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Acme Packet, Inc. (NASDAQ:APKT)

Q2 2010 Earnings Call Transcript

July 29, 2010 5:00 pm ET

Executives

Brian Norris – Director, IR

Andy Ory – Co-Founder, President and CEO

Peter Minihane – CFO

Analysts

Paul Silverstein – Credit Suisse

John Marchetti – Cowen & Company

Brian Modoff – Deutsche Bank

Simona Jankowski – Goldman Sachs

Catharine Trebnick – Avian Securities

Rich Valera – Needham & Company

Simon Leopold – Morgan Keegan

Sanjiv Wadhwani – Stifel Nicolaus

Jeffrey Britt – Janney Montgomery Scott

Operator

Good afternoon, ladies and gentlemen and welcome to the Acme Packet's conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) Also as a reminder, ladies and gentlemen, this conference call is being recorded.

I would now like to introduce your host for today's call, Brian Norris, Director of Investor Relations for Acme Packet. Please go ahead.

Brian Norris

Thank you, Tony. Good afternoon, everyone. Welcome to our 16th quarterly conference call. I am Brian Norris, Director of Investor Relations and I'm joined by Andy Ory, our President and Chief Executive Officer and Peter Minihane, our Chief Financial Officer and Treasurer.

The format for the call is as follows, Andy will begin with a high level review of our second quarter results. Peter will then follow with a detailed financial review and a discussion of our updated outlook for 2010. Andy will then provide an update on the key growth drivers for 2010. We will then open the call up for Q&A.

All results and expectations we review this afternoon are on a non-GAAP basis unless otherwise described as GAAP. During our call, we will be referring to non-GAAP net income and non-GAAP net income per share, which are non-GAAP financial measures, which for all periods presented exclude stock based compensation expense and amortization of intangible assets related to the company's acquisition of Covergence in April of 2009.

Our non-GAAP results for the three-month period ended June 30, 2009 also excludes merger and integration related costs again related to the acquisition of Covergence. The press release announcing our second quarter financial results along with our financial statements and our reconciliation of GAAP to non-GAAP measures is available on the Investor Relations section of our website at www.ir.acmepacket.com.

Statements made during this call that are not historical fact may be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such forward-looking statements may relate, among other things to our expected financial and operating results for our future business prospects and to forecasted 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 our actual results to differ materially from those anticipated. A discussion of these risks and uncertainties is contained in our recent filings with the SEC, including those factors discussed under the caption Risk Factors in such filings. Investors should not place undue reliance on these statements, which are current only as of the day they are made and we disclaim any obligation to update them. In light of Regulation Fair Disclosure, we will not comment on our business outlook during the quarter unless we do so explicitly through a public disclosure.

Before I turn the call to Andy, we’ll briefly bring our attention for upcoming investor event on August 9, it will be in Vail, Colorado for the Pacific Crest Technology Leadership Forum and on 11th will be in New York for the Morgan Keegan Technology conference. Well, September 14 will be in San Francisco for the Deutsche Bank Technology conference and finally on September 15 will be in Boston, Credit Suisse small cap conference. One last calendar item, please make plans to join us at 5 00 p.m. Eastern Time on Thursday, October 29 for our third quarter earnings results conference call. For more details on our IR outreach plans for the third quarter, please feel free to contact me at 781-328-4790.

With that, I'd like to turn the call over to Andy.

Andy Ory

Thank you, Brian and good afternoon, everyone. We are pleased to be reporting the strongest quarter in the company's history. Our second quarter results were highlighted by record revenue, gross margin, operating margin, earnings and ending cash.

Total revenue increased to a record $53.3 million in the second quarter, reflecting growth of 62% year-over-year. Gross margin expanded to a record 84% we now expect gross margins to remain in the low 80s for the remainder of the year.

Operating margin expanded to a record 36%. We now expect operating margin to be in the low to mid30s for the remainder of the year. Longer term we are modeling operating margin in the low 30s as we make investments across the organization to drive further top line revenue growth.

We reported record non-GAAP EPS of $0.18, up from $0.07 in the second quarter of last year. We reported record GAAP EPS of $0.14 up from $0.03 in the second quarter of last year. We further bolstered the strength of our balance sheet. We ended the second quarter with a record $217 million in cash up nearly $29 million sequentially while deferred revenue was unchanged sequentially, deferred product revenue increased by approximately $2.8 million. DSOs improved to 46 days, down from 52 days in the first quarter.

Beyond the financial highlights, we added 54 new customers in the second quarter. This included 23 new service provider customers and 31 new enterprise customers, including six members of the Global 500. We added over 125 new customers in the first half of 2010 and now serve the needs of over 1100 customers in over 100 countries.

We continue to see evidence of our expanding market share. According to Infonetics Research, our share of the service provider SBC market had expanded to 62% by the end of the first quarter of 2010 compared to approximately 50% at the end of the first quarter of 2009.

We extended the reach of our solutions to small and medium enterprise sites and small contact centers with the launch of the powered by Acme Packet Program. This initiative enables IP communication solution providers to embed Acme Packet's Net-Net OS-E session border controller software into network elements at the rapidly growing number of enterprise IP borders.

On the product innovation front, we introduced our new Net-Net 3820 platform, which is targeted at both small and midsized IP communication service providers and mission critical enterprise and contact center applications.

Based on the strength of the business during the first half of the year and the growth drivers we are seeing in our key markets, we are again raising our outlook for 2010. We are updating our earlier outlook, which called for 45% revenue growth and 90% earnings growth in 2010.

We now expect revenue of between 214 million and $218 million, an increase of approximately 53% over 2009. We expect to report sequential revenue growth in both Q3 and Q4. We now expect non-GAAP EPS of between $0.72 and $0.74 per share, an increase of approximately 109% over 2009. We believe we can deliver on this upwardly revised business plan while also properly positioning the company for 2011.

For a closer look at the numbers and our outlook, let me turn the call over to Peter.

Peter Minihane

Thank you, Andy. This afternoon I will review our financial results for the second quarter of 2010 and then discuss our updated outlook for the remainder of the year.

As a reminder, all financial results and expectations reviewed this afternoon related to our statement of income are on a non-GAAP basis unless otherwise described as GAAP. Our discussion of sequential changes in our financial results compares the second quarter of 2010 to the first quarter of 2010. Finally, please note that all earnings per share amounts are on a fully diluted basis. With that, I'll begin with a brief review of our second quarter 2010 results.

Total revenue was $53.3 million, an increase of 4% sequentially. We expect to report sequential growth in product and service revenues in both Q3 and Q4. Product revenue was $42 million, unchanged from Q1. It is worth noting that we sustained our Q1 product revenue level despite the fact that product revenue increased 31% sequentially in the first quarter of 2010.

Maintenance, support and service revenue was $11.3 million, an increase of 26% sequentially. This primarily reflects the timing of maintenance renewals, as well as growth from our installation and training organizations.

One direct customer accounted for 10% or more of revenue and that was Verizon Business at 10%. The distribution of revenue was 49% direct and 51% indirect, consistent with prior quarters, the distribution of revenue with 49% and 51%, consistent with prior quarters.

