Riverbed Technology Q3 2007 Earnings Call Transcript

Riverbed Technology Inc. (RVBD)

Q3 2007 Earnings Call

October 23, 2007 5:30 PM ET

Executives

Jerry Kennelly - Chairman, President and CEO

Randy Gottfried - CFO

Eric Wolford - SVP of Marketing and Business Development

Chris Danne - IR, The Blueshirt Group

Analysts

Jeffrey John - Citigroup

Cobb Sadler - Deutsche Bank

Bill Choi - Jefferies & Company

Jason Ader - Thomas Weisel

Jonathan Curtis - Nollenberger Capital Partners

Ryan Hutchinson- WR Hambrecht

Samuel Wilson - JMP Securities

Erik Suppiger - Signal Hill Capital Group

Presentation

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. And welcome to the Riverbed Technology's Third Quarter 2007 Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions) This conference is being recorded Tuesday, October 23, 2007.

I would now like to turn the conference over to Mr. Chris Danne. Please go ahead sir.

Chris Danne

Thanks Nicole. Good afternoon and thank you for joining us on today's conference call to discuss Riverbed's third quarter 2007 results. This call is also being broadcast live over the web and can be accessed in the Investor Relations section of Riverbed's website at: www.riverbed.com for 30 days.

With me on today's call are Jerry Kennelly, Riverbed's Chairman, President and Chief Executive Officer; Randy Gottfried, Chief Financial Officer; Eric Wolford, Senior Vice President of Marketing and Business Development.

After the market closed today, Riverbed issued a press release with the results for its third quarter ended September 30th, 2007.

If you would like a copy of the release you can access it online at the Company's website. We would like to remind you that during the course of this conference call, Riverbed's management may make forward-looking statements including financial projections, statements as to the plans and objectives of management for future operations. Statements as to management's beliefs regarding the potential size of the WDS market, its growth characteristics and statements as to the company's future economic performance, financial condition or results of operations.

These forward-looking statements are not historical facts, but rather are based on Riverbed's current expectations and beliefs, and are based on information currently available to us. Words such as: “may”, “will”, “expects”, “intends”, “plans”, “believes”, “targets”, “estimates”, and variations of these words are intended to identify forward-looking statements. By discussing our current perception of our market, and making these forward-looking statements, we are not undertaking an obligation to provide updates in the future.

Riverbed's actual results may differ materially from those projected in these forward-looking statements, and no one should assume at a later date that these comments from today are still valid. The risk factor section of our 10-Q and subsequent reports filed with the SEC discloses risks that could cause these differences.

Any future product, feature or related specification that may be referenced in today's call are for information purposes only and are not commitments to deliver any technology or enhancements. Riverbed reserves the right to modify future product plans at any time.

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

Jerry Kennelly

Thank you, Chris. Good afternoon and thank you for joining us on today's conference call to discuss our third quarter 2007 results. The third quarter was another strong quarter progress at Riverbed. Let me just expand it to $63.3 million, representing a 157% year-over-year growth. This rapid growth rate was achieved with broad-based market success, with no major concentration of customer, no major concentration of vertical, and no major concentration of channel partner.

New customer growth also continued at a rapid pace and clearly our investments are growing our sales, marketing infrastructure and R&D are paying off.

We also continued to differentiate our technology, and expand the market for our products, with the introduction Steelhead Mobile late in the quarter. And this week’s announcement of Riverbed's optimization system 4.1.

We believe the wide area data services market is huge and growing opportunity, have it still on [consistency]. And we will continue to work to position the company to leave this market for many years to come.

Our market leadership is clearly reflected in our third quarter numbers. Revenues in Q3 grew by 17% sequentially and a 157% year-over-year boosted by a very strong performance in the U.S.

Our customer growth continued in third quarter accumulative customers now total to more than 3000.

And finally our bottom-line continue to improve even while we invested heavily in our future growth. During the quarter we achieved 18% non-GAAP operating margins.

We've always talked about some day reaching a target of 25% and, based on the execution this year, we’re now willing to say that we believe we can hit this target as we exit 2008.

Our leadership position is most evident in our continued success in adding new customers, specifically the larger enterprise customers and government agencies, with networks of 1000’s of remote sites.

During the quarter we added a number of mark key wins, and at quarter end we had over 100 of the Fortune 500 customers. We believe our competitive advantages are at their peak with the largest global customers.

Some recent wins included one of the largest providers of financial services, who recently awarded us the global standard for WAN optimization. This is during over a year long battle involving exhaustive trials and we won out over Cisco and Blue Coat who are both incumbent providers.

In China, we won a global technology brand with billions in sales after intense competition. Our product was chosen for superior technical performance, despite a strong relationship with incumbent Cisco.

