The following is a discussion of our results of operations and current financial position. This discussion should be read in conjunction with our unaudited 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, 2008.

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" 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 and the ability to raise capital through financing activities;

• 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. Also note that we 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

Headquartered in Los Gatos, CA, Procera Networks, Inc. ("Procera" or the "Company") is a leading provider of bandwidth management and control products that deliver a broad set of capabilities which include congestion management, operational intelligence, and service creation capabilities for broadband service providers worldwide. The Company's products offer network administrators of service providers, governments, universities and enterprises intelligent network traffic identification, control and service management solutions.

The Company's proprietary software application, PacketLogic, offers users the ability to monitor network use on an application and user-specific basis in real-time, and offers improvements over existing deep packet inspection, or DPI, solutions. This capability allows network administrators to improve network utilization, reducing the need for additional infrastructure investment. PacketLogic's modular, traffic and service management software is comprised of five individual modules: traffic identification and classification, traffic shaping, traffic filtering, flow statistics and web-based statistics.

More than 600 service providers, higher-education institutions and other organizations (with over 1,300 systems installed) have chosen PacketLogic as their network traffic management solution.

The Company faces competition from suppliers of standalone DPI products such as Allot Communications, Arbor Networks, Blue Coat Systems, Brocade Communications Systems, Cisco Systems, Ericsson, Juniper Networks, 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 the Company's 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 the Company. As a result of such competition, the Company could lose market share and sales, or be forced to reduce its prices to meet competition. However, the Company does not believe there is a dominant supplier in its market. Based on the Company's belief in the superiority of its technology, the Company sees an opportunity to capture meaningful market share and benefit from what the Company believes will be growth in the DPI market.

Following the acquisition of Netintact AB and Netintact PTY in 2006, the Company's core products and business changed substantially. PacketLogic, the flagship product and technology of Netintact, now forms the core of the Company's sales and product offering. The Company sells its products through its direct sales force, resellers, distributors and system integrators in the Americas, Asia Pacific and Europe.

The Company continues to monitor the current unfavorable and uncertain domestic and global economic conditions, and the potential impact on IT spending, including spending for the products it sells. While the Company believes that its products may be less affected by current conditions than many other network products, the Company also believes that its customers are more carefully scrutinizing spending decisions, which could negatively impact its future revenues.

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. 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. Our significant accounting policies are summarized in Note 2 to our audited financial statements in our Annual Report on Form 10-K for the year ended December 31, 2008 filed with the SEC on March 16, 2009.

Management believes that there have been no significant changes during the nine months ended September 30, 2009 to the items that we disclosed as our critical accounting policies and estimates in Management's Discussion and Analysis of Financial Condition and Results of Operations section of our Annual Report on Form 10-K for the year ended December 31, 2008, filed with the SEC on March 16, 2009. In accordance with SEC guidance, the Company believes the following critical accounting policies reflect our most significant estimates, judgments and assumptions used in the preparation of our consolidated financial statements:

· Revenue Recognition;

· Valuation of Goodwill, Intangible and Long-Lived Assets;

· Allowance for Doubtful Account;

· Stock-Based Compensation; and

· Accounting for Income Taxes.

These critical accounting policies and related disclosures appear in our Annual Report on Form 10-K for the year ended December 31, 2008.

Recent Accounting Pronouncements

In February 2008, the Financial Accounting Standards Board ("FASB") issued an accounting standard update that delayed the effective date of fair value measurements accounting for all non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until the beginning of the first quarter of 2009. The Company adopted this accounting standard update effective January 1, 2009. The adoption of this update to non-financial assets and liabilities, as codified in ASC 820-10, did not have any impact on our consolidated financial statements. Our non-financial assets, such as goodwill, intangible assets, and property, plant and equipment, are measured at fair value when there is an indicator of impairment and recorded at fair value only when an impairment charge is recognized. No impairment indicators were present during the three and nine month periods ended September 30, 2009. When impairment indicators are present, we utilize various methods to determine the fair value of its non-financial assets. For example, to value property plant and equipment, we would use the cost method for determining fair value; for goodwill we would use a combination of analyzing our market capitalization based on the market price of our common stock and a determination of discounted cash flows of our operations.

Effective January 1, 2009, we adopted an accounting standard that requires unvested share-based payments that entitle employees to receive nonrefundable dividends to also be considered participating securities, as codified in ASC
260. The adoption of this accounting standard had no impact on the calculation of our earnings per share because we have not issued participating securities.

Effective April 1, 2009, we adopted three accounting standard updates which were intended to provide additional application guidance and enhanced disclosures regarding fair value measurements and impairments of securities. They also provide additional guidelines for estimating fair value in accordance with fair value accounting. The first update, as codified in ASC 820-10-65, provides additional guidelines for estimating fair value in accordance with fair value accounting. The second accounting update, as codified in ASC 320-10-65, changes accounting requirements for other-than-temporary-impairment for debt securities by replacing the current requirement that a holder have the positive intent and ability to hold an impaired security to recovery in order to conclude an impairment was temporary with a requirement that an entity conclude it does not intend to sell an impaired security and it will not be required to sell the security before the recovery of its amortized cost basis. The third accounting update, as codified in ASC 825-10-65, increases the frequency of fair value disclosures. These updates were effective for fiscal years and interim periods ended after June 15, 2009. The adoption of these accounting updates did not have any impact on our consolidated financial statements.

