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Riverbed Technology, Inc. Q4 2008 Earnings Call Transcript

February 03, 2009 | about: RVBD

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Riverbed Technology, Inc. (RVBD)

Q4 2008 Earnings Call Transcript

February 3, 2009, 5:00 pm ET

Executives

Renee Lyall – Director of Investor Relations

Jerry M. Kennelly – Chairman, President and Chief Executive Officer

Randy S. Gottfried – Chief Financial Officer

Eric Wolford – Senior Vice President of Marketing and Business Development

Analysts

Jason Ader – William Blair & Company

Troy Jensen – Piper Jaffray

Samuel Wilson – JMP Securities

Nikos Theodosopoulos – UBS

John Marchetti – Cowen and Company

Simona Jankowski – Goldman Sachs

Kenneth Muth – Robert W. Baird

Sanjiv Wadhwani – Stifel Nicolaus & Company

Jonathan Ruykhaver with Thinkequity

Alex Kurtz - Merriman, Curhan Ford & Co

Erik Suppiger – Signal Hill Group LLC

Rohit Chopra – Wedbush Morgan Securities Inc

Scott Zeller – Needham & Company

Presentation

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Riverbed Technology fourth quarter 2008 conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions). This conference is being recorded today, February 3, 2009.

I'd now like to turn the conference over to Renee Lyall, Director of Investor Relations. Please go ahead.

Renee Lyall

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

Before we began let me cover some administrative item. A press release detailing our fourth quarter financial results was distributed today at 1:15 pm Pacific Time via Business Wire. The press release is available on our website at www.riverbed.com.

This conference call is being website live via the Internet at riverbed.com/investor and will be achieved on our website for the next 12 months. The information represent discuss today will include forward-looking statements including without limitation statements about Riverbed’s financial results, business, financial outlook and stock repurchase program. These forward-looking statements are only predictions and involve risks and uncertainties such that actual results may vary significantly. These risks are set forth in detail on our form 10-K for the fiscal year ended December 31, 2007, and in our form 10-Q for the third quarter ended September 30, 2008.

These forward-looking statements reflect belief, estimate and predictions as of the date of this call. Riverbed disclaims any obligation to update any forward-looking statements. Certain financial information that we review on today's conference call is presented on a non-GAAP basis. The non-GAAP results exclude certain expenses to provide what Riverbed believes is a more complete understanding of our underlying operational results and trends.

Non-GAAP financial measures should be considered in addition to results prepared in accordance with GAAP but should not be considered a substitute for or superior to GAAP results. The most directly comparable GAAP information, the reasons why management uses such information and a reconciliation between non-GAAP and GAAP figures is provided in our Q4 2008 press release which has been furnished to the SEC on Form 8-K today.

We will also refer to certain non-GAAP financial measures on today's call such as non-GAAP gross margins and tax rate that were not reconciled to comparable GAAP measures in today's press release. We have posted a reconciliation of these non-GAAP financial measures to their most directly comparable GAAP measure on the Investor Relations portion of our website.

On this call Riverbed will also give guidance for the first fiscal quarter of 2009 using non-GAAP financial measure. We had not reconcile the forward-looking non-GAAP guidance that we will discuss today to comparable GAAP guidance because we can not readily estimate the impact of our future stock price on our future stock-based compensation expenses.

Any future product, future or related specification that maybe referenced in today's call are for informational purposes only and are non-commitments to deliver any technology or enhancement. Riverbed reserves the right to modify future product clients at any time.

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

Jerry Kennelly

Thank you. Renee. Welcome everyone and thank you for joining us this afternoon to discuss our fourth quarter and full year of 2008 financial results. We are pleased with the results we delivered in Q4. Despite weakness and uncertainty in the global economy, we generated record revenues of $92.2 million and exceeded our guidance on both the top and bottom lines.

Our revenue and non-GAAP operating profit both increased more than 20% year-over-year and our balance sheet is healthy with a solid cash balance of $268 million and no debt. For the full year of 2008, Riverbed achieved 41% revenue growth over 2007. We added more than 2000 new customer and now boost more than 5500 customers worldwide.

During the fourth quarter, we have some significant wins, including two Global 100 pharmaceutical companies, two global 100 insurance firms. One of our largest consumer goods companies was annual sales exceeding $30 billion. With these recent additions, we now come 49 of Forbes Global 100 as Riverbed customers. 2008 marked to turning point for WAN optimization and Riverbed in three key areas. First of all, WAN optimization has now become a main stream proven technology solution, appearing as a top priority item on CIO service.

WAN optimization deployed across all verticals in a largest companies and government organizations around the world. Secondly, Riverbed is widely recognized as the innovator and technology leader in growing WAN optimization market. For example, we net named Riverbed WAN acceleration as one of the top ten most influential business technology products of 2008 along site Amazon’s Web Services, Apples iPhone and force.com from sales force.

