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Riverbed Technology (NASDAQ:RVBD)

Q3 2008 Earnings Call

October 23, 2008 5:45 pm ET

Executives

Renee Lyall - Director of IR

Jerry Kennelly – President & CEO

Randy Gottfried - CFO

Eric Wolford - Sr. VP Marketing & Business Development

Analysts

Troy Jensen - Piper Jaffray

[Jason Ader] – William Blair

Samuel Wilson - JMP Securities

Kenneth Muth - Robert W. Baird

Ryan Hutchinson - Lazard Capital Markets

Erik Suppiger - Signal Hill

Cobb Sadler - Deutsche Bank Securities

Rohit Chopra - Wedbush Morgan

Matt Robison – Pacific Growth Equities

Tim Long – Banc of America

Steven Freitas - BMO Capital Markets

Bill Choi - Jefferies & Co.

Operator

Good afternoon ladies and gentlemen. Welcome to the Riverbed Technology third quarter 2008 conference call. (Operator Instructions) I'd now like to turn the conference over to Renee Lyall, Director of Investor Relations; please go ahead.

Renee Lyall

Good afternoon and thank you for joining us on today's conference call to discuss Riverbed's third quarter fiscal 2008 results. I’m Renee Lyall, Riverbed’s Director of Investor Relations. Joining me on the call today are Jerry Kennelly, Riverbed's President, Chairman and Chief Executive Officer; Randy Gottfried, Riverbed’s Chief Financial Officer; and Eric Wolford, Riverbed’s Senior Vice President of Marketing and Business Development.

Before we begin let me cover some administrative items. A press release detailing our third quarter financial results was distributed today at 1:30 pm Pacific Time via Business Wire. The press release is available on our website at www.riverbed.com.

We would like to remind you that during the course of this conference call, we may make forward-looking statements, including financial projections, statements as to the plans and objectives of management for future operations, statements as to management's beliefs regarding the potential size of the markets for our products and market growth including uncertain vertical markets and customer demand characteristics, statements regarding expected customer rollout plans and expected traction with service providers and system integrators, statements regarding the general commercial availability of our Atlas appliance, expected purchases under the stock repurchase program, statements regarding future tax rates and product margins and statements as to the company's future performance, financial condition or results of operations.

These forward-looking statements are not historical facts but rather are based on Riverbed's current expectations and beliefs and are based on information currently available to us. Words such as may, will, expect, intend, plan, belief, target, estimate, and variations of these words and similar words are intended to identify forward-looking statements.

By discussing our current perception of our market and making these forward-looking statements, we're not undertaking an obligation to provide updates in the future. Riverbed's actual results may differ materially from those projected in these forward-looking statements and no one should assume at a latter date that these comments from today are still valid.

The Risk Factors section of our 10-K and subsequent reports filed with or furnished to the SEC disclose risks that could cause these forward-looking statements to be incorrect. Any future product, feature or related specification that may be referenced in today's call are for informational purposes only and are not commitments to deliver any technology or enhancements.

Riverbed reserves the right to modify future product plans at any time. Riverbed’s management will also be discussing non-GAAP financial measures in today's call. Operating results for the third quarter of 2008 that exclude the impact of stock-based compensation, stock-based payroll expenses and related tax effects will be used. Also excluded from the third quarter operating results are expenses related to the settlement of our patent lawsuit with Quantum.

These non-GAAP financial measures are provided to facilitate meaningful year-over-year and quarter-over-quarter comparisons. Please see the exhibit to Riverbed's earnings press release issued earlier today for a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures and an explanation of why these non-GAAP financial measures are useful and how they are used by management.

On this call, Riverbed will also give guidance for the fourth fiscal quarter of fiscal 2008 using non-GAAP financial measures. We have not reconciled the forward-looking non-GAAP guidance that we will discuss today to comparable GAAP guidance because we cannot readily estimate the impact of our future stock price on our future stock-based compensation expenses.

I'd now like to turn the call over to Riverbed's Chairman, President and CEO, Jerry Kennelly.

Jerry Kennelly

Thank you Renee, welcome to our third quarter fiscal 2008 earnings conference call and I thank you joining us this afternoon.

We’re very pleased with the results we delivered for our third quarter despite weakness and uncertainty in the global economy Riverbed generated record revenues of $86.5 million and exceeded our guidance on both the top and bottom line.

Our revenues and non-GAAP operating income both increased 37% year-over-year. We generated more then $26 million in cash from operations in the quarter and our balance sheet is very healthy of solid cash balance and zero debt.

