- | - | ------- | ------ | ------ | 
|                                                                 |                                                                                                                                                     |                                      
|                                                                 |                                                                                                                                                     | Years Ended December 31,             
|                                                                 |                                                                                                                                                     |                                      
|                                                                 |                                                                                                                                                     | 2002                                  |        | 2001   |        | 2000
|                                                                 |                                                                                                                                                     |                                       |        |        |        |     
|                                                                 |                                                                                                                                                     |                                      
|                                                                 |                                                                                                                                                     | (In thousands, except per share data)
|Net revenues:                                                    |                                                                                                                                                     |                                       |        |        |        |      |         |        |         |   |         |       
|                                                                 | Product revenues                                                                                                                                    |                                       | $      | 47,192 |        |      | $       | 41,108 |         |   | $       | 38,118 |       
|                                                                 | Service revenues                                                                                                                                    |                                       |        | 7,822  |        |      |         | 5,553  |         |   |         | 2,979  |       
|                                                                 |                                                                                                                                                     |                                       |        |        |        |      |         |        |         |   |         |       
|                                                                 |                                                                                                                                                     | Total net revenues                    |        |        | 55,014 |      |         |        | 46,661  |   |         |        | 41,097 | 
|Cost of revenues:                                                |                                                                                                                                                     |                                       |        |        |        |      |         |        |         |   |         |       
|                                                                 | Product costs                                                                                                                                       |                                       |        | 9,816  |        |      |         | 10,860 |         |   |         | 10,718 |       
|                                                                 | Service costs                                                                                                                                       |                                       |        | 3,036  |        |      |         | 3,007  |         |   |         | 1,867  |       
|                                                                 | Amortization of acquired technology                                                                                                                 |                                       |        |       |        |      |         | 1,199  |         |   |         | 678    |       
|                                                                 |                                                                                                                                                     |                                       |        |        |        |      |         |        |         |   |         |       
|                                                                 |                                                                                                                                                     | Total cost of revenues                |        |        | 12,852 |      |         |        | 15,066  |   |         |        | 13,263 | 
|                                                                 |                                                                                                                                                     |                                       |        |        |        |      |         |        |         |   |         |       
|Gross profit                                                     |                                                                                                                                                     |                                       | 42,162 |        |        |      | 31,595  |        |         |   | 27,834  |       
|Operating expenses:                                              |                                                                                                                                                     |                                       |        |        |        |      |         |        |         |   |         |       
|                                                                 | Research and development, excluding amortization
    of stock-based compensation of $183, $663 and $558 for 2002,
    2001 and 2000, respectively   |                                       |        | 10,694 |        |      |         | 11,697 |         |   |         | 8,760  |       
|                                                                 | Sales and marketing, excluding amortization of
    stock-based compensation of $151, $442 and $892 for 2002, 2001
    and 2000, respectively        |                                       |        | 23,269 |        |      |         | 22,417 |         |   |         | 18,614 |       
|                                                                 | General and administrative, excluding
    amortization of stock-based compensation of $51, $128 and $233
    for 2002, 2001, and 2000, respectively |                                       |        | 4,585  |        |      |         | 5,704  |         |   |         | 4,824  |       
|Amortization of goodwill                                         |                                                                                                                                                     |                                       |       |        |        |      | 11,017  |        |         |   | 6,424   |       
|Impairment of goodwill and intangibles                           |                                                                                                                                                     |                                       |       |        |        |      | 52,552  |        |         |   |        |       
|Amortization of stock-based compensation                         |                                                                                                                                                     |                                       | 385    |        |        |      | 1,233   |        |         |   | 1,683   |       
|                                                                 |                                                                                                                                                     |                                       |        |        |        |      |         |        |         |   |         |       
|                                                                 |                                                                                                                                                     | Total operating expenses              |        |        | 38,933 |      |         |        | 104,620 |   |         |        | 40,305 | 
|                                                                 |                                                                                                                                                     |                                       |        |        |        |      |         |        |         |   |         |       
|Net income (loss) from operations                                |                                                                                                                                                     |                                       | 3,229  |        |        |      | (73,025 | )      |         |   | (12,471 | )     
|Interest and other income                                        |                                                                                                                                                     |                                       | 1,392  |        |        |      | 3,170   |        |         |   | 4,020   |       
|Interest and other expense                                       |                                                                                                                                                     |                                       | (477   | )      |        |      | (1,133  | )      |         |   | (618    | )     
|                                                                 |                                                                                                                                                     |                                       |        |        |        |      |         |        |         |   |         |       
|Net income (loss) before income taxes                            |                                                                                                                                                     |                                       | 4,144  |        |        |      | (70,988 | )      |         |   | (9,069  | )     
|Provision for income taxes                                       |                                                                                                                                                     |                                       | 415    |        |        |      |        |        |         |   | 300     |       
|                                                                 |                                                                                                                                                     |                                       |        |        |        |      |         |        |         |   |         |       
|Net income (loss)                                                |                                                                                                                                                     | $                                     | 3,729  |        |        | $    | (70,988 | )      |         | $ | (9,369  | )     
|                                                                 |                                                                                                                                                     |                                       |        |        |        |      |         |        |         |   |         |       
|Basic and diluted net income (loss) per share                    |                                                                                                                                                     | $                                     | 0.12   |        |        | $    | (2.40   | )      |         | $ | (0.35   | )     
|                                                                 |                                                                                                                                                     |                                       |        |        |        |      |         |        |         |   |         |       
|Shares used in computing basic net income
    (loss) per share   |                                                                                                                                                     |                                       | 30,205 |        |        |      | 29,559  |        |         |   | 27,152  |       
|                                                                 |                                                                                                                                                     |                                       |        |        |        |      |         |        |         |   |         |       
|Shares used in computing diluted net income
    (loss) per share |                                                                                                                                                     |                                       | 30,718 |        |        |      | 29,559  |        |         |   | 27,152  |       
|                                                                 |                                                                                                                                                     |                                       |        |        |        |      |         |        |         |   |         |       

See accompanying notes to consolidated financial
statements.

39



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PACKETEER, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY AND COMPREHENSIVE (LOSS) INCOME

|                                                                                         |                                |                |        |            |  |             |    |               |  |             |         |              |  |         |        |               |  |        |     |      |   |   |      |   |  |   |          |         |   |   |         |         |   |   |          |         |  
|---------------------------------------------------------------------------------------- | ------------------------------ | -------------- | ------ | ---------- |  | ----------- | -- | ------------- |  | ----------- | ------- | ------------ |  | ------- | ------ | ------------- |  | ------ | --- | ---- | - | - | ---- | - |  | - | -------- | ------- | - | - | ------- | ------- | - | - | -------- | ------- | -
|                                                                                         |                                |                |        |            |  |             |    |               |  | Accumulated |         |              |  |         |        |               |  |       
|                                                                                         |                                |                |        |            |  |             |    | Other         |  | Notes       |         |              |  |         |        |              
|                                                                                         |                                | Common Stock   |        | Additional |  | Deferred    |    | Comprehensive |  | Receivable  |         |              |  |         |        | Comprehensive
|                                                                                         |                                |                |        | Paid-in    |  | Stock-Based |    | Income        |  | from        |         | Accumulated  |  |         |        | (Loss)       
|                                                                                         |                                | Shares         |        | Amount     |  | Capital     |    | Compensation  |  | (Loss)      |         | Stockholders |  | Deficit |        | Total         |  | Income
|                                                                                         |                                |                |        |            |  |             |    |               |  |             |         |              |  |         |        |               |  |       
|                                                                                         |                                |               
|                                                                                         |                                | (In thousands)
|Balances as of December 31, 1999                                                         |                                |                | 26,792 |            |  | $           | 27 |               |  | $           | 88,848  |              |  | $       | (2,138 | )             |  | $      | (58 | )    |   | $ | (738 | ) |  | $ | (26,821  | )       |   | $ | 59,120  |         |   | $ | (26,879  | )      
|Stock-based compensation to non-employees                                                |                                |                |       |            |  |             |   |               |  |             | 151     |              |  |         |       |               |  |        |    |      |   |   |     |   |  |   |         |         |   |   | 151     |         |   |   |          |        
|Issuance of common stock upon exercise of stock
    options                              |                                |                | 694    |            |  |             |   |               |  |             | 2,045   |              |  |         |       |               |  |        |    |      |   |   |     |   |  |   |         |         |   |   | 2,045   |         |   |   |          |        
|Charges in lieu of income taxes associated with
    alternative minimum income tax       |                                |                |       |            |  |             |   |               |  |             | 300     |              |  |         |       |               |  |        |    |      |   |   |     |   |  |   |         |         |   |   | 300     |         |   |   |          |        
|Issuance of common stock pursuant to Employee
    Stock Purchase Plan                    |                                |                | 98     |            |  |             |   |               |  |             | 1,303   |              |  |         |       |               |  |        |    |      |   |   |     |   |  |   |         |         |   |   | 1,303   |         |   |   |          |        
|Issuance of common stock upon exercise of
    warrants, net                              |                                |                | 74     |            |  |             |   |               |  |             |        |              |  |         |       |               |  |        |    |      |   |   |     |   |  |   |         |         |   |   |        |         |   |   |          |        
|Issuance of common stock and stock options
    related to the Workfire acquisition       |                                |                | 1,806  |            |  |             | 2  |               |  |             | 69,498  |              |  |         |       |               |  |        |    |      |   |   |     |   |  |   |         |         |   |   | 69,500  |         |   |   |          |        
|Repurchase of common stock                                                               |                                |                | (30    | )          |  |             |   |               |  |             | (27     | )            |  |         |       |               |  |        |    |      |   |   | 2    |   |  |   |         |         |   |   | (25     | )       |   |   |          |        
|Repayments of notes receivable from stockholders                                         |                                |                |       |            |  |             |   |               |  |             |        |              |  |         |       |               |  |        |    |      |   |   | 550  |   |  |   |         |         |   |   | 550     |         |   |   |          |        
|Deferred compensation related to stock options
    issued in the acquisition of Workfire |                                |                |       |            |  |             |   |               |  |             |        |              |  |         | (1,109 | )             |  |        |    |      |   |   |     |   |  |   |         |         |   |   | (1,109  | )       |   |   |          |        
|Amortization of stock- based compensation                                                |                                |                |       |            |  |             |   |               |  |             |        |              |  |         | 1,532  |               |  |        |    |      |   |   |     |   |  |   |         |         |   |   | 1,532   |         |   |   |          |        
|Comprehensive loss:                                                                      |                                |                |        |            |  |             |    |               |  |             |         |              |  |         |        |               |  |        |     |      |   |   |      |   |  |   |          |         |   |   |         |         |   |   |          |        
|                                                                                         | Unrealized gain on investment  |                |        |           |  |             |    |              |  |             |         |             |  |         |        |              |  |        |     | 135  |   |   |      |  |  |   |          |        |   |   |         | 135     |   |   |          | 135     |  
|                                                                                         | Net loss                       |                |        |           |  |             |    |              |  |             |         |             |  |         |        |              |  |        |     |     |   |   |      |  |  |   |          | (9,369  | ) |   |         | (9,369  | ) |   |          | (9,369  | )
|                                                                                         |                                |                |        |            |  |             |    |               |  |             |         |              |  |         |        |               |  |        |     |      |   |   |      |   |  |   |          |         |   |   |         |         |   |   |          |        
|Comprehensive loss                                                                       |                                |                |        |            |  |             |    |               |  |             |         |              |  |         |        |               |  |        |     |      |   |   |      |   |  |   |          |         |   |   |         |         |   |   | (9,234   | )      
|                                                                                         |                                |                |        |            |  |             |    |               |  |             |         |              |  |         |        |               |  |        |     |      |   |   |      |   |  |   |          |         |   |   |         |         |   |   |          |        
|Balances as of December 31, 2000                                                         |                                |                | 29,434 |            |  |             | 29 |               |  |             | 162,118 |              |  |         | (1,715 | )             |  |        | 77  |      |   |   | (186 | ) |  |   | (36,190  | )       |   |   | 124,133 |         |   |   | (36,113  | )      
|Stock-based compensation to non-employees                                                |                                |                |       |            |  |             |   |               |  |             | 51      |              |  |         |       |               |  |        |    |      |   |   |     |   |  |   |         |         |   |   | 51      |         |   |   |          |        
|Issuance of common stock upon exercise of stock
    options                              |                                |                | 401    |            |  |             | 1  |               |  |             | 840     |              |  |         |       |               |  |        |    |      |   |   |     |   |  |   |         |         |   |   | 841     |         |   |   |          |        
|Issuance of common stock pursuant to Employee
    Stock Purchase Plan                    |                                |                | 141    |            |  |             |   |               |  |             | 1,437   |              |  |         |       |               |  |        |    |      |   |   |     |   |  |   |         |         |   |   | 1,437   |         |   |   |          |        
|Repurchase of common stock                                                               |                                |                | (25    | )          |  |             |   |               |  |             | (40     | )            |  |         |       |               |  |        |    |      |   |   | 20   |   |  |   |         |         |   |   | (20     | )       |   |   |          |        
|Repayments of notes receivable from stockholders                                         |                                |                |       |            |  |             |   |               |  |             |        |              |  |         |       |               |  |        |    |      |   |   | 83   |   |  |   |         |         |   |   | 83      |         |   |   |          |        
|Amortization of stock- based compensation                                                |                                |                |       |            |  |             |   |               |  |             |        |              |  |         | 1,182  |               |  |        |    |      |   |   |     |   |  |   |         |         |   |   | 1,182   |         |   |   |          |        
|Reversal of unamortized deferred stock-based
    compensation for terminated employees   |                                |                |       |            |  |             |   |               |  |             | (133    | )            |  |         | 133    |               |  |        |    |      |   |   |     |   |  |   |         |         |   |   |        |         |   |   |          |        
|Comprehensive loss:                                                                      |                                |                |        |            |  |             |    |               |  |             |         |              |  |         |        |               |  |        |     |      |   |   |      |   |  |   |          |         |   |   |         |         |   |   |          |        
|                                                                                         | Unrealized gain on investments |                |        |           |  |             |    |              |  |             |         |             |  |         |        |              |  |        |     | 10   |   |   |      |  |  |   |          |        |   |   |         | 10      |   |   |          | 10      |  
|                                                                                         | Other                          |                |        |           |  |             |    |              |  |             |         |             |  |         |        |              |  |        |     | (105 | ) |   |      |  |  |   |          |        |   |   |         | (105    | ) |   |          | (105    | )
|                                                                                         | Net loss                       |                |        |           |  |             |    |              |  |             |         |             |  |         |        |              |  |        |     |     |   |   |      |  |  |   |          | (70,988 | ) |   |         | (70,988 | ) |   |          | (70,988 | )
|                                                                                         |                                |                |        |            |  |             |    |               |  |             |         |              |  |         |        |               |  |        |     |      |   |   |      |   |  |   |          |         |   |   |         |         |   |   |          |        
|Comprehensive loss                                                                       |                                |                |        |            |  |             |    |               |  |             |         |              |  |         |        |               |  |        |     |      |   |   |      |   |  |   |          |         |   |   |         |         |   |   | (71,083  | )      
|                                                                                         |                                |                |        |            |  |             |    |               |  |             |         |              |  |         |        |               |  |        |     |      |   |   |      |   |  |   |          |         |   |   |         |         |   |   |          |        
|Balances as of December 31, 2001                                                         |                                |                | 29,951 |            |  |             | 30 |               |  |             | 164,273 |              |  |         | (400   | )             |  |        | (18 | )    |   |   | (83  | ) |  |   | (107,178 | )       |   |   | 56,624  |         |   |   | (107,196 | )      
|Stock-based compensation to non-employees                                                |                                |                |       |            |  |             |   |               |  |             | 4       |              |  |         |       |               |  |        |    |      |   |   |     |   |  |   |         |         |   |   | 4       |         |   |   |          |        
|Issuance of common stock upon exercise of stock
    options                              |                                |                | 441    |            |  |             | 1  |               |  |             | 1,565   |              |  |         |       |               |  |        |    |      |   |   |     |   |  |   |         |         |   |   | 1,566   |         |   |   |          |        
|Issuance of common stock pursuant to Employee
    Stock Purchase Plan                    |                                |                | 207    |            |  |             |   |               |  |             | 885     |              |  |         |       |               |  |        |    |      |   |   |     |   |  |   |         |         |   |   | 885     |         |   |   |          |        
|Repayments of notes receivable from stockholders                                         |                                |                |       |            |  |             |   |               |  |             |        |              |  |         |       |               |  |        |    |      |   |   | 29   |   |  |   |         |         |   |   | 29      |         |   |   |          |        
|Amortization of stock- based compensation                                                |                                |                |       |            |  |             |   |               |  |             |        |              |  |         | 381    |               |  |        |    |      |   |   |     |   |  |   |         |         |   |   | 381     |         |   |   |          |        
|Comprehensive income:                                                                    |                                |                |        |            |  |             |    |               |  |             |         |              |  |         |        |               |  |        |     |      |   |   |      |   |  |   |          |         |   |   |         |         |   |   |          |        
|                                                                                         | Unrealized gain on investments |                |        |           |  |             |    |              |  |             |         |             |  |         |        |              |  |        |     | 78   |   |   |      |  |  |   |          |        |   |   |         | 78      |   |   |          | 78      |  
|                                                                                         | Other                          |                |        |           |  |             |    |              |  |             |         |             |  |         |        |              |  |        |     | 105  |   |   |      |  |  |   |          |        |   |   |         | 105     |   |   |          | 105     |  
|                                                                                         | Net income                     |                |        |           |  |             |    |              |  |             |         |             |  |         |        |              |  |        |     |     |   |   |      |  |  |   |          | 3,729   |   |   |         | 3,729   |   |   |          | 3,729   |  
|                                                                                         |                                |                |        |            |  |             |    |               |  |             |         |              |  |         |        |               |  |        |     |      |   |   |      |   |  |   |          |         |   |   |         |         |   |   |          |        
|Comprehensive income                                                                     |                                |                |        |            |  |             |    |               |  |             |         |              |  |         |        |               |  |        |     |      |   |   |      |   |  |   |          |         |   |   |         |         |   |   | 3,912    |        
|                                                                                         |                                |                |        |            |  |             |    |               |  |             |         |              |  |         |        |               |  |        |     |      |   |   |      |   |  |   |          |         |   |   |         |         |   |   |          |        
|Balances as of December 31, 2002                                                         |                                |                | 30,599 |            |  | $           | 31 |               |  | $           | 166,727 |              |  | $       | (19    | )             |  | $      | 165 |      |   | $ | (54  | ) |  | $ | (103,449 | )       |   | $ | 63,401  |         |   | $ | (103,284 | )      
|                                                                                         |                                |                |        |            |  |             |    |               |  |             |         |              |  |         |        |               |  |        |     |      |   |   |      |   |  |   |          |         |   |   |         |         |   |   |          |        

