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Executives

Renee Lyall

Jerry M. Kennelly - Co-Founder, Executive Chairman, Chief Executive Officer and President

Randy S. Gottfried - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Business Services

Eric S. Wolford - Executive Vice President and General Manager of Products Group

Analysts

Alexander B. Henderson - Needham & Company, LLC, Research Division

Jason Ader - William Blair & Company L.L.C., Research Division

Ryan Hutchinson - Lazard Capital Markets LLC, Research Division

Ittai Kidron - Oppenheimer & Co. Inc., Research Division

Natarajan Subrahmanyan - TheJudaGroup, Research Division

Brent A. Bracelin - Pacific Crest Securities, Inc., Research Division

Amitabh Passi - UBS Investment Bank, Research Division

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

Kent Schofield - Goldman Sachs Group Inc., Research Division

Brian T. Modoff - Deutsche Bank AG, Research Division

Daniel H. Ives - FBR Capital Markets & Co., Research Division

Sanjiv Wadhwani - Stifel, Nicolaus & Co., Inc., Research Division

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

William H. Choi - Janney Montgomery Scott LLC, Research Division

Riverbed Technology (RVBD) Q3 2012 Earnings Call October 18, 2012 4:30 PM ET

Operator

Good afternoon, my name is Jamaria, and I will be your conference operator today. At this time, I would like to welcome everyone to the Riverbed's Third Quarter 2012 Financial Results Conference Call. [Operator Instructions] I will now turn the call over to Ms. Renee Lyall, Director of Investor Relations. Madam, you may begin.

Renee Lyall

Thank you, Jamaria. Welcome to our conference call for the third quarter of 2012. The speakers today are Jerry Kennelly, President and CEO; Randy Gottfried, Chief Financial Officer; and Eric Wolford, EVP and General Manager of Products. A press release detailing our third quarter results was distributed today at approximately 1:05 p.m. Pacific time over Business Wire. The press release is available on our website at riverbed.com. This conference call is being webcast live at riverbed.com/investors and will 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 our products, partners, markets, performance, strategies and financial outlook. 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 reviewed on today's conference call is presented on a non-GAAP basis. Historical non-GAAP items are described and reconciled to GAAP results in today's press release and in a supplemental reconciliation available on the Investor Relations portion of our website. Any future products, feature or related specification 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.

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

Jerry M. Kennelly

Thank you, Renee, and good afternoon. We are pleased to report record revenue of $219 million, up 10% sequentially and 15% year-over-year. Sales to enterprise, that is nongovernment customers, grew a strong 8% sequentially and 21% year-over-year.

Our operating margin increased more than 400 basis points sequentially to 29%, and we achieved record net income of $46 million, an increase of 23% compared with the second quarter of 2012.

Across large enterprise, government and midsized businesses, we are seeing a move to virtual data centers, hybrid cloud computing and, ultimately, the software defined data center. This evolution is enabled by technology innovation, and Riverbed is one of the leaders who can deliver on this vision of a data center without walls.

The strategic partnerships we have developed, the acquisitions we have made, the products we bring to the market have all been done knowing that every customer has unique requirements. Our solutions enable flexibility and scalability that can meet the needs of private and public cloud, Hybrid and outsourced models. Across our products, we ultimately deliver the best performance and highest availability for our customers' chosen IT infrastructure.

Earlier this year, we brought to market the next generation of WAN optimization with the Steelhead CX, and EX appliances and Granite, which delivers Edge virtual server infrastructure.

Two weeks ago, we announced the CX 5055 and CX 7055, 2 high performance data center appliances that deliver up to 50% increase in WAN capacity compared to their predecessors. On the same day, we announced an enhanced virtual services platform that leverages VMware's ESX server and is fully integrated with vSphere vCenter. This integration allows IT to essentially manage all virtual servicers running on Steelhead EX appliances. When combined with Granite, the solution is even more powerful, extending the data center to the virtual Edge.

During Q3, we also previewed another solution leveraging Granite to deliver higher performance VDI with VMware view. Granite allows the servers on which the desktops are hosted in the data center to be projected to the Edge, delivering manlike performance and protection from WAN outages while still maintaining the control on the data center.

Granite revenue increased in Q3, and customer interest is growing fast for Edge virtual server infrastructure. Riverbed is the only company selling this disruptive and revolutionary solution.

I also want to highlight another quarter of strong growth in our virtual Steelhead products. We believe we are a leader in software WAN optimization, and we are beginning to see broader adoption of our virtual Steelhead. We also announced further integration of Cloud Steelhead with vCloud Director. This integration allows customers to leverage WAN optimization as a service in the Cloud, moving VMs between virtual data centers. We expect continued growth of WAN optimization led by our new products and solutions.

Cascade delivered an exceptional quarter with revenue growing 45% year-over-year to $17 million. Application-aware network performance management becomes more important in virtual and in software-defined data centers because higher virtualization leads to decreased visibility for network operations.

IT organizations often find that dynamic and on-demand can lead to a lack of control. Cascade returns that control to IT, building a bridge for the network to the applications, ensuring the best performance and highest availability of both.

In August, we announced our plans to provide visibility and performance management to VXLAN Networks. VXLAN is a core technology for VMware software defined network. We also announced our plans to introduce a virtual version of all Cascade products.

