Acme Packet, Inc. Q4 2008 Earnings Call Transcript

Feb. 5.09 | About: Acme Packet, (APKT)

Acme Packet, Inc. (NASDAQ:APKT)

Q4 2008 Earnings Call

February 5, 2009 5:00 pm ET

Executives

Ryan Norris – Director, Investor Relations

Andy Ory – President, Chief Executive Officer

Peter Minihane – Chief Financial Officer, Treasurer

Analysts

Paul Silverstein – Credit Suisse

Simona Jankowski – Goldman Sachs

Gregg Mesniaeff – Needham & Company

[Steven O'Brien – J.P. Morgan]

Catherine Trebnick – Avian Securities

Brian Modoff – Duetsche Bank

Ted Jackson – Cantor Fitzgerald

Sanjiv Wadhwani – Stifel Nicolaus

[Andrew Nowinski – Piper Jaffray]

Operator

Welcome to Acme Packet's fourth quarter earnings release conference call. (Operator Instructions) I would now like to introduce your host for today's call, Ryan Norris, Director of Investor Relations for Acme Packet.

Ryan Norris

Good afternoon everyone and welcome to Acme Packet's fourth quarter earning release conference call. With me on the call are Andy Ory, our President and Chief Executive Office and Peter Minihane, our Chief Financial Officer and Treasurer.

The format for today's call is as follows: Andy will begin with an overview of key highlights from the quarter. Peter will then review the details of our financial results and discuss our outlook for 2009. Andy will then discuss our future opportunities. Finally, we'll open the call for Q&A.

The press release announcing our fourth quarter results along with our financial statements and a reconciliation of non-GAAP financial measures and the most directly comparable GAAP measures is available on the investor relations section of our web site at www.ir.acmepacket.com.

Please note that all results and projections we review this evening are on a non-GAAP basis unless otherwise explicitly described as GAAP. During this afternoon's call we'll be referring to non-GAAP net income and non-GAAP net income per share which are non financial to the non-GAAP financial measures that include stock based compensation expense for all periods presented.

Let me remind you that the statements made during this call that are not historical fact may be forward-looking statements within the meaning of section 27(a) of the Securities Act of 1933 and section 21(e) in the Securities Exchange Act of 1934. Such forward-looking statements may relate among other things to expected financial operating results, and the future business prospects and market conditions. Such forward-looking statements do not constitute guarantees of future performance and are subject to a variety of risks and uncertainties that could cause actual results to differ materially from those anticipated.

A discussion of these risks, uncertainties and additional factors that could cause actual results to differ materially from those projected or suggested in any forward-looking statements is contained in our recent filings with the SEC including those factors discussed under the caption risks factors in such filings. Investors should not place undue reliance on these statements which are current only to the date they are made and we disclaim any obligation to update them.

Before I turn the call over to Andy, let me briefly remind investors of our upcoming investor conference scheduled. We'll be attending the Goldman Sachs technology conference in Las Vegas on February 26 and the Credit Suisse networking conference in Boston on March 10. For more details on our IR outreach plans for the first quarter, please contact the investor relations team.

One last calendar item, please make plans to join us at 5:00 p.m. on Thursday, April 30 for our first earnings results conference call. With that, I'd like to turn the call over to Andy.

Andy Ory

Good afternoon everyone. We're pleased to be reporting strong fourth quarter results which reflect momentum in all areas of the business. Revenues were $30.6 million up 8% sequentially from the third quarter of 2008. Our top lines were strengthened by the addition of 45 new customers in the fourth quarter and the continued expansion of existing deployments throughout our customer base.

Gross margin was 79% reflecting the relative strength and competitiveness of our product offering. Operating margin expanded to 20%, again reflecting the leverage in our business model. We delivered non-GAAP EPS of $0.09 in the fourth quarter. Our balance sheet continues to be strong as we ended the year with $125.7 million in cash and no debt.

We generated positive cash flow from operations of $7 million in the fourth quarter and $28.7 million for the full year. We were also active buyers of our stock during the quarter through our stock repurchase program.

Looking ahead, we are today introducing our business outlook for 2009. This is without question a challenging time to be providing forecast data, but we feel that it is important to provide our shareholders with a transparent view as to our current estimate on full year guidance.

In developing our plan for the new year, we gave careful consideration to a number of factors including the current macro economic climate, the activity we are seeing within our customer base and our recent and forecasted bookings activity.

Accordingly, our outlook for 2009 calls for total revenue to range between approximately $120 million to $125 million and for non-GAAP EPS to range between $0.22 and $0.26. For a closer look at our fourth quarter results, and our 2009 outlook, let me turn the call over to Peter.

Peter Minihane

This afternoon I'll take a few moments to review our financial for the fourth quarter and then provide some details as to our outlook for 2009. As a reminder, all financial results and projections we review this afternoon related to our statement of income are on a non-GAAP basis unless otherwise and explicitly described as GAAP.

Our discussion of year over year changes and our financial results compares the fourth quarter of 2008 to the fourth quarter of 2007. Our discussion of sequential changes in our financial results compares our results for the fourth quarter of 2008 to the third quarter of 2008. And finally, please note that all earnings per share results we review this afternoon are on a fully diluted basis.

