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Riverbed Technology (NASDAQ:RVBD)

Q3 2010 Earnings Call

October 21, 2010 4:30 p.m. ET

Executives

Renee Lyall – Director of IR

Jerry Kennelly – Co Founder, Executive Chairman, Chief Executive Officer, President and Member of the Stock Option Committee

Randy Gottfried – Chief Financial Officer – Principal Accounting Officer and Senior Vice President of Business Services

Eric Wolford – Senior Vice President of Business Development & Marketing

Analysts

Ryan Hutchinson – Lazard Capital Markets LLC

Jason Ader – William Blair & Company, L.L.C.

John Marchetti – Cowen and Company

Alex Henderson – Miller Tabak

Sanjiv Wadhwani – Steifl Nicolaus & Co.

Bill Choi - Jefferies

Brent [Inaudible] Pacific Crest Securities

Ari [inaudible] – Standard and Poors

Paul Mansky – Canaccord

Mark Sue – RBC Capital Markets

Eric [Inaudible] – Signal Hills

Daniel Ives – FER

Nicholus Achilleas Stephanou - UBS.

Troy Jensen – Piper Jaffray

Michael Genovese - Folay Securities

John Slack – Citigroup

Operator

Good afternoon. My name is Thea and will be the conference operator today. At this time, I would like to welcome everyone to the Riverbed Technology’s Third Quarter 2010 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. At this time I would like to turn the conference over to Ms. Renee Lyall. Ma’am, you may begin.

Renee Lyall

Thank you, Thea. Good afternoon, and thank you for joining us on today’s conference call to discuss Riverbed’s Third Quarter Fiscal Year 2010 Results.

I'm 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, 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 and two-for-one stock split distributed today at 1:05 p.m. Pacific Time via business wire.

We also announced the acquisition of Cace Technologies. Those press releases are available on our website at Riverbed.com. This conference call is being webcast live via the Internet at Riverbed.com/investors and will be archived on our website for the next 12 months.

The information the presenters discuss today will include forward-looking statements including, without limitations, statements about Riverbed’s current and future products and partners, our financial outlook, or sales pipeline, our competitive market position, the impact of our acquisition of Cace Technologies and the impact, if any, on the company of its trading price related to the stock split.

These forward-looking statements are only predictions and involve risk and uncertainties such that actual results may vary significantly. These risk that are set forth in our press releases filed today with the FEC and on our Form 10Q for the quarter ended June 30th, 2010.

These forward-looking statements reflect beliefs, estimates and predictions as of the date of this call. Riverbed disclaims any obligation to update any forward-looking statements. Unless otherwise stated, financial information that we review on today’s conference call is presented on a non-GAAP basis. Non-GAAP net income excludes the impact of stock-based compensations, stock-based payroll expenses, amortization of required and tangible assets, acquisition-related expenses and related income tax effects. Non-GAAP financial measure should be considered in addition to results prepared in accordance with GAAP, but not as looking forward or superior to GAAP results. The most directly comparable GAAP information, reason why management uses non-GAAP information and a reconciliation between non-GAAP and GAAP figures is provided in our Q3 2010 Press Release which has been furnished to the FEC on Form 8K today. Any future products, feature or related specifications that may be referenced in today’s call are for informational purposes only and are not commitments to deliver any technology enhancement. Riverbed reserves the right to modify or cancel future product plans at any time.

I’d know like to turn the call over to President and CEO, Jerry Kennelly.

Jerry Kennelly

Thank you, Renee. Welcome everyone, and thank you for joining us this afternoon. Riverbed’s reporting another record-braking quarter having achieved the highest revenue, operating profit and net income in our history. Revenue for the third quarter was $148 million, up 17% sequentially and up 44% compared to the third quarter of last year.

Product revenue grew 22% sequentially and 48% year over year. This marks the fifth consecutive quarter of accelerating year over year product revenue growth. This was strongest sequential product revenue growth rates we have achieved in three years.

Our operating profit increased 36% over the previous quarter and 84% over the prior year to $42 million as we achieve an operating margin of 28%.

Revenue growth in the third quarter was driven by product sales with growth across all platforms. We are seeing larger deployments with recurring purchases in the enterprise as our footprint and mindshare continues to expand in the largest companies in the world.

Riverbed now counts 76 of the Forbes Global 100 as customers and we exited the quarter with more than 8,700 cumulative customers. Some of our biggest yields during the quarter were household names who required WAN optimization to make their global IT infrastructure function at the highest level. These customers span financial services, healthcare, manufacturing, governments and other verticals.

