Riverbed Technology's (RVBD) CEO Jerry Kennelly on Q2 2014 Results - Earnings Call Transcript

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 |  About: Riverbed Technology, Inc. (RVBD)
by: SA Transcripts

Operator

Good afternoon. My name is Jay, and I will be your conference operator today. At this time, I would like to welcome everyone to the Riverbed Second Quarter 2014 Financial Results Conference Call. [Operator Instructions] Thank you. I would now like to hand the call over to Ms. Shanye Hudson, Senior Director of Investor Relations.

Shanye Hudson

Thank you, Jay. Welcome, everyone, to Riverbed's conference call for the second quarter of fiscal 2014. Here with me today are Jerry Kennelly, Chairman and CEO; and Ernie Maddock, Chief Financial Officer.

A press release detailing our second quarter results was distributed today at approximately 1:05 p.m. Pacific Time over Business Wire. This press release is also available on our website at riverbed.com. The conference call is being webcast live at riverbed.com/investors and will also be archived on our website for the next 12 months on the Quarterly Earnings and Events pages.

Our discussion today will include forward-looking statements, including statements regarding adoption of our products and our Application Performance Platform; product introductions; our forecasts for operating performance, including revenue and earnings growth, and expected non-GAAP revenue, gross margin, operating expenses and earnings per share; share repurchase activities and cash generation; as well as other statements about the company's expectations, beliefs, opportunities and strategies. Forward-looking statements are only predictions and involve risks and uncertainties that may cause our actual results to differ materially from those expressed or implied by these statements. Factors that may affect our results are summarized in our quarterly release and described in detail in our SEC filings. Forward-looking statements are made as of today's date only, and Riverbed disclaims any obligation to update any forward-looking statements.

Unless otherwise stated, financial information discussed on today's conference call is presented on a non-GAAP basis. Non-GAAP items are described and reconciled to GAAP results in today's press release and also in a supplemental reconciliation available on the Investor Relations portion of our website.

Any future products, features or related specifications that may be referenced during today's call are for informational purposes only and are not commitments to deliver any technology or enhancements. Riverbed reserves the right to modify or cancel future product plans at any time.

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

Jerry M. Kennelly

Thank you, Shanye. Good afternoon, and thank you for joining our second quarter 2014 earnings call. Revenue for the quarter was $264 million, consistent with last week's announcement, and up 4% compared to last year. Our revenue shortfall was concentrated in North America, largely in the government vertical, and while our non-U.S. regions performed at expected levels, although we are disappointed in our top line results, we were able to achieve operating leverage through solid expense management and as a result, drove a 4 percentage point improvement in operating margin and EPS of $0.26, $0.02 higher than the first quarter.

As noted in our prerelease, we experienced longer sales cycles on some of our larger and more complex transactions in the second quarter. In terms of larger deals, our results were impacted by a few sizable orders in the government vertical. Some involved state and local government agencies and in general, the approval processes took longer than expected. In others, Riverbed was one part of a multi-vendor solution delivered through our service providers. We're highly confident that these orders will close in the September quarter.

The number of customers purchasing multiple Riverbed products has grown as we've become a more strategic partner to our customers. By way of example, multiproduct sales exceeding the $1 million mark reached an all-time high in the second quarter. These are very positive trends for Riverbed, but not without challenge.

Enterprises and governments today are faced with many choices and important strategic decisions that will significantly impact the future of their businesses as they build out their IT infrastructures. They must determine what applications and hardware are hosted on premise, what to manage internally versus what to outsource and how to best leverage the cloud, just to name a few. Each decision impacts the next, and these decisions are often made serially, leading to longer sales cycles.

Similarly, when selling multiple products to a single customer, or when our products are included as part of a larger deal through one of our channel partners, more decision-makers are involved, leading to longer review and approval cycles. Our challenge, as we continue to navigate the transition from a single product to a multiproduct platform company, is to continue to improve forecasting and selling into this environment. We are committed to improving by more closely reviewing and monitoring the progress of these multiproduct transactions through our sales processes.

This challenge and opportunity is most evident in our SteelCentral product line. We are integrating these products into an increasing number of proposals to provide customers with a more comprehensive solution set for Location-Independent Computing. This results in larger revenue opportunities. This also broadens the base of decision makers and often extends the sales cycle time. Because of this, we experienced slower-than-anticipated growth in both the APM and NPM products. While our SteelCentral performance did not with our expectations, we're encouraged by key wins and our outlook for opportunities supporting long-term growth. During the second quarter, we closed several multimillion-dollar-plus transactions for SteelCentral and combinations of SteelCentral with SteelHead. I hear from the sales teams more and more frequently about our opportunities to increase deal sizes with SteelCentral, and the pipeline is beginning to reflect this opportunity.

