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Acme Packet (NASDAQ:APKT)

Q3 2012 Earnings Call

October 25, 2012 4:30 pm ET

Executives

Brian Norris - President Elect

Andrew D. Ory - Co-Founder, Chief Executive Officer, President and Director

Peter J. Minihane - Chief Financial Officer, Principal Accounting Officer and Treasurer

James J. Hourihan - Senior Vice President of Corporate Strategy

Analysts

Paul Silverstein - Crédit Suisse AG, Research Division

Catharine Anne Trebnick - Northland Capital Markets, Research Division

Richard Valera - Needham & Company, LLC, Research Division

James M. Kisner - Jefferies & Company, Inc., Research Division

Rod B. Hall - JP Morgan Chase & Co, Research Division

Ehud A. Gelblum - Morgan Stanley, Research Division

Todd K. Koffman - Raymond James & Associates, Inc., Research Division

Brian T. Modoff - Deutsche Bank AG, Research Division

Simona Jankowski - Goldman Sachs Group Inc., Research Division

Victor Chiu

Dmitry Netis - William Blair & Company L.L.C., Research Division

Operator

Ladies and gentlemen, good afternoon and welcome to Acme Packet's Conference Call. [Operator Instructions] As a reminder, ladies and gentlemen, this conference 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, sir.

Brian Norris

Thank you and good afternoon, everyone, and welcome to the conference call. I'm joined by Andy Ory, our President and CEO; Peter Minihane, our CFO and Treasurer; and Seamus Hourihan, our Senior Vice President of Corporate Strategy.

The press release announcing our third quarter results and management's business outlook for 2012, as well as a reconciliation of management's use of non-GAAP financial measures, as compared to the most applicable GAAP measures, are available on the Investor Relations section of our website at www.ir.acmepacket.com.

All results and expectations we review are on a non-GAAP basis, unless otherwise described as GAAP. Our non-GAAP financial measures exclude stock-based compensation and related payroll tax expenses, amortization of intangible assets and merger-related expenses associated with the company's acquisition activities. Also please note that all earnings per share amounts are on a fully-diluted basis.

All statements made during this call that are not historical fact may be forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934. These 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 can be found in our recent filings with the SEC. 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. One calendaring item, please make plans to join us on January 31, 2013, when we will host our fourth quarter earnings release conference call. With that, I'd like to turn the call over to Andy.

Andrew D. Ory

Thank you, Brian, and good afternoon, everyone. I will start with a brief overview of our third quarter results and then share a few thoughts on what we are seeing in the business. Revenues and earnings were in line with our expectations.

Revenues in the third quarter were $65.3 million and non-GAAP EPS was $0.07 per share. Gross margin was 82%, in line with prior quarters. Cash from operations was $6.7 million. We repurchased 1.6 million shares for $29 million. We ended the quarter with $374 million in cash. For the full year, we expect to deliver revenues of $270 million to $275 million and non-GAAP earnings of $0.44 to $0.46 per share.

Looking at some of our non-financial highlights. We again experienced strong new customer adoption. We added 81 new customers and now serve over 1,850 customers in 109 countries. We added 24 new service provider customers and 57 new enterprise customers. We believe this is a meaningful leading indicator of future expansion opportunity.

We now have shipped over 20,000 units and served the needs of 89 of the top 100 service providers, 18 of the top 25 cable operators, globally, and over 700 enterprises around the world.

We extended our technology leadership with the introduction of our new Net-Net 6300, which delivers the industry's highest levels of SBC performance and capacity. The Net-Net 6300 is the most important new product launch in the company's history. The Net-Net 6300 is available today and the response from our customers has been excellent.

Over the last several years, we have invested significant R&D dollars into the design and development of the Net-Net 6300. The result, it improves our capabilities to meet our customers' needs in 3 areas: for high-capacity network Interconnect between service providers, including wireless to wireline interconnect; for large-scale subscriber access environment, such as VoLTE, where encryption is mandatory; and for large-scale contact center and enterprises, where maximum signaling performance and media capacity is essential.

Powered by our Net-Net OS, the Net-Net 6300 supports all, 100% of the SBC functions and features of our Net-Net 4500. More specifically, this includes thousands of configuration parameters and individual request for enhancements that our existing customers depend upon everyday for session delivery. These capabilities are the reasons why Acme Packet continues to win new projects from both existing and new customers.

Upgrading to the Net-Net 6300 is virtually plug-and-play. The Net-Net 6300 quad-core CPU and memory module supports 1 million subscribers, and is capable of handling up to 200,000 calls or sessions at a time. It features up to four 10-Gigabit Ethernet ports and a total system throughput of up to 40 gigabits per second. That's more than 8x our previous platforms. Powered by the most advanced multi-core encryption in digital signaling processors, the Net-Net 6300 can support up to 1 million IPsec connected subscribers and, when available, up to 50,000 transcoded sessions.

We are very excited about the Net-Net 6300, and I want to personally thank our engineering team for their incredibly hard work in its design and the development.

Next, I will share several observations from the first 9 months of the year. As we have discussed on previous calls, the North American Tier 1 service provider market continues to be CapEx challenged. This has impacted our financial results and market share disproportionately because of our strong position among the largest Tier 1 service providers in North America. We believe that the largest service providers globally will account for the majority of the market opportunity and our position with these Tier 1s globally, will continue to be very strong. We are confident that when Tier 1 service provider spending resumes, our financial results and market share will improve.

The European service provider market continues to be a bright spot for us. Some of our strongest and most strategic relationships are among the Tier 1 service providers in Europe. We see acceleration of 4G LTE planning and deployment, rolling interest in cloud and over-the-top architectures, as an alternative to traditional methods, broad support for our Diameter signaling controller and the broad increase in RFP and RFQ activity throughout the region. EMEA leads all regions with regards to engagement for LTE data services, VoLTE and RCSC.