We continue to expend our lead against the competition. This is supported by the most recent [inaudible] Report which shows Riverbed holds more than 40% of the advanced-plaform WAN optimization markets, more than 11 share points ahead of the closest competitor.

Our third quarter result leave no doubt that Riverbed is the clear leader in this very strategic market. Several IT survey reports published over the past few weeks have an increasing importance in WAM optimization to IT decision makers and indicates spending on this technology is expected to increase in the coming quarters.

Riverbed is benefiting from the secular IT trends in the market today. Collaboration, document sharing, consolidation in as many forms for DDI to cloud computing all require a high-performance reliable and fully optimized wide area network.

These trends require the WAN to perform as well as the LAN and Riverbed’s technology and product are what enable the network to support these IT initiatives.

As I said earlier, we experienced growth across all our platforms. The most notable product line growth was the Steelhead 7050, introduced in February of this year, the 7050 is our largest and most scalable Steelhead appliance, purpose build for data center to data center deployments. It’s also employed as the data center appliance in traditional data center’s remote office WAN installations.

Earlier this month the 7050 achieved qualification with the MC’s Recover Point Replication Solution. We view this as another positive step as we strengthen our position of data center to data center and storage optimization markets.

The Riverbed Services Platform, or RSP continues to be a real competitive advantage for Riverbed and was included in a number of our largest deals in the quarter.

During the third quarter we added three new qualified partner modules, Accordance for steaming media, IBM Fastback for data protection and recoveries, and McAfee Web Gateway for Security.

On Monday of this week we announced accelerated deliver in SAP Netweaver on the RSP. As of today, RSP supports 18 qualified solutions. The ability to consolidate more is very important to customers and RSP is the stepping stone to complete brand office sparks solution for Riverbed that will be able to support more service.

Cascade also had a solid quarter with $7 million of revenue. In the first three quarters of 2010 we have almost doubled the Cascade revenue contribution over 2009.

With the acquisition of Cace Technologies, announced today, we extend our market and technological reach which we believe further enhanced Cascade’s growth. Cace specializes in high-speed packet-capture, visualization and analysis tools that work in conjunction with the open-source tool Wireshark for which they have the corporate sponsor.

Wireshark is the world’s most popular open-source packet analysis with millions of users. The integration of Cace with Cascade positions Riverbed to compete in the adjacent application-aware, network performance management market for MPM.

MPM plays a critical role in today’s IT infrastructure and it’s estimated to be a $3.5 billion market in 2010. A survey of over 100 IT managers published last week, 74% identified MPM as a high or critical priority. A combination of Cace and Cascade will create a complete application where network performance monitoring solution with business mobile discovery and end-to-end performance monitoring, and the ability to dive deep into packet-level analysis. The application MPM market is underpenetrated and growing rapidly and we will enter it with a highly competitive product and the solid team supporting it. Cace will be fold into and be managed by the Cascade business unit.

The combination of WAN optimization and network performance management as a solution enhances our position as the leading provider or total network optimization. On the strength of our or technology solutions continue to improve, executing our channel strategy has been a key driver of the success we have seen to date, remains the focus area for the company.

As you recall, we transitioned to [inaudible] distribution in North American at the beginning of the second quarter. Only two quarters in, we are seeing a positive impact to our financials. We recruited several new strategic high-quality buyers to resell Riverbed’s products and are rapidly achieving our targeted goals.

We expect the benefits of this model to continue as the activities we are engaged in ramp in the coming quarters. We’re also seeing continued traction with our with our system integrator and service provider partners with revenue generated by this category continuing to grow.

In just a few weeks, a few of these partners will join us on stage at our Into the Cloud Event in New York City. We hope to see you there.

I will now turn the call over to Randy to finish the financials and provide guidance for our fourth quarter.

Randy Gottfried

Thanks, Jerry. As a reminder unless stated otherwise, the numbers I’ll discuss today are non-GAAP according to records.

In addition to the reconciliation included in the press release, we posted a supplemental reconciliation of non-GAAP financial measures to the directly comparable GAAP measures on the Investor Relations portion of our website.

As Jerry said earlier, Q3 was a record-breaking quarter for Riverbed. The revenue increased 17% sequentially and 44% year over year. Third quarter product revenue increased 22% over the second quarter and 48% over the prior year to $103 million. 95% of our product revenue is generated by Steelhead and related products with Cascade contributing about 5%.