With that, I'll begin with a review of our fourth quarter results. Revenues were $30.6 million an increase of 8% sequentially and a decrease of 3% year over year. Product revenues were $22.5 million an increase of 1% sequentially and a decrease of 14% year over year.

Excluded from product revenue in the fourth quarter of 2008 is approximately $1.7 million which the company categorized as maintenance, support and service revenues to reflect the company's decision to grant one customer discounts on 2008 maintenance and support received in the fourth quarter.

Product revenues also reflect an increase in the average selling price of systems sold as well as an increase in the quantity of systems sold, particularly our recently introduced Net-Net 4500 platform.

Maintenance, support and service revenues increased to $8.1 million up 32% sequentially and 55% year over year. Again, it's important to note that maintenance, support and service revenues includes $1.7 million not categorized as product revenue for the reason I just described.

The growth in maintenance, support and service revenue also reflects the increase of maintenance and support fees associated with the growth in our installed product base over the last 12 months.

The distribution of revenues was 42% direct and 58% indirect. One direct customer accounted for 10% or more of revenue and that customer was Sprint at 16%. One channel partner accounted for 10% or more of our revenue and that partner was Alcatel Lucent at 23%. Alcatel Lucent like many of our channel partners represents dozens of end user customers.

We received orders on behalf of 235 end user customers in the quarter which is a record for any one quarter. Geographically, 55% of our total revenues came from the United States and Canada and 45% came from our international customers.

Gross margin was 79% for the fourth quarter of 2008 which is consistent with prior quarters. Total operating expenses in the fourth quarter were $18.1 million which is flat sequentially and up 8% year over year. Fourth quarter operating expenses reflect the elimination of the management bonus program for 2008, a decision we made since we did not meet our full year financial target.

Other income net was $199,000 in the fourth quarter compared to $726,000 in the third quarter of 2008 and $1.6 million in the fourth quarter of 2007. This decrease primarily reflects lower average interest rates and losses related to fluctuations in foreign exchange rates.

Our effective tax rate for the fourth quarter of 2008 was approximately 10% compared to approximately 38% in both the third quarter of 2008 and the fourth quarter of 2007. Our earlier guidance issued in November 2008 forecasted an effective tax rate of 29.5% for the fourth quarter of 2008.

The change of the estimated tax rate primarily reflects the timing of additional R&D tax credits as well as a lower than planned effective state income tax rate. The lower than planned tax rate contributed approximately $1.2 million or $0.02 per share for the company's net income on both a GAAP and non-GAAP basis in the fourth quarter of 2008.

Net income for the fourth quarter on a non-GAAP basis was $5.6 million or $0.09 per share compared to $3.4 million or $0.05 per share in the third quarter of 2008 and $6.5 million or $0.10 per share in the fourth quarter of 2007.

Net income for the fourth quarter on a GAAP basis was $3.7 million or $0.06 per share compared to $2 million or $0.03 per share in the third quarter of 2008 and $5.2 million or $0.08 per share in the third quarter of 2007.

Non-GAAP net income differs from GAAP net income as it excludes stock based compensation charges net of tax of approximately $1.9 million or $0.03 per share in the fourth quarter of 2008 compared to $1.3 million or $0.02 per share in each of the third quarter of 2008 and the fourth quarter of 2007.

Head count at the end of 2008 was 381 compared 377 at the end of the third quarter of 2008 and 327 at the end of 2007. We continue to remain cautious in our head count growth but do anticipate hiring a limited number of employees in 2009 in strategic and revenue generating positions.

Now, a few observations on our full year results. Full year revenues grew to a record $116.4 million, an increase of 3% year over year. Growth in North America as well as adoption of our new Net-Net 4500 platform in the second half of the year enabled us to drive improved top line results.

One direct customer accounted for 10% or more of revenue and that customer was Sprint at 10%. Two channel partners accounted for 10% or more of revenue, Alcatel Lucent at 17% and Nokia Siemens at 15%.

We received orders on behalf of 477 end user customers in 2008, the highest end user total in the company's history. Composition of revenues was 59% indirect and 41% direct. This is in line with 2007 when the composition of revenues was 61% indirect and 39% direct.

Geographically, 51% of revenues came from the United States and Canada and 49% came from our international customers. Again, this is consistent with 2007 when 48% came from the United States and Canada and 52% came from our international customers.

Full year gross margin was 80% consistent with 2007. Other income net was $3 million compared to $6.4 million in 2007 primarily reflecting the lower interest rates on our investments. Net income on a non-GAAP basis was $17.1 million or $0.27 per share in 2008 compared to $23.9 million or $0.36 per share in 2007.

Net income on a GAAP basis was $11.6 million or $0.18 per share in 2008 compared to $19.6 million or $0.30 per share in 2007. Non-GAAP net income differs from GAAP income as it excludes stock based compensation charges net of tax of approximately $5.5 million or $0.09 in 2008 and approximately $4.3 million or $0.06 per share in 2007.

Taking a look at the balance sheet, we ended the fourth quarter of 2008 with cash and cash equivalents of $125.7 million compared to $127 million at the end of the third quarter of 2008 and $136.4 million at the end of 2007.