We continue to see opportunity, generally, in the APAC market, which is home to 4.5 billion people, or about 65% of the world's total population. There are over 3 billion mobile subscribers and 150 mobile operators in the region. We are investing in APAC and have recently brought on board senior sales and business development leadership to manage our growth in the region.

While we are pleased to say that our position in the largest and most complex global enterprise accounts continues to grow, with 48 of the Fortune 100 companies now our customers, we are disappointed with the slow rate of market growth, as measured by external industry and analysts and our own overall performance in the broad enterprise segment year-to-date. Given the current weakness in the North American market, we now expect our enterprise business to be up by less than 5% in 2012.

We see 2 dynamics at play here. First, the broad-based adoption of SIP trunking outside the U.S. has been slower than previously expected. Our conversations with both service providers operating outside the U.S. and the enterprise customers they serve inform our belief that broad-based market awareness of the benefits SIP trunking remains limited and ROI challenged as service providers in many foreign markets still find themselves in the final stages of their legacy TDM infrastructure investment. Second, within the U.S., reports suggest that a greater percentage of the buying activity this year in the enterprise SBC market has been by small and medium-sized businesses, which has disproportionately affected our market share in the overall enterprise SBC market. Acme Packet's traditional focus and widely acknowledged strength has been at meeting the unique requirements of very large enterprises, contact centers and government entities who require quality, performance, security and interoperability at large scales.

Recognizing these trends, we have taken significant steps to strengthen our position and improve our execution moving ahead. In June, we introduced a virtualized SBC, designed to better address the needs of smaller and midsize enterprises who want Acme Packet performance and security but whose requirements for scale, transcoding and other features may be less.

In the last 90 days, we have also welcomed the new leadership for both direct and channel sales in Asia-Pacific, for our North America enterprise region, as well as in product management and marketing. We have hired high quality talent with experience from enterprise-centric companies, including Riverbed, Cisco, Avaya and EMC, that will benefit our long-term performance in this segment.

That's a high-level look at our third quarter results and some of the dynamics we are seeing the business. Let me turn the call over to Peter at this time, for a closer look at the numbers. Peter?

Peter J. Minihane

Thank you, Andy. As a reminder, all financial information reviewed this afternoon, both historic and forecasted, related to our statements of income, are on a non-GAAP basis unless otherwise described as GAAP. And that any reference to sequential change, compares to second quarter of 2012 to the third quarter of 2012.

Total revenue in the third quarter was $65.3 million, which included $46.8 million in product revenue and $18.5 million in maintenance, support and service revenue. Geographically, 49% of our revenue in the third quarter came from the United States and Canada, while 51% came from the rest of the world. The distribution of our third quarter revenue was 37% direct and 63% indirect. During the third quarter, our revenue was split 27% enterprise and 73% service provider.

Two channel partners represented at least 10% of total revenue, and they were Dimension Data at 11% and Westcon Group at 10%. As we've mentioned on previous calls, one channel partner can represent dozens of end-user customers.

Gross margin was 82% in the third quarter, unchanged sequentially. Product gross margin was 82%, also unchanged sequentially. Service gross margin was 81%, down from 84% in the second quarter of 2012, reflecting an increase in the cost to fulfill our maintenance and service obligations. Total operating expenses were $45.5 million in the third quarter, in line with the estimates we shared on our last conference call. We continue to invest in all areas as we build a great stand-alone company.

Non-GAAP net income in the third quarter was $4.7 million or $0.07 per share. We ended the third quarter with approximately $374 million in cash and investments, down from approximately $402 million, as of June 30. The primary driver of the decrease in cash and investments was the activity under our stock repurchase program. If you recall, in July 2012, the Board of Directors authorized the repurchase of up to $200 million of our common stock over the next year. During the third quarter, we repurchased approximately 1.6 million shares for approximately $29 million. Cash provided by operations were $6.7 million for the third quarter while total capital expenditures were $5.2 million.

Accounts receivable net was $57.2 million at the end of the third quarter, increasing DSOs to 79 days at September 30, from 66 days at June 30. The increase in DSOs reflects the timing of revenue within the quarter, as well as a significant increase in the contribution from our channel partners who tend to have longer payment terms than our direct customers.

Inventory at the end of the third quarter decreased to $11.4 million. Deferred revenue was $28.6 million at the end of the third quarter compared to $31.9 million at the end of the second quarter. The sequential decline reflects amortization of annual maintenance contracts during the quarter.

As we have stated on previous calls, deferred revenues can fluctuate from period-to-period based on the timing of shipments and maintenance renewals along with the associated revenue recognition, and we do not believe it should be relied upon as an indicator of the health of the business.

I will close with a few forward-looking statements to help you better understand how we are thinking about the remainder of the year. This afternoon, we are reaffirming our full year revenue outlook of $270 million to $275 million. We are updating our full-year non-GAAP EPS outlook to $0.44 to $0.46 per share compared to our previous outlook of $0.43 to $0.47 per share. We will provide our 2013 outlook on our fourth quarter earnings release conference call on January 31, 2013.

Let me turn the call back over to Andy for his thoughts on the future market opportunity.

Andrew D. Ory

Thank you, Peter. Longer term, there are 3 major growth drivers for our business: enterprise, interconnect and wireless. The primary driver of growth in the enterprise market continues to be large enterprise SIP trunking. In the future, we see expanding opportunities in multi-vendor unified communications enablement, including the session management in Microsoft Lync and session recording.