See accompanying notes to consolidated financial
statements

40



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##### Table of Contents



PACKETEER, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                         |                                                                                                            |                                                                                    |                                   |                                                         |       |        |        |         |        |       |        |         |       |        |        |  
|-------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------- | --------------------------------- | ------------------------------------------------------- | ----- | ------ | ------ | ------- | ------ | ----- | ------ | ------- | ----- | ------ | ------ | -
|                                                         |                                                                                                            |                                                                                   
|                                                         |                                                                                                            | Years Ended December 31,                                                          
|                                                         |                                                                                                            |                                                                                   
|                                                         |                                                                                                            | 2002                                                                               |                                   | 2001                                                    |       | 2000  
|                                                         |                                                                                                            |                                                                                    |                                   |                                                         |       |       
|                                                         |                                                                                                            |                                                                                   
|                                                         |                                                                                                            | (In thousands)                                                                    
|Cash flows from operating activities:                    |                                                                                                            |                                                                                    |                                   |                                                         |       |        |        |         |        |       |        |        
|                                                         | Net income (loss)                                                                                          |                                                                                    | $                                 | 3,729                                                   |       |        | $      | (70,988 | )      |       | $      | (9,369  | )    
|                                                         | Adjustments to reconcile net income
    (loss) to net cash provided by (used in) operating
    activities: |                                                                                    |                                   |                                                         |       |        |        |         |        |       |        |         |      
|                                                         |                                                                                                            | Depreciation                                                                       |                                   |                                                         | 1,270 |        |        |         | 1,910  |       |        |         | 1,181 |       
|                                                         |                                                                                                            | Amortization of goodwill and other intangibles                                     |                                   |                                                         |      |        |        |         | 12,263 |       |        |         | 7,128 |       
|                                                         |                                                                                                            | Impairment of goodwill and other intangibles                                       |                                   |                                                         |      |        |        |         | 52,552 |       |        |         |      |       
|                                                         |                                                                                                            | Amortization of stock-based compensation                                           |                                   |                                                         | 385   |        |        |         | 1,233  |       |        |         | 1,683 |       
|                                                         |                                                                                                            | Other non-cash charges                                                             |                                   |                                                         | 105   |        |        |         | 86     |       |        |         | 79    |       
|                                                         |                                                                                                            | Charges in lieu of income taxes associated with
    alternative minimum income tax |                                   |                                                         |      |        |        |         |       |       |        |         | 300   |       
|                                                         |                                                                                                            | Changes in operating assets and liabilities:                                       |                                   |                                                         |       |        |        |         |        |       |        |         |       |       
|                                                         |                                                                                                            |                                                                                    | Accounts receivable               |                                                         |       | (1,373 | )      |         |        | 1,828 |        |         |       | (3,954 | )     
|                                                         |                                                                                                            |                                                                                    | Other receivables                 |                                                         |       | (227   | )      |         |        | 914   |        |         |       | (1,062 | )     
|                                                         |                                                                                                            |                                                                                    | Inventories                       |                                                         |       | (102   | )      |         |        | 365   |        |         |       | (2,031 | )     
|                                                         |                                                                                                            |                                                                                    | Prepaids and other current assets |                                                         |       | (264   | )      |         |        | 146   |        |         |       | (668   | )     
|                                                         |                                                                                                            |                                                                                    | Accounts payable                  |                                                         |       | (930   | )      |         |        | 88    |        |         |       | 432    |       
|                                                         |                                                                                                            |                                                                                    | Accrued compensation              |                                                         |       | 1,370  |        |         |        | (328  | )      |         |       | 930    |       
|                                                         |                                                                                                            |                                                                                    | Other accrued liabilities         |                                                         |       | (446   | )      |         |        | (392  | )      |         |       | 2,131  |       
|                                                         |                                                                                                            |                                                                                    | Deferred revenue                  |                                                         |       | 1,862  |        |         |        | 739   |        |         |       | 2,155  |       
|                                                         |                                                                                                            |                                                                                    |                                   |                                                         |       |        |        |         |        |       |        |        
|                                                         |                                                                                                            |                                                                                    |                                   | Net cash provided by (used in) operating
    activities |       |        | 5,379  |         |        |       | 416    |         |       |        | (1,065 | )
|                                                         |                                                                                                            |                                                                                    |                                   |                                                         |       |        |        |         |        |       |        |        
|Cash flows from investing activities:                    |                                                                                                            |                                                                                    |                                   |                                                         |       |        |        |         |        |       |        |        
|                                                         | Purchases of property and equipment                                                                        |                                                                                    |                                   | (2,920                                                  | )     |        |        | (966    | )      |       |        | (2,606  | )    
|                                                         | Purchases of investments                                                                                   |                                                                                    |                                   | (67,586                                                 | )     |        |        | (92,710 | )      |       |        | (42,298 | )    
|                                                         | Proceeds from sales and maturities of investments                                                          |                                                                                    |                                   | 60,546                                                  |       |        |        | 118,441 |        |       |        | 50,104  |      
|                                                         | Acquisition, net of cash acquired                                                                          |                                                                                    |                                   |                                                        |       |        |        |        |        |       |        | (3,327  | )    
|                                                         | Other assets                                                                                               |                                                                                    |                                   | (38                                                     | )     |        |        | 435     |        |       |        | (427    | )    
|                                                         |                                                                                                            |                                                                                    |                                   |                                                         |       |        |        |         |        |       |        |        
|                                                         |                                                                                                            |                                                                                    |                                   | Net cash provided by (used in) investing
    activities |       |        | (9,998 | )       |        |       | 25,200 |         |       |        | 1,446  |  
|                                                         |                                                                                                            |                                                                                    |                                   |                                                         |       |        |        |         |        |       |        |        
|Cash flows from financing activities:                    |                                                                                                            |                                                                                    |                                   |                                                         |       |        |        |         |        |       |        |        
|                                                         | Net proceeds from issuance of common stock                                                                 |                                                                                    |                                   | 1,566                                                   |       |        |        | 841     |        |       |        | 2,045   |      
|                                                         | Sale of stock to employees under the ESPP                                                                  |                                                                                    |                                   | 885                                                     |       |        |        | 1,437   |        |       |        | 1,303   |      
|                                                         | Proceeds from stockholders notes receivable                                                               |                                                                                    |                                   | 29                                                      |       |        |        | 83      |        |       |        | 550     |      
|                                                         | Repurchase of common stock                                                                                 |                                                                                    |                                   |                                                        |       |        |        | (20     | )      |       |        | (25     | )    
|                                                         | Borrowings under line of credit                                                                            |                                                                                    |                                   |                                                        |       |        |        | 8,542   |        |       |        | 2,900   |      
|                                                         | Repayments of line of credit                                                                               |                                                                                    |                                   | (851                                                    | )     |        |        | (10,370 | )      |       |        | (1,111  | )    
|                                                         | Proceeds from notes payable                                                                                |                                                                                    |                                   |                                                        |       |        |        | 551     |        |       |        |        |      
|                                                         | Payments of notes payable                                                                                  |                                                                                    |                                   | (172                                                    | )     |        |        | (101    | )      |       |        | (2,629  | )    
|                                                         | Proceeds from lease financing                                                                              |                                                                                    |                                   |                                                        |       |        |        |        |        |       |        | 1,500   |      
|                                                         | Principal payments of capital lease obligations                                                            |                                                                                    |                                   | (703                                                    | )     |        |        | (738    | )      |       |        | (195    | )    
|                                                         |                                                                                                            |                                                                                    |                                   |                                                         |       |        |        |         |        |       |        |        
|                                                         |                                                                                                            |                                                                                    |                                   | Net cash provided by financing activities               |       |        | 754    |         |        |       | 225    |         |       |        | 4,338  |  
|                                                         |                                                                                                            |                                                                                    |                                   |                                                         |       |        |        |         |        |       |        |        
|Currency impact                                          |                                                                                                            |                                                                                    |                                  |                                                         |       |        | (105   | )       |        |       |       |        
|Net increase (decrease) in cash and cash
    equivalents |                                                                                                            |                                                                                    | (3,865                            | )                                                       |       |        | 25,736 |         |        |       | 4,719  |        
|Cash and cash equivalents at beginning of year           |                                                                                                            |                                                                                    | 50,009                            |                                                         |       |        | 24,273 |         |        |       | 19,554 |        
|                                                         |                                                                                                            |                                                                                    |                                   |                                                         |       |        |        |         |        |       |        |        
|Cash and cash equivalents at end of year                 |                                                                                                            | $                                                                                  | 46,144                            |                                                         |       | $      | 50,009 |         |        | $     | 24,273 |        
|                                                         |                                                                                                            |                                                                                    |                                   |                                                         |       |        |        |         |        |       |        |        
|Supplemental disclosures of cash flow information:       |                                                                                                            |                                                                                    |                                   |                                                         |       |        |        |         |        |       |        |        
|                                                         | Cash paid during year for interest                                                                         |                                                                                    | $                                 | 251                                                     |       |        | $      | 543     |        |       | $      | 479     |      
|                                                         |                                                                                                            |                                                                                    |                                   |                                                         |       |        |        |         |        |       |        |        
|                                                         | Cash paid during year for taxes                                                                            |                                                                                    | $                                 | 89                                                      |       |        | $      | 40      |        |       | $      |        |      
|                                                         |                                                                                                            |                                                                                    |                                   |                                                         |       |        |        |         |        |       |        |        
|Non cash investing activities:                           |                                                                                                            |                                                                                    |                                   |                                                         |       |        |        |         |        |       |        |        
|                                                         | Common stock issued in the Workfire acquisition                                                            |                                                                                    | $                                 |                                                        |       |        | $      |        |        |       | $      | 64,300  |      
|                                                         |                                                                                                            |                                                                                    |                                   |                                                         |       |        |        |         |        |       |        |        
|                                                         | Stock options assumed in the Workfire acquisition                                                          |                                                                                    | $                                 |                                                        |       |        | $      |        |        |       | $      | 5,200   |      
|                                                         |                                                                                                            |                                                                                    |                                   |                                                         |       |        |        |         |        |       |        |        

See accompanying notes to consolidated financial
statements.