Two channel partners accounted for 10% or more of our revenue in the second quarter. Alcatel-Lucent accounted for 13% of our second quarter revenue while Nokia Siemens Networks accounted for 12% of our second quarter revenue. I remind you that ALU and NSN like many of our channel partners represent dozens of end user customers.

Geographically 66% of our revenue came from the United States and Canada and 34% came from our international customers. This reflects increased demand for our solutions from Tier 1 services providers here in North America.

Gross margin increased to a record 84% up from 82% in the first quarter. As Andy mentioned, we now expect gross margins to remain in the low 80s for the remainder of the year. We are also raising our long term gross margin target. We now believe that long-term gross margins are likely to be in the upper 70s to low 80s compared to our previous target in the upper 70s.

Product gross margin increased to 84%, up from 83% in the first quarter. This reflected the continued strong adoption of our high capacity, software rich products including the Net-Net 4500. Service gross margin increased to 83%, up from 77% in the first quarter, this reflected the increase in maintenance revenue related to service renewals, as well as an overall decrease in costs associated with the fulfillment of maintenance obligations.

Total operating expenses were $25.4 million, a slight increase sequentially. We expect operating costs will increase in both Q3 and Q4 as we accelerate hiring in all areas of the company to support our long term strategic plans.

Operating margin expanded to 36% compared to 33% in the first quarter of 2010. As Andy mentioned earlier, we now expect operating margin to remain the low to mid 30s for the remainder of the year. Longer term we are modeling operating margin in the low 30s as we make investments throughout the organization to meet our long term strategic goals.

Our effective GAAP and non-GAAP tax rate was approximately 36%. Net income on a non-GAAP basis was a record $12.4 million compared to $10.7 million in the first quarter of 2010, reflecting an increase of 16% sequentially. Earnings per share on a non-GAAP basis was $0.18 compared to $0.16 in the first quarter of 2010, reflecting an increase of 13% sequentially.

Net income on a GAAP basis was a record $9.7 million or $0.14 per share compared to the first quarter of 2010 when we reported net income on a GAAP basis of $8.3 million or $0.13. Non-GAAP net income differed from GAAP net income in the second quarter of 2010 as it excluded stock-based compensation expense of $2.4 million net of taxes or $0.04 per share, as well as amortization of acquired intangible assets net of taxes of approximately $300,000.

Non-GAAP net income differed from GAAP net income in the first quarter of 2010 as it excluded stock-based compensation expense of $2.1 million net of taxes or $0.04 per share, as well as amortization of acquired intangible assets net of taxes of approximately $300,000. We ended the second quarter with 509 – I'm sorry – 503 employees compared to 474 at the end of the first quarter.

Moving to the balance sheet, we ended the second quarter with record cash, cash equivalents and investments of approximately $217.3 million compared to $188.6 million at the end of the first quarter of 2010. This represents an increase of $28.7 million sequentially.

We generated $15.1 million in cash from operations during the second quarter, primarily driven by GAAP net income of $9.7 million. Cash flow provided by financing activities was approximately $17.4 million, primarily reflecting $8.2 million in proceeds from stock option exercises and $9.3 million related to excess tax benefit recognized upon the exercise of those stock options.

Total capital expenditures in the second quarter were $3.3 million, which includes $1 million in expenditures related to the relocation and expansion of our corporate headquarters earlier this week. We anticipate capital expenditures of approximately $10 million to $12 million in the second half of 2010. This includes approximately $5 million to $6 million related to the relocation and expansion of our corporate headquarters.

Accounts receivable net was $27.5 million at June 30, 2010 compared to $29.5 million at March 31, 2010, primarily reflecting timing of customer shipments, increased collection efforts and the timing of customer payments.

DSOs improved to 46 days at June 30, 2010 compared to 52 days at March 31, 2010. This afternoon we are adjusting our targeted DSO range to 55 to 60 days compared to our previous target range of between 60 and 70 days.

Inventory at June 30, 2010 was $5.9 million compared to $5.2 million at March 31. Inventory turns was consistent with our expectations in the second quarter at 5 turns, reflecting the continued hard work and focus by our manufacturing team to maintain appropriate inventory levels. Finished goods at customers at June 30, 2010 were $3.2 million compared to $2.3 million at March 31, 2010.

Finally, deferred revenue was $33.4 million at June 30, 2010 unchanged from March 31. This net amount includes a $2.8 million increase in deferred product revenue in the second quarter offset by a $2.7 million decrease in deferred service revenue, reflecting the amortization of customer service contracts.

As we have discussed on previous calls, deferred revenues can fluctuate from period to period based on the timing of order receipts and revenue recognition and it should not necessarily be relied upon as an indicator of the health of the business.

To help you better understand how we are looking at our growth plans; 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 for our business, which may change at any time. We undertake no obligation to update these comments. Let me also remind you in light of Regulation FD, we’ll not comment on our business outlook during the quarter unless we do so through an explicit public disclosure.

During our call in April, we discussed our revised outlook for 2010, which called for revenue of approximately 45% and earnings per share growth of approximately 90%. Since then, we've had the benefit of completing another quarter highlighted by record revenues and improved visibility.

We are again raising our outlook for full year revenue growth to approximately 53%. We now expect revenue in 2010 to range between $214 million to $218 million compared to our earlier outlook of between $204 million and $208 million.

As we mentioned earlier, we expect sequential growth in product and service in both Q3 and Q4. We expect to end the year with approximately 590 employees up from our previous forecast of 560 employees. We are raising our outlook for full year earnings growth. We now expect non-GAAP earnings per share to grow by approximately 109% in 2010 and our GAAP earnings per share to grow by approximately 100%.

We now expect non-GAAP EPS to range between $0.72 to $0.74 per share compared to our earlier outlook of between $0.65 to $0.70 per share, we expect GAAP EPS to range between $0.53 to $0.55 per share. We expect non-GAAP net income to differ from GAAP net income in 2010 as it is expected to exclude stock-based compensation expense of approximately $10.2 million or $0.15 per share on a diluted basis and amortization of acquired intangible assets of approximately $1.2 million or $0.02 per share on a diluted basis. Our earnings outlook on a non-GAAP basis assumes a full year GAAP and non-GAAP effective tax rate of approximately 36%.

Finally, we now expect our full year weighted average diluted shares outstanding to be approximately 68 million shares compared to our earlier forecast of 67 million shares. This reflects the impact of the significant increase that our stock has had on the treasury stock method it also reflects the full effect of employee stock options grants awarded in Q1 of 2010.

To summarize, we had a very strong second quarter highlighted by record revenue, gross margin, operating margin, earnings and ending cash. Our outlook calls for continued strong performance for the balance of the year. During our next earnings release conference call on October 29, 2010, we will share with you the highlights from the third quarter of 2010.

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

Andy Ory

Thank you, Peter. We are pleased to report a very strong first half for 2010. Our improved financial results in the second quarter are a reflection of our ability to capitalize on the broad secular trends that are redefining the global communications landscape.

As we described in our last call in April, next generation IP networks being deployed by service providers and enterprises require unified service delivery architecture based on an expanding definition of session border control. Session border control is much more than SBC, it is a service delivery architecture that encompasses other product categories, including session routing proxies, multiservice security gateways and session aware load balancers.

