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Acme Packet, Inc. (NASDAQ:APKT)

Q1 2008 Earnings Call

May 07, 2008 5:00 pm ET

Executives

Andy Ory - President and Chief Executive Officer

Keith Seidman - Chief Financial Officer

Seamus Hourihan - Vice President of Marketing and Product Management

Brian Norris - Director of Investor Relations

Analysts

Simona Jankowski - Goldman

Eric Keyner - Think Pan Europe

Vijay Bhagavath - Deutsche Bank

Joanna Makris - Brean Murray Carret

Catharine Trebnick - Americas Growth Capital

Greg Mesniaeff - Needham & Co

Paul Silverstein - Credit Suisse

Sanjiv Wadhwani - Stifel Nicolaus

Anil Doradla - Caris & Co

Ehud Gelblum - JP Morgan

Presentation

Operator

Welcome to the Acme Packet first quarter 2008 earnings release conference call. (Operator Instructions) I would now like to introduce your host for today’s call Brian Norris, Director of Investor Relations for Acme Packet.

Brian Norris

With me on the call this evening is Andy Ory our President and Chief Executive Officer, Keith Seidman our Chief Financial Officer and Seamus Hourihan our Vice President of Marketing and Product Management. Today after the market closed we issued our first quarter 2008 earnings result press release which will be the focus for this evenings call.

Before we begin I would like to remind you that statements made during this call that are not historical facts maybe 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 position in the session border controller market, our expected financial and operating results, including expected revenue and earnings per share for full year fiscal 2008 on both a GAAP and non-GAAP basis, our ability to build and grow Acme Packet, the benefits of our products and our ability to achieve our goals, plans and objectives.

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, 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 under reliance on such statements which are current only as of the day they are made and we disclaim any obligation to update them. All result and projections we review this evening are on a non-GAAP basis; almost otherwise and explicitly described as GAAP. During this call we will be referring to non-GAAP earnings and non-GAAP net income and non-GAAP net income per share which are non-GAAP financial measures that exclude stock based compensation expense for all periods presented.

A copy of our earnings press release along with the accompanying income statement, balance sheet and operating specifics, as well as the reconciliation of non-GAAP financial measures to the most directly comparable GAAP measure is available on the Investor Relations section of our website at www.ir.acmepacket.com.

At this time I would like to turn the call over to Andy.

Andrew Ory

We are delighted to be reporting another strong quarter highlighted by record revenue, solid earnings growth and record cash flow from operations. This marks our 10th consecutive quarter of reporting both sequential and year-over-year revenue growth which we believe is further evidence of both our expanding market leadership and the growing value our solutions provide in the next generation network of service providers, enterprisers and contact centers.

First quarter revenues were a record $31.7 million, an increase of 26% year-over-year. Our growth in the first quarter was fueled by the addition of nearly 2000 new customers and deepening deployments within our existing customer base. Revenues in the US and Canada grew by 22% sequentially and 37% compared to the first quarter of last year. Our presence among the top 100 tier service providers continued to expand. Our solutions are now at 84 of the top 100 service providers in the world up from 75 such customers a year ago.

Our leadership among the very largest tier 1’s is even stronger. We now serve the need of 29 of the top 30 service providers in the world. We added several new enterprise and contact centre customers in the first quarter across multiple industries. These are markets that we continue to view as strategic to our success in 2009 and beyond. Channel revenues increased by 34% compared to the first quarter of last year which we believe continues to validate the importance of our solutions in our partnered success.

We delivered gross margins of 82%, up from 79% in the first quarter of last year. We believe this expansion reflects the strength of our core value proposition to our customers who are actively adopting next generation network based on our IP. We were able to drive much of our top line growth and gross margin expansion directly to the bottom line.

Operating margin increased to 27%, up from 25% in the first quarter of last year. Non-GAAP net income increased to $6.1 million, an increase of 21% compared to the first quarter of last year. Non-GAAP EPS increased to $0.09, up 13% compared to the first quarter of last year. We also generated over $13 million in cash from operations. We ended the first quarter with $144.8 million in cash that’s up $8.3 million from the $136.4 million in cash we had on hand at the end of fiscal 2007.

Our ending cash position is net of the approximately $4.2 million we used to buy back stock under our recently announced stock repurchase program. We are seeing momentum build across our business. We see a lot of exciting things developing and feel very good about our leadership position in this market place.

We are also optimistic about the nature of the strategic discussions we are having with our customers and prospects and are encouraged also by the level of activity in the market place. For these reasons, we are reaffirming our previous outlook which calls for a full year revenue growth a 26% to 30% in 2008 with sequential growth in each quarter of the year and full year non-GAAP earnings of $0.38 to $0.42 per share.

For a closer look at the numbers I will turn the call over to Keith.

Keith Seidman

We are pleased to be reporting solid first quarter results which reaffirm our growth plans for the full year. Tonight, I will walk through the financial highlights from the first quarter and then share with you our outlook for 2008.

As a remainder all results and projections that we review this evening are on a non-GAAP basis unless otherwise and explicitly described as GAAP. All earnings per share amounts are on a diluted basis. I will begin with our first quarter results. Revenues grew to a record $31.7 million in the first quarter up 26% compared to the first quarter of 2007. Our top line performance reflected strong year-over-year growth both internationally and domestically.

Product revenues grew to $26.5 million in the first quarter up 25% year-over-year. This growth was primarily due to an increase in the quantity of systems sold and the increase in the average selling prices due to change in the product software configuration mix and an increase in the level of software license upgrade. Maintenance support and service revenues grew to $5.2 million up 33% year-over-year reflecting growth in our installed customer base as well as increases in installation, professional services and training revenue.