Turning to WAN optimization. We are very confident in our ability to grow this business, which is comprised of SteelHead and SteelFusion. SteelHead revenue was most impacted by the deals that didn't close in the quarter. Had those larger deals closed, revenue would be tracking to the growth targets we projected. Importantly, we add more than 500 new SteelHead customers every quarter, and this quarter was no exception. We continue to sell very large deployments of SteelHead to existing and new customers as enterprises have an ongoing need to accelerate access to applications across distance in a consolidated environment. SteelHead also enables the transition from legacy architecture to hybrid cloud and SaaS models. Last week, Microsoft launched the Azure certified partner program, and Riverbed's SteelHead CX is one of the first products certified as interoperable with Azure. SteelHead can now optimize and accelerate the delivery of applications across 90% of public clouds.

We also see new opportunities for growth in what are under-penetrated verticals for Riverbed. As an example, one of the largest SteelHead purchases in the quarter was in the retail vertical for a chain seeking to improve the in-store experience for its customers by accelerating and improving page load times from almost 1 minute, down to only 5 seconds. As consumers, we can all relate to the frustration of waiting for help in a crowded store and the benefit that this improvement provides. With Riverbed's Steelhead solution in place, we hear the sales staff has been able to assist more customers and to do so more quickly, improving overall efficiency and offering a strong ROI.

SteelFusion was an increasing component of WAN op this quarter, with customer count and product revenue doubling compared to last year. We are hitting our stride with this product, selling larger appliances and the architectural value of a branch-converged infrastructure. Customers are buying SteelFusion to enable massive consolidation to support critical applications, to reduce the operated costs of burning [ph] the branch back up, and to reduce the risk associated with data in less secure locations. SteelFusion is tracking to hit its targeted annual growth rate, and it allows us to upsell the SteelHead base resulting in much larger WAN optimization deals. The SteelHead and SteelFusion product lines together should generate the high single-digit WAN op growth targeted for this year.

As we look ahead, we see opportunities that solidify our leadership position in the $11 billion Application Performance Infrastructure market, and we continue to add key hires that complement our existing power pool and help us achieve our goals and scales. Riverbed's Application Performance Platform is highly relevant to IT executives today. Enterprises are becoming hybrid in terms of IT, transforming into a mix of owned applications, running as hybrid data centers, and applications in the cloud being delivered as services. Data is moving over private networks, being joined by public networks. This combination of private and public data centers and networks is complex, and masking that complexity to the end users is the role that Riverbed products play. Our comprehensive suite of products ensures that applications perform as expected, data is available when needed and performance issues are detected and fixed before disrupting the business. With our platform, Riverbed provides the essential infrastructure to the evolving hybrid enterprise.

And with that, I will turn the call to Ernie to discuss our second quarter results in more detail and provide guidance for the third quarter.

Ernest E. Maddock

Thank you, Jerry. Good afternoon to everyone and thanks for joining us on the call today. As a reminder, the income statement data presented today is on a non-GAAP basis, while the balance sheet and cash flow are predominantly GAAP.

Riverbed's second quarter results were in line with our revised guidance, with revenue of $264 million up 4% compared to last year. On a year-to-date basis, comparing first half of '14 with first half of '13, Riverbed's top line is up 5% year-on-year while our EPS is up 11%.

As we noted, top line results were challenged this quarter. We've shared in the past that we typically record between 50% and 60% of our revenue during the third month of the quarter. And in Q2, our reliance on business in the month of June was toward the higher end of that continuum. Ultimately, a number of deals that we forecast to close in Q2 didn't make it across the June 30 finish line, the impact of which is evident in our results. The preponderance of this shortfall impacted the SteelHead and SteelCentral product lines. For the quarter, product revenue represented about 55% of sales, totaling $145 million, with Support & Service revenue contributing $119 million, or 45% of total sales. Given that the shortfall for the quarter was predominantly product-related, we would expect the proportion of service and support to return to more normalized levels in the lower 40% range going forward.