Effective April 1, 2009, we adopted a new accounting standard for subsequent events, as codified in ASC 855-10. The update modifies the names of the two types of subsequent events either as recognized subsequent events (previously referred to in practice as Type I subsequent events) or non-recognized subsequent events (previously referred to in practice as Type II subsequent events). In addition, the standard modifies the definition of subsequent events to refer to events or transactions that occur after the balance sheet date, but before the financial statements are issued (for public entities) or available to be issued (for nonpublic entities). It also requires the disclosure of the date through which subsequent events have been evaluated. The update did not result in significant changes in the practice of subsequent event disclosures, and therefore the adoption did not have any impact on our consolidated financial statements.

Effective July 1, 2009, we adopted the "FASB Accounting Standards Codification" and the Hierarchy of Generally Accepted Accounting Principles (ASC 105). This standard establishes only two levels of U.S. GAAP, authoritative and nonauthoritative. The FASB Accounting Standards Codification (the "Codification") became the source of authoritative, nongovernmental GAAP, except for rules and interpretive releases of the SEC, which are sources of authoritative GAAP for SEC registrants. All other non-grandfathered, non-SEC accounting literature not included in the Codification became nonauthoritative. We began using the new guidelines and numbering system prescribed by the Codification when referring to GAAP in the third quarter of 2009. As the Codification was not intended to change or alter existing GAAP, it did not have any impact on the our consolidated financial statements.

In October 2009, the FASB issued Update No. 2009-13, "Multiple-Deliverable Revenue Arrangements-a consensus of the FASB Emerging Issues Task Force" (ASU 2009-13). It updates the existing multiple-element revenue arrangements guidance currently included under ASC 605-25, which originated primarily from the guidance in EITF Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables" (EITF 00-21). The revised guidance primarily provides two significant changes: 1) eliminates the need for objective and reliable evidence of the fair value for the undelivered element in order for a delivered item to be treated as a separate unit of accounting, and 2) eliminates the residual method to allocate the arrangement consideration. In addition, the guidance also expands the disclosure requirements for revenue recognition. ASU 2009-13 will be effective for the first annual reporting period beginning on or after June 15, 2010, with early adoption permitted provided that the revised guidance is retroactively applied to the beginning of the year of adoption. We are currently assessing the future impact of this new accounting update to our consolidated financial statements.

In October 2009, the FASB issued Update No. 2009-14, "Certain Revenue Arrangements that Include Software Elements-a consensus of the FASB Emerging Issues Task Force" ("ASU 2009-14"). ASU 2009-14 amends the scope of pre-existing software revenue guidance by removing from the guidance non-software components of tangible products and certain software components of tangible products. ASU 2009-14 will be effective for the first annual reporting period beginning on or after June 15, 2010, with early adoption permitted provided that the revised guidance is retroactively applied to the beginning of the year of adoption. We are currently assessing the future impact of this new accounting update to our consolidated financial statements.

Results of Operations

Comparison of Three and Nine Months ended September 30, 2009 and 2008

Revenue

                           Three Months Ended                            Nine Months Ended
                              September 30,                                September 30,
                           2009           2008         Increase          2009          2008         Increase
                            ($ in thousands)                              ($ in thousands)

Net product revenue     $    3,787      $   2,210              71 %   $    8,509     $   5,748              48 %
Net support revenue            796            480              66 %        2,255         1,272              77 %
Total revenue           $    4,583      $   2,689              70 %   $   10,765     $   7,020              53 %

Our revenue is derived from two sources: product revenue, which includes sales of our hardware appliances bundled with software licenses, and service revenue, which includes revenue from support and services.

The increase in product revenue of 71% and 48% for the three and nine months ended September 30, 2009, respectively, compared with the same periods in 2008 reflected increased sales volume of our high-end PL10000 series product, which was introduced in the second quarter of 2008.

The increased support revenue of 66% and 77% for the three and nine months ended September 30, 2009, respectively, when compared with the same periods in 2008 reflected the continued expansion of the installed base of our product to which we have sold ongoing support services.

Based on our current sales growth and recent new product introductions such as the PL10000, we believe that our revenue will continue to grow in the fourth quarter of 2009 as compared with the same period in 2008.