We added more than 500 new customers during the quarter and our cumulative customer count now exceeds 5,000. Our customers crossed every vertical and include small and medium sized businesses, large enterprises, and government entities.

Of the more notable Q3 wins include one of the world’s largest telecommunications companies, a large European insurance company, three of the largest biotechnology companies, and a global cosmetics company with annual sales of over $20 billion among others.

With these new additions we now count 147 of the Fortune 500 as Riverbed customers. Our customer base continued to purchase and deploy more Riverbed product during the quarter contributing $40.6 million to revenue.

Sales from existing customers have increased every quarter for more than two years. We believe our install base is one of our most valuable assets particularly if we begin to see tighter budget scrutiny going forward.

Within our customer base Riverbed’s value is proven and we benefit from ongoing deployment plans at many of these customers.

Our competitive position remains strong and we saw some good boomerangs in the quarter where deals where we replaced a competitors product. In one instance a customer was offered a free upgrade to a newer version of a competitive product. Instead this customer chose to rip out their old equipment and currently plan to replace all 70 sites with steelhead appliances.

We see this over and over again. Riverbed made several strategic announcements with both technology and channel partners during the quarter. Our acceptance into the Microsoft protocol optimization licensing program is important. Our relationship with Microsoft continues to evolve and we believe it has never been stronger.

Separately we announced an OEM agreement to imbed VMware software as the virtualization technology for the Riverbed services platform. With the VMware platform and [side] steelhead appliances, enterprises can further consolidate their IT infrastructure and improve manageability by running up to five different third party software modules without the need for separate dedicated servers.

We also announced two new service provider relationships, one with Digital Hands and one Pacnet. As of September 30 we counted almost 750 resellers worldwide as our channel partners. And in the next few weeks British Telecom will announce a new fully managed [inaudible] optimization service that will run worldwide. This new service is built on Riverbed steelhead product family.

BT chose Riverbed because our products performed the best in their testing, the steelhead family accelerates the broadest range of applications and has a superior mobile offering.

In the third quarter we also introduced new models of our steelhead appliance and we’re bringing additional models to market this year. The new 50 series of the steelhead platform has come out and it offers customers higher performance, better upgradability and a simpler support model.

The new hardware has more disks, greater data capacity, increased connections and handles more bandwidth. We believe this new platform will further enhance our competitive position.

As well you should know we recently hosted our first Analyst Day. At this event we outlined our technology vision of the new Atlas appliance. Atlas take the core deduplication technology of steelhead and extends it one step further to primary storage.

The long-term vision for the Atlas appliance is the ability to move and manage data as if it were all in one location. We do for service and storage what we did for [inaudible] networks.

As of now we have eight alpha customers up and running. We remain on target to make Atlas generally available in the first half of 2009.

Riverbed solves many of the problems IT managers face today when optimization is often critical to data center consolidation. It improves their productivity by distributed workforce and enables overall IT cost reduction.

By deploying steelhead many of our customers have been able to extend the life of their existing infrastructure and delay the purchase of additional bandwidth.

In the future we believe our customers will be able to delay the purchase of additional storage by deploying the Atlas appliance. We save our customers money. That fact resonates in any environment but we believe it is an especially strong message in the current economy.

With that I will turn the call over to Randy to discuss our third quarter results and provide our guidance for the fourth quarter.

Randy Gottfried

Thanks Jerry, revenue for the third quarter was $86.5 million up 6% compared to $81.6 million in the second quarter and up 37% compared to the $63.3 million one year ago.

Product revenue increased 4% sequentially and 24% year-over-year to $65.2 million. During the third quarter we added more then 500 new customers. New customers contributed 38% to product revenue and existing customers contributed 62%.

This is consistent with the second quarter. Taking a more detailed look at our steelhead products, the majority of our product revenue came from our 1U and 3U platforms followed by desktop and then mobile.

Sales of steelhead mobile increased slightly quarter on quarter and represented 4% of product revenue compared to less then 1% one year ago. Today more than 900 customers have purchased mobile and we estimate well in excess of 100,000 users.

The government vertical was especially strong in the third quarter at about 20% of product revenue. This vertical represents US Federal, state, local government as well as foreign government agencies. We made excellent progress in this area building a solid government sales team over the last year. That investment paid off in Q3.

We had no 10% end users during the quarter. We do have one US federal reseller that represented 11% of total revenue. We don’t expect that reseller to contribute more then 10% for the full fiscal year.