In total, we believe that the market for our solutions will reach $2 billion annually by 2014 with growth of 25% per year. Session border controllers or SBCs control sessions at IP network borders. We believe that the market for SBCs among service providers, enterprise, government and contact centers will grow to over $850 million by 2014 with a compounded annual growth rate of 23%.

Session routing proxies route SIP sessions to and from borders both access and interconnect. They also serve as the breakout gateway control function in IMS networks. We believe that the session routing proxy market may grow to approximately $400 million by 2014 with a compounded annual growth rate of approximately 4%.

Multiservice security gateways transport all services and applications, including voice, video and data, across the un-trusted Internet to private service provider network borders via IPsec sessions. We believe that the MSG market may grow to approximately $675 million by 2014 with a compounded annual growth rate of over 50%.

Session aware load balancers are used to dramatically scale SBC deployments. We believe this market may grow to over $40 million by 2014 with a compounded annual growth rate of approximately 111%.

Our customers deploy our products to deliver next generation interactive communication services with the same quality assurance and security as they historically have offered over their legacy telephone networks. Our products are found at the borders between IP communication networks and serve to connect and manage the separate and ever-increasing number of IP communication service islands.

The proliferation of these network islands is fueling what we believe will become a multibillion dollar global market for our solutions over the next several years. As the clear market leader, we are well positioned to benefit from the proliferation and the number of IP communication network islands among fixed line, mobile and over-the-top service providers, as well as enterprises.

Fixed line service providers use our solutions to deliver services to residential, small and medium businesses and enterprise customers over their access network borders. Mobile service providers use our solutions to deliver interactive communications and data services to their mobile subscribers.

Over-the-top and application service providers use our solutions to deliver services and applications from their data centers to users over the public Internet or the managed IP network of a third party network service provider.

Enterprises, including government agencies and contact centers, use our solutions at SIP trucking borders to connect to the PSTN, federated enterprise and consumer groups, outsourced contact centers and hosted services they are also used to secure the public Internet border connecting remote workers and their offices.

According to Infonetics Research, the enterprise session border control market grew by more than 50% in 2009, which is in sharp contrast to the 22% decline in the PBX market. We believe that this growth has been driven largely by the rapid adoption of SIP trunking and the need to support interoperability across growing network environments.

We continue to make investments to support our position in this market as exemplified by the Powered by Acme Packet Program we announced last week. This program enables IP communications solutions providers to embed our Net-Net OS-E SBC software in network elements at enterprise IP borders. It extends our reach from the enterprise and large contact center segment into small and medium enterprise and contact center sites.

It enables IP communication solution providers to embed our SBC software into a wide range of hardware platforms, including those for IP PBXs, unified communications and contact center service, as well as multiservice business gateways, firewalls and routers. This provides enterprises and managed service providers with a comprehensive, cost effective SBC solution that occupies a smaller footprint and provides several service delivery advantages at a lower cost.

Small and medium businesses, as well as large enterprises with smaller sites, need more cost effective, integrated session border control solutions. Our Powered by Acme Packet Program enables OEMs to deliver best-of-breed SBC functionality to their customers while leveraging the Acme Packet brand, channel and domain expertise.

Last week we announced an extension to our partnership with Avaya, the global leader in business communication systems, software and services. Our SBC capabilities are now part of the Avaya Aura communication platform. The Avaya Aura session border controller Powered by Acme Packet provides enterprises with an end-to-end SIP based solution that delivers greater security, interoperability, control and manageability of real time multimedia communications across IP network borders.

The Avaya Aura session border controller Powered by Acme Packet leverages Acme Packet's Net-Net OS-E software embedded within the Avaya Aura system platform. This offers a more cost-effective solution for midsize enterprises, branch offices and small contact centers. It also complements the Acme Packet Net-Net SBC solutions currently available from Avaya and Avaya Connect channel partners for enterprise and government customers.

The Avaya Aura session border controller offers a rich set of features and functions for securing, controlling and managing SIP trunking and hosted IP services, as well as a broad range of UC or unified communications applications. The Avaya Aura SBC is a component of the Avaya Aura system platform virtualization technology, which significantly reduces the overall hardware footprint and enhances serviceability.

Leveraging our distribution and OEM partnerships to enhance our market penetration is one element of our plan to profitably grow our markets and technology leadership in this second half of 2010 and beyond.

In 2010 for the second half, we will be focused on continuing to build additional predictability into the business, delivering the solutions that meet the evolving requirements of our customers, leveraging new technologies to enhance our product performance and scalability and facilitating and promoting interconnects among our growing customer base.

We believe we are well-positioned in the growing marketplace for our products with a broad, deep product portfolio and an experienced workforce in session border control solutions. I want to thank all of our employees for their continued hard work and dedication to achieving our vision. Thank you for joining us this afternoon and for your continued support of Acme Packet.

With that, let me turn the call back over to Brian.

Brian Norris

Thank you, Andy. Before we open the call up to Q&A, I'd like to notify listeners that our quarterly report on Form 10-Q for the second quarter is now on file with the SEC.

Tony, with that we'd like to open the call up to Q&A, please.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question in queue, that will come from the line of Paul Silverstein with Credit Suisse. And your line is open.

Paul Silverstein – Credit Suisse

Hey guys, a couple if I may. First off, maybe I missed it, but can you tell us what enterprise was as a percentage of revenue or bookings and you also talked about the respective growth rates for the service provider and enterprise markets?

Andy Ory

Yeah. Enterprise was – it was roughly 17%.

Paul Silverstein – Credit Suisse

And from a growth perspective, Andy, I think it was around 17, 18 last quarter if I remember. What are you seeing in those two markets in terms of growth? You spoke about customer account, but can you give us more insight?

Andy Ory

Yeah. I mean, we're definitely seeing the enterprise funnel grow much more quickly. It is going to be a quicker growing market there's no question about it. It is working off of a smaller base and we're continuing to see outperformance on our service provider side, so that's probably holding the numbers back a little bit. But we have very high hopes on the enterprise side we're very excited by what we're seeing.

Paul Silverstein – Credit Suisse

Right. And the new apps that you've spoken about, whether IPv4 or IPv6, serve multiservice security gateway, et cetera can you give us some more insight, I think you had mentioned in the past that you had several dozen customers. Can you give us any update on traction for those and when we should expect it to impact revenue?

Andy Ory

I think it's going to stay around the range that it is. I mean, still its well north of 90% our basic session border controllers we continue to sell the other solutions, but I think for the remainder of 2010 I wouldn't expect from a revenue point of view to see much change in the components of the revenue.

Paul Silverstein – Credit Suisse

But, Andy in the last 90 days, how about from a customer uptake standpoint?

Andy Ory

It's a good question. I've seen more customers that have increased interest in the multiservice security gateway principally because they want to leverage wireline backhaul to offload their macro RAN and I do think that that's going to be one of the faster growing categories. Additionally we're seeing a lot of interest in our session load balancer, both on the access side, as well as we're getting pushed on the trunk side to find ways to scale that IP border and not have to backhaul everything to centralized locations. We're doing an awful lot of work in both of those categories and we're getting an awful lot of inbound requests for us to come on out and share with them our solution.