Application acceleration revenue, comprised of the WAN optimization and ADC product lines, was $205 million, equating to 78% of total sales. WAN optimization, which includes SteelHead and SteelFusion, was $191 million, an increase of 4% compared with the second quarter of last year. Importantly, 2014 sales from SteelFusion more than doubled from the comparable period in 2013, and we continue to be encouraged by this growth trajectory. SteelApp ADC revenue was $13 million, up roughly 6% year-over-year and flat quarter-on-quarter. SteelCentral accounted for the remaining 22% of total revenue at $59 million, down about 3% from the prior quarter and up about 2% year-over-year. All of the quarterly change from this product line is attributed to a decline in one of the legacy products. And while the growth of the newer core products was not at expected levels, we did see positive sequential and year-on-year growth in these areas.

Turning to distribution. 91% of our second quarter revenue came from indirect channels, while 9% was sold direct. Two distributors contributed more than 10% to revenue in the quarter, with Arrow at 19% and AppNet at 13%. We had no 10% end-user customers in the quarter. Geographically, the Americas represented 59% of total revenue, EMEA was 26%, and APJ was 15%.

Turning to verticals. Our largest contributors remained consistent with financial services, government, manufacturing and professional services and technology each contributing 10% or more to total revenue during the quarter. The government vertical was 14% and contributed less than we expected, as several larger transactions moved out of the second quarter.

Ongoing operational improvements enabled us to deliver improved gross margin performance of 79% in the second quarter. Product gross margin improved to 82.5%, while Support & Service gross margin was relatively flat at 74.8% and in line with our historical average.

Operating expenses for the second quarter were $149 million, below our guidance range and the result of lower variable compensation expenses associated with a lower revenue. We will continue to closely manage expenses, while making prudent investments necessary to support our growth. The combination of healthy gross margins and lower operating expenses resulted in an operating margin of 23%, in line with our guided range. Taken together, these quarterly results reflect operating income growth of 10% year-over-year on revenue growth of 4%, a demonstration of our ongoing focus on leveraging our revenue growth.

Interest expense for the June quarter was approximately $3 million and our tax rate was 26%, both consistent with expectations. Net income for the quarter was nearly $43 million, translating to $0.26 per diluted share and in line with our revised expectations. Our fully diluted share count was 165 million shares. And as Jerry noted earlier, versus the March quarter, this represents $0.02 EPS increase on essentially flat revenue. We ended the quarter with approximately 2,650 employees, up slightly from the March quarter.

Turning to the balance sheet and cash flows. We ended the June quarter with total assets of $1.9 billion and cash and investments of $520 million. Inventory was at $18 million, down approximately $4 million from the prior quarter as we continue to actively manage inventory performance. Deferred revenue decreased by 2% sequentially to $319 million, while day sales outstanding were 37 days for the quarter. We generated $37 million in cash from operations, with free cash flow at $21 million based on capital expenditures of $16 million.

During the second quarter, we repurchased approximately 3.8 million Riverbed shares for $75 million at an average price of $19.83 per share. 288 million of our current repurchase authorization remains, and we plan to continue to make opportunistic share repurchases. Year-to-date, we have returned approximately $100 million to shareholders in the form of share repurchases, roughly double our free cash flow over the same period.

Turning to our outlook for the third quarter. Our non-GAAP guidance is as follows. Total revenue is expected to be in the range of $285 million to $291 million, up between 8% and 10% compared with the September quarter of 2013 and a similar amount versus the June quarter of 2014. This revenue level considers Q3 seasonality in the government vertical, as well as the additional revenue we should see from our second quarter delays.

Gross margin is expected to be between 78.5% and 79.5%. And operating expenses are expected to be between $154 million and $156 million, supporting an operating margin of approximately 25%.

Finally, we are guiding earnings per share to be between $0.30 and $0.32 based on a tax rate in the mid-20% range and a diluted share count of 165 million. At the respective guidance midpoints, this represent EPS growth of 19% on revenue growth of 9% quarter-on-quarter.

With the first half of the year behind us, it's appropriate to update our perspectives on 2014 performance. This perspective was developed after thoughtful consideration of our past performance, the current industry and customer environment and the pipelines for each of our products. We are very comfortable with our ability to grow the WAN optimization business, which includes SteelHead and SteelFusion, and deliver year-over-year revenue growth in the upper single-digit range, in line with our targets. As Jerry shared with you earlier, we continue to make progress towards achieving our growth objectives for SteelCentral performance management. We are also executing our plans to expand the SteelApp ADC business with the introduction of an appliance around the end of this year, which we believe will allow us to more deeply penetrate the enterprise.