The InfoWorld named our Steelhead Appliances technology of the year as best WAN accelerated for the fifth year running. We have been awarded this honor every year since we began shipping. My own personal experiences and those of the sales team reinforce these positive reviews. We don’t have to spend as much time talking about why choose Riverbed anymore. The Riverbed has proven that it is best in class and our win rate continues at 9 out of 10. The turnkey theme we saw in 2008 was at ROI and short pay back period of deploying Riverbed solutions are compiling. Back in 2006 and 2007 our customers were buying our products primarily to prove the application performance little effort at low cost.

The times have changed in 2008 and as we entered 2009, IT organizations have come under pressure to save money, to drive cost on their infrastructure, to do more with what they have. And this increasingly challenging environment, IDT departments are doing their hard work to rearchitect their network and data infrastructures to make them more efficient. They are virtualizing service consolidating data centers and eliminating as many boxes as they can for the remote offices.

WAN optimization in place a critical role in the rearchitecting of IT infrastructures and is often a must have in this budget constrained environment. Riverbed provides the only end-to-end platform that optimizes performance while cutting cost from IT. Here are two customer examples. Leveraging Riverbed WAN optimization as a critical component of its consolidation strategy, when customer is able to differ telecom spending and more quickly consolidate local servers and centralized applications across 100's of sites.

This company estimates $6.5 million in net savings for the first year alone. Over a five year period the customer projects savings in servers energy consumptions, telecom and head count to be $100 million. Another customer are large U.S. based software company presumably cut product testing time in half by deploying Steelhead appliances.

The time to market advantage here isn’t measurable. For these another reasons I am carefully optimistic about the opportunity before us. We are selling a proven and differentiated product, that reduce this costs and results real business problems, and selling this into an interpenetrated market. Switching gears I want to highlight recent announcements that reinforce our strategic value to COIs.

Two weeks ago, we announced our agreement to acquire Mazu networks. We’re excited about of the feature of the combined company. Our sales kick off to place the same week as we made this announcement and the reaction from our sales force was overwhelming positive. We believe there is considerable opportunity to sell Mazu’s products just within our existing customer base. Last week HP ProCurve announced their Open Network Ecosystem with Riverbed as the only WAN optimization provider.

Our inclusion in ProCurve ONE highlights our position as the technology leader and preferred WAN optimization vendor for HP. It still had a plans in ProCurve switches can be sold as a combined solution today by any of HP’s resellers. A fully integrated blade solution will also be available for the second half of this year. Today we announced our E-Lab publication with EMCs SRDF/A product. This is an important qualification by a major storage vendor for a business continuity and disaster recovery solution and it opens up a new revenue opportunity for us in 2009.

We are pursuing additional qualifications with other storage vendors and hope to be updating you soon. Finally, we recently announced new managed service offerings with NTT America and SingTel. Currently we have more than 60 service provider partners and we have got managed service offerings with more than a dozen of them. Some of our largest managed service partners include AT&T, British Telecom, Orange and Verizon, remain focused on this targeted area of growth and we believe we will experience increased traction as a managed service offering with the addition among this product through existing sweeter products.

I would also like to provide an update on our RiOS product, were down through more than three months of wafer testing with dozen of our customers. These after deployments and real customer environments have provided invaluable information, far beyond what to be learned in a lab. Customers clearly liked the concept and the hard benefit of the duplication through their out there infrastructure. While we have also seen that original approach can be simplified to better address customer needs and give us a bigger market opportunity.

We remain excited by the long-term opportunity we will be delaying an initial shipments through 2009 in order to make the necessary product adjustments. We promised a very engaged in testing with our customers and prospects throughout the year. Before I turn the call to Randy, I want to talk briefly about how we are managing our operations in the current economic climate.

We are actively controlling our expenses, we hire relatively few people in the fourth quarter and in 2009 any headcount including backdoors will be approved on case by case basis. We are carefully evaluating all spending decisions, Riverbed remains the growth company and we will continue to prudently allocated resources of take advantage of our market opportunity while maintaining their commitment to profitability. With that now I would like to turn it over to our CFO, Randy Gottfried.

Randy Gottfried

Thanks Jerry. We are please by our performance in the December quarter with continued growth in revenue and new customer acquisitions. Total revenue increased 7% sequentially and 21% year-over-year to $92.2 million in the fourth quarter. Product revenue grew 3% sequentially and 6% year-over-year to $67.4 million.

Revenue from new customers in the fourth quarter represented 41% of a product revenue up from 38% in Q3. 59% of our product revenue came from existing customers. The government verticals were strong again in the fourth quarter contributing about 20% to product revenue. And this vertical represents U.S. federal state and local as well as foreign governments.

Our revenue stream continues to be very diversified. For the year we had no 10% customers or channel partners, also consistent with last year, we had about six verticals each contribute plus or minus 10% to product revenue and the remaining verticals each contributed about 5% to product revenue.

Despite the disruption in the financial industry, financial services represented the same percentage of product revenue in 2008 as we did in 2007, right around 10%.