Paul Silverstein – Credit Suisse

All right, two other quick ones. Cisco, Juniper and Sonus are the other competitors, can you talk about the competitive landscape, if you're seeing any change?

Andy Ory

Well, if you look over the last 12 months, our market share went up in the market where I think market share is statistically relevant on the service provider side from – I don't know if it went from 50% to 60%, somewhere in that range. We still – we continue to enjoy a very, very high win rate and we really haven't seen much dispositional change. Peter and I did sit down and listen to the European, as well as CALA and North American account reviews over the last three weeks and I would say that the competitive disposition remains the same as it was six months ago and six months before that.

Paul Silverstein – Credit Suisse

And let me push you. The last 90 days, have you seen any change, meaningful change, in your win rate in any region have you seen…

Andy Ory

No.

Paul Silverstein – Credit Suisse

No. So you haven't, you're not seeing Sonus, you're not seeing Cisco, you're not seeing Juniper at this point?

Andy Ory

We’re seeing people that are out there, as we always have. In the service provider space, it's always been fragmented. So we'll see folks based upon – in North America, we'll see some equipment manufacturers if they have relationships for soft switches and gateways, they're going to show at the party, it doesn't mean that they're going to enjoy much of a win rate, but they're going to show up, we see Huawei in Asia. But it's a very fragmented, distant group of number two in terms of market share and in terms of win rate in our core market. In the enterprise market, it's the same. It's really Acme Packet and Cisco.

Paul Silverstein – Credit Suisse

Right. Last question, my apologies. From a linearity standpoint and we're now almost a month into the new quarter, I know you just gave us guidance, but looking for linearity with last quarter and looking at the first month of this quarter, what are you seeing relative to the last 90 days that you're – what are you seeing relative to the quarter before that, you had explosive growth in the first quarter, it moderated in the second from a revenue standpoint. What are you seeing incrementally in terms of business trends and talk about the first 30 – the first month of this quarter?

Andy Ory

Yeah. And I think, Paul, that some of the key takeaways is that our DSOs actually went down. I mean, they were historically low and we wouldn't guide anybody into the 40s. We've been saying 50 to 70 days. I think that given the strength of the business and the inherent increase in our visibility, we've come down off the 50 to 70, 55 to 65. I think that that is a pretty important data point as you think about linearity. Peter, go ahead.

Peter Minihane

Yeah. Paul, if I think about linearity within the quarter, month one has for the past three or four quarters been about 25% of our business, so we don't have a 60%, 70% number that we have to do in the last month of any quarter. So from the linearity side, I think it's about 25%, 30% in the first month of the quarter.

Andy Ory

And it's been roughly, I guess the question is from Q2 to Q1, is it…

Peter Minihane

It's about the same for Q1, Q2 and Q3 now.

Andy Ory

Right. Okay.

Paul Silverstein – Credit Suisse

So, Andy finally, in terms of what you saw over the past 90 days versus the 90 days before that, putting your guidance aside, which leaves some room for interpretation…

Andy Ory

Sure.

Paul Silverstein – Credit Suisse

In terms of Q3, what are you seeing in terms of ongoing trends?

Andy Ory

Well, I mean, the business continues to outperform in just about every metric. The activity level has never been higher we're accelerating our hiring plans. There's more interest from partners the value proposition is easier to explain to partners and to customers. And it appears to be a very big market; there are a number of new people on this call. And I think to contextualize it '09 over '08 was a 22% growth year. And, Paul, when we first were with you out in Phoenix, we were talking to the Street about a 20% growth of '10 over '09. And then in February we moved it to 30% and then in May we moved it to 45% and now we're moving it to 53%. The way we think about the business is that we're delighted with what we're seeing in 2010. We're hyper focused on making sure that we invest and we execute for sustained growth in 2011, 2012 and 2013. And I think we're doing the right things to do that because I really think there's a remarkable opportunity.

Paul Silverstein – Credit Suisse

Okay. Thanks guys.

Andy Ory

Sure.

Peter Minihane

Thanks Paul.

Operator

Thank you. Our next question in queue now will come from the line of John Marchetti with Cowen and Company. Please go ahead.

John Marchetti – Cowen & Company

Thanks very much. Guys, I was wondering if you could spend a minute just talking about the flat revenue on a sequential basis. Can you talk a little bit whether or not, I know you don't give sort of sequential guidance, but how that came in relative to plan. I think you made a point that you were happy with sort of holding the Q1 strength, but just curious how that performed relative to the plan you had internally. And then within that, can you give us a sense of in the quarter was enterprise a little better was service provider weaker, just some color around that flat sort of sequential product performance in the quarter.

Andy Ory

Thank you for saying that because when – John, first of all, it's good to talk to you. When you first introduced the question, you talked about flat revenue it was up 4% to 4.5% that's 18% to 20% annualized growth. At some point when we start eclipsing 50% growth in a year, particularly as we start reaching midyear, we started – I was saying to Paul earlier we started thinking about 2011 and 2012, we – Peter can talk about the timing of the revenue and the makeup, it is worth noting that our visibility increased once again in this quarter. It was a strong bookings quarter, lots of product came in. We – there is a little bit of a separation from product coming in and a purchase order versus the quarter being made with how the revenue is recognized.

Peter Minihane

So I think if you combine that, John and you referenced to the plan, we have exceeded our business plan I think for each of the past eight or ten quarters. So I think realistically what we do is we focus on the business plan and I think was mentioned to you, Paul and others historically that we have kicked off and just about finalized a three to five years strategic plan headed up by Seamus Hourihan, our VP of Marketing. That is going to be our guiding light from both a short term plan that is the remainder of 2010 as we head into '11 and '12. So I think it came in approximately where we thought it was going to it did exceed our internal plan. And I think what we're looking forward to is continued product and service revenue here for the remainder of 2010 along with strong gross margins and strong operating margins.

Andy Ory

And the one thing, John that I think is also important to note because I think it talks a lot about our – the competitive landscape, the value proposition. Cash was up, gross margins were up to record levels, operating margins were up to record levels and DSOs were down at record levels. And those matter to me a lot, too.

Peter Minihane

Well, I'm just not so sure how it could get a lot better, John. I don't know how many companies you follow that perhaps you could shed a light on, but I think if you gave us a report card here in this current quarter, I think you'd be very happy to take that report card home to mom and dad at this point. I really do.

John Marchetti – Cowen & Company

I wouldn't subject you to bringing home a report card to my parents. But I'm just curious, you know, as we're looking into that second half of the year and you're talking about improved visibility is it both in the enterprise and service provider, is it a little bit more service provider focused with CapEx budgets in the second half? And you talked about product and services up sequentially, as we go through the year, is there one area that you expect a little bit more strength in than others?

Andy Ory

Well, I mean, clearly North America has continued to be strong. And we've invested a lot more time in the service provider market. And so we are seeing the fruits of that labor. We are seeing a dramatically increasing enterprise funnel, but that's going to take some time, I mean, the length of sales cycle it's not measured in a few months, generally it's measured in quarters. So we – it will impact, we expect to see growth across both enterprise and service provider for the remainder of the year. I would expect to see real, tangible enterprise gains in the first half of next year, if I didn't, it would only be because the service provider would outperform what my expectations are. But generally we're – I'd have to say we're seeing strong demand across all market segments across all our GOs.