41



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

(In thousands, except per share
data)




|   |                                                                           
|-- | --------------------------------------------------------------------------
|1. | Description of Business and Summary of
    Significant Accounting Policies



| |                        
| | -----------------------
| | Description of Business

Packeteer, Inc., along with its subsidiaries
(collectively referred to herein as the Company)
provides application traffic management systems designed to
enable enterprises to gain visibility and control for networked
applications, extend network resources and align application
performance with business priorities. For service providers,
Packeteer systems provide a platform for delivering
application-intelligent network services that control quality of
service, expand revenue opportunities and offer compelling
differentiation. The Company was incorporated on
January 25, 1996, and commenced principal operations in
1997, at which time the Company began selling its products and
related services. The Company currently markets and distributes
its products via a worldwide network of resellers, distributors
and systems integrators.



| |                     
| | --------------------
| | Basis of Preparation

The accompanying consolidated financial
statements include the accounts of the Company and its wholly
owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation. Certain
previously reported amounts have been reclassified to conform to
the current presentation.



| |                 
| | ----------------
| | Use of Estimates

The preparation of consolidated financial
statements in conformity with generally accepted accounting
principles requires us to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and
expenses and related disclosures of contingent assets and
liabilities. On an ongoing basis, we evaluate our estimates,
including those related to inventory valuation, valuation of
long-lived assets, valuation allowances including sales return
reserves and allowance for doubtful accounts, and other
liabilities, specifically warranty reserves. We base our
estimates on historical experience and on various other
assumptions that are believed to be reasonable under the
circumstances. Actual results may differ from these estimates
under different assumptions or conditions.



| |                    
| | -------------------
| | Revenue Recognition

Product revenue consists primarily of sales of
our PacketShaper and AppCelera products, which include hardware,
as well as software licenses. Service revenue consists primarily
of maintenance revenue and, to a lesser extent, training revenue.

The Company applies the provisions of Statement
of Position 97-2, Software Revenue Recognition,
as amended by Statement of Position 98-9,
Modification of SOP 97-2, Software Revenue
Recognition, With Respect to Certain Transactions, to all
transactions involving the sale of hardware and software
products. Revenue is generally recognized when all of the
following criteria are met, as set forth in paragraph 8 of
SOP 97-2:



| |   |                                              
| | - | ---------------------------------------------
| |  | persuasive evidence of an arrangement exists,
|
| |  | delivery has occurred,                       
|
| |  | the fee is fixed or determinable, and        
|
| |  | collectibility is reasonably assured.        

This standard revenue recognition policy includes
modifications under certain circumstances as follows: Product
revenue on sales to major new distributors are recorded based on
sell-through to the end user customers until such time as the
Company has established significant experience with the
distributors product exchange activity. Additionally, when
the Company introduces new product into its distribution channel
for

42



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


which there is no historical customer demand or
acceptance history, revenue is recognized on the basis of
sell-through to end user customers until such time as demand or
acceptance history has been established.

The Company has analyzed all of the elements
included in its multiple element arrangements and has determined
that it has sufficient vendor specific objective evidence
(VSOE) of fair value to allocate revenue to the maintenance
component of its product and to training. VSOE is based upon
separate sales of maintenance renewals and training to
customers. Accordingly, assuming other revenue recognition
criteria are met, revenue from product sales is recognized upon
delivery using the residual method in accordance with
SOP 98-9. Revenue from maintenance is recognized ratably
over the maintenance term and revenue from training is
recognized when the training has taken place.



| |                      
| | ---------------------
| | Sales Return Reserves

Management makes estimates of potential future
product returns related to current period product revenue in
accordance with SFAS 48, Revenue Recognition When
Right of Return Exists. These sales return reserves are
recorded as a reduction to revenue. The Companys estimate
for sales returns is based on its historical return rates.



| |                                    
| | -----------------------------------
| | Allowance for Doubtful
    Accounts

The allowance for doubtful accounts reduces trade
receivables to their net realizable value. When evaluating the
adequacy of the allowance for doubtful accounts, management
reviews the aged receivables on an account-by-account basis,
taking into consideration such factors as age of the
receivables, customer history and estimated continued
credit-worthiness, as well as general economic and industry
trends.

The following provides additional details on the
allowance for doubtful accounts:

|                             |                                                              |                          |     |      |  |      |     |      |   |   |     |     |  
|---------------------------- | ------------------------------------------------------------ | ------------------------ | --- | ---- |  | ---- | --- | ---- | - | - | --- | --- | -
|                             |                                                              |                         
|                             |                                                              | Years Ended December 31,
|                             |                                                              |                         
|                             |                                                              | 2002                     |     | 2001 |  | 2000
|                             |                                                              |                          |     |      |  |     
|                             |                                                              |                         
|                             |                                                              | (In thousands)          
|Balance at beginning of year |                                                              | $                        | 132 |      |  | $    | 223 |      |   | $ | 217 |    
|                             | Provision, charged to general and administrative
    expense |                          |     | 12   |  |      |     | 15   |   |   |     | 16  |  
|                             | Writeoffs, net of recoveries                                 |                          |     | 1    |  |      |     | (106 | ) |   |     | (10 | )
|                             |                                                              |                          |     |      |  |      |     |      |   |   |     |    
|Balance at end of year       |                                                              | $                        | 145 |      |  | $    | 132 |      |   | $ | 223 |    
|                             |                                                              |                          |     |      |  |      |     |      |   |   |     |    



| |                 
| | ----------------
| | Cost Of Revenues

Cost of revenues consists primarily of costs of
product, overhead and maintenance support costs. The Company
provides currently for the estimated costs that may be incurred
under product warranties when products are shipped.

Amortization of acquired technology is also
included in total cost of revenues. During the third quarter of
2001, the Company performed an assessment of the carrying value
of goodwill and other intangibles, including acquired
technology. Based on this review, we recorded an impairment
charge that included the unamortized portion of the acquired
technology. For further discussion, see Goodwill and Other
Intangible Assets below.



| |                          
| | -------------------------
| | Cash and Cash Equivalents

The Company considers all highly liquid
investments with a maturity of three months or less from date of
purchase to be cash equivalents. Cash and cash equivalents
consist primarily of cash on deposit with banks, money market
instruments and investments in commercial paper that are stated
at costs which approximate fair market value.

43



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |            
| | -----------
| | Investments

Management determines the appropriate
classification of investment securities at the time of purchase
and reevaluates such designation as of each balance sheet date.
As of December 31, 2002 and 2001, all investment securities
are designated as available-for-sale.
Available-for-sale securities are carried at fair value based on
quoted market prices, with the unrealized gains
(losses) reported as a separate component of
stockholders equity. The cost of investments sold is
determined on the specific identification method.



| |            
| | -----------
| | Inventories

Inventories consist primarily of finished goods
and are stated at the lower of cost (on a first-in, first-out
basis) or market. We record inventory reserves for excess and
obsolete inventories based on historical usage and forecasted
demand. If future demand or market conditions are less favorable
than our projections, additional inventory write-downs may be
required and would be reflected in cost of sales in the period
the revision is made.



| |                       
| | ----------------------
| | Property and Equipment

Property and equipment, including equipment
acquired under capital lease, are recorded at cost. Depreciation
and amortization are provided using a straight-line method over
the estimated useful lives of the assets, generally
18 months to four years. Leasehold improvements are
amortized over the shorter of estimated useful lives of the
assets or the lease term, generally five years.

The Company accounts for long-lived assets under
SFAS 144, Accounting for Impairment or Disposal of
Long-Lived Assets. Under SFAS 144, the Company
regularly performs reviews to determine if the carrying value of
its long-lived assets is impaired. The purpose for the review is
to identify any facts or circumstances, either internal or
external, which indicate that the carrying value of the assets
cannot be recovered. Such facts or circumstances might include
significant underperformance relative to expected historical or
projected future operating results or significant negative
industry or economic trends. If such indicators are present, we
determine whether the sum of the estimated undiscounted cash
flows attributable to the assets in question is less than their
carrying value. If less, we recognize an impairment loss based
on the excess carrying amount of the assets over their
respective fair values. If quoted market prices for assets are
not available, the fair value is estimated based on the present
value of expected future cash flows. The fair value of the asset
then becomes the assets new carrying value.



| |                                          
| | -----------------------------------------
| | Advertising and Sales Promotion
    Costs

Advertising and sales promotion costs are
expensed as incurred. These costs were $166,000, $345,000 and
$316,000 for the years ended December 31, 2002, 2001 and
2000, respectively.



| |                                         
| | ----------------------------------------
| | Goodwill and Other Intangible
    Assets

The Company adopted SFAS No. 142,
Goodwill and Other Intangible Assets and SFAS
No. 144, Accounting for Impairment or Disposal of
Long-Lived Assets on January 1, 2002. SFAS
No. 142 changes the accounting for goodwill from an
amortization method to an impairment-only approach. As a result
of the goodwill write-off in the third quarter of 2001, the
adoption of SFAS No. 142 on January 1, 2002, had no
effect on the Companys results of operations or financial
position. SFAS No. 144 requires that long-lived assets be
measured at the lower of their carrying amount or fair value,
less cost to sell. Adoption of this statement did not have a
material impact on the Companys results of operations or
financial position.



| |                  
| | -----------------
| | Warranty Reserves

Upon shipment of products to its customers, the
Company provides for the estimated cost to repair or replace
products that may be returned under warranty. The Companys
warranty period is typically 12 months

44



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


from the date of shipment to the end user
customer. For existing products, the reserve is estimated based
on actual historical experience. For new products, the required
reserve is based on historical experience of similar products
until such time as sufficient historical data has been collected
on the new product. Packeteer adopted the provisions of FASB
Interpretation No. 45, Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others, in December 2002.
For the required disclosures regarding a reconciliation of
changes in the Companys product warranty liabilities see
Note 9.



| |                                   
| | ----------------------------------
| | Research and Development
    Costs

Development costs incurred in the research and
development of new products and enhancements to existing
products are expensed as incurred. Costs for the development of
new software products and enhancements to existing products are
expensed as incurred until technological feasibility has been
established, at which time any additional development costs
would be capitalized in accordance with SFAS No. 86,
Accounting for Costs of Computer Software To Be Sold,
Leased, or Otherwise Marketed. To date, the Companys
software has been available for general release concurrent with
the establishment of technological feasibility, and accordingly,
no costs have been capitalized.



| |                                               
| | ----------------------------------------------
| | Concentrations of Credit and Business
    Risk

Financial instruments, which potentially subject
the Company to concentrations of credit risk, consist primarily
of cash, cash equivalents, investments and accounts receivable.
The Companys cash, cash equivalents and investments are
maintained with highly accredited financial institutions and
investments are placed with high quality issuers. The Company
believes no significant concentration of credit risk exists with
respect to these financial instruments. Concentrations of credit
risk with respect to trade receivables are limited as the
Company performs ongoing credit evaluations of its customers.
Based on managements evaluation of potential credit
losses, the Company believes its allowances for doubtful
accounts are adequate.

The Company relies on one contract manufacturer
for the production of its product. The inability of the
manufacturer to fulfill supply requirements of the Company could
negatively impact future results. If the Companys contract
manufacturer cannot manufacture its products at required
volumes, on a cost effective basis, in a timely manner, or at
all, the Company will have to secure additional manufacturing
capacity. Even if this additional capacity is available on
commercially acceptable terms, the qualification process could
be lengthy and could cause disruptions to shipments. The Company
attempts to mitigate these risks by working closely with this
manufacturer regarding production planning and product
introduction timing. Additionally, the Company believes that it
carries sufficient finished goods and semi-finished goods
inventory to cover a portion of the transition lead-time if it
needs to secure additional manufacturing capacity.

The Companys products, application traffic
management systems, which are sold worldwide, are designed to
resolve a broad spectrum of problems faced by enterprises and
service providers. Accordingly, the Companys future
success depends upon the capital spending patterns of such
customers and the continued demand by such customers for the
Companys products. The networking industry is
characterized by rapidly changing technology, evolving industry
standards, changes in end-user requirements and frequent new
product introductions and enhancements.

The Companys continued success will depend
upon its ability to enhance existing products and to develop and
introduce, on a timely basis, new products and features that
keep pace with technology developments and emerging industry
standards. Furthermore, as a result of its international sales,
the Companys operations are subject to risks of doing
business abroad including, but not limited to, export duties,
changes to import and export regulations, longer payment cycles,
and greater difficulty in collecting accounts receivable. While
to date these factors have not had an adverse material impact on
the Companys consolidated results of operations, there can
be no assurance that there will not be such an impact in the
future.