Composition of our first quarter revenues was 55% indirect and 45% direct. Two channel partners each accounted for 10% or more of our total first quarter revenue; Alcatel Lucent and Nokia Siemens networks which in the aggregate represented 33% of our total revenues for the quarter. Alcatel Lucent and Nokia Siemens Networks like many of our distribution partners represent dozens of end user customers with whom we do not have a direct commercial relationship. Additionally one direct customer in North America represented slightly more than 10% of our first quarter revenue.

Geographically 55% of our revenues came from the United States and Canada and 45% came from our international customers. Gross margin was 82% reflecting a favorable product configuration mix as well as the high level of software content including software upgrades. Total operating expenses in the first quarter was $17.6 million reflecting growth in head count in all functional areas, higher variable compensation expense related to our top line growth and higher public company costs.

Operating margin increased to 27% in the first quarter compared to 25% in the first quarter of last year. Operating earnings increased 34% from the first quarter of 2007. Total other income was $1.3 million compared to $1.5 million in the first quarter of last year reflecting the impact of lower interest rates despite our increased cash balances.

Pre-tax income was $9.7 million up 24% compared to the first quarter of last year. Our effective tax rate on a non-GAAP basis in the first quarter was approximately 37.5%. Net income for the first quarter on a non-GAAP basis with $6.1 million or $0.09 per share compared to $5 million or $0.08 per share in the first quarter of last year. Net income on a GAAP basis was $5 million or $0.08 per share compared with $4.3 million or $0.06 per share in the first quarter of last year.

Non-GAAP net income differs from GAAP net income as it excludes stock based compensation charges net of tax of approximately $1 million or $0.01 per share in the first quarter of 2008 and approximately $700,000 or $0.02 per share in the first quarter of last year. Headcount at the end of the first quarter was 343 compared to 327 at the end of 2007 and 275 at the end of the first quarter 2007.

Now let’s take a look at the balance sheet. We ended the first quarter with cash and cash equivalents of $144.8 million up $8.3 million from the end of the fourth quarter 2007. We generated $13 million in cash from operations in the quarter. During the first quarter we announced that our Board of Directors approved a $20 million common stock repurchase program. During the first quarter we repurchased approximately 563,000 on nearly 1% of our total offset in shares at an average purchase price of $7.51 per share.

Day Sales Outstanding or DSO decreased to 81 day at March 31 from 86 day at December 31 primarily reflecting a lower revenue contribution from our indirect partners and international customers which tend to have longer payment terms in our domestic and direct customers. Inventory at the end of the first quarter was $6.7 million a level which we continue to be comfortable with given our broadening product portfolio and growing customer base.

Finally differed revenue at the end of the first quarter was $12.8 million up 28% sequentially; primarily reflecting the timing of service contract renewals. 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 indication for our business, which may change at anytime. We undertake no obligation to update these comments.

As outlined in our press release issued earlier today, we are updating our full year outlook for 2008. We continue to expect revenues in 2008 to range between $142 million to $147 million, which represents growth of between 26% and 30% for the full year. We expect sequential growth of each subsequent quarter of the year and we also expected our growth rate will accelerate in the second half of the year.

We continue to expect diluted Non-GAAP net income in 2008 to be between $0.38 per share and $0.42 per share. We will continue to model gross margins in the upper 70s for 2008. We are continuing to model operating margins in the mid 20s for the full year. Certain of our full year assumptions have been modified slightly though they do not have any aggregate of any impact on the full year non-GAAP earnings expectations.

We now expect full year interest income to be approximately $4.4 million compared to the $5 million we previously forecast. Despite our growing cash balances this lowered interest income forecast, reflects the current interest rate environment. Our full year earnings projections assume a non-GAAP effective tax rate of approximately 37.5% slightly higher than our previous assumption of 36.5% due to the exploration of the R&D tax credit.

At present we expect our weighted average fully diluted share count to be approximately $66.5 million shares in 2008 compared to the $67 million shares we had previously forecast. We are increasing our forecast range for GAAP net income to be between $0.29 and $0.33 per share from our earlier forecast of between $0.28 and $0.32 per share. This increase reflects our expectation of a slightly lower full year stock based compensation expense compared to our earlier forecast.

Our estimates for Non-GAAP net income in 2008 differs from GAAP net income as it excludes estimated stock based compensation expense of approximately $5.5 million or $0.09 per share, down from our earlier estimate of $6.5 million or $0.10 per share primarily reflecting the recapture in the first quarter of expenses associated with certain options which were forfeited prior to exercise.

In summary we reached new company records in every key measure of the business for the first quarter. We remain excited about and committed to the growth plan that we outline tonight. We look forward to updating you on our progress to our future calls. With that I will turn the call back over to Andy.

Andy Ory

We are pleased with our first quarter results which were highlighted by record revenues, solid earnings growth and record cash flow from operations. This strong performance extends our track record of solid financial results and reaffirms our growth trajectory for 2008. The March quarter was the tenth consecutive quarter, we delivered both sequential and year-over-year revenue growth. We also continued our track record of solid and sustained margin expansion highlighted by first quarter gross margin of 82% and operating margin of 27% both above the high end of our target operating range.

Our revenue growth coupled with our prudent expense management enabled us to drive strong earnings growth of 21% year-over-year. To help you better understand what is fundamentally driving our improved financial results, I want to take a few minutes to share some key market trends and growth drivers that we are seeing and the things we are doing to capitalize on them.

As we have reviewed in the past there is a migration underway among service providers, enterprises and contact centers which are moving from centrally owned circuit switch technology networks or TDM to internet protocol or IP based networks. The largest service providers in the world as well as more and more enterprises and contact centers are making the investments to lower their operating costs and to introduce new IP enabled service offerings, such as residential Voice over Internet Protocol or VOIP, Video over IP, IP Centrac, instant messaging, gaming and distance learning.