Turning to distribution, 93% of our revenue came from indirect channels with the remaining 7% coming from direct sales of the indirect portion of our business about 30% came from Systems Integrators, and Service Providers. Geographically the U.S. represented 55% of total revenue, EMEA contributed 30% and Rest of World was 15%. In absolute dollars revenue from EMEA was at record levels increasing 37% sequentially and 79% year-over-year.

Revenue contribution from the Rest of the World increased 13% sequentially and it was about flat year-over-year. Fourth quarter service revenue was $24.9 million compared to $21.3 million in the third quarter and $13 million one year ago.

The majority of our service comes from our support contracts. Shifting to the cost side as a remainder of the number I will discuss our non-GAAP, the most direct comparable GAAP information and the reconciliation between non-GAAP and GAAP figures is available on our website at riverbed.com/investors.

Product gross margin was 77.4% in Q4, services gross margin came in at 71.8%, combined our gross margin was 75.9% we excited December with 857 employes.

Sales and marketing expense increase sequentially in absolute dollars and as a percentage of revenue to 37% in Q4, as we had added some sales people and paid year-end commission accelerators.

R&D expense increased versus Q3 in absolute dollars, but remained flat at 13% of revenues. G&A expenses decreased quarter-over-quarter and absolute dollars and as a percentage of revenue to 7%. With the settlement of the last two in the third quarter, legal cost reductions made up most of the decline. Our operating margin was 19% this quarter up from 18% in Q3.

The non-GAAP tax rate for the fourth quarter was 27.7% compared to 14% one year ago, as a reminder our tax rate this quarter benefitted from the renewal of R&D tax credit late in the year and generated a year-to-date catchup. Non-GAAP net income was $13.6 million or $0.19 per share up from net income of $11 million or $0.15 per share in Q3. We generated a GAAP profit of $23.3 million or $0.33 per diluted in Q4.

GAAP net income was possibly impacted by the release of $28.7 million related to our deferred tax asset valuation allowance, which resulted in a net $16.7 million tax benefit in the quarter. Moving to the balance sheet, Riverbed ended the December quarter with cash and cash equivalents and marketable securities of $267.8 million and we continue to have no debt. As a reminder we made $11 million loss with settlement payment in October excluding this payment non-GAAP cash flow from operations was $20 million in the fourth quarter.

Accounts receivable days sales outstanding were as 46 days flat from third quarter and below our targeted 50 to 60 day range. Despite the challenging credit market our collections remained strong. Inventory totaled $10.6 million at December 31, down 23% from $13.8 million at September 30. Total deferred revenue was $58.2 million an increase of 16% over the third quarter, the majority of our deferred revenue to arise from maintenance and support contracts.

Total equity was $293.8 million as of December 31. During the fourth quarter, we purchased 2.5 million shares or $25 million of Riverbed stock under our buyback program at an average price of $10.08 per share. Turning to our forward outlook given the limited visibility in this unprecedented and unpredictable global economy will only be providing formal guidance for our first quarter. The numbers I am going to discuss are non-GAAP, which excludes stock-based compensation, stock-based payroll and related income tax effects and certain charges related to the acquisitions of Mazu.

Our first quarter estimates also exclude a purchase accounting adjustment to Mazu’s deferred revenue. Looking forward, we see several positives. Our pipeline remains solid, our competitive position is strong and we are selling the lean product into potentially large an untapped market. There is a low total cost of ownership for Riverbed products and we believe companies will continue to spend a technology that allows them to leverage their existing investments and delivers a tangible ROI.

Partially offsetting these positives is a seasonally weaker first quarter and a very uncertain economy. While we believe Riverbed is well positioned, we are unsure what the customer-spending environment will be.

Our first quarter guidance assumes the Mazu acquisition gives us about one month of revenue and expenses. We expect first quarter revenue to be in the range of $83 to $86 million growing 14% to 18% over the prior year. This assumes about $1 million of revenue contribution from Mazu in the first quarter as part of Riverbed. We expect non-GAAP gross margin to be roughly flat with the fourth quarter. Operating expenses will be up slightly from Q4, as we will have full quarter of expenses from people who have joined in the December quarter along with a handful of new hires to start in Q1. Certain payroll taxes like FICA in the U.S. that knocks out for many before a yearend also restart beginning in January.

Again we expect to also have about one month of Mazu expenses. We expect other income to drop from about $1.5 million in Q4 to a $1 million in Q1. As interest rates and treasuries and other high quality securities have fallen dramatically over the last six months, we're starting to see a significant drop in other income as our older securities mature and have to be reinvested at the new low rates. We expect the Q1 non-GAAP tax rate of 35%.

Mazu is expected to be dilutive by about a penny share in Q1, inclusive about we're forecasting non-GAAP earnings between $0.09 and $0.10 per share based on approximately $72 million diluted shares outstanding. Looking beyond the first quarter and to 2009 our general approach is to hold the expense essentially flat from the Q1 level normalized for the addition of Mazu and for getting the revenue traction we expect we've planned it carefully add some resources to provide fuel for that growth.