Inclusive of services, Cascade’s total revenue contribution was $7 billion. Approximately 1/3 of our Steelhead revenue was from data center appliances and 2/3s from our desktop and [inaudible] appliances typically deployed in remote offices.

Third quarter service revenue grew 8% sequentially and 36% year over year to $45 million. The majority of our service revenue is from maintenance contracts with a small contribution from professional services.

Turning to distribution, 95% of our revenue in Q3 came from indirect channels with the remaining 5% coming from direct sales. Sales tied to our systems integrator and service provider partners was approximately 1/3 of our revenue.

As a reminder, Riverbed recognizes revenue on a shell-through basis regardless of channels.

We saw sequential and year-over-year growth in every major geography during the third quarter. As a percentage of total revenue, the U.S. represented 55%, and India 26%, and the rest of the world 19%.

Overall our business remains very well diversified across all major industry verticals. The government showed solid growth as expected, and was the largest vertical at 21% of product revenue. The enterprise came in very strong this quarter with particular strength in the financial, healthcare and consumer verticals. In the third quarter, no customer or channel partner contributed 10% or more to revenue.

Shifting to cost and expenses, gross margins were up slightly on a sequential basis in the third quarter at 78%. Product gross margin was 79.6% and service gross margin came in at 74.5%.

Total operating expenses were $75 million, up about 10% compared to the second quarter. Sales and marketing expenses are represented 33% of revenue compared to 35% in the second quarter.

R&D was 12% of revenue and G&A was 6% of revenue, both about flat with the prior quarter.

Operating profit increased 36% over the Q2 and 84% over the prior year to $42 million. Operating margin increased almost 4 percentage points sequentially to 28.1% as we surpassed our long-term target of 25%.

We’re very proud of the progress we made here. We exited the third quarter with 1,161 employees, an increase of 59 compared to Q2. The tax rate for the quarter was 37% and income was $27 millon or $0.34 per diluted share. And income increased 38 percent sequentially and 34% year over year.

Moving to the balance sheet and cash flows, Riverbed ended the September quarter with cash and investments of $469 million, an increase of more than $47 million over the balance of June 30th, and an increase of more than $170 million over last year. We continue to have no debt.

Cash flow from operations was $42 million, compared to $21 million in the second quarter and $38 million in the year-ago period. Strong collections resulted in Q3 day sales outstanding of 27 days compared to 32 days in the second quarter and 42 days one year ago. Good linearity and shift in two-tier distribution in North America also contributed to the improvement.

Our inventory balance increased to $13 million. This compares to $10 million in the second quarter and $12 million one year ago. The increase was planned as we boosted our supply chain safety stops.

Total deferred revenue was $108 million, up 6% sequentially and up 42% over the prior year.

Before I provide our fourth quarter outlook, I want to talk through the Cace acquisition and stock split announced today.

Cace is based in Davis, California and has 20 employees, all of whom we plan to retain. We expect the acquisition to be neutral to EPS in the fourth quarter and accretive in 2011. Cace has about $1 million in quarterly bookings right now. While we’re not providing a future revenue target at this time, we obviously expect to increase that runway over the next 12 months.

We also announced a two-for-one stock split today. The decision reflects our optimism and confidence in Riverbed. As we mention in the press release, the record date is November 1st, with a stock dividend date of November 8th.

Here’s our view as we look into the fourth quarter. Again, these numbers are non-GAAP.

We expect 155 to $158 million in revenue representing 37 to 40% in year-over-year growth for the quarter. Gross margins are expected to be within our targeted 76 to 78% range and roughly flat with Q3.

We’re planning for operating expenses between 77 and $79 million. We’re targeting a tax rate of 37% assuming the R&D tax credit is not renewed.

This results in forecast earnings per share up about $0.35 based on 80 million pre-split shares.

And now, I’ll turn the call back over to Jerry for his closing comments.

Jerry Kennelly

Thank you, Randy. As I said when I began this call, the third quarter results leave no doubt that Riverbed is the clear leader in the WAN optimization market. As the consistent market-share leader with 40% more revenue than our closest competitor, according to [inaudible] Report, we feel very confident about our position.

The product enabling parts we plan to be in the market and the acquisition of Cace Technologies enhance our product suite making Riverbed the best and most complete solution for network optimization in the market. We look forward to telling you more about upcoming products at our Into the Cloud Event on November 10th in New York City.

