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APKT > SEC Filings for APKT > Form 10-Q on 26-Oct-2012All Recent SEC Filings

Show all filings for ACME PACKET INC

Form 10-Q for ACME PACKET INC


26-Oct-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

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 ability to retain and hire necessary employees and appropriately staff our operations;

our financial performance;

our expectations regarding our revenue, cost of revenue and our related gross profit and gross margin;

our development activities, expansion of our product offerings and the emerging opportunities for our solutions;

our position in the session delivery network solutions market and our competitors;

the effect of the worldwide economy on the demand of our products;

the expectations about our growth and acquisitions of new technologies;

the demand for and the growth of worldwide revenues for session delivery network solutions;

the benefit of our products, services, or programs;

our ability to establish and maintain relationships with key partners and contract manufacturers;

potential natural disasters in locations where we, our customers, or our suppliers operate;

the advantages of our technology as compared to that of our competitors;

our expectations regarding the realization of recorded deferred tax assets;

our common 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 and employees, 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., or Acme Packet, is the leader in session delivery network solutions which enable the trusted, first class delivery of next-generation voice, video, data and unified communications services and applications across Internet Protocol, or IP, networks.

A session delivery network helps individuals and organizations overcome the limitations inherent in using the Internet, or other best-efforts, unsecured IP networks, for session-based voice, video, data, unified communications and collaboration. A session delivery network "layers" complementary intelligence and controls "over" an IP transport network composed of IP routers and Ethernet switches. With the IP transport network providing basic packet routing and delivery services, the "overlay" session delivery network provides critical session border control and session management functions that ensure prioritized, secure and trusted delivery of a broad range of services and applications encompassing voice, video, data, and unified communications and collaboration.

Session delivery networks are comprised of several different product categories that work together to deliver trusted, first class services and applications. Acme Packet is the world's leading provider of session border controllers, or SBCs, that are the cornerstones of session delivery networks. SBCs control session delivery across defined border points where IP networks connect, known as network borders. SBCs are deployed at network borders between two service providers or between a service provider and its enterprise, residential or mobile customers.

In addition to SBCs, session delivery networks need additional products to perform critical roles:

The session manager, or SM, manages user access and interface application servers;

The multiservice security gateway, or MSG, secures session delivery of data and voice services over untrusted Internet and wireless fidelity, or WiFi, access networks;


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The diameter signaling controller, or DSC, controls diameter signaling within long-term evolution, or LTE, networks and enable LTE data and voice session roaming;

The session-aware load balancer, or SLB, scales border control for SBC, MSG and DSC deployments;

The session routing proxy, or SRP, routes sessions to and from access and interconnect borders;

The application session controller, or ASC, enables Web 2.0 server applications to initiate and control sessions;

The session recorder, or SR, performs session recording for the session delivery network; and

Network management tools, such as Palladion, which provide real-time network management.

Acme Packet's session delivery network solutions are used by over 1,850 Acme Packet customers in 109 countries. Our customers include fixed line, cable, mobile, transit and over-the-top, or OTT, communication service providers, as well as enterprises, contact centers and government organizations.

We sell our products and support services through over 300 distribution partners and through our direct sales force. Our distribution partners include many of the largest networking and IP communications equipment vendors throughout the world.

Our headquarters are located in Bedford, Massachusetts. We maintain offices in Beijing, China; Berlin, Germany; Frankfurt, Germany; Ipswich, United Kingdom; Madrid, Spain; Moscow, Russia; Seoul, South Korea and Tokyo, Japan. We also have employees and independent contractors in Argentina, Australia, Belgium, Brazil, Canada, Columbia, Croatia, Czech Republic, France, Ghana, Hong Kong, India, Indonesia, Israel, Italy, Malaysia, Mexico, the Netherlands, New Zealand, Peru, Poland, Portugal, Saudi Arabia, Singapore, South Africa, Sweden, Taiwan, Thailand, United Arab Emirates and throughout the U.S. We expect to selectively add personnel 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. Similarly, enterprises have traditionally used the PSTN for voice services and the Internet for data applications. 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 traffic 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.

Both service providers and enterprises are migrating to a single IP network architecture to serve as the foundation for their next generation voice, video, multimedia and data services and applications. In order to provide trusted, secure and high quality interactive communications on a converged IP network, service providers and enterprises must be able to control the communications flows that comprise communication sessions.

Evolution to a Converged IP Network

IP networks can be designed and operated more cost effectively than the PSTN. In addition, IP networks are capable of delivering converged voice, video and data services and applications. Service providers are seeking to provide these next-generation services to enhance their profitability by generating incremental revenue and by reducing subscriber turnover. Enterprises are searching for ways to unify their communications by seamlessly integrating voice, video, instant messaging and collaboration while reducing costs. Managing two distinct networks, the PSTN and an IP network, is not a viable economic alternative. As a result, service providers and enterprises have begun to migrate to a single IP network architecture to serve as the foundation for their next-generation services and applications. In order to successfully transition to a single IP network, however, they must maintain the same reliability, quality and security that have for decades exemplified their delivery of voice services.