Peter Minihane

Yeah. For example, I think that probably in the last three quarters, John, we've had the strongest kind of if you apply the gold, silver and bronze awards, Europe has been strong for the past three quarters and would receive each of those medals for each of those individual quarters. I think North America continues to be strong.

Andy Ory

Yeah.

Peter Minihane

And just across the board within all segments of North America, whether it be Canada or just the U.S. So I think to Andy's point, it's both service providers and enterprise and we're looking forward here to the second half.

John Marchetti – Cowen & Company

Great. Just one last question and I'll jump back in the queue. Is there a significant difference in the deal size between the service provider and the enterprise side of the business?

Andy Ory

Absolutely. What we are seeing is that the initial enterprise deals that we were doing direct were smaller, they've increased, they've more than doubled in size over the last year. And so that to me is really heartening. To the extent that we use distribution and we do some OEM for Acme Packet Powered, you will see some smaller deal sizes, but that's why we want to leverage distribution for the medium and the small enterprises.

John Marchetti – Cowen & Company

Thanks.

Andy Ory

Sure. Thanks, John.

Peter Minihane

Thanks, John.

Operator

Thank you. Our next question in queue that will come from the line of Brian Modoff with Deutsche Bank. And your line is open.

Brian Modoff – Deutsche Bank

Hi guys, a few things. So sequentially on the product side, you – it sounds like you expect growth there. Would you expect that to grow more than the services side given the jump you had in services in the previous quarter? Then I've got a few more questions.

Peter Minihane

I think the strength that we had in the service segment of our business in the second quarter was a little stronger than we had anticipated…

Andy Ory

Yeah.

Peter Minihane

But in line with kind of a range, Brian. I think we can see the growth returning across the board in having total revenues also up for Q3 versus Q2 and the same for Q4 versus Q3.

Brian Modoff – Deutsche Bank

Okay. And then in terms of obviously Avaya's been a nice partner for you on the enterprise side and are you working on other vendors on the IP PBX market like say NEC or some of the other players? And when could you see more – a broader range of those types, that seems like a rather symbiotic relationship there and do you see that expanding out with other vendors?

Andy Ory

Absolutely. I mean, we really believe that there are going to be a whole host of elements that touch the control plane where Acme Packet Powered, Powered by Acme Packet will make a difference. And we talked about routers and firewalls and multiservice gateways, as well as IP PBXs. And we are – this has been something that we've been working on now for a few years it's not something that happens quickly. It is picking up steam there is a lot more interest in the marketplace. I would say that job one is to make Avaya successful and that really is a prime focus for us, but clearly there are other elements in the network that would by symbiotic where you could see our technology appear.

Brian Modoff – Deutsche Bank

When could you see Avaya as say 5% of revenues or perhaps 10% (inaudible)?

Andy Ory

Yeah. No. That's a good question. Not 2010.

Brian Modoff – Deutsche Bank

Sometime in 2010?

Andy Ory

No. Not 2010. We have trained hundreds and hundreds, if not more, folks from Avaya, as well as hundreds and hundreds of folks who are partners of Avaya, it's just – it's a big effort, they're a very large company. They're the leader in these business communication services and software globally. We're engaging them and with them in every theater and it requires a little bit of patience on our behalf. And we're making the investment, we're patient. It will make a very big difference.

Brian Modoff – Deutsche Bank

So you see really the enterprise next year, the results of all of this. So if I'm looking at this year, it's going to continue to be carrier dominated. And, you know, so you – would you be north of 20% in Q4 in terms of enterprise revenues?

Andy Ory

It is possible except that the service provider business is continuing to pick up and there's a lot of leverage on the service provider side from a revenue point of view because the numbers are so much bigger. I mean, if you look ironically at who our only 10% customer was for the quarter it was Verizon Business, which is really for enterprise.

Brian Modoff – Deutsche Bank

Yeah, that is. And so if you were to look at the enterprise or the carrier space, what percent of that sales are geared towards the kind of, the interconnect between the carrier and an enterprise versus the interconnects between carriers?

Andy Ory

You know, I'm going to make it up just in the spirit of Reg FD, but I'd bet it's 50/50.

Brian Modoff – Deutsche Bank

So you're really seeing a lot of what you…

Andy Ory

Yeah.

Brian Modoff – Deutsche Bank

Enterprise space is really bigger, it's being driven by – but it's being driven by carriers outsourcing or offering IP PBX function or SBC function to enterprise customers.

Andy Ory

When a large enterprise buys session by IP connectivity and uses a session border controller, the service provider they're connecting to also is using a session border controller.

Brian Modoff – Deutsche Bank

Yeah.

Andy Ory

And so there are 140, 150, 134 SIP trunking providers globally right now. And if not everyone, certainly the vast majority of them use Acme Packet on their edges. And so part of the Covergence acquisition a year and a quarter ago was all about the symbiotic relationship at the access edge on both sides.

Brian Modoff – Deutsche Bank

Yeah.

Andy Ory

The carrier's border and the enterprise border. And it has to happen from the inside of the network out. What surprised us about the enterprise market is that we thought in 2007 and 2008 it was ready to go, but it really – the packetization had to happen in the service provider space first and it's now happening. And so what we're seeing is a real rapid uptake of interest on the enterprise side and it is going to grow. And we will be able to get to almost every major enterprise in the world based upon our relationships with the SIP trunking providers and folks like Avaya.

Brian Modoff – Deutsche Bank

So what percent of this market do you think you have penetrated at this point?

Andy Ory

In the enterprise itself?

Brian Modoff – Deutsche Bank

In the enterprise and also in the carrier enterprise markets?

Andy Ory

Well, I think in the carrier side to the enterprise it's a majority. I mean, clearly. And we have folks like Infonetics, who talk about a 60% market share, if you just applied that market share evenly across the two, which that's not what they do. I don't have the data either, but that's one way to think about it. And you can see that we have a dominant position.

Brian Modoff – Deutsche Bank

Well, I know you have a dominant position now. I'm talking about just in terms of their installations of SBC to accommodate the shift to IP on – and on their customer base.

Andy Ory

So, Brian, you're asking me…

Brian Modoff – Deutsche Bank

How penetrated is the market?

Andy Ory

How penetrated is the market. It's very early on, single digits.

Brian Modoff – Deutsche Bank

Okay.

Andy Ory

And to answer your other question, which I thought you asked which was our market share in this – on the enterprise side of session border controllers, I believe Infonetics, also released something that talked about Acme Packet and Cisco as being the two dominant players and I think that's pretty accurate.

Brian Modoff – Deutsche Bank

And is there kind of a – is there a border there in terms of like Acme is kind of a certain size enterprise and above and Cisco is a certain size enterprise and below, is there a demarcation that you see between you two on the relative size of the customer base?

Andy Ory

No. In fact, the 3820 is an example of a smaller form factor session border controller to go after smaller contact centers and enterprises and then the Acme Packet Powered program is about going all the way down to one session.

Brian Modoff – Deutsche Bank

Okay. Good enough. Thank you very much.