With regards to the company's cash resources, we have always maintained a very conservative investment policy and are invested primarily in money market funds which are focused on high grade U.S. government securities.

We reported positive cash flow from operations of $7 million during the quarter and $28.7 million for the year. Cash flow used in investing activities reflects total capital expenditures of approximately $800,000 during the quarter and $4 million during the year.

Cash flows used in financing activities was $7.5 million during the quarter and $35.3 million during the year, primarily reflecting the activity under our share repurchase program.

In February 2008, the Board of Directors authorized the repurchase of up to $20 million of our common stock. The plan was subsequently expanded in August of 2008 by another $35 million to $55 million in the aggregate. During the fourth quarter of 2008 we repurchased approximately 1.9 million shares for $8.2 million.

Since December 31, 2008 into and including the business today, we have not repurchased any additional shares of common stock. In the aggregate, since implementing the program in February 2008 we have repurchased approximately 6.8 million shares for $37.5 million leaving $17.5 million available for repurchase activity under the plan.

The repurchase program is schedule to expire at the end of this month but can be extended and/or expanded by the Board at any time.

Day sales outstanding or DSO was 77 days at December 31, 2008 compared to our target range of 80 to 90 days. Please note that the balance sheet presentation both in 2008 and in 2007 reflects a reclassification of accounts receivable and deferred revenue to the extent that we have billed our customers for maintenance and support but have not yet begun to recognize related revenue.

Inventory at the end of 2008 was $7 million compared to $9 million at the end of the third quarter of 2008 and $5.8 million at the end of 2007. Finally, deferred revenue at the end of 2008 increased to $16.9 million and $12.8 million at the end of the third quarter of 2008 and $7.6 million at the end of 2007.

Finally, a brief comment on our channel partner, Nortel Networks. As of December 31, 2008 our financial results reflect the write down of any and all Nortel related exposure.

To help you better understand how we are looking at our growth plan; let me close with a few forward-looking comments. I remind you that the comments I am about to make are based on the current indications of our business which may change at any time. We undertake no obligations to update these comments.

As outlined in our press release issued earlier today, our current business outlook for 2009 is as follows: we expect revenues to range between $100 million and $125 million. We expect non-GAAP EPS to range between $0.22 and $0.26 per share on a fully diluted basis. We are modeling gross margins to remain in the upper 70's and operating margins in the upper teens.

We expect other income net, primarily interest income to be approximately $1 million with little to no improvement in the interest rate environment. Our earnings projections assume a non-GAAP effective tax rate of approximately 37%. At present, we expect our weighted average diluted shares outstanding to be approximately 61 million shares.

Our estimate to non-GAAP income differs from GAAP net income as it excludes estimated stock based compensation expense net of taxes of approximately $6.3 million or $0.10 per share. During our next earning release conference call which will be held on Thursday, April 30, we will share with you the highlights from our first quarter of 2009. We look forward to updating you on our progress during future calls.

With that, I'll turn the call back over to Andy.

Andy Ory

I want to share with you our view of the SBC market including key trends and growth drivers as well as briefly recap some of the key operating highlights from the fourth quarter and full year. As we've discussed on previous calls, we believe there is a fundamental shift in global communications that's fueling growth in the SBC market.

The largest service providers and enterprises in the world are upgrading their Legacy networks from century old circuit switch technology to next generation network based on internet protocol, or IP. They are doing this to lower operating costs and introduce new service offerings only available by IP such as voice over internet protocol, or VOIP.

With the advent of the internet, service providers and enterprises have delivered voice and data service separately over the public switch telephone network or PSCN and the internet. Managing these two distinct networks is not a viable economic alternative.

Service providers and enterprises are instead migrating to a single IP network architecture to serve as the foundation as their next generation server and applications. This migration requires a highly advanced network element that enables the delivery of trusted, first class IP communication services.

This element is a session border controller which is deployed at the borders between IP communication networks and serves to unify the separate and every increasing number of IP communication networks.

This in turn is driving growth in the SBC market. The [Deloral] Group, a market research and consulting firm specializing in networking and telecommunications projects the total addressable markets for SBC's to grow from approximately $200 million in 2008 to over $500 million by 2012.

It's worth noting that this forecast includes the service provider market only and does not include significant adjacent opportunities within enterprise and contact management. We believe SBC will be used to support tens of thousands of IP network edges, and as the clear market leader, we are well positioned to leverage this growth opportunity.

As proof points of our market leadership, consider that we completed 2008 with nearly SBCs deployed in 92 countries around the world. We now have over 635 customers with the addition of 125 new service providers and enterprises in 2008. We continue to maintain strong market leadership position with a market share three to four times greater than our closest competitor.

In 2008 our presence among the top 100 tier one service providers increased from 82 to 89 which we view as important given the capacity of these very large service providers to expand their deployment over time. In fact, our growth strategy has always been predicated on our ability to drive expansion within our existing customers.

After making our customers successful, we believe we have an opportunity to expand each of these deployments over time to support additional IP based service offerings and additional subscriber growth.

Back in 2007 we introduced a number of ways to measure our customer depth and breadth. We told you then that we intended to refresh the data annually so that you can determine the progress we are making.