The second driver of growth is the need for SIP interconnects among service providers. Nearly all interconnects among Tier 1 use decades old legacy TBM technology. There is a large opportunity to interconnect all of the Tier 1 service providers around the world with one another natively through SIP. These will be large scale deployments which will require a new dimension of technology. The Net-Net 6300 is precisely the right solution, at the right time, to meet the needs of billions of people impacted by this trend.

The third and perhaps the most significant driver of growth is VoLTE, which will redefine the communications market. Consider that there are 6 billion wireless endpoints today and that less than 1% of these are IP-enabled for voice or video. Next generation VoLTE networks will change all of that. We expect that VoLTE services, offered by service providers, will ramp in 2014. The first wave of adoption involves LTE data services, where we already have 9 wins with our Diameter signaling controller. This includes 4 wins in the last 30 days alone. What's more, we are actively engaged with over 75 other opportunities.

The second wave of adoption will be the build out of voice and other services over these LTE networks, commonly referred to as VoLTE. Beyond the 10 architectural VoLTE wins we have already secured, we are actively pursuing 38 additional opportunities, up from just 26 a quarter ago. VoLTE presents an opportunity to sell nearly all of our session delivery network solutions, including our access in interconnect SBCs, SIP Multimedia-Xpress with the IMS core, Session-aware Load Balancers, session routing proxies for core SIP routing, Diameter signaling controllers for Core Diameter Routing, multi-service security gateways for offloading traffic to small cells and mobile network integrated Wi-Fi networks and Palladian, for session deliver network and service management.

2012 has been a challenging year. That said, it is not the first time we've dealt with adverse market and macroeconomic conditions. Today, our resolve and our confidence remain steadfast. We believe we are well-positioned to leverage the broad transformation that is redefining the way the world communicates. We look forward to our next call in January, at which time, we will update you on our progress for the fourth quarter and share with you our plans for 2013. With that, I'll turn the call back over to Brian.

Peter J. Minihane

Thank you, Andy. At this time, we'd like to open the call up for Q&A. Again, we ask participants to limit themselves to one question and one follow up question.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Paul Silverstein with Credit Suisse.

Paul Silverstein - Crédit Suisse AG, Research Division

Andy, can you talk about the pricing environment. What's -- the margins have been coming down on both products and services. Can you talk about what's going on there?

Andrew D. Ory

Sure, Tommy. I believe that we couldn't give any guidance, at least non-GAAP gross margins in the low 80s, and I think it's been 82% for quite some time. Is that right, Peter?

Peter J. Minihane

Yes.

Andrew D. Ory

And I think that the service gross margins purely reflect the amount of service required in any one period and tend to fluctuate based upon whether or not more service, or less service, is required by customers in the field, but I think that seems pretty constant as well.

Unknown Analyst

Peter, what is -- for services, I see there's been fluctuation, but it looks like there's been a down trend. Well, going forward, what should we expect?

Peter J. Minihane

Paul, I think we've always given guidance in the low 80s and, occasionally, it will creep into the mid 80s. However, the service gross margins are impacted by the 91-day period activity that it takes us to support our existing maintenance and warranty obligations. So we think it's still a low 80s to maybe mid-80s. However, I think our mindset has been, both from a product and service side, to be in the low 80s.

Unknown Analyst

All right. And then Andy, can you revisit your commentary about both Diameter and the traditional SBC opportunity with respect to VoLTE. Any incremental insight you can give in terms of the nature -- you talked about the activity, I think you referenced 75 different engagements on, I think with Diameter and 38 on SBC. Can you talk about the nature of the discussions and I heard you say 2014 as the commercial opportunity. But any incremental insight you can give in terms of where -- what the nature of conversations and the perspective time frame? What's you're hearing?

James J. Hourihan

Paul, this is Seamus. As we mentioned, we've made a significant gain here in last quarter around Diameter signaling controller wins. Last quarter we're at 4, we're now at 9. The number of opportunities we're engaged in went from 23 to 76. Again, just recapping where these products fit in the network. They exist in the core of larger scale LTE data networks, again, to route and manage Diameter traffic internally to that network. Two examples of that would be Telefonica Germany, that we announced in Q3, or one example of that. Another example would be the IPS carriers, that's basically interconnect mobile and fixed operators to one another and they needed to carry Diameter signaling as part of that. For our customers, we announced was Aicent, out of the APAC, primarily. And then the other plays in the network is the interconnect border of a mobile operator where they may connect to a IPX carrier like Aicent. So those -- that's where this is happening and again, Europe, in terms of the number of engagements that we're still pursuing, just a lot of activity for Diameter signaling controller, SBCs and more for Voice over LTE and RCSC. Again, primarily an SBC play.

Operator

And your next question comes from Catharine Trebnick with Northland Securities.

Catharine Anne Trebnick - Northland Capital Markets, Research Division

Two questions and on the same line of questioning that Paul had. Number one, Andy, could you pretty much, geographically, I know you can't name operators, but distinguish VoLTE timing perhaps North America, Asia PAC and Europe? And then the follow-on question is for you, Seamus. Could you just clearly articulate, because there's a lot of confusion as to SIP in the LT network and what it plays. And back to Paul's question, Diameter. We have a very distinct understanding between where your SIP plays and where Diameter plays. So I'll let you address the first question, Andy.

Andrew D. Ory

Sure. Diameter is a protocol between elements within a network. SIP has to do with signaling communications to subscribers and endpoints. Was that...

Peter J. Minihane

More specifically, SIP is used to establish subscriber registration from a signaling perspective and identify where in the network they're located. And then actually used to initiate control and tear down a call or a session. Diameter is used from an endpoint that -- or device perspective to authenticate the device, authorize it and keep track of its location from a mobile network perspective. And that information is shh! Diameter signaling is used to send that information from mobile management entities in the LTE network to the subscriber database, the HSS. Diameter is also used to control -- or let this information be known by policy servers, proxy CSCF, et cetera. They are completely -- they have completely different roles in a network and both are critical.