With that said, Eric, Randy and I will now be happy to answer your questions. Operator Thea, can you open the queue?

Question-and-Answer Session

Operator

(Operator instructions) The first question will come from Ryan Hutchinson from Lazard Capital.

Ryan Hutchinson – Lazard Capital Markets LLC

Good afternoon, and congrats on a great quarter. Just a few questions. First a clarification. Did you say the government was 21% of product revenue?

Randy Gottfried

Yes.

Ryan Hutchinson – Lazard Capital Markets LLC

Okay, great. So I guess as the quarter progressed, given the significant up sight, can you just talk to the drivers there and how you rank them, you know, mainly end market demand improving versus the competitive position?

Jerry Kennelly

Yeah, there’s some mixed together. I mean, we’re in – Ryan, this is Jerry, on the great spot of being the acknowledged market leader, a technology that’s been accepted mainstream and important technology for the biggest enterprises and government networks of the world, while in an environment where demand was improving. So those things worked together to make kind of a perfect storm of synergy and gave us a great quarter.

Ryan Hutchinson – Lazard Capital Markets LLC

Okay. And then as far as the product and service split for deferred, can you provide that? And then what are the expectations given the uptick in renewals that you talked about last quarter? Should we still expect a nice uptick in Q4 and Q1? And then if so, maybe you could provide a growth rate on that front.

Randy Gottfried

Sure Ryan. So at the end of Q3, we had about 102, a little over 102 million of deferred support revenue which was up over the both the prior quarter and the prior year. Product was also up about $1 million quarter on quarter. Again, and product is a very small number, you know, 5 to $6 million. The reason why it went up at all was simply because we had some product sold into the channel that we only recognized on sell-through.

Ryan Hutchinson – Lazard Capital Markets LLC

Okay. And then finally just on the – on the Cace acquisition here, can you just walk through the competitive landscape and then the purchase price? I don’t think it was included in the release.

Eric Wolford

Yeah, sure. This is Eric. Let me address the first part of your question, Ryan. Cace is a tuck-in product that is allowing us, particularly our cascade business unit to further expand into adjacent to WAN optimization at this application-aware network performance management market that we’re seeing a very amount of demand for. And the thing that were mentioning is they make a crude parallel, a DVR-type functionality called Pack-it Capture and Analysis that we needed to add to more compete in that market.

The price, it was a modest amount. To put it in scale, less than $20 million

Ryan Hutchinson – Lazard Capital Markets LLC

Okay, great. Thanks guys, congrats.

Eric Wolford

Thank you.

Operator

(Operator instructions) The next question is from Jason Ader with William Blair

Jason Ader – William Blair & Company, L.L.C.

Hey, guys, thanks a lot. I wanted to ask you about the data center. Is that driving a lot of this strength of your overall large deal sizes, or what else is going on there?

Eric Wolford

Jason, this is Eric. They’re broad based, across all product lines. It definitely did benefit the employment, but equally as important was build outs of enterprise deployments into remote offices. So you add data center to data center and data center to remote office where it’s very broad. You couldn’t hang it on just the data center thing, although the data center thing is a big contributor.

Jason Ader – William Blair & Company, L.L.C.

And then just a follow up on that, sorry. Can you give us a sense of size, like the largest size deployment you have in terms of nodes for those products?

Eric Wolford

It’s over 1,000. I don’t know the specific numbers, but it’s well into 1,000.

Jason Ader – William Blair & Company, L.L.C.

Okay. Thank you.

Operator

The next question will come from John Marchetti with Cowen and Company.

John Marchetti – Cowen and Company

Thanks very much. Jerry, I just want to – I know that you’re not giving any kind of guidance to ’11, but I was just curious, there’s an awful lot of concern about what government spending might look like for next year. He obviously had a real good quarter here. Do you have any sense, you know, as you’re talking with those customers through the channel what that business looks like as you’re heading into 2011?

And then just real quick, Randy, again, sorry Renee, can you give us an RSP of tax rate for the quarter?

Jerry Kennelly

Okay. So we’re not talking about 2011. We’ll do that in January when we do the summer/fall. What we know about right now, it’s one of our verticals and it’s in the upper 20s each quarter, has been for several years now and the government networks has the same need for cost savings and efficiency that the enterprise ones does. In fact, people seeking to save money use LAN optimization. That’s why we were one of the very few, or only companies in the sector that grew all the way into the three years of downturn in the recession because of the ROI cost savings that comes from our product.