And we won an international conglomerate that is part of the Global 100, working closely with one of our key distributors, Orange. This customer chose us over three competitors based on ease of use, multi protocol acceleration and scalability.

Overall, we’ve seen our competitive win rate remain at historically high levels and in some cases improve. At the same time WDS continues to be a very large and mostly untapped market opportunity. We want to continue expanding the reach for our distribution organization and continue delivering industry leading innovative products.

With this in mind, I would like to walk you through some of the key investments in R&D and sales and marketing that will drive our growth. First, we are focusing more than 25% of our development head count budget on future technologies to expand beyond our current market. The remainder of our spending is concentrated on ensuring that our core product continues to be clearly superior in the market place.

As an example, this week we announced the introduction of RiOS 4.1 and a new Steelhead model 6120, which was specifically built for disaster recovery. This new release further distances Riverbed from our competition by offering competitors even more speed, scalability and security. Among other features RiOS 4.1 provides organizations an encryption capability for the data stored on disk and Steelhead appliances.

Securing data risk builds on Riverbed’s ability to accelerate encrypted data in flight over the WAN without compromising the security trust model. This combination of security features gives Riverbed customers the industry's only, WDS solution that preserves end-to-end to security.

Additionally, with RiOS 4.1, we are now the only WDS supplier to provide application specific acceleration that via Oracle 11i E-Business Suite.

Finally, with the combination of a new disaster recovery functionality in RiOS 4.1 and the processing and storage capacity of the Steelhead appliance model 6120, we are now able to deliver up to 4x additional acceleration for disaster recovery operations, further distancing us from the competition.

Time-and-time again, the superiority of our technological approach has been borne out and compared to [break costs] and we continue to invest to extend our technological lead. Beyond our core product, we have been very pleased with the introduction of Steelhead Mobile.

Coming out in just the final weeks of the quarter, we won over 40 customers, representing thousands of remote workers. These customers typically “trial a product” like this before buying and we were very pleased with this quick response, which reflects that a high percentage of our data customers ordered the product.

The pipeline continues to grow, and we now have more than a 100 organizations trialing mobile. Customer interests has exceeded our expectations, and while we continue to predict that the real impact of mobile will start to ramp up in 2008 as planned.

We are encouraged by the reaction of potential customers to our product and pricing strategy. Importantly, we also saw that 25% of our customers in a recent survey invested the potential availability of value Steelhead Mobile as a primary or secondary motivation for purchasing our equipment.

Not only does this give us confidence that mobile can be a significant growth driver for us, but it also demonstrates that our early lead in this marketplace further differentiates our overall product offering from the competition.

While we continue to invest our technology, we are also investing in our sales and marketing infrastructure. We don’t like to miss deals due to a lack of sales coverage and we are working hard to rapidly expand our reach.

For example, we recently entered the Latin American market and are expanding into Eastern Europe, the Nordics and additional countries in Asia. On the channel front, we continue to make progress with larger partners that are helping to win more Fortune 500 customers, many of which are just starting to contribute to revenues.

Last quarter, we added 23% more people to our sales and marketing organization, bringing our total there to 250. Let me remind you that the average sales person takes around six months to wrap the full production, so these investments will bear fruit only in 2008. Our revenue and customer growth continue to demonstrate our very attractive market opportunity and our leadership position in it. We are running full speed ahead to make sure we are in a position to execute on these opportunities. On that note, I would like to turn the call to Randy Gottfried. Randy?

Randy Gottfried

Thanks, Jerry. We are very pleased by our performance in the September quarter with continued strong growth in revenues and new customer acquisitions. Total revenue increased 17% sequentially and a 157% year-over-year to $63.3 million. We didn’t have any 10% customers in the period.

Product revenue grew 163% year-over-year, fueled by sales growth across all major geographies, as we continue to see broad based demand across a wide variety of verticals. Product revenue from our peak purchases represented 58% of the total in Q3, up slightly from the 54% we achieved in Q2. 42% of product revenue came from new customers. About 88% of our total revenue came from indirect channels in Q3 and the remaining 12% were direct sales.

Approximately 61% of our revenue was generated in the U.S. with the remaining 39%, from coming outside the country. We saw strong momentum in our domestic market, which grew 18% quarter-to-quarter while we experienced some normal seasonal growth reduction internationally as expected.

Services revenue grew 191% year-over-year, as we continue to grow our installed base of customers with support contracts.

Routable products and related services revenue is our smallest revenue line item, representing about 3% of the total and with $2 million in the September quarter.

Let me shift over to the cost side, one important note, when I talk about cost and expenses I am talking about non-GAAP numbers, that excludes stock based compensation, and stock based payroll taxes. Be sure to look at our press release, for our reconciliation of non-GAAP to GAAP amounts.

We’re pleased to report another strong quarter that demonstrated the operating leverage in our business. We continue to see robust product margins and increase in net income, even as we “ramped” our investment in operating expenses, to take advantage of the market opportunity in front of us.