Andrew D. Ory

Two plays. One at 10,000 feet, one at 50,000 feet.

Peter J. Minihane

But yes, so there you go. You have a top level answer and you have Seamus' more detailed answer.

Catharine Anne Trebnick - Northland Capital Markets, Research Division

Okay. And then before I turn it over...

Peter J. Minihane

Let's go with the VoLTE timing. And Seamus, actually, has been involved in a lot of the VoLTE conversations with the operators and with the industry. There's actually an awful lot of activity in EMEA and we're seeing a very large increase in RFP, RFQ, RFX activities, for people to deploy VoLTE. In North America, 2 of the Tier 1 service providers have moved their date back into 2013. We typically believe that 2014 is when you see subscriber ramps, and 2013 is when you see investments. But Seamus, if you want to give some more data on that, feel free.

James J. Hourihan

No. I think, Andy, that's fair. I mean, I think that -- what's interesting in my perspective, you just look at the engagement that we're still in the offers on, pursuing right now. The number of LTE engagements for data service without DFC is 76, okay? And that has to happen before they layer in Voice over LTE services on top of it. And then the number for Voice over LTE, at this point in time, engagements that we haven't won is 38. So it's just about half. But those numbers make a lot of sense to me, because the LTE data network has to be an excellent network before they can layer in services, so they have to be reliable. It has to be high quality and low latency for the delivery of Voice. And so making investments to make sure that their LTE data network is excellent, it needs to happen first.

Andrew D. Ory

Right.

James J. Hourihan

And at a very high level, Catharine, the way I think about it, is that LTE is a flat-routed IP network providing mobile broadband connectivity. VoLTE is an architecture where the network can be involved to provide, through signaling media management, so it can provide interoperability, regulatory compliance, quality of experience, so they can guarantee that interactive communications across an IP network have the kind of quality, security and trust that we get on a regular telephone network.

Andrew D. Ory

Well said.

Operator

And we'll go to the line of Rich Valera with Needham & Company.

Richard Valera - Needham & Company, LLC, Research Division

Question on enterprise business. It sounds like, if I heard you right, you went from expecting that to be up 20% this year, to being up 5% or less. And that would seem to be a headwind of high-single-digit millions, yet you maintained the full year. So can we assume that your service provider business is actually stronger than expected? And/or should we assume that we're now biased towards the low end of that previous revenue range for the year?

Andrew D. Ory

Again, Rich, I think as we outlined in our prepared comments, we think the $270 million to $275 million is where we will wind up. I think in our Q2 commentary in late July, I think we said for the value of simplicity, use $135 million in the second half of the year for revenue. Again, I think we are looking at that number consistently with the way we reviewed in late July. So I think there maybe a little bit of a shift between service provider and enterprise, of the mix within the mix, in Q4, but again, I don't think there's any dramatic changes, one way or the other.

Peter J. Minihane

Right. And the enterprise business is still a relatively small business. So the shift still represents, like you said, relatively small.

Andrew D. Ory

Could pick up a million dollars, right?

Richard Valera - Needham & Company, LLC, Research Division

Next is on bookings, can you talk about whether you've had a positive book to bill in the quarter and what your expectations are for book to bill for the year and/or the second half?

Andrew D. Ory

Yes, I mean, that way we would look at Q3 is about one. We would hope that in the Q3, Q4 mix, should be slightly above one. But again, we'll have to wait and see what Q4 looks like. As Peter said, we sat down in the middle of the year and we've felt comfortable at a $135 million of revenue, is the right way to think about the business and that's still consistent with our outlook.

Peter J. Minihane

Right. And I think, Rich, what we did in Q2 is we came in at approximately one. I think we looked back to Q1 and said it was within 4, 5 percentages of 1 -- points of 1, and I think we're about in the same position in Q3. To Andy's point, I think our anticipation, as we outlined again last July, was that we would attempt to build some backlog in the second half of the year so that, in total, 2012 would be about a one for the entire year.

Operator

And we'll go to the line of James Kisner with Jefferies & Company.

James M. Kisner - Jefferies & Company, Inc., Research Division

I just want to reconcile something you were saying about interest in VoLTE being sort of strong in Europe and, on the previous call, I believe you said that operators were concerned about the economics of IMS and it just seems like the European region would be the area where they would be most concerned about the cost. I'm just wondering, are we -- it's just that these European carriers are -- they're thinking about adopting SMX, defining where costs of [indiscernible] voice to do this and kind of like, could you just say what the motivation there?

Andrew D. Ory

Yes. Sure, James. And you know, maybe Seamus and I, we'll both do it. I mean, from my perspective, they are. Just about every operator is concerned with the cost of IMS. And there is the way people expected IMS will be implemented and there's the way that the Web would do it. And our technologies play in both. We certainly can be an access SBC and appearing SBC and help normalize and secure an IMS core. And the service provider could go out and spend an awful lot of money on what the traditional IMS was. The whole notion of the SMX, coupled to our SBC, is about an IMS that looks like the way Google would do it. It's full 3GPP compliant. But it's much more weblike. And we actually see that message getting a lot of traction in EMEA. These service providers, they have to rake the LTE, because it's just the physics of their access networks and the growth of wireless data. At the same time, they want to have network-involved branded services. They don't want to see disservices to over-the-top players and so they're trying to find how can their network be involved in a 3GPP compliant way. And they are working very hard to figure out how to bring VoLTE in. Seamus, I don't know if you want to provide the additional...

Peter J. Minihane

Right. I made an example that architecture that's in production phase, telephonic and digital which we now back in Q2 that are using our SMX and our load balancers to deliver -- in this case, an over-the-top service. The same infrastructure can be delivered -- used to deliver same type of services using an IMS compliant infrastructure.

