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EX-32.1 - EX-32.1 - ACME PACKET INCb82620exv32w1.htm
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2010
or
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 001-33041
ACME PACKET, INC.
(Exact name of registrant as specified in its charter)
     
Delaware   04-3526641
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)
100 Crosby Drive
Bedford, MA 01730

(Address of principal executive offices) (zip code)
(781) 328-4400
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes   o No
     Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). o Yes   o No
     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o Accelerated filer þ  Non-accelerated filer o
(Do not check if a smaller reporting company)
Smaller reporting company o
     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes   þ No
     The number of shares outstanding of each of the issuer’s classes of common stock, as of October 26, 2010: 63,509,788
 
 

 


 

ACME PACKET, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2010
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 EX-10.1
 EX-31.1
 EX-31.2
 EX-32.1

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PART I — FINANCIAL INFORMATION
ITEM 1 — Financial Statements
ACME PACKET, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(in thousands, except share and per share data)
                 
    September 30,     December 31,  
    2010     2009  
ASSETS
               
Current assets:
               
Cash and cash equivalents
  $ 110,642     $ 90,471  
Short-term investments
    126,380       39,990  
Accounts receivable, net of allowance of $1,312 and $1,311, respectively
    30,289       25,604  
Inventory
    6,279       4,372  
Deferred product costs
    2,501       3,400  
Deferred tax asset
    1,567       1,567  
Other current assets
    10,065       2,710  
 
           
Total current assets
    287,723       168,114  
Long-term investments
          44,526  
Property and equipment, net
    15,661       6,437  
Intangible assets, net of accumulated amortization of $2,011 and $706, respectively
    9,923       11,228  
Deferred tax asset, net
    15,622       15,622  
Other assets
    818       799  
 
           
Total assets
  $ 329,747     $ 246,726  
 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable
  $ 3,971     $ 3,895  
Accrued expenses and other current liabilities
    10,980       9,261  
Deferred revenue
    29,708       31,506  
 
           
Total current liabilities
    44,659       44,662  
 
           
Deferred rent, net of current portion
    1,612        
 
           
Deferred revenue, net of current portion
    1,530       1,841  
 
           
Contingencies (Note 10)
               
Stockholders’ equity:
               
Undesignated preferred stock, $0.001 par value: Authorized — 5,000,000 shares; Issued and outstanding — 0 shares
           
Common stock, $0.001 par value: Authorized — 150,000,000 shares; Issued 70,165,205 and 65,459,593 shares, respectively
    70       65  
Additional paid-in capital
    242,005       188,871  
Treasury stock, at cost — 6,756,693 and 6,756,687 shares, respectively
    (37,522 )     (37,522 )
Accumulated other comprehensive income (loss)
    55       (2 )
Retained earnings
    77,338       48,811  
 
           
Total stockholders’ equity
    281,946       200,223  
 
           
Total liabilities and stockholders’ equity
  $ 329,747     $ 246,726  
 
           
See accompanying Notes to Condensed Consolidated Financial Statements.

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ACME PACKET, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except share and per share data)
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
Revenue:
                               
Product
  $ 45,328     $ 27,726     $ 129,452     $ 75,020  
Maintenance, support and service
    11,286       8,621       31,548       25,175  
 
                       
Total revenue
    56,614       36,347       161,000       100,195  
 
                       
Cost of revenue (1):
                               
Product
    7,903       5,178       22,886       15,280  
Maintenance, support and service
    2,556       1,773       6,964       3,903  
 
                       
Total cost of revenue
    10,459       6,951       29,850       19,183  
 
                       
Gross profit
    46,155       29,396       131,150       81,012  
 
                       
Operating expenses (1):
                               
Sales and marketing
    17,012       13,703       50,062       37,647  
Research and development
    8,896       7,271       26,235       20,513  
General and administrative
    3,906       3,253       10,785       9,674  
Merger and integration-related costs
                      1,102  
 
                       
Total operating expenses
    29,814       24,227       87,082       68,936  
 
                       
Income from operations
    16,341       5,169       44,068       12,076  
 
                       
Other income (expense):
                               
Interest income
    157       40       397       205  
Other income (expense)
    32       (12 )     (43 )     (55 )
 
                       
Total other income, net
    189       28       354       150  
 
                       
Income before provision for income taxes
    16,530       5,197       44,422       12,226  
Provision for income taxes
    6,065       1,617       15,895       4,195  
 
                       
Net income
  $ 10,465     $ 3,580     $ 28,527     $ 8,031  
 
                       
Net income per share (Note 8):
                               
Basic
  $ 0.17     $ 0.06     $ 0.46     $ 0.14  
Diluted
  $ 0.15     $ 0.06     $ 0.43     $ 0.13  
Weighted average number of common shares used in the calculation of net income per share:
                               
Basic
    62,772,466       58,143,857       61,371,085       56,622,433  
Diluted
    68,426,272       62,927,591       67,114,486       60,904,244  
 
(1)    Amounts include stock-based compensation expense, as follows:
 
Cost of product revenue
  $ 202     $ 125     $ 557     $ 381  
Cost of maintenance, support, and service revenue
    279       154       737       415  
Sales and marketing
    2,006       1,261       5,339       3,537  
Research and development
    1,254       934       3,551       2,537  
General and administrative
    847       322       1,761       848  
See accompanying Notes to Condensed Consolidated Financial Statements.

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ACME PACKET, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
                 
    Nine Months Ended  
    September 30,  
    2010     2009  
Operating activities
               
Net income
  $ 28,527     $ 8,031  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    4,521       3,379  
Amortization of intangible assets
    1,305       410  
Provision for bad debts
    54       511  
Amortization of premium/discount on investments
    1,419        
Impairment of fixed assets
          94  
Stock-based compensation expense
    11,945       7,718  
Excess tax benefit related to exercise of stock options
    (20,429 )     (723 )
Change in operating assets and liabilities, net of acquisition:
               
Accounts receivable
    (4,739 )     1,786  
Inventory
    (1,907 )     (422 )
Deferred product costs
    899       (411 )
Other assets
    339       (577 )
Accounts payable
    76       1,865  
Accrued expenses. other current liabilities and deferred rent
    12,848       283  
Deferred revenue
    (2,109 )     7,395  
 
           
Net cash provided by operating activities
    32,749       29,339  
 
           
Investing activities
               
Purchases of property and equipment
    (10,546 )     (3,786 )
Purchases of marketable securities
    (151,003 )      
Proceeds from sale and maturities of marketable securities
    107,777        
Cash received from the acquisition, net
          5,965  
Increase (decrease) in other assets
          (105 )
 
           
Net cash (used in) provided by investing activities
    (53,772 )     2,074  
 
           
Financing activities
               
Proceeds from exercise of stock options
    20,765       942  
Excess tax benefit related to exercise of stock options
    20,429       723  
 
           
Net cash provided by financing activities
    41,194       1,665  
 
           
Net increase in cash and cash equivalents
    20,171       33,078  
Cash and cash equivalents at beginning of period
    90,471       125,723  
 
           
Cash and cash equivalents at end of period
  $ 110,642     $ 158,801  
 
           
 
               
Supplemental disclosure of noncash investing and operating activities:
               
Capital additions as a result of lease incentives
  $ 3,199     $  
See accompanying Notes to Condensed Consolidated Financial Statements.

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ACME PACKET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(in thousands, except share, restricted stock unit and per share data)
1. Business Description and Basis of Presentation
Business Description
     Acme Packet, Inc., or the Company, is a leading provider in session border control solutions which enable the delivery of trusted, first-class interactive communications — voice, video and multimedia sessions — and data services across internet protocol, or IP, network borders.
     Session border control is a service delivery architecture encompassing many different product categories. The Company’s Net-Net product family of session border controllers, session aware load balancers, session routing proxies and multiservice security gateways supports multiple applications in enterprise networks and fixed line, mobile, over-the-top and application service provider networks. These applications range from voice over IP, or VoIP, trunking to hosted enterprise and residential services to fixed-mobile convergence. The Company’s products satisfy critical security, service assurance and regulatory requirements in these networks.
Basis of Presentation
     The accompanying interim condensed consolidated financial statements are unaudited. These financial statements and notes should be read in conjunction with the audited consolidated financial statements and related notes, together with Management’s Discussion and Analysis of Financial Condition and Results of Operations, contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.
     The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission, or SEC. Certain information and footnote disclosures normally included in financial statements prepared in accordance with United States generally accepted accounting principles, or U.S. GAAP, have been condensed or omitted pursuant to such SEC rules and regulations. In the opinion of management, the unaudited condensed consolidated financial statements and notes have been prepared on the same basis as the audited consolidated financial statements contained in the Company’s Annual Report on Form 10-K, and include all adjustments (consisting of normal, recurring adjustments) necessary for the fair presentation of the Company’s financial position at September 30, 2010, statements of income for the three and nine months ended September 30, 2010 and 2009 and statements of cash flows for the nine months ended September 30, 2010 and 2009. The interim periods are not necessarily indicative of the results to be expected for any other interim period or the full year.
     The Company has evaluated all subsequent events and determined that there are no material recognized or unrecognized subsequent events requiring disclosure.
     As of September 30, 2010, the Company’s significant accounting policies and estimates, which are detailed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, have not changed.
2. Cash, Cash Equivalents, Short-Term and Long-Term Investments and Restricted Cash
Cash, Cash Equivalents, Short-term and Long-term Investments
     Cash, cash equivalents, short-term and long-term investments as of September 30, 2010 and December 31, 2009 consist of the following:
                                 
    As of September 30, 2010  
    Contracted     Amortized     Fair Market     Carrying  
    Maturity     Cost     Value     Value  
Cash
  Demand   $ 8,262     $ 8,262     $ 8,262  
Money market funds
  Demand     102,380       102,380       102,380  
 
                         
Total cash and cash equivalents
          $ 110,642     $ 110,642     $ 110,642  
 
                         
U.S. agency notes — available-for-sale
  22 — 420 days   $ 66,699     $ 66,752     $ 66,752  
U.S. agency notes — held-to-maturity
  68 — 210 days     59,628       59,969       59,628  
 
                         
Total short-term marketable securities
          $ 126,327     $ 126,721     $ 126,380  
 
                         

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    As of December 31, 2009  
    Contracted     Amortized     Fair Market     Carrying  
    Maturity     Cost     Value     Value  
Cash
  Demand   $ 8,789     $ 8,789     $ 8,789  
Money market funds
  Demand     81,682       81,682       81,682  
 
                         
Total cash and cash equivalents
          $ 90,471     $ 90,471     $ 90,471  
 
                         
U.S. agency notes — available-for-sale
  263—346 days   $ 4,985     $ 4,983     $ 4,983  
U.S. agency notes — held-to-maturity
  42—346 days     35,007       35,028       35,007  
 