Turning to distribution 7% of our revenue was sold direct while 93% was through indirect channels. Geographically the US represented 63% of total revenue, EMEA contributed 24% and APAC plus rest of world was 13%. The increase in US as a percentage of revenue from 58% in Q2 to 63% in Q3 can be attributed to strong federal sales.

In absolute dollars revenue from EMEA was at record levels for Riverbed in the third quarter. We expanded our coverage in the EMEA region during 2007. It typically takes a sales person three to four quarters to ramp. EMEA has been strong for us year-to-date and better then expected during their slower summer months.

Our performance in APAC was not as robust as other geographies and an area we’d like to improve. third quarter service revenue was $21.3 million compared to $19 million in the second quarter and $10.8 million one year ago.

The majority of our service revenue comes from our support contracts and a small portion is from professional services. Let me shift over to the cost side.

non-GAAP product gross margin in Q3 was 74.6%. Our product gross margin was negatively impacted by significantly higher inventory obsolescence charges as we transitioned to a new hardware platform in the period.

As Jerry touched on earlier during the third quarter we began shipping the new 50 Series of our steelhead appliance. We introduced 10 new models in the third quarter and will be shipping three new models this month.

As we exit October we will have completely updated our hardware families. We expect this new hardware platform to provide a higher product gross margin over time.

The uptake of the 50 Series was more rapid then we expected. As a result during the third quarter we incurred $2.3 million of inventory obsolescence charges related to older hardware beyond the charges we incurred in Q2.

Excluding the impact of these additional charges from our reported Q3 results our non-GAAP product gross margin would have been 78.1% in the third quarter compared to 76.8% in the second quarter of 2008 and 73.3% in the third quarter of 2007.

Services gross margin for the third quarter was 71.6% compared to 70.2% in the prior quarter and 69.4% one year ago. Combined our non-GAAP corporate gross margin was 73.8%. Excluding the $2.3 million of additional charges in the third quarter our blended gross margin would have been 76.5% compared to 75.3% in Q2 and 722.7% one year ago.

During the third quarter we added 53 employees bringing our total headcount as of September 30 to 814. Non-GAAP operating expenses for the third quarter were $48 million. Consistent with our original guidance our third quarter expenses were almost flat with our second quarter expenses.

Sales and marketing expenses increased sequentially by $570,000. We increased headcount and incurred higher commissions in Q3 as compared to Q2 but we spent less on marketing programs in the third quarter. The second quarter is typically a heavier quarter for marketing programs.

Research and development expenses decreased somewhat from Q2 though headcount increased second quarter expenses related to the new 50 Series steelhead platform included some third party hardware design and testing fees that were non recurring.

General and administrative expense increased slightly to $7.9 million in Q3 from $7.7 million in Q2. Legal fees related to our IP litigation were approximately $2 million in the third quarter compared to about $1.4 million in the second quarter.

The non-GAAP operating margin was 18% compared to 17% in the second quarter and 18% one year ago. The non-GAAP tax rate for the third quarter was 36% compared to 14% one year ago.

Non-GAAP earnings were $0.15 per share based on approximately 74 million diluted shares outstanding compared to non-GAAP earnings per share of $0.13 in the second quarter and $0.17 one year ago at the lower tax rate.

non-GAAP net income excludes stock-based compensation, stock-based payroll expenses and related income tax effects and a one-time $11 million charge for the settlement of the patent infringement lawsuit with Quantum.

Settlement payment was made in October and you’ll see that payment reflected in our cash balance when we report our fourth quarter early next year.

On a GAAP basis we experienced a net loss of $0.17 per basic and diluted share in the third quarter. Moving on to the balance sheet Riverbed ended the third quarter with cash, cash equivalents, and marketable securities of $281.5 million, an increase over the June 30 balance of $269.3 million.

Accounts receivable days sales outstanding were 45 days compared to 50 days in the second quarter. We benefited from a handful of transactions that were paid with cash up front along with generally better collections.

Our targeted DSO range remains 50 to 60 days. Cash flow from operations was $26.5 million a substantial increase over $9.8 million in the second quarter. Our inventory balance at the end of the third quarter was $13.8 million. The sequential increase was expected due to the product transition I referenced earlier.

Total deferred revenue was $50.3 million an increase of 13% over the second quarter. The majority of our deferred revenue derives from maintenance and support contracts. Total equity was $217.1 million as of September 30. during the third quarter we purchased approximately 750,000 shares or $12.5 million of Riverbed stock at an average price of $16.59 a share under our buyback program.

We have $75 million remaining under the Board authorized buyback and we plan to continue to be active in the market in the fourth quarter. Looking forward I want to provide some guidance as we enter the fourth quarter.