45



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


We develop products in the United States and sell
in North America, Asia, Europe and the rest of the world. As a
result, our financial results could be affected by factors such
as changes in foreign currency exchange rates or weak economic
conditions in world-wide markets. All sales are currently made
in U.S. dollars; however, a strengthening of the dollar could
make our products less competitive in foreign markets. We have
no foreign exchange contracts, option contracts or other foreign
currency hedging arrangements.



| |             
| | ------------
| | Income Taxes

The Company uses the asset and liability method
of accounting for income taxes. Under this method, deferred tax
assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities
and their respective tax bases. 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 to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment
date. The measurement of deferred tax assets is reduced, if
necessary, by a valuation allowance for any tax benefits of
which future realization is uncertain.



| |                         
| | ------------------------
| | Stock-Based Compensation

The Companys stock-based employee
compensation plans are described more fully in Note 12 to
the consolidated financial statements. The Company adopted
SFAS 148, Accounting for Stock-Based
Compensation  Transition and Disclosure, which
amended SFAS 123, Accounting for Stock-Based
Compensation, in December 2002. As permitted under
SFAS 148, Packeteer has elected to continue to follow the
intrinsic value method in accounting for its stock-based
employee compensation arrangements. No stock-based employee
compensation cost is reflected in net income, as all options
granted under those plans had an exercise price equal to the
market value of the underlying common stock on the date of
grant. The following table illustrates the effect on net income
and earnings per share if the Company had applied the fair value
recognition provisions of SFAS 123 to stock-based employee
compensation.

|                                                                                                              |  |                        |        |      |  |      |          |   |  |   |         |  
|------------------------------------------------------------------------------------------------------------- |  | ---------------------- | ------ | ---- |  | ---- | -------- | - |  | - | ------- | -
|                                                                                                              |  | 2002                   |        | 2001 |  | 2000
|                                                                                                              |  |                        |        |      |  |     
|                                                                                                              |  |                       
|                                                                                                              |  | (In thousands,        
|                                                                                                              |  | except per share data)
|Net income (loss) as reported                                                                                 |  | $                      | 3,729  |      |  | $    | (70,988  | ) |  | $ | (9,369  | )
|Add: Stock-based compensation under APB 25                                                                    |  |                        | 381    |      |  |      | 1,182    |   |  |   | 1,532   |  
|Deduct: Stock-based employee compensation expense
    determined under fair value-based method for all awards |  |                        | (7,854 | )    |  |      | (30,198  | ) |  |   | (21,667 | )
|                                                                                                              |  |                        |        |      |  |      |          |   |  |   |         |  
|Net loss pro forma                                                                                            |  | $                      | (3,744 | )    |  | $    | (100,004 | ) |  | $ | (29,504 | )
|                                                                                                              |  |                        |        |      |  |      |          |   |  |   |         |  
|Earnings per share:                                                                                           |  |                        |        |      |  |      |          |   |  |   |         |  
|Basic and diluted  as reported                                                                               |  | $                      | 0.12   |      |  | $    | (2.40    | ) |  | $ | (0.35   | )
|Basic and diluted  pro forma                                                                                 |  | $                      | (0.12  | )    |  | $    | (3.38    | ) |  | $ | (1.09   | )

Compensation expense for pro forma purposes is
reflected over the vesting period. Note 12 contains the
significant assumptions used in determining the underlying fair
value of options.



| |                              
| | -----------------------------
| | Foreign Currency Transactions

The Companys sales to international
customers are U.S. dollar-denominated. As a result, there are no
foreign currency gains or losses related to these transactions.

The functional currency for the Companys
foreign subsidiaries is the U.S. dollar. Accordingly, the
entities remeasure monetary assets and liabilities at period-end
exchange rates, while non-monetary items are remeasured at
historical rates. Income and expense accounts are remeasured at
the average rates in effect

46



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


during the year. Remeasurement adjustments are
recognized in income as transaction gains or losses in the year
of occurrence. To date, the effect of such amounts on net income
has not been significant.



| |                                       
| | --------------------------------------
| | Other Comprehensive Income or
    Loss

The Company reports comprehensive income or loss
in accordance with the provisions of SFAS No. 130,
Reporting Comprehensive Income. SFAS No. 130
establishes standards for reporting comprehensive income and
loss and its components in financial statements. For the
Company, the primary differences between reported net income
(loss) and comprehensive income (loss) are unrealized
gains or losses on securities available for sale. Tax effects of
the components of other comprehensive income or loss are not
considered material for any periods presented.



| |                            
| | ---------------------------
| | Net Income (Loss) Per Share

Basic net income (loss) per share has been
computed using the weighted-average number of shares of common
stock outstanding during the period, less the weighted-average
number of shares of common stock that are subject to repurchase.
Diluted net income (loss) per share has been computed using the
weighted average number of common and potential common shares
outstanding during the period. All warrants for common stock and
outstanding stock options have been excluded from the
calculation of diluted net loss per share for periods where
their inclusion would be antidilutive.

The following table presents the calculation of
basic and diluted net income (loss) per share:

|             |                                               |                           |                                                         |                                                                                                 |  |        |        |         |   |        |        |        |   |        |        | 
|------------ | --------------------------------------------- | ------------------------- | ------------------------------------------------------- | ----------------------------------------------------------------------------------------------- |  | ------ | ------ | ------- | - | ------ | ------ | ------ | - | ------ | ------ | 
|             |                                               |                          
|             |                                               | Years Ended December 31, 
|             |                                               |                          
|             |                                               | 2002                      |                                                         | 2001                                                                                            |  | 2000  
|             |                                               |                           |                                                         |                                                                                                 |  |       
|             |                                               |                          
|             |                                               | (In thousands,           
|             |                                               | except per share amounts)
|Numerator:   |                                               |                           |                                                         |                                                                                                 |  |        |        |         |   |        |        |       
|             | Net income (loss)                             |                           | $                                                       | 3,729                                                                                           |  |        | $      | (70,988 | ) |        | $      | (9,369 | )
|             |                                               |                           |                                                         |                                                                                                 |  |        |        |         |   |        |        |       
|Denominator: |                                               |                           |                                                         |                                                                                                 |  |        |        |         |   |        |        |       
|             | Basic:                                        |                           |                                                         |                                                                                                 |  |        |        |         |   |        |        |        |  
|             |                                               |                           | Weighted-average shares of common stock
    outstanding |                                                                                                 |  | 30,206 |        |         |   | 29,578 |        |        |   | 27,452 |       
|             |                                               |                           | Less: shares subject to repurchase                      |                                                                                                 |  | 1      |        |         |   | 19     |        |        |   | 300    |       
|             |                                               |                           |                                                         |                                                                                                 |  |        |        |         |   |        |        |       
|             |                                               |                           |                                                         | Basic weighted-average common shares outstanding                                                |  |        | 30,205 |         |   |        | 29,559 |        |   |        | 27,152 | 
|             |                                               |                           |                                                         |                                                                                                 |  |        |        |         |   |        |        |       
|             |                                               | Diluted:                  |                                                         |                                                                                                 |  |        |        |         |   |        |        |        |   |       
|             |                                               |                           |                                                         | Basic weighted-average common shares outstanding                                                |  |        | 30,205 |         |   |        | 29,559 |        |   |        | 27,152 | 
|             |                                               |                           |                                                         | Add: potentially dilutive common shares from
    stock options and shares subject to repurchase |  |        | 513    |         |   |        |       |        |   |        |       | 
|             |                                               |                           |                                                         |                                                                                                 |  |        |        |         |   |        |        |       
|             |                                               |                           | Diluted weighted-average common shares                  |                                                                                                 |  | 30,718 |        |         |   | 29,559 |        |        |   | 27,152 |       
|             |                                               |                           |                                                         |                                                                                                 |  |        |        |         |   |        |        |       
|             | Basic and diluted net income (loss) per share |                           | $                                                       | 0.12                                                                                            |  |        | $      | (2.40   | ) |        | $      | (0.35  | )
|             |                                               |                           |                                                         |                                                                                                 |  |        |        |         |   |        |        |       

47



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


The following table sets forth the potential
common shares that were excluded from the net income (loss)
computation as their effect would have been anti-dilutive.

|                                                                  |  |                          |       |      |  |      |       |  |  |  |       | 
|----------------------------------------------------------------- |  | ------------------------ | ----- | ---- |  | ---- | ----- |  |  |  | ----- | 
|                                                                  |  |                         
|                                                                  |  | Years Ended December 31,
|                                                                  |  |                         
|                                                                  |  | 2002                     |       | 2001 |  | 2000
|                                                                  |  |                          |       |      |  |     
|                                                                  |  |                         
|                                                                  |  | (In thousands)          
|Shares issuable under stock options                               |  |                          | 1,881 |      |  |      | 3,216 |  |  |  | 3,848 | 
|Shares of unvested stock subject to repurchase                    |  |                          |      |      |  |      | 19    |  |  |  | 300   | 
|Shares issuable pursuant to warrants to purchase
    common stock |  |                          | 45    |      |  |      | 45    |  |  |  | 45    | 
|Shares held in escrow                                             |  |                          |      |      |  |      |      |  |  |  | 183   | 

For fiscal year 2002, certain employee stock
options and warrants were excluded from the computation because
the exercise price was greater that the average market price.
For fiscal years, 2001 and 2000, all employee options and
warrants were excluded from the computation as, due to the net
losses, the effect would have been anti-dilutive.



| |                      
| | ---------------------
| | Financial Instruments

The carrying value of cash, cash equivalents,
accounts receivable, accounts payable and accrued expenses
approximates their estimated fair value due to the relative
short maturity of these instruments. The carrying value of
long-term debt and capital lease obligations approximates
estimated fair value based on the market interest rates
available to the Company for debt of similar risk and maturities.



| |                                     
| | ------------------------------------
| | Recent Accounting
    Pronouncements

In June 2001, the FASB issued SFAS No. 143,
Accounting for Asset Retirement Obligations.
SFAS 143 addresses the financial accounting and reporting
for obligations and retirement costs related to the retirement
of tangible long-lived assets. Packeteer is required to adopt
SFAS 143 for our fiscal year beginning January 1,
2003. Adoption of this statement is not expected to have an
impact on the Companys results of operations or financial
position.

In June 2002, the FASB issued SFAS No. 146,
Accounting for Costs Associated With Exit or Disposal
Activities. SFAS 146 addresses financial accounting
and reporting for costs associated with exit or disposal
activities and requires the costs to be recorded at their fair
values when a liability has been incurred. Under previous
guidance, certain exit costs were accrued upon managements
commitment to an exit plan, which is generally before an actual
liability has been incurred. Packeteer is required to adopt
SFAS 146 for any exit or disposal activities initiated
after December 31, 2002. At this time we do not believe the
adoption of SFAS 146 will have a material impact on the
Companys results of operations or financial condition.

In November 2002, the Emerging Issues Task Force
(EITF) issued EITF 00-21, Revenue Arrangements with
Multiple Deliverables. EITF 00-21 provides guidance
on determining whether a revenue arrangement contains multiple
deliverable items and if so, requires revenue be allocated
amongst the different items based on fair value. EITF 00-21
also requires revenue on any item in a revenue arrangement with
multiple deliverables not delivered completely must be deferred
until delivery of the item is complete. EITF 00-21 is
effective for all arrangements entered into in fiscal periods
beginning after June 15, 2003. We have not yet determined
the impact, if any this Statement will have on our consolidated
financial statements.

In January 2003, the FASB issued FASB
Interpretation No. 46, Consolidation of Variable
Interest Entities. FIN 46 requires consolidation of
variable interest entities by the entitys primary
beneficiary if the equity investors in the entity do not have
the characteristics of a controlling financial interest or
sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support
from other parties. FIN 46 is effective for all new
variable interest entities created or acquired after
January 31, 2003. FIN 46 must be applied beginning
July 1, 2003 to variable entities existing prior to
February 1, 2003. The

48



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


adoption of FIN 46 will not have a material
impact on the Companys results of operations or financial
condition.



|   |            
|-- | -----------
|2. | Acquisition

On September 13, 2000, Packeteer completed
the acquisition of Workfire for a total purchase price of
$72.8 million in a transaction accounted for as a purchase.
Workfire develops software that delivers accelerated Internet
services to Internet users. Packeteer exchanged 1,806,000 shares
of Packeteer common stock with a fair value of
$64.3 million for all of the outstanding stock of Workfire.
Of the total common shares issued, 183,000 shares were placed in
an escrow account to secure and collateralize the
indemnification obligations of Workfire shareholders to
Packeteer. Packeteer also assumed all of the outstanding stock
options of Workfire with a fair value of approximately
$5.2 million. The options were valued using the
Black-Scholes option pricing model with the following
assumptions: no dividends, 110% volatility, 4.5 years
expected life, and 6.1% for the risk-free interest rate. In
addition, Packeteer paid certain liabilities having an aggregate
value of $1.8 million on behalf of Workfire.com, the sole
shareholder of Workfire. There were also $1.5 million of
direct transaction costs consisting primarily of professional
fees related to this transaction.

The acquisition was accounted for under the
purchase method of accounting in accordance with APB Opinion
No. 16. Under the purchase method of accounting, the
purchase price is allocated to the assets acquired and
liabilities assumed based on their estimated fair values. The
results of operations for Workfire have been included with the
Companys results since September 13, 2000.

The Company recognized stock-based compensation
expense associated with unvested stock options issued to
employees in conjunction with the acquisition. This amount is
included as a component of stockholders equity and is
being amortized by charges to operations over the vesting period
of the options, consistent with the method described in FIN
No 28. Amortization of stock-based compensation associated
with this acquisition totaled $153,000, $555,000 and $310,000
for the years ended December 31, 2002, 2001 and 2000,
respectively.

The following is a summary of the Workfire
purchase price allocation (in thousands):

|                                  |       |   |        |        | 
|--------------------------------- | ----- | - | ------ | ------ | 
|Property and equipment            |       | $ | 349    |       
|Other assets                      |       |   | 45     |       
|Lease obligations                 |       |   | (159   | )     
|Accounts payable                  |       |   | (696   | )     
|Deferred tax liability            |       |   | (1,400 | )     
|Deferred stock-based compensation |       |   | 1,109  |       
|Developed and core technology     |       |   | 7,194  |       
|Assembled workforce               |       |   | 281    |       
|Goodwill                          |       |   | 66,104 |       
|                                  |       |   |        |       
|                                  | Total |   | $      | 72,287 | 
|                                  |       |   |        |       

The following unaudited pro forma summary
represents the Companys consolidated results of operations
for the year ended December 31, 2000 as if the preceding
acquisition had been consummated at the beginning of fiscal
2000. The pro forma consolidated results of operations include
certain pro forma adjustments, including amortization of
goodwill and other intangible assets and amortization of
deferred stock-based compensation.