I am pleased to report that each measure of customer depth and breadth improved in 2008. The number of customer who have purchased at least 25 Acme Packet session border controllers increased from 33 at the end of 2007 to 41 at the end of 2008. The number of customers who have purchased at least 100 Acme Packet session border controllers increased from 10 at the end of 2007 to 13 at the end of 2008.

The number of customers who have invested at least $1 million in Acme Packet products and services increased from 40 at the end of 2007 to 54 at the end of 2008. Finally, the number of customers who have invested more than $10 million in Acme Packet products and services increased from 4 at the end of 2007 to 7 at the end of 2008.

Based on the expansions we are seeing in our own customer base, we believe this growth will continue as service providers convert to all IP networks.

We made important progress in 2008 in both new customer option and expansion within our existing customer base. Ultimately, this is a measure of the performance of our solutions and our focus on product innovation. Over the last year, we expanded our portfolio with the delivery of three new products; our new multi-service security gateway configuration or MSG, our session routing proxy configuration or SRP, and our new Net-Net 4500 platform.

Our new MSG configuration enables fixed mobile substitution and fixed mobile convergence by securing the delivery of voice and data services over untrusted internet and Wi-Fi networks to sensor cells and dual mode end points. It is designed to enable wireless service providers to maximize revenue and minimize cost by accelerating six mobile substitutions and supporting the transition to all IP network.

Our new SRP configuration selects the best border point per session, crossing into another network on their path to a subscriber. This reduces the cost and complexity inherent in routing large numbers of fixed based voice, video, instant messaging and multi-media sessions within and in between service provider mobile fixed line and transit networks.

Finally, our new Net-Net 4500 platform increases the performance and capacity of our Net-Net 4000 series by 100%. This additional speed and capacity is critical as our customer support in every increasing number of users and volume of session. As Peter indicated, the reception by our customers to the 4500 has been excellent.

I would like to address some of the major trends we are seeing in our various customer markets and share with you what we're doing to capitalize on the opportunities in each. In the tier one wire line and wireless market, we believe we are well positioned with nearly 175 tier one customers. Some customers using our solutions to support as many as ten to fifteen separate projects.

In the wireless service provider market, our solutions are deployed at both the inter-connect and peering point and for the delivery of services over fixed line networks. We believe the deployment of all IP for four G radio access networks including LTE and mobile WiMax will ultimately reduce costs by leveraging a single IP based service infrastructure for all voice and data services.

In two weeks we'll be showcasing our wireless access and inter-connect solutions at the GSMA mobile World Congress in Barcelona. Visitors will see first hand how our solutions can smartly simplify the delivery of IP voice video and data services over 3G and 4G ratio access networks, six mobile convergence networks, voice inter-connects and core transport of networks.

In the enterprise and context end of market, the primary driver continues to be set trunking and the compelling ROI it can deliver. We believe that the majority of large enterprises today, having already deployed ITPBX's are about to rapidly embrace set trunking to reduce costs and set the foundation for enabling end to end IP communications, presence based voice, video, messaging and collaboration.

To meet this opportunity head on, we have made investment to develop both our position and our product set. We have added many new features and enhancements to our product offerings which are applicable to our core service provider customers as well.

We view the opportunity in the enterprise and context markets as strategic to our success in 2009 and beyond and believe that we're properly positioned to capitalize on this growth opportunity.

In the cable market, we have built a strong market position highlighted with our presence within nine of the ten largest North American cable companies. Cable companies here in the U.S. as well as in Europe and Asia are moving to IP inter-connect using the SBC's and core set routing using session routing proxy's to support this subscriber growth. In 2008 we also saw success supporting contact center operations in some of these large cable operators.

I am excited about our future. In 2009 our objectives are to positively grow our market and technology leadership. To be successful, we plan to continue to build additional predictability into the business, deliver the solutions that meet the rapidly evolving requirements of our customers, strengthen our position in key adjacent markets including enterprise contact centers and wireless, leverage new technologies to enhance our product performance and salability, invest in quality and responsive support, facilitate and promote inter-connect among our growing customer base and leverage our distribution partnerships to further enhance market penetration.

Our plan for 2009 is designed to drive sustained market share gains and economic value for our shareholders. We believe we are well positioned in what is expected to be a very large market with the broadest, deepest product portfolio and the most experienced work force in session oriented IT communications. We look forward to executing on the next stage of our growth.

I want to thank you for joining us. With that, I'll turn the call back over to Brian.

Question-and-Answer Session

Operator

(Operator Instructions) Your first call comes from Paul Silverstein – Credit Suisse.

Paul Silverstein – Credit Suisse

Andy, I appreciate the annual guidance. Can you tell us what you're expecting for the first quarter in terms of a base for your view of the year?

Andy Ory

There is seasonality in our business. I think the way we're looking at the first quarter is roughly flat.

Paul Silverstein – Credit Suisse

That's informed by what you're hearing from your customers, your pipeline, just your general sense? How much visibility do you have right now?

Andy Ory

You know that we embarked on a program. On August 7 call we talked about wanting to try and build visibility into our business and I do feel that we've been able to do that to some extent. I think we did also sit down and talk to our entire field sales organization one by one in the middle of January and asked them to give us a pretty exhaustive review.

