The following is a discussion of our results of operations and current financial position. This discussion should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included elsewhere in this report and the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the SEC on March 15, 2012, and as amended by Form 10-K/A, filed with the SEC on April 6, 2012.

As used in this Quarterly Report on Form 10-Q, references to the "Company," "we," "us," "our" or similar terms include Procera Networks, Inc. and its consolidated subsidiaries.

Cautionary Note Regarding Forward-Looking Statements

Our disclosure and analysis in this Quarterly Report on Form 10-Q contain certain "forward-looking statements," as such term is defined in Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). These statements set forth anticipated results based on management's plans and assumptions. From time to time, we also provide forward-looking statements in other materials we release to the public as well as oral forward-looking statements. Such statements give our current expectations or forecasts of future events; they do not relate strictly to historical or current facts. We have attempted to identify such statements by using words such as "anticipate," "estimate," "expect," "project," "intend," "plan," "believe," "will," "could," "initial," "future," "may," "predict," "potential," "should" and similar expressions in connection with any discussion of future events or future operating or financial performance or strategies. Such forward-looking statements include, but are not limited to, statements regarding:

? our services, including the development and deployment of products and services and strategies to expand our targeted customer base and broaden our sales channels;

? the operation of our company with respect to the development of products and services;

? our liquidity and financial resources, including anticipated capital expenditures, funding of capital expenditures and anticipated levels of indebtedness;

? trends related to and management's expectations regarding results of operations, required capital expenditures, revenues from existing and new products and sales channels, and cash flows, including but not limited to those statements set forth below in this Item 2; and

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

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

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

Our forward-looking statements are subject to a variety of factors that could cause actual results to differ significantly from current beliefs and expectations, identified under the caption "Risk Factors" and elsewhere in this Quarterly Report on Form 10-Q, as well as general risks and uncertainties such as those relating to general economic conditions and demand for our products and services.

Overview

We are a leading provider of Intelligent Policy Enforcement ("IPE") solutions that enable mobile and broadband network operators and entities managing private networks including higher education institutions, businesses and government entities (collectively referred to as network operators), to gain enhanced visibility into, and control of, their networks. Our solutions provide granular network intelligence intended to enable network operators to improve the quality and longevity of their networks, better monetize their network infrastructure investments, control security hazards and create and deploy new services for their users. We believe that the intelligence we provide about users and their usage enables qualified business decisions. Our network operator customers include mobile service providers, broadband service providers, cable multiple system operators ("MSOs"), Internet Service Providers ("ISPs"), educational institutions, enterprises and government agencies.

Our IPE products are part of the market for mobile packet and broadband core products. According to Infonetics Research, the market for IPE products is expected to grow from $344 million in 2010 to $2.1 billion in 2015, a compound annual growth rate of 43%. We have also entered the Application Delivery Networking market, which was a $2.6B addressable market in 2011, with our announcement of Carrier Grade NAT and Advanced Traffic Steering. Our solutions deliver a key element of the mobile packet and broadband core ecosystems by creating a policy enforcement layer in the network. Our solutions are often integrated with additional elements in the mobile packet and broadband core including Policy Management, Charging and Network Monitoring, Optimization and Assurance functions and are compliant with the widely adopted 3rd Generation Partnership Program ("3GPP") standard. In order to respond to rapidly increasing demand for network capacity due to increasing subscribers and usage, network operators are seeking higher degrees of intelligence, optimization, network management, service creation and delivery in order to differentiate their offerings and deliver a high quality of experience to their subscribers. We believe the need to create more intelligent and innovative mobile and broadband networks will continue to drive demand for our products.

Our products are marketed under the PacketLogic brand name. We have a broad spectrum of products delivering IPE at the access, edge and core layers of the network. Our products are designed to offer maximum flexibility to our customers and enable differentiated services and revenue-enhancing applications, all while delivering a high quality of service for subscribers.

We face competition from suppliers of standalone IPE and deep packet inspection ("DPI") products including Allot Communications Ltd., Arbor Networks (a subsidiary of Tektronix), Blue Coat Systems, Inc., Brocade Communications Systems, Inc., Cisco Systems, Inc., Cloudshield Technologies, Inc. (a subsidiary of SAIC, Inc.), Ericsson, Huawei Technologies Company, Ltd., Juniper Networks, Inc. and Sandvine Corporation. Some of our competitors supply platform products with different degrees of DPI functionality, such as switch/routers, routers, session border controllers and VoIP switches.