So we’re not at this time thinking anything odd is going to happen in the government sector.

Eric Wolford

And this is Eric. It was a strong quarter for RSP. The tax rate – overall it was about 20%, but for most office boxes it was particularly strong in the mid-20s.

John Marchetti – Cowen and Company

Thanks.

Operator

The next question will come from Alex Henderson with Miller Tabak.

Alex Henderson – Miller Tabak

Great. Thank you. Two quick question actually. One is very fast. Can you just tell us what the lineare looks like? And the other one is a little bit more of a how are you thinking question, which is given your margins have expanded the way they have, is it reasonable to think that you’re still in the mode of trying to build growth capacity and therefore margin expansion from this level should be fairly temperate? How should we think about the way you’re managing the margins on the operating lines going forward?

Randy Gottfried

I’ll take that, Alex. First on linearity, we don’t talk about specifics, as we said before, we target about 50% the last month of the quarter, about 50% in the first two months of the quarter. There’s always some range or variation, we were obviously good at that range for the third quarter.

You asked also about margins, so you know, the good news is we’ve talked a long time about a long-term target of 25%. We sort of blew right through that in the third quarter. It really demonstrates the great leverage potential in the model we have, but you know, the primary focus of the management team and everybody in the company has always been growing the topline and growing the bottom line. The percent sort of just falls out of that. You know, we think we’re still, despite all the success we’ve had, it’s been a very underpenetrated area, we’re still making what we think are prudent investments to get more and better coverage in the field. We continue to build new products that span our technology base. So it’s a delicate trade off. But again, we’re most focused on revenue growth and the progresses that we’ve demonstrated so far come from that.

Alex Henderson – Miller Tabak

So is it reasonable to think though that you would not need to push the operating margin back down even though you’ve gone through your targets, now that you’re at this level, you’re still targeting growing top line and growing bottom line at or slightly faster pace. Is that the right metric to think through?

Jerry Kennelly

You know, we’ll eventually talk about more future periods, but it’s just inferred by the guidance we gave is roughly flat operating margins to get structure.

Alex Henderson – Miller Tabak

Great Thank you.

Operator

The next question will come from Sanjiv Wadhwani with Stiefl Nicolaus & Co.

Sanjiv Wadhwani – Steifl Nicolaus & Co.

Thanks. Let me make my congratulations also. Any color on the 7050, how large it is now as a percentage of revenues? And looking out into 2011, or maybe even beyond that, you know, how large could sort of the data center product become as a percentage of the overall product revenue of the company, or the overall revenue of the company?

Eric Wolford

Sure. This is Eric. So I think we said on the call that about 1/3 of our revenue came from our data center products. And while we don’t call out specific results for any particular model; since the 7050 was new, we just call out it was one of our fastest growing models this quarter.

So it did very well, it had a strong quarter. Data centers had a strong quarter, but at the same time, so did remote offices. So about a third, and what can it get to, you know that is hard to say. I can’t imagine – there’s so much remote office business out there that a 60/40 split maybe would be what you could think you could get to. But we’re not – that isn’t something we’re targeting. We’re targeting all ends; remote offices, data centers, all endpoints.

Sanjiv Wadhwani – Steifl Nicolaus & Co.

Thank you.

Operator

The next question will come from Bill Choi with Jefferies.

Bill Choi - Jefferies

Okay. Thanks. Great quarter. You started off, Jerry, with the comment about very strong current revenue from existing customers. It does seem that way just because it looks like the number of new customers were actually down slightly. So this dollar amount per new customers and dollar amount you received from the visiting customer seems like it had a nice bump up. Can you talk about what is driving that, whether it’s expansion with existing customers, or there’s some level of refresh going on from customers who might have deployed three-four years ago?

Eric Wolford

Yes, sure. So this is Eric again. We’re having a pretty good amount of success getting into enterprise customers. Enterprise customers, as you know, have larger long-term deployments. They don’t deploy all at once. They deploy over time and something that we’ve said that’s nice about what we do is that first sale is often small, but the second and third sales are very large. Now it’s over 8,000, or over 8,700 customers. That’s a very big base that is underpenetrated as well as the rest of the market is underpenetrated. So it’s kind of a target-rich environment. But I think our progress with enterprise customers is very good.

Bill Choi - Jefferies

What’s the percentage of sales coming from new versus existing customers?