Andy Ory

Thank you, Brian.

Operator

Thank you. Our next question in queue that will come from the line of Simona Jankowski with Goldman Sachs. Please go ahead.

Simona Jankowski – Goldman Sachs

Hi. Thank you so much. Just wanted to follow up on your comment, Andy on your increasing visibility in the quarter. It sounded like that was a reflection of strong bookings and I just wanted to kind of get a sense of how that translates into deferred revenue, which was flat. And also if I look at it on a year-over-year basis, it was up about 36% and your guidance would imply more like 40% to 50% year-over-year growth in the next couple of quarters. So it seems like the deferred revenue is going to really contribute less to that growth that you're looking for and it's going to be kind of more coming from the book, ship and build kind of business. So can you just explain those dynamics a little bit for us?

Andy Ory

Certainly. In fact, I'll take the first half, Simona and I'll let Peter answer the hard part. No, we're not going to transition; I don't anticipate us transitioning to a book, ship and build business. Visibility increased and it increased across every measure, it was not just bookings. It was activity, customer engagements, partner interest, just the funnel building. I mean, across the board visibility increased. And that makes me feel very good about heading into the third and fourth quarter of the year, which is why we felt comfortable raising our guidance yet again. As far as the impact of deferred revenue into the increase for the quarter, I see Peter has a calculator and numbers and Peter, I don't know how you want to handle that.

Peter Minihane

So I think overall, Simona, our deferred revenue is about 30% higher, greater than it was at June 30, 2009 overall. And I think if you looked at just our product piece of deferred revenue, you'd find that's probably up 50% to 60% year-over-year, so the product aspect of it grew greater than the overall. And, again a large piece of this is support and maintenance revenue that we just amortize over the course of generally speaking a 12 month period. So I think the product – the deferred product revenue has absolutely outpaced the other aspects of deferred revenue.

Simona Jankowski – Goldman Sachs

Okay. So then it sounds like a lot of your services deferred is – was been recognized and kind of helped along in the last couple of quarters. Are there just some kind of more sizable contracts that are now close to expiring and that's why you're seeing the deferred kind of flattening out here the last couple of quarters and so should we look for your services revenue to flatten out as well or kind of what's going on there?

Peter Minihane

No, I think it's a combination of items, Simona. I think we have historically found that most of our customers will place orders with us in Q4 and Q1 to renew their service and maintenance agreements. In the case of somebody giving us an order at the end of March for the period of January 1 up to and including December 31 of that year, we would have to recognize a third – I'm sorry – three months, 25% in that current quarter. So I think we have historically found very large, active booking quarters in Q4 and Q1 and we find that we then just amortize it out over our Q2 and Q3. And I think that's where we find ourselves right now.

Simona Jankowski – Goldman Sachs

Okay. And then on a somewhat related note, your guidance would imply sequential growth in the third and fourth quarter that is below your normal seasonality. Is that just more a function of how the math works given the first half was so strong or is there some kind of a second derivative slowdown that you're anticipating within that guidance?

Andy Ory

No. I mean, there is no slowdown in the business. I think we just sort of, again, feel that as we start crossing the 50% threshold halfway through the year, we start turning to 2011. I mean, anything's possible in the second half of 2010. Certainly the business feels strong by every metric that we're measuring; we're excited about our ability to execute on Q3 and Q4. We didn't look at how hard to lean into it where it's going to be, it's just we felt 53% looked fine. And I think that we – the trees don't grow to the sky and at some point I just want to focus on 2011.

Peter Minihane

Right. And continuing to have a very strong Q3 and Q4.

Andy Ory

Absolutely.

Simona Jankowski – Goldman Sachs

Yeah.

Peter Minihane

And so this is just overall if you look at our visibility, which we define more than just bookings backlog, it’s activity, it's funnel activity, it's the meeting that Andy referred to that we had in our North American sales and our EMEA sales organizations here in the past two weeks, the enthusiasm. And, again sales guys are a strange breed, as you know, but they have genuine enthusiasm here I think in the past two weeks at both of those locations.

Andy Ory

Right. And, Simona, it is fair of you to note that historically the second half of the year is stronger than the first half of the year. And we have had a historic first half year we're just reticent to sit there and say that we're going to apply the same multiple factor to the second half of the year for first half over second half growth. And it's not anything to do with the performance of the company or what we're seeing. It's just we're reticent to do it because the numbers are already so high.

Simona Jankowski – Goldman Sachs

Yeah. And I think that makes sense. And then just last – one last question is on the split between the direct and the indirect business. Looks like your direct business almost doubled on a year-over-year basis. And the indirect business was up about 30% or another way you can put it is that now it's about a 50/50 split and about a year ago it used to be two thirds, indirect and a third direct. If you can just give us a little more color on the dynamic there and what's driving it?

Andy Ory

Yeah. I think what you'd find is that aligned with the domestic versus the international business. And we define domestic as the United States and Canada and that typically is direct whereas international is typically indirect. And we have just seen very strong business in the United States and Canada and so that's why it's skewed just a little bit.

Peter Minihane

Right. So just rough numbers, we had approximately 11.5 million in Q2 in North America direct last year. Now we're at 24 million, 24.5 million for this current year. And, again, if you combine that with a very strong showing by Verizon Wireless in Q1 and Verizon Business in Q2 two different companies in our minds because we have two different contractual agreements and we have two different relationships, they were very strong in the second quarter of 2010. And they had nice Q2s a year ago, but nowhere near the strength that they've demonstrated here in the first six months of the year.

Andy Ory

Correct, right. We're seeing what you're writing and what you're finding, too, that the CapEx and IT, communications and IP services is increasing as it rotates out of GDM.

Simona Jankowski – Goldman Sachs

Well, I appreciate it very much. Thank you.

Andy Ory

Sure. Thank you, Simona.

Operator

Thank you. And our next question in queue that will come from the line of Catharine Trebnick with Avian Securities. And your line is open.

Catharine Trebnick – Avian Securities

Hi. Congratulations.

Andy Ory

Thanks Catharine. How are you doing?

Peter Minihane

Thanks Catharine. How are you?

Catharine Trebnick – Avian Securities

Good, very good. Okay, a couple quick questions on the new software SBC and I understand it's not new because it really came from the Covergence acquisition. Can you discuss how many suppliers have adopted this so far to-date?

Andy Ory

Well, we'll announce them as they adopt it. There are more people who want to sit at the table than we have seats at the table in the very short run and there are a few, Avaya being the one that we've named, that we care deeply about making very successful first. So you should stay tuned. We've been talking about this for quite some time and I would not be surprised if you saw our technology pop up in other areas.

Catharine Trebnick – Avian Securities

And then how is the WestTel partnership coming along?

Andy Ory

So I – do you mean Westcon?

Catharine Trebnick – Avian Securities

Westcon, thanks, yeah, sorry.

Andy Ory

It's coming along fine. I mean, it's – there are many, many folks that sell Avaya gear, sell Acme gear and we have a fine relationship with them. I don't have anything to report on the call specifically.

Catharine Trebnick – Avian Securities

No, I just thought I'd ask in general because – and have you signed a similar relationship with AT&T business services as you have with the Verizon?