                         
Total short-term marketable securities
          $ 39,992     $ 40,011     $ 39,990  
 
                         
U.S. agency notes — held-to-maturity
  375—435 days   $ 44,526     $ 44,385     $ 44,526  
 
                         
Total long-term marketable securities
          $ 44,526     $ 44,385     $ 44,526  
 
                         
     To date, realized gains or losses from the sale of cash equivalents or short-term or long-term investments have been immaterial.
3. Inventory
     Inventory is stated at the lower of cost, determined on a first in, first out basis, or market, and consists primarily of finished products.
4. Concentrations of Credit Risk and Off-Balance-Sheet Risk
     The Company has no significant off-balance-sheet risk such as foreign exchange contracts, option contracts, or other international hedging arrangements. Financial instruments that potentially expose the Company to concentrations of credit risk consist mainly of cash, cash equivalents and short-term investments and accounts receivable. The Company maintains its cash, cash equivalents and short-term investments principally in accredited financial institutions of high credit standing. The Company assesses the credit worthiness of its customers both at the inception of the business relationship and then routinely on an ongoing basis. The Company does not require collateral from its customers. Due to these factors, no additional credit risk beyond amounts provided for collection losses is believed by management to be probable in the Company’s accounts receivable.
     The Company had certain customers whose revenue individually represented 10% or more of the Company’s total revenue, as follows:
                                 
    Three Months Ended   Nine Months Ended
    September 30,   September 30,
    2010   2009   2010   2009
Customer A
    15 %     11 %     12 %     16 %
Customer B
    13       *       *       *  
Customer C
    *       10       *       14  
 
*   Less than 10% of total revenue.
     The Company had certain customers whose accounts receivable balances individually represented 10% or more of the Company’s accounts receivable, as follows:
                 
    September 30,   December 31,
    2010   2009
Customer A
    25 %     16 %
Customer C
    *       15  
5. Product Warranties
     Substantially all of the Company’s products are covered by a standard warranty of ninety days for software and one year for hardware. In the event of a failure of hardware product or software covered by this warranty, the Company must repair or replace the software or hardware product or, if those remedies are insufficient, and at the discretion of the Company, provide a refund. The Company’s customers typically purchase maintenance and support contracts, which supersede its warranty obligations. The Company’s warranty reserve reflects estimated material and labor costs for potential or actual product issues in its installed base that are not covered under maintenance contracts, but for which the Company expects to incur an obligation. The Company’s estimates of anticipated rates of warranty claims and costs are primarily based on historical information and future forecasts. The Company periodically assesses the adequacy of the warranty allowance and adjusts the amount as necessary. If the historical data used to calculate the adequacy of the warranty allowance are not indicative of future requirements, additional or reduced warranty reserves may be required.

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     The following is a summary of changes in the amount reserved for warranty costs for the nine months ended September 30, 2010:
         
Balance at December 31, 2009
  $ 140  
Provision for warranty costs
    1,076  
Uses/Reductions
    (1,039 )
 
     
Balance at September 30, 2010
  $ 177  
 
     
6. Stock-Based Compensation
     The Company recorded stock-based compensation expense of $4,588 and $2,796 for the three months ended September 30, 2010 and 2009, respectively, and $11,945 and $7,718 for the nine months ended September 30, 2010 and 2009, respectively. As of September 30, 2010, there was $37,598 of unrecognized stock-based compensation expense related to stock-based awards that is expected to be recognized over a weighted average period of 2.77 years.
     The following is a summary of the status of the Company’s stock options as of September 30, 2010 and the stock option activity for all stock option plans during the nine months ended September 30, 2010:
                                         
                    Weighted     Weighted        
                    Average     Average        
                    Exercise     Remaining     Aggregate  
    Number of     Exercise Price     Price Per     Contractual     Intrinsic  
    Shares     Per Share     Share     Life (Years)     Value(1)  
Outstanding at December 31, 2009
    12,236,695     $ 0.20 — 16.86     $ 5.43                  
Granted
    3,378,500       13.04 — 36.06       17.01                  
Canceled
    (107,832 )     4.35 — 27.60       11.60                  
Exercised
    (4,561,202 )     0.20 — 16.86       4.57             $ 105,118  
 
                                   
Outstanding at September 30, 2010
    10,946,161       0.20 — 36.06       9.31       5.53     $ 313,413  
 
                                   
Exercisable at September 30, 2010
    3,517,852       0.20 — 26.69       4.78       4.92     $ 116,639  
 
                                   
Vested or expected to vest at September 30, 2010 (2)
    9,689,626       0.20 — 36.06       9.12       5.51     $ 279,265  
 
                                   
 
(1)   The aggregate intrinsic value was calculated based on the positive difference between the fair value of the Company’s common stock on September 30, 2010 of $37.94, or the date of exercise, as appropriate, and the exercise price of the underlying options.
 
(2)   This represents the number of vested options as of September 30, 2010 plus the number of unvested options expected to vest as of September 30, 2010, based on the unvested options outstanding at September 30, 2010, adjusted for an estimated forfeiture rate.
     The Company has entered into restricted stock unit agreements with certain of its employees. Under the terms of the agreements, the Company grants restricted stock units, or RSUs, to its employees pursuant to the Acme Packet, Inc. 2006 Equity Incentive Plan. Vesting occurs periodically at specified time intervals, ranging from one to three years, and in specified percentages. Upon vesting, the holder will receive one share of the Company’s common stock for each unit vested. A summary of the Company’s unvested RSUs outstanding at September 30, 2010 and the changes during the nine months then ended, is presented below:
                 
            Weighted
            Average
    Number of   Grant Date
    RSUs   Fair Value
Unvested at December 31, 2009
    385,818     $ 6.00  
Granted
    238,000       13.04  
Vested
    (159,151 )     6.46  
Forfeited
    (47,500 )     7.58  
 
               
Unvested at September 30, 2010
    417,167       9.66  
 
               
7. Comprehensive Income
     Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. Accumulated other comprehensive income is presented separately on the balance sheet as required, and relates to unrealized gains on the Company’s available-for-sale securities.

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     Comprehensive income for the periods indicated are as follows:
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
Net income
  $ 10,465     $ 3,580     $ 28,527     $ 8,031  
Unrealized gain on available-for-sale securities
    18             55        
 
                       
Comprehensive income
  $ 10,483     $ 3,580     $ 28,582     $ 8,031  
 
                       
     Other comprehensive income consists entirely of unrealized gains on available for sale securities at September 30, 2010 and December 31, 2009.
8. Net Income Per Share
     A reconciliation of the number of shares used in the calculation of basic and diluted net income per share is as follows:
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
Weighted average number of shares of common stock
    62,772,466       58,144,105       61,371,085       56,624,143  
Less: Weighted average number of unvested restricted common shares outstanding
          (248 )           (1,710 )
 
                       
Weighted average number of common shares used in calculating basic net income per share
    62,772,466       58,143,857       61,371,085       56,622,433  
Weighted average number of common shares issuable upon exercise of outstanding stock options, based on treasury stock method
    5,441,418       4,651,104       5,533,717       4,180,339  
Weighted average number of unvested restricted common shares outstanding
          226             1,547  
Weighted average number of common shares issuable upon vesting of outstanding restricted stock units
    212,388       132,404       209,684       99,925  
 
                       
Weighted average number of common shares used in computing diluted net income per share
    68,426,272       62,927,591       67,114,486       60,904,244  
 
                       
     In the computation of the diluted weighted average number of common shares outstanding, 638,685 and 3,606,572 weighted average common share equivalents underlying outstanding stock options have been excluded from the computation during the three months ended September 30, 2010 and 2009, respectively, and 402,176 and 5,086,498 during the nine months ended September 30, 2010 and September 30, 2009, respectively, as their effect would have been antidilutive.
9. Income Taxes
     For the three months ended September 30, 2010 and 2009, the Company’s effective income tax rate was approximately 37% and 31% respectively, and for the nine months ended September 30, 2010 and 2009, the Company’s effective income tax rate was approximately 36% and 34%, respectively. As of September 30, 2010, the Company expects to realize recorded net deferred tax assets of $17,189. The Company’s conclusion that these assets will be recovered is based upon its expectation that current and future earnings will provide sufficient taxable income to realize the recorded tax asset. The realization of the Company’s net deferred tax asset cannot be assured, and to the extent that future taxable income against which these tax assets may be applied is not sufficient, some or all of the Company’s recorded net deferred tax assets would not be realizable. Approximately $7,085 of the deferred tax asset recorded as of September 30, 2010 was attributable to benefits associated with stock-based compensation charges. In accordance with the provision of Accounting Standards Codification, or ASC, 718, Compensation-Stock Compensation, no valuation allowance has been recorded against this amount. However, in the future, if the underlying amounts expire with an intrinsic value less than the fair value of the awards on the date of grant, some or all of the benefits may not be realizable.

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10. Contingencies
Litigation
     From time to time and in the ordinary course of business, the Company may be subject to various claims, charges, and litigation. At September 30, 2010 and December 31, 2009, the Company did not have any pending claims, charges, or litigation that it expects would have a material adverse effect on its consolidated financial position, results of operations, or cash flows.
     Subsequent to September 30, 2010, Nortel Networks, Inc., or Nortel, a customer of the Company, filed a complaint against the Company in the United States Bankruptcy Court in the District of Delaware. The complaint alleges that prior to the acquisition of Covergence Inc., or Covergence, in April 2009, Covergence received a preferential payment prior to Nortel’s bankruptcy petition in January 2009. Based on the early stage of this litigation, the Company is unable to reasonably estimate the outcome of this claim.
Other
     Certain of the Company’s arrangements with customers include clauses whereby the Company may be subject to penalties for failure to meet certain performance obligations. The Company has not incurred any such penalties to date.
11. Segment Information
Geographic Data
     Total revenue to unaffiliated customers by geographic area is as follows:
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
United States and Canada
  $ 32,915     $ 19,456     $ 97,587     $ 54,373  
International
    23,699       16,891       63,413       45,822  
 
                       
Total
  $ 56,614     $ 36,347     $ 161,000     $ 100,195  
 
                       
     During the three and nine months ended September 30, 2010 and 2009, no one international country contributed more than 10% of the Company’s total revenue.
     As of September 30, 2010 and 2009, property and equipment at locations outside the United States was not material.
12. Fair Value Measurements
     Fair value is defined as an exit price, representing the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants based on the highest and best use of the asset or liability. As such, fair value is a market based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. The Company uses valuation techniques to measure fair value that maximize the use of observable inputs and minimize the use of unobservable inputs. These inputs are prioritized as follows:
    Level 1: Observable inputs such as quoted prices for identical assets or liabilities in active markets;
 
    Level 2: Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly such as quoted prices for similar assets or liabilities or market corroborated inputs; and
 