They then went out and began selling activity in the second half of January and we feel this is a reasonable target for the company to have.

Paul Silverstein – Credit Suisse

Just to clarify, right now the numbers aren't far different from what March '08 and December '08. When you say flat you obviously say flat over December.

Andy Ory

That's correct.

Paul Silverstein – Credit Suisse

You gave us some nice information in terms of your $1 million, over $10 million, but can you tell us, if you looked at your top five, ten customers, I don't know how you want to cut the data, but can you give us some sense for how much of the revenues generated. You broke out your 10% customers but give us some sense for what the top five or top ten would be as a percentage of total.

Andy Ory

You're asking the top five end user customers?

Paul Silverstein – Credit Suisse

Top five, top ten, whatever you want to give us.

Andy Ory

Let me say this. It does get a little confusing because we break out Alcatel Lucent and Nokia Siemens as our two greater than 10% customers and Sprint, and Spring is really the only end user customer represented there.

Some people do ask about customer concentration. One of the things we wanted to do is show you the breadth of customers we dealt with, our end user customers in Q4 and throughout the year because we really think that we don't have significant customer concentration.

We think that we do enjoy a real breadth of penetration into this market. I guess what you're looking for is maybe what our top ten customers might represent, top ten end user customers. I can see if we can work that into some of the answers on this call in a little bit. I don't have the data right in front of me that I can give you.

I can say that we do have each of our managing directors, we have four regions, Apac, Cal, Amea and North America and I would say that the top ten customers in each one of those regions probably represent 70% of that region's activity. Remember, that's 40 customers right there.

Paul Silverstein – Credit Suisse

I know we've all been worried about the competitive landscape for a long time. Are you seeing, have you seen to date in any of your major tier one customers, Cisco or in terms of the integrated router parts and wins of theirs that you're aware of?

Andy Ory

I'm in my office and I'm looking at my wall here and I see a press release from Cisco announcing their XPC Pure Play Killer, and it's dated 12/12/05. So no, we haven't seen any dispositional change in competition on the competitive landscape.

Operator

Your next question comes from Simona Jankowski – Goldman Sachs.

Simona Jankowski – Goldman Sachs

I wanted to ask a little bit more about your 2009 guidance because most companies are not providing 2009 guidance so you're certainly in the minority there. A, you are giving visibility into that number then B, you're guiding about 5% revenue growth and that's despite the fact that you're number of customer is up by my math about 27% year on year. And on top of that you commented that you've got a larger number of customers who are spending more money each of them on your products. So what is the dis-connect between that increase in number of customers and increased spending per customer and then the guidance of 5%?

Andy Ory

There are two real questions that you're asking. One is to guide or not to guide. The other is how did we come up with our guidance.

This is the most challenging environment we have ever seen. However, we do have to run a business. We have to provide an annual plan to our Board and we do have to make a decision about what we think are reasonable expectations and reasonable investment based upon the return we can expect.

And I think in the spirit of being really transparent with the marketplace and our shareholders, I think we have to share with you some sort of targets that we're looking at. And so we made the decision that we would continue to provide annual guidance with obviously the caveat that 2009 is going to be a year that has a large amount uncertainty baked into it.

We have done as much diligence as we reasonably could in terms of talking to our customers, talking to our channels and doing diligence on our sales organization, and we do feel comfortable that we ought to have a year that is cash flow positive, profitable and sequentially up over the 2008 year, and our guidance reflects that.

As far as actually what to guide you at, while it is true that we do see ourselves continuing to enjoy our market share, we do continue to see expansion within both our service provider and our enterprise customer base, and the expansion that we expect to see in those markets doesn't necessarily square with the numbers we've given you, but I think that's us trying to provide a level of caution into the optimism that we have.

So I think that we probably, we're going to update you every quarter, but that's sort of how we made the decision to provide guidance and then what kind of numbers to guide you to.

Simona Jankowski – Goldman Sachs

It's still kind of a big dis-connect. Should we assume that those 130 plus new customers that you're adding in the last year are each buying a lot less than prior customers had, which I guess would make sense because you're early over the larger ones?

Andy Ory

I wouldn't necessarily say that. I would say that clearly the tier ones in every market are the ones who can buy the most and as we look at the customers that are continuing to go above the $10 million spend in the aggregate and above the 100 session border controllers, we're seeing more and more of those folks are defenders not attackers.

These are people that really have large installed customer base. They got breadth of resources. They're generally profitable. They've got large marketing engines and we are optimistic that they will be in business two, three, four years from now just providing voice services not over TDM but IT. So we would expect to continue to see tier one customers representing a disproportionate amount of the revenue opportunity that we're going after.

As far as why you see us providing guidance that's only 5% up, I guess I can say it's 2009 and we feel that our investment strategy right now is to be cautious in our optimism.

Simona Jankowski – Goldman Sachs]

It looks like Sprint was up about 30% quarter on quarter. Can you just comment on what drove the strength there and then also how you see them progressing in 2009?

Andy Ory

Sprint is an interesting customer. They're somebody that we have done, realized more than $50 million in the aggregate in terms of products and services. We continue to do business with them each and every quarter. They're a very good customer. We feel a great partnership with them.