Service providers and enterprises that were early adaptors of IP networks did so to leverage IP within their own network. This first ways of IP adoption required gateways that could connect TDM to IP and IP to TDM. This market underwent growth during the early part of this decade growing to reach about $1.5 billion by 2006, however growth in the media gateway market is expected to slow as customers move to end-to-end IP communication.

Market forecasters such as Infonetics expect the gateway market to grow on average by single digits annually through 2011. Well, at the same time they forecast the session border controller market to be growing by at least 25% to 30% a year. Delora Group expects that the SBC market will grow more then three times faster then the media gateway market in 2008. In fact in it’s recently issued market study the Delora Group forecasted that the SBC market will grow from $215 million in 2007 to about $350 million in 2008 and nearly $900 million by 2011.

We believe that over the next several years end-to-end IP communications will create tens of thousands of edges within the network of service providers and very large enterprises. We believe that each of these IP edges will require an SBC to meet critical security, quality, inner operability and regulatory requirement. As the leading provider in the market with over 5000 SBC’s deployed and a market share over two times that of its closest competitor we believe that Acme Packet is well positioned to leverage this growth opportunity.

Infonetics recently reported that our market share had grown to 51% with the number two player in a distant second with 19% followed by dramatic market fragmentation. A look forward by the Delora Group reported similar market share lead for Acme Packet in their most recent industry report issued in February.

This market leadership is very important when you consider the size of the growth opportunity. Consider for a moment the opportunity for a single IP enabled service offerings with residential VOIP. There were about $80 million residential and so called VOIP subscribers world wide at the end of 2007. Infonetics expects that number to climb to just over $200 million by 2011 or about $30 million new subscribers each year.

Session border controllers are deployed at both the asset edge and interiors of these VOIP networks. Today on the access side our customers typically deployed two SBC’s for every 30,000 VOIP subscribers they add to their network. Extrapolating that deployment rate 30 million new VOIP subscribers could drive demand for over 2,000 SBC’s every year just to support to the AXA subscriber growth for VoIP. As the leading provider of SBC’s with more than 50% market share and a presence established in 84 of the 100 largest tier one service providers in the world, we believe we are well positioned to leverage this growth.

Our recent announcements related to our deployments at cricket communications and Excel communications are testimonies to the proliferation of VoIP. Cricket communications the operating subsidiary of lead wireless international has deployed our SBC’s to securely interconnect its VoIP core network to other service providers. Cricket is one of the first mobile operators in the United States to interconnect its VoIP core via IP to other service providers for PSTN origination and termination.

After initial deployments of our Net-Net 4000 in 2006 Cricket is now expanding with the deployment of our Net-Net 9000 in multiple path to meet the increasing traffic demand as Cricket subscriber base continues to grow.

Excel communication, the leading provider of communication services for businesses including 50% of the fortune 500 and leading cable companies, carriers, content providers and mobile operators is increasing its deployment of Acme Packet SBC’s to support wholesale service provider VoIP customers. Launched in 2005, Excel’s wholesale VoIP services enabled service providers to originate and terminate customer voice calls throughout the United States with a single connection to the Excel IP network. This service helps Excel’s service provider customers to reduce cost in market where they offer service, enter new markets more quickly and more efficiently to manage voice traffic on a nation wide basis.

The growing adoption of all IP based communications is driving the growth of our market. We are able to leverage this market growth because of our experience serving the needs of the largest tier 1 service providers in the world and our commitment to constant innovation. This innovation has in turn enabled us to rapidly evolve our product portfolio. In fact we are currently at the early stages of deploying two additional categories of products; session routing proxies and multi service security gateway.

We recently announced the deployment of our Open Session Routing or OSR architectural products and partnership. Our tier 1 wire line, wireless and cable service providers are using this solution for a more open and cost effective core session routing solution to scale their networks in terms of Zip routing performance and capacities. Our solution, simplified session routing in the core and between networks and it’s designed to reduce both capital expense and operating expense.

The architecture for OSR features our Net-Net session router working in conjunction with routing data base products and services from our OSR eco system partners. These complementary product vendors and service providers offers centralized routing databases supporting a wide selection of both IP and PSTN oriented parameters for dynamic route selection.

Our Net-Net session router queries our partner’s databases using open industry standard protocol like ENAM, STEP and DNS. Using these databases our Net-Net session router is able to dynamically route sessions between all types of borders including access and interconnects. More specifically our Net-Net session router, routes sessions between stateful service control elements such as our own SBC , wireless mobile switching centers for MSC, IMS subscriber call control element, classified soft switches, cable modem termination systems or CMTS and talk switches controlling media gateway.

These deployments of our open session routing solutions signal an impending change away from monolithic session stateful talk switches to session stateless routing proxies leveraging open routing databases. Our recently announced Net-Net security gateway is a multi-server security gateway which enables mobile service providers to maximize revenues by accelerating six mobile substitution and convergence and to lower operating costs by supporting the transition to all IP networks.

Our security gateway, secures the delivery of multiple services both voice and data over the untrusted internet using IP set tunnels to subscribers using Censor sales or WiFi access points. It is configurable as a stand alone product to support both 3GP, UMA and SIP based I-WLAN architecture. It is also available at the tightly integrated solution when combined with our net session border controllers.

Our security gateway features IPsec tunnel system capacity, density, high performance IPsec encryption and tunnel setup, integrated DoS, DDoS protection and Carrier-class high availability support. Further evidence of our commitment to innovation is our recent announcement to finding the complementary role of session border controllers in delivering trusted first class unified communications within Microsoft Office communication server deployment.