Most of our competitors are larger and more established enterprises with substantially greater financial and other resources. Some competitors may be willing to reduce prices and accept lower profit margins to compete with us. As a result of such competition, we could lose market share and sales, or be forced to reduce our prices to meet competition. However, we do not believe there is a dominant supplier in our market. Based on our belief in the superiority of our technology, we believe that we have an opportunity to capture meaningful market share and benefit from what we believe will be growth in the DPI market.

We were incorporated in 2002 and became a public company in October 2003 following our merger with Zowcom, Inc., a publicly-traded Nevada corporation. In 2006, we completed acquisitions of the Netintact entities. Our Company is headquartered in Fremont, California and we have regional headquarters in Varberg, Sweden and Singapore. We sell our products through our direct sales force, resellers, distributors and systems integrators in the Americas, Asia Pacific and Europe.

Critical Accounting Estimates

Our discussion and analysis of our financial condition and results of operations are based upon financial statements which have been prepared in accordance with Generally Accepted Accounting Principles in the United States ("U.S. GAAP"). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate these estimates. We base our estimates on historical experience and on assumptions that are believed to be reasonable. These estimates and assumptions provide a basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, and these differences may be material.

We believe the following critical accounting policies reflect our most significant estimates, judgments and assumptions used in the preparation of our consolidated financial statements:

These critical accounting policies and related disclosures appear in our Annual Report on Form 10-K for the year ended December 31, 2011.

Results of Operations

Comparison of Three and Six Months Ended June 30, 2012 and 2011

Revenue

Revenue for the three and six months ended June 30, 2012 and 2011 was as follows
(in thousands, except percentages):

                        Three Months Ended                        Six Months Ended
                              June 30,                                 June 30,
                         2012          2011       Increase        2012         2011        Increase

Net product revenue   $    11,863     $ 8,263            44 %   $ 21,692     $ 13,878             56 %
Net support revenue         2,802       1,393           101 %      5,305        2,701             96 %
Total revenue         $    14,665     $ 9,656            52 %   $ 26,997     $ 16,579             63 %

Total revenue for the three and six months ended June 30, 2012 was $14.7 million and $27.0 million, an increase of 52% and 63%, respectively, from the comparable periods in the prior year. Product revenue in the three and six months ended June 30, 2012 was $11.9 million and $21.7 million, an increase of 44% and 56%, respectively. Support revenue in the three and six months ended June 30, 2012 was $2.8 million and $5.3 million, an increase of 101% and 97%, respectively. The increase in product revenue in the three and six months ended June 30, 2012 compared to the same periods in 2011 reflected increased sales to wireline, wireless and cable service provider customers. The increase in product revenue also continued to reflect increased sales of our mid-range PL8000 series products. The increase in the support revenue in 2012 compared to the first six months of 2011 reflected the continued expansion of the installed base of our product to which we have sold ongoing support services. For the three months ended June 30, 2012, revenues from Shaw Communications, Inc. and two additional customers represented 16%, 22%, and 11% of net revenues, respectively, with no other single customer accounting for more than 10% of net revenues. For the six months ended June 30, 2012, revenues from Shaw Communications, Inc. and one additional customer represented 18% and 12% of net revenues, respectively, with no other single customer accounting for more than 10% of net revenue. For the three months ended June 30, 2011, revenues from three customers represented 19%, 14% and 13% of net revenues, respectively, and for the six months ended June 30, 2011, revenue from three customers represented 19%, 12% and 11% of net revenues, respectively, with no other single customer accounting for more than 10% of net revenue.

Sales to customers located in the United States as a percentage of total revenues were 57% and 59% for the three and six months ended June 30, 2012, respectively. Sales to customers located in the United States as a percentage of total revenues were 40% and 45% for the three and six months ended June 30, 2011, respectively.

Cost of Sales

Cost of sales includes direct labor and material costs for products sold, costs expected to be incurred for warranty, adjustments to inventory values, including the write-down of slow moving or obsolete inventory and costs for support personnel.