While we remain confident in our ability to grow both of these businesses, we expect it will take a bit longer to realize the market opportunities that we see.

Additionally, our support business is also growing at levels consistent with or slightly above our model. Taken together, we now expect annual revenue growth between 7% and 8% this year. And within that range, we remain confident in our ability to achieve EPS growth at or near the targeted 20% range supported by our laser focus on managing expenses. We also continue to see the ability to achieve a peak quarter margin of 28% and a full year operating margin of 24%.

With that, I will turn the call back over to Jerry for his closing comments.

Jerry M. Kennelly

Thank you, Ernie. Despite our Q2 challenge, we continue to have confidence in our ability to grow the business and deliver targeted earnings performance, and our third quarter guidance is reflective of this confidence.

At our Analyst Day last November, we reintroduced Riverbed, a company built on a solid foundation of innovation and market leadership with a vision of a broadened performance platform and increased relevancy to our customers. We continue to focus on that vision to enable Location-Independent Computing with best-of-breed products, outstanding customer support and the promise that Riverbed will be there to help our customers on their journey. Our employees, partners and suppliers focus on realizing that vision each and every day. We also remain keenly aware of the expectations of our shareholders and are working equally hard to deliver strong results by continuing to support the ongoing growth of the business.

With that, Ernie and I will be happy to take your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from James Faucette with Morgan Stanley.

James E. Faucette - Morgan Stanley, Research Division

I have a couple of questions related to, I guess, sales execution and the like. I think that you mentioned previously that you had sent some OPNET direct salespeople to Europe and Asia to help in education in those markets. And looking at the results in the different geographies, I'm just wondering if how much help you may have gotten there, and if you feel like that, that may have compromised a little bit the sales here in the U.S. That's my first question. My second question is that you mentioned that you reached -- that your highest ever level of combination sales of WAN optimization performance management. Can you give us a sense of context on what portion the deal is that -- those are? And I guess as part of that also, how should we be thinking about the growth in combination deals going forward?

Jerry M. Kennelly

Yes, Okay. So I'll take the first part. I'll let Ernie take the second part. So we didn't send -- just to be clear, we didn't send OPNET salespeople out of the U.S. into other markets. What we've done is reallocate headcounts. And part of the original premise of doing the OPNET is that they are underrepresented both in Europe and Asia Pacific, and we needed more staff in there. And so as we work with our sales model, we make movements around. That really had no impact on the quarter. The fact is, actually, if you look at the revenue, and this is probably the key question of the quarter and the key question, I think, we'll get from other people is we had pretty good performance across most territories and most geos. Europe had a strong quarter. Asia Pacific had a good quarter. Most of the Americas had a good quarter. The shortfall was really somewhat capsulated in a few areas and in -- mostly in a single vertical. We had a very strong Q4 where we came in $10 million above expectations. We had a very strong Q1 where we had raised the guidance by $10 million above what people expected. And that same flow has continued for most of the company into Q2. And had we had not had this problem with deals at the end of the quarter in the government vertical, and by government, I mean not just federal, but we also got some state and local issues. And state and local is run in each territory by the local reps. It's not a separate vertical run by people training in the state and local business. You would've come out just fine. So there was not a collapse of our business across the world. Business was strong in most areas, continuing what we saw in both Q4 and Q1. And we're certainly disappointed by having to have this shortfall in Q2. But the market is there, the pipeline is there and that's the basis for our going forward with Q3. Our guidance for Q3 really is a continuation of the performance. We saw across most geos 3 quarters in a row with just decent correct performance in the big government vertical, which we expect in Q3, which is the big vertical for government. And so that's really what laid out across Q2. And that's the direction of the company, and that's why we're confident in our Q3 guidance. With that, I'll let Ernie talk to the second part of your question.

Ernest E. Maddock

So James, just to be sure that I answer the question that you asked, were you referring to large multiproduct deals or large deals in general?

James E. Faucette - Morgan Stanley, Research Division

Large multiproduct deals. Sorry, if I wasn't clear.

Ernest E. Maddock

Yes, sorry. Of the 15 largest multiproduct deals of the company, SteelCentral was represented in about 75% to 80% of those. And it was often represented to a very significant degree, sometimes as much as 50% of the transaction. So we would expect to see that continue going forward. We've been talking for a while about how synergistic the WAN optimization business is with the SteelCentral business. And part of -- as we noted in our prepared comments, right, part of the delay that we saw was the incorporation of those products into larger and larger transactions with our customers. So we would expect to see that trend continue on a going-forward basis.