Andy Ory

I believe that the only thing that we've talked about publicly with AT&T business services is that they did a press release talking about using Acme Packet session border controllers as part of their services, but – and I'm not sure group at AT&T specifically, but it was geared towards the enterprise.

Catharine Trebnick – Avian Securities

All right, thanks a lot.

Andy Ory

But there hasn't been anything that we've talked about publicly.

Catharine Trebnick – Avian Securities

No. Thank you very much.

Andy Ory

Sure.

Brian Norris

Thanks Catharine. Tony, next question please.

Operator

Thank you. That will come from the line of Rich Valera with Needham & Company. Please go ahead.

Rich Valera – Needham & Company

Thank you. Good evening, gentlemen.

Peter Minihane

Hey Rich. How are you?

Andy Ory

Hi Rich.

Rich Valera – Needham & Company

Great. Question on the operating model if I could, obviously some pretty strong outperformance relative to your longer term model on the op margin line, yet you did acknowledge and actually increased your long term gross margin target, but you're sticking with your long term op margin target I guess in the low 30% range. It just seems I guess with that increased headroom on the gross margin side that your op margin would naturally drift up even with some pretty significant reinvestment, so I was just hoping you could add some color around that?

Peter Minihane

Well, if you really at it at a very high level, Rich without going into excruciating detail, if we look at the high 70s to low 80s in gross margin, so just pick a number of 78% to 82% and if you take that low end at 78% and we spend somewhere in the area of 48% to 52% of operating expenses, you'll wind up exactly in the range that we were talking about in the low to mid 30s. So I think we've actually increased our gross margin model from – a little bit, not an awful lot. We do have some headroom there. We have enjoyed gross margins of 82%, 83%, 84% here recently and I think we are behind in our hiring plans. We do want to make sure that we hire to ensure that we capitalize on this great opportunity.

Andy Ory

Right.

Peter Minihane

And so I think what will happen is you'll find that OpEx will grow in Q3 and Q4 and that it's very difficult, at least I think it is to increase our gross margin any more than where they are today. I mean, we're rapidly approaching the ceiling from a gross margin side at 84%.

Andy Ory

Right.

Peter Minihane

So I think within reason if you kind of look at the longer term model of low to mid 30s, I think those ranges of gross margin combined with OpEx would fit nicely.

Andy Ory

Right. And, Rich, I would also say that it's not impossible that our operating margins are higher than what we're guiding you to, even long term, but when we look at where we are in the market, when we see this conversion from TDM to IP, the connection of all of these different service islands and the proliferation of these applications that are going to move across these service islands, there is a very large opportunity for Acme Packet. And it's important to us that we invest so that we strategically can execute on achieving that opportunity and so we don't what to set models that could constrain our ability to really execute strategically in terms of winning in the global market, but that isn't to say that what you're – that there's any hard and fast reason why it needs to be in the low 30s, it just seems like the kind of prudent latitude to talk about.

Rich Valera – Needham & Company

No, that's helpful color. I appreciate it.

Andy Ory

Sure.

Rich Valera – Needham & Company

And one more if I could on your new products, which you have acknowledged I guess at this point are below 10% or well below 10%.

Andy Ory

Yeah.

Rich Valera – Needham & Company

Could you give us any sense? I know you've been reticent to sort of really put a stake in the ground as far as numbers with them, but in your thinking, is it sort of maybe a 2011 timeframe where they reach say 10% or more in a single quarter or should we be thinking more about 2012?

Andy Ory

No, I think that 2011 is a good way to think about it. I mean, the issue is that as we sell more of these other elements; they're going to drag more and more session border controllers along with them. I mean, these elements are either specialized session border controllers to deal with different types of edges, like the multiservice security gateway is a session border controller, except it's designed to handle the wireline Internet and the wireless radio networks. So it's dealing with fixed/mobile convergence. The load balancer, as well as the session route proxy are all about scaling IP traffic to and from network borders, which need more session border controllers. So in a funny sort of a way, there's real leverage in these other products in terms of their impact to our ability to sell session border controllers.

Rich Valera – Needham & Company

Okay. That's helpful. Thank you.

Andy Ory

Sure.

Peter Minihane

Thanks Rich.

Operator

Our next question in queue that will come from the line of Simon Leopold with Morgan Keegan. Please go ahead.

Simon Leopold – Morgan Keegan

Great. Thank you very much. I actually had a couple of questions left. One, you talked a bit about Avaya as a partner. I wonder if you could talk about other partners and the one that comes to my mind who is Juniper, they've had some slides up at their analyst meeting identifying Acme Packet as a partner. If you could elaborate on that and also touch on is Juniper both a partner and a competitor? Thanks.

Andy Ory

Yeah. I mean, they're really not much of either actually. I don't quite understand the reference to Acme being a partner of Juniper unless they're saying that somehow we use some of their routers. The thing about Juniper is there's two markets that we really are focused on. In the service provider space, Juniper's not really a player at all, I don't know if they have any market share, but we certainly don't see them anywhere. And on the enterprise space, the real issue that Juniper has is that they don't sell end-user applications or peripherals, they don't sell IP PBXs and the associated services. So what allows Avaya, Cisco and Microsoft to be so successful in terms of their messaging is that they're not selling infrastructure they're selling applications. They're selling peripherals and devices that end users can touch and feel and the purchasing of the network is almost secondary. And so I would think we don't see Juniper really at the enterprise either and I think it's because all of the deals get driven by the applications in the endpoint first and then the associated infrastructure that needs to be bundled to enable it. So we don't really run into them all that frequently in either market.

Simon Leopold – Morgan Keegan

Okay. Yeah. They actually had you on a slide during one of their meetings talking about their ecosystem, so I think that's kind of interesting. But just to follow up then, drilling down kind of on the growth rates, in this quarter sounds like enterprise was in line with the percent of sales as it was in the previous quarter. Just wondering if you could talk to the growth rate year over year enterprise versus carrier? It sounds like enterprise is still a faster grower, but just want to see if you could quantify it?

Andy Ory

Sure. The activity level in the enterprise is increasing faster than the activity level in the service provider space. We would expect that enterprise over a 24 month period would certainly have faster growth than the service provider space the last nine months if you've been tracking our business; there has just been a significant increase in the service provider growth. And given the size of the contracts, there's a lot more inherent leverage. And I think that's why it's held in the mid to slightly higher teens for the enterprise business as it relates to revenue but certainly I would not say that what we're seeing inside the business is reflected by that. What we're seeing inside the business is that the enterprise opportunities are increasing more quickly.

Simon Leopold – Morgan Keegan

And maybe another way to help me think about this is if you could talk about your unit growth this quarter. So product revenue was sequentially flat. What was your unit growth sequentially?

Peter Minihane

Unit growth was up slightly. Quarter-over-quarter our average sales price was approximately the same. So there wasn't any large variance from Q1.

Simon Leopold – Morgan Keegan

Okay. And then one last one, you did mention that you're behind on your hiring. Just wondering what you can attribute that to, what's been the obstacle in terms of finding enough qualified staff? Thanks.

Peter Minihane

Well, I think within reason we've hired over 60 new employees, 64 employees I think in the first half of the year, which by any measure is about a 15% growth on our – in our headcount rough numbers.