    Level 3: Unobservable inputs for which there is little or no market data, which require the reporting entity to develop its own assumptions about how market participants would price the assets or liabilities.
     The valuation techniques that may be used to measure fair value are as follows:
    Market approach — Uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities;
 
    Income approach — Uses valuation techniques to convert future amounts to a single present amount based on current market expectations about those future amounts, including present value techniques, option pricing models and excess earnings method; and
 
    Cost approach — Based on the amount that currently would be required to replace the service capacity of an asset (replacement cost).
     The following table sets forth the Company’s financial instruments carried at fair value within the accounting standard hierarchy and using the lowest level of input as of September 30, 2010:

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    Quoted Prices in     Significant              
    Active Markets     Other     Significant        
    for     Observable     Unobservable        
    Identical Items     Inputs     Inputs        
    (Level 1)     (Level 2)     (Level 3)     Total  
Assets:
                               
Money market funds
  $ 82,068     $     $     $ 82,068  
U.S. agency notes
          20,312             20,312  
Restricted cash
    837                   837  
 
                       
Total cash equivalents and restricted cash
    82,905       20,312             103,217  
 
                       
Short-term U.S. agency notes
          126,380             126,380  
 
                       
Total assets
  $ 82,905     $ 146,692     $     $ 229,597  
 
                       
     Realized gains and losses from sales of the Company’s investments are included in “Other income” and unrealized gains and losses from available-for-sale securities are included as a separate component of equity unless the loss is determined to be other-than-temporary.
     The Company measures eligible assets and liabilities at fair value with changes in value recognized in earnings. Fair value treatment may be elected either upon initial recognition of an eligible asset or liability or, for an existing asset or liability, if an event triggers a new basis of accounting. The Company did not elect to remeasure any of its existing financial assets or liabilities, and did not elect the fair value option for any financial assets and liabilities transacted in the three and nine months ended September 30, 2010.
13. Recent Accounting Pronouncements
     In September 2009, the Financial Accounting Standards Board, or FASB, ratified ASU 2009-13, Revenue Arrangements with Multiple Deliverables, which would modify the objective and reliable evidence of fair value threshold as it relates to assigning value to specific deliverables in a multiple element arrangement. This authoritative guidance would allow the use of an estimated selling price for undelivered elements for purposes of separating elements included in multiple element arrangements and allocating arrangement consideration when neither Vendor Specific Objective Evidence, or VSOE, nor acceptable third party evidence of the selling price of the undelivered element are available. Additionally, the FASB ratified ASU 2009-14, Certain Revenue Arrangements that Include Software Elements, which provides that tangible products containing software components and non-software components that function together to deliver the product’s essential functionality should be considered non-software deliverables, and therefore, will no longer be within the scope of the revenue recognition guidance. Both FASB updates are required to be adopted in annual periods beginning after June 15, 2010. The Company is currently evaluating the effect that the adoption of both pieces of authoritative guidance may have on the Company’s consolidated financial position and results of operations.

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation
Cautionary Statement
     This Quarterly Report on Form 10-Q, including the information incorporated by reference herein, contains, in addition to historical information, forward -looking statements. We may, in some cases, use words such as “project,” “believe,” “anticipate,” “plan,” “expect,” “estimate,” “intend,” “continue,” “should,” “would,” “could,” “potentially,” “will,” “may” or similar words and expressions that convey uncertainty of future events or outcomes to identify these forward looking statements. Forward looking statements in this Quarterly Report on Form 10-Q may include statements about:
    our ability to attract and retain customers;
 
    our ability to retain and hire necessary employees and appropriately staff our operations;
 
    our financial performance;
 
    our expectations regarding our revenue, cost of revenue and our related gross profit and gross margin;
 
    our development activities, expansion of our product offerings and the emerging opportunities for our solutions;
 
    our position in the session border control market;
 
    the effect of the economy on purchases of our products;
 
    the expectations about our growth and acquisitions of new technologies;
 
    the demand for and the growth of worldwide revenues for session border control solutions;
 
    the benefit of our products, services, or programs;
 
    our ability to establish and maintain relationships with key partners and contract manufacturers;
 
    the advantages of our technology as compared to that of our competitors;
 
    our expectations regarding the realization of recorded deferred tax assets; and
 
    our cash needs.
     The outcome of the events described in these forward-looking statements is subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated by these forward looking statements. These important factors include our financial performance, our ability to attract and retain customers, our development activities and those factors we discuss in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K under the caption “Risk Factors.” You should read these factors and the other cautionary statements made in this Quarterly Report on Form 10-Q as being applicable to all related forward looking statements wherever they appear in this Quarterly Report on Form 10-Q. These risk factors are not exhaustive and other sections of this Quarterly Report on Form 10-Q may include additional factors which could adversely impact our business and financial performance.
Company Background
     We are a leading provider in session border control solutions which enable the delivery of trusted, first-class interactive communications — voice, video and multimedia sessions — and data services across internet protocol, or IP, network borders.
     We were incorporated in the State of Delaware on August 3, 2000. We relocated our headquarters to Bedford, Massachusetts from Burlington, Massachusetts in July 2010. We maintain sales offices in Madrid, Spain; Seoul, Korea; Tokyo, Japan; and Ipswich, United Kingdom. We also have sales personnel in Argentina, Australia, Belgium, Brazil, Canada, China, Columbia, Croatia, Czech Republic, France, Germany, Hong Kong, India, Indonesia, Italy, Malaysia, Mexico, the Netherlands, Peru, Poland, Russia, Singapore, South Africa, Sweden, Taiwan, Thailand, United Arab Emirates and throughout the United States. We expect to selectively add personnel to provide additional geographic sales and technical support coverage.

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     As of September 30, 2010, approximately 1,180 end user customers in 105 countries have deployed our products. We sell or license our products and support services through our direct sales force and 112 distribution partners, including many of the largest network and IP communications equipment vendors throughout the world.
Industry Background
     Service providers traditionally have delivered voice and data services over two separate networks: the public switched telephone network, or PSTN, and the internet. The PSTN provides high reliability and security but is costly to operate and is limited in its ability to support high bandwidth video and other interactive multimedia services. The internet is capable of cost effectively transmitting any form of traffic that is IP-based, including interactive voice, video and data, but it transmits traffic only on a best efforts basis, because all forms of traffic have the same priority. Therefore, the internet attempts to deliver all traffic without distinction, which can result in significantly varying degrees of service quality for the same or similar types of traffic transmissions. Internet based services are also subject to disruptive and fraudulent behavior, including identity theft, viruses, unwanted and excessively large input data, known as SPAM, and the unauthorized use and attempts to circumvent or bypass security mechanisms associated with those services, known as hacking.
     Service providers are migrating to a single IP network architecture to serve as the foundation for their next generation voice, video, multimedia and data service offerings. Recently, an increasing number of enterprises, including contact centers and government agencies have begun to migrate to a single IP network architecture as well. In order to provide secure and high quality interactive communications on a converged IP network, service providers and enterprises must be able to control the communications flows that comprise communication sessions.
Acme Packet Solutions
     Our session border control solutions provide controls in five areas:
    Security — Our products protect themselves, softswitches, IP private branch exchanges, or IP PBXes, unified communication, or UC, servers and other service delivery infrastructure elements, as well as customer networks, systems and relationships. They protect customer networks and session privacy, and provide denial of service, or DoS/DDoS, protection from malicious attacks and non-malicious overloads.
 
    Service and application reach maximization — Our products extend the reach of interactive communications by enabling interoperability to maximize the different types of networks and devices supported. Support is provided for enabling sessions to traverse existing data firewall/network address translation, or NAT, devices, bridging private networks using overlapping IP addresses and virtual private networks, or VPNs, mediating between different signaling, transport and encryption protocols, converting between incompatible codecs, and translating signaling layer telephone numbers, addresses and response codes.
 
    Service level agreement assurance — Our products play a critical role in assuring session capacity and quality. They perform admission control to ensure that both the network and service infrastructure has the capacity to support a session with high quality. Our products also monitor and report actual session quality to determine compliance with performance specifications set forth in service level agreements between service providers and enterprises, and their external or internal customers.
 
    Regulatory compliance — Our products enable compliance with government mandated regulations worldwide, including emergency services such as E-9-1-1, national government priority services such as Government Emergency Telecommunications Service, or GETS, and lawful intercept such as the Communications Assistance for Law Enforcement Act, or CALEA, in the United States.
 
    Revenue and cost management — Our products enable organizations to increase revenues and control costs by protecting against both bandwidth and quality of service theft, by routing sessions optimally to minimize costs and by providing accounting and related mechanisms to maximize billable sessions.

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Acme Packet Products
     Session border control is a service delivery architecture that encompasses several product categories that control voice, video and data sessions not only at IP network borders but also across IP networks to these borders. The product categories in our current portfolio include session border controllers, session aware load balancers, session routing proxies and multiservice security gateways, or MSGs. Infonetics Research, a market research and consulting firm specializing in networking and IP communications, projects that the cumulative worldwide addressable market opportunity for our products may exceed $2 billion annually by 2014. More specifically:
    SBCs control sessions at the IP network borders. Infonetics Research estimates that the market for SBCs among service providers and enterprises will grow to over approximately $900 million by 2014, with a compounded annual growth rate of approximately 24%.
 
    Session routing proxies route Session Initiation Protocol, or SIP, sessions to and from borders — both access and interconnect — and directly compete with CLASS 4 softswitches. They also serve as the Breakout Gateway Control Function in IP multimedia subsystem, or IMS, networks. Infonetics Research estimates that the session routing proxy market may grow to approximately $375 million by 2014, with a compounded annual growth rate of approximately 6%.
 
    MSGs transport all services and applications including voice, video and data across the untrusted Internet to private service provider network borders via IP security, or IPsec, sessions. Infonetics Research estimates that the MSG market may grow to approximately $600 million by 2014, with a compounded annual growth rate of over 69%.
Acme Packet Markets
     Today, our solutions are used by four different market segments to deliver trusted, first class interactive communications—voice, video and multimedia sessions—and data services across IP network borders.
    Fixed line service providers use our solutions to deliver services to residential, small and medium business and enterprise customers over their cable, digital subscriber line, or DSL, fiber to the x, or FTTx, Ethernet and leased line access network borders. They also use our solutions to deliver these services across their interconnect and peering borders to other service providers for PSTN termination, IP transit or IP service connections to other subscriber populations. Our solutions support a wide range of services including basic voice, IP Centrex, hosted unified communications and SIP trunking.
 
    Mobile service providers use our solutions to deliver interactive communications and data services to their mobile subscribers over 3G, long term evolution, or LTE, femtocell, wireless fidelity, or WiFi, and worldwide interoperability for microwave access, or WiMAX, access network borders. They also use our solutions to deliver services across their interconnect and peering borders to other service providers for PSTN termination, IP transit, roaming subscribers and connections to other subscriber populations. We offer specific solutions for SIP services over 3G, global system for mobile communications, or GSM, Rich Communications Suite and IP exchange, or IPX, Voice-over-LTE, or VoLTE, macro radio access network, or RAN, off-load, and fixed-mobile convergence. Our solutions support services ranging from basic voice to presence-enabled voice, interactive video, messaging and collaboration, and Internet data service.
 