Operator

Your next question comes from Kim Watkins with Citi.

Kimberly A. Watkins - Citigroup Inc, Research Division

I want to just dig into this state and local shortfall because I'm a little surprised to hear you talking about this given that we haven't really heard others, so far, this earnings season, although I guess it's a little bit early, talk about this. And it would be helpful if you could give a little bit more insight into some concrete examples of what occurred, what was involved in these deals and kind of why they were held up? And then just would like to explore a little bit more your level of confidence in Q3, and you talked about the guidance relying on those deals closing. Have any of those closed so far, and what gives you the confidence that's going to occur?

Jerry M. Kennelly

Yes, so we won't dissect a handful of transactions one by one a great deal to you all, but let's just say we had a pipeline of forecasts of some good-sized deals just gave [ph] up, which is a relatively new vertical for us, administered by our commercial people in each state. And the requirements to get them closed, along with the partners, didn't make it across June 30. I can't be any more specific than that. But those are live deals and we do expect them to close. With some situations in federal, where, actually, we have some very large deals that were part of bigger transactions being run by service providers that involved our product plus the products of other network companies where an agency was doing a big refresh and their need was to have -- they've done it with a single transaction with a single purchase order. And our part of the transaction was ready, but the other vendors was not, and so they couldn't issue the order until both sides were done, and that was something that we couldn't control. We also had a number of deals inside again, where, in fact, the deals have grown and they have decided to add other products in our portfolio to the size of the transaction. And that caused us to stray across quarter boundaries. And some of these, again it's a vertical, it's in the Americas and it's not a generalized impact across our business. We believe the vast majority of these will close in Q4. Some have already closed. And we think we'll have a relatively straightforward Q3 with our business.

Kimberly A. Watkins - Citigroup Inc, Research Division

Okay. So it almost sounds it's more of a Riverbed-specific situation, not a macro comment that you're making. But my last question, can you just give us a sense of the order of magnitude of these multiproduct deals versus your average deal size? Like how much larger are they?

Ernest E. Maddock

Kim, this is Ernie. I think that there are sort of 2 ways you can compare it. So certainly, the multiproduct deals have the same equivalent deal size of some of our larger single product deals. So in any given quarter, the company may have a small handful of deals that exceed $1 million. Some of them could well exceed that. And so you're seeing that in 2 dimensions. It can be a large deal for a single product, a large deal for multiple products. So there is not really a clear pattern or distinction between the 2. But these would all be among the company's top 10 deals, for example, in a quarter.

Operator

Your next question from Jayson Noland with Robert Baird.

Jayson Noland - Robert W. Baird & Co. Incorporated, Research Division

As you look out into the September quarter, is your assumption for gov as a percentage of revenue, Ernie, in the upper teens?

Ernest E. Maddock

Certainly, we are being very thoughtful about how we contemplate that. So we are presuming a strong -- clearly, a stronger quarter than we had in Q2. You add to that what we see coming across from Q2 into Q3, and we should see kind of that upper double -- upper teens sort of performance ratio potentially just to do a little bit better. But we are certainly being very thoughtful in how we contemplate that vertical and ensuring that we do everything we can reasonably do to preclude disappointing again.

Jayson Noland - Robert W. Baird & Co. Incorporated, Research Division

But said specifically, a lot of those deals would have to close in the September quarter, correct?

Ernest E. Maddock

That's correct.

Jayson Noland - Robert W. Baird & Co. Incorporated, Research Division

Okay. Final question from me on these larger and multiproduct opportunities. Have you changed the way you think about your pipeline or forecast, given it sounds like sales cycles may be that were 3 or 6 months are now 9 to 12 months? Or how do you think about that internally?

Jerry M. Kennelly

Yes, it's more deal-specific, but it certainly has rung the bell to chase these, basically, day-in and day-out through all 90 days of the quarter and give a very close sales management and executive management attention as we go through it day by day now. So we're on full alert for these things.

Operator

Your next question comes from Mark Sue with RBC Capital Markets.