49



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Pro forma results for the year ended
December 31, 2000 are as follows (in thousands, except per
share data):

|                                     |  |      |         |  
|------------------------------------ |  | ---- | ------- | -
|                                     |  | 2000
|                                     |  |     
|Revenues                             |  | $    | 41,097  |  
|Net loss                             |  |      | (27,717 | )
|Basic and diluted net loss per share |  |      | (0.98   | )



|   |                                                                          
|-- | -------------------------------------------------------------------------
|3. | Goodwill and Other Intangible
    Assets  Adoption of FASB Statement 142

The following table presents the impact of SFAS
No. 142, Goodwill and Other Intangible Assets,
on net income (loss) and net income (loss) per share had the
standard been in effect for fiscal 2001 and 2000:

|                                      |                                 |                          |       |      |  |      |         |        |   |   |        |       |  
|------------------------------------- | ------------------------------- | ------------------------ | ----- | ---- |  | ---- | ------- | ------ | - | - | ------ | ----- | -
|                                      |                                 |                         
|                                      |                                 | Years Ended December 31,
|                                      |                                 |                         
|                                      |                                 | 2002                     |       | 2001 |  | 2000
|                                      |                                 |                          |       |      |  |     
|                                      |                                 |                         
|                                      |                                 | (In thousands, except   
|                                      |                                 | per share amounts)      
|Reported net income (loss)            |                                 | $                        | 3,729 |      |  | $    | (70,988 | )      |   | $ | (9,369 | )    
|                                      | Add back: Goodwill amortization |                          |       |     |  |      |         | 11,017 |   |   |        | 6,424 |  
|                                      |                                 |                          |       |      |  |      |         |        |   |   |        |      
|Adjusted net income (loss)            |                                 | $                        | 3,729 |      |  | $    | (59,971 | )      |   | $ | (2,945 | )    
|                                      |                                 |                          |       |      |  |      |         |        |   |   |        |      
|Basic and diluted earnings per share: |                                 |                          |       |      |  |      |         |        |   |   |        |      
|                                      | Reported net income (loss)      |                          | $     | 0.12 |  |      | $       | (2.40  | ) |   | $      | (0.35 | )
|                                      | Goodwill amortization           |                          |       | 0.00 |  |      |         | 0.37   |   |   |        | 0.24  |  
|                                      |                                 |                          |       |      |  |      |         |        |   |   |        |      
|                                      | Adjusted net income (loss)      |                          | $     | 0.12 |  |      | $       | (2.03  | ) |   | $      | (0.11 | )
|                                      |                                 |                          |       |      |  |      |         |        |   |   |        |      

During the third quarter of 2001, the Company
performed an assessment of the carrying value of the goodwill
and other intangible assets related to its acquisition of
Workfire pursuant to the Companys stated policy.
Managements determination of the existence of impairment
indicators included continued general economic slowing, broad
based declines in the values of networking technologies and a
review of current, historical and future projections of cash
flows related to these assets. The conclusion of the assessment
was a determination that the carrying value of the goodwill and
other intangible assets exceeded its fair value. The fair value
was determined based on Company projections of the present value
of future net cash flows to be generated over the expected lives
of these assets. Accordingly, the Company recorded an impairment
charge of $52.6 million during the third quarter of 2001
for the entire unamortized balance.

50



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|   |                      
|-- | ---------------------
|4. | Financial Instruments

The Companys cash equivalents and
investments consist of the following at December 31, 2002
and 2001:

|                                                                      |                       |                               |        |            |  |            |     |            |  |   |     |     |   |   |        |        | 
|--------------------------------------------------------------------- | --------------------- | ----------------------------- | ------ | ---------- |  | ---------- | --- | ---------- |  | - | --- | --- | - | - | ------ | ------ | 
|                                                                      |                       |                              
|                                                                      |                       | Available-For-Sale Securities
|                                                                      |                       |                              
|                                                                      |                       |                               |        | Gross      |  | Gross      |     |           
|                                                                      |                       | Amortized                     |        | Unrealized |  | Unrealized |     | Estimated 
|                                                                      |                       | Cost                          |        | Gains      |  | Losses     |     | Fair Value
|                                                                      |                       |                               |        |            |  |            |     |           
|                                                                      |                       |                              
|                                                                      |                       | (In thousands)               
|DECEMBER 31, 2002                                                     |                       |                               |        |            |  |            |     |            |  |   |     |     |   |   |        |       
|Commercial paper, corporate bonds and notes and
    medium-term notes |                       | $                             | 46,498 |            |  | $          | 12  |            |  | $ |    |     |   | $ | 46,510 |       
|                                                                      |                       |                               |        |            |  |            |     |            |  |   |     |     |   |   |        |       
|                                                                      | Total debt securities |                               |        | 46,498     |  |            |     | 12         |  |   |     |    |   |   |        | 46,510 | 
|Government securities                                                 |                       |                               | 17,186 |            |  |            | 154 |            |  |   | (1  | )   |   |   | 17,339 |       
|                                                                      |                       |                               |        |            |  |            |     |            |  |   |     |     |   |   |        |       
|                                                                      |                       | $                             | 63,684 |            |  | $          | 166 |            |  | $ | (1  | )   |   | $ | 63,849 |       
|                                                                      |                       |                               |        |            |  |            |     |            |  |   |     |     |   |   |        |       
|Amounts included in cash and cash equivalents                         |                       | $                             | 44,518 |            |  | $          | 1   |            |  | $ |    |     |   | $ | 44,519 |       
|Amounts included in short-term investments                            |                       |                               | 11,245 |            |  |            | 94  |            |  |   |    |     |   |   | 11,339 |       
|Amounts included in long-term investments                             |                       |                               | 7,921  |            |  |            | 71  |            |  |   | (1  | )   |   |   | 7,991  |       
|                                                                      |                       |                               |        |            |  |            |     |            |  |   |     |     |   |   |        |       
|                                                                      |                       | $                             | 63,684 |            |  | $          | 166 |            |  | $ | (1  | )   |   | $ | 63,849 |       
|                                                                      |                       |                               |        |            |  |            |     |            |  |   |     |     |   |   |        |       
|DECEMBER 31, 2001                                                     |                       |                               |        |            |  |            |     |            |  |   |     |     |   |   |        |       
|Commercial paper, corporate bonds and notes and
    medium-term notes |                       | $                             | 55,418 |            |  | $          | 141 |            |  | $ | (56 | )   |   | $ | 55,503 |       
|                                                                      |                       |                               |        |            |  |            |     |            |  |   |     |     |   |   |        |       
|                                                                      | Total debt securities |                               |        | 55,418     |  |            |     | 141        |  |   |     | (56 | ) |   |        | 55,503 | 
|Government securities                                                 |                       |                               | 4,993  |            |  |            | 2   |            |  |   |    |     |   |   | 4,995  |       
|                                                                      |                       |                               |        |            |  |            |     |            |  |   |     |     |   |   |        |       
|                                                                      |                       | $                             | 60,411 |            |  | $          | 143 |            |  | $ | (56 | )   |   | $ | 60,498 |       
|                                                                      |                       |                               |        |            |  |            |     |            |  |   |     |     |   |   |        |       
|Amounts included in cash and cash equivalents                         |                       | $                             | 48,336 |            |  | $          | 4   |            |  | $ | (54 | )   |   | $ | 48,286 |       
|Amounts included in short-term investments                            |                       |                               | 8,539  |            |  |            | 87  |            |  |   | (2  | )   |   |   | 8,624  |       
|Amounts included in long-term investments                             |                       |                               | 3,536  |            |  |            | 52  |            |  |   |    |     |   |   | 3,588  |       
|                                                                      |                       |                               |        |            |  |            |     |            |  |   |     |     |   |   |        |       
|                                                                      |                       | $                             | 60,411 |            |  | $          | 143 |            |  | $ | (56 | )   |   | $ | 60,498 |       
|                                                                      |                       |                               |        |            |  |            |     |            |  |   |     |     |   |   |        |       

The amortized cost and estimated fair value of
the Companys investments as of December 31, 2002,
shown by contractual maturity date, are as follows (in
thousands):

|                                           |  |                   |        |            |  |   |        | 
|------------------------------------------ |  | ----------------- | ------ | ---------- |  | - | ------ | 
|                                           |  |                  
|                                           |  | December 31, 2002
|                                           |  |                  
|                                           |  | Amortized Cost    |        | Fair Value
|                                           |  |                   |        |           
|Mature in one year or less                 |  | $                 | 55,763 |            |  | $ | 55,858 | 
|Mature between one year through five years |  |                   | 7,921  |            |  |   | 7,991  | 
|                                           |  |                   |        |            |  |   |        | 
|                                           |  | $                 | 63,684 |            |  | $ | 63,849 | 
|                                           |  |                   |        |            |  |   |        | 

51



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|   |            
|-- | -----------
|5. | Inventories

Inventories consisted of the following at
December 31 (in thousands):

|                   |             |      |       |       |  |   |       |       | 
|------------------ | ----------- | ---- | ----- | ----- |  | - | ----- | ----- | 
|                   |             | 2002 |       | 2001 
|                   |             |      |       |      
|Components         |             | $    | 48    |       |  | $ | 71    |      
|Completed products |             |      | 2,243 |       |  |   | 2,118 |      
|                   |             |      |       |       |  |   |       |      
|                   | Inventories |      | $     | 2,291 |  |   | $     | 2,189 | 
|                   |             |      |       |       |  |   |       |      



|   |                       
|-- | ----------------------
|6. | Property and Equipment

Property and equipment consisted of the following
at December 31 (in thousands):

|                                                |  |      |       |      |  |   |       | 
|----------------------------------------------- |  | ---- | ----- | ---- |  | - | ----- | 
|                                                |  | 2002 |       | 2001
|                                                |  |      |       |     
|Computers and equipment                         |  | $    | 3,118 |      |  | $ | 2,205 | 
|Equipment under capital lease                   |  |      | 2,199 |      |  |   | 3,143 | 
|Furniture and fixtures                          |  |      | 673   |      |  |   | 236   | 
|Leasehold improvements                          |  |      | 1,540 |      |  |   | 79    | 
|                                                |  |      |       |      |  |   |       | 
|                                                |  |      | 7,530 |      |  |   | 5,663 | 
|Less: accumulated depreciation and amortization |  |      | 4,503 |      |  |   | 4,286 | 
|                                                |  |      |       |      |  |   |       | 
|Property and equipment, net                     |  | $    | 3,027 |      |  | $ | 1,377 | 
|                                                |  |      |       |      |  |   |       | 

Accumulated depreciation and amortization
includes accumulated amortization of approximately
$2.0 million and $2.7 million on equipment under
capital lease as of December 31, 2002 and 2001,
respectively.



|   |                         
|-- | ------------------------
|7. | Revolving Loan Agreement

In January 2002, the Company renewed a revolving
loan agreement with a maximum line of credit of
$10.0 million. Advances are limited to the lesser of the
maximum line or the borrowing base, which is 80% of eligible
domestic receivables and 90% of eligible international
receivables. Additionally, the Company is required to maintain
certain financial covenants related to working capital and
quarterly net income (loss) amounts. The outstanding
principal balance accrues interest at a per annum rate equal to
the prime rate (which was 4.25% at December 31, 2002) and
is secured by all present and future collateral of the Company.
As of December 31, 2002, the outstanding balance on the
line was $1.0 million. The agreement expires in May 2003.
As of December 31, 2002 the Company was in compliance with
all terms of the revolving loan agreement.



|   |             
|-- | ------------
|8. | Note Payable

In August 2001, the Company secured a $551,000
equipment loan. Borrowings under this agreement are
collateralized by the purchased equipment, bear interest at the
rate of 11.1%, and are repayable in monthly installments over a
three-year period. At December 31, 2002, approximately
$328,000 was outstanding under this note.



|   |            
|-- | -----------
|9. | Commitments

The Company leases its facility and certain
equipment under non-cancelable lease agreements that expire at
various dates through 2010. Rent expense was $1.8 million,
$1.4 million, and $1.1 million for the years

52



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


ended December 31, 2002, 2001 and 2000,
respectively. As of December 31, 2002, the future minimum
rental payments under capital and operating leases are as
follows (in thousands):

|                                                                       |            |         |       |           |  |   |       |       | 
|---------------------------------------------------------------------- | ---------- | ------- | ----- | --------- |  | - | ----- | ----- | 
|Years Ending                                                           |            | Capital |       | Operating
|December 31,                                                           |            | Lease   |       | Lease    
|                                                                       |            |         |       |          
|                                                                       | 2003       |         | $     | 643       |  |   | $     | 1,365 | 
|                                                                       | 2004       |         |       | 490       |  |   |       | 1,205 | 
|                                                                       | 2005       |         |       |          |  |   |       | 1,211 | 
|                                                                       | 2006       |         |       |          |  |   |       | 1,425 | 
|                                                                       | 2007       |         |       |          |  |   |       | 1,195 | 
|                                                                       | Thereafter |         |       |          |  |   |       | 201   | 
|                                                                       |            |         |       |           |  |   |       |      
|Total future minimum lease payments                                    |            |         | 1,133 |           |  | $ | 6,602 |      
|                                                                       |            |         |       |           |  |   |       |      
|Less amounts representing interest at 6.47%-12.00%                     |            |         | 130   |           |  |   |       |      
|                                                                       |            |         |       |           |  |   |       |      
|Present value of future minimum lease payments
    under capital lease |            |         | 1,003 |           |  |   |       |      
|Less current portion                                                   |            |         | 598   |           |  |   |       |      
|                                                                       |            |         |       |           |  |   |       |      
|Long-term portion                                                      |            | $       | 405   |           |  |   |       |      
|                                                                       |            |         |       |           |  |   |       |      

Packeteer has outstanding purchase order
commitments for completed products of approximately
$1.2 million at December 31, 2002. Packeteer expects
the purchase orders to be fulfilled in the first quarter of 2003.

The Company records a liability for estimated
warranty obligations at the date products are sold. Adjustments
are made as new information becomes available. The provisions of
FASB Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness to Others, which
Packeteer adopted in December 2002, require disclosures about
the guarantees that an entity has issued, including a
reconciliation of changes in the entitys product warranty
liabilities. The following provides a reconciliation of changes
in Packeteers warranty reserve. The Company provides no
other guarantees.

|                             |                                  |                                        |     |      |      |      |     |      |   |   |     |      |   | 
|---------------------------- | -------------------------------- | -------------------------------------- | --- | ---- | ---- | ---- | --- | ---- | - | - | --- | ---- | - | 
|                             |                                  |                                       
|                             |                                  | For the Years Ended                   
|                             |                                  | December 31,                          
|                             |                                  |                                       
|                             |                                  | 2002                                   |     | 2001 |      | 2000
|                             |                                  |                                        |     |      |      |     
|                             |                                  |                                       
|                             |                                  | (In thousands)                        
|Balance at beginning of year |                                  | $                                      | 552 |      |      | $    | 577 |      |   | $ | 313 |     
|                             | Provision for current year sales |                                        |     | 227  |      |      |     | 531  |   |   |     | 747  |  
|                             |                                  | Adjustments of prior accrual estimates |     |      | (128 | )    |     |      |  |   |     |      |  | 
|                             | Warranty costs incurred          |                                        |     | (367 | )    |      |     | (556 | ) |   |     | (483 | )
|                             |                                  |                                        |     |      |      |      |     |      |   |   |     |     
|Balance at end of year       |                                  | $                                      | 284 |      |      | $    | 552 |      |   | $ | 577 |     
|                             |                                  |                                        |     |      |      |      |     |      |   |   |     |     



|    |            
|--- | -----------
|10. | Contingency

In November 2001, Packeteer, certain company
officers and directors, and its underwriters were named as
defendants in a securities class-action lawsuit filed in the
United States District Court for the Southern District of New
York. The complaint, captioned Antoniono v. Packeteer,
Inc. et. al.,alleges violations of Sections 11, 12(a)2
and 15 of the Securities Act of 1933, as amended,
Section 10(b) of the Securities Exchange Act of 1934 and
Rule 10b-5 promulgated thereunder on behalf of a purported
class of purchasers of Packeteer common stock between
July 27, 1999 and December 6, 2000. The plaintiffs
seek unspecified damages. Various plaintiffs have filed similar
actions asserting virtually identical allegations against more
than 300 other issuers. These cases have all been assigned
to the Hon. Shira A. Scheindlin.