If our estimates are materially asked we’ll appropriately manage our expenses to get them inline with the revenue outlook. I'll now turn the call back over to Jerry.

Jerry Kennelly

Thank you, Randy. To summarize, we're overall pleased with the direction of our business, Riverbed has recognized as the IT infrastructure performance company that gives CIOs in order of magnitude boost in the value of their existing network and application investments that allows them to cut dollars from the budget without sacrificing their IT strategy.

We are selling what we believe is the must have for budget constrained CIOs. There is no doubt 2009 will be a challenging year, but we believe we are in an amiable position. Our low cost of ownership Riverbed products offer a fast and measurable ROI which is the best message to be selling in this environment.

With that said Eric, Randy and I would now be happy to answer any questions that you may have. [Nicole] you can open it up for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) Our first question comes from the line of Jason Ader with William Blair, please go ahead.

Jason Ader – William Blair

Thank you guys. How are you doing?

Jerry Kennelly

Hi, Jason.

Jason Ader – William Blair

So, the questions I had first for the fourth quarter do you have any 10% customers you talked about for the full year, you didn’t, but I was wondering for the fourth quarter?

Jerry Kennelly

No.

Randy Gottfried

No.

Jason Ader – William Blair

Okay, and then, this is kind of a Atlas question and I want to ask one general question, but on the Atlas could you go into some more detail on what exactly you found as you went for the alpha testing that has caused to you to delay the launch and you’ll go back and work on the product?

Eric Wolford

You bet Jason, this is Eric. Yeah, I agree with you. We are obviously disappointed in the delay to market, but we did learn a lot from the alpha process. We had some great results with some customers got some key validation points. But at the same time we did find some changes that they were going to be necessary. And I can’t go into much detail for competitive reasons, but we did learn specifically that we could simplify our design to make our products easier to deploy, manage and faster performing. This also will help us to get outside of our Riverbed base of customers. So, it has a positive as well.

Jason Ader – William Blair

So, am I might right infer then that it may not have to be used necessarily in conjunction with Steelhead, from that comment?

Eric Wolford

Yeah, it may or may not. That’s correct.

Jason Ader – William Blair

Okay, all right. And would that cause a significant change in the R&D planning, Randy?

Randy Gottfried

No, no. I think basically that we have people devoted to storage now and again we well continue to work on projects.

Eric Wolford

Jason. There shouldn’t be any change on the R&D line. For a company of our size and maturity you look at our R&D spend and I think it’s what you would expect and as we look for we don’t see any big changes.

Jason Ader – William Blair & Company

Okay, great. And so the last question for Jerry, I don’t want to leave you out Jerry

Jerry Kennelly

Yes Jason.

Jason Ader – William Blair & Company

We looked back so we let’s say we finished 2009 and we looked back on a year and I think if you do worse then you expect it’s probably going to be because of the economy. I think that’s probably an easy answer but if you better than you expect better than expected in 2009, What do you think the key drivers for that outperform will have been or would have been?

Jerry Kennelly

Yeah so, we have some basic advantages, which is an installed base that is in the middle of long-term deployments that they planned over the long period of time and that will continue rollout deployments that necessary for them to meet their IT schedules now and didn’t vote in a product that let’s people do to more with less, and if you look at our numbers 41% growth in 2008. 2008 was a full year recession. We are still in 41% growth and there are lot of people that equal at 8, 10, 12% who are feeling pretty positive about 2009 so, we are awake and we are aware and we’re cautious, but and we are starting from a high rate of growth and we expect real positive growth in 2009.

Jason Ader – William Blair & Company

Okay, thank you.

Jerry Kennelly

Thanks Jason.

Operator

Thank you. Our next question comes from the line of Troy Jensen with Piper Jaffray. Please go ahead.

Troy Jensen – Piper Jaffray

Hey congrats on the nice quarter gentlemen.

Jerry Kennely

Thanks Troy.

Randy Gottfried

Thanks Troy.

Troy Jensen – Piper Jaffray

Hey a quick one for Randy here. Randy if you look back gross margins in Q3, if you take out the two one-time items are about 23%, operating margins were about 23% and they will take that about 19% in Q4 here so, curious where there any one-time items in Q4 here or was it just the commission accelerators that it was a decline or I guess I am trying figure out what cost the de leveraging?

Randy Gottfried

Well, in general we have the second best gross margins of our company's life and we came in through at least as good as our original guidance. There were certainly some items in Q3, which attracted from the Q3 numbers. Q4 came in about what we expected. On the expense side, yes we did anticipate and baked into our upfront guidance, an increase in sales and marketing as a percent largely from accelerators that kick in primarily year-end.

Troy Jensen – Piper Jaffray

There have been no other one-time items neither anything in legal expenses?

Randy Gottfried

Nothing major.

Troy Jensen – Piper Jaffray

All right, and then I just go over two things. Did you see the expenses the expense guidance roughly flat, OpEx expense?

Randy Gottfried

I think we said our expenses would be up slightly.