James M. Kisner - Jefferies & Company, Inc., Research Division

Okay, great and this a follow up, I just want to clarify, again, on VoLTE timing and you're talking about ramp in 2014, are you talking about services ramping and therefore your revenues in 2013, are you talking about your revenues for VoLTE kind of ramping in 2014?

Andrew D. Ory

So what we've seen to date is that it does take several quarters from acquisition of the technology to when you really can rollout a viable service. And so, we actually look at what the analyst have to say, the industry analyst, and we agree that 2014 is when you're going to start to see subscriber growth rate and that's how does this -- the RFX activity we're seeing this year, we would expect the ought to materialize into purchase-based opportunities in 2013 to support 2014 rollout.

Operator

I got in line with Rod Hall with JPMorgan.

Rod B. Hall - JP Morgan Chase & Co, Research Division

Just a further clarification on VoLTE and then a couple of other questions. Can you talk us through, if they are looking to add subscribers in 2014, how much money are they going to spend on SBC capacity in -- this year? Would it be a relatively small amount, initially to support some initial users and then you see a bigger ramp, maybe through 2014, 2015? Or just talk us through kind of how the trajectory of spending for a typical carrier might look? And then I also want to ask you guys, if you could talk a little bit about product revenues, I mean the product revenue number was down in the quarter, can you talk us through the linearity of the quarter for product revenue specifically? Did you see any tailing off towards the end of the quarter? And then also, with the net product revenue behind, I assume the North American weakness plays into that, so can you talk a little bit about what's going on North America, what caused the drop in revenues there?

Andrew D. Ory

Okay. From an LTE purchase point of view, or a VoLTE purchase point of view, there are very, very few carriers in the world that are actually doing this for now. And one example would be MetroPCS. And they purchased for several quarters, before they finally had the infrastructure ready to start rolling out that kind of service. So it isn't -- it wouldn't be done on a pilot basis, it's our expectation that a service provider are looking to rollout VoLTE, we'd, actually, from a strategic point of view, select the customer, have some sort of integration of all the products and services and fill out a large portion of their footprint to be able to offer services. So we do...

Peter J. Minihane

As we've discussed before, in terms of their purchasing activity, after RFX, the ward, they typically buy equipment for inoperable testing and really testing the collection of vendors and devices that are going to be part of the solution. And then we'll go into internal trial and external trial, there may be some incremental purchasing activity there. And then, production. The scope of equipment or product required for production depends upon how aggressive they are in their plans, in terms of subscriber expectations, physical deployment considerations and the like. So it's a lot of...

Andrew D. Ory

So sitting in October 2012, it's hard to call the ball in 2013. Further putting a wildcard into it is, are we going to be involved in the actual control plane routing or not?

Peter J. Minihane

Yes. Nearly all of our products can play a role in VoLTE. We can access and interconnect SBCs. The Diameter signaling controller, load balancers, session running proxies, so it's also a function of the exact product mix that they're using Acme Packet for.

Andrew D. Ory

That's correct.

Peter J. Minihane

And if you take a look at the linearity within the quarter from a revenue side, Q3 was one of our more challenging quarter, as we had in excess 70% of our revenue done in the third month of the quarter. That was a similar percentage to Q1 of this year. That has a dramatic impact on our ability to then collect that money and so it will show, obviously, in DSOs. So if you go back to Q1, at the time, we had a similar third month phenomenon, we had 77 days sales outstanding, we have 79 days here in the third quarter. Again, both mirroring the fact that we were just much too heavily weighted to the third month of the quarter. So I think one of the items that we continue to strive to do, although the third quarter's a difficult quarter, in the sense that you have the summer months of July and August. July some impact. And from the U.S., August, is a complete European shutdown even though our EMEA operations did a great job on the quarter. I think what we have to try to do is to try to return much more to the profile that we had 18, 24 months ago.

Rod B. Hall - JP Morgan Chase & Co, Research Division

Yes, Peter, people just out here talking to companies, talking about a lot of enterprise spending weakness. And just wondering if you guys are picking up on that or do you feel like things were jut so loaded into that last month that it's hard to tell.

Peter J. Minihane

No, I think we have seen weakness in the enterprise in the third quarter. As I think Andy outlined in his prepared comments. Again, or think we had a quarter that was consistent, internally, with what we have outlined on our July call for the third of the -- I'm sorry, of the remaining -- one of the 2 remaining quarters in the year that is Q3, as we head into Q4. So it may have been a little bit of a mix. That service provider was a little stronger than we had anticipated, although that's a typical statement for us to say, based on the impact of the North American service providers have had on our business over the past year. But again, I think we did see some weakness in our enterprise business.

Andrew D. Ory

Right. And Rod, I think tying into that, our goal is -- I don't know whether it's the top 25, the top 50 or the top 100, but these are the service providers that will dominate the spending environment and the subscriber management, of services over the next 5 to 10 years. And our goal is to win as many of those providers as we can, to diversify away from the reliance on 1 or 2, or even a region. As it relates to North America, there are a few very large service providers that have been very important customers to Acme Packet, that have recently talked about CapEx and their spending. And it certainly does impact us. There's no question that if you were to look at the rest of the world, it looks very different than North America. North America, typically, it's 50% of our revenue. I think this is the first quarter in the company's history that North America, loosely defined as Canada and the United States, has dropped below the 50%. And so, the silver lining in this is that the company is working very hard to diversify away from reliance on any region and any few service providers. So we do expect that we ought to play a major role in many, many of these Tier 1 service providers.

Operator

We're in the line of Ehud Gelblum with Morgan Stanley.