Challenges of IP Networks in Delivering Session-based Communications

IP networks were designed initially to provide reliable delivery of data services such as file downloads and website traffic that are not sensitive to latency or time delay. If data packets are lost or misdirected, an IP network exhibits tremendous resiliency in re-transmitting and eventually executing the desired user request, which generally is an acceptable result for these types of data services. However, IP networks historically have not been capable of guaranteeing real time, secure delivery of high quality sessions-based communications such as interactive voice and video.


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A session is a communications interaction that has a defined beginning and end, and is effective only when transmitted in real time without latency or delays. In order to enable a session-based communication, control of the session from its origination point to its defined end point is required. No single IP network extends far enough to enable that level of control and the Internet lacks the fundamental quality of service and security mechanisms necessary to consistently deliver the security and quality of real time multimedia communications that consumers and businesses require. In order to gain the trust of users, service providers and enterprises must be able to assure secure and high quality interactive communications across one or more networks.

Key Financial Statistics

Some of our key financial statistics for the third quarter of 2012, as compared to the same metric for the third quarter of 2011, include the following:

Total revenue was $65.3 million compared to $70.6 million,

Net (loss) income was $(5.5) million compared to $7.9 million,

Net (loss) income was $(0.08) per share on a diluted basis compared to $0.11 per share,

Cash provided by operating activities was $6.7 million compared to $16.4 million, and

Cash (used in) provided by financing activities was $(28.4) million compared to $9.4 million.

The Acme Packet Strategy

Principal elements of our strategy include:

Continuing to satisfy the evolving session delivery network requirements of enterprises and fixed-line, mobile and OTT service providers. Our network deployments position us to gain valuable knowledge that we can use to expand our product portfolio and enhance our products' features and functionality. We may develop new products organically or through selective acquisitions.

Implementing 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 their costs.

Investing in quality and responsive support. As we broaden our product family and increase the capabilities of our session delivery network solution, we will continue to provide comprehensive service and support targeted at maximizing customer satisfaction and retention.

Facilitating and promoting service interconnects and federations among our customers. We intend to drive increased demand for our products by helping our customers to extend the reach of their services and applications and, consequently, to increase the value of their services to their users.

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 session delivery network 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 and spending initiatives of some of our core customers - service providers, enterprises, government agencies and contact centers - may be affected by ongoing worldwide economic conditions. Our ability to generate revenue from these core customers is dependent on the status of such budgets and initiatives.

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 and product configurations sold, (c) the level of software license upgrades, (d) the cost of acquiring our products for sale, (e) new product introductions, (f) the mix of sales channels through which our products are sold, (g) the costs of manufacturing our hardware products and providing our related support services, and (h) stock-based compensation expense. Customers license our software in various configurations depending on each customer's 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, support for higher number of security protocols and a larger number of feature groups) will generally have a higher average selling price than those systems sold and licensed with lower software content. If customers begin to purchase systems with lower software content, this may have a negative impact on our revenue and gross margins.


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Competition. Competition in our product categories is strong and constantly evolving. While we believe we are currently the market leader in the service provider and enterprise markets for session delivery network solutions, we expect competition to persist and intensify in the future as the market grows. Our competitors vary by market segment and product category. In the service provider market, our primary competitors include GENBAND Inc., Telefonaktiebolaget LM Ericsson, Huawei Technologies Co., Ltd., Metaswitch Networks Ltd. and Sonus Networks Inc. In the enterprise market segment, our primary competitor is Cisco Systems, Inc. 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 also believe our products are priced competitively with our competitors' offerings. As the session delivery network solutions market opportunity grows, we expect competition from additional networking and IP communications equipment suppliers, including distribution partners.

Evolution of the Session Delivery Network Solutions Market. The market for our products 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 and enterprises to continue to implement our solutions. Demand is also dependent upon the respective geographic regions where our customers are located. For example, in 2011 and through the third quarter of 2012, we experienced a level of demand that was lower than we had expected from our service provider customers in North America, which had an adverse effect on our operations.

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 session delivery network solutions is characterized by rapid technological change, frequent new product introductions, and evolving industry requirements. We intend to continue to invest in our research and development efforts, which we believe are essential to maintaining our competitive position.

Managing Growth. We significantly expanded our operations in 2011 and the first nine months of 2012. During the period from January 1, 2011 through September 30, 2012 we increased the number of our employees and full time independent contractors by 51%, from 570 to 863, with 30 of such employees added through the acquisition of IPTEGO GmbH, or Iptego, in April 2012. 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, the expansion of which could occur organically or through future acquisitions.