    Over-the-top and application service providers use our solutions to deliver services and applications from their data centers to users over the public Internet or the managed IP network of a third party network service provider. These services range from basic voice to presence enabled voice, video, messaging and collaboration delivered over both fixed line and mobile networks for both consumers and businesses. They also include a wide variety of hosted services for enterprises and service providers such as audio, video and web conferencing, outsourced contact centers, SIP trunking, session recording and E-9-1-1.
 
    Enterprises, including government agencies and contact centers, use our solutions at SIP trunking borders to connect to the PSTN, federated enterprise and consumer groups, outsourced contact centers and hosted services such as audio, video and web conferencing; hosted customer relationship management, or CRM, and business process management, or BPM, applications, session recording and E-9-1-1. They are also used to secure the public Internet border connecting remote workers and offices. In extremely security conscious organizations, they are also used to secure IP PBX and UC servers from internal employees located on the enterprise campus local area network, or LAN, and in offices connected via a private wide area network, or WAN, such as multiprotocol label switching, or MPLS, and VPNs. Our solutions support a wide range of services and applications such as basic voice, video conferencing, telepresence and presence enabled unified communications and collaboration.

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Key Financial Highlights
     Some of our key financial highlights for the third quarter of 2010 include the following:
    Total revenue was $56.6 million compared to $36.3 million in the same period of 2009.
 
    Net income was $10.5 million compared to $3.6 million in the same period of 2009.
 
    Earnings per share was $0.15 per share on a diluted basis compared to $0.06 per share on a diluted basis in the same period of 2009.
 
    Cash provided by operating activities was $9.7 million compared to $4.1 million in the same period of 2009.
The Acme Packet Strategy
     Principal elements of our strategy include:
    Continuing to satisfy the evolving border requirements of enterprises and fixed line, mobile and over-the-top service providers. Our product deployments position us to gain valuable knowledge that we can use to expand and enhance our products’ features and functionality. We may develop new products organically, or through selective acquisitions.
 
    Implementing new technologies to enhance product performance and scalability. We will seek to leverage new technologies as they become available to increase the performance, capacity and functionality of our product family, as well as to reduce our costs.
 
    Investing in quality and responsive support. As we broaden our product platform and increase our product capabilities, we will continue to provide comprehensive service and support targeted at maximizing customer satisfaction and retention.
 
    Facilitating and promoting service interconnects and federations among our customers. We intend to drive increased demand for our products by helping our customers extend the reach of their services and applications and, consequently, to increase the value of their services to their customers.
 
    Leveraging distribution partnerships to enhance market penetration. We will continue to invest in training and tools for our distribution partners’ sales, systems engineering and support organizations, in order to improve the overall efficiency and effectiveness of these partnerships.
 
    Actively contributing to architecture and standards definition processes. We will utilize our breadth and depth of experience with SBC deployments to contribute significantly to organizations developing standards and architectures for next generation IP networks.
Factors That May Affect Future Performance
    Global Macroeconomic Conditions. We believe that the capital budgets and spending initiatives of some of our core customers — service providers, enterprises, government agencies and contact centers — may be affected by current worldwide economic conditions. Our ability to generate revenue from these core customers is dependent on the status of such budgets and initiatives.
 
    Gross Margin. Our gross margin has been, and will continue to be, affected by many factors, including (a) the demand for our products and services, (b) the average selling price of our products, which in turn depends, in part, on the mix of product and product configurations sold, (c) the level of software license upgrades, (d) new product introductions, (e) the mix of the sales channels through which our products are sold, and (f) the costs of manufacturing our hardware products and providing our related support services. Customers license our software in various configurations depending on each customer’s requirements for session capacity, feature groups and protocols. The product software configuration mix will have a direct impact on the average selling price of the system sold. Systems with higher software content (higher session capacity, support for higher number of security protocols and a larger number of feature groups) will generally have a higher average selling price than those systems sold with lower software content. If customers begin to purchase and license systems with lower software content, this may have a negative impact on our revenue and gross margins.

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    Competition. Competition in our product categories is strong and constantly evolving. While we believe we are currently the market leader in the service provider and enterprise markets for session border controller solutions, we expect competition to persist and intensify in the future as the market grows. Our primary competitors for session border controller solutions generally consist of specialty vendors, such as GENBAND Inc., and more established network and component companies such as Cisco Systems, Inc. and Huawei Technologies Co., Ltd. We also compete with some of the companies with which we have distribution partnerships, such as Alcatel Lucent, Nokia Siemens Networks and Telefonaktiebolaget LM Ericsson. We believe we compete successfully with all of these companies based upon our experience in interactive communications networks, the breadth of our applications and standards support, the depth of our border control features, the demonstrated ability of our products to interoperate with key communications infrastructure elements, and our comprehensive service and support. We also believe our products are priced competitively with our competitors’ offerings. As the session border control market opportunity grows, we expect competition from additional networking and IP communications equipment suppliers, including our distribution partners.
 
    Evolution of the Session Border Control Market. The market for our products is in its early stages and is still evolving, and it is uncertain whether these products will continue to achieve and sustain high levels of demand and market acceptance. Our success will depend, to a substantial extent, on the willingness of interactive communications service providers and enterprises to continue to implement our solutions.
 
    Research and Development. To continue to achieve market acceptance for our products, we must effectively anticipate and adapt, in a timely manner, to customer requirements and must offer products that meet changing customer demands. Prospective customers may require product features and capabilities that our current products do not have. The market for session border control solutions is characterized by rapid technological change, frequent new product introductions, and evolving industry requirements. We intend to continue to invest in our research and development efforts, which we believe are essential to maintaining our competitive position.
 
    Managing Growth. We significantly expanded our operations in 2009 and in the first nine months of 2010. From January 1, 2009 through September 30, 2010, we increased the number of our employees and full time independent contractors by 39%, from 381 to 529. We anticipate that further expansion of our infrastructure and headcount will be required to achieve planned expansion of our product offerings, projected increases in our customer base and anticipated growth in the number of product deployments. In the future, we expect to continue to carefully manage the increase of our operating expenses based on our ability to expand our revenues, the expansion of which could occur organically or through future acquisitions.
Revenue
     We derive product revenue from the sale of our Net-Net hardware and the licensing of our Net-Net software. We generally recognize product revenue at the time of product delivery, provided all other revenue recognition criteria have been met. For arrangements that include customer acceptance or other material non-standard terms, we defer revenue recognition until after delivery, assuming all other criteria for revenue recognition have been met.
     We generate maintenance, support and service revenue from (a) maintenance associated with software licenses, (b) technical support services for our software product, (c) hardware repair and maintenance services, (d) implementation, training and consulting services and (e) reimbursable travel and other out-of-pocket expenses.
     We offer our products and services indirectly through distribution partners and directly through our sales force. Our distribution partners include networking and telecommunications equipment vendors throughout the world. Our distribution partners generally purchase our products after they have received a purchase order from their customers and, generally, do not maintain an inventory of our products in anticipation of sales to their customers. Generally, the pricing offered to our distribution partners will be lower than to our direct customers.
     The product configuration, which reflects the mix of session capacity, signaling protocol support and requested features, determines the price for each product sold. Customers can purchase our products in either a standalone or high availability configuration and can license our software in various configurations, depending on the customers’ requirements for session capacity, feature groups and protocols. The product software configuration mix will have a direct impact on the average selling price of the system sold. As the market continues to develop and grow, we expect to experience increased price pressure on our products and services.

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     We believe that our revenue and results of operations may vary significantly from quarter to quarter as a result of long sales and deployment cycles, variations in customer ordering patterns, and the application of complex revenue recognition rules to certain transactions. Some of our arrangements with customers include clauses under which we may be subject to penalties for failure to meet specified performance obligations. We have not incurred any such penalties to date.
Cost of Revenue
     Cost of product revenue consists primarily of (a) third party manufacturers’ fees for purchased materials and services, combined with our expenses for (b) salaries, wages and related benefits for our manufacturing personnel, (c) related overhead, (d) provision for inventory obsolescence, (e) amortization of intangible assets and (f) stock-based compensation. Amortization of intangible assets represents the amortization of developed technologies from our acquisition of Covergence.
     Cost of maintenance, support and service revenue consists primarily of (a) salaries, wages and related benefits for our support and service personnel (b) related overhead, (c) billable and non-billable travel, lodging, and other out-of-pocket expenses, (d) material costs consumed in the provision of services and (e) stock-based compensation.
Gross Profit
     Our gross profit has been, and will be, affected by many factors, including (a) the demand for our products and services, (b) the average selling price of our products, which in turn depends, in part, on the mix of product and product configurations sold, (c) the mix between product and service revenue, (d) new product introductions, (e) the mix of sales channels through which our products are sold, (f) the volume and costs of manufacturing our hardware products and (g) personnel and related costs for manufacturing, support and services.
Operating Expenses
     Operating expenses consist of sales and marketing, research and development, and general and administrative expenses. Personnel related costs are the most significant component of each of these expense categories. During the period from January 1, 2009 through September 30, 2010, we increased the number of our employees and full time independent contractors by 39%, from 381 to 529. We expect to continue to hire new employees to support our expected growth.
     Sales and marketing expense consists primarily of (a) salaries and related personnel costs, (b) commissions, (c) travel, lodging and other out-of-pocket expenses, (d) marketing programs such as trade shows, (e) stock-based compensation and (f) other related overhead. Commissions are recorded as expense when earned by the employee. We expect sales and marketing expense to increase in absolute dollars as we expand our sales force to continue to increase our revenue and market share. We anticipate that sales and marketing expense will moderately increase as a percentage of total revenue in the future.
     Research and development expense consists primarily of (a) salaries and related personnel costs, (b) payments to suppliers for design and consulting services, (c) prototype and equipment costs relating to the design and development of new products and enhancement of existing products, (d) quality assurance and testing, (e) stock-based compensation and (f) other related overhead. To date, all of the costs related to our research and development efforts have been expensed as incurred. We intend to continue to invest in our research and development efforts, which we believe are essential to maintaining our competitive position. We expect research and development expense to increase in absolute dollars. However, we anticipate that research and development expense will remain relatively consistent as a percentage of total revenue in the future.
     General and administrative expense consists primarily of (a) salaries, wages and personnel costs related to our executive, finance, human resource and information technology organizations, (b) accounting and legal professional fees, (c) expenses associated with uncollectible accounts, (d) stock-based compensation and (e) other related overhead. We expect general and administrative expense to increase in absolute dollars as we invest in infrastructure to support continued growth and incur ongoing expenses related to being a publicly traded company, including increased audit and legal fees, costs of compliance with securities and other regulations, investor relations expense, and higher insurance premiums. However, we anticipate that general and administrative expense will decrease as a percentage of total revenue in the future.