Eric Wolford

No, for Q1, Randy for Q1.

Randy Gottfried

We said expenses would be up somewhat from Q4.

Troy Jensen – Piper Jaffray

Nice. Perfect.

Randy Gottfried

Now it come through a month of expenses from Mazu.

Troy Jensen – Piper Jaffray

Right understood. And the one for Eric just curious if you guys bumped into Cisco's was for that one release and your thoughts competitively if that improve much.

Eric Wolford

Sure. Troy. We bumped into it regularly that’s for sure. The competitive situation is similar to where it was last quarter except that obviously we're now when we compete with Cisco we are competing with for that one. Our win rate actually improved quarter-on-quarter not by a lot but it did improve but it’s still at 9 out of 10. We still see Cisco, the vast majority of the time, and then Juniper and BlueCoat are sort of two, three.

Troy Jensen – Piper Jaffray

Fair guys keep up the good work.

Eric Wolford

Thanks.

Operator

Thank you. Our next question comes from the line of Samuel Wilson with JMP Securities, please go ahead.

Samuel Wilson – JMP Securities

Good afternoon. Just a couple of clarifications and I'm not trying to be generous here. On Atlas, I'm confused when you say delayed. Do you mean you are not going to ship at this year, you are delaying it for few months and, you expect general release before the end of the year, because you made the comment delayed throughout the year, I don’t know what that much mean by that?

Jerry Kennelly

Yeah, delayed in 2009 expected to shipments in 2010.

Samuel Wilson – JMP Securities

Got it, and then on, you made a comment HP resellers. And with the announcement last week, you have access to HP research. Can you talk a little bit about that?

Eric Wolford

Yeah sure Sam, its Eric. As you know we did that HP ProCurve ONE launch where we were on stage with the ProCurve team as well as several partners like F5 and McAfee Microsoft, and so we have a two-phase intention. First is immediately right now we have a lot of course go to market activities where we meet in the channel and bundle in the channel and have interoperability testing in papers for our customers to use. And then Phase II is where we take our software and we put it onto and HP Blade that runs in their ProCurve switch. And so that’s the two phase process and we are going sort of arm-in-arm with HP to their channel and our channel. And talking us the business models as need in the channel so it isn’t an OEM business model it is meet in the channel business model.

Samuel Wilson – JMP Securities

Well Eric, it’s a followup. Basically HP sales guys, I mean do they get talked to that at all for selling Riverbed Steelhead to a client today, is it a?

Eric Wolford

Yeah and they actually have for a while now the we’ve had a relationship with the HP services team for several years now and have had a lot of success in selling our product through that team, so that team will continue to sell the Riverbed products and the HP ProCurve products and they will just have more attention drawn to it and then ultimately there will be a skew, a software skew that will work on hardware blade that works in ProCurve switch.

Jerry Kennelly

And finally, we saw quite a bit through EDS as well as which now HP loan.

Eric Wolford

Yeah, another very big partner of us.

Samuel Wilson – JMP Securities

So is there, and then sort of my last question is follow about HP, is it there a more of this I don’t want call HP a larger size, but larger, size large partner activity going on at Riverbed that isn’t publically announced yet?

Eric Wolford

Yeah. I think we certainly, already said we are very committed to systems integrated service providers and I think Randy noted in his comment that I think we're up to over 30% of revenue was coming from those big partners. So, we are very committed and we do anticipate making ongoing relationship announcements in that area.

Samuel Wilson – JMP Securities

So, I guess in asking you Eric is there a current bigger size you are not doing business within 2009. We could expect that may be you’ll start doing business with?

Eric Wolford

I am meeting to announce at this time, but we have right now our relationships with System integrators as far as we have a good suite sweet with them right now or so our biggest interest I think is working effectively with the one that we have.

Samuel Wilson – JMP Securities

Got it. Thank you very much.

Operator

Thank you. Our next question comes from the line of Nikos Theodosopoulos with UBS. Please go ahead.

Nikos Theodosopoulos – UBS

Yeah. Can you hear me?

Jerry Kennelly

Yes we can. Hi, Nikos.

Nikos Theodosopoulos – UBS

Hi, just a couple of questions, sequentially the EMEA region was very, very strong for you. The U.S. was not I think people understand why the U.S. what wasn’t but the strength in Europe has kind of surprised me. Can you elaborate what caused that?

Jerry Kennelly

A couple of things when we had a very good quarter in government in Europe that helped, but I would say that just in general, our European team has executed very well the strategy of selling to the largest companies in their market selling through the biggest and the most prestigious service integrators and service providers and have executed extremely well.

Eric Wolford

North America also had a pretty strong Q3 given U.S. federal sales they were good in the quarter.

Nikos Theodosopoulos – UBS

Okay, but overall government that the percentage changed much when you look at U.S. and Europe from third quarter to fourth quarter?

Jerry Kennelly

The total was similar at about 20%, but the composition by region was a little bit different Q4, we're stronger. We had a very strong quarter in Q4 in European government business.