Ehud A. Gelblum - Morgan Stanley, Research Division

A couple of questions. First of all, you talked about you -- clearly you talked about 10% customers being Dimension Data and Westcon. I guess, those are the only 10% customers and so no carriers for 10% customers?

Andrew D. Ory

That's correct.

Ehud A. Gelblum - Morgan Stanley, Research Division

Okay, appreciate it. Andy, can you walk us through a VoLTE SBC deployment on a per subscriber basis? I know networks are probably different. But is it possible, use MetroPCS an example and say, for x number of subscribers, and they've obviously only done Dallas, so far. But give us a sense as to what they had to buy to light up Dallas. And then we can kind of do our math as to extrapolate from there? Is that possible?

Andrew D. Ory

I don't have that level of granularity. But -- and Seamus feel free to jump in, but, Hudi, I want say something a little different. When people think of VoLTE, and our role in VoLTE, we don't make the application servers. What we do is we secure the application servers and we extend their reach to every single access network, and we provide security at the access network as well as at the peering network. And people -- when size this stuff, often times they size it in an optimal way but, as more interconnects emerge, as more services flow, they need more and more connectivity normalization and security capacity. It's a lot like firewalls, if you will. And so the initial deployment of our technology to secure a VoLTE core for a single service is going to look very, very different than subsequent services in more complex interconnect arrangements that will emerge, which makes it hard. I mean, we do have a couple of large customers that have spent, each, $100 million or more with us. And it's a small minority of their subscribers that have actually moved from TDM to IP. And I think that's probably a decent proxy. The way I tend to think about it is that it's -- I've given this number out in the past but -- gosh, I think that if you really want to offer VoLTE and you want to normalize all these different subscribers and pathways, these very large Tier 1s could easily spend $200 million , $300 million or more, just to do that. And Seamus, I don't know if...

James J. Hourihan

Yes again, it's all a function of their subscriber base. There's no doubt that all their mobile subscribers, at some point in time, will move on to LTE networks. Why? Because they are going to go out of business trying to run 2 or 3 mobile networks. They need to re-farm spectrum. So it's not a question of effort, it's only a question of when.

Andrew D. Ory

And numbers that we've seen in the market, that people talk about, and Seamus, you can comment on this, these are an active packet numbers. It used to be that their IMS -- they were talking about EUR 12 per subscriber, and now they're down to EUR 2 per subscriber for VoLTE-like services and may be a euro per subscriber to secure and normalize that. You can think of that as the SBC function. So the SBC and the SMX would cover...

James J. Hourihan

Those are dither numbers.

Andrew D. Ory

Right. So the SBC and the SMX would cover those 2 numbers. But then, things get really complex, in terms of networking and you're going to see a lot more requirement for technology emergent areas that aren't just that initial VoLTE point.

James J. Hourihan

And actually SBC is incremental to that.

Andrew D. Ory

The MSG Wi-Fi offload is incremental to that.

Ehud A. Gelblum - Morgan Stanley, Research Division

Well yes, the good part is that, now the euro is $1.30, instead of $1.20. That certainly helps. Two more questions, if I could. Can you give us -- does enterprise, the 27% enterprise split that you gave, I don't remember you giving such detail before. Can you just give us a sense of what Q1 and Q2 were? And that -- and what 2011 was, in the way you count enterprise? So that we can do our growth from there. The one number we have is enterprise grew 28% in the first half, but it would be great to have the actual splits.

Peter J. Minihane

So if I looked at enterprise revenue for the third quarter, Hudi, it was, again, 73% service provider, 27% enterprise. Q2, it was 80% service provider, 20% enterprise. The same for Q1 of 2012, and then Q1 of 2011, was 82, 18; Q2, 80, 20; Q3, 72, 28. And again, that's from a revenue side.

Todd K. Koffman - Raymond James & Associates, Inc., Research Division

Very helpful. Do you have Q4 as well?

Peter J. Minihane

For 2012, Hudi? or for 2011?

Ehud A. Gelblum - Morgan Stanley, Research Division

'11.

Peter J. Minihane

Q4 2011 were 77 and 23.

Ehud A. Gelblum - Morgan Stanley, Research Division

That's very helpful. And these are of total revenue, not just product, right?

Peter J. Minihane

Total revenue.

Ehud A. Gelblum - Morgan Stanley, Research Division

]

All right, that's extremely helpful, I appreciate that. The Westcon seem to come in at 10% or same with Dimension Data. And so that reflects your indirect that went up to 63%, and it was much less last quarter. I usually think of the indirect sales as being enterprise sales, not service provider. So...

Andrew D. Ory

Let me help you with that.

Ehud A. Gelblum - Morgan Stanley, Research Division

Yes, because they both went in different directions. Indirect went up, but enterprise went down.

Andrew D. Ory

Yes, yes. So typically -- the majority of our direct sales activity is to the Tier 1 service providers in North America. North America service provider tends to be the majority of direct sales. International service provider tends to be indirect as does the majority of enterprise. So they're a little bit different.

Peter J. Minihane

I think, from a profile side, though, Hudi, I think within reason, you could say Dimension Data looks and feels like a service provider distributor. And Westcon Group is much more an enterprise related. And I think for the most part, they are a two-tier distribution arm for us.

Ehud A. Gelblum - Morgan Stanley, Research Division

So the rise of Dimension Data is what we should correlate with the rise of international service provider in your revenue.

Peter J. Minihane

Not necessarily. I think that our data -- we could go back, Hudi, if it would help you, and take a look and see how much of that was domestic versus international. Again, I don't think it jumps out to us that Di Data is 84% this and 92% that. We can get it for you as opposed to guessing.

Operator

I'm going to go to the line of Brian Modoff of Deutsche Bank.