The following table presents the breakdown of cost of sales by category for the three and six months ended June 30, 2012 and 2011 (in thousands, except percentages):

                                  Three Months Ended                        Six Months Ended
                                       June 30,                                  June 30,
                            2012         2011       Increase       2012          2011         Increase
Product costs           $     5,171     $   3,563         45 % $     8,619     $   6,147              40 %
Percent of net product
revenue                          44 %          43 %                     39 %          44 %

Support costs                   247           125         98 %         469           261              80 %
Percent of net support
revenue                           9 %           9 %                      9 %          10 %

Total cost of sales       $   5,418     $   3,688         42 %   $   9,088     $   6,408              39 %
Percent of total net
revenue                          37 %          38 %                     34 %          39 %

Total cost of sales in the three and six months ended June 30, 2012 increased by $1.7 million and $2.7 million, respectively, compared to the three and six months ended 2011. Cost of sales as a percentage of revenue decreased by 1 and 5 percentage points for the three and six months ended June 30, 2012, respectively, from the comparable periods in the prior year. The increase in cost of sales in 2012 primarily reflected higher material costs associated with increased product sales. The decrease in cost of sales as a percentage of revenue for the three and six months ended June 30, 2012 primarily reflected increased sales of our appliance-based PL8000 series products, which have lower material costs compared with our other products, and an increased proportion of license revenue. Stock-based compensation recorded to cost of sales in the three and six months ended June 30, 2012 was $30,000 and $64,000, respectively, compared to $26,000 and $51,000, respectively, in the corresponding periods of 2011.

Gross Profit

Gross profit for the three and six months ended June 30, 2012 and 2011 was as
follows (in thousands, except percentages):

                                  Three Months Ended                           Six Months Ended
                                        June 30,                                    June 30,
                          2012         2011          Increase         2012          2011         Increase

Gross profit            $   9,247     $   5,968              58 %   $  17,909     $  10,171              78 %
Percent of total net

Our gross profit margin for the three and six months ended June 30, 2012 increased to 63% and 66%, respectively, from the comparable periods in the prior year. The improvement in margins for the three and six months ended June 30, 2012 was a result of a favorable mix of our appliance-based hardware, which have higher margins compared to our chassis based products, and a higher proportion of license revenue.

 Operating Expense

Operating expenses for the three and six months ended June 30, 2012 and 2011
were as follows (in thousands, except percentages):

                                   Three Months Ended                    Six Months Ended
                                         June 30,                             June 30,
                              2012        2011       Change        2012         2011       Change

Research and development     $ 1,791     $ 1,241          44 %   $  3,482     $  2,279          53 %
Sales and marketing            4,474       3,143          42 %      8,480        5,208          63 %
General and administrative     2,078       1,313          58 %      4,437        2,589          71 %
Total                        $ 8,343     $ 5,698          46 %   $ 16,399     $ 10,076          63 %

Research and Development

Research and development expenses include costs associated with personnel
focused on the development or improvement of our products, prototype materials,
initial product certifications and equipment costs. Research and development
costs include sustaining and enhancement efforts for products already released
and development costs associated with planned new products. Research and
development expenses for the three and six months ended June 30, 2012 were as
follows (in thousands, except percentages):

                                  Three Months Ended                           Six Months Ended
                                        June 30,                                    June 30,
                          2012          2011         Increase         2012          2011         Increase

Research and
development             $   1,791     $   1,241              44 %   $   3,482     $   2,279              53 %
As a percentage of

Research and development expenses for the three and six months ended June 30, 2012 increased by $0.6 million and $1.2 million, respectively, compared to the three and six months ended June 30, 2011 as a result of increased research and development personnel and the corresponding additional employee compensation costs, and costs for testing and testing equipment for new product introductions. Additional personnel are expected to allow us to enhance our core product features and functionality in order to support new sales and to achieve follow-on sales to our current customers. Stock-based compensation recorded to research and development expenses in the three and six months ended June 30, 2012 was $0.1 million and $0.2 million, respectively, compared to $22,000 and $64,000, respectively, in the corresponding periods in 2011.

Sales and Marketing

Sales and marketing expenses primarily include personnel costs, sales
commissions and marketing expenses, such as trade shows, channel development and
literature. Sales and marketing expenses for the three and six months ended June
30, 2012 were as follows (in thousands, except percentages):

                                  Three Months Ended                           Six Months Ended
                                        June 30,                                    June 30,
                           2012          2011          Change          2012          2011          Change
                            ($ in thousands)                            ($ in thousands)

Sales and marketing     $    4,474     $   3,143             42 %   $    8,480     $   5,208             63 %
As a percentage of

Sales and marketing expenses for the three and six months ended June 30, 2012 increased by $1.3 million and $3.3 million, respectively, compared to the three and six months ended June 30, 2011. The increase reflected the addition of sales and marketing personnel in 2012 and the corresponding higher compensation costs, and higher commission costs as a result of the increase in revenue. Stock-based compensation recorded to sales and marketing expenses in the three and six months ended June 30, 2012 was $0.3 million and $0.6 million, respectively, compared to $0.1 million and $0.2 million, respectively, in the corresponding periods in 2011.