Product gross margins were at the record level of 73.4% in Q3, up from 71.6% in Q2. The improvement was primarily from reduced costs.

Service gross margins were improved to 69.5%, up from 67.1% in Q2. The combination led to record gross margins of 72.7%.

While we increased spending in absolute dollars, sales and marketing remained relatively flat as a percentage of revenue at 32% in Q3, in line with our expectations. As did R&D which came in at 13%.

D&A expenses increased this quarter to about 9%, as we incurred expenses for our Sarbanes-Oxley poor compliance efforts and continue to invest in our internal systems. As with last quarter, our operating margin was 18%.

Total headcount increased 24% in the period, going from 445 people at the end of June, to 551 people at the end of September.

Our pro-forma tax rate, which is based on our pro-forma pre-tax income, was 14% in Q3, higher than the 10% rate we originally projected, which cost us almost a penny a share. In the fourth quarter, we believe the rate will end up at approximately 10%

As I mentioned in our prior calls, since we’re in our first year of profits, we have experienced some variability of tax rates that may continue in the near term.

Q3 non-GAAP, net income was $12.4 million or $0.17 per share, up from a net income of $11.7 million or $0.16 per share in Q2. We generated a GAAP profit of $2.8 million or $0.04 per share.

We finished September with $232 million of cash and short-term investments. Cash from operations in Q3 totaled $15 million.

Moving down to balance sheet, we ended the quarter with $38 million of accounts receivable, which represents 53 days sale outstanding, up from 44 days in Q2.

Our revenue linearity in the third quarter was within the range of historical results, but was bit more backend loaded than Q2. Q3 and Q1 due tend to be a bit more backend loaded. As we've mentioned for sometime, our long-term target for DSOs is between 50 days and 60 days.

Inventory total of $10 million as of September 30th, up from June 30th. Much of our inventory is evaluation inventory in the field. Deferred revenue, current and long-term portions, totaled $28 million at quarter end.

In summary, we were pleased by our performance in Q3. Looking forward here is some guidance as we go on to the fourth quarter of 2007.

Again the profit numbers I am going to mention are non-GAAP, which excludes stock based compensation and stock based payroll taxes.

Stock based compensation includes expenses derived from the issuance of options and shares under employees stock purchase plan. We exclude these items from our numbers, as we don't use them for our internal operational decisions. And also because it requires estimates of our future stock price, which is obviously unknown, and a big driver for those calculations.

We entered Q4 with solid business momentum and we expect continued top line growth, to $69 million to $71 million of revenues, which will increase our full year revenue target to approximately $230 million, up from previous guidance of $220 million to $225 million.

We’ll continue to ramp operating expenses, to support our rapid growth. And we still expect to grow expenses at a fast rate through the fourth quarter, and a seasonally softer first quarter of 2008. Most of that expanse increase would be in our sales and marketing areas, as we continue to expand our sales coverage and invest to further improve our channel success and marketing air cover.

Even with that in mind, we expect non-GAAP EPS to be approximately $0.19 per share in the fourth quarter. Our weighted average share outstanding is expected to be about $76 million. Depending on the share price, which will drive treasury method calculations.

With that let me turn back over to Jerry.

Jerry Kennelly

Thank you, Randy. To summarize, we had another strong quarter. Revenues were up almost 160% year-over-year. At the same time we significantly improved our gross margins.

We now have over 3000 customers world wide, after another quarter rapid expansion. We generated solid cash flow, and our balance sheet is strong. And importantly we continue to lead the market and expand our addressable opportunity.

We believe the strength of our technology and competitive leadership is clearly evident in our results.

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

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) Our first question comes from things line of Paul Mansky with Citigroup. Please go ahead.

Jeffrey John - Citigroup

Hi, guys it's [Jeffrey John], I have come on for Paul. Quick house keeping item and then maybe a couple of strategic questions, can we flush up the tax rate a little bit for December and the calendar year '08? You are rapidly drawing down your NOL’s how should we be thinking about a fully tax number for December?

Randy Gottfried

I would say I would stick to our guidance of about 10% effective tax rate based on pro forma numbers for Q4. The tax topic is very complicated, we could take much of call of this call with just the tax detail, but suffice to say, for Q4 we are assuming about a 10% rate in 2008 we are still assuming about a 40% rate.

Jeffrey John - Citigroup

Okay. And then a little more strategically, can you give us any feel for the competitive dynamic, are you seeing any new comers or is the competitive dynamic changing at all in the industry?

Eric Wolford

Yes sure, John. This is Eric, and we have done our usual in the quarter review of who we compete with and where we didn’t compete with, and when we were and why and it’s the same. We continue to see predominantly Cisco and Juniper and then there is a big drop off and then next up is a group of about 4 to 5 competitors; Packeteer, Blue Coat, a little bit of F5 and Citrix kind of make up the guys that we see the most.