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Stock-Based Compensation
     Cost of revenue and operating expenses include stock-based compensation expense. We expense stock-based payment awards with compensation cost for stock-based payment transactions measured at fair value. For the three months ended September 30, 2010 and 2009, we recorded an expense of $4.6 million and $2.8 million, respectively, and for the nine months ended September 30, 2010 and 2009, we recorded an expense of $11.9 million and $7.7 million, respectively. Based on stock-based awards granted from 2006 through 2010, a future expense of non-vested options of $37.6 million is expected to be recognized over a weighted average period of 2.77 years.
Other Income (Expense), Net
     Other income (expense), net consists primarily of interest income earned on cash, cash equivalents and investments. We have invested cash in high quality securities generally of a short duration and are not materially affected by fluctuations in interest rates. Other income (expense) also includes gains (losses) from foreign currency translation adjustments of our international activities. The functional currency of our international operations in Europe and Asia is the United States, or U.S., dollar. Accordingly, all assets and liabilities of these international subsidiaries are re-measured into U.S. dollars using the exchange rates in effect at the balance sheet date, or historical rate, as appropriate. Revenue and expenses of these international subsidiaries are re-measured into U.S. dollars at the average rates in effect during the period. Any differences resulting from the re-measurement of assets, liabilities and operations of the European and Asian subsidiaries are recorded within other income (expense).
Application of Critical Accounting Policies and Use of Estimates
     Our financial statements are prepared in accordance with United States generally accepted accounting principles, or U.S. GAAP. The preparation of these financial statements requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ significantly from these estimates under different assumptions or conditions. There have been no material changes to these estimates for the periods presented in this Quarterly Report on Form 10-Q. For a detailed explanation of the judgments made in these areas, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2009, which we filed with the Securities and Exchange Commission, or SEC, on March 9, 2010.
Results of Operations
Comparison of Three Months Ended September 30, 2010 and 2009
Revenue
                                                 
    Three Months Ended September 30,        
    2010     2009        
            Percentage             Percentage        
            of Total             of Total     Period-to-Period Change  
    Amount     Revenue     Amount     Revenue     Amount     Percentage  
    (dollars in thousands)  
Revenue by Type:
                                               
Product
  $ 45,328       80 %   $ 27,726       76 %   $ 17,602       63 %
Maintenance, support and service
    11,286       20       8,621       24       2,665       31  
 
                                     
Total revenue
  $ 56,614       100 %   $ 36,347       100 %   $ 20,267       56 %
 
                                     
Revenue by Geography:
                                               
United States and Canada
  $ 32,915       58 %   $ 19,456       54 %   $ 13,459       69 %
International
    23,699       42       16,891       46       6,808       40  
 
                                     
Total revenue
  $ 56,614       100 %   $ 36,347       100 %   $ 20,267       56 %
 
                                     
Revenue by Sales Channel:
                                               
Direct
  $ 27,299       48 %   $ 14,535       40 %   $ 12,764       88 %
Indirect
    29,315       52       21,812       60       7,503       34  
 
                                     
Total revenue
  $ 56,614       100 %   $ 36,347       100 %   $ 20,267       56 %
 
                                     

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     The $17.6 million increase in product revenue was primarily due to an increase in the number of systems recognized as revenue, reflecting an increase in our customer base, coupled with an increase in the average selling price of our systems due to changes in both our product software configuration mix, including software upgrades, and the mix of system platforms purchased by our customers. The product configuration, which reflects the mix of session capacity support for signaling protocols and requested features, determines the price for each system sold. Customers can license our software in various configurations, depending on requirements for session capacity, feature groups and protocols. The product software configuration mix has a direct impact on the average selling price of a system sold. Systems with higher software content (higher session capacity support for higher number of signaling protocols and a higher number of feature groups) will generally have a higher average selling price than those systems sold with lower software content. The growth in product revenue was primarily due to our direct sales channel and, to a lesser extent, our indirect sales channel. Direct product revenues increased $11.6 million, primarily due to an increase attributable to customers in the United States and Canada. Indirect product revenues increased $6.0 million primarily due to a $5.7 million increase attributable to our international customers as well as an increase of $365,000 in indirect product revenues related to customers in the United States and Canada.
     Maintenance, support and service revenue increased by $2.7 million primarily due to increases in maintenance and support fees associated with the growth in our installed product base.
Cost of Revenue, Gross Profit and Gross Margin
                                                 
    Three Months Ended September 30,        
    2010     2009        
            Percentage             Percentage        
            of Related             of Related     Period-to-Period Change  
    Amount     Revenue     Amount     Revenue     Amount     Percentage  
    (dollars in thousands)  
Cost of Revenue:
                                               
Product
  $ 7,903       17 %   $ 5,178       19 %   $ 2,725       53 %
Maintenance, support and service
    2,556       23       1,773       21       783       44  
 
                                         
Total cost of revenue
  $ 10,459       18 %   $ 6,951       19 %   $ 3,508       50 %
 
                                         
Gross Profit:
                                               
Product
  $ 37,425       83 %   $ 22,548       81 %   $ 14,877       66 %
Maintenance, support and service
    8,730       77       6,848       79       1,882       27  
 
                                         
Total gross profit
  $ 46,155       82 %   $ 29,396       81 %   $ 16,759       57 %
 
                                         
     The $2.7 million increase in cost of product revenue was primarily due to (a) a $1.5 million increase in direct product costs resulting from an increase in the number of systems recognized as, (b) a $655,000 increase in costs associated with amounts reserved against inventory deemed to be excess or obsolete, (c) a $213,000 increase in depreciation of fixed assets and amortization of developed technology acquired in the acquisition of Covergence, (d) a $140,000 increase in salaries, wages and related benefits, (e) a $104,000 increase in freight costs and (f) a $77,000 increase in stock-based compensation expense. The balance was due to increased overhead and other manufacturing related costs.
     The $783,000 increase in cost of maintenance, support and service revenue was primarily due to (a) a $365,000 increase in the reserve for warranty repairs and product costs associated with performance of our maintenance obligations due to the expansion of our customer install base, (b) a $186,000 increase in salaries and related benefits corresponding to a 26% increase in employee headcount for our support and services organization to support our rapidly growing customer base, (c) a $125,000 increase in stock-based compensation expense and (d) a $38,000 increase in travel expenses. The balance was due to increases in overhead and other maintenance, support and service related costs.
     Product gross margin increased 2 percentage points primarily due to an increase in the number of units sold in the three months ended September 30, 2010 compared to the three months ended September 30, 2009, which resulted in fixed manufacturing costs being absorbed by a higher product volume base. The product platform mix was also a factor for the increase in the average selling price of systems sold in the three months ended September 30, 2010.
     Gross margin on maintenance, support and service revenue decreased 2 percentage points, primarily due to an increase in reserves for warranty repairs and product costs associated with performance of our maintenance obligations. The 26% increase in employee headcount for our support and services organization to support our rapidly growing customer base was also a factor for the increase in salaries and related benefits.
     We expect cost of product revenue and cost of maintenance, support and service revenue each to increase at approximately the same rate as the related revenue for the foreseeable future. As a result, we expect that gross profit will increase, but that the related gross margin will remain relatively consistent for the foreseeable future.

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Operating Expenses
                                                 
    Three Months Ended September 30,        
    2010     2009        
            Percentage             Percentage        
            of Total             of Total     Period-to-Period Change  
    Amount     Revenue     Amount     Revenue     Amount     Percentage  
    (dollars in thousands)  
Sales and marketing
  $ 17,012       30 %   $ 13,703       38 %   $ 3,309       24 %
Research and development
    8,896       16       7,271       20       1,625       22  
General and administrative
    3,906       7       3,253       9       653       20  
 
                                     
Total operating expenses
  $ 29,814       53 %   $ 24,227       67 %   $ 5,587       23 %
 
                                     
     The $3.3 million increase in sales and marketing expense was primarily due to (a) a $1.6 million increase in salaries, commissions associated with increased revenues, bonuses and other benefits associated with a 26% increase in the number of sales and marketing personnel, (b) a $745,000 increase in stock-based compensation expense, (c) a $303,000 increase in depreciation and amortization expense due to capital expenditures for evaluation systems, (d) a $303,000 increase in facility costs related to a larger sales office in Madrid, Spain and the amortization of deferred rent for our corporate headquarters in Bedford, MA, (e) a $283,000 increase in expenditures associated with marketing programs, including trade shows, (f) a $243,000 increase in travel and entertainment expenses reflecting the afore mentioned increase in related headcount and (g) a $92,000 increase in professional search fees. These increases were partially offset by a $130,000 decrease in training costs and a $112,000 decrease in third party services. The balance was due to increased overhead costs. We expect sales and marketing expense to continue to increase in absolute dollars for the foreseeable future as we expand our sales force to continue to increase our revenue and market share. We anticipate that sales and marketing expense will modestly increase as a percentage of total revenue for the foreseeable future.
     The $1.6 million increase in research and development expense was primarily due to (a) a $864,000 increase in salaries, bonuses and other benefits associated with an 13% increase in the number of employees working on the design and development of new products and enhancement of existing products, quality assurance and testing, (b) a $320,000 increase in stock-based compensation expense, (c) a $174,000 increase in facility costs, (d) a $66,000 increase in software and other maintenance costs for lab and other engineering equipment, (e) a $63,000 increase in third party services and (f) a $62,000 increase in computer and engineering supplies. The balance was primarily due to increased overhead costs. The addition of personnel and our continued investment in research and development were driven by our strategy of maintaining our competitive position by expanding our product offerings and enhancing our existing products to meet the requirements of our customers and market. We expect research and development expense to increase in absolute dollars for the foreseeable future. However, we anticipate that research and development expense will remain relatively consistent as a percentage of total revenue for the foreseeable future.
     The $653,000 increase in general and administrative expense was primarily due to (a) a $525,000 increase in stock-based compensation expense, (b) a $244,000 increase in salaries, bonuses and other benefits associated with an 22% increase in the number of employees and (c) a $44,000 increase in facility costs. These increases were partially offset by a $285,000 decrease in corporate taxes. The balance was due to increased overhead costs. We expect general and administrative expense to continue to increase in absolute dollars as we invest in infrastructure to support continued growth and incur expenses related to being a publicly traded company, including increased audit and legal fees, costs of compliance with securities and other regulations, insurance costs and investor relations expense. However, we expect general and administrative expense will decrease as a percentage of total revenue for the foreseeable future.
Operating and Other Income
                                                 