The profit numbers I’m going to mention are non-GAAP which excludes stock-based compensation, stock-based payroll and related income tax effects.

We exclude these items from our guidance as we don’t use them for our internal operational decisions and also because it requires estimates of our future stock price which is obviously unknown and a significant driver for those calculations.

What the global economy is now experiencing is unprecedented and the macroeconomic environment remains uncertain. We still believe we’re selling into potentially very large market. Looking forward into the fourth quarter we see several positives.

Our pipeline remains robust, the new 50 Series platform will be generally available and we’ll be launching enhanced versions of our operating system, mobile client software, and Riverbed services platform during the fourth quarter.

As Jerry said earlier we believe that even as budgets may tighten companies will continue to spend on technology that provides a rapid and quantifiable return on investment. Also the fourth quarter typically exhibits seasonally stronger enterprise spending.

Offsetting these positives are a tight credit market, and an uncertain global economy. While we believe Riverbed is well positioned we’re unsure what the customer spending environment will be in the quarter. We are therefore taking a conservative position with respect to our guidance.

Assuming that the environment doesn’t change significantly we expect fourth quarter revenue between $87 million and $90 million. This brings our expectation for the full fiscal year to total revenue in the range of $328 million to $331 million which would be approximately 40% growth for the full year.

We expect fourth quarter non-GAAP gross margins between 76% and 77%. We expect a Q4 non-GAAP tax rate of 30%. This lower tax rate reflects the passage of the R&D tax credit in October and includes a year-to-date catch up benefit.

Longer term we expect our non-GAAP tax rate to be between 37% and 39%. We expect fourth quarter non-GAAP earnings between $0.15 and $0.17 per share based on approximately 74 million diluted shares outstanding.

We’re going through our planning for 2009 right now and we hope to provide more color on our fourth quarter call.

Jerry Kennelly

To summarize we had a solid third quarter and we’re encouraged by our growth in this economic climate. We continue to add new customers each quarter and each of these customers has the potential to be a much larger revenue contributor in the future.

While we’re cautious in the near-term, we remain confident in the long-term. Our vision is to change the nature of data so that information and applications can be instantly accessed from anywhere. We believe its clear that Riverbed has the potential to become a critical of the IT infrastructure and strategic vendor to every CIO.

With that said, we’ll be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Troy Jensen - Piper Jaffray

Troy Jensen - Piper Jaffray

The M relationship, could you give us an update on when you think that product will be ready for shipment and what has customer interest been to date?

Jerry Kennelly

That product will ship this quarter, a fourth quarter new product release. The customer interest is quite high. It’s a fascinating product to most CIOs to be able to run three, four, five different applications on top of the Riverbed hardware out in a branch office. A lot are running Windows servers on top of the steelhead in the branch office so we think it really is a competitive differentiator and something people really want.

Troy Jensen - Piper Jaffray

Juniper just reported on their earnings call that their WX series declined again, just curious what you see competitively, do you see Blue Coat more frequently or is it just you and Cisco?

Eric Wolford

For sure we see Cisco the most and that’s consistent with previous quarters but yes this quarter was the first time that the combination of Blue Coat and Packeteer was greater then Juniper. Juniper has been sort of in terms of our frequency of competing with them, has been on the decline the past two or three quarters.

Jerry Kennelly

Basically in the race for third and fourth place, Blue Coat is pulling ahead of Juniper.

Operator

Your next question comes from the line of [Jason Ader] – William Blair

[Jason Ader] – William Blair

Can you talk about what you’re seeing by geography right now, any color you can provide, heard a lot about weakness in western Europe. Obviously we know the US has been somewhat soft for awhile but are you seeing any major differences across the geography or is it just generally lousy everywhere.

Jerry Kennelly

We actually had a pretty good Q3 in Europe, Europe early on made a play even three years ago for a very large multi national companies with very large ongoing deployments and we’ve established a good team over there and so actually in summer, usually the weak quarter seasonally for most people in Europe, we had a very strong quarter there.

In terms of looking at Q4, the pipeline is robust in all places. Of course we’re cautious started about six months ago in our guidance requiring more dollars of pipeline per dollar of revenue guidance and that worked last quarter and we’re doing it again this quarter and so I wouldn’t say there’s huge differences right now between Europe and the US but its kind of wait and see. We have an optimistic sales force and a good pipeline and we just have to see how the economic effects make people buy or hold back.

[Jason Ader] – William Blair

Is it fair to say that you added an additional haircut of conservatism on the Q4 guidance relative to what you’ve done over the last two quarters?