Jeffrey John - Citigroup

Great, and then finally -- let me just finish it up. Can you give a little, any clarity on how much Steelhead contributed or Steelhead mobile product contributed in the quarter? Any visibility on pricing or reference account, give us some color on the call on the commentary, but any news you could put to those or any thing like that?

Jerry Kennelly

I think in general it's tracking right where we expected, the product came out in the later part of the quarter, so here we had, I think we mentioned over 40 customers. The most important thing in the quarter was getting a product out there. Getting it to you guys, so that customers will start trialing it more purchasing and get some momentum over time.

Randy Gottfried

It was brought to be immaterial for the quarter for tracking the plan.

Eric Wolford

John, the good fact was that there’s 100 customers out there right now, about at least 100 evaluating the product, the first mission I want to [give] a product is just get it out there, get it into the hands of potential buyers. It's very similar to a pattern we experienced at Steelhead.

Jeffrey John - Citigroup

Was there mobile revenue booked in the quarter or was it all demoing?

Eric Wolford

We did make sales in the quarter, so there are some revenues that were contributed by mobile.

Jeffrey John - Citigroup

Okay, that’s all.

Operator

Thank you, our next question comes from the line of Cobb Sadler with Deutsche Bank. Please go ahead.

Cobb Sadler - Deutsche Bank

Thanks a lot guys. I had a question just on your sales expense. It actually went up as a percentage of sales, was there some kind of one-time item in fact you hired a lot of people but probably some items associated with the launch of Mobile Steelhead or I guess, the question is do you expect sales as a percentage of revenue to go down quarter-to-quarter from here on now, I think it was up a little bit this quarter?

Jerry Kennelly

I won’t say there is anything one time in the quarter first for sales, nothing of material nature. We continued to try to expand our coverage and that’s a key thing for us as we try to get better geographic coverage, better channel coverage. So we continue to invest in and bring out new people. Long-term our target is to get sales and marketing into the low 30s close to the 32% we're at right now. So over the long-term there is a little bit of squeeze out over there, but not a whole lot.

Cobb Sadler - Deutsche Bank

Okay.

Eric Wolford

We are working on our growth figures and future growth, continued growth. We have industry leading growth, requires a good solid distribution organization and we intend to have it going into the future.

Cobb Sadler - Deutsche Bank

Yeah, I agree makes it particularly early on. The tax rate you talked about Q4 and I think (inaudible) and probably some other models have 40% tax modeled for Q1 '08. Are you ready to talk to talk about Q1 '08, do you think it will be 40% or do you thinking it will something between 10 and 40?

Jerry Kennelly

I think that’s our working assumption right now. In general for 2008, we have maybe some more granularity into our guidance after the fourth quarter, but for now the working assumption is 40% tax rate.

Cobb Sadler- Deutsche Bank

And the way that they are working it literary could move to pretty close to 40 or you just want to wait, talk about it later?

Jerry Kennelly

In general it would go from where it will be in Q4 up to a 40%, that’s our assumption.

Cobb Sadler - Deutsche Bank

Okay, and could you give me the DSO one more time, I missed that by accident?

Jerry Kennelly

DSO was 53 days in the third quarter.

Cobb Sadler - Deutsche Bank

Okay. And you don’t talk about back-log or book-to-bill, but I guess how does visibility look rather to where, its sounds like that the European business was or the international business was slowed down, but it still grew like [17%] quarter-on-quarter. And would you expect that to snap back in Q4 as seasonal strength likely happens as opposed to doing this?

Eric Wolford

We are off to a good start to Q4, the momentum’s there. We have already in the first three weeks gotten some very big name market customers in all geographies and but the final we have is big. We don’t have the legal book backlog, people like to talk about backlog is that the demand in our install-base. Our install-base is now much bigger than it was last quarter and that demand is as robust as it has ever been.

Cobb Sadler - Deutsche Bank

And you expect the percentage of revenue from existing customers is probably increased as it has last few quarters, quarter-on-quarter in Q4?

Eric Wolford

It’s certainly been between 50% to 60% of revenue, and overtime it will grow trend up more than anything else. Although it's always healthy to have a good revenue from new customers in the quarter.

Cobb Sadler - Deutsche Bank

Okay.

Eric Wolford

We saw it likely as the install base getting bigger and bigger, a large number checks in and you can depend on your install-base, when you have a strong product you yield revenue for a long-time.

Cobb Sadler - Deutsche Bank

Sounds great, thanks very much.

Operator

Thank you. Our next question comes from the line of Bill Choi with Jefferies & Company. Please go ahead.