Stingray, our virtual ADC offering, provides the scalability and agility that cannot be matched by hardware ADCs. The virtual ADC ties into the same evolution to the data center without walls, freeing users from hardware limitations. Stingray allows IT to consolidate applications and move applications easily between physical and virtual data centers. This flexibility is critical for customers with hybrid cloud environments, and we are seeing customers adapt to this model.

Whitewater, our Cloud storage Gateway, also delivers performance and availability to the customer choosing Cloud backup. In September, we introduced a new 3010 appliance to handle larger enterprise workloads.

To summarize, during the third quarter, we continued to see large deals from customers whose purchase is centered on traditional WAN optimization usage cases, including accelerating access to applications, the enablement and consolidation and disaster recovery.

We're also beginning to see more customers and Cloud service providers align with Riverbed as a strategic vendor as infrastructures evolve to take advantage of the benefits of hybrid cloud computing and virtual data centers.

It is my belief that Riverbed has never been better positioned to take advantage of these IT trends.

I will now turn the call over to Randy to review the financials.

Randy S. Gottfried

Thanks, Jerry. As a reminder, unless stated otherwise, the numbers I'll discuss are non-GAAP. Third quarter revenue was $219 million, up 10% sequentially and up 15% year-over-year.

Third quarter product revenue was $145 million or 66% of total sales. Product revenue grew 12% sequentially and 9% over the prior year.

Service & Support revenue was $74 million in the third quarter, representing 34% of total sales. Service & Support revenue grew 7% sequentially and 27% over last year.

WAN optimization was 87% of total revenue in the third quarter, NPM was 8% and ADC contributed 5%.

Total WAN optimization revenue increased 7% sequentially and 9% over the prior year to $191 million. Within WAN optimization, sales of our new Steelhead CX and EX models continued to grow, and for the fourth quarter contributed more than 50% of remote office appliance revenue.

Our Cascade revenue grew 27% sequentially and 45% year-over-year to $17 million. Total Stingray revenue was $10 million in Q3 compared to $7 million in Q2 and $4 million a year ago. We recognized about $4 million from Juniper in the third quarter.

Turning to distribution. 95% of our Q3 revenue came from indirect channels and 5% was sold direct. One distributor contributed more than 10% to total revenue with Arrow Electronics at 17%. We had no 10% end-user customers in the third quarter.

As a reminder, we report the following geographies: Americas, EMEA, and APJ as a percentage of total revenue. The Americas contributed 61% to revenue, EMEA 26% and APJ was 13%. We saw a good growth in the Americas and EMEA while APJ remains an area of lower growth, and we continued to work on improvements.

Looking at verticals. Government, which includes federal, state, local and international, was 20% of total revenue. Other large verticals in Q3 were manufacturing, technology, financial and professional services.

Moving to cost and expenses. Product gross margin was 81.2% in Q3, up from 79.4% in Q2. The sequential improvement is largely related to product and channel mix, along with lower product and logistics cost. We saw some modest improvement in dry prices during the quarter that should benefit product gross margin going forward.

Service gross margin came in at 76.5% compared to 75% in Q2. And in general, revenue growth outpaced spending. As we catch up on spending, we would expect the support gross margin to return to a 73% to 75% range in Q4.

Q3 total gross margin was 79.6% compared to 77.8% in Q2. Total operating expenses were $111 million. During Q3, headcount came in somewhat lower than planned as did litigation expenses related to our patent infringement suit against Silver Peak. As a result, our operating margin for the quarter was 29%, up more than 400 basis points compared to the second quarter.

We added 67 employees in the third quarter and ended September with headcount of 1,806. Our tax rate for the quarter was 27.7% and expect our tax rate to be between 27% and 28% in the fourth quarter and 2013. These rates are somewhat higher due to the regional revenue mix.

Net income was $46 million or $0.28 per diluted share. Net income grew 23% sequentially and 15% year-over-year.

Moving on to the balance sheet and cash flows. As of September 30, cash and investments totaled $670 million, an increase of $120 million compared to June 30. We continue to have no debt.

During the third quarter, we repurchased $26 million of Riverbed shares. A balance of $138 million remains under the repurchase program.

Cash flow from operations was $142 million for Q3 compared to $30 million at prior quarter and $91 million in Q3 2011.

Q3 cash flow includes the benefit of the previously announced technology partnership with Juniper. As a reminder, we announced that Juniper would pay Riverbed $75 million pursuant to that partnership. $65 million was paid upfront in July and we'll receive the remaining $10 million next year. At quarter end, more than $61 million remains in deferred revenue related to this transaction.

Days sales outstanding was 36 days compared to 39 days in Q2 and 33 days 1 year ago. Inventory totaled $19 million exiting the third quarter compared to $18 million at June 30 and $15 million 1 year ago.

Total deferred revenue was $241 million. If we exclude the payment from Juniper, total deferred revenue increased approximately 4% sequentially and 22% over the prior year.

Turning to guidance. Revenue in the fourth quarter is expected to be in the range of $230 million to $236 million. Gross margins are expected to be in the range of 78% to 80%.

In the fourth quarter, we typically have a seasonal peak in commissions, both in dollars and a percent of revenue, that along with general hiring should result in operating expenses between $116 million