Mark Sue - RBC Capital Markets, LLC, Research Division

Gentlemen, it's encouraging to see the operational improvement despite your lower revenues. When we talk to investors, they view this stock as a value stock. And so they were asking about the cost structure and the shareholder returns. Are there things that Riverbed can do to structurally change its cost structure? You're spending a lot of money on share repurchases, but it's not really materially decreasing the share count. So 2 parts of that would be the dilution impact and possible accretion. Maybe how you can actually reduce the cost structure from a regional point of view or structural point of view, any thoughts there would be great.

Ernest E. Maddock

We have talked now for a while about trying to prudently grow the cost structure so that we leverage the revenue growth. And certainly, I think our performance demonstrates our commitment to doing that. If you look at the company's inventory turns, what's happened with inventory in the midst of a revenue environment that, frankly, compared to the first half of last year, is still up. I think we're demonstrating across the board that the broad-based focus within the company on looking at and managing that cost structure. I don't know that we would contemplate any dramatic restructuring of the way the company looks or operates. But every single day, we continue to look at the way we're doing things and seek opportunities to improve. And where those opportunities are clear to us, we take advantage of them. And certainly, relative to share repurchase, we are committed to continue to return capital to our shareholders and are looking at a number of other activities that would allow us to deliver improved results to a bottom line.

Mark Sue - RBC Capital Markets, LLC, Research Division

Ernie, just a follow-up on that. Is there a future framework that's developing in terms of what the percentage of free cash flow should go back to -- should go to share repurchases and eventual dividend?

Ernest E. Maddock

We've always talked about that in the context of the relative share price. And obviously, at share prices that we consider to be relatively attractive vis-à-vis our growth opportunities, we're going to devote more of that free cash flow towards that end. And as the share price moves around and our assessment of its relative value changes, we've reserved the right to think about deploying free cash flow, for example, to pay for the debt or other things. So there is a framework, but it is a variable framework that is -- contemplates a broader-based scenario than just sort of a single decision-making rule.

Jerry M. Kennelly

I'll add one thing to that, Mark, which is that we've always taken -- we take kind of a zero-based approach to what goes on around here. We don't fund things each year just because it's linear growth off of last year. Everything has to justify its existence in this company.

Operator

Your next question comes from Kent Schofield with Goldman Sachs.

Shanye Hudson

Perhaps we could come back to Kent.

Operator

Our next question comes from Brian Modoff with Deutsche Bank.

Brian T. Modoff - Deutsche Bank AG, Research Division

Jerry, can you talk a little bit about kind of you've made in previous conferences, sell-side conferences, growing 2x the market growth rate of 7%, 8%. And now you're talking about kind of 7%, 8% for your growth overall for this year. Is there a change in your view of WAN optimization's growth rate, or is it something more specific to Riverbed?

Jerry M. Kennelly

Brian, when we talked about -- so the market rates that some of the people like Gartner had put out for WAN op were in the 3% to 4% range. And we thought that we could have WAN op in the higher -- high single digits range. And so that's 2x, and we still believe in that. So we haven't backed off of that.

Operator

Your next question comes from Amitabh Passi with UBS.

Eva Yee Man Leung - UBS Investment Bank, Research Division

This is Eva Leung speaking for Amitabh Passi. Can you give us more color on the Granite? How big is it as a percentage of your total sales? And just in general, what's your expectation for this business?

Ernest E. Maddock

We've talked before about the fact that at its current revenue levels, it doesn't make sense to break it out. There are some operational things within the company in terms of the platform commonality and things that really are not going to be helpful in specifically disclosing that. We have spoken about the fact that if our growth rates and growth targets are achieved, that it would become material as we move into 2015. And right now, we're tracking towards that. So no specific disclosure with SteelFusion at the moment.

Jerry M. Kennelly

This is Jerry. I will add that it had a strong quarter. And if you understand the rollout of that product, we needed 2 things that came out in the fourth quarter which was the bigger, more robust larger-sized appliance, which came out in the fourth quarter, and also the ability to do private channel, which also came out -- which has been the pace we've added to its growth. So it's like [ph] it's been in the market now for 2 quarters, and we're starting to see take up on that. And we're also starting to see it as a very powerful product, and specifically in the retail vertical. So we feel as good as ever about SteelFusion Granite, as you say.

Eva Yee Man Leung - UBS Investment Bank, Research Division

Can I just, as a follow-up question, kind of more on the SteelApp, do you expect there is a deceleration in SteelApp ahead of the introduction of your appliance form factor? Are you seeing any pipeline, are you building for the appliance version already?

