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| APKT > SEC Filings for APKT > Form 10-Q on 10-Nov-2008 | All Recent SEC Filings |
10-Nov-2008
Quarterly Report
Cautionary Statement
This Quarterly Report on Form 10-Q, including the information incorporated by reference herein, contains, in addition to historical information, forward-looking statements. We may, in some cases, use words such as "project," "believe," "anticipate," "plan," "expect," "estimate," "intend," "continue," "should," "would," "could," "potentially," "will," "may" or similar words and expressions that convey uncertainty of future events or outcomes to identify these forward-looking statements. Forward-looking statements in this Quarterly Report on Form 10-Q may include statements about:
† our ability to attract and retain customers;
† our financial performance;
† our development activities;
† our position in the session border controller market;
† the effect of the worldwide markets on purchases of our products;
† the expectations about our growth;
† the benefit of our products, services, or programs;
† the advantages of our technology as compared to that of others;
† our ability to establish and maintain intellectual property rights;
† our ability to retain and hire necessary employees and appropriately staff our operations;
† our spending of our proceeds from our public offering;
† our expectations regarding the realization of recorded deferred tax assets;
† our stock repurchase program; and
† our cash needs.
The outcome of the events described in these forward-looking statements is subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated by these forward-looking statements. These important factors include our financial performance, our ability to attract and retain customers, our development activities and those factors we discuss in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K under the caption "Risk Factors." You should read these factors and the other cautionary statements made in this Quarterly Report on Form 10-Q as being applicable to all related forward-looking statements wherever they appear in this Quarterly Report on Form 10-Q. These risk factors are not exhaustive and other sections of this Quarterly Report on Form 10-Q may include additional factors which could adversely impact our business and financial performance.
Overview
Acme Packet, Inc. is the leading provider of session border controllers, or SBCs, that enable service providers and enterprises to deliver secure and high quality interactive communications-voice, video and other real-time multimedia sessions-across defined border points where Internet Protocol networks connect, known as network borders. As of September 30, 2008, more than 580 customers, consisting of both service providers and enterprises in nearly 85 countries have purchased our products. We sell our products and support services and license our software through approximately 50 distribution partners and our direct sales force. Our distribution partners include many of the largest networking and telecommunications equipment vendors throughout the world.
Our headquarters are located in Burlington, Massachusetts. We maintain sales offices in Burlington, Massachusetts; Madrid, Spain, Tokyo, Japan and the United Kingdom. We also have sales personnel in Argentina, Australia, Belgium, Brazil, Canada, China, Croatia, France, Germany, Hong Kong, India, Italy, Korea, Malaysia, Mexico, the Netherlands, New Zealand, Peru, Russia, South Africa, Taiwan, Thailand and throughout the United States. We expect to continue to add personnel in the United States and internationally to provide additional geographic sales and technical support coverage.
Industry Background
Service providers traditionally have delivered voice and data services over two separate networks: the Public Switched Telephone Network, or PSTN, and the Internet. The PSTN provides high reliability and security but is costly to operate and is limited in its ability to support high bandwidth video and other interactive multimedia services. The Internet is capable of cost-effectively transmitting any form of traffic that is IP-based, including interactive voice, video and data, but it transmits only on a best-efforts basis, because all forms of traffic have the same priority. Therefore, the Internet attempts to deliver all traffic without distinction, which can result in significantly varying degrees of service quality for the same or similar types of traffic transmissions. Internet-based services are also subject to disruptive and fraudulent behavior, including identity theft, viruses, unwanted and excessively large input data, known as SPAM, and the unauthorized use and attempts to circumvent or bypass security mechanisms associated with those services, known as hacking.
Service providers are beginning to migrate to a single IP network architecture to serve as the foundation for their next-generation voice, video and data service offerings. In order to provide secure and high quality interactive communications on a converged IP network, service providers must be able to manage and integrate the communications flows that comprise communication sessions for applications such as interactive video and voice over IP, or VoIP, which allows the routing of voice conversations over the Internet.
Prior to the advent of the SBC, IP network infrastructure equipment, such as softswitches, routers and data firewalls, was able to initiate and route undifferentiated data but lacked the ability to target specifically the management of interactive communication sessions. We believe that there is significant demand for SBCs that can facilitate the delivery of secure and high quality real-time interactive communications across all IP network borders. Dell'Oro Group, a market research and consulting firm specializing in networking and telecommunications, projects that worldwide revenue for SBC's will increase from $191 million in 2007 to $970 million in 2012.
Key Financial Measures
Some of our key financial measures for the third quarter of 2008 include:
† Net revenues were $28.4 million for the third quarter 2008 compared to $29.6 million in the same period last year.
† Net income for the third quarter of 2008 was $2.0 million compared to $5.5 million in the same period last year.