Randy Gottfried

That would be fair to say, yes.

[Jason Ader] – William Blair

The competition from Cisco seems to be pretty intense I would say, what are you seeing from a product standpoint when you’re in front of customers? What do they not like about Cisco, what do they like about Riverbed, why are you winning when you win?

Eric Wolford

When we win which is as we mentioned in the past a vast majority of the time when we get in and compete we’re winning basically because the product performs better at some scale measure. They want to deploy to 10, 20, 50, 100 sites and we’re able to produce quite a few references of customers who are using it and who have bought more and are expanding their deployments and we find that is one of our biggest areas of strength is by pointing directly to happy customers and happy deployments and we take advantage of that in competitive situations.

[Jason Ader] – William Blair

Could you talk about any seven figure deals?

Randy Gottfried

We had a handful of bigger deals. Like most of our quarters the vast majority of our transactions are under $100,000, most of our revenue is under $100,000 transactions, so no dramatic this quarter certainly then our last couple of quarters.

[Jason Ader] – William Blair

Do you think that’s an advantage that your deal sizes are under $100,000 in this kind of environment?

Randy Gottfried

I think so, we have a very nice diversified revenues stream both in, with a lot of smaller transactions with a diverse customer base and I think that’s overall goodness. Its not to say we don’t focus a lot of attention on bigger customers because they ultimately have a lot of revenue potential but again it’s a nice fact that we have a very diversified customer base.

Operator

Your next question comes from the line of Samuel Wilson - JMP Securities

Samuel Wilson - JMP Securities

You mentioned $2 million in litigation expenses for the third quarter as you wrapped up the Quantum settlement, does that imply that that won’t be needed in the fourth quarter or the first quarter, is that sort of it for litigation?

Randy Gottfried

The vast majority of expenses related to Quantum for us were incurred in the third quarter. The settlement took place at the very end of the quarter.

Samuel Wilson - JMP Securities

So do you have any other big outstanding litigation issues right now or is that just you can finally stop spending money on lawyers?

Randy Gottfried

Certainly that was our big chunk right there.

Samuel Wilson - JMP Securities

You mentioned Asia Pacific did a little weaker then expected, you said you were going to work on it, what’s the idea to work on it, just blocking, tackling issues.

Jerry Kennelly

Yes, Asia Pacific is our newest area, its an emerging market, it’s a smaller market for us, it just tends to be chunky and lumpy sometimes and we have a good team out there and a good customer base but, exactly its execution, blocking and tackling and going after it.

Samuel Wilson - JMP Securities

Give us your two cents on what’s going on in the financial services vertical from your perspective.

Jerry Kennelly

Financial services for us was in its normal range. We talk about this group of customers that are usually between 8% and 12% of revenue each quarter and they were in that range again this quarter. I wouldn’t call it a robust group and they were more toward the lower end of the range this time but they keep buying. Some of the names you hear about as the most troubled, made reasonable sized buys from us this quarter.

We become part of deployments that are important for their overall cost cutting. If you’ve committed to a server consolidation, data center consolidation program to get your overall cost structure down, you need to keep going with it and really banks are just big computers these days. We’re blessed in that they’re not a huge part of our revenue stream but they continue to buy and we expect them to continue to buy.

Operator

Your next question comes from the line of Kenneth Muth - Robert W. Baird

Kenneth Muth - Robert W. Baird

Can you give us any sense of what you’re seeing right now the first few weeks of October and how things have tracked because it sounds like just in general a lot of people saw a slowness in the last two weeks of September to end the quarter, I’m just wondering if things changed in October.

Jerry Kennelly

The last two weeks of September we sold a lot of products even in a troubled market. We don’t comment specifically on the current quarter other then to say that we’ve encompassed what we’ve seen into the guidance we’ve given for Q4. we’re cautiously optimistic.

Kenneth Muth - Robert W. Baird

On the international front, any things you’re hearing back in those outside international markets, currency headwinds and anybody asking for discounts, or any feedback you’re getting from potential customers overseas about being disgruntled about exchange rates turning around.

Jerry Kennelly

We haven’t seen any broad move on that front, that is something that you have to be concerned about. The truth is the currencies are jumping back and forth in both directions and so trend has emerged yet but we’re keeping our eye on that. Our international expenses are based in foreign currency not US dollars so we’ll get some benefit there.

Kenneth Muth - Robert W. Baird

On the federal government that obviously was very strong, I would assume just the normal year end kind of budget flush if you will, how do you expect that to be next year as obviously things are changing in the Presidential situation?