Jerry M. Kennelly

So we don't expect deceleration, but we clearly need the appliance to address the bigger market consistently. 95% of the market for ADC is the appliance form factor. And we have multiple examples of customers who love our software, love our approach, love our functionality but wanted it in the appliance form factor. And so I don't think it'll decelerate to [indiscernible] But we won't get a lot of growth until the appliance factor comes out, and we're very much looking forward to that.

Operator

Your next question comes from Alex Kurtz with Sterne Agee.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

Ernie, just back to the sequential setup here for September and just given, historically, sort of how the company's performed between this enterprise and government moves from June to September. Just on the face, it doesn't seem like there's a lot of margin for errors. So is there a large percentage of these deals that flipped that have already closed, as Jerry alluded to? Or is there some other kind of pipeline that gives you the confidence in that sequential ramp? That would be helpful.

Ernest E. Maddock

Certainly, there are some of the transactions from the June quarter that have closed. We have done a fairly thorough scrubbing of the pipeline, as you might imagine, as a result of what we've experienced over the last couple of weeks, and are very comfortable and confident in the guidance that we provided. And we do see, as you would normally expect to see, good seasonality in the government vertical, but we also see continued robust strength in enterprise as well. So without going through it deal by deal, transaction by transaction, and showing you what we can see, I can tell you that we feel comfortable and confident in our future guide.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

And -- understood. And Jerry, just on the multiproduct strategy, do you feel like there has to be a change potentially in compensation across the sales force as those deals become a little bit more complex in multi quarter, or the setup that you have now is working?

Jerry M. Kennelly

We have -- I think we have a pretty good set up. We have the overlay specialists, we have the core reps. The comp plan is quite rich, actually. And it's more just more familiarity, more cross-training with the channel partners who take it to the customer. And it's working. Like I said, we didn't fall off a cliff. We missed at the margin, right? And so in general, it's working, but it could work a little better.

Operator

Your next question comes from Paul Silverstein with Cowen.

Paul Silverstein - Cowen and Company, LLC, Research Division

Jerry, Ernie, if it was already asked, I apologize to you and others on the call. But in terms of the shortfall you identified relative to these big deals, can you tell us how many deals we're talking about? And if we -- exiting out the big deals, if we look to your North America enterprise business, what did the growth rate look like?

Ernest E. Maddock

So the North America enterprise business was actually quite strong for the quarter. And relative to your first question about the number of transactions, I would say you're dealing with a number, a handful to maybe 10 to 15 of which we're counting on some proportion closing.

Paul Silverstein - Cowen and Company, LLC, Research Division

Or you can't -- when you say quite strong, you can't quantify that force, can you?

Ernest E. Maddock

I -- yes. It's up a very substantial percent over the quarter, over the previous quarter. So it's probably up 5% year-on-year from prior -- on a year-on-year basis and on a quarter-on-quarter basis, among one of the strongest quarters we've had.

Operator

Your next question comes from Rod Hall with JPMorgan.

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

I just wanted to follow up on the government thing. I -- if I look at your original guidance and I look at the percentage of government that you guys have done in the last couple of years in the quarter, call it 18%, and I know that may fluctuate a little bit, I end up with about $50 million worth of revenue, maybe in the original guidance. And now, you're saying -- I think you said 14% of the revenue that you just reported, which would put it at about $37 million. So call it, I don't know, a $13 million shortfall. So I wanted to check and make sure that math is right. And then also ask you, maybe Ernie, if you could give us any idea of what the -- between this thing, local and the federal issue, what the split of that is? Is it roughly 50-50 or is it 2/3, 1/3? And then the other thing I wanted to ask you, Jerry, it sounds like you're saying that those 2 types of shortfall, both -- you would expect both of them to come back. Could you guys comment about when it comes back? Is it 2 quarters' worth of time that it takes to recover the revenue shortfall? Or when should we see that completely repaid, if you will?

Ernest E. Maddock

Okay. So we'll try to knock off all the questions. So your math is correct. We've historically done sort of an upper teens number. We did 14. And the delta between those 2 things is very close to sort of the challenge we experienced this quarter. The second piece of that, I would say, reasonable to think about somewhere between 1/3 and -- 2/3 and 3/4 fed, 1/3 and 1/4 non-fed, but still government or government agencies. And...

Jerry M. Kennelly

I'm not sure I caught the [indiscernible]. So I mean, our guidance for Q3 is -- you have it. So -- and then we'll give you Q4. And I think we gave you the full year guidance. So that encompasses whatever recovery [indiscernible].