Brian T. Modoff - Deutsche Bank AG, Research Division

A couple of questions. So first, can you talk about what percentage of those 10 carriers you have, include control plane, core control plane, as part of the contract? And of the deals that you're currently engaged in, bidding on, what percentage of those would also include control? When another [indiscernible] aren't like -- more like an AT&T versus Verizon architecture?

Andrew D. Ory

Brian, when you say control plane -- control plate must mean both Diameter and SIP -- SIP gateway. SIP gateway is part of the Evolved Packet Core. That's...

James J. Hourihan

Brian, can I -- let me try to dip because there's a lot of technology. The first one is that some people haven't yet figured out, in our opinion, that VoLTE is not -- is inherently not secure. Just like IMS stands for: Is Missing Security. We think that VoLTE is also not secure. And that session border controllers play a critical role on the access side of the network to secure, as well as normalize and manage the traffic coming to that VoLTE core. So there aren't going to be carriers that use us, perhaps, on the interconnect side, but haven't yet committed or see the value of session border controllers. And that ends up being a very small minority. The majority of the engagement are for the access and the interconnect, because we're actually doing a pretty good job now of educating people of the normalization and security requirements on both the access and interconnect side. We still think of that is non-control plane involved. We think of that as an SBC providing security. When we think of control plane, we think of our SMX, which actually provides the P-CSCF, the S-CSCF, the I-CSCF. So the core routed elements that actually work in tandem with the session border controller, and that means that an SMX with an SBC is really what you need to outrun -- I mean, you need HSF and one other thing, and you're off to the races. So most of our deals tend to be where we're the access and peering SBC in a traditional IMS environment. However, we're starting to get a lot of traction, that people saying a more weblike architecture would be us involved in the control plane with the SMX.

Andrew D. Ory

And we talked about that in Barcelona about the P-CSCF function.

Brian T. Modoff - Deutsche Bank AG, Research Division

And at that time, you were very uncertain as to how much traction you'd get with your product. Have they heard you, you had some things changed but it sounds like you're still talking along the same lines.

Andrew D. Ory

We -- when Peter and I went out and met with the sales organization at the beginning of Q3, and we also met with the sales organization, mostly via teleconference in the beginning of the Q4, we are finding an awful lot of traction and interest in the control plane, or the SMX, where we are not only an SBC, but the PDS and the I. And the reason is they recognize that LTE is an IP network and service that is being delivered over IP are not anything new. It's been happening for the last 15 years and Google was the proxy for it. And when you look at how they do it, they basically have Web servers, load balancers and application platforms. And our SMX takes the place of those Web servers and load balancers and then they can put application platforms into their network and, all of a sudden, they've got an IMS service that looks the way Google did it, but doesn't cost the way the ITU had -- would've figured it would have cost in 12 years ago, 3GPP. I'm sorry. So we're getting a lot of traction.

Brian T. Modoff - Deutsche Bank AG, Research Division

And last question. So if you look at 5% growth in the enterprise, VoLTE early being more of a 2014 event, what can of growth do you think you have next year? Could you be flat from this year?

Andrew D. Ory

So we are -- we're not going to comment on 2013, we're going to finish 2012, we're going to get data on -- and then we'll give you some, I think, some pretty good data in the end of January, in 2013. However, we do believe that VoLTE, interconnect and enterprise are all going to contribute revenue next year.

Operator

And we'll go to Simona Jankowski with Goldman Sachs.

Simona Jankowski - Goldman Sachs Group Inc., Research Division

A few more VoLTE questions for you. When you talked about having 10 wins so far, have you tracked whether you've lost any VoLTE wins to, for example, some of the large IMS vendors? And also, of the ones you have won, the 10, are you single sourced or dual sourced? And then kind of third point then, if you are dual sourced in any, do you have the majority or the minority share?

James J. Hourihan

Simona, this Seamus. It's really hard to characterize any of the 10 wins as being exactly the same. In some cases we're playing multiple product roles that I enumerated before, so I won't go through that again. And in some cases, we are single sourced. In other cases, they're looking at potentially looking through it, deploying or evaluating dual vendors, where they actually put in production dual, that's still to be determined. So I think, we have one customer that's in production, [indiscernible] it's Metro. Again, the others are looking -- of the 10 for sometime in early stages to either late 2013, or production services in 2014, early 2014 that's sort of where we sit. And again, it's a long time between, relatively speaking, now and then. But again, as Mini mentioned, if they want to make tighter schedules they'll need acquire equipment, on average, 6 months ahead of time.

Andrew D. Ory

And, I think, Simona, to be really fair, it's a hard question to answer, only because these services haven't been deployed and it so early on. Our strategy is very simple, which is to provide the most comprehensive solution and provide the greatest capacity to meet their needs most cost effectively. So oftentimes, when we end up competing, why we win isn't because our element is better than someone else's element. It's usually because our approach is that of a disruptor, do it the Web way. Or our approach is more comprehensive, with multiple elements. And that makes a very, very big difference. And lastly, we have spent 2-plus years working on the 6300 and you do hear people come out with boards for their media gateways or brand-new platforms. But this is not that. This is a new platform technology that leverages every single software development release that we've done in the last 12 years. It truly is plug-and-play. And so what we've brought to market, the 6300, is by far and away, are going to be a superior product, anything that's out there. And it is our engine for the connection of LTE network. And we think that's really going to continue to drive up at the same position in the wireless base that we've enjoyed in the wireline base.

Simona Jankowski - Goldman Sachs Group Inc., Research Division

And just a quick follow-up on the 6300, would you, obviously you're going to be targeting in for the LTE networks, are you also targeting it for upgrade of existing equipment that you had out in the field? And maybe, as we think about, basically, you're installed base in the more wireline networks that you're in right now, is that starting to get upgraded? Or another way to ask the question, is how much of your carrier business today is upgrading existing equipment versus getting your footprint?