Jerry Kennelly

We had a very robust quarter, what we did was, almost 18 months ago we doubled down in the federal market with staff and people focused on that and that paid off very well for us in the third quarter. We expect the fourth quarter to be decent, probably not as robust as Q3 but we expect year-over-year growth in the fourth quarter in federal and it’s a good market. The government is the one that seems to have money to spend. On the same tone about 12 months ago we started investing in the service provider space and we’re starting to see those things come to fruition and expect some benefit in 2009 from what we’ve done in the service provider space similar to the benefit we’ve seen in the federal.

Operator

Your next question comes from the line of Ryan Hutchinson - Lazard Capital Markets

Ryan Hutchinson - Lazard Capital Markets

Coming off your Analyst Day a lot has transpired, just wanted to get a sense of the final two weeks of the quarter you indicated you sold a lot of product but maybe quantify the deal slippage versus cancellations and deals that perhaps have since closed to give us some comfort in the guidance you provided for Q4.

Jerry Kennelly

I’m unaware of deal cancellations frankly. It was strong right until midnight last day of the quarter, it was pretty robust around here. I think there probably was some slippage and in a better environment we would have had a much bigger number to announce for September but I’m not aware of anything that actually has gone away for good.

Ryan Hutchinson - Lazard Capital Markets

On Atlas, just a progress with beta customers expectations perhaps on potential OEM relationships if that make sense for the product and then if you’re willing to talk pricing just in terms of margin structure versus the corporate average.

Eric Wolford

We are in alpha as we said we were going to go into and we have eight alpha customers. The expected for taking revenue on the product is still in the first half of 2009, so no change in the month since we talked last. Things are progressing. In terms of margin structure we don’t expect, its still too early we’re not announcing pricing but from a planning perspective you might think margins that are similar to what we’ve done in the past.

Ryan Hutchinson - Lazard Capital Markets

The largest carrier customer I guess you talked about is that a US based carrier and is that a managed service offering and if so how large of an opportunity do you think that could be.

Jerry Kennelly

I talked about British Telecom, so they’re a global service provider and they do a lot of managed services for customers and they want to have a specific optimization offering globally for all their customers and that’s Asia Pacific, that’s US and that’s EMEA and there was actually an event today in London where there was some hoopla and they’ll put out a press release in the next couple of weeks announcing it broadly so we think they’re a big major global service provider. We’re in progress with virtually all the others and we’re doing one-off nice size deals with all of them right now and hope to do with a number of them what we’re doing with BT which is specific managed service offerings on their price list that’s easy for their reps to sell in a systematic way rather then it having to be a one-off. Service providers move a lot of equipment and a lot of software particularly to the larger customers we seek to go to and they give us the feet on the street that we need to go up against some of those big guys that you may be familiar with. We have a great guy, the head of our service provider organization, he’s doing a great job and we’re optimistic what that will yield for us in 2009.

Ryan Hutchinson - Lazard Capital Markets

A lot of investors are kind of itching to understand how things shape up over the next six to 12 months obviously and there’s a lot of unknowns out there, but just generally speaking do you think that you’re in a position given the growth opportunity to grow sequentially at a nominal rate, but grow sequentially throughout the next four quarters?

Randy Gottfried

I think we’re in our planning process right now. There’s a little more uncertainty in the environment right now. I think in general we remain as optimistic as we ever have been about the long-term potential in the business. We’ll talk more on 2009 after this quarter.

Jerry Kennelly

Again 2008 hasn’t been easy for anyone, not just this quarter but all the way back to the beginning and yet here we have a company, we’ve done 40% year on year growth in a year that’s been tough for everyone in a market where most people are thrilled to get the 15% or 20% growth so we have a strong story and a great product.

Operator

Your next question comes from the line of Erik Suppiger - Signal Hill

Erik Suppiger - Signal Hill

Just on linearity, can you discuss how the quarter progressed between the three months then as you got into September how was business in the first half of September versus the second half?

Randy Gottfried

We typically don’t go into much detail, in general it was within the realm of historical norms. Typically July and August are somewhat lighter months.

Erik Suppiger - Signal Hill

And was September half of your sales?

Randy Gottfried

We’ve not given our specifics on that. Our general goal is roughly 50% in the first two months of the quarter and 50% in the last part of the quarter with some variation quarter on quarter.

Erik Suppiger - Signal Hill

And was that the case this quarter?

Randy Gottfried

I would say it was not far from there.

Erik Suppiger - Signal Hill

On the BT relationship is that something that gradually ramps over time, or is that something that takes in volume in terms of initial shipments or how does that work?