Eric Wolford

In the third quarter we had about 85% of revenue coming from existing, about 15% coming from new customers. I’ll say that’s the metric we – as I’ve mentioned a number of times on these calls, we try to get away from because it hasn’t been that useful for us given the dynamics.

Bill Choi - Jefferies

Right. But the – the average dollar just distributed just shot up this quarter and I'm wondering, it’s been relatively stable for a number of quarters for a very long time. It just shot up this quarter. What is driving this quarter and going forward?

Eric Wolford

Actually I’ll tell it, it hasn’t varied. The stats over the last couple of years has varied. You know it is a little bit lower this quarter, but again, the way these numbers got calculated, you buy one box, you’re an existing customer. You buy your second purchase, 100 boxes, that counts as a repeat buy. So that’s why we try to shy away from that metric. We’re still disclosing it on request, but we found internally it’s not especially useful.

Bill Choi - Jefferies

So nothing unusual about this quarter and some of the revenue coming from existing customers on a per-customer basis?

Eric Wolford

Just the clients are better bigger, you know, it’s deployments are getting larger and what’s most important is for us to get into customers that have high potential and we’re getting into customers with high potential. This is an 18-month tie for new enterprise customers adding new big enterprise customers was very strong for us. So get into customers with high potential and then overtime they’ll sell to them, and sell to them, and sell to them. I think you’re seeing the results of that in this quarter.

Bill Choi - Jefferies

Yep, great job.

Renee Lyall

It’s Renee. I think I would add to that that though all of our biggest deals in the quarter, our top yields were the same customers. So really the existing customer base was very strong for us. And I hate to be the bad guy, but as a reminder, please limit yourselves to one question. We have a long queue. Thank you.

Operator

The next question will come from Brent [Inaudible] with Pacific Crest Securities.

Brent [Inaudible] Pacific Crest Securities

I think you might want questions on the operating margin profile. Obviously a very good margin expansion, well above kind of what you guided to I think on higher volumes, but do you think about long-term profitability of this business model now that you’re kind of seeing scalable for the data center and branch office remote side? What are you thinking in terms of margin – margin potential? Clearly, I know you’re not giving 2011 guidance, but how should we think about leverage in this model?

Jerry Kennelly

You know, I think we’ll talk more to that over the next couple quarters, you know, again, we’re looking that there will be flat operating margins. I think the nature of our business model being an appliance-based approach, a heavy software component, it has the potential for a lot of leverage. We’ve shown that today. We’re not being much more specific than that. Maybe over the long terms there some upside, but for now we’re really most focused on growing the topline and the absolute dollars of profits.

Brent [Inaudible] Pacific Crest Securities

Thank you.

Operator

The next question will come from Ari [inaudible] with Standard and Poors

Ari [inaudible] – Standard and Poors

Thank you. There’s been some concerns among your peers with the environment in Europe and I’m just wondering, you had a very strong quarter last quarter and you seemed to grow sequentially again with a solid quarter. Look at the geographies, where have you seen pending concerns or what’s the mood out there per geography?

Jerry Kennelly

This is Jerry. Yeah, we – yeah, Europe grew 55% year over year and the total company was 44%. So they had a great quarter. The strength in Europe for us traditionally and still has been Norther Europe where early on in Europe – more even than in the U.S. we focused from the beginning on the largest industrial enterprise customers and that’s carried us through. So you know, our guidance encompasses what we see worldwide including Europe in the fourth quarter and you know, we’re going forward.

Ari [inaudible] – Standard and Poors

Thank you.

Operator

Our next question will come from Paul Mansky with Canaccord. Paul, your line is open. The next question will come from Mark Sue with RBC Capital Markets

Mark Sue – RBC Capital Markets

Thank you. Should we expect over gross to gross sequentially in the December quarter? And along those lines, which protocol are you seeing the fastest rate of flow, or which vertical is least infiltrated when things are really percolating?

Jerry Kennelly

Typically, seasonally we often have government be a little bit lower in the fourth quarter. In general the great thing about our business is how diversified our customer base is. We’ve got – really, our customer base cuts across all major verticals and while they’re within in quarter or two there may be some variation, it’s provided a nice broad base foundation for our revenue. So other than government, there’s not much to add.

Mark Sue – RBC Capital Markets

Any vertical that’s really underpenetrated for your view? That’s more market rich?