† Net income per share was $0.03 on a diluted basis for the third quarter of 2008 compare to $0.08 per share on a diluted basis in the same period last year.
The Acme Packet Strategy
Principal elements of our strategy include:
† Continuing to satisfy the evolving border requirements of large service providers, enterprises and contact centers. Our numerous SBC deployments in the wireline, wireless and cable networks of Tier-1 and other large service providers, as well as in large enterprises and contact centers, position us to gain valuable knowledge that we can use to expand and enhance our products' features and functionality.
† Exploiting new technologies to enhance product performance and scalability. We will seek to leverage new technologies as they become available to increase the performance, capacity and functionality of our product family, as well as to reduce our costs.
† Investing in quality and responsive support. As we broaden our product platform and increase our product capabilities, we will continue to provide comprehensive service and support targeted at maximizing customer satisfaction and retention.
† Facilitating and promoting service interconnects among our customers. We intend to increase demand for our products by helping our customers to extend the reach of their services and, consequently, to increase the value of their services to their customers.
† Leveraging distribution partnerships to enhance market penetration. We will continue to invest in training and tools for our distribution partners' sales, systems engineering and support organizations, in order to improve the overall efficiency and effectiveness of these partnerships.
† Actively contributing to architecture and standards definition processes. We will utilize our breadth and depth of experience with SBC deployments to contribute significantly to organizations developing standards and architectures for next-generation IP networks.
Factors That May Affect Future Performance
† Global Macroeconomic Conditions. We believe that the capital budgets of some of our core customers - service providers and large enterprises and contact centers - may be affected by the recent uncertainly in the global financial markets. Our ability to generate revenue from these core customers is dependent on the status of such capital budgets. Should the current uncertainty in these global financial markets continue, our revenues could be adversely impacted.
† Gross Margin. Our gross margin has been, and will continue to be, affected by many factors, including (a) the demand for our products and services, (b) the average selling price of our products, which in turn depends in part on the mix of product configurations sold, (c) the level of software license upgrades, (d) new product introductions, (e) the mix of sales channels through which our products are sold, and (f) the volume and costs of manufacturing our hardware products. Customers license our software in various configurations depending on the customers' requirements for session capacity, feature groups and protocols. The product software configuration mix will have a direct impact on the average selling price of the system sold. Systems with higher software content (higher session capacity and a larger number of feature groups) will generally have a higher average selling price than those systems sold with lower software content. If customers begin to purchase systems with lower software content, this will have a negative impact on our gross margins.
† Competition. The market for SBC's is competitive and constantly evolving. While we believe we are currently the market leader, we expect competition to persist and intensify in the future as the SBC market grows. Our primary competitors generally consist of start-up vendors, such as Newport Networks and more established network and component companies such as Audiocodes, through its acquisition of Netrake, Sonus Networks and Cisco Systems. We also compete with some of the companies with which we have distribution partnerships, such as Ericsson. We believe we compete successfully with all of these companies based upon our experience in interactive communications networks, the breadth of our applications and standards support, the depth of our border control features, the demonstrated ability of our products to interoperate with key communications infrastructure elements, and our comprehensive service and support. We expect sales and marketing expense to continue to increase in absolute dollars for the foreseeable future as we expand our sales force to continue to increase our revenue and market share.
† Evolution of the SBC Market. The market for SBCs is in its early stages and is still evolving, and it is uncertain whether these products will continue to achieve and sustain high levels of demand and market acceptance. Our success will depend, to a substantial extent, on the willingness of interactive communications service providers to continue to implement SBCs.
† Research and Development. To continue to achieve market acceptance for our products, we must effectively anticipate, and adapt in a timely manner to customer requirements and must offer products that meet changing customer demands. Prospective customers may require product features and capabilities that our current products do not have. The market for SBCs is characterized by rapid technological change, frequent new product introductions, and evolving industry requirements. We intend to continue to invest significantly in our research and development efforts, which we believe are essential to maintaining our competitive position.
† Managing Growth. We significantly expanded our operations in 2007 and the first nine months of 2008. During the period from December 31, 2006 through September 30, 2008 we increased the number of our employees and full-time independent contractors by 50%, from 252 to 377, and we opened new sales offices in Spain and the United Kingdom. We anticipate that further expansion of our infrastructure and headcount will be required to achieve planned expansion of our product offerings, projected increases in our customer base and anticipated growth in the number of product deployments. In the future, we expect to continue to carefully manage the increase of our operating expenses based on our ability to expand our revenues.
Revenue
We derive product revenue from the sale of our Net-Net hardware and the licensing of our Net-Net software. We generally recognize product revenue at the time of product delivery, provided all other revenue recognition criteria have been met, pursuant to the requirements of Statement of Position, or SOP, 97-2, Software Revenue Recognition, as amended by SOP 98-9, Software Revenue Recognition with Respect to Certain Transactions. For arrangements that include customer acceptance or other material non-standard terms, we defer revenue recognition until after delivery, and all other criteria for revenue recognition have been met.