Bill Choi - Jefferies & Company

Okay, thanks. Can you talk about the growth and deferred revenue, it seems like the growth there is a little lighter than what you have been normally growing at, which is typically around to $3 million to $6 million per quarter can you talk about the makeup of that and why perhaps this mandate growing as quickly when your overall revenue is still growing at quite a nice growth.

Jerry Kennelly

Most of our deferred revenues are the support contracts, support contract typically are the annual contracts paid in advance. If you look at our history we have had some variability quarter on quarter in that number. And since it's based on accumulative number of customers and accumulative number of support contracts, it would sort of grow more slowly necessarily than the quarter-to-quarter revenue rate.

Bill Choi- Jefferies & Co

Okay. Then nothing unique in terms of what happens in the quarter particularly with the mobile shipping.

Jerry Kennelly

No, I don't think there is anything material.

Bill Choi- Jefferies & Co

Okay. I actually want to understand, fewer thoughts on pricing for mobile, has it evolved any, since the initial introduction and is their anything unique in terms of the way you would recognize revenue on this product, since it's primarily software based?

Eric Wolford

Yeah. Let me answer the first part and Randy will answer the recognition of the revenue part. This is Eric, Bill. So, one of things we definitely got confirmed was strong support for a concurrent user licensing. So, that was something we had tested with our beta customers, but now we've had a chance to pitch it to a broad range of customers.

And in concurrent user licensing, where they don't get charged for the software, they can put the software wherever they want and then they have to pay for the aggregation of the concurrent users, is definitely the right way to price them.

Bill Choi- Jefferies & Co

Actually, is that still about $100 per concurrent user?

Eric Wolford

It ends up been around $300 per concurrent user, which averages out some where around $80 something per user, when you think about three or four or five end users turning to one concurrent user.

Bill Choi- Jefferies & Contain

Okay.

Jerry Kennelly

And on the recognized revenue side, there is basically two pieces much like our appliance business, there is this mobile, it is a similar structure and in that there is a product piece and a support piece. So, the product piece we would recognize as we ship the product and as it gets sold through the channel. And then in the support, we would recognize over the support contract life, which is typically a year.

Bill Choi- Jefferies & Co

So, the $300, lets say per concurrent user, that’s all recognized revenue on the quarter of the license signing?

Jerry Kennelly

That's correct.

Bill Choi- Jefferies & Co

Okay. Alright and I guess not ready to talk about how big that number was whether its still getting up to a million or seven figures?

Jerry Kennelly

More material, we will talk about it more again. Your keeping for the third quarter is, we only got on the board, we got the product out. We had some revenue product. We are very pleased by the number of customer we had, who bought in early. And we’re now trying to ramp the evaluation, so we start to see more meaningful revenues as we go down the road.

Bill Choi- Jefferies & Co

Okay. And then you mention the linearity, can you talk about what percentage of your business came in the final month please?

Jerry Kennelly

We do not call out the specifics month-to-month. We typically target roughly 50% in the first two months of the quarter, 50% in the last month of the quarter. This was higher than it was in Q2. It was sort of almost total history, but that's all the detail we are able to provide.

Bill Choi- Jefferies & Co

Okay. Thanks.

Operator

Thank you. Our next question comes from the line of Jason Ader with Thomas Weisel. Please go ahead.

Jason Ader - Thomas Weisel

Yeah thanks. So, just kind of trying to reconciles some of the stuff here for the quarter. The top line peak guidance, definitely a lot less than last couple of quarters, the last few quarters since you have been public. So, what I’m trying to figure out is, was there an area in the business that didn’t meet your expectations?

Maybe its sales cycles, being longer than you expected. But I know it's hard to squeeze that 17% sequential growth, but it does seem like this is probably a little bit below your internal expectations given that the external guidance is typically quite a bit below internal expectation for companies?

Randy Gottfried

Thanks Jason. Now I won't jump to that conclusion, we gave our guidance for 59 to 61, that was honest guidance. We came in at 63.3, so we beat our guidance. We were happy to do that. We beat the consensus, we are happy to do that.

And what the world wants to think on that, they are welcome too. But this is industry-leading growth for anyone, the numbers are getting bigger. For us to have this type of growth, connected with this high profitability, 18% operating margin, heading towards 25%, is also industry-leading profitability. That’s a very powerful combination, so we don’t feel we had any sort of miss this quarter.

Jason Ader -Thomas Weisel

So, from a competitive stand point it's not getting tougher out there than it's been?

Eric Wolford

No. Jason, this is Eric. You know that the staff, the interviews, the conversations with people, and in fact all of the regional kickoffs, just confirmed that Riverbed's competitive position is as strong now as it ever was. And both medium size customers and especially large customers, we have just some great brand name wins where there were in a long term bake-offs that Riverbed won. So, in terms of the competitive positioning, we feel as good now if not better than we've thought in the past.