Jerry Kennelly

Not really, Mark. You know, we’re basically in every vertical. So anyone who has more than two offices connected by a wide-area network line is a target for us. And you know verticals were people have lots of offices spread globally, of course are the most target rich verticals and that has been covered in pharmaceutical, manufacturing, financial services, insurance, consulting, retail, so you know.

Mark Sue – RBC Capital Markets

Thank you

Operator

Our next question will come from Eric [Inaudible] with Signal Hills.

Eric [Inaudible] – Signal Hills

Congratulations. Talk about deal sizes growing for quite a while, can you describe what some of your larger deal sizes, what kind of range they are these days?

Jerry Kennelly

Sure, so it’s a little bit tough to answer, so deployments in general keep growing because people keep coming back for more and more as they more fully deploy our product throughout their network. The transaction, the flow hasn’t changed a lot in that within a given quarter, we have a handful of $1 million plus transactions, but most of the volume tends to be relatively modest size under $100,000 deals. The average or medium deal size is prepped up a little bit over time, but what’s striking and what’s really driven our revenue growth is that a lot of these big customers come back time and time again as they continue to flush out their network. And then at some point down the road, they’ll start to refresh their network, which again provides sort of an ongoing stream for all these customers that have standardized on Riverbed.

Eric [Inaudible] – Signal Hills

Were there any particular deals this quarter that were unusually large?

Jerry Kennelly

No. No 10% customers, channel partners.

Eric [Inaudible] – Signal Hills

Okay, and then one other quick question, just on the service provider front, you talked about the service provider sales being about a third service provider systems integrator, can you give us a sense for how much of that is resold by service providers versus service providers using as a managed service?

Jerry Kennelly

We probably can’t give you the sale. It’s always either they resell it, or they use it as CP on the customer equipment. None of it is deployed in their network, so I cut that part out, but none of it is in their central offices. What is happening is the trend is that it’s going from resell to a greater percent of managed services to where it’s the CPE equipment that they’re bundling with their managed service. Unfortunately, there’s 17 shades and flavors of a managed service, so the trend is toward managed services, not resell, but the exact split we can’t give you right now.

Eric [Inaudible] – Signal Hills

Very good, thank you very much.

Operator

The next question will be from Daniel Ives with FER.

Daniel Ives – FER

Yeah, on the two-tier model, can you maybe speak to why you think it’s been you’re more successful than you guys thought? What’s the dynamic that’s going on there, and I think it’s also surprising you are on ASPs, and what do you think is really driving that?

Jerry Kennelly

This is Jerry. So I guess for something that just really began barely six months ago, it has ramped very quickly, so that is a sign of success. And a lot of effort by a lot of people, and part of its ramping is cutting of our own sales and marketing costs in terms of internally cutting process time, helping with DSOs, and giving us a broader reach to reach a bigger market place. So by all the metrics we put in place when we launched that effort, it seems to have gone faster, farther, better than we might have thought back in April when it first started.

Operator

The next question will come from Nicholus Achilleas Stephanou with UBS.

Nicholus Achilleas Stephanou - UBS.

Yeah, hi, this is [Inaudible] of [Inaudible]. About the case acquisition, can we perhaps talk a little bit about wonder kind of the logic behind build versus buy acquiring the company versus developing the product in-house, as well as the gross margin structure for this company. I’m assuming this is software rich kind of environment over here.

Jerry Kennelly

I’ll go first. Randy will go second. So the logic behind doing it is just obviously speeds market, and we very much value the Wireshark relationship. It’s used by millions of users, so there is an established community there. And Case has developed a great reputation for working with that community. And then it’s a faster time to market quite candidly to buy a great product, and add it to the cascade family, and go after this adjacent market more completely.

Randy Gottfried

The second part of your question was on gross margin impact. I’d say on gross margins, the overall financial model, in the near term, we don’t see a big impact on gross margins. Year-over-year long term, we don’t see a big impact, hardware and software. Obviously long-term, we’re buying them for more revenue growth, and again a high margin model of ultimately higher profits.

Nicholus Achilleas Stephanou - UBS.

Thank you, and just a quick follow-up on that revenue growth issue. You’re sizing the market at $3.5 billion, is that including Cascade, or is this incremental, and how are you kind of coming to that number?

Randy Gottfried

At the third party number, and that’s for the NPM market, network performance management market. And Cascade does participate in that market, yes.

Nicholus Achilleas Stephanou - UBS.

Great, thanks.

Jerry Kennelly

And it’s incremental to the win optimization market.

Operator

The next question will be from Troy Jensen with Piper Jaffray.