The Microsoft OCS combines or unifies all enterprise communication including presence enabled voice, video, instant messaging, conferencing and collaboration such as white boarding and application share. Our SBC satisfied critical enterprise requirements in the areas of comprehensive security for Microsoft OCS and IP PBX infrastructure, IP PBX interoperability, SIP trunking and overall solution scalability that complement Microsoft architecture and reduced overall total cost of ownership.

We are pleased with the progress in our product development effort. We believe that the complexity and velocity of the product development required to be successful in this market, demands a level of flexibility and innovation with which larger more diversified companies are hard for us to keep pace. This continued to be a key competitive advantage and one that is central for the advancement of our technology and position in the SBC, MFG and SRB product category.

During the balance of the year and in support of the financial plans we review this evening we plan to continue to satisfy the evolving border requirements of large service providers and leverage our position among customers to expand and enhance our product features and functionality, strengthen our position in key adjacent markets including enterprise, contact center and wireless backups by continuing to invest in both our sales and marketing efforts as well as in our product development efforts and bright new technologies to enhance our product performance and scalability with the continual focus on reducing cost.

Continue to promote IP interconnect among our customers which we believe increases the value of their services to their customers and drive increased demand for both our customer services and for our products and continue to leverage our distribution partnerships to enhance market penetration.

So as we have shared with you this evening we are pleased with our first quarter results and we believe we are well positioned to meet our growth plans for 2008. We are excited about the level of activity throughout our customer base and the new products that we have launched which drives the next stage of our growth. We look forward to our next call in August at which time we will update you on our progress for the second quarter. With that let’s open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Simona Jankowski - Goldman Sachs.

Simona Jankowski - Goldman Sachs

Just wondering first of all if you can just help us identify a little bit more precisely the main areas of growth for you in 2008 slicing it by new customers versus increasing business with existing customers and also some of the adjacent areas you are getting into such as your enterprise business.

Andy Ory

I mean basically the majority of our revenue will come from different customers simply because we have 84 of the top 100 and we have a large majority of the service provider’s world wide. We are seeing a lot of activity in the enterprise and contact centre space. We do expect that the activity there will yield a lot of new customers in ’08 but really it will move the need or it will become more strategic in ’09. Keith, I don’t know if you have anything you want to add to it.

Keith Seidman

I think what we are seeing is growth in all aspects of -- from a geographic standpoint US and Canada were the strongest this quarter, European activity as well as KalanA pack are strong as well, so we are seeing activity in the strong basis globally.

Andy Ory

I think what we said on the last call is that we had seen activity pick up in all geographies and all market segments and I think we would reaffirm that; that that is just continuing.

Simona Jankowski - Goldman Sachs

Following fiscals comments from earlier this week about a slow down in the order pattern they are seeing from their service providers segments is there any color you can give us on that front as far as the linearity of the orders or just any kind trend you are seeing there and if you view that as any particular slow down or anything happening in North America specifically?

Andy Ory

Typically a fair amount of our revenue in any given quarter is what we call book ship and bill where we get the order within the quarter, ship it and recognize revenue according to the contract and provisions, so the timing of revenue recognition is somewhat different than our bookings but in Q1 we’ve had a pretty smooth bookings input -- throughput and that’s our expectation in any give quarter and to know what happens in based on who the customer is? Is it direct, is it a partner? Then we file the revenue recognition criteria in the contract.

Keith Seidman

And to comment on the CISCO macro economic environment, I mean we are obviously very much smaller and I think that a lot of people that are working with us are doing so for strategic reasons where the timing is not related let's say to the financial market, so we are currently not seeing any macro economic issues in any of our market segments.

Operator

Your next question comes from Ehud Gelblum - JP Morgan.

Ehud Gelblum - JP Morgan

You were talking about some of the raw numbers and what the market is going to do. If you looked at your share according to what Deloris said the market was I think it is about 215 and size of the market and as that grows to next year Deloris is looking at around 315 in terms of the market size; your guidance would suggest that you are loosing share, so do you think therefore I doubt you are loosing share given your gross margins are as strong as they are.

Doesn’t sound like there is anyone else out there who is really competing with you, otherwise you wouldn’t have such strong gross margins; so how do you kind of correlate what the market share numbers would look like in ‘08 according to what Deloris said the market size is versus kind of what your guidance is for ’08?

Keith Seidman

Yes, I mean I think two words that come to mind are directionality and magnitude. I mean the directionality is that the market is growing, that the people that survey the size of the address of the market keep adjusting their numbers up and from a magnitude point of view were they were at 49% or 56% its very hard to know what those numbers really are and we contribute our numbers to their survey, but I don’t know where they get all their numbers.

I am comfortable though that the directionality and magnitude are correct and that’s all I would really read into it. I think if you are to look at our results in part to fine with what each industry researcher says there might be a few points here or there but I think that differential is not something that is indicative of the trend.

Ehud Gelblum - JP Morgan

Just a little bit more in terms of the business; you didn’t talk that much about backlog, but can you give us a sense of what backlog looks like now versus kind of where was the quarter before. I know you don’t have a great visibility in the business but you think the backlog can give you some sort of visibility. Seasonally how does your backlog usually look at this point in the year after your Q1 and how does it look this year. Is it stronger or is it bigger and also versus last quarter, if you can give us a sense as to what’s the change reflected in the backlog?

Keith Seidman

Sure, I mean we have not really seen any change in the relative composition between the back log component, the book, shift and build component in terms of our overall revenue numbers for the quarter. Clearly what we would like to do is to try -- is to change that but for the last many quarters I think it has been relatively constant. We also see that 45, 55 when we took the first eight quarters from 2006 and 2007. 45% first half, 55% second half, was really the numbers that we saw for the business, so I do think there is some seasonal buying, some second half increased contribution to the revenue.