General and Administrative

General and administrative expenses consist primarily of personnel and
facilities costs related to our executive, finance functions and service fees
for professional services. Professional services include costs for legal advice
and services, accounting and tax professionals, independent auditors and
investor relations. General and administrative expenses for the three and six
months ended June 30, 2012 were as follows (in thousands, except percentages):

                                  Three Months Ended                           Six Months Ended
                                        June 30,                                    June 30,
                           2012          2011          Change          2012          2011          Change
                            ($ in thousands)                            ($ in thousands)

General and
administrative          $    2,078     $   1,313             58 %   $    4,437     $   2,589             71 %
As a percentage of

General and administrative expenses for the three and six months ended June 30, 2012 increased by $0.8 million and $1.9 million, respectively, compared to the three and six months ended June 30, 2011, reflecting higher accrued bonus costs associated with exceeding revenue targets, business development expenses of $0.6 million, higher legal and audit fees and increased use of contractors and professionals as we scale the business. Stock-based compensation recorded to general and administrative expense in each of the three and six months ended June 30, 2012 was $0.2 million and $0.4 million, respectively, compared to $0.3 million and $0.4 million, respectively, in the corresponding periods in 2011.

Interest and Other Income (Expense), Net

                                    Three Months Ended                              Six Months Ended
                                         June 30,                                       June 30,
                           2012             2011          Change          2012             2011          Change
                             ($ in thousands)                               ($ in thousands)

Interest and other
income (expense), net $ (54 ) $ (34 ) 59 % $ (53 ) $ (65 ) 18 %

Interest and other income (expense), net in the three and six months ended June 30, 2012, reflected foreign exchange losses, partially offset by interest income earned on our cash and investment balances. Interest and other income (expense), net in the three and six months ended June 30, 2011 primarily reflected interest expense associated with our credit facility. Interest expense in the three and six months ended June 30, 2012 decreased from the prior year comparable periods, reflecting no borrowings currently under our credit facility.

Provision for Income Taxes

                                    Three Months Ended                     Six Months Ended
                                          June 30,                              June 30,
                               2012          2011      Change         2012         2011      Change
                               ($ in thousands)                      ($ in thousands)

Provision for income taxes $ 84 $ 55 53 % $ 112 $ 79 41 %

We are subject to taxation primarily in the U.S., Australia, Japan, Singapore and Sweden as well as in a number of U.S. states, including California. The increase in the tax provision for the three and six months ended June 30, 2012 compared to the three and six months ended June 30, 2011 reflects higher state and foreign taxes as a result of the increase in taxable income.

We have established a valuation allowance for substantially all of our deferred tax assets. We calculated the valuation allowance in accordance with the provisions of ASC 740, which requires that a valuation allowance be established or maintained when it is "more likely than not" that all or a portion of deferred tax assets will not be realized. We will continue to reserve for substantially all net deferred tax assets until there is sufficient evidence to warrant reversal.

Liquidity and Capital Resources

Cash and Cash Equivalents and Investments

The following table summarizes the changes in our cash balance for the periods
indicated:

                                                                  Six Months Ended
                                                                      June 30,
                                                                 2012          2011
                                                                  ($ in thousands)
Net cash provided by operating activities                      $   6,009     $  4,619
Net cash used in investing activities                            (46,634 )       (640 )
Net cash provided by financing activities                         89,684       25,020
Effect of exchange rate changes on cash and cash equivalents         (66 )        (69 )
Net increase in cash and cash equivalents                      $  48,993     $ 28,930

During the six months ended June 30, 2012, we generated $6.0 million in cash from operating activities as compared to $4.6 million for the six months ended June 30, 2011. Cash provided by operating activities during the six months ended June 30, 2012 primarily consisted of our net income of $1.3 million, non-cash charges of $2.2 million and net working capital sources of cash of $2.4 million. Non-cash charges consisted primarily of stock-based compensation of $1.4 million and depreciation expense of $0.3 million. Working capital sources of cash consisted primarily of a decrease in accounts receivable of $2.0 million due to . . .