53



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


In October 2002, the plaintiffs agreed to dismiss
the Companys officers and directors from the litigation
without prejudice, in return for a tolling agreement. The
Company moved to dismiss the claims against it. The Court
recently denied the motion. As a result, the case may proceed to
the discovery phase. We believe that we have meritorious
defenses to the lawsuit and will defend ourselves vigorously in
the litigation. We are not presently able to estimate the
losses, if any, related to this lawsuit, and accordingly, as of
December 31, 2002, no accrual for this contingency has been
recorded.

The Company is routinely involved in legal and
administrative proceedings incidental to its normal business
activities and believes that these matters will not have a
material adverse effect on financial position, results of
operations or cash flows.



|    |             
|--- | ------------
|11. | Income Taxes

Net income (loss) before income taxes is
attributable to the following geographic locations for the
periods ended December 31:

|              |                                        |                |        |       |  |      |         |         |   |   |        |        |  
|------------- | -------------------------------------- | -------------- | ------ | ----- |  | ---- | ------- | ------- | - | - | ------ | ------ | -
|              |                                        | 2002           |        | 2001  |  | 2000
|              |                                        |                |        |       |  |     
|              |                                        |               
|              |                                        | (In thousands)
|United States |                                        | $              | (2,894 | )     |  | $    | (10,939 | )       |   | $ | (1,858 | )     
|Foreign       |                                        |                | 7,038  |       |  |      | (60,049 | )       |   |   | (7,211 | )     
|              |                                        |                |        |       |  |      |         |         |   |   |        |       
|              | Net income (loss) before incomes taxes |                | $      | 4,144 |  |      | $       | (70,988 | ) |   | $      | (9,069 | )
|              |                                        |                |        |       |  |      |         |         |   |   |        |       

Our income tax provision for 2002 is primarily
attributable to income taxes payable in foreign jurisdictions.
The Company recorded no income tax provision or benefit in 2001,
as the Company reported a net loss. The income tax provision of
$300,000 for 2000 consists of charges in lieu of income taxes
associated with alternative minimum tax.

The provision (benefit) for income taxes
differs from the amount computed by applying the statutory
federal tax rate to income (loss) before tax as follows (in
thousands):

|                               |                                  |      |        |      |  |      |         |   |  |   |        |     | 
|------------------------------ | -------------------------------- | ---- | ------ | ---- |  | ---- | ------- | - |  | - | ------ | --- | 
|                               |                                  | 2002 |        | 2001 |  | 2000
|                               |                                  |      |        |      |  |     
|Federal tax at statutory rate  |                                  | $    | 1,409  |      |  | $    | (24,136 | ) |  | $ | (3,084 | )  
|State taxes                    |                                  |      | 6      |      |  |      |        |   |  |   |       |    
|Deferred tax asset utilized    |                                  |      |       |      |  |      |        |   |  |   | (4,465 | )  
|Operating loss not benefited   |                                  |      | 940    |      |  |      | 3,681   |   |  |   | 308    |    
|Non deductible expenses        |                                  |      | 43     |      |  |      | 21,652  |   |  |   | 2,226  |    
|Alternative minimum income tax |                                  |      |       |      |  |      |        |   |  |   | 300    |    
|Imputed interest               |                                  |      |       |      |  |      |        |   |  |   | 102    |    
|Intercompany revenue           |                                  |      |       |      |  |      |        |   |  |   | 4,913  |    
|Foreign tax differential       |                                  |      | (1,983 | )    |  |      | (1,197  | ) |  |   |       |    
|                               |                                  |      |        |      |  |      |         |   |  |   |        |    
|                               | Total provision for income taxes |      | $      | 415  |  |      | $       |  |  |   | $      | 300 | 
|                               |                                  |      |        |      |  |      |         |   |  |   |        |    

54



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


The types of temporary differences that give rise
to significant portions of the Companys net deferred tax
assets are set forth below (in thousands):

|                        |                                                                   |                           |         |        |        |   |         |        |        | 
|----------------------- | ----------------------------------------------------------------- | ------------------------- | ------- | ------ | ------ | - | ------- | ------ | ------ | 
|                        |                                                                   | 2002                      |         | 2001  
|                        |                                                                   |                           |         |       
|Deferred tax assets:    |                                                                   |                           |         |        |        |   |         |       
|                        | Various accruals and reserves not deductible for
    tax purposes |                           | $       | 1,251  |        |   | $       | 1,274  |       
|                        | Property and equipment                                            |                           |         | 409    |        |   |         | 421    |       
|                        | Net operating loss carryforwards                                  |                           |         | 19,574 |        |   |         | 18,535 |       
|                        | Tax credit carryforwards                                          |                           |         | 2,853  |        |   |         | 2,237  |       
|                        | Capitalized start-up expenditures                                 |                           |         |       |        |   |         | 22     |       
|                        |                                                                   |                           |         |        |        |   |         |       
|                        |                                                                   | Gross deferred tax assets |         |        | 24,087 |   |         |        | 22,489 | 
|Valuation allowance     |                                                                   |                           | (24,087 | )      |        |   | (22,489 | )     
|                        |                                                                   |                           |         |        |        |   |         |       
|Net deferred tax assets |                                                                   | $                         |        |        |        | $ |        |       
|                        |                                                                   |                           |         |        |        |   |         |       

The net change in the total valuation allowance
was an increase of $1.6 million and $8.5 million for the
years ended December 31, 2002 and 2001, respectively.
Although we reported net income in fiscal 2002, the Company has
previously reported net losses since inception, therefore it has
provided a full valuation allowance on its deferred tax assets.
Management believes that, based on a number of factors, the
available objective evidence creates sufficient uncertainty
regarding the realizability of the deferred tax assets such that
a full valuation allowance has been recorded.

Approximately $9.5 million of the valuation
allowance for deferred tax assets is attributable to employee
stock option deductions, the benefit from which will be
allocated to additional paid-in capital when and if subsequently
realized.

Deferred tax liabilities have not been recognized
for undistributed earnings of foreign subsidiaries because it is
managements intention to indefinitely reinvest such
undistributed earnings outside the U.S.

At December 31, 2002 the Company has net
operating loss carryforwards for federal and California income
tax purposes of approximately $52.3 million and
$23.4 million, respectively. If not utilized, the federal
net operating loss carryforwards will begin to expire in 2011,
and the California net operating loss carryforwards will begin
to expire in 2004. In addition, the Company had net operating
loss carryforwards of approximately $753,000 for Canadian income
tax purposes. If not utilized, these carryforwards will begin to
expire in 2005. At December 31, 2002, the Company had
federal and California research credit carryforwards of
approximately $1.7 million each. If not utilized, the
federal research credit carryforwards will begin to expire in
2011. The California research credit carryforwards can be
carried forward indefinitely.

Federal and California tax laws impose
substantial restrictions on the utilization of net operating
loss and tax credit carryforwards in the event of an
ownership change as defined in Internal Revenue Code
Section 382. The Company has not yet determined whether an
ownership change has occurred due to significant stock
transactions in the reporting years disclosed. If an ownership
change occurred, utilization of the net operating loss
carryforwards could be reduced significantly.

12.     Stockholders
Equity



| |                           
| | --------------------------
| | Preferred and Common Stock

The Companys Board of Directors has
authorized 5.0 million shares of preferred stock. The
authorized preferred stock shares are undesignated and the Board
has the authority to issue and to determine the rights,
preference and privileges thereof.

The Companys Board of Directors has
authorized 85.0 million shares of common stock.

55



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |         
| | --------
| | Warrants

As of December 31, 2002, 45,000 warrants to
purchase common stock were outstanding and exercisable with a
$6.25 average exercise price per share and an expiration date in
May 2009.



| |                                      
| | -------------------------------------
| | 1999 Employee Stock Purchase
    Plan

In May 1999, the Companys Board of
Directors adopted the 1999 Employee Stock Purchase Plan (the
ESPP). The ESPP became effective July 27, 1999.
At that time, 500,000 shares were reserved for issuance under
this plan. The number of shares reserved under this ESPP
automatically increases annually beginning on January 1,
2000 by the lesser of one million shares or 2% of the total
number of shares of common stock outstanding. The ESPP permits
participants to purchase common stock through payroll deductions
of up to 15% of an employees compensation, including
commissions, overtime, bonuses and other incentive compensation.
The purchase price per share is equal to 85% of the fair market
value per share on the participants entry date into the
offering period or, if lower, 85% of the fair market value per
share on the semi-annual purchase date. As of December 31,
2002, 447,000 shares had been issued under the plan and
1.8 million were available for future issuance. The fair
value of the discount and look-back features are considered
compensation for purposes of computing the Companys
pro-forma earnings for stock based compensation.



| |                          
| | -------------------------
| | 1999 Stock Incentive Plan

The 1999 Stock Incentive Plan (the 1999
Plan) is intended to serve as the successor program to our
1996 Equity Incentive Plan (the 1996 Plan). In May
1999, the Companys Board of Directors approved the 1999
Plan, which became effective on July 27, 1999, under which
900,000 shares were reserved for issuance. Previously, 515,000
shares were authorized under the 1996 Plan. In addition, any
shares not issued under the 1996 Plan will also be available for
grant under the 1999 Plan. The number of shares reserved under
the 1999 Plan automatically increases annually beginning on
January 1, 2000 by the lesser of three million shares or 5%
of the total number of shares of common stock outstanding. Under
the 1999 Plan, eligible individuals may be granted options to
purchase common shares or may be issued shares of common stock
directly. The 1999 Plan is administered by the Board of
Directors, which sets the terms and conditions of the options.
Non-statutory stock options and incentive stock options are
exercisable at prices not less than 85% and 100%, respectively,
of the fair value on the date of grant. The options become 25%
vested one year after the date of grant with 1/48 per month
vesting thereafter and expire at the end of 10 years from
date of grant or sooner if terminated by the Board of Directors.
The options may include a provision whereby the option holder
may elect at any time to exercise the option prior to the full
vesting of the option. Unvested shares so purchased shall be
subject to a repurchase right by the Company at the original
purchase price. Such right shall lapse at a rate equivalent to
the vesting period of the original option. As of
December 31, 2002, less than 1,000 shares were subject to
repurchase.

In October 2001, the Company announced a
voluntary stock option exchange program, or Offer to
Exchange, for all employees except executive officers.
Under the program, these employees had the opportunity to cancel
certain outstanding options previously granted to them that had
an exercise price at or above $5.00 in exchange for an equal
number of new options to be granted at a future date. The Offer
to Exchange was outstanding until 5:00 p.m., Pacific
Daylight Time on November 30, 2001 (the Expiration
Date). The exercise price of the new options was to be
equal to the fair market value of the Companys common
stock on the date of grant, which was June 3, 2002.
Participants electing to exchange any options were also required
to exchange all options granted to him or her during the six
months before the date of the Offer to Exchange and were
precluded from receiving any options during the six months after
the Expiration Date. Options totaling 1.5 million shares
were canceled under this program in November 2001. Options
totaling 1.4 million were reissued on June 3, 2002 at
an option price of $6.10 per share, which was the fair
market value on the date of grant.

56



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


A summary of stock option activity under 1996 and
1999 Plans follows:

|                                 |                                 |                                       |       |                     |   |                  |       |        |   |  |       |       | 
|-------------------------------- | ------------------------------- | ------------------------------------- | ----- | ------------------- | - | ---------------- | ----- | ------ | - |  | ----- | ----- | 
|                                 |                                 |                                       |       |                    
|                                 |                                 |                                       |       | Options Outstanding
|                                 |                                 | Available                             |       |                    
|                                 |                                 | For                                   |       | Number of           |   | Weighted-Average
|                                 |                                 | Grant                                 |       | Shares              |   | Exercise Price  
|                                 |                                 |                                       |       |                     |   |                 
|                                 |                                 |                                      
|                                 |                                 | (In thousands, except per share data)
|Balances as of December 31, 1999 |                                 |                                       | 1,155 |                     |   |                  | 2,727 |        |   |  | 5.68  |      
|                                 | Shares made available for grant |                                       |       | 1,340               |   |                  |       |       |   |  |       |      | 
|                                 | Repurchased                     |                                       |       | 30                  |   |                  |       |       |   |  |       |      | 
|                                 | Granted                         |                                       |       | (2,043              | ) |                  |       | 2,043  |   |  |       | 29.99 | 
|                                 | Exercised                       |                                       |       |                    |   |                  |       | (606   | ) |  |       | 3.07  | 
|                                 | Cancelled                       |                                       |       | 316                 |   |                  |       | (316   | ) |  |       | 16.70 | 
|                                 |                                 |                                       |       |                     |   |                  |       |        |   |  |       |      
|Balances as of December 31, 2000 |                                 |                                       | 798   |                     |   |                  | 3,848 |        |   |  | 18.09 |      
|                                 | Shares made available for grant |                                       |       | 1,474               |   |                  |       |       |   |  |       |      | 
|                                 | Repurchased                     |                                       |       | 25                  |   |                  |       |       |   |  |       |      | 
|                                 | Granted                         |                                       |       | (2,203              | ) |                  |       | 2,203  |   |  |       | 9.84  | 
|                                 | Exercised                       |                                       |       |                    |   |                  |       | (395   | ) |  |       | 2.10  | 
|                                 | Cancelled                       |                                       |       | 2,440               |   |                  |       | (2,440 | ) |  |       | 25.38 | 
|                                 |                                 |                                       |       |                     |   |                  |       |        |   |  |       |      
|Balances as of December 31, 2001 |                                 |                                       | 2,534 |                     |   |                  | 3,216 |        |   |  | 8.88  |      
|                                 | Shares made available for grant |                                       |       | 1,498               |   |                  |       |       |   |  |       |      | 
|                                 | Granted                         |                                       |       | (2,420              | ) |                  |       | 2,420  |   |  |       | 5.49  | 
|                                 | Exercised                       |                                       |       |                    |   |                  |       | (430   | ) |  |       | 3.59  | 
|                                 | Cancelled                       |                                       |       | 196                 |   |                  |       | (196   | ) |  |       | 6.87  | 
|                                 |                                 |                                       |       |                     |   |                  |       |        |   |  |       |      
|Balances as of December 31, 2002 |                                 |                                       | 1,808 |                     |   |                  | 5,010 |        |   |  | 7.77  |      
|                                 |                                 |                                       |       |                     |   |                  |       |        |   |  |       |      