    Three Months Ended September 30,        
    2010     2009        
            Percentage             Percentage        
            of Total             of Total     Period-to-Period Change  
    Amount     Revenue     Amount     Revenue     Amount     Percentage  
    (dollars in thousands)  
Income from operations
  $ 16,341       29 %   $ 5,169       14 %   $ 11,172       216 %
Interest income
    157             40             117       293  
Other income (expense)
    32             (12 )           44       (367 )
 
                                     
Income before provision for income taxes
    16,530       29       5,197       14       11,333       218  
Provision for income taxes
    6,065       11       1,617       4       4,448       275  
 
                                     
Net income
  $ 10,465       18 %   $ 3,580       10 %   $ 6,885       192 %
 
                                     

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     Interest income (expense) consisted of income generated from the investment of our cash balances. The increase in interest income was primarily due to higher average interest rates due to a change in the nature of our investments as well as an increase in the average cash balance in the three months ended September 30, 2010.
     Other income primarily consisted of foreign currency translation adjustments of our international subsidiaries and sales consummated in foreign currencies. The increase in other income was primarily due to fluctuations in the value of the Euro and British Pound.
     Our effective tax rate was approximately 37% and 31% for the three months ended September 30, 2010 and 2009, respectively. The increase in the effective tax rate was primarily due to the disallowance of the United State federal research and development tax credit in 2010, which was available in 2009. We currently expect to realize recorded net deferred tax assets as of September 30, 2010 of $17.2 million. Our conclusion that these assets will be recovered is based upon the expectation that our current and future earnings will provide sufficient taxable income to realize the recorded tax assets. The realization of our net deferred tax assets cannot be assured, to the extent that future taxable income against which these tax assets may be applied is not sufficient, some or all of our recorded net deferred tax asset would not be realizable. Approximately $7.1 million of the deferred tax assets recorded as of September 30, 2010 is attributable to benefits associated with stock-based compensation charges. In accordance with the guidance in Accounting Standards Codification, ASC, 718, Compensation-Stock Compensation, no valuation allowance has been recorded against this amount. However, in the future, if the underlying amounts expire with an intrinsic value less than the fair value of the awards on the date of grant, some or all of the benefits may not be realizable.
Comparison of Nine Months Ended September 30, 2010 and 2009
Revenue
                                                 
    Nine Months Ended September 30,        
    2010     2009        
            Percentage             Percentage        
            of Total             of Total     Period-to-Period Change  
    Amount     Revenue     Amount     Revenue     Amount     Percentage  
    (dollars in thousands)  
Revenue by Type:
                                               
Product
  $ 129,452       80 %   $ 75,020       75 %   $ 54,432       73 %
Maintenance, support and service
    31,548       20       25,175       25       6,373       25  
 
                                     
Total revenue
  $ 161,000       100 %   $ 100,195       100 %   $ 60,805       61 %
 
                                     
Revenue by Geography:
                                               
United States and Canada
  $ 97,587       61 %   $ 54,373       54 %   $ 43,214       79 %
International
    63,413       39       45,822       46       17,591       38  
 
                                     
Total revenue
  $ 161,000       100 %   $ 100,195       100 %   $ 60,805       61 %
 
                                     
Revenue by Sales Channel:
                                               
Direct
  $ 78,989       49 %   $ 38,037       38 %   $ 40,952       108 %
Indirect
    82,011       51       62,158       62       19,853       32  
 
                                     
Total revenue
  $ 161,000       100 %   $ 100,195       100 %   $ 60,805       61 %
 
                                     
     The $54.4 million increase in product revenue was primarily due to an increase in the number of systems recognized as revenue in the nine months ended September 30, 2010 as compared to the same period in 2009, reflecting a significant increase in our customer base, coupled with an increase in the average selling price of our systems due to a change in both our product software configuration mix, including software upgrades, and the mix of system platforms purchased by our customers. The product configuration, which reflects the mix of session capacity, requested features and protocols, determines the prices for each system sold. Customers can license our software in various configurations, depending on requirements for session capacity, feature groups and protocols. The product software configuration mix has a direct impact on the average selling price of a system sold. Systems with higher software content (higher session capacity and a higher number of feature groups) will generally have a higher average selling price than those systems sold with lower software content. The growth in product revenue was primarily due to our direct sales channel and, to a lesser extent, our indirect sales channel. Direct product revenues increased $38.9 million, primarily due to a $37.9 million increase attributable to customers in the United States and Canada, and to a lesser extent, an increase of $1.0 million in direct product revenues generated by our international customers. Indirect product revenues increased $15.5 million primarily due to a $14.0 million increase attributable to our international customers, and, to a lesser extent, an increase of $1.5 million attributable to our customers in the United States and Canada.

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     Maintenance, support and service revenue increased by $6.4 million primarily due to increases in maintenance and support fees associated with the growth in our installed product base.
Cost of Revenue, Gross Profit, and Gross Margin
                                                 
    Nine Months Ended September 30,        
    2010     2009        
            Percentage             Percentage        
            of Related             of Related     Period-to-Period Change  
    Amount     Revenue     Amount     Revenue     Amount     Percentage  
    (dollars in thousands)  
Cost of Revenue:
                                               
Product
  $ 22,886       18 %   $ 15,280       20 %   $ 7,606       50 %
Maintenance, support and service
    6,964       22       3,903       16       3,061       78  
 
                                         
Total cost of revenue
  $ 29,850       19 %   $ 19,183       19 %   $ 10,667       56 %
 
                                         
Gross Profit:
                                               
Product
  $ 106,566       82 %   $ 59,740       80 %   $ 46,826       78 %
Maintenance, support and service
    24,584       78       21,272       84       3,312       16  
 
                                         
Total gross profit
  $ 131,150       81 %   $ 81,012       81 %   $ 50,138       62 %
 
                                         
     The $7.6 million increase in cost of product revenue was primarily due to (a) a $4.7 million increase in direct product costs resulting from an increase in the number of systems recognized as revenue in the nine months ended September 30, 2010 as compared to the same period in 2009, (b) a $1.1 million increase in depreciation and amortization of developed technology acquired in the acquisition of Covergence, (c) a $954,000 increase in costs associated with amounts reserved against inventory deemed to be excess or obsolete, (d) a $412,000 increase in salaries, wages and related benefits, (e) a $181,000 increase in freight costs, (f) a $176,000 increase in stock-based compensation expense and (g) a $79,000 increase in manufacturing supplies. The balance was due to increased overhead and other manufacturing related costs.
     The $3.1 million increase in cost of maintenance, support and service revenue was primarily due to (a) a $1.3 million increase in the reserve for warranty repairs and product costs associated with performance of our maintenance obligations, (b) a $1.1 million increase in salaries and related benefits corresponding to a 26% increase in employee headcount for our support and services organization to support our rapidly growing customer base, (c) a $322,000 increase in stock-based compensation expense, (d) a $118,000 increase in freight costs associated with our maintenance and warranty obligations and (e) a $98,000 increase in travel expense. The balance was due to increased overhead and other maintenance, support and service related costs.
     Product gross margin increased 2 percentage points primarily due to an increase in the number of units sold in the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. In addition, the average selling price of our products increased as a result of a change in our product mix. Both of these factors resulted in our fixed manufacturing costs being absorbed by a higher product volume base.
     Gross margin on maintenance, support and service revenue decreased 6 percentage points, due to an increase in salaries and related benefits corresponding to a 26% increase in employee headcount for our support and services organization to support our rapidly growing customer base without a corresponding increase in maintenance, support and service revenue. The increase in reserve for warranty repairs and product costs associated with performance of our maintenance obligations was also a factor.
Operating Expenses
                                                 
    Nine Months Ended September 30,        
    2010     2009        
            Percentage             Percentage        
            of Total             of Total     Period-to-Period Change  
    Amount     Revenue     Amount     Revenue     Amount     Percentage  
    (dollars in thousands)  
Sales and marketing
  $ 50,062       31 %   $ 37,647       38 %   $ 12,415       33 %
Research and development
    26,235       16       20,513       20       5,722       28  
General and administrative
    10,785       7       9,674       10       1,111       11  
Merger and integration-related costs
                1,102       1       (1,102 )     (100 )
 
                                     
Total operating expenses
  $ 87,082       54 %   $ 68,936       69 %   $ 18,146       26 %
 
                                     

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     The $12.4 million increase in sales and marketing expense was primarily due to (a) a $7.3 million increase in salaries, commissions associated with increased revenues, bonuses and other benefits associated with a 26% increase in the number of sales and marketing personnel, (b) a $1.8 million increase in stock-based compensation expense, (c) a $923,000 increase in depreciation and amortization expense due to capital expenditures for evaluation systems, (d) a $747,000 increase in travel expenses resulting from the increase in our headcount, (e) a $730,000 increase in facility costs related to a larger sales office in Madrid, Spain as well as the amortization of deferred rent for our corporate headquarters in Bedford, MA, (f) a $510,000 increase in expenditures associated with marketing programs, including trade shows, (g) a $220,000 increase in professional search fees associated with the growth in headcount and (h) a $129,000 increase in software and other maintenance fees. The balance was due to increased overhead costs.
     The $5.7 million increase in research and development expense was primarily due to (a) a $3.5 million increase in salaries, bonuses and other benefits associated with a 13% increase in the number of employees working on the design and development of new products and enhancement of existing products, quality assurance and testing, (b) a $1.0 million increase in stock-based compensation expense, (c) a $479,000 increase in facility costs, (d) a $277,000 increase in outside consulting services, (e) a $175,000 increase in software and other maintenance fees for lab and other engineering equipment, (e) an $87,000 increase in depreciation and amortization expense due to capital expenditures for lab and other engineering equipment, (f) an $80,000 increase in travel expenses and (g) a $76,000 increase in professional service fees. The balance was due to increased overhead costs. The addition of personnel and our continued investment in research and development were driven by our strategy of maintaining our competitive position by expanding our product offerings and enhancing our existing products to meet the requirements of our customers and market.
     The $1.1 million increase in general and administrative expense was primarily due to (a) a $913,000 increase in stock-based compensation expense, (b) a $523,000 increase in salaries, bonuses and other benefits associated with a 22% increase in the number of employees, (c) a $114,000 increase in office and computer supplies and (d) a $52,000 increase in travel expenses. These increases were partially offset by (a) a $549,000 decrease in bad debt expense and (b) a $131,000 decrease in depreciation expense. The balance was due to increased overhead costs.
     During the nine months ended September 30, 2009, we incurred $1.1 million of merger and integration-related costs associated with our acquisition of Covergence in April 2009, including $585,000 of transaction expenses and $517,000 of severance related charges pertaining to 20 employees of Covergence across all functional areas who were terminated on April 30, 2009. There were no such costs incurred in the nine months ended September 30, 2010.
Operating and Other Income
                                                 
    Nine Months Ended September 30,        
    2010     2009        
            Percentage             Percentage        
            of Total             of Total     Period-to-Period Change  
    Amount     Revenue     Amount     Revenue     Amount     Percentage  
                    (dollars in thousands)                  
Income from operations
  $ 44,068       28 %   $ 12,076       12 %   $ 31,992       265 %
Interest income
    397             205             192       94  
Other expense
    (43 )           (55 )           12       (22 )
 
                                     
Income before provision for income taxes
    44,422       28       12,226       12       32,196       263  
Provision for income taxes
    15,895       10       4,195       4       11,700       279  
 
                                     
Net income
  $ 28,527       18 %   $ 8,031       8 %   $ 20,496       255 %
 
                                     
     Interest income consisted of income generated from the investment of our cash balances. The increase in interest income was primarily due to higher average interest rates due to a change in the nature of our investments as well as an increase in the average cash balance in the nine months ended September 30, 2010.
     Other expense primarily consisted of foreign currency translation adjustments of our international subsidiaries and sales consummated in foreign currencies. The decrease in other expense was primarily due to fluctuations in the value of the Euro and British Pound.
     Our effective tax rate was approximately 36% and 34% for the nine months ended September 30, 2010 and 2009, respectively. The increase in the effective tax rate was primarily due to the disallowance of the United State federal research and development tax credit in 2010, but which was available in 2009.