They're generating revenue using our product and people use our products for two reasons; to try and cut their costs and also try to generate revenue with new services. And I think Sprint squarely falls in the latter and so we're obviously excited about that.

Operator

Your next question comes from Gregg Mesniaeff – Needham & Company.

Gregg Mesniaeff – Needham & Company

Looking at your deferred revenues, there was a nice pick up sequentially from Q3 to Q4 and I can't help but wonder whether this kind of signals better visibility and more reliance on a backlog driven revenue model which perhaps gives you the confidence to give the guidance that you were just talking about. Can you comment on that?

Andy Ory

When we had our conference call on August 7, 2008 and we talked about the shortfall in Q2 of 2008 and what we were going to do in Q3 and Q4 of 2008 people asked were we going to make up that revenue? Did we lose that revenue? And we felt very confident that we weren't losing any of that revenue to anybody, that the timing was off, and I believe that we provided some data on the third quarter conference call that the majority of that revenue was realized in the quarter as bookings in Q3.

But one of the things that colored the kind of guidance that we gave, the modified guidance on August 7 about the remainder of 2008 is not only that we wanted to make sure that we would be able to execute on the remaining two quarters, but that we would also put ourselves in a position where we'd feel more comfortable about executing 2009 and some of that is about visibility.

We have been working on improving the visibility in our business and we have to some extent done that. And that is one of the factors that gets mixed into the synthesis of do we provide guidance for 2009 or not.

Gregg Mesniaeff – Needham & Company

So it's fair to say that your current visibility is at least in part a function of greater reliance on backlog as opposed to just a turns business.

Andy Ory

That's a fair assessment.

Gregg Mesniaeff – Needham & Company

Your OpEx lines in Q4 particularly in R&D and sales and marketing showed a decline in terms of percentages as well as absolute dollar numbers and at the same time your head count did not decrease, in fact it increased a little. So I can't help but wonder how you were able to achieve that.

Andy Ory

I'm going to answer at a philosophical level and Peter can fill in if he desires at an operational level. We are committed to running this business profitably and with positive cash flow. We are committed to investing appropriately in our business and providing a quality and innovative product and we believe we can do that by increasing some of the leverage in the organization.

And I think we've done that in each of the last two quarters. We continue to review our expenses, our investments, our operations and I feel very, very good. In fact I think that the organization at Acme Packet has done an outstanding job in managing it's operational expenses and not compromising any of our capabilities to acquire customers and deliver on the commitments that we have made.

And that's a commitment that we will continue to make to you and report to you every single quarter. Peter, I don't know if you want to comment specifically on sales and marketing and engineering.

I can say that when we did reforecast on the August 7 call, we also were very careful to make sure that if we were going to adjust our guidance downward from $142 million to $147 to I believe $116 million to $119 million, as we adjusted it downward, we made the decision that we would slow the hiring down and be focused only on strategic and revenue generating hires, and I think we've been able to do that.

Peter Minihane

There are a couple of issues that occurred during Q4. I think we mentioned one of them in my section of the formal remarks, we talked about a decision that we made if we did not meet our full year financial targets of effectively reversing our three-quarter accrual of that bonus program to and including September 30. We reversed that in Q4.

However, we also had Nortel Networks petition for bankruptcy as we all know in mid January and so what we did was effectively, those changes went to the G&A line, so you'll see them go up by $2.6 million up to $3.2 million. And everybody else, sales and marketing basically flat. Research and development was down from $5.2 million to $4.7 million and that reflects the reversal basically of the management bonus for people within the R&D organization and Andy's point of recalibrating who we were hiring for the remainder of the year from mid August through and including December 31.

So it's a combination of four or five items, two or three principal items; one, the reversal of bonus and again the net effect of Nortel Networks.

Operator

Your next question comes from [Steven O'Brien – J.P. Morgan].

[Steven O'Brien – J.P. Morgan]

Looking at inventories this quarter which declined sequentially, it helped on the cash flow side of the business, but I guess in fairness current liabilities also hurt cash. Whose inventory cycle at Acme, when do the SBCs get in inventory and when do they get shipped and did the decline in inventory reflect on the rough outlook for a flat quarter entering Q1 given the much higher inventory entering Q4?

Peter Minihane

I think we mentioned in our conference call for Q3 that both Andy and myself were basically unhappy with the inventory levels of approximately $9 million. What we wanted to do, and I think we've started that journey is to have our inventory go somewhere between three and a half to four turns in 2009 and I think it just reflects our Q4 $7 million inventory balance is just the first step in that direction.

From an overall standpoint, we basically have revenue recognition policies that are tied to shipments and/or acceptance, so we will remove the product from inventory at such point in time as we recognize the revenue.

99% of our inventory activity is to a third party, sub contract manufacturing, two operations that we have here in the local Burlington, Massachusetts area and so we take that inventory onto our books and records upon receipt from our sub contract manufacturer.

[Steven O'Brien – J.P. Morgan]

On the guidance, the 2009 guidance especially with a flat Q1, you'd already be at the run rate to the low end of your full year guidance. Does that mean that there's going to be a very, very modest seasonality in 2009 that every quarter will look roughly similar?