We generate maintenance, support and service revenue from (a) maintenance
associated with software licenses, (b) technical support services for our
product software, (c) hardware repair and maintenance services,
(d) implementation, training and consulting services and (e) reimbursable travel
and other out-of-pocket expenses paid to us by our customers.
We offer our products and services indirectly through distribution partners and directly through our sales force. Our distribution partners include networking and telecommunications equipment vendors throughout the world. Our distribution partners generally purchase our products after they have received a purchase order from their customers and do not maintain an inventory of our products in anticipation of sales to their customers. Generally, the pricing offered to our distribution partners will be lower than to our direct
customers.
The product configuration, which reflects the mix of session capacity and requested features, determines the price for each SBC sold. Customers can purchase our SBCs in either a standalone or high availability configuration and can license our software in various configurations, depending on the customers' requirements for session capacity, feature groups and protocols. The product software configuration mix will have a direct impact on the average selling price of the system sold. As the market continues to develop and grow, we expect to experience increased price pressure on our products and services.
We believe that our revenue and results of operations may vary significantly from quarter to quarter as a result of long sales and deployment cycles, variations in customer ordering patterns, and the application of complex revenue recognition rules to certain transactions. Some of our arrangements with customers include clauses under which we may be subject to penalties for failure to meet specified performance obligations. We have not incurred any such penalties to date.
Cost of Revenue
Cost of product revenue primarily consists of (a) payments to third party manufacturers for purchased materials and services, (b) salaries and benefits related to personnel, (c) related overhead and (d) provision for inventory obsolescence.
Cost of maintenance, support and service revenue consists primarily of
(a) salaries and benefits related to professional services and technical support
personnel (b) related overhead, (c) billable and non-billable travel, lodging,
and other out-of-pocket expenses and (d) contract manufacturer services for
repairs and warranty services.
Gross Profit
Our gross profit has been, and will be, affected by many factors, including
(a) the demand for our products and services, (b) the average selling price of
our products, which in turn depends, in part, on the mix of product
configurations sold, (c) new product introductions, (d) the mix of sales
channels through which our products are sold, and (e) the volume and costs of
manufacturing of our hardware products.
Operating Expenses
Operating expenses consist of sales and marketing, research and development, and general and administrative expenses. Personnel-related costs are the most significant component of each of these expense categories. During the period from September 30, 2007 through September 30, 2008, we increased the number of our employees and full-time independent contractors by 17%, from 323 to 377. We expect to continue to hire new employees to support our growth.
Sales and marketing expense consists primarily of (a) salaries and related personnel costs, (b) commissions, (c) travel, lodging and other out-of-pocket expenses, (d) marketing programs such as trade shows and (e) other related overhead. Commissions are recorded as expense when earned by the employee. We expect sales and marketing expense to continue to increase in absolute dollars for the foreseeable future as we expand our sales force to continue to increase our revenue and market share. However, we anticipate that sales and marketing expense will decrease as a percentage of total revenue in the long term.
Research and development expense consists primarily of (a) salaries and related personnel costs, (b) payments to suppliers for design and consulting services, (c) prototype and equipment costs relating to the design and development of new products and enhancement of existing products, (d) quality assurance and testing and (e) other related overhead. To date, all of the costs related to our research and development efforts have been expensed as incurred. We intend to continue to invest significantly in our research and development efforts, which we believe are essential to maintaining our competitive position. We expect research and development expense to increase in absolute dollars for the foreseeable future. However, we anticipate that research and development expense will decrease as a percentage of total revenue in the long term.
General and administrative expense consists primarily of (a) salaries and personnel costs related to our executive, finance, human resource and information technology organizations, (b) facilities expenses, (c) audit and legal professional fees, and (d) other related overhead. We expect general and administrative expense to continue to increase in absolute dollars for the foreseeable future as we invest in infrastructure to support continued growth and incur ongoing expenses related to being a publicly traded company, including increased audit and legal fees, costs of compliance with securities and other regulations, investor relations expense, and higher insurance premiums.
Stock-Based Compensation
Cost of revenue and operating expenses include stock-based compensation expense. Effective January 1, 2006, we adopted the requirements of Statement of Financial Accounting Standards, or SFAS, No. 123(R), Share Based Payment. SFAS No. 123(R) addresses all forms of stock-based awards, including shares issued under employee stock purchase plans, stock options, restricted stock, restricted stock units and stock appreciation rights. SFAS No. 123(R) requires us to expense stock-based payment awards with compensation cost for stock-based payment transactions measured at fair value. For the three months ended September 30, 2008 and 2007, we recorded expense of $2.0 million and $1.7 million, respectively, and for the nine months ended September 30, 2008 and
2007, we recorded expense of $5.3 million and $4.2 million, respectively. Based on stock-based awards granted during the nine months ended September 30, 2008 and fiscal years 2007 and 2006, a future expense related to unvested awards of $19.7 million is expected to be recognized over a weighted-average period of 2.48 years.