Jerry Kennelly

It should ramp over time. We do deals with BT right now here and there, one by one. This gives it more of a vehicle to make that more systematic and standard particularly for the BT sales organization but any of those giant companies, it’ll ramp through the first, three, four, six, nine months and then pick up a lot of momentum and hopefully throw up a bunch of revenue over time.

Erik Suppiger - Signal Hill

Its not as though it has a material impact on the Q4?

Jerry Kennelly

No there’s no big order that comes with signing the deal. But they do come.

Erik Suppiger - Signal Hill

On the government piece, I think that was 20% can you discuss how much of that is the federal government versus worldwide.

Randy Gottfried

We’re not going through much detail but most of it, certainly the majority of it is US federal.

Erik Suppiger - Signal Hill

You got some more models coming out, are those again just chassis upgrades or are you going to be introducing any extension of the existing product line right now?

Eric Wolford

This quarter we’re announcing new models, new hardware platforms of our 3U platform, the 50, we’re also announcing new software, [Rios] 5.5 will be announced and that comes with a whole suite of features. I think we talked about RSP with VMware and our ability to have five separate individual third party software modules working on steelheads. There’s a raft of other things that are coming as well. It’s a big quarter for new software release and new hardware platforms.

Operator

Your next question comes from the line of Cobb Sadler - Deutsche Bank Securities

Cobb Sadler - Deutsche Bank Securities

On the management services vendors that you currently ship to, are you breaking out a number, like EDS or maybe some Telco that you’ve already signed up, what percent of revenue that is, do you break that out or not?

Jerry Kennelly

We breakout systems integrated services provider together and I think it was 25% of the business this quarter.

Cobb Sadler - Deutsche Bank Securities

And that I guess next year with some new carriers that you’re signing up that’ll go up, any target level that you might want that to hit?

Jerry Kennelly

No target yet, actually we’re hoping to expand the whole business as well as just take over the business. We’re looking for market expansion.

Cobb Sadler - Deutsche Bank Securities

On the Atlas product you say that you’ve got eight alpha customers now, but I’m assuming they’re trialing a box that works, and so and you’re talking about GA basically first F09, should we be looking at the first half of 2009 given that the box does work today?

Eric Wolford

Because this is a one [inaudible] product and it is in a storage environment, in storage environments and storage businesses, often the alpha beta process is a bit longer because you have to be particularly sure that you’ve ironed out all of the bugs and so we are allowing for, purposely, for a very long alpha beta process.

Cobb Sadler - Deutsche Bank Securities

On Asia Pac was the book-to-bill there greater then one, was it, is business slowing down or was it just kind of a lower revenue quarter for you?

Randy Gottfried

I’d say the latter.

Operator

Your next question comes from the line of Rohit Chopra - Wedbush Morgan

Rohit Chopra - Wedbush Morgan

On the BT deal was that competitive or are there any other service provider deals where there have any exclusivity?

Jerry Kennelly

In general exclusivity is not generally part of the way that business works. Its really the service providers want to sell what the customers want to buy and they determine the customers want to buy steelheads. I think most of them will also make available other products from other competitors. Its usually not exclusive.

Eric Wolford

Often times its not contractually exclusive but what ends up happening with service providers is that functionally they only institutionalize or operationalize or systematize two at the most three, vendors for a managed service. So there is some notion of a functional partial exclusivity that one gets when you become that managed service that they proactively offer.

Rohit Chopra - Wedbush Morgan

You mentioned a bunch of segments where deals were signed, can you just point to some where maybe spending continues, spending through the cycle, maybe some strong verticals specifically?

Jerry Kennelly

As an example other verticals that were especially strong in the third quarter along with federal were energy, we had insurance I think we had a solid quarter for as well. It varies. The great thing about the business has been just how diversified its been and we’ve had quarters of variability over the course of since been shipping but that sort of portfolio effect has served us well.

Rohit Chopra - Wedbush Morgan

I’m assuming there’s not change in any long-term targets or anything like that, even given your caution.

Randy Gottfried

No our long-term targets remain the same.

Operator

Your next question comes from the line of Matt Robison – Pacific Growth Equities

Matt Robison – Pacific Growth Equities

Are you looking for any more alpha customers for the Atlas?

Eric Wolford

We’re always looking for alpha, but we’re probably progressing now from alpha to beta.

Matt Robison – Pacific Growth Equities

How many more in your normal flow would you expect to have to have to have the right kind of statistics you need to get through beta?