Troy Jensen – Piper Jaffray

Hey, congrats on the great quarter guys.

Jerry Kennelly

Thanks.

Eric Wolford

Thanks, Troy.

Troy Jensen – Piper Jaffray

So just the other night we heard from Juniper that they had Fed business about, obviously you had a pretty good Fed quarter, but did you guys experience any slippages in Fed business?

Eric Wolford

No, not really.

Jerry Kennelly

No real surprise in that category.

Troy Jensen – Piper Jaffray

All right, perfect.

Jerry Kennelly

The next question.

Operator

The next question will come from Michael Genovese with Folay Securities.

Michael Genovese - Folay Securities

Great, thanks a lot, may I add my voice to the course of congratulations. Everything from the numbers and from what you’re saying just sounds and looks incredibly bullish. What is it that you would be most worried about at this point? Is it macro? Is it the competition? Is it something else?

Jerry Kennelly

This is Jerry. We’ve kind of blown through a lot of the normal risks you have doing this, and the two risk atoms are actually execution risk. And we’ve shown a pretty good track record of dealing with those. You know, execution risks are keeping the company on track with hyper growth, dealing with competition, and facing the macro environment. We went through the worst of the macro environment probably better than any company in tech. We don’t see it deteriorating. Personally, I don’t see the double dip. Who knows, but in any event, we’re buckled in, and solid, and ready to go through it. So our outlook is actually relatively positive. We think we will continue to take more market share. We think we have the right product at the right time, and the right market. We have new products coming out. This Case acquisition actually opens up a much bigger market for Cascade than it’s had, significantly bigger. So we’re feeling pretty good about what’s coming up.

Operator

The next question will come from John Slack with Citigroup.

John Slack – Citigroup

Great, another congrats as well. Any color on the initial uptake of the virtual steel head? I believe it leases GA towards the end of the quarter. Any color on maybe used cases that the revenue [inaudible] would be helpful.

Jerry Kennelly

Yeah, sure, so did I did GA the middle of September, so it’s been in the market a couple of weeks. And obviously, the amount of sales was very small, but there were sales. So we did make some. The best way to characterize it is the demand that is coming for that product is kind of around the edges of where appliances wouldn’t fit. You could say that it’s kind of a niche demand right now. What it will be tomorrow is a number right now. That’s what we see. And so we don’t want to set too big an expectation on that particular product yet.

John Slack – Citigroup

Great, thanks.

Operator

The next question will come from Willhead Chofer with Wilber’s Securities.

Willhead Chofer – Wilber Securities

About the competitive environment, and my question is, has the competitive environment got even better for you guys with maybe some execution issues that Blue Coat and Sysco perhaps focused on more of their core business.

Eric Wolford

Yeah, I think, this is Eric again. I think the ultimate scorecard for that is market share. And if you look at market share, I think we have a 10, 11 point share advantage, which is one of the largest we’ve had in a long time. So I think yes, there is, we are expanding that gap, and I do think there is focus issues, and what their really top two, three priorities are. But in the end, we see Sysco as a top competitor. We still compete with Blue Coat. We still compete with Juniper. We still battle and so from a street level, it feels similar, but from a market share result, it feels like we’re winning.

John Slack – Citigroup

Let me answer that. At the high end in the biggest companies with the biggest deployments of the most complex require the most scalability, it’s a Riverbed world. We sort of just, the high end of the market is really come to us in a very robust way in terms of the analysts, the customers, everything that’s happening out there. That’s really what’s driving the market share and our top position.

Renee Lyall

Okay, well, we want to thank everyone for joining us today. During the fourth quarter, we will be participating in the Goldman Sachs Techconics Conference. Both the Piper Jaffray and Wells Fargo TMC Conferences, and Stifel Nicolaus Midwest Conference in November. In December, we’ll be at both the Credit Suissess and [Inaudible] Capital Technology Conferences, and the Nasdaq [Inaudible] Lending Conference. As Jerry mentioned, we’re hosting the Into the Cloud event with some of our key partners presenting on November 10th in New York City, and we hope to see you there. We always welcome investors to call or visit us at our headquarters in San Francisco. Our next quarterly conference call to discuss our fourth quarter and fiscal year 2010 results will be on Thursday, January 27th, 2011. If you have any questions about this call, or Riverbed in general, please contact investor relations. Have a great evening.

Operator

Ladies and gentlemen, thank you for participating. You may now disconnect.

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