Other Income (Expense), Net
Other income (expense) primarily consists of interest income earned on cash balances. We historically have invested our cash in money market funds. Other income (expense) also includes gains (losses) from foreign currency translation adjustments of our foreign subsidiaries. The functional currency of our foreign operations in Europe and Asia is the U.S. dollar. Accordingly, all assets and liabilities of these foreign subsidiaries are remeasured into U.S. dollars using the exchange rates in effect at the balance sheet date. Revenue and expenses of these foreign subsidiaries are remeasured into U.S. dollars at the average rates in effect during the period. Any differences resulting from the remeasurement of assets, liabilities and operations of the European and Asian subsidiaries are recorded within other income (expense).
Application of Critical Accounting Policies and Use of Estimates
Our financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ significantly from these estimates under different assumptions or conditions. There have been no material changes to these estimates for the periods presented in this Quarterly Report on Form 10-Q.
We believe that of our significant accounting policies, which are described in the notes to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2007 and the notes to our unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our financial condition and results of operations.
Revenue Recognition
We recognize revenue in accordance with SOP 97-2, as amended by SOP 98-9, and Emerging Issues Task Force, or EITF, Issue No. 03-5, Applicability of AICPA Statement of Position 97-2 to Nonsoftware Deliverables in an Arrangement Containing More-Than-Incidental Software. We have determined that the software element of our product is "more than incidental" to the products as a whole. As a result, in accordance with EITF Issue No. 03-5, we are required to recognize revenue under SOP 97-2 and SOP 98-9.
In all of our arrangements, we do not recognize any revenue until we can determine that persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and we deem collection of the related accounts receivable to be probable. In making these judgments, we evaluate these criteria as follows:
† Persuasive evidence of an arrangement exists. We consider a non-cancelable agreement signed by the customer and us to be representative of persuasive evidence of an arrangement.
† Delivery has occurred. We consider delivery to have occurred when product has been delivered to the customer and no significant post-delivery obligations exist. In instances where customer acceptance is required, delivery is deemed to have occurred when customer acceptance has been achieved.
† Fees are fixed or determinable. We consider the fee to be fixed or determinable unless the fee is subject to refund or adjustment or is not payable within normal payment terms. If the fee is subject to refund or adjustment, we recognize revenue when the right to a refund or adjustment lapses. If offered payment terms exceed our normal terms, we recognize revenue as the amounts become due and payable or upon the receipt of cash.
† Collection of the related accounts receivable is deemed probable. We conduct a credit review for all transactions at the inception of an arrangement to determine the creditworthiness of the customer. Collection is deemed probable if, based upon our evaluation, we expect that the customer will be able to pay amounts under the arrangement as payments become due. If we determine that collection is not probable, revenue is deferred and recognized upon the receipt of cash.
A substantial percentage of our revenue is generated by multiple-element arrangements, such as products, maintenance, professional services and training. When arrangements include multiple elements, we allocate the total fee among the various elements using the residual method. Under the residual method, revenue is recognized when vendor-specific objective evidence, or VSOE, of fair value exists for all of the undelivered elements of the arrangement, but does not exist for one or more of the delivered elements of the arrangement. Each arrangement requires us to analyze the individual elements in the transaction and to estimate the fair value of each undelivered element, which typically includes maintenance and services. Revenue is allocated to each of the undelivered elements based on its respective fair value, with the fair value determined by the price charged when that element is sold separately.
Maintenance and support services include telephone support, return and repair services, and unspecified rights to product upgrades and enhancements, and are recognized ratably over the term of the service period, which is generally 12 months. Maintenance and support revenue generally is deferred until the related product has been accepted and all other revenue recognition criteria have been met. Professional services and training revenue is recognized as the related service is performed.
Our products and services are distributed indirectly through distribution partners and directly through our sales force. Revenue arrangements with distribution partners are recognized when the above criteria are met and only when we receive evidence that the distribution partner has an order from an end-user customer. We typically do not offer contractual rights of return, stock balancing or price protection to our distribution partners, and actual product returns from them have been insignificant to date. As a result, we do not maintain reserves for product returns and related allowances.
Stock-Based Compensation
On January 1, 2006, we adopted the provisions of SFAS No. 123(R), Share-Based Payment, which requires us to recognize expense related to the fair value of stock-based compensation awards. SFAS No. 123(R) requires nonpublic companies that used the minimum value method under SFAS No. 123, Accounting for Stock-Based Compensation,for either recognition or pro forma disclosures to apply SFAS No. 123(R) using the prospective-transition method. As such, we will . . .
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