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

Can I clarify the question? What I was asking if there was a $13 million shortfall, or somewhere in that ballpark, how -- when does that the -- it sounds like you think the full $13 million comes back to you. It's just a question of timing. Does it -- does that $13 million get recuperated over the next 2 quarters? Or when -- by when does all the $13 million come back as...

Jerry M. Kennelly

Yes, we didn't -- so we -- specific deals will close, but you don't -- it never really works out, that dollar for dollar, later on, you get it back, however. That's just not the way the world works. And I think we've just given it a fresh full year view that encompasses the fact that you don't get it all back. But we're saying we'll have a relatively normal revenue run rate again starting in Q3. And it's not running off of a lower rate of Q2. It's a more normal run rate. And so we get back to normality in terms of revenue generation and profitability. But you don't, dollar for dollar, recover those things. That's just not the way things work.

Operator

Your next question comes from George Notter with Jefferies.

George C. Notter - Jefferies LLC, Research Division

I wanted to ask about linearity. I think you mentioned, Ernie, that you guys were, I guess, pushing towards 60% of the business shipped in last month of the quarter. And here we are, kind of raising expectations sequentially for Q3. I realize that the government business will be stronger. But it seems to me that you're anticipating another heavily back-end weighted quarter for Q3. Is that right way to think about it? And then does it make sense over time for Riverbed to continue to run the business with that much of a back-end weighting? Do you see a point where you could make the business more linear somehow, is it either by kind of backing off on expectations, or just kind of growing the business more aggressively through new products, or -- I guess I'm trying to understand the perspective on why this business has to be run so -- such a back-end loaded way?

Ernest E. Maddock

Yes, I don't think that's a Riverbed unique circumstance. So our company was negotiating with several of our IT vendors. And we negotiated with them at 11:59 on June 30 because we know that when we negotiate with them at that time, we stand the chance of getting the best price. So I don't think our circumstances are particularly unique. If we can do a quarter where we get 50% of the business in, in the first couple months of the year -- or sorry, first couple months of the quarter, we're actually quite happy. And what I cited is, that in a range of 50 to 60, we were really pushing the upper end of that range. And so we will be monitoring linearity quite closely. It's something that we have done for the last few quarters. It's had positive results. In this particular case because of the size of some of those late quarter deals, we bore the consequences of that. But I don't think there's anything that Riverbed can do to change what is, fundamentally, a 20-year tradition in IT that suggests that customers tend to leverage suppliers by doing so at the 11th hour of the third month of the quarter.

George C. Notter - Jefferies LLC, Research Division

All right, fair enough. The other question I wanted to ask was just on the xx20 series. Steelhead's, I believe in the springtime, you guys announced end of support on those products. Was that something that gives you a tailwind in terms of the top line these days, or is that not much of a factor?

Ernest E. Maddock

We think it's embedded in the run rate. Clearly, there are customers who are refreshing. There are customers who may have refreshed that product set 6 months ago because their business circumstances, as opposed to our discontinuation of maintenance support, was the driving factor there. So we continue to incorporate that into our thinking as we provide our guidance on a going forward basis.

Operator

Your next question comes from Matt Robison with Wunderlich.

Matthew S. Robison - Wunderlich Securities Inc., Research Division

Jerry, I was hoping that maybe you could elaborate a little bit more on how the -- how you plan to go to market with the SteelApp appliance, how it's going to be differentiated and how it's going to fill out your ability to execute in that realm?

Jerry M. Kennelly

So it's a little premature for that. We'll do a big launch late in the year with pricing and features, yada yada yada. Fundamentally, it's the form factor to deliver what is a really great piece of software. So thank you for the question, but it's just a little premature at this time.

Operator

There are no additional questions at this time. I'll turn the call back to our presenters.

Shanye Hudson

Thank you, Jay. And on behalf of the entire management team I'd like to thank you for joining us on the call this afternoon. Within the third quarter, Riverbed will be participating in the Pacific Crest Global Technology Leadership Forum and Oppenheimer Technology, Internet & Communication Conference in August, as well as the Citi Global Technology Conference in September. We'd also like to invite you to save the date for our next investor and institutional analyst meeting, which is scheduled for November 5 here in the Bay Area.

As always, if you have any further questions, please direct them to Investor Relations. And with that, have a good evening.

Operator

This concludes today's conference call. You may now disconnect.

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