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Liquidity and Capital Resources
Resources
     Since 2005, we have funded our operations primarily with the growth in our operating cash flows. In October 2006, we completed an initial public offering, or IPO, of our common stock in which we sold and issued 9.7 million shares of our common stock, including 1.7 million shares sold by us pursuant to the underwriters’ full exercise of their over-allotment option, at an issue price of $9.50 per share. We raised a total of $92.4 million in gross proceeds from the IPO, or $83.2 million in net proceeds after deducting underwriting discounts and commissions of $6.5 million and other offering costs of $2.7 million. To date we have not used or designated any of the proceeds from our IPO.
     Key measures of our liquidity are as follows:
                 
            As of and
    As of and for   for the
    the Nine   Year
    Months Ended   Ended
    September 30,   December 31,
    2010   2009
    (in thousands)
Cash and cash equivalents
  $ 110,642     $ 90,471  
Short-term and long-term investments
    126,380       84,516  
Accounts receivable, net
    30,289       25,604  
Working capital
    243,064       123,452  
Cash provided by operating activities
    32,749       45,146  
Cash used in investing activities
    (53,772 )     (84,156 )
Cash provided by financing activities
    41,194       3,758  
     Cash, cash equivalents, short-term and long-term investments. Our cash and cash equivalents at September 30, 2010 were invested primarily in high quality securities of a short duration and are not materially affected by fluctuations in interest rates. Our short-term and long-term investments consist of high quality government treasuries and bonds. The cash and cash equivalents are held for working capital purposes. We do not enter into investments for trading or speculative purposes. Restricted cash, which totaled $837,000 and $1.1 million at September 30, 2010 and December 31, 2009, respectively, is not included in cash and cash equivalents, and was held in certificates of deposit as collateral for letters of credit related to the lease agreements for our former corporate headquarters in Burlington, Massachusetts, our sales office in Madrid, Spain as well as our new corporate headquarters in Bedford, Massachusetts to which we relocated to in July 2010.

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     Accounts receivable, net. Our accounts receivable balance fluctuates from period to period, which affects our cash flow from operating activities. The fluctuations vary depending on the timing of our shipping and billing activity, cash collections, and changes in our allowance for doubtful accounts. In some situations we receive cash payment from a customer prior to the time we are able to recognize revenue on a transaction. We record these payments as deferred revenue, which has a positive effect on our accounts receivable balances. We use days sales outstanding, or DSO, calculated on a quarterly basis, as a measurement of the quality and status of our receivables. We define DSO as (a) accounts receivable, net of allowance for doubtful accounts, divided by (b) total revenue for the most recent quarter, multiplied by (c) 90 days. DSO was 48 days at September 30, 2010 and 56 days at December 31, 2009. The decrease in DSO at September 30, 2010 was primarily due to the receipt of cash on product orders prior to their recognition as revenue during the three months ended September 30, 2010.
     Operating activities. Cash provided by operating activities primarily consists of net income adjusted for certain non-cash items including depreciation and amortization, deferred income taxes, provision for bad debts, stock-based compensation, tax benefits associated with stock option exercises and the effect of changes in working capital and other activities. Cash provided by operating activities in the nine months ended September 30, 2010 was $32.7 million and consisted of (a) $28.5 million of net income, (b) non-cash adjustments of $1.2 million (consisting primarily of $11.9 million of stock-based compensation expense, $5.8 million of depreciation and amortization expense, and $1.4 million of amortization of the premium/discount on investments), and (c) $5.4 million provided by working capital and other activities, partially offset by $20.4 million related to excess tax benefits from the exercise, by employees, of stock options and $54,000 for the bad debts provision. Cash provided by working capital and other activities primarily reflected increases of $12.8 million in accrued expenses and other current liabilities and decreases of $899,000 and $76,000 in deferred product costs and accounts payable, respectively, partially offset by increases of $4.7 million in accounts receivable, $1.9 million in inventory, $339,000 in other assets and a $2.1 million decrease in deferred revenue. The increase of $12.8 million in accrued expenses primarily represents the effect of excess tax benefits used to offset our tax liability in the nine months ended September 30, 2010. The level of benefits available in the same period in 2009 was significantly less. The increase of $4.7 million in accounts receivable and the $1.9 million increase in inventory is primarily attributable to the amount of revenue recognized in the nine months ended September 30, 2010 as compared to the same period in 2009. The $2.1 million decrease in deferred revenue is attributable to the timing of revenue recognition on customer orders. The timing of revenue recognition is affected by, among other things, the timing of the receipt of customer orders, and the contractual acceptance terms under which these orders are placed.
     Investing activities. Cash used in investing activities in the nine months ended September 30, 2010 was $53.8 million, which included $151.0 million in purchases of marketable securities and $10.6 million in purchases of property and equipment, all of which were partially offset by the receipt of $107.8 million in proceeds from sales and maturities of marketable securities.
     Financing activities. Net cash provided by financing activities included proceeds from the exercise of common stock options in the amount of $20.8 million during the nine months ended September 30, 2010 and $20.4 million of excess tax benefits from the exercise of stock options.
     Anticipated cash flows. We believe our existing cash, cash equivalents and short-term and long-term investments and our cash flow from operating activities will be sufficient to meet our anticipated cash needs for at least the next twelve months. Our future working capital requirements will depend on many factors, including the rate of our revenue growth, our introduction of new products and enhancements, and our expansion of sales and marketing and product development activities. To the extent that our cash, cash equivalents, short-term and long-term investments and cash flow from operating activities are insufficient to fund our future activities, we may need to raise additional funds through bank credit arrangements or public or private equity or debt financings. We also may need to raise additional funds in the event we determine in the future to effect one or more acquisitions of businesses, technologies and products that will complement our existing operations. In the event additional funding is required, and given the current condition of the global financial markets, we may not be able to obtain bank credit arrangements or affect an equity or debt financing on terms acceptable to us or at all.
Requirements
     Capital expenditures. We have made capital expenditures primarily for equipment to support product development, evaluation systems for sales opportunities, improvements to our leased corporate headquarters in Bedford, Massachusetts and other general purposes to support our growth. Our capital expenditures totaled $10.6 million in the nine months ended September 30, 2010. We expect to spend an additional $1.0 million to $2.0 million in capital expenditures in the remainder of 2010, excluding any investment related to the expansion of our headquarters in July 2010.
     Contractual obligations and requirements. Our only significant contractual obligations relate to the lease of our corporate headquarters in Bedford, Massachusetts to which we relocated in July 2010 and our office facilities in Madrid, Spain.

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     On December 10, 2009 we entered into a lease dated as of November 23, 2009 with MSCP Crosby, LLC to secure office space for our corporate headquarters at 100 Crosby Drive, Bedford, Massachusetts. The commencement date for occupancy under the lease was June 1, 2010. The lease for our former corporate headquarters at 71 Third Avenue, Burlington, Massachusetts expired on July 31, 2010.
     The lease for our new corporate headquarters at 100 Crosby Drive, Bedford, Massachusetts provides for the rental of 123,788 square feet of space and has an initial term of six years and six months. We can, subject to certain conditions, extend this term for an additional period of five years. We are not required to pay any rent for the first six months of the initial lease term. Thereafter, the annual rent will be $2.4 million, or approximately $201,156 per month. The total base rent payable in the initial lease term is $14.5 million.
     In addition to base rent, the lease for our new corporate headquarters requires us to pay our proportionate share of certain taxes and operating expenses, as further set forth in the lease. We received lease incentives, including free rent for the first six months of occupancy, which totaled approximately $1.2 million, and allowances for tenant improvements totaling approximately $3.2 million. We are recognizing the total base rent payable of $14.5 million ratably over the initial lease term of the lease which is 78 months. The allowances for tenant improvements is being amortized on a straight-line basis over the initial lease term as a reduction of rental expense.
     On July 12, 2010 we entered into a lease amendment dated as of June 1, 2010 with MSCP Crosby, LLC to secure additional office space at our new corporate headquarters. The commencement date for occupancy under the amendment is July 1, 2010. The lease amendment provides for an additional 27,161 square feet of space. We are not required to pay any rent on this additional space until August 1, 2011 at which point our rent will be $245,292 per month for the entire facility. In addition to the free rent, we are receiving allowances for tenant improvements totaling approximately $447,000.
     In connection with the signing of the lease for our new headquarters, we have deposited with the landlord an unconditional, irrevocable letter of credit in the landlord’s favor in the amount of approximately $603,000.
Off-Balance-Sheet Arrangements
     As of September 30, 2010, we did not have any significant off-balance-sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.
     Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in foreign exchange rates and interest rates. We do not hold or issue financial instruments for trading purposes.
Foreign Currency Exchange Risk
     To date, substantially all of our international customer agreements have been denominated in U.S. dollars. Accordingly, we have limited exposure to foreign currency exchange rates and do not enter into foreign currency hedging transactions. The functional currency of our international operations in Europe and Asia is the U.S. dollar. Accordingly, all operating assets and liabilities of these international subsidiaries are re-measured into U.S. dollars using the exchange rates in effect at the balance sheet date. Revenue and expenses of these international subsidiaries are re-measured into U.S. dollars at the average rates in effect during the period. Any differences resulting from the re-measurement of assets, liabilities and operations of the European and Asian subsidiaries are recorded within other income in the consolidated statements of income. If the foreign currency exchange rates fluctuated by 10% as of September 30, 2010, our foreign exchange exposure would have fluctuated by less then $10,000.
Interest Rate Risk
     At September 30, 2010, we had unrestricted cash, cash equivalents and short-term investments totaling $237.0 million. These amounts were invested primarily in high quality securities of a short duration and are not materially affected by fluctuations in interest rates. The cash and cash equivalents are held for working capital requirements. We do not enter into investments for trading or speculative purposes. Due to the short nature of our short-term investments, we believe that we do not have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates. Declines in interest rates, however, would reduce future interest income.