Jason Ader -Thomas Weisel

So, its sounds like the sustainability of this level of growth, maybe not the same numbers exactly. But just the continue growth is going to hinge to a large extent on just broadening your sales footprint and distribution footprint is that right?

Randy Gottfried

That’s a big part of it, and then just sure execution. So, we are really almost a hyper-growth company and we have a track record of executing this and we have the mobile coming out, it's started, may be modest in the first quarter.

But we've always said we still and we still believe very strongly that in the mid-term which is 2008, which is very close, probably expected to be a big producer for us and we continue to win, really big companies who are committing over two to three years big deployments and global networks and that just becomes clearer and clearer and the distance between us and the competition seems stronger than ever.

It is now almost a year anniversary, when the biggest players out there, Cisco, brought out there a [launch] product; a year later they really in fact gained almost no ground on us, and if anything we are becoming the de facto standard for the large corporate and government deployments and we feel very good about the future.

Jason Ader -Thomas Weisel

Okay thanks guys.

Randy Gottfried

Thank you.

Operator

Thank you. Our next question comes from the line of Jonathan Curtis with Nollenberger Capital Partners. Please go ahead

Jonathan Curtis - Nollenberger Capital Partners

Great. Thanks a lot. Can you talk a little about what’s going on with the Quantum lawsuit and they sort of implied that they have been talking to you guys for eight months. What was going on during that eight month period of time and where did the discussion go and then I have a follow up?

Jerry Kennelly

Yeah, so we believe it to be a meritless lawsuit. We know our products, we have read their patents and we do not infringe their patents and we try to tell them that for eight months and we tend to be kind of polite nice people and they may have mistaken our niceness for weakness. I don’t know, but we expect to prevail on this and to just go on.

Jonathan Curtis - Nollenberger Capital Partners

Is there any level at which you would be able to do a settlement or is your plan to go through the court system and work it out that way?

Jerry Kennelly

We will work to that. We are not irrational people. So quite frankly, when you don’t infringe, we expect a dismissal.

Jonathan Curtis - Nollenberger Capital Partners

Got it. And then, so your number of new customers or the growth in the new customers during the quarter, seemed a little bit low. I know it is a seasonally weak quarter for overall enterprise spending, but up line of plus 7% quarter-on-quarter, can you talk little bit about what happened there? And were you disappointed in that?

Jerry Kennelly

I don’t think growing from 2,500 to 3,000 is not really low. It’s just again large absolute numbers look smaller in percentage as the bases grow larger but we’re not disappointed by our growth in the customer base.

Jonathan Curtis - Nollenberger Capital Partners

And if you talk a little bit, specifically about what happened with financial services during the quarter. Did you see any deals slip out or any business slop and obviously you had a, sounds like at least one solid win there and then how has that, the contribution from financial services trended over the past in the few quarters or so?

Randy Gottfried

We don’t really have any one vertical, whether its financial services or manufacturing or insurance or petroleum or pharmaceuticals, that is more than 10% of our revenue and that continued be true this quarter. One of beauties of our business model, one of this, the risk-mitigated factors of our company like us, and financial services were the solid contributor in its vertical this quarter. A specific kind of product, you really want to buy when you are on cost-price pressure frankly, because you have rights for compelling.

Jonathan Curtis - Nollenberger Capital Partners

Got it. And just one final question, you have spoken in the past about that percent of uncontested deals that are out there, any color there, is that changed at all?

Eric Wolford

Sure. Yeah. John, this is Eric. Yeah, that, it bounces around quarter-to-quarter from, it’s just our own calculations, right somewhere around 30% to 40% and it was still within that same region, in the 30% to 40% range.

Jonathan Curtis - Nollenberger Capital Partners

Great. Thanks for taking my questions.

Eric Wolford

Yes.

Operator

Thank you, our next question comes from the line of Ryan Hutchinson with WR Hambrecht. Please go ahead.

Ryan Hutchinson- WR Hambrecht

Good afternoon, guys. Few question here, just in terms of the 4.1 release, can you just walk through competitively what that brings to the table and what it doesn’t bring to the table, and I guess the plans there for the next release in terms of possibly adding more security functionality or QoS functionality into the box. Do you feel that a necessary component, as we move forward here over the next 12 months?

Eric Wolford

Yeah. You bet, Ryan. So 4.1 had four different things. One of them was Oracle 11i J-Initiator, specific optimization. This is where we can crack open the J-Initiator client traffic, and we can optimize it, but prior to that we just have to pass it through. So now like we do for similar in some ways what we do for SSL we’re able to deal with that type of traffic. So that builds on a tradition that everybody has, it is application specific optimization. So this is yet another one that others don’t have.