Eric Wolford

We tend to be on the big side historically, Riverbed went with a large alpha beta program for the steelhead product. We like to do that because it gives us the best broadest experience about what real world workloads look like. And so I would expect us to get into double-digits for alpha and beta customers.

Operator

Your next question comes from the line of Tim Long – Banc of America

Tim Long – Banc of America

On some of the expense items, first of all the inventory write-down, $2.3 million in obsolescence, is that correct?

Randy Gottfried

That was additional, yes.

Tim Long – Banc of America

That’s going to be most likely a one-time type of charge with no new products that are coming out or anything like that that are going to have that roll into fourth quarter, right?

Randy Gottfried

We certainly believe that’s the case.

Tim Long – Banc of America

The litigation fees they’re going to come out of operating expenses or do you think you’re going to move that money around within your operating budget.

Randy Gottfried

Technically we won’t necessarily re incur those expenses. In general when we think about our operating expenses in Q4 we are still selectively carefully hiring. We have other things that we’re doing as a company but technically those litigation expenses go away.

Operator

Your next question comes from the line of Steven Freitas - BMO Capital Markets

Steven Freitas - BMO Capital Markets

Regarding the types of applications that people are using this technology for, are you seeing any patterns in terms of relative strength of say data center to data center application versus branch centralization and optimization?

Eric Wolford

The patterns remain consistent which is that there’s four main reasons why people write the checks. All I would say that’s sort of changing is that cost savings is now becoming a bigger part of our conversation with the customer even more then it already was so things that drive a very hard return on investment, a very quick payback which include things like consolidation, remote site consolidation, bandwidth reduction where instead of going to an OC12, I use my OC3 and I buy boxes at both ends to avoid that bandwidth upgrade. Those types of value propositions are of more interest then they were in the past.

Steven Freitas - BMO Capital Markets

Is there anything new that you see percolating, one that comes to mind is BDI as a tool to improve that--?

Eric Wolford

The thing that is really appealing to us is the notion that cloud computing is often talked about as this sort of general concept but the idea that data is consolidating and concentrating in one place and users are far, far away, the distance between data and users increasing is a wonderful trend that continues and will continue to grow because of people looking at cost control and one of the best ways to control cost is to consolidate.

Steven Freitas - BMO Capital Markets

And in terms of customer size, you see any particular strength or weakness in large customers, large enterprise, global enterprise versus smaller or vise versa?

Eric Wolford

No we don’t. I can’ say we’ve seen a different pattern from the previous quarters. We get a mix, we get some very large customers who are buying and we get medium and smaller customers so that pattern has remained consistent.

Steven Freitas - BMO Capital Markets

But in terms of pushback in terms of budget, is any one customer size segment--?

Eric Wolford

Nothing obvious.

Operator

Your final question comes from the line of Bill Choi - Jefferies & Co.

Bill Choi - Jefferies & Co.

On that answer to cloud computing can you confirm whether you are involved in some of these major cloud computing build out that’s going on, guys like Microsoft are spending a lot of money doing the data center push, how do you fit into this and in competing for those businesses where they would now determine what goes into their own data center, how do you compete with guys like Cisco for those kinds of deployments?

Eric Wolford

Cloud computing represents both an architecture which is where you consolidate things into just a few data centers and a business model which is do you buy these from a service provider or do you do it yourself. Certainly we are selling into the do it yourself cloud computing model inside of enterprises today, that is sort of a bread and butter for Riverbed. An opportunity for Riverbed as we look forward is getting into the business model of companies that are providing these cloud computing services. We do see that as an opportunity for us. It doesn’t represent a big part of our base our revenue and does represent an opportunity for us and yes, I’m sure we’ll be competing with our regular set of competitors, namely Cisco as we try to make advances there.

Bill Choi - Jefferies & Co.

If these build outs are going on today, when do you think the win optimization portion of the decisions will be made?

Eric Wolford

There’s two things that are happening, first the applications that people are using initially are light weight not heavy weight data applications and as the applications that people are using in those cloud computing environments become more heavy weight where there’s more data that is being passed back and forth, then the need and the problem will be much more apparent and that’s probably something that I imagine will be a battle for first half, second half 2009.

Bill Choi - Jefferies & Co.

I think Microsoft which hasn’t made a GA yet, but I heard they have 10 beta customers, are you specifically in those beta testing?

Eric Wolford

Not that I know of.

Jerry Kennelly

Well thank you everyone for participating. We appreciate the support and the interest and we’ll go forward into Q4 and be talking to you again in January.

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Source: Riverbed Technology Q3 2008 (Qtr End 09/30/08) Earnings Call Transcript
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