Nikos Theodosopoulos – UBS

Right okay, and back on the HP question. With HP and EDS and the new relationship and with the new initiative, do you think that they will be at some point a consistent 10% customer for the company, the HP and EDS combined?

Jerry Kennelly

It’s an excellent question. We don’t know. We just want as much revenue from that group as we can get.

Nikos Theodosopoulos – UBS

Okay. Just last question on OpEx can you remind me what the reasonable quarterly addition that the Mazu acquisition would add?

Jerry Kennelly

Well we’re adding mid 60’s as a number of people quarter-on-quarter, we’ve not any specific guidance in general we have said, infusing together some public information we expect to be roughly break even in 2009. If you do the math on what I described there is a couple of million of operating expense in Q1 from Mazu. Just a partial quarter.

Nikos Theodosopoulos – UBS

Great. Thank you.

Jerry Kennelly

Thank you.

Operator

Our next question comes from the line of John Marchetti with Cowen and Company. Please go ahead.

John Marchetti – Cowen and Company

Thanks. Jerry I was wondering if you guys could just comment about how you sort of ended Q4 in terms of the orders that were coming in both in the U.S. and maybe in Europe and then maybe how your January has started off at least relative to what you've seen historically. If you are seeing any changes there, if you are seeing any weakness or as things are maturing if you are actually more interest there?

Jerry Kennelly

Right, Q4 felt relatively normal to our reliefs and was not along those frantic type of quarters at all. So, we haven't, we don’t comment on where were we are somewhere in Q1, but we've probably have better visibility than most tech companies and from the way we saw and from the amount service revenue we have and that’s all encompassed in our guidance for the first quarter. But Q4 is actually relatively normal in terms of linearity was not a frantic panic driven quarter by any means whatsoever.

John Marchetti – Cowen and Company

And then just getting back to Atlas real quick when you first sort of talked to everyone about it, it coming out obviously one of the strengths that go to market strategy was the fact that you would be sort of going to your largest Steelhead customers with the idea that this would fit seamlessly into that environment, and sort of use those appliances in order to do some of the things here. With the way it sounds like, this may change, does it really change sort of how you are going to have to market with this product as you look out into 2010?

Jerry Kennelly

It will make some slight change but actually we think we end up with a smarter situation and people may not recall us when we announce Atlas, it was going to come out in the two phased, a version one that was in the middle of 2009, and then a version two, late in 2010. And the version one was going to be kind of a simple bare bones released within, really generate a lot of revenue and the version two late in 2010 was going to be the delightful featured, go for the big market push and so with this change we've a bigger market earlier in a smarter way and we also won’t be kind of trend a shoot balls in the economic environment of 2009 where we think it’s smarter to stick with our core products. So, we'll give more details later, but we actually think, although we hate announced our delay who likes to read that in the end of smarter for us and we think we'll get more money earlier over the long-term display.

John Marchetti – Cowen and Company

Just to be clear there Jerry, now there won’t be two releases there will really be just sort of one release and is that still late 2010 or is that sort of move forward now with one release in 2010?

Jerry Kennelly

We are just saying 2010 for the moment but and we'll…

John Marchetti – Cowen and Company

With just the one release?

Jerry Kennelly

One release that’s correct.

John Marchetti – Cowen and Company

Okay, thank you.

Operator

Thank you. Our next question comes from the line of Simona Jankowski with Goldman Sachs, please go ahead.

Simona Jankowski – Goldman Sachs

Hi guys thank you. Can you give us a sense of the size of your pipeline of opportunities getting into the first quarter and into the New Year. And also how has your conversion rate of those opportunities been changing if at all in recent months?

Randy Gottfried

This is Randy, Simona. In general, we would praise that we have solid pipeline going into this quarter. We never like to quantify that. In general, your overall visibility I think is similar to the last few quarters, we recalibrated some of our own methodology as we entered through the recession in the first part of 2008 and overall I would say there has been a whole a lot of change recently.

Simona Jankowski – Goldman Sachs

Well I guess just kind of origin the question is that remember you know close to a year going and things first started really weakening from an economy perspective. Your pipeline of opportunities was actually still expanding pretty rapidly but it is seen that the conversion rate were slowing. Had we seen kind of a stabilization in that conversion rate, where it’s no longer contracting but kind of it a steady state now, or things to influx?

Randy Gottfried

Well, we are not going into lot of detail. I think what saw in the beginning of 2008 was a very sort of noticeable extension in how long it took to close bigger deals in particular. And that was pretty meaningful change for us. Since sort of recalibrating on that in 2008 in the last two quarters – the last few quarters of forecasting precision I think it improved a lot.

Simona Jankowski – Goldman Sachs

Okay, and then also it seems like because you commented that the quarter felt pretty normal in kind of wasn’t a big rush at the end. So can we infer from that it’s also less likely to kind of have a bit of repeat of last year’s Q1 where it seem like a bit of the pipeline that what is happening in Q1 actually ended up being pulled into Q4, for then Q1 maybe came in a little forward. It sounds like you guys feel pretty comfortable that that scenario doesn’t repeat this year?