Peter Minihane

Based on what we said, that would be a fair way to model it, but it also means we're in 2009. I think that from our point of view we have more visibility in the first quarter than we do in the third and fourth quarter. We do have a general belief that we will experience growth in 2009. It's unclear exactly how much it's going to be and so this is the initial range that we're looking at.

[Steven O'Brien – J.P. Morgan]

Also within 2009 the high teens operating margin guidance, sounds like a slight down tick from Q4. Is that due to this Nortel/less bonus impact which helped your Q4 operating margin or are there some other factors laying on the operating margin in 2009?

Peter Minihane

I think the operating margins in 2009 are fairly consistent with what we've enjoyed for the past two quarters. Again, Nortel does have an impact in Q4 obviously as does the reversal of the management bonus that we just quite frankly didn't earn. We decided in a compensation committee and our Board agreed with us and that's why we reversed it.

I think we're very strong from a gross margin side. We've always been in the high 70's, 80% and I think that's going to continue to be our focus as is the high teens to 20%. Longer term we do have a higher income operating model, but we think as Andy mentioned, who knows what's going on in 2009.

We've done a detailed review as Andy also mentioned with each of our sales guys in mid January, with each of the people who run the various regions whether it be North America, Asia Pac, Ocala, so we have a little bit of everything that goes into the mix. There's no single formula. We try out best to focus on high gross margins and strong operating income.

Andy Ory

I think the thing I'd want to add as well, and this ties into some earlier comments. We are still acquiring market share. We are still acquiring customers. I think we are increasing the breadth of opportunity for this company to experience leverage if or when this market really starts to pick up.

And given that we are still generating cash and still generating profit, I am very reticent to cut back on some of the additional investments in business development, relationship management, sales, direct account management and key strategic engineering initiatives.

And so there probably is a point or two of a little bit of investment there, but I think there is a lot of leverage inherent in this business if you were to see the revenue line increase. You would not see our expense line increase in step with it. We would enjoy more fall into the bottom line.

Operator

Your next question comes from Catherine Trebnick – Avian Securities.

Catherine Trebnick – Avian Securities

Do you know if the addressable market that [Deloral] put out also includes any of this IPX managed service, inter-connect service or is it not that granular?

Andy Ory

Actually I don't believe it's that granular. Again, mostly focus on service providers specifically over the next six year.

Catherine Trebnick – Avian Securities

That's service provider. That's wireless.

Andy Ory

It may. I guess I'd have to direct that to Shamus.

Catherine Trebnick – Avian Securities

Catch up with me maybe Monday, Tuesday on that. The other question has to do with basically the trunking. You discussed as much as enterprise play but could you add some background color as to where the tier one operators, the alternative carriers, and the cable companies are and looking into deploying that service?

Andy Ory

We've actually seen a big change in the second half of 2008 in terms of the availability of SIP IP inter-connectors, SIP trunk for large enterprises and contracts. The United States appears to be six plus months ahead of Europe but we're finding that our key service provider customers are getting increasingly interested in extending their IP networks strategically into large enterprise customers using SIP based IP trunks and Acme Packet has been aggressively developing technology to meet those needs, and that's something we'll probably talk about in the future over the next 90 days.

But we're really seeing that as a very good opportunity for us. I can't say that 100% of our tier one service providers think that way. In every region you're going to run into one or two that are deciding that rather than accelerate the cannibalization of their TDM margins to IP, they're going to wait until they lose market share and then make the change.

But we're finding that in every region there are some existing market entrance that are deciding to become early adopters and we're certainly seeing it all over the world.

Operator

Your next question comes from Brian Modoff – Duetsche Bank.

Brian Modoff – Duetsche Bank

When you look at this year, is there any specific set of customers or market segments or geographies where you see the most success from the sales perspective for your products?

Andy Ory

We actually expect 2009, the second half of 2008 rather performed in line and the annualized numbers that Peter read off about distribution direct and indirect in regions on North America versus rest of world, we actually expect to 2009 to fall pretty much in line with that. We don't really expect to see much change. Everything seems to be moving in the right direction is unison.

If you want me to be more specific, certainly WiMax is a great opportunity. It's part of our wireless play. We continue to see that. We continue to see more and more opportunities to smartly simplify the routing within these IP networks, the delivery of SET base of session oriented services. Cable continues to invest. We're excited about that.

We are seeing growth in Asia. Asia performed pretty well last year. The key markets in Asia appear to be on track this year although it is very early to say a specific market level. The key incumbent is continuing to invest in line with what we would expect.

Brian Modoff – Duetsche Bank

Are you seeing equipment vendors king of getting up to capitalize on the spending in the public sector, especially in the U.S., so how are your products and your business overall reorganizing or better targeting public sector opportunities this year?

Andy Ory

I apologize. I don't understand the question.

Brian Modoff – Duetsche Bank

The question is, are you seeing spending pick up this year in the government, public sector opportunities. So how is your company and your product gearing up for this new wave of spending.

Andy Ory

We have been working on partnerships with key technology and infrastructure providers to the government and we have been investing. We have done business with the government. We treat the government as the largest enterprise in the world, but it has some particulars both in terms of distribution and requirement.

And we're investing in technologies that make sense for the government opportunities as well, and it's something that we are optimistic about over time, but it will take some time. Our technology development as well as some of the emerging partnerships we have, should carry us pretty well with government opportunities.