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ITEM 4. Controls and Procedures.
     Our management, with the participation of our Chief Executive Officer and Chief Financial Officer (our principal executive officer and our principal financial officer), evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2010. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act of 1934, as amended (the “Exchange Act”), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of September 30, 2010, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level to enable us to record, process, summarize and report information required to be included in our periodic filings under the Exchange Act and to ensure that information required to be disclosed in such filings is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.
     No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the quarter ended September 30, 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II—OTHER INFORMATION
ITEM 1. Legal Proceedings.
     We are not currently a party to any material litigation, and we are not aware of any pending or threatened litigation against us that could have a material adverse effect on our consolidated financial position, results of operations, or cash flows. The software and communications infrastructure industries are characterized by frequent claims and litigation, including claims regarding patent and other intellectual property rights, as well as improper hiring practices. As a result, we may be involved in various legal proceedings from time to time.
ITEM 1A. Risk Factors.
     In addition to the other information set forth in this Quarterly Report on Form 10-Q and the risks discussed below, you should carefully consider the factors discussed under the heading, “Risk Factors” in Item 1A of Part I of our most recent Annual Report on Form 10-K, some of which are updated below. These are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Quarterly Report on Form 10-Q. Because of the following factors, as well as other variables affecting our operating results, past financial performance should not be considered as a reliable indicator of future performance and investors should not use historical trends to anticipate results or trends in future periods. These risks are not the only ones facing the Company. Please also see “Cautionary Statement” on page 12 of this Quarterly Report on Form 10-Q.
Risks Relating to Our Business
We rely on many distribution partners to assist in selling our products, and if we do not develop and manage these relationships effectively, our ability to generate revenue and control expenses will be adversely affected.
     As of September 30, 2010, we had 112 distribution partners. Our success is highly dependent upon our ability to continue to establish and maintain successful relationships with these distribution partners from whom, collectively, we derive a significant portion of our revenue, and who may comprise a concentrated amount of our accounts receivable at any point in time. Revenue derived through distribution partners accounted for 52% and 60% of our total revenue in the three months ended September 30, 2010 and 2009, respectively, and 51% and 62% in the nine months ended September 30, 2010 and 2009, respectively. One distribution partner accounted for 25% and two for 31%, of our total accounts receivable as of September 30, 2010 and December 31, 2009, respectively. Given the current global economic conditions, there is a risk that one or more of our distribution partners could cease operations. For example, one of our distribution partners entered into bankruptcy proceedings in January 2009, which caused us to increase our allowance for doubtful accounts as of December 31, 2008. Although we have entered into contracts with each of our distribution partners, our contractual arrangements are not exclusive and do not obligate our distribution partners to order, purchase or distribute any fixed or minimum quantities of our products. Accordingly, our distribution partners, at their sole discretion, may choose to purchase solutions from our competitors rather than from us. Under our contracts with our distribution partners, they generally order products from us by submitting purchase orders that describe, among other things, the type and quantities of our products desired, delivery date and terms applicable to the ordered products. Accordingly, our ability to sell our products and generate significant revenue through our distribution partners is highly dependent on the continued desire and willingness of our distribution partners to purchase and distribute our products and on the continued cooperation between us and our distribution partners. Some of our distribution partners may develop competitive products in the future or may already have other product offerings that they may choose to offer and support in lieu of our products. Divergence in strategy, change in focus, competitive product offerings, potential contract defaults, and changes in ownership or management of a distribution partner may interfere with our ability to market, license, implement or support our products with that party, which in turn may have a material adverse effect on our consolidated financial position, results of operations, or cash flows. Some of our competitors may have stronger relationships with our distribution partners than we do, and we have limited control, if any, as to whether those partners implement our products rather than our competitors’ products or whether they devote resources to market and support our competitors’ products rather than our offerings.
     Moreover, if we are unable to leverage our sales, support and services resources through our distribution partner relationships, we may need to hire and train additional qualified sales, support and services personnel. We cannot be assured, however, that we will be able to hire additional qualified sales, support and services personnel in these circumstances and our failure to do so may restrict our ability to generate revenue or implement our products on a timely basis. Even if we are successful in hiring additional qualified sales, support and services personnel, we will incur additional costs and our operating results, including our gross margin, may have a material adverse effect on our consolidated financial position, results of operations, or cash flows.

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We depend on a limited number of customers for a substantial portion of our revenue in any period, and the loss of, or a significant shortfall in orders from, key customers could significantly reduce our revenue.
     We derive a substantial portion of our total revenue in any period from a limited number of customers as a result of the nature of our target market and the current stage of our development. During any given period, a small number of customers may each account for 10% or more of our revenue. For example, two customers accounted for 28% and 21% of our total revenue in the three months ended September 30, 2010 and 2009, respectively, and one and two such customers accounted for 12% and 30% of our total revenue in the nine months ended September 30, 2010 and 2009, respectively. Additionally, we do not enter into long term purchase contracts with our customers, and we have no contractual arrangements to ensure future sales of our products to our existing customers. Our inability to generate anticipated revenue from our key existing or targeted customers, or a significant shortfall in sales to them could have a material adverse effect on our consolidated financial position, results of operations, or cash flows. Our operating results in the foreseeable future will continue to depend on our ability to effect sales to existing and other large customers.
If we are unable to manage our growth and expand our operations successfully, our business and operating results will be harmed and our reputation may be damaged.
     We continued to expand our operations in 2009 and the first nine months of 2010. For example, during the period from January 1, 2009 through September 30, 2010, we increased the number of our employees and full-time independent contractors by 39%, from 381 to 529. We have also increased the number of our employees and full-time independent contractors located outside the United States in multiple countries and as a result we are required to comply with varying local employment and tax laws for each of these new locations. In connection with the acquisition of Covergence in April 2009, we added 39 employees. In addition, our total operating expenses increased by 53% in 2007, 18% in 2008, 23% in 2009, and for the nine months ended September 30, 2010 were 26% higher than for the nine months ended September 30, 2009. We anticipate that further expansion of our infrastructure and headcount will be required to achieve planned expansion of our product offerings, projected increases in our customer base and anticipated growth in the number of product deployments. Our rapid growth has placed, and will continue to place, a significant strain on our administrative and operational infrastructure. Our ability to manage our operations and growth, domestically and across multiple countries, will require us to continue to refine our operational, financial and management controls, human resource policies, and reporting systems and procedures.
     We may not be able to implement improvements to our management information and control systems in an efficient or timely manner and may discover deficiencies in existing systems and controls. If we are unable to manage future expansion, our ability to provide quality products and services could be harmed, which would damage our reputation and brand and may have a material adverse effect on our consolidated financial position, results of operations, or cash flows.
Over the long-term we intend to increase our investment in engineering, sales, marketing, service, manufacturing and administration activities, and these investments may achieve delayed or lower than expected benefits, which could harm our operating results.
     Over the long-term, we intend to continue to add personnel and other resources to our engineering, sales, marketing, service, manufacturing and administrative functions as we focus on developing emerging technologies, the next wave of advanced technologies, capitalizing on our emerging market opportunities, enhancing our evolving support model and increasing our market share gains. We are likely to recognize the costs associated with these investments earlier than some of the anticipated benefits, and the return on these investments may be lower, or may develop more slowly, than we expect. If we do not achieve the benefits anticipated from these investments, or if the achievement of these benefits is delayed, our consolidated financial position, results of operations, or cash flows may be adversely affected.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds.
(a) Sales of Unregistered Securities
     None.

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(b) Use of Proceeds from Public Offering of Common Stock
     In October 2006, we completed an initial public offering, or IPO, of common stock pursuant to a registration statement on Form S-1 (Registration No. 333-134683) which the SEC declared effective on October 12, 2006. Pursuant to the registration statement, we registered the offering and sale of an aggregate of 9,721,179 shares of our common stock, and another 3,474,528 shares of our common stock sold by selling stockholders. The offering did not terminate until after the sale of all of the shares registered in the registration statement. We sold and issued 9,721,179 shares of our common stock, including 1,721,179 shares sold by us pursuant to the underwriters’ full exercise of their over-allotment option, at an issue price of $9.50 per share. The managing underwriters for the offering were Goldman, Sachs & Co., Credit Suisse, JPMorgan and Think Equity Partners LLC.
     We raised a total of $92.4 million in gross proceeds from the IPO, or approximately $83.2 million in net proceeds after deducting underwriting discounts and commissions of $6.5 million and other estimated offering costs of approximately $2.7 million. None of our net proceeds from the IPO have been utilized to support business operations. Pending such application, we have invested the remaining net proceeds in money-market mutual funds and United States agency notes, in accordance with our investment policy. None of the remaining net proceeds were paid, directly or indirectly, to directors, officers, persons owning ten percent or more of our equity securities, or any of our other affiliates.
ITEM 3. Defaults Upon Senior Securities.
     None.
ITEM 4. Removed and Reserved.
ITEM 5. Other Information.
     None.
ITEM 6. Exhibits.
The following is an index of the exhibits included in this report:
     
Exhibit No.   Description
 
   
2.1
  Agreement and Plan of Merger dated as of April 29, 2009 by and among Acme Packet, Inc., PAIC Midco Corp., CIAP Merger Corp., Covergence, Inc. and the stockholder representative named therein (incorporated by reference to Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed on April 30, 2009 (Commission File No. 001-33041)).
 
   
3.1
  Amended and Restated Certificate of Incorporation of the Registrant (incorporated by reference to Exhibit 3.3 to the Registrant’s Registration Statement on Form S-1 (Commission File No. 333-134683)).
 
   
3.2
  Second Amended and Restated Bylaws of the Registrant (incorporated by reference to the Registrant’s Current Report of Form 8-K filed on December 11, 2007 (Commission File No. 001-33041)).
 
   
10.1
  Lease Amendment entered into on July 12, 2010 and dated as of June 1, 2010 to the Lease, dated November 23, 2009, by and between MSCP Crosby, LLC and the Registrant.
 
   
31.1
  Certification of Chief Executive Officer, pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
   
31.2
  Certification of Chief Financial Officer, pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
   
32.1
  Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES
     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
  ACME PACKET, INC.
(Registrant)
 
 
Date: October 28, 2010  By:   /s/ Andrew D. Ory    
    Andrew D. Ory   
    President and Chief Executive Officer
(Principal Executive Officer)
 
 
 
     
Date: October 28, 2010  By:   /s/ Peter J. Minihane    
    Peter J. Minihane   
    Chief Financial Officer and Treasurer
(Principal Financial Officer)
 
 
 

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