Ehud Gelblum - JP Morgan

And you start seeing some of in your back log now or is it too early to see that effect get into your back log?

Keith Seidman

I think we see it in the activity, but our back log isn’t something that would give us visibility into the second half of the year. I would say that our feelings about the second half of the year are all driven by activity with existing customers and new customer’s activity really representing substance of conversation with people that we believe have budget and have and will continue to deploy and expand.

Ehud Gelblum - JP Morgan

Okay, along the same lines your deferred revenue is looking good as well, but usually it’s just services revenue; is that still basically primarily all services or is it whether it can be perhaps in the deferred revenue respective?

Keith Seidman

Consistent with what we have said in the past, the service portion of our deferred revenue represents greater than 90% of that amount and as customers buy during the year we then turn them into annual service contracts, so theoretically even though that these contracts made renew on January 1, we may not get the contract until the first several weeks of the year, but what we see in Q1 is really just renewals of service contracts from existing customers and that’s what the deferred revenue does represent.

There is a small portion of deferred revenue rather with any payments received without having recognized revenue as well as customer deposits that we are acquiring some of our small tier 3 customers, but as in the past greater than 90% of our differed revenue representing an amortized portion of our service revenue.

Ehud Gelblum - JP Morgan

Okay so that’s something we read in the product. Andy, on the these new products that you are coming out with, you did touch on the gateways and one of them you touched on mobile application, mobile IP and security on the three way gateway product, how close is that to this GDSM’s and PDSM’s that are out there in terms of functionality?

Andy Ory

I mean one way to think about it and Seamus can comment as well is that we are almost like the opposite of the GGSM. So GGSM would take devices that are trusted in a trusted environment and give them access on trusted environments; like cell phones that would be in a trusted carrier network, that want an IP address to access the internet.

We are the opposite of that. We take devices like SIPclient and so forth that aren’t inside the trusted network of that mobile operator and give them access to trusted services like voice and data services inside that mobile operator’s environment. So we really are the invert of a GGSM, the way we are deployed and where we are deployed subsequently are also different.

Seamus Hourihan

Yes we are also not providing mobile IP addressing, that’s the role with GGSM. This product is a security gateway. Basically tonation point for IP set tunnel -- within the tunnel it’s basically, it carried voice and data, because these circuits switch voice in the UMA application and packet data or in a SIPbased environment, the SIPbase sessions, voice, video and other thing as well as packet data Walled Garden services so that’s basically what’s going on; really complimentary role to existing products.

Operator

Your next question comes from [Eric Keyner - Think Pan Europe].

[Eric Keyner - Think Pan Europe]

On the fourth quarter call you mentioned that you saw wireless operators starting to dig in to what you call soft handoff. I wonder if you can kind of update us on how that’s rolling out.

Andy Ory

Yes, now we see that trend continuing. We think it’s largely going to be a North American phenomenon first throughout the 2008 and in 2009 and beyond it will be something that would happen in Europe later, but no, we do see that starting to happen.

[Eric Keyner - Think Pan Europe]

Now if we were trying to get into the heads of the European operators, why wouldn’t they also be looking to deploy that cost saving technology this year. I mean why are they kind of a year delayed if you will.

Andy Ory

I mean there are a couple of different issues. One is technology issues, CDMA versus GSM, the base radio active network, the base stations in CDMA networks are more able to hand IP out right now and GSM networks probably won’t be able to do that probably until next year, but our larger contacts of the soft hand off is on the network-to-network interfaces. There are on regulatory environments, there are competitive reasons inside of Europe which is more fragmented from a telecommunications point of view than the United States and sort of overcoming those issues are going to be pretty important.

Dino Di Palma

Also from a business perspective the European environment is much more characterized by traditional PSTN billing models in terms of per call termination charge and transfer charges and all that. I mean there is much more willingness within the US to again pursue this bill-and-keep model that helps enable these soft -- or take advantage of these soft hand offs and it will happen in Europe -- it’s just going to happen in the US first.

[Eric Keyner - Think Pan Europe]

Okay just a kind of I guess link to Seamus comment there, you also mentioned last quarter that bill-and-keep was really kind of looking to be a US or North American phenomenon this year and kind of broadening out then later on into international. Can I assume that that’s the kind of the same driver the fragmented regulation and the PSTN billing models?

Andy Ory

Yes you can and I would also overlay that cable plays a part in that because now there’s alternative termination, alternative origination and in the US there is a increasingly robust cable origination and termination environment. It does not exist in the same way throughout Europe. So that’s complimentary to the wireless operators converting to IP.

[Eric Keyner - Think Pan Europe]

Last topic that I really wanted to address here is the deferred revenue issue. Obviously we saw a big spike up there and I understand that a good 90% of that is from services bookings, but if I look out at what happened defectively in the last first quarter, I think we saw a 600K ramp sequentially and here we’re obviously seeing a much, much bigger ramp. I mean, is there something else going like -- or you’re getting bigger service contracts as a percentage of overall revenues or something along those lines. I mean it seem like there is something else going on under the coverage.

Andy Ory

The reason, it is as our installed product base grows when these customers come up from the service renewal standpoint, the renewals themselves are higher and we’ve grown continually from the product standpoint over the last eight quarters, it’s just a period timing of the service renewal. We do get into situations where sometimes it takes a month or two after the stocks, you get a service renewal contract we introduced and that is the 120 new customer last year and as these customers get into the second, third years, fourth years of operations with their products its like a snowball; every year we would expect the service revenue to grow.

Operator

Your next question comes from Vijay Bhagavath - Deutsche Bank.