Then we added an encrypted disc capability which is, it’s sort of you need to weave security in to your products. That doesn’t necessarily mean we’re a security provider, but we’re able to security integrate much better with, like for example, when you have SSL traffic, its secured going over the wire. If you store it on disc, you may want to have it secured on disc, because it was already secured going over the wire. So provide them more complete end-to-end security story. And in that regard, we think we’re pretty unique in being able to provide both SSL and the ability to encrypt it on disc at the same time.

So, that you don’t compromise any security [hold]. And then, we introduced a model with some hardware changes and software changes to focus on big data center to data center replication. So we doubled the size of our capacity of disc, great, more than double that in our model called the 6120. Increased the number of spindles and added intelligent software that recognizes data replication applications and more intelligently puts step on disc, picks step off disc more efficiently and has a more efficient replacement algorithm. The net-net of that is we are better able to deal with those big heavy data center-to-data center workloads.

Ryan Hutchinson- WR Hambrecht

Okay. And then I guess competitively do you see yourself adding more security functionality or QoS functionality down the road?

Eric Wolford

Yes, security will be something we will just continue to add, to integrate with. I wouldn’t position Riverbed as a company that’s going to become a security vendor in the like of Check Point. But we will, we do have to integrate with networks, and integrate with security systems.

And then in terms of QoS absolutely, we will continue to improve and invest. Not just in QoS, but its sister technology, which is visibility, applications specific fine drain visibility and QoS kind of go hand-in-hand. And so, we will definitely be continuing to invest in that.

Ryan Hutchinson- WR Hambrecht

Okay. And then as a follow-up to that, Jerry in the prepared remarks talked about a large win. I believe it was in the financial services verticals against Blue Coat and Cisco. Can you walk us through the dynamics there, how long was the overall evaluation, etcetera? And then at the end of the day why did you guys win this deal against those two competitors?

Eric Wolford

Okay. The overall process in big companies is pretty consistently the same there is a power point bake-off, and then there is the shortlist. And then there is enough capacity to do two or three vendors in terms of proof-of-concept trials or lab evaluations. And there the customer decides what is most important to them. Are they trying to speed up applications or they trying to consolidate or they trying to replicate data?

Tthey are maybe trying to do all three, in this particular case they were trying to do all three. And so they run us all through the tests, and see which vendor has the fastest performing solution for the applications they care about. And which is the easiest to deploy and manage, those end up been the two most important success criteria. And so, we were put through the paces with every one else and came out on top.

Jerry Kennelly

Exhaustive testing.

Ryan Hutchinson- WR Hambrecht

Okay. And then maybe Randy for you, I mean clearly your weighing revenue growth against operating margin expansion here, can you just help us understand over the next couple of quarters how we should view that? It sounds to me as if, there is going be a significant ramp here on the OpEx side on the front end, and then you'll gradually reach this 25% operating margin towards the end of 2008. Is that the way that we should be looking at this? And then just in terms of the leverage there, specifically as it relates to the Q3, should we expect the G&A starts to grow at a slower rate then that of sales and marketing and R&D.

Randy Gottfried

First to get to those long-term targets is technically easy. If you wanted to invest less in certain things for our future, we can get to our long-term target pretty fast. We continued to add people though, because we see some ROI opportunities.

So we will continue to hire a lot of people. Not sure if we are looking for any big uptake, other than just continued strong expansion and investment in the business. And we'll give more 2008 guidance, when next quarter after Q4. But for now we are in the high teens.

We are moving nicely. Towards the end of next year, that’s when we'll see more of movement towards our 25% range that we talked about.

On G&A specifically we are seeing some cost as we invest in infrastructure, and getting to our compliance and so on. Which in absolute dollars boost up some of our spending. Over time we would target getting G&A as a percentage of revenue into that mid single-digits versus where it is now, which is in the upper single-digits.

Ryan Hutchinson- WR Hambrecht

Okay. And is it fare to assume that in typical fashion you view this guidance you provided today is conservative?

Randy Gottfried

I don’t think there’s been any change in our guidance really.

Ryan Hutchinson- WR Hambrecht

Thanks a lot.

Operator

Thank you. We do have time to take two more questions, and our next question comes from the line of Samuel Wilson with JMP Securities. Please go ahead

Samuel Wilson - JMP Securities

I got on late. Can you just clarify or repeat what was the percentage of repeat business? And second can you just talk qualitatively about these larger companies as they deploy. Once they start to deploy a given sort of vendor’s technology, are they after first phase sort of opening it up potentially changing vendors or is it just sort of once you win one of these large customers or once one of your competitors wins one of these large customers, at this part of the market the vendor is fairly locked in?

Jerry Kennelly

Thanks Sam. Hey, Randy why don’t you give the reply?

Randy Gottfried

On the actual stat, in the third quarter, 58% of our business came from repeat buys, up slightly from the prior quarter.