Brian Modoff – Duetsche Bank

Is our product ready from a requirements perspective for these government opportunities or is there custom work that needs to be done?

Andy Ory

It really depends upon which sector of the government you're working with. For the general government opportunities, absolutely our product has been ready and we are distributing. And then there are some additional requirements, technology requirements that we continue to invest in that are a bit heightened relative to what a regular enterprise would require. Some of those are available this year currently, and some will be available throughout the year.

Operator

Your next question comes from Ted Jackson – Cantor Fitzgerald.

Ted Jackson – Cantor Fitzgerald

I wanted to ask several questions relative to model and guidance and really its just relative to sort of one off aspects of the fourth quarter. On the revenue front, you had $1.7 million of revenue that normally would have been categorized as product revenue and services. So when we think about the first quarter, is it fair to assume that we would see some sort of decline in services and maybe an outside uptick in product revenue to sort of right that shift?

Peter Minihane

I think if you just reduce the service revenue by the $1.7 million and increase the product revenue by the same amount it would probably more clearly reflect the actual operations as opposed to what we wanted to do from a one time carve up.

Ted Jackson – Cantor Fitzgerald

On the margin front, if you look at your services margins, they were well above anything you've done before in the past. Could you give us a sense as to what your services margins would have been if you hadn't had that $1.7?

Peter Minihane

If you take that $1.7 million and assume that it was in product revenue, you would enjoy the same 80% gross margin less those cost and cost of goods sold for product.

Ted Jackson – Cantor Fitzgerald

So you put a $1.7 of revenue in services with no associated cost.

Peter Minihane

That's exactly right. And that again is consistent with GAAP policies as it relates to visa.

Ted Jackson – Cantor Fitzgerald

And going down to the operating expense lines, you didn't amortize for your bonuses and more than that, you actually did a reversal. When we think about the first quarter, would be because of that would we expect some substantial uptick in terms of operating expenses on a sequential basis?

Peter Minihane

I would think what you'd have is something in the area of approximately $18.5 million to $19 million in OpEx in Q1.

Ted Jackson – Cantor Fitzgerald

And that's on a pro forma basis?

Peter Minihane

Right.

Ted Jackson – Cantor Fitzgerald

On your giving of guidance, I wanted to congratulate you on it because I think that it would have been really easy not to do it so I just wanted to tell you thank you very much.

Peter Minihane

Again, to Andy's point, we felt compelled to give you everything that we have heard about, talked about, from our customers and all of our field sales personnel that we had in mid January together. We thought it was a reasonable thing to do.

Operator

Your next question comes from Sanjiv Wadhwani – Stifel Nicolaus.

Sanjiv Wadhwani – Stifel Nicolaus

Any color on how the quarter progressed? Was it front end loaded, back end rated, just in terms of trends as the quarter progressed? And then second question, on the enterprise side, I guess I realized there is still a small portion of their revenues, but is it sort of touching to 5%, maybe higher than that? What do you expect '09 to be for that portion of your business?

Andy Ory

In terms of a trend, Q4 really did perform in line actually in all three months were quite good. I don't know Peter if you have data in front of you that can say exactly how it worked out.

Peter Minihane

On the revenue side we had for example in Q4 and again, these are approximate numbers, of 23% in the first, 22% in the second month and 55% in the third month. Our bookings were somewhat similar although some a little stronger. So within reason, we had a nice balance in the quarter.

Andy Ory

You asked a question about the enterprise side. It's north of 5%. It's making a difference in a couple of different ways. Clearly as these access service providers start to extend the edges of their network to large enterprise and contact centers, they're creating more edges on the edge of their networks as well as on the edges of the edge of the customer or enterprise.

So really, you almost think of it as a bridge where you have product on each side of the bridge. And so it drives a fair bit of access revenue as well. So in the aggregate it's pretty strategic.

Sanjiv Wadhwani – Stifel Nicolaus

So north of 5%, less than 10%. Is that sort of the range I should be thinking about?

Andy Ory

It could even go higher than that, but it's very hard for us to say to break it down to that level of granularity at this early date in '09.

Operator

Your next question comes from [Andrew Nowinski – Piper Jaffray]

[Andrew Nowinski – Piper Jaffray]

Nokia Siemens dropped off as a 10% customer this quarter? Any comment on that?

Andy Ory

The business with Nokia Siemens did perform in line for the year and I think it was more just a function of fluctuation within the quarter. In fact, we were happy with the relationship. I think both sides were and we expect similar kinds of results in 2009.

[Andrew Nowinski – Piper Jaffray]

Could you break out any assumptions you made regarding wireless segments?

Andy Ory

When we think of wireless it includes the wireless access edge as well as the wireless inter-connect into the wire line network and the core routing in the wireless network. It's certainly going to be well north of 10% and probably less than 35%. I'm not trying to be coy. There's a fair bit of opportunity in those markets and it's just hard to know exactly which is going to happen this year and which is going to happen next year.

Operator

You have no further questions at this time.

Andy Ory

Thank you for that final question. Thank you for joining us this evening. We look forward to our next conference call when we can update you on our continuing progress. Good night.

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