The following tables summarize information about
stock options outstanding under the 1996 and 1999 Plans as of
December 31, 2002 (in thousands, except per share data):

|                |              |                     |  |                     |       |          |  |             |      |          |  |   |       |  |  |  |       |  |  |   |       | 
|--------------- | ------------ | ------------------- |  | ------------------- | ----- | -------- |  | ----------- | ---- | -------- |  | - | ----- |  |  |  | ----- |  |  | - | ----- | 
|                |              |                     |  |                     |       |         
|                |              | Options Outstanding |  |                    
|                |              |                     |  | Options Exercisable
|                |              |                     |  | Weighted            |       |          |  |            
|                |              |                     |  | Average             |       | Weighted |  | Number      |      | Weighted
|                |              | Number              |  | Remaining           |       | Average  |  | Exercisable |      | Average 
|Range of        |              | Outstanding         |  | Contractual         |       | Exercise |  | at          |      | Exercise
|Exercise Prices |              | at 12/31/02         |  | Life (Years)        |       | Price    |  | 12/31/02    |      | Price   
|                |              |                     |  |                     |       |          |  |             |      |         
|                | $0.25-$3.13  |                     |  |                     | 294   |          |  |             | 5.14 |          |  | $ | 2.19  |  |  |  | 252   |  |  | $ | 2.68  | 
|                | $3.35-$3.50  |                     |  |                     | 1,194 |          |  |             | 7.92 |          |  |   | 3.50  |  |  |  | 563   |  |  |   | 3.50  | 
|                | $3.70-$4.71  |                     |  |                     | 787   |          |  |             | 8.84 |          |  |   | 4.65  |  |  |  | 220   |  |  |   | 4.68  | 
|                | $4.75-$6.06  |                     |  |                     | 287   |          |  |             | 9.03 |          |  |   | 5.13  |  |  |  | 66    |  |  |   | 5.06  | 
|                | $6.10        |                     |  |                     | 1,320 |          |  |             | 7.69 |          |  |   | 6.10  |  |  |  | 748   |  |  |   | 6.10  | 
|                | $6.13-$16.88 |                     |  |                     | 908   |          |  |             | 8.26 |          |  |   | 11.38 |  |  |  | 385   |  |  |   | 12.44 | 
|                | $48.06       |                     |  |                     | 220   |          |  |             | 7.07 |          |  |   | 48.06 |  |  |  | 160   |  |  |   | 48.06 | 
|                |              |                     |  |                     |       |          |  |             |      |          |  |   |       |  |  |  |       |  |  |   |       | 
|                | $0.25-$48.06 |                     |  |                     | 5,010 |          |  |             | 7.93 |          |  |   | 7.77  |  |  |  | 2,394 |  |  |   | 8.74  | 
|                |              |                     |  |                     |       |          |  |             |      |          |  |   |       |  |  |  |       |  |  |   |       | 

57



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


|                                                                                       |  |                                       |       |                  |  |        |      |                  |  |        |       |                  |  |   |      |  |  |  |       |  |  |   |       | 
|-------------------------------------------------------------------------------------- |  | ------------------------------------- | ----- | ---------------- |  | ------ | ---- | ---------------- |  | ------ | ----- | ---------------- |  | - | ---- |  |  |  | ----- |  |  | - | ----- | 
|                                                                                       |  |                                      
|                                                                                       |  | Years Ended December 31,             
|                                                                                       |  |                                      
|                                                                                       |  |                                       |       |                  |  |       
|                                                                                       |  | 2002                                  |       | 2001             |  | 2000  
|                                                                                       |  |                                       |       |                  |  |       
|                                                                                       |  |                                       |       | Weighted-Average |  |        |      | Weighted-Average |  |        |       | Weighted-Average
|                                                                                       |  | Shares                                |       | Fair Value       |  | Shares |      | Fair Value       |  | Shares |       | Fair Value      
|                                                                                       |  |                                       |       |                  |  |        |      |                  |  |        |       |                 
|                                                                                       |  |                                      
|                                                                                       |  | (In thousands, except per share data)
|Weighted-average fair value of options granted
    during the year at market           |  |                                       | 2,420 |                  |  | $      | 5.49 |                  |  |        | 2,203 |                  |  | $ | 9.84 |  |  |  | 1,888 |  |  | $ | 22.75 | 
|Weighted-average fair value of options granted
    during the year at less than market |  |                                       |      |                  |  |        |     |                  |  |        |      |                  |  |   |     |  |  |  | 155*  |  |  |   | 33.55 | 



---



|  |                                                                              
|- | -----------------------------------------------------------------------------
|* | These option grants relate to options assumed in
    the Workfire acquisition

In the year ended December 31, 2002, 10,250
shares were issued as a result of the exercise of non-plan
options granted before the July 28, 1999 initial public
offering. As of December 31, 2002, there were 61,000
non-plan options outstanding with a weighted average exercise
price of $1.12 per share.



| |                         
| | ------------------------
| | Stock-Based Compensation

In connection with options granted in fiscal
years 1999 and 1998, the Company has recorded deferred
stock-based compensation of $3.9 million and $787,000,
respectively, representing the difference between the exercise
price and the fair value of the Companys common stock at
the date of grant. In fiscal year 2000, the Company recorded
deferred stock-based compensation of $1.1 million related
to employee options assumed in the Workfire acquisition. The
amounts are being amortized over the vesting period for the
individual options, generally four years. Amortization of
stock-based compensation of $385,000, $1.2 million and
$1.7 million was recognized during the years ended
December 31, 2002, 2001 and 2000, respectively.

For proforma purposes, the fair value of the
Companys stock option awards was estimated assuming no
expected dividends and the following weighted-average
assumptions for the years ended December 31:

|                         |  |         |      |      |  |      |      |   |  |  |      |  
|------------------------ |  | ------- | ---- | ---- |  | ---- | ---- | - |  |  | ---- | -
|                         |  |        
|                         |  | Options
|                         |  |        
|                         |  | 2002    |      | 2001 |  | 2000
|                         |  |         |      |      |  |     
|Expected life (years)    |  |         | 3    |      |  |      | 4    |   |  |  | 4    |  
|Expected volatility      |  |         | 124  | %    |  |      | 146  | % |  |  | 137  | %
|Risk-free interest rates |  |         | 3.14 | %    |  |      | 3.16 | % |  |  | 5.24 | %

To comply with pro forma reporting requirements
of SFAS 123, compensation cost is also estimated for the fair
value of ESPP issuances, which are included in the pro forma
totals above. The fair value of purchase rights granted under
the ESPP is estimated on the date of grant using the
Black-Scholes option pricing model with the same expected
volatility as the above assumptions, an expected life of
0.5 years and risk-free interest rates of 1.46%, 1.77% and
5.24% for the years 2002, 2001 and 2000, respectively. The
weighted-average fair value of the purchase rights granted under
the ESPP during fiscal 2002, 2001 and 2000 was $2.80, $7.50 and
$19.00, respectively.

58



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |                            
| | ---------------------------
| | Comprehensive Income (Loss)

The following table reflects the accumulated
balances of other comprehensive income (loss) in thousands:

|                          |                     |                |     |             |  |               |      |      |   |   |     |     |  
|------------------------- | ------------------- | -------------- | --- | ----------- |  | ------------- | ---- | ---- | - | - | --- | --- | -
|                          |                     |                |     |             |  | Accumulated  
|                          |                     | Gains (Losses) |     |             |  | Other        
|                          |                     | on Marketable  |     | Other       |  | Comprehensive
|                          |                     | Securities     |     | Adjustments |  | Income (Loss)
|                          |                     |                |     |             |  |              
|Balance December 31, 1999 |                     | $              | (58 | )           |  | $             |     |      |   | $ | (58 | )  
|                          | Current year change |                |     | 135         |  |               |      |     |   |   |     | 135 |  
|                          |                     |                |     |             |  |               |      |      |   |   |     |    
|Balance December 31, 2000 |                     |                | 77  |             |  |               |     |      |   |   | 77  |    
|                          | Current year change |                |     | 10          |  |               |      | (105 | ) |   |     | (95 | )
|                          |                     |                |     |             |  |               |      |      |   |   |     |    
|Balance December 31, 2001 |                     |                | 87  |             |  |               | (105 | )    |   |   | (18 | )  
|                          | Current year change |                |     | 78          |  |               |      | 105  |   |   |     | 183 |  
|                          |                     |                |     |             |  |               |      |      |   |   |     |    
|Balance December 31, 2002 |                     | $              | 165 |             |  | $             |     |      |   | $ | 165 |    
|                          |                     |                |     |             |  |               |      |      |   |   |     |    

Tax effects of the components of other
comprehensive income or loss are not considered material for any
periods presented.

13.     401(k)
Plan

In 1997, the Company adopted a 401(k) plan
(401(k)). Participation in the 401(k) is available
to all employees. Entry date to the 401(k) is the first day of
each month. Each participant may elect to contribute an amount
up to 100% of his or her annual base salary plus commission and
bonus, but not to exceed the statutory limit as prescribed by
the Internal Revenue Code. The Company may make discretionary
contributions to the 401(k). To date, no contributions have been
made by the Company.



|    |                  
|--- | -----------------
|14. | Segment Reporting

The Company has adopted the provisions of SFAS
No. 131, Disclosures about Segments of an Enterprise
and Related Information. The Companys chief
operating decision maker is considered to be the Companys
CEO. The CEO reviews financial information presented on a
consolidated basis substantially similar to the consolidated
financial statements. Therefore, the Company has concluded that
it operates in one segment and accordingly has provided only the
required enterprise-wide disclosures.

The Company operates in the United States and
internationally, and derives its revenue from the sale of
products and software licenses and maintenance contracts related
to these products. In 2002, three customers accounted for 21%,
13% and 11% of net revenues respectively. In 2001 and 2000, one
customer accounted for 22% and 12% of net revenues,
respectively. Sales outside of North America accounted for 58%,
55% and 54% of the Companys total revenues in 2002, 2001,
and 2000, respectively.



| |                       
| | ----------------------
| | Geographic Information

|              |                          |                          |   |        |        |      |   |        |        |  |   |        |        | 
|------------- | ------------------------ | ------------------------ | - | ------ | ------ | ---- | - | ------ | ------ |  | - | ------ | ------ | 
|              |                          |                         
|              |                          | Years Ended December 31,
|              |                          |                         
|              |                          | 2002                     |   | 2001   |        | 2000
|              |                          |                          |   |        |        |     
|              |                          |                         
|              |                          | (In thousands)          
|Net revenues: |                          |                          |   |        |        |      |   |        |        |  |   |       
|              | North America            |                          | $ | 23,109 |        |      | $ | 20,805 |        |  | $ | 18,791 |       
|              | Asia Pacific             |                          |   | 17,997 |        |      |   | 12,106 |        |  |   | 11,608 |       
|              | Europe and rest of world |                          |   | 13,908 |        |      |   | 13,750 |        |  |   | 10,698 |       
|              |                          |                          |   |        |        |      |   |        |        |  |   |       
|              |                          | Net revenues             |   | $      | 55,014 |      |   | $      | 46,661 |  |   | $      | 41,097 | 
|              |                          |                          |   |        |        |      |   |        |        |  |   |       

59



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Total net revenues reflect the destination of the
product shipped.

Long-lived assets are primarily located in North
America. Long-lived assets located outside North America are not
significant.



|    |                                                
|--- | -----------------------------------------------
|15. | Quarterly Results of Operations
    (Unaudited)

|                                       |  |                                          |        |               |  |          |        |           |  |   |        |  |  |   |        |  
|-------------------------------------- |  | ---------------------------------------- | ------ | ------------- |  | -------- | ------ | --------- |  | - | ------ |  |  | - | ------ | -
|                                       |  |                                         
|                                       |  | 2002 Quarter Ended                      
|                                       |  |                                         
|                                       |  | December 31,                             |        | September 30, |  | June 30, |        | March 31,
|                                       |  |                                          |        |               |  |          |        |          
|                                       |  |                                         
|                                       |  | (In thousands, except per share amounts)
|Net revenues                           |  | $                                        | 15,626 |               |  | $        | 14,037 |           |  | $ | 13,110 |  |  | $ | 12,241 |  
|Gross profit                           |  |                                          | 12,145 |               |  |          | 10,853 |           |  |   | 9,993  |  |  |   | 9,171  |  
|Net income (loss) from operations      |  |                                          | 1,888  |               |  |          | 1,078  |           |  |   | 354    |  |  |   | (91    | )
|Net income                             |  |                                          | 1,868  |               |  |          | 1,248  |           |  |   | 499    |  |  |   | 114    |  
|Basic and diluted net income per share |  |                                          | 0.06   |               |  |          | 0.04   |           |  |   | 0.02   |  |  |   | 0.00   |  

|                                     |  |                                          |        |               |  |          |         |           |  |   |        |   |  |   |        |  
|------------------------------------ |  | ---------------------------------------- | ------ | ------------- |  | -------- | ------- | --------- |  | - | ------ | - |  | - | ------ | -
|                                     |  |                                         
|                                     |  | 2001 Quarter Ended                      
|                                     |  |                                         
|                                     |  | December 31,                             |        | September 30, |  | June 30, |         | March 31,
|                                     |  |                                          |        |               |  |          |         |          
|                                     |  |                                         
|                                     |  | (In thousands, except per share amounts)
|Net revenues                         |  | $                                        | 11,464 |               |  | $        | 10,928  |           |  | $ | 13,088 |   |  | $ | 11,181 |  
|Gross profit                         |  |                                          | 8,497  |               |  |          | 7,770   |           |  |   | 8,556  |   |  |   | 6,772  |  
|Net loss from operations             |  |                                          | (1,167 | )             |  |          | (54,978 | )         |  |   | (7,227 | ) |  |   | (9,653 | )
|Net loss                             |  |                                          | (833   | )             |  |          | (54,282 | )         |  |   | (6,454 | ) |  |   | (9,419 | )
|Basic and diluted net loss per share |  |                                          | (0.03  | )             |  |          | (1.83   | )         |  |   | (0.22  | ) |  |   | (0.32  | )

60



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|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes In and Disagreements With
    Accountants on Accounting and Financial Disclosure

Not Applicable.