Jerry Kennelly

And on the large customers, they are not completely locked in. If the stuff doesn't work they will pass it out and bring in the competitor. And more often than not, it's whether one part in if not someone else isn’t working. Once you are working, you become an integral part of how they deploy servers. How they do backup. How they use applications across the network. And it becomes a very sticky application, a very sticky technology. And the trend is to extend the roll out to more and more offices.

Eric Wolford

So, Sam, the other thing is, its not just first to get two boxes in; it is the first to get some meaningful deployment? Right?

Samuel Wilson - JMP Securities

Sure.

Eric Wolford

Once you get a meaningful deployment, and you have proven that it works. Then yes, your odds of doing well in that account are very, very high. But Jerry brought up a very good point, and that is we have experienced, and I should probably offer that in my remarks, we have experienced in the past quarter, a fair amount of customers who had gone with a different vendor, and it didn’t work. Even though, they were promised they would work and the customers came to Riverbed, we didn’t know about the opportunity. They came to us and were coming in. And those are deployments as much as 20 boxes that have gone in and that are coming back out.

Samuel Wilson - JMP Securities

So this is one for, for either Eric or Jerry, is it your sense that, on these, that your percentage of business that will come from these VP customers, will sort of continue to trend up overtime. I don’t know what the magic number is, is it some larger number but just in general?

Jerry Kennelly

Yes about absolutely, that’s our network we feel between 50% and 60% overtime, I think it will be because, as our likely installed base becomes very large, relative to current quarter, so 60%, 70%, 75%, it’s very healthy and normal for a market leader in any technology business.

Samuel Wilson - JMP Securities

Perfect. Thank you very much, gentlemen.

Eric Wolford

Thanks Sam.

Operator

Thank you, our final question comes from the line of [David Kazerowski] with Signal Hill Capital Group. Please go ahead.

Erik Suppiger - Signal Hill Capital Group

This is Erik Suppiger here, out with Signal Hill.

Jerry Kennelly

Hey, Eric.

Erik Suppiger - Signal Hill Capital Group

Hello. A couple of things. First off, just on the storage functionality on the products from yesterday’s announcement, can you discuss a little bit about the road map on the storage front?

Eric Wolford

Yeah. So we have constantly been going after two parts of storage that are very attractive to us. One is consolidation -- site consolidation, bringing file servers, mail servers, take backup systems from a remote site into data centers. And then the second area has been business continuity and disaster recovery, which someone just termed replication and backup. And so, those are areas where we continue to do both application specific optimizations in software and we continue to make changes in hardware that we can better meet that demand set. So that’s a very attractive opportunity and we’ll continue to invest in those two areas.

Erik Suppiger - Signal Hill Capital Group

And how long does it take to get a broad platform for the replication and backup side of the business?

Eric Wolford

How long does it take to get it installed?

Erik Suppiger - Signal Hill Capital Group

What’s its going to take to fill out your product line?

Eric Wolford

Oh there, it makes it more complete. Yeah. Well, if I take the combination of ongoing software changes and hardware changes, the scale, the data scale that we’re talking about if you are go into the data center is 50, 100s of terabytes of data and as you scale the software and scale the hardware systems there is a need to make improvements to deal with those very large data centers.

Erik Suppiger - Signal Hill Capital Group

And then the second question, I am sure you are aware stock traded off, some in light of the results today and I think their was some surprise that you had grown maybe $11 million sequentially in the June quarter, and then $9 million this quarter and I am just, from an outsiders perspective, might you just discuss a little bit about why you might have that kind of fluctuation? Is there anything that, in terms of hires or in terms of sale cycles that would have changed the dollar growth that you see from quarter-to-quarter?

Randy Gottfried

Quarter-to-quarter, there is a relatively a modest amount of variation. It’s a million or two this time, frankly it’s the summer quarter. We think our momentum is fine. Our competitive position is fine. And we’re growing vastly forward in the Q4.

Erik Suppiger - Signal Hill Capital Group

Well you increased your guidance by, you guided up from $6 million to $8 million versus guiding up $5 million to $7 million last quarter. It sounds like you would feel optimistic that we could potentially see some acceleration, is that a reasonable assessment?

Jerry Kennelly

We’ve had very positive Q4’s in the past. We have a sales force that’s very motivated. They are mostly in their acceleration parts of their commission schedule on the fourth quarter. The companies have annual budgets at peak in the fourth quarter, and based on what we see, we feel very good about the fourth quarter that’s reflected in our guidance.

Erik Suppiger - Signal Hill Capital Group

Very good. Thank you.

Jerry Kennelly

All right, well thank you everyone. Thanks for being on the call. We appreciate your support and we look forward to updating you on our progress as we go through time. Thank you. Operator?

Operator

Thank you. That does conclude our conference for today. Thank for your participation. You may now disconnect. Thank you for using ACT.

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