Cost of Sales

Cost of sales included: (i) direct labor and direct material costs for products
sold, (ii) costs expected to be incurred for warranty, and (iii) adjustments to
inventory values, including the write-down of slow moving or obsolete
inventory. The following table presents the breakdown of cost of sales by
category:

                           Three Months Ended                            Nine Months Ended
                              September 30,                                September 30,
                           2009           2008          Change           2009          2008          Change
                            ($ in thousands)                              ($ in thousands)

Materials and per-use
licenses                $    2,347      $     916                     $    4,077     $   2,049
Percent of net
product revenue                 62 %           41 %           21 %            48 %          36 %           12 %
Applied labor and
overhead                       223            302                          1,124           703
Percent of net
product revenue                  6 %           14 %           (8 )%           13 %          12 %            4 %
Other indirect costs           146            188                            691           312
Percent of net
product revenue                  4 %            9 %           (5 )%            8 %           5 %            3 %
Product Costs                2,716          1,406                          5,892         3,064
Percent of net
product revenue                 72 %           64 %            8 %            69 %          53 %           19 %

Support costs                  126            126                            330           424
Percent of net
support revenue                 16 %           26 %          (10 )%           15 %          33 %          (18 )%

Amortization of
acquired assets                254            382                          1,017         1,145
Percent of total net
revenue                          6 %           14 %           (8 )%            9 %          16 %           (9 )%

Total costs of sales    $    3,096      $   1,914                     $    7,239     $   4,633
Percent of total net
revenue                         68 %           71 %           (3 )%           67 %          66 %            1 %

Total cost of sales increased during the three and nine months ended September 30, 2009 compared to the same periods in 2008, as a result of material costs associated with increased product revenues, per-use technology license fees negotiated in the second quarter of 2009 of approximately $260,000 and consigned inventory write-offs of $175,000, both of which were recorded in the second quarter of 2009.

Gross Profit

Gross profit for the three and nine month periods ended September 30, 2009 and
2008 was as follows:

                                   Three Months Ended                           Nine Months Ended
                                     September 30,                                September 30,
                           2009          2008           Change          2009          2008          Change
                            ($ in thousands)                             ($ in thousands)
Gross profit            $     1,488     $     775             92 %   $    3,525     $   2,387             48 %
Percent of total net

Gross profit margin for the three months ended September 30, 2009, increased by 3 percentage points to 32% from 29% in the comparable period in the prior year. This increase reflected a decrease in amortization of acquisition related intangible assets to $254,333 in the three months ended September 30, 2009, compared with $381,500 in the three months ended September 30, 2008.

Gross profit margin for the nine months ended September 30, 2009, decreased by 1 percentage point to 33% from 34% in the comparable period in the prior year. This decrease reflects the impact of increased technology license fees of approximately $260,000 and consigned inventory write-offs of approximately $175,000 that were recorded in the second quarter of 2009; partially offset by the margin rate benefit of fairly flat overhead against increased sales.

Operating Expense

Operating expenses for the three and nine month periods ended September 30, 2009
and 2008 were as follows:

                                       Three Months Ended                          Nine Months Ended
                                          September 30,                              September 30,
                                2009          2008         Decrease        2009          2008         Decrease
                                 ($ in thousands)                           ($ in thousands)

Research and development     $      584     $     809           (28) %   $   1,903     $   2,498           (24) %
Sales and marketing               1,622         2,094           (23) %       4,961         6,436           (23) %
General and administrative        1,088         1,897           (43) %       3,807         5,393           (29) %
Total                        $    3,294     $   4,800           (31) %   $  10,672     $  14,326           (26) %

Research and Development

Research and development expenses consisted of 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 efforts for products already released and development
costs associated with new products.

                                    Three Months Ended                            Nine Months Ended
                                      September 30,                                 September 30,
                           2009             2008         Decrease         2009          2008         Decrease
                             ($ in thousands)                              ($ in thousands)

Research and
development             $       584       $     809           (28) %   $    1,903     $   2,498           (24) %
As a percentage of

Research and development expenses for the three and nine months ended September 30, 2009 decreased by $225,463 and $594,547, respectively, compared to the same periods in 2008 as a result of reduced research and development headcount and employee compensation costs, and decreased stock-based compensation costs. These reductions related to the outsourcing of hardware development while retaining software development. Stock-based compensation recorded to research and development expense in the three and nine months ended September 30, 2009 was $8,585 and $25,869, respectively, a decrease from $72,267 and $213,136 in the same periods in 2008.

Sales and Marketing

Sales and marketing expenses primarily included personnel costs, sales
commissions, and marketing expenses such as trade shows, channel development and
literature.

                                  Three Months Ended                           Nine Months Ended
                                     September 30,                               September 30,
                           2009          2008         Decrease         2009          2008         Decrease
                            ($ in thousands)                            ($ in thousands)

Sales and marketing     $    1,622     $   2,094           (23) %   $    4,961     $   6,436           (23) %
As a percentage of

Sales and marketing expenses for the three and nine months ended September 30, 2009 decreased by $471,810 and $1,474,419, compared to the same periods in 2008, reflecting decreased headcount and employee compensation costs, decreases in stock-based compensation costs, decreases in acquisition related intangible asset amortization expense and reductions in discretionary marketing spending, such as expenses related to trade shows. Acquisition related intangible asset amortization expense recorded to sales and marketing expense in the three and nine months ended September 30, 2009 was $244,905 and $964,405, respectively, a decrease from $359,750 and $1,079,250 in the same periods of 2008. Stock-based compensation recorded to sales and marketing expense in the three and nine months ended September 30, 2009 was $57,694 and $217,291, respectively, a decrease from $110,358 and $346,223 in the same periods in 2008.

General and Administrative

General and administrative expenses consisted primarily of personnel and
. . .