PART III

Pursuant to General Instruction G to
Form 10-K, the information required by Items 10, 11,
12, and 13 of Part III is incorporated by reference to our
definitive Proxy Statement with respect to our 2003 Annual
Meeting of Stockholders to be filed pursuant to
Regulation 14A with the Securities and Exchange Commission
not later than 120 days after December 31, 2002.






|         |                        
|-------- | -----------------------
|Item 14. | Controls and Procedures



|   |                                                     
|-- | ----------------------------------------------------
|a. | Evaluation of Disclosure Controls and
    Procedures

Within the 90 day period prior to the filing
date of this report, we carried out an evaluation, under the
supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures, as such term is defined
under Rule 13a-14 promulgated under the Securities Exchange
Act of 1934, as amended. Based upon that evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures were effective as of that
date.



|   |                             
|-- | ----------------------------
|b. | Changes in Internal Controls

There have been no significant changes (including
corrective actions with regard to significant deficiencies or
material weaknesses) in our internal controls or in other
factors that could significantly affect these controls
subsequent to the date of the evaluation referred to above.






|         |                                                                    
|-------- | -------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules and
    Reports on Form 8-K

(a)(1) Financial Statements



| |                                                                            
| | ---------------------------------------------------------------------------
| | See the Consolidated Statements beginning on
    page 38 of this Form 10-K.

(2) Financial Statement
Schedule



| |                                                                                                                                                                                                 
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | All financial statement schedules are omitted as
    the required information is inapplicable or the information is
    presented in the consolidated financial statements or related
    notes.

(3) Exhibits



| |                                                        
| | -------------------------------------------------------
| | See the Exhibit Index at page 66 of
    this Form 10-K.

(b) Reports on Form 8-K

A Current Report on Form 8-K dated
October 7, 2002, reporting under Item 5 
Other Events, was filed announcing Dave Côté had been
appointed President and CEO of the Company.

(c) See the Exhibit Index at
page 66 of this Form 10-K.

(d) See the Consolidated Financial
Statements beginning on page 38.

61



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##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, as amended, the
Registrant has duly caused this Annual Report on Form 10-K
to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Cupertino, State of California, on
this 20th day of March, 2003.



| |                
| | ---------------
| | PACKETEER, INC.



| |     |              
| | --- | -------------
| | By: | /s/ DAVE CÔTÉ

| |                                          
| | -----------------------------------------
| |                                          
| | Dave Côté                                
| | President and Chief Executive
    Officer

Date: March 20, 2003

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each
person whose signature appears below hereby constitutes and
appoints, jointly and severally, Dave Côté and David
Yntema, and each of them acting individually, as his
attorney-in-fact, each with full power of substitution and
resubstitution, for him or her in any and all capacities, to
sign any and all amendments to this Annual Report on
Form 10-K (including post-effective amendments), and to
file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact full power and
authority to do and perform each and every act and thing
requisite and necessary to be done in connection therewith as
fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that said
attorneys-in-fact, or their substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities
Exchange Act of 1934, this Report has been signed below by the
following persons on behalf of the Registrant and in the
capacities and on the dates indicated.

|                                   |  |                                                                                            |  |                |  | 
|---------------------------------- |  | ------------------------------------------------------------------------------------------ |  | -------------- |  | 
|                                   |  |                                                                                            |  |               
|Name                               |  | Title                                                                                      |  | Date          
|                                   |  |                                                                                            |  |               
|                                  
|/s/ DAVE CÔTÉDave Côté             |  | President and Chief Executive Officer (Principal
    Executive Officer)
    and Director   |  | March 20, 2003
|                                  
|/s/ DAVID YNTEMADavid Yntema       |  | Chief Financial Officer and Secretary (Principal
    Financial and
    Accounting Officer) |  | March 20, 2003
|                                  
|/s/ HAMID AHMADIHamid Ahmadi       |  | Director                                                                                   |  | March 20, 2003
|                                  
|/s/ STEVEN CAMPBELLSteven Campbell |  | Director                                                                                   |  | March 20, 2003
|                                  
|/s/ CRAIG ELLIOTTCraig Elliott     |  | Director                                                                                   |  | March 20, 2003

62



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|                                       |  |          |  |                |  | 
|-------------------------------------- |  | -------- |  | -------------- |  | 
|                                       |  |          |  |               
|Name                                   |  | Title    |  | Date          
|                                       |  |          |  |               
|                                      
|/s/ BRETT GALLOWAYBrett Galloway       |  | Director |  | March 20, 2003
|                                      
|/s/ JOSEPH GRAZIANOJoseph Graziano     |  | Director |  | March 20, 2003
|                                      
|/s/ L. WILLIAM KRAUSEL. William Krause |  | Director |  | March 20, 2003
|                                      
|/s/ PETER VAN CAMPPeter Van Camp       |  | Director |  | March 20, 2003

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##### Table of Contents



CERTIFICATIONS

I, Dave Côté, certify that:



| |                                                                                                                                                                                                                                                                                                                                                
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1. I have reviewed this annual report on
    Form 10-K of Packeteer, Inc.;                                                                                                                                                                                                                                                                     
|
| | 2. Based on my knowledge, this annual report
    does not contain any untrue statement of a material fact or omit
    to state a material fact necessary to make the statements made,
    in light of the circumstances under which such statements were
    made, not misleading with respect to the period covered by this
    annual report;
|
| | 3. Based on my knowledge, the financial
    statements, and other financial information included in this
    annual report, fairly present in all material respects the
    financial condition, results of operations and cash flows of the
    registrant as of, and for, the periods presented in this annual
    report;                   
|
| | 4. The registrants other certifying
    officer and I are responsible for establishing and maintaining
    disclosure controls and procedures (as defined in Exchange Act
    Rules 13a-14 and 15 d-14) for the registrant and we
    have:                                                                                                   



| |                                                                                                                                                                                                                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (a) designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this quarterly report is being prepared;
|
| | (b) evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                         
|
| | (c) presented in this annual report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                                   



| |                                                                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 5. The registrants other certifying
    officer and I have disclosed, based on our most recent
    evaluation, to the registrants auditors and the audit
    committee of registrants board of directors:



| |                                                                                                                                                                                                                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (a) all significant deficiencies in the
    design or operation of internal controls which could adversely
    affect the registrants ability to record, process,
    summarize and report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | (b) any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    



| |                                                                                                                                                                                                                                                                                                                                                                                                                 
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 6. The registrants other certifying
    officer and I have indicated in this annual report whether or
    not there were significant changes in internal controls or in
    other factors that could significantly affect internal controls
    subsequent to the date of our most recent evaluation, including
    any corrective actions with regard to significant deficiencies
    and material weaknesses.



| |                                                                            
| | ---------------------------------------------------------------------------
| | /s/ DAVE CÔTÉ 
     _______________________________________ 
     Dave Côté
| | President and Chief Executive
    Officer                                  

Date: March 20, 2003

64



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##### Table of Contents



I, David Yntema, certify that:



| |                                                                                                                                                                                                                                                                                                                                                
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1. I have reviewed this annual report on
    Form 10-K of Packeteer, Inc.;                                                                                                                                                                                                                                                                     
|
| | 2. Based on my knowledge, this annual report
    does not contain any untrue statement of a material fact or omit
    to state a material fact necessary to make the statements made,
    in light of the circumstances under which such statements were
    made, not misleading with respect to the period covered by this
    annual report;
|
| | 3. Based on my knowledge, the financial
    statements, and other financial information included in this
    annual report, fairly present in all material respects the
    financial condition, results of operations and cash flows of the
    registrant as of, and for, the periods presented in this annual
    report;                   
|
| | 4. The registrants other certifying
    officer and I are responsible for establishing and maintaining
    disclosure controls and procedures (as defined in Exchange Act
    Rules 13a-14 and 15 d-14) for the registrant and we
    have:                                                                                                   



| |                                                                                                                                                                                                                                                                                                                 
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (a) designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this annual report is being prepared;
|
| | (b) evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                      
|
| | (c) presented in this annual report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                                



| |                                                                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 5. The registrants other certifying
    officer and I have disclosed, based on our most recent
    evaluation, to the registrants auditors and the audit
    committee of registrants board of directors:



| |                                                                                                                                                                                                                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (a) all significant deficiencies in the
    design or operation of internal controls which could adversely
    affect the registrants ability to record, process,
    summarize and report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | (b) any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    



| |                                                                                                                                                                                                                                                                                                                                                                                                                 
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 6. The registrants other certifying
    officer and I have indicated in this annual report whether or
    not there were significant changes in internal controls or in
    other factors that could significantly affect internal controls
    subsequent to the date of our most recent evaluation, including
    any corrective actions with regard to significant deficiencies
    and material weaknesses.



| |                        
| | -----------------------
| | /s/ DAVID YNTEMA       
| |                        
| | David Yntema           
| | Chief Financial Officer

Date: March 20, 2003

65



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##### Table of Contents






EXHIBIT INDEX

|        |    |        |  |             |  |                                                                                                                                                                              
|------- | -- | ------ |  | ----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |        |  |            
|Number  |    |        |  | Description
|        |    |        |  |            
|        | 3  | .1(2)  |  |             |  | Registrants Amended and Restated
    Certificate of Incorporation.                                                                                                          
|        | 3  | .3(5)  |  |             |  | Registrants Amended and Restated Bylaws.                                                                                                                                    
|        | 4  | .1(2)  |  |             |  | Form of Registrants Specimen Common Stock
    Certificate.                                                                                                                  
|        | 10 | .2(2)  |  |             |  | OEM Agreement between Packeteer and ADC
    Telecommunications, Inc., dated December 17, 1998.                                                                               
|        | 10 | .4(2)  |  |             |  | Loan and Security Agreement between Packeteer and
    Silicon Valley Bank, dated January 1, 1999.                                                                            
|        | 10 | .5(2)  |  |             |  | Export-Import Bank Loan and Security Agreement
    between Packeteer and Silicon Valley Bank, dated
    January 19, 1999.                                                    
|        | 10 | .7(2)  |  |             |  | Master Lease Agreement between Packeteer and
    Comdisco, Inc., dated June 3, 1997.                                                                                         
|        | 10 | .8(2)  |  |             |  | Registrants 1996 Equity Incentive Plan.                                                                                                                                     
|        | 10 | .9(2)  |  |             |  | Registrants 1999 Stock Incentive Plan.                                                                                                                                      
|        | 10 | .10(2) |  |             |  | Registrants 1999 Employee Stock Purchase
    Plan.                                                                                                                          
|        | 10 | .11(2) |  |             |  | Form of Indemnity Agreement entered into by
    Registrant with each of its executive officers and directors.                                                                
|        | 10 | .13(2) |  |             |  | OEM Agreement between Packeteer and Lucent
    Technologies, Inc. dated June 25, 1999.                                                                                       
|        | 10 | .14(2) |  |             |  | OEM Agreement between Packeteer and Adtran, Inc.
    dated June 29, 1999.                                                                                                    
|        | 10 | .15(3) |  |             |  | Amendment dated February 2, 2000 to the Loan
    and Security Agreement and the Export-Import Bank Loan and
    security agreement between Packeteer and Silicon Valley Bank.
|        | 10 | .16(3) |  |             |  | Master Lease Agreement between Packeteer and
    Pentech Financial Services, Inc., dated November 1, 1999.                                                                   
|        | 10 | .19(5) |  |             |  | Amendment dated March 13, 2001 to the Loan
    and Security Agreement and the Export-Import Bank Loan and
    security agreement between Packeteer and Silicon Valley Bank.  
|        | 10 | .20(6) |  |             |  | Amendment dated January 9, 2002 to the Loan
    and Security Agreement and the Export-Import Bank Loan and
    Security Agreement between Packeteer and Silicon Valley Bank. 
|        | 10 | .21(6) |  |             |  | Amendment dated May 23, 2001 to the 1999
    Stock Incentive Plan.                                                                                                           
|        | 10 | .22(7) |  |             |  | Amendment dated May 22, 2002 to the 1999
    Stock Incentive Plan.                                                                                                           
|        | 10 | .23(7) |  |             |  | Facilities Lease Agreement dated July 15,
    2003, between NMSPCSLDHB, a California Limited Partnership, and
    the Company.                                               
|        | 10 | .24(1) |  |             |  | Employment Agreement dated September 27,
    2002 between Dave Côté and Packeteer, Inc.                                                                                      
|        | 21 | .1(1)  |  |             |  | Subsidiaries of Packeteer.                                                                                                                                                   
|        | 23 | .1(1)  |  |             |  | Consent of KPMG LLP, Independent Accountants.                                                                                                                                
|        | 24 | .1(1)  |  |             |  | Power of Attorney (see page 62).                                                                                                                                             
|        | 99 | .1(1)  |  |             |  | Sarbanes-Oxley Section 906
    Certification  CEO.                                                                                                                          
|        | 99 | .2(1)  |  |             |  | Sarbanes-Oxley Section 906
    Certification  CFO.                                                                                                                          



---



|    |                                                                                                                          
|--- | -------------------------------------------------------------------------------------------------------------------------
|(1) | Filed herewith.                                                                                                          
|   
|(2) | Incorporated by reference from Packeteers
    Registration Statement on Form S-1 (Reg.
    No. 79333-79077), as amended.
|   
|(3) | Incorporated by reference from Packeteers
    10-K dated March 23, 2000.                                                
|   
|(4) | Incorporated by reference from Packeteers
    10-Q dated November 13, 2000.                                             
|   
|(5) | Incorporated by reference from Packeteers
    10-K dated March 29, 2001.                                                
|   
|(6) | Incorporated by reference from Packeteers
    10-K dated March 22, 2002.                                                
|   
|(7) | Incorporated by reference from Packeteers
    10-Q dated August 13, 2002.