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. For arrangements that include customer acceptance or other material non-standard terms, we recognize revenue after acceptance or when the non-standard terms are resolved, assuming 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 software product, (c) hardware repair and maintenance services,
(d) implementation, training and consulting services and (e) reimbursable travel and other out-of-pocket expenses.

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 customer and, generally, 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, signaling protocol support and requested features, determines the price for each product sold and licensed. Customers can purchase our products in either a standalone or high availability configuration and can license our software in various configurations, depending on the customers' requirements for session capacity, functionality 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.


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Cost of Revenue

Cost of product revenue consists primarily of (a) third party manufacturers' fees for purchased materials and services, combined with our expenses for
(b) salaries, wages and related benefits for our manufacturing personnel,
(c) related overhead, (d) provision for inventory obsolescence, (e) amortization of intangible assets and (f) stock-based compensation. Amortization of intangible assets represents the amortization of developed technologies from our acquisitions of Covergence Inc., Newfound Communications, Inc., or Newfound Communications and Iptego.

Cost of maintenance, support and service revenue consists primarily of
(a) salaries, wages and related benefits for our support and service personnel,
(b) related overhead, (c) billable and non-billable travel, lodging, and other out-of-pocket expenses, (d) material costs consumed in the provision of services, (e) stock-based compensation and (f) warranty costs.

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 and product configurations sold or licensed, (c) the mix between product and service revenue, (d) the cost of acquiring our products, (e) new product introductions,
(f) the mix of sales channels through which our products are sold, (g) the volume and costs of manufacturing our hardware products, (h) the costs associated with fulfilling our maintenance and warranty obligations, and
(i) personnel and related costs for manufacturing, support and services.

Operating Expenses

Operating expenses consist of sales and marketing, research and development, general and administrative, and merger and related expenses. Personnel related costs are the most significant component of our operating expenses. During the period from January 1, 2011 through September 30, 2012, we increased the number of our employees and full time independent contractors by 57%, from 486 to 761.

Sales and marketing expense consists primarily of (a) salaries and related personnel costs, (b) commissions and bonuses, (c) travel, lodging and other out-of-pocket expenses, (d) marketing programs such as trade shows,
(e) stock-based compensation and (f) other related overhead. Commissions are recorded as expense when earned by the employee. We anticipate that sales and marketing expense will continue to increase in absolute dollars and decrease as a percentage of revenue in the future, until we reach historical levels.

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, (e) stock-based compensation and (f) other related overhead. To date, all of the costs related to our research and development efforts have been expensed as incurred as technological feasibility is determined at the same time as release. We intend to continue to invest 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. However, we anticipate that research and development expense will decrease as a percentage of total revenue in the future, until we reach historical levels.

General and administrative expense consists primarily of (a) salaries, wages and personnel costs related to our executive, finance, human resource and information technology organizations, (b) accounting and legal professional fees, (c) expenses associated with uncollectible accounts, (d) stock-based compensation and (e) other related overhead. We expect general and administrative expense to increase slightly in absolute dollars as we invest in infrastructure to support continued growth and incur ongoing expenses related to being a publicly-traded company. However, we anticipate that general and administrative expense will decrease as a percentage of total revenue in the future, until we reach historical levels.

Merger and related expenses consist of transaction expenses related to business acquisitions and generally consist of costs related to the work of professional service organizations.

Stock-Based Compensation

Cost of revenue and operating expenses include stock-based compensation expense. We expense share-based payment awards with compensation cost for share-based payment transactions measured at fair value. For the three months ended September 30, 2012 and 2011, we recorded expense of $13.4 million and $9.7 million, respectively, and for the nine months ended September 30, 2012 and 2011, we recorded expense of $40.6 million and $25.0 million, respectively, in connection with share-based payment awards. Based on share-based awards granted from 2007 through 2012, a future expense of non-vested options of $104.3 million is expected to be recognized over a weighted-average period of 2.60 years.

Other Income (Expense)

Other income (expense) consists primarily of gains or losses from foreign currency translation adjustments of our international activities. The functional currency of our international operations in Europe and Asia is the U.S. dollar. Accordingly, all assets and liabilities of these international subsidiaries are re-measured into U.S. dollars using the exchange rates in effect at the balance sheet date, or historical rate, as appropriate. Revenue and expenses of these international subsidiaries are re-measured into U.S. dollars at the average rates in effect during the period. Any differences resulting from the re-measurement of assets, liabilities and operations of the European and Asian subsidiaries are recorded within other income (expense). Other income (expense) also includes interest income earned on cash equivalents and investments. We have invested cash in high quality securities and are not materially affected by fluctuations in interest rates.


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Application of Critical Accounting Policies and Use of Estimates

Our financial statements are prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires that we make estimates and assumptions that affect the reported amounts . . .

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