Vijay Bhagavath - Deutsche Bank

Just a two part question; the first part is kind of the trends you are seeing in the service provider managed Voice over IP market place and the follow up to that is in terms of your strategy to expand business by penetrating into your installed base, what kind of measures you are taking and what success you are seeing in that strategy and what risks are involved in penetrating your base versus keep adding new customers.

Andy Ory

Okay, well I mean I guess lets take them in reverse order. I mean clearly we want to win every single deal, every single valuable opportunity that’s out there and our win loss rate is very, very high. I think when we talk about 84 of the top 100 tier 1 service providers in the world, I think that that sort of gives an idea of, at least the base line, the floor what we find acceptable and would like to win everyone.

There is only so many service providers out there; at certain point you need to look at growing within the service providers and places like BT well you might be in 14 different project, some of this domestic major tier 1’s. In the United States we are in eight, nine, ten different projects, so when we find that a service provider has made the investment in converting their network for PDM to IP and we form a commercial relationship with them direct or indirect and they start buying our products and investing and understanding our products it’s at that point that we start to put more system and sales engineering resources and product focus and training resources on those particular customers because really it’s the top 50, top 100 service providers that can make a huge difference overtime and so our level of attention, amount of cycles that we can focus increases.

There is -- we are starting to see certain trends obviously, so one example is in the United States SIPbased IP interconnect to large enterprises and contact centers. Boy is that turning on and that’s making a big difference in some of the adjacent markets like the large enterprises and contact centers because you start to need session border of controllers on both sides of the length for all the reasons that you need a session border controller.

So, by focusing on our key customers and by helping to broaden in their different projects, it helps drive adjacent market. I mean we’re -- cable as I said in my last call continues to pickup in 2008. I think you are going to continuously to see cable in the United States, in fact a lot of activity in the wireless segment, we -- in the second half of the year we saw a big increase over the first half of the year in terms of wireless revenue and wireless customer acquisition and wireless activity and I would say that that really is continuing in the first half of 2008.

Operator

Your next question comes from Joanna Makris - Brean Murray Carret.

Joanna Makris - Brean Murray Carret

You are obviously seeing an increased mix towards software. Maybe you could describe anecdotally what are some of the features and functionalities that are driving that and may be give us a sense for where your customer base is in terms of adoption or some of the recently introduced software features and how that might change going forward?

Patrick MeLampy

I mean the software that we are seeing contributes the most meaningfully to our business is the session capacity. So, in other words people are buying bigger systems and those system are full and they are trying to figure out how they continue to grow and how they buy more systems and when somebody has a system that for the next system they buy is going to be a big system not a small system and that makes a very, very big difference to our business model.

I would say that in the last 6 months we have seen a few climbs inside our professional services organization, what you would see that we are helping our customers on is managing their growth they really are starting to pass the cap on. I would bet and I -- obviously I can’t do this because I don’t have the data but I would as a guess that if you took a look at our systems in the field globally, the vast majority of them are very, very full and that’s really good, people are really starting to use this in a significant way. Keith I don’t know if you want to add anything to that?

Keith Seidman

The two other components to these, what we call the software component of the product are also the protocols and the feature groups. We are unique in our spaces that we offer multi protocol applications whether its SIPbased MGCP or HR 323, so many of our customers would put more than one protocol in a single system and that software licensing; as well as we offer several feature groups whether its load balancing, counting quality of service, loss of intercept; so as our customers license these products the software piece of the total system it becomes a higher percentage of the total, I suppose it’s just a hardware element, but the bigger drivers and they indicate is the session capacity. As people buy larger systems, as people upgrade from a 1 to 2000 session to a 4000 session system that’s a peer licensing software.

Operator

Your next question comes from Catharine Trebnick - Americas Growth Capital.

Catharine Trebnick - Americas Growth Capital

Quick question on the multi service gateway; so, if you already installed in a Vodafone or an integrated operator and you have already been through the process of being tested and have a vendor contract do you need to go to the same process with this piece of equipment because the product is substantially different in effect that its more on the access side of the network?

Seamus Hourihan

Within all of our tier 1’s like Vodafone as we have mentioned a number of times we are involved in multiple projects. The use -- the question of our SPC for Vodafone related to historically their broadband access -- I mean they also provide DSL services, residential VoIP and business VoIP as well, but these projects involve fixed-mobile convergence requiring the multi service security gateway, are separate projects, separate decisions and we do have an advantage being our reflective for not a different type of project but vendors when certain clients are looking to consolidate vendors, single elements for multiple purposes and so they give an advantage in these new projects.

Andy Ory

Right but I would say just to add onto that yes when there is a different project and comes out of different projects often times people want to do some level of inner testing to make sure that it’s going to work well. Now there are a range of the customers where we are the corporate standard for all projects and if we are not selected there seems to be a very good reason why. In other cases each project is bid separately.

Seamus Hourihan

Right, I guess it does different from carrier to carrier right.

Catharine Trebnick - Americas Growth Capital

Yes I know it does differ from carrier to carrier having been on the other side negotiating these contracts, but I also was wondering if there has also been -- if its going FMC then it would have to be a new RFC process.

Andy Ory

Oh you -- oh an RFC process.

Catharine Trebnick - Americas Growth Capital

Yeah.

Andy Ory

One of the things that Acme has done very well is we have an awful lot of thought leadership and we are able to get into an awful lot of these new projects and existing customers without having RFP and often when an RFP is written we have so much influence over it because we are the central point in providing a lot of the inauguration and reconciliation of different vendors products that its an exercise for us to actually provide more value to the carrier, to the service provider and for us to be put at to the test.

Catharine Trebnick - Americas Growth Capital

Okay and just a quick follow on; competitively then have -- who personally do you run into a more on the FMP side?