Randy Gottfried

Yeah, we learnt pretty good from experience so we think our guidance encompasses a good hard look at the pipeline on the way we booked revenue.

Simona Jankowski – Goldman Sachs

Okay, great. And then last quick clarification on the HP deal. What are the margins that you think will be coming in from that business relative to your average right now?

Eric Wolford

Yeah so again, this is Eric, Simona. It is not an incremental resell deal rights so the margins should be very similar to what we’ve done in the past for 2009. When we do come out with a software skew towards the end of the year and into next year then that particular product obviously will have a completely different gross margin structure because it will be a software skew.

Simona Jankowski – Goldman Sachs

It should higher for that product?

Eric Wolford

Correct.

Simona Jankowski – Goldman Sachs

Okay. Okay thank you very much.

Eric Wolford

Thank you.

Operator

Thank you. Our next question comes from the line of Ken Muth with Robert W. Baird. Please go ahead.

Kenneth Muth – Robert W. Baird

Hi Randy, just quickly on the tax rate for Q1. What is the non-GAAP tax rate?

Randy Gottfried

35%.

Kenneth Muth – Robert W. Baird

35% okay. And then how do you guys think about adjusting the market what you are seeing out there on a macro basis of potentially running in the incremental pricing pressure now that Cisco’s 401 is out there and kind of that will kind of pricing mechanism?

Randy Gottfried

Our experience what I mean believe in competing on Cisco since the day we starting shipping our products. And certainly we haven't seen a whole lot of pricing change and this kind of structure haven't changed dramatically and we have been competing against 401 for a couple of quarter now. We've been competing against free from Cisco for a long time.

Eric Wolford

If your question presumes that 4.1 somehow closes the GAAP of scalability and stability and performance it really doesn’t, so it hasn’t changed the game on pricing.

Kenneth Muth – Robert W. Baird

Okay, and just any comments you can give around the counter average deal size last quarter and this quarter?

Randy Gottfried

No great change. In general the fact has held out for sometime which is the vast majority of our transactions are under $100,000.

Kenneth Muth – Robert W. Baird

Okay, great thank you much.

Randy Gottfried

Thank you.

Operator

Our next question comes from the line of Sanjiv Wadhwani with Stifel Nicolaus. Please go ahead.

Sanjiv Wadhwani – Stifel Nicolaus & Company

Thanks. Randy just to clarify sort of to get an apples-to-apples comparison I guess if you ex-out Mazu, it looks like revenues, it looks EPS for the sort of organic Riverbed is going to be in the $0.10 to $0.11 range. Is that sort of right number?

Randy Gottfried

I think we have given guidance. Yeah. I’m sorry, yes. 10 to 11 that's correct.

Sanjiv Wadhwani – Stifel Nicolaus & Company

But if you ex-out Mazu basically?

Randy Gottfried

Yes.

Sanjiv Wadhwani – Stifel Nicolaus & Company

We got it okay. So I guess I’m just the drop off in operating margins looks like that comes around sort of the low teens. Any specific areas that are resulting in that. I mean I’m just curious given that euro closed to sort of 19% on the December quarter?

Randy Gottfried

As you looked to roll forward Q4 to Q1, I mean the biggest driver is going to be the revenue decline, not necessarily the dramatic change in expenses.

Sanjiv Wadhwani – Stifel Nicolaus & Company

Got it.

Randy Gottfried

So, the box or the majority of that change is going to be just from lower revenue in Q1.

Sanjiv Wadhwani – Stifel Nicolaus & Company

Got it. So basically Q4 to Q1 OpEx is generally flat if you ex-out Mazu essentially and then the drop off in operating margins is coming from drop off in revenues essentially?

Randy Gottfried

To be overly precise, the expense will be up slightly from some of the things I mentioned we have a full quarter of some people we added in Q4, we’ve got certain payroll taxes that often ex-out mid year that restart January for, so I would phrase it as up slightly in Q1 on Riverbed core expenses and then some additional expenses from Mazu.

Sanjiv Wadhwani – Stifel Nicolaus & Company

Got it okay. And then just one quick question on larger deals any color on seven figure deals during the quarter and how that sort of trend is progressing? Thanks.

Eric Wolford

Well it was a fairly normal quarter we usually have $2 million to $5 million plus deals and that was the same this quarter.

Sanjiv Wadhwani – Stifel Nicolaus & Company

All right. It sounds good. Thanks so much guys.

Operator

Thank you. Our next question comes from the lines of Jonathan Ruykhaver with Thinkequity. Please go ahead.

Jonathan Ruykhaver – Thinkequity LLC.

Nice quarter.

Jerry Kennelly

Thank you.

Jonathan Ruykhaver – Thinkequity LLC.

Have you seen any change in competitive dynamics now with Blue Coat’s focus not only on the acceleration in security, but also the visibility control features that they have talked about with Packeteer?