Simon Leopold – Morgan Keegan

Right.

Andy Ory

And when we say behind, too it's very small percentage.

Peter Minihane

Right.

Andy Ory

However, that gets increased as we now decide that we're going to raise our revenue targets for the second half of the year and we're going to raise the number of employees we want to hire. So we feel like we're more behind than we actually are by numbers but we are a few percentage points behind.

Simon Leopold – Morgan Keegan

And is there some problem or is it just sort of the process?

Peter Minihane

No, I think, for example, if you look at our month of July, which is rapidly coming to a close here for all of us, I think we've hired 15 people in the month of July, a combination of either souls who have arrived here to work throughout the world from our sales, services and support organization or from offers that have been extended that will start here in the next two weeks.

Simon Leopold – Morgan Keegan

Right.

Peter Minihane

So it's no one issue. It's a combination of things, we also had in our own mind, we didn't want people arriving the last week and a half to two weeks as we exited a facility and moved into a new facility here just the past two or three days. So I think that will all iron itself out in the next three to four months.

Simon Leopold – Morgan Keegan

Thanks. That makes sense. Thank you.

Andy Ory

Sure.

Brian Norris

Tony, we have time for about just two more questions if we could, please.

Operator

Certainly. That next question will come from Sanjiv Wadhwani with Stifel Nicolaus. And your line is open.

Sanjiv Wadhwani – Stifel Nicolaus

Thanks so much. A couple of simple questions. Verizon Wireless, could you talk about how they trended sequentially?

Andy Ory

I mean, Verizon Wireless continues from a bookings point of view to order product each and every quarter.

Peter Minihane

Right.

Andy Ory

The revenue rec is – I recognize is a whole different algorithm, but that disconnected from the pace of the business on the ordering, so I'll let Peter address that.

Peter Minihane

So I think within reason we had very large revenue in Q1, as I think everybody knows about. And that was a function of a revenue recognition issue from the acceptance of product that had been shipped in prior quarters. The bookings activity for the Verizon Wireless and Verizon Business have been relatively strong every quarter, not reaching to the levels of 10% or 15% obviously, but again, I think demonstrating they're a very strong customer.

Sanjiv Wadhwani – Stifel Nicolaus

Got it. So fair to say sort if you ex-out the acceptance of the product in Q1, sequentially if you just look at bookings they were up sequentially, flattish I mean, somewhere in that category?

Peter Minihane

No, I think up on a quarter-by-quarter basis.

Sanjiv Wadhwani – Stifel Nicolaus

Okay. Fair enough. And then on the deferred revenue side, Peter, how large is product as a percentage of your total deferred revenue?

Peter Minihane

Yeah. We've historically not broken that out, but I think if you look at it, it's probably about – rough numbers it's about 50% of the total deferred revenue.

Sanjiv Wadhwani – Stifel Nicolaus

Fair enough, okay. And last question, on the gross margin side, obviously great performance and you're increasing your target. I'm just curious, between the enterprise and the service provider side, is the gross margin fairly similar in terms of profile?

Andy Ory

I mean, gross margin really is a function of software content more than anything else. I mean, clearly we've made specific products on the high end for the service providers that have a lot more hardware. And we've also introduced products on the low end for enterprises that specifically have a lot less hardware. And that is a way to maintain a relatively margin neutral disposition, but, again, it had to do with how much software content, how many sessions people are going to buy. Large enterprises and service providers, the margin is roughly the same as you start getting into medium and small enterprises, the margin drops somewhat. I would say that much more importantly is the go-to-market strategy becomes more important, so the cost of goods as a total cost of sales is a lot less than actually everything else, such as fielding salespeople to go sell a low-end product. And that's why partners, distribution and OEMs are really important. Those things combined should maintain a relatively margin neutral disposition in the enterprise business versus the service provider business.

Peter Minihane

Right. So the 2000 and 3000 series of products are probably a little lower gross margin products than the 4000 and 9000 series of products.

Andy Ory

Right.

Peter Minihane

And I think the enterprises will be driven much more to the 2000 or 3000 series product, higher gross margins from a pure OS-E.

Andy Ory

Right. The OS-E…

Peter Minihane

It’s a 100% margin, but the absolute dollars…

Andy Ory

Is less.

Peter Minihane

From the gross profit side would be less.

Andy Ory

Right, probably like, cancel each other, right.

Peter Minihane

Yeah.

Sanjiv Wadhwani – Stifel Nicolaus

Perfect, all right, that's helpful. Thanks so much.

Andy Ory

Sure. Thank you.

Operator

Thank you. We'll take our final question from the line of Jeffrey Britt with Janney Montgomery Scott. Please go ahead.

Jeffrey Britt – Janney Montgomery Scott

Hello. Thank you. It has been answered. It was about the competition and especially, Sonus gearing up with some second generation platform they're talking about. Is that much of a wave threat to you?

Andy Ory

No. I mean, I think – again, I think that the desire for folks over time to have a second source is a bigger competitive threat to us globally than anything else. From our point of view, there is – there are so many rapidly emerging requirements for our technology that the domain expertise, the pace of investment and the relationships and the experience that we have advantage us over anyone else to maintain this kind of market position. Seeing other people, I mean, clearly as the market continues to grow, the folks who have a smaller percentage, it's going to be more dollars. So you will see more dollars that will go other places, but I think you're going to see a dramatic increase of the dollars that go to Acme Packet.

Jeffrey Britt – Janney Montgomery Scott

That's what I suspected. But I guess they did say that they had some partnerships and that they could probably go back to a lot of their voice over IP gateway customers and sell them all IP solutions, so I thought maybe they had some built-in market there.

Andy Ory

Yeah. No. I mean, we haven't seen the competitive disposition change much in the last 90, 180 or more days. I mean, clearly we are seeing folks introduce their second and third or in Cisco's case fourth attempt at a session border controller and that does validate the market and everyone does look at it and some people do take it into the lab we understand all of that. But by and large we think it should be steady as she goes as it relates to our path through this current market.

Jeffrey Britt – Janney Montgomery Scott

Very well, thank you.

Andy Ory

Yeah. Thank you very much.

Peter Minihane

Thanks very much.

Operator

Thank you. At this time I’ll turn the conference back over to Mr. Ory.

Andy Ory

Okay. Well, thank you everyone, for joining us this evening. It was another very strong quarter with record financial results and an upwardly revised outlook for 2010. We look forward to seeing as many of you as possible during this outreach period and updating you on our continuing progress during our next conference call. Thank you and goodnight.

Operator

Thank you. And ladies and gentlemen, this conference will be available for replay after 7:00 p.m. Eastern Time today through August 13, 2010 at midnight. You may access the AT&T TeleConference replay system at any time by dialing 1800-475-6701 and using the access code of 163908. International participants may dial 320-365-3844. Once again, those telephone numbers are 1800-475-6701 and 320-365-3844 using the access code of 163908. And that does conclude our conference call for today. We do thank you for your participation and for using AT&T's Executive TeleConference. You may now disconnect.

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Source: Acme Packet, Inc. Q2 2010 Earnings Call Transcript
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