Andy Ory

It is sort of wide range of vendors there; people like Clavestor that is resold by Erickson to -- we see start ups some of which have recently got our business like they only started recently.

Catharine Trebnick - Americas Growth Capital

Have you run up against Erwana, they have new?

Dino Di Palma

Not, not at this point in time, no.

Operator

Your next question comes from Greg Mesniaeff - Needham & Company.

Greg Mesniaeff - Needham & Co

In your prepared remarks you spend sometime talking about your enterprise opportunity and some of the new product development initiatives in that area. I was wondering if you can give us some indication as to what percentage of revenue in this first quarter was from enterprise customers and also talk about how continued development or focus on the enterprise as suppose to the carrier market can or will impact your R&D spending throughout the year thanks.

Andy Ory

Sure, sure we have grouped enterprise and contact center together when we talked about general contribution even though they are separate markets; they are two market adjacencies that come from the service provider and we have said that likely it won’t be even 10% this year for Acme Packet and I think that’s probably a fair way to think about it. It will be somewhere in the single digit, but what we are seeing is an increase, it’s a pretty robust demand across the enterprise, large enterprises and contact centers for these solutions.

Additionally when we work in the enterprise, often times we are helping to solve some of the issues that our carrier customers would have once they interconnect their network core to these enterprises and try and accept the traffic terminate originate trend of traffic. We’ve done an awful lot of the development to work with the Eco System of infrastructure suppliers in the enterprise, so hopefully there isn’t a large uptick of R&D for us to continue on our plan.

Operator

Your next question comes from Sanjiv Wadhwani - Stifel Nicolaus.

Sanjiv Wadhwani - Stifel Nicolaus

A couple of questions; you had a 10% direct customer which you haven’t disclosed the name of and I am guessing you want to keep it that way but I am wondering if you could give us more color; is it a new customer; is it wireless, is it a wire line customer ,any color that would be helpful.

Andy Ory

Unfortunately the only thing we really can say is that it is a North American customer and it’s an existing customer.

Sanjiv Wadhwani - Stifel Nicolaus

Got it and then as far as the enterprise side of the equation is concerned I am just curious is the pricing on the enterprise market quite a bit different from the service provider market. What I am trying to get at is, is there going to be any impact on gross margins as the enterprise market gets say larger than 10% of revenues in 09?

Andy Ory

When you look at the large enterprises and contact centers the cost of VoIP transport could go down to zero, but the importance of a reliable managed service so that they always have connectivity is very, very high and so those customers are motivated to pay for value and to pay for carrier class technology and we are seeing that in large enterprises and contact centers; it feels an awful lot like the service provider market.

We think that that’s a very large market when you look at the global 1000 enterprises and we look at the large contact centers throughout the world, it seems a very, very large market. If Acme Packet were to go into the smaller segment of the market we would have to take a look at how we would enter that market, what our cost of sales would be and what our cost of product would be, but at this time about 2008 and into the foreseeable future of 2009 we don’t -- really don’t see it having much of an impact.

Sanjiv Wadhwani - Stifel Nicolaus

Keith given where interest rates are and clearly that’s impacting our interest income are you likely to remain aggressive on the stock buyback or is that not a determining factor at all?

Keith Seidman

So the Board of Directors did authorize up to $20 million through the first quarter of 2008 and there is impact by about $4.2 million so there is room under the program. We will continue to look at the stock price and we give you the opportunity and determine on a periodic basis whether we will -- how much and the frequency of which we will do the buy back.

Operator

Your next question comes from Paul Silverstein - Credit Suisse.

Paul Silverstein - Credit Suisse

Has anybody asked about new versus existing customers in the quarter, did you all go into that?

Keith Seidman

Again the major component of our revenue comes from a existing customers; single digit come from new customers in any given period, this is nothing that’s different from other quarters but the majority of our revenue continues to be from existing customer.

Andy Ory

And we did acquire 22 new customers.

Keith Seidman

22 new customers and again they buy small and then as they multiply get larger but it’s pretty much in line with growing it historically.

Paul Silverstein - Credit Suisse

And do you think you are running out of new customers to acquire?

Andy Ory

Well no, there is still some. We want to get them all.

Paul Silverstein - Credit Suisse

Okay and did anyone ask about Sprick. I know there is only so much you can or would want to say about any individual customer, but concerns the [Inaudible] which may be resolved with this new injection capital and its a clear wire, but any insight you can give us there had been an meaningful customer for you?

Andy Ory

I mean Sprick continues to be an inline performer from what we would expect Sprick to be and they purchased -- I guess they were our customers last quarter we expect them to be our customer throughout the year. Yes, no real impact. I am happy to see what they are doing. I think that as they decide to address aggressively into a new access high speed infrastructure for wireless it’s going to create both competition and lots of edges and that’s good for Acme Packet.

Paul Silverstein - Credit Suisse

Sure and finally on the competitive landscape I trust there’s really nothing new here and I’m sure it must have come up earlier in the call but VSO1000 seems to be the only product there that may be an issue and it’s probably early, that product hasn’t hit the market yet but anything you’re seeing there new and different from a competitive standpoint including any insight you have on that product and the impact it could have.

Andy Ory

A session border controller does a whole bunch of things. A small portion of what it does would be a border gateway for media and the ASR 1000 appears to be something that does even a subset of that. No, I mean we -- the thing about Cisco and we consider it a great company, the fact that they now have three different session border controllers and three different groups and validates in our minds or confirms in our minds anyway that they believe this is a big market but we really don’t run into them in any meaningful stance and I feel very, very comfortable that if customers get educated they are not going to choose Cisco at all. Not anyway, not when we’re able to get there.