Jerry Kennelly

Yeah. Sure. So we track it very carefully, so we used to track Blue Coat and Packeteer separately and now they are combined together and as we sort of look trending backward-to-forward the aggregate competitiveness of Blue Coat and rather they are combined with Packeteer versus when they were separate is very similar. So, we see Blue Coat more now but it is sort of like that because they added Packeteer and so that that kind of explains that. Most of the time that when we compete with Blue Coat, it’s a little different thing competing with Juniper or Cisco. Often times the customer ends up or has some interest in doing a secure web gateway, which is an adjacent product to what we end up selling and so lot of the times when we win it’s because the customer wanted consolidation and wanted what our core product does in the times when we’ve lost it may have we win 9 out of 10 and then as we lost because the customer has been mostly interested in a Secure Web Gateway.

Jonathan Ruykhaver – Thinkequity LLC.

Right but you are making the point the application visibility control features that’s not something that is enabling Blue Coat to be more competitive in direct deals with Riverbed?

Jerry Kennelly

Yeah no not at all, because they are separate products. They are separate boxes to multiple box type purchase. And so we've been competing with both of those products and boxes for 20 quarters and we know exactly what it is and how to compete with that and do very well.

Jonathan Ruykhaver – Thinkequity LLC.

Does the potential integration of that capability on the SG platform, a Blue Coat’s changed that necessity or value proportion or do you think that doesn’t have too much impact in the market?

Jerry Kennelly

I mean obviously that will be a good thing for them to try to do, but the main thing you go back to what the customers want the most and they want that return on investment. That’s what they are looking for right now, cost savings. And the cost savings comes from the core capabilities that Steelhead plants has, and so that’s were we have an advantage in the area that is highest wanted right now for customers: speed and cost reduction, those are the areas were we perform our best.

Jonathan Ruykhaver – Thinkequity LLC.

Okay good. And just one other quick question, the new 50 series deal ahead shipping. I think Randy you mentioned expectations run a higher product gross margin over time, because of that should we expect gross margin on the product side to stay at about 77% or kind of get go higher as that mix becomes greater?

Randy Gottfried

I think we just prices simply that in the very near term we expect roughly flat gross margins, but yeah we do think that the profile the new products over time allows us some up sight, without being specific.

Jonathan Ruykhaver – Thinkequity LLC.

Okay, great. All right, thanks again.

Operator

Thank you. Our next question comes from the line of Alex Kurtz with Merriman. Please go ahead.

Alex Kurtz - Merriman, Curhan Ford & Co.

Yeah, thanks for taking the question. Can you guys talking about this qualification from EMC with the driver was there. I imagine you might to be displacing several peak systems on and sort of like a financial target you might be taken about over the next year?

Eric Wolford

You bet, Alex. This is Eric.

Alex Kurtz - Merriman, Curhan Ford & Co.

Eric Wolford

So data center to data center types of communication, they are very heavyweight FRDRA links two big, EMC storage systems, symmetric storage systems, and so that’s usually DS3, OC3, OC12, big pipes and so in order to get our boxes installed in those environments. It is prerequisite that you get the qualification and blessing and support from EMC. And so we literally had, I don’t know 30, 40 deals that were just sort of held at advance because we needed to get this qualification. It’s a good market. It’s an attractive market. It’s one we weren’t able to participate in before, so by getting this qualification we are now able to address a market that we couldn’t really participate in.

Alex Kurtz - Merriman, Curhan Ford & Co.

So 30 or 40 deals that you are expect to close over the coming quarters that were sort held back from the qualification?

Eric Wolford

You know the timing of when they close is I would love it to be all the next quarter, it will close when they close but certainly it’s a meaningful step. It’s not just a good marketing relationship it is also a very good business relationship.

Alex Kurtz - Merriman, Curhan Ford & Co.

And if you were to look at your pipeline now and compared to maybe last year, would you say the more of your pipeline is consisting of data center to data center, disaster recovery or remote replication kind of deals that all revolve around storage. Is that increase from this time last year?

Eric Wolford

It has increased from small to more meaningful but the more relevant thing that is impacting us in terms of why people are writing check is costs saving around storage consolidation, server consolidation, box consolidation, virtualization, that is a bigger factor than just a data center to data center stuff. Data center stuff is growing both last year but ROI cost saving is came right now.

Alex Kurtz - Merriman, Curhan Ford & Co.

Okay and a quick question for Randy. Just giving your guidance of 83 to 86 on the top line. Is there are any reason to think that your product, support and services line won’t be flat sequentially, and if you’re adding new customers shouldn’t that be sort of flat to slightly up?

Randy Gottfried

I would say in general yes, it would grow overtime. They are occasionally some anomalies but in general not expected to grow.

Alex Kurtz - Merriman, Curhan Ford & Co.

Okay, thanks a lot guys.

Eric Wolford

Thank you.

Operator

Thank you. Our next question comes from the line of Erik Suppiger with Signal Hill. Please go ahead.