Andrew D. Ory

Right now, almost -- I won't say almost all, but a very, very high portion of our business is new equipment going out into new opportunities. However, we do have thousands of units that have been running for very long time and given that the 6300 is a plug-and-play, from the back office OA&M, as well as from a feature functionality and call flow point of view, it's not unreasonable for all of us to expect that people will look at that and say, wow. I can go from an old product to a brand-new product. I can go from 1 gig to 10 gig to 40 gig, that's quite attractive. So we do think that should be an opportunity.

Operator

We'll go to the Simon Leopold with Raymond James.

Victor Chiu

This is Victor Chiu for Simon Leopold. I just want to ask really quickly about market share. You mentioned market share ships a few times in your prepared remarks, which, I think you attribute it to the overall -- the weakness in the overall spending. But are you seeing any changes in the competitive landscape?

Andrew D. Ory

Not really. I mean, the numbers be what they are, right? You can't have a business that contracts 10% of its revenue in a market that's even growing a little bit and not lose transactional market share. I mean, that's just going to happen. If you look at our service provider market share, that second half 2011 versus the first half of 2012, it's held roughly steady around 50% or so. Our feeling is that our market share is going to be predicated solely, to a large extent, on the service provider side, on where the top 100 service providers are in their buying cycle. And when a few of the large Tier 1s decide to take a pause on buying that, cyclically, is going to impact us to the negative. And when they start buying again, that's going to impact us to the positive. And that's separate from the enterprise market share. The enterprise market share, partly is -- we've had an awful lot of focus on the large enterprises and if you look at in a fanatic state, they cut the market growth in 2012 for the large enterprise market. And the lower end of the enterprise market has grown at a faster clip and that, traditionally, hasn't been where a lot of our focus has been. And that's an area that's important to us, as well as bringing on some new marketing and sales resources, we think it's going to make a difference in the enterprise market share. But Seamus, I don't know if you have anything to add? Is that helpful, Victor?

Victor Chiu

Yes, that's definitely helpful. And I guess, I just have one quick question on international opportunities? The VoLTE opportunities with North American providers are being pushed out. But can you speak something about what's impacting the trends for the timing for the service providers in EMEA and APAC? And maybe just kind of -- how does the hesitation from international, maybe European service providers, compare to what's driving the hesitation in North American service providers?

Andrew D. Ory

Well, so from a hesitation -- when you think about it, if you're a service provider, you've been offering a branded service, voice, and you've been doing it over an architecture for the last 70 years, it's virtually unchanged. It's pretty complicated.

Peter J. Minihane

Yes, and it's really high quality. And people market their network as differentiators, and stuff like that. So when you get -- when you add voice to it, an LTE network, you have to make sure it is as good, or better, than your existing network.

Andrew D. Ory

Right. So the hesitation Is really all around, trying to understand the technology architecture, the ability to provide the quality and what the participation's going to be in the brand creation and the service delivery. And that's -- they're working very hard, they're working -- for these service providers, they're working at light speed. And there is no question about it, that the world and every single country, and every single user, is going to expect high-quality voice and video that's fully regulatory compliant, that's trusted, that's secure, that is ubiquitous in terms of devices being able to reach devices, and the only way that's going to happen is with these service providers participating, and they're working really hard. I mean, the fact that MetroPCS was able to get something out was pretty darn unbelievable. You heard AT&T Sprint... The fact that we've been able to get AT&T and Verizon and talked a lot about 2013, with their initial deployments, I think you'll see some of that in Europe as well. But the real ramp is going to be in 2014. We don't see much of a change, region-to-region, do you, Seamus?

James J. Hourihan

No.

Operator

And our final question will come from Dmitry Netis with William Blair.

Dmitry Netis - William Blair & Company L.L.C., Research Division

Guys, couple of questions. Can you give us a sense on the non-SBC product side versus your SBC products? What's the rough split is today and whether we broke into the 10% threshold yet? That's the first one. And then second question, if you could talk about the software SBC and how that might trend versus your appliances. I suppose it's probably very little percentage of revenue today, and where do you think that might go over time?

Andrew D. Ory

So Dmitry, we introduced the software SBC part of the channel assembly program in June. So it's very early days. We are selling that product and we're excited about it. But it's very hard to actually forecast when and what kind of impact it's going to have. We do find that people are really -- they enjoy the benefits of an integrated appliance, where they're able, from one vendor to get the hardware and the software and, they like that. So we're going to win either way. But it is interesting to see how people like having an integrated appliance.

Peter J. Minihane

[indiscernible] Software SBC, excuse me. For the enterprise, comes in conjunction with a price we have for the service providers that auto configures the enterprise premise SBC, they call it [indiscernible] Express. And that's just about to be delivered. So that's really when the management side comes into play, in terms of, again, automating the configuration of the premise-based SBC and, not only your software-based products but the harder ones as well.

Andrew D. Ory

And the last question you had is on greater than 10%. What's interesting is that as we do more analysis, what we find is that multiple elements are required to bring the whole solution to market, a session delivery network. But there are more and more edges that emerge, and so it ends up levering or scaling the number of SBCs that we sell. So to some of our large customers that are buying these complete solutions, they need the session load balancer, they need the session route proxy, but it begets a lot more SBCs. We have not broken the 10% in the aggregate, barrier. Though, I don't know Peter if you have the exact number, in terms of...

Peter J. Minihane

We don't. But it's still single digits.

James J. Hourihan

But one of our early 6300 customers is a large contact center environment. They purchased the SBC for maximum signaling performance, MIDI control. That will be used in a call recording environment. Initial call recording capacity is not that much but will grow over time.

Unknown Executive

Thank you, everyone, for joining with us this evening. 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 good night.

Operator

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.

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