As far as competition elsewhere, the landscape hasn’t really changed -- I guess I would say that one of the changes is that the private venture backed companies we are running into less and less and less, I think what’s happening is that product innovation and disruption is not giving way but people are now looking for the kind of partnering from their vendor where they can bring resources to bear for quality training support on a global basis and so we feel that we have the best solution and the best capabilities but we also represent something in terms of a supplier to these tier 1 service providers that they are also increasingly valuing and we think that’s a strategic advantage. Well we think that is probably why we are seeing less and less of the small private companies.

Operator

Your next question comes from Anil Doradla - Caris & Company.

Anil Doradla - Caris & Co

The gross margins seem to be doing well how much of it was due to new software applications versus perhaps shift of the weight from direct versus indirect.

Andy Ory

Yes I think the shift from direct to indirect really doesn’t have an impact on our gross margin. The driver really is the session capacity. If you look at again the three components in the software element -- so what we are seeing is people are just buying the larger systems and that is really what’s the driver. Then the secondary would be upgrades from existing systems as well as growth in our service revenue relative to installed customer base.

Anil Doradla - Caris & Co

Okay and in terms of end applications, were there any particular end applications that you thought was interesting from a customer base?

Andy Ory

VOIP was that I think -- I mean I think they’re all interesting.

Anil Doradla - Caris & Co

Or was there any see other than VOIP was there any other particular end application that stood out?

Andy Ory

No, I would say that one of the things that I learn that was interesting is that large enterprises aren’t just buying into SIPbased IP interconnect to interconnect their IP, their VoIP infrastructure with a carrier VoIP infrastructure to reduce costs or even simplify operations so that’s important, but the whole notion of IP being more resilient, being able to tolerate failure more readily for disaster recovery and the importance that that has to the large contact centers and enterprises with the people learning that I had of last 90 days doesn’t change the need in the market but the interest.

Anil Doradla - Caris & Co

Now any plans to integrate a session border controller in a IP PBX or do you already have a product like that?

Andy Ory

No we do not make applications and I think you are going to see us continuing to compliment application servers like that, like the Microsoft OTS architecture and other IPX and IP PBX architectures. That -- we don’t want to do that.

Anil Doradla - Caris & Co

And finally Andy it sounds like a 30% year-over-year growth story. Now going into ‘08 not withstanding some of the upside on the enterprising and all that stuff what is the downside here. I mean we were hearing a lot of micro stuff weakness going on. Is it -- I mean what are the down side risks going into ‘08 in your opinion?

Andy Ory

We I think the down side risks going into ‘08 for are have to do with the fact that 55% of our revenue comes in the second half of the year and a fair bit of it is book, ship and bill, so I am not sitting here with any deferred revenue on my books just waiting to deliver a software application or meet some criteria of a contract to take revenue on it, so it is on the comp and there is an risk in that. Now how we feel good about it is that we are hearing all the same thing from all the same sectors from all the diverse customers and that’s the form of insurance from our point of view. We are not depended upon any one customer or any one distributor to make the year.

Operator

Your final question comes from Patrick Calory - Piper Jaffray.

Patrick Calory - Piper Jaffray

You gave us a little bit of color on gross margins and what I am interested in understanding is you guys have been kind of out performing your target range for several quarters now and while you are still modeling coming back into those high 70s could you tell us about how that’s going to come down quarter-over-quarter and what sort of things are going to be pulling that margin down for what you are modeling?

Andy Ory

There I mean there is no specifics that we think are going to pull it down I think that on we just feel from a business point of view picking high 70s for gross margins, it seems the prudent thing to do, but there is no particular piece of pressure today and we don’t really see a glide back from where we are to there but I don’t know Keith might feel that at some point we might want to invest in some customers at some point where we would be slightly more hardware then software and that mix would impact our growth margin.

Keith Seidman

Terrific Patrick do you follow question?

Patrick Calory - Piper Jaffray

Oh good, thanks for that and I guess also just generally we have been seeing the -- your channel partners maintain pretty high mix over the past couple of quarters how do you see that evolving kind of as the market takes place and you guys get a little bit more attraction with some of the -- in terms of direct supplies was in the tier1?

Andy Ory

I mean we are completely agnostic whether it’s how the products are procured so long as we are able to provide the message to the end customer. They understand where the value is coming from for this element and this solution.

I actually think that a number of our partners are looking more and more at becoming systems integrators and providing a breadth of services that a global equipment manufacture can provide to a very large multinational tier 1 and I think to the extended that they embrace that, they are going to find that Acme will continue to be a really good partner.

We are very delighted with the partners that we do work with, we continue to increase the number of partners we have and I would expect to see a partner contribution of our revenue over the next eight quarters to continue to be very robust, I don’t see any change in it. Do you Keith?

Keith Seidman

Over the past hive quarters it ranged anywhere from 52% of the revenues to the high 60%. A lot of that has to do with whether it international or direct but our partners have always represented a majority of our revenue and we continue to work very closely with them.

Andy Ory

Well thank you for that final question. So very briefly the key take away from our Q1 results are as follows. We posted records quarterly revenues marking our tenth consecutive quarter of sequential and year-over-year top line growth with gross margins of 82% and operating margins of 27%, we continue to show that there’s a great leverage in our business model, we updated our financial and operating objectives for 2008 which continues to call for top line revenue growth of between 26% and 30% and an appropriate spending plan which will enable us to deliver non-gape EPF of between $0.38 to $0.42 per share; so with that on behalf of Keith, Seamus and Brian thank you for joining us tonight. We look forward for our next conference call when we can update you on our continuing progress. Good night.

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Source: Acme Packet, Inc. Q1 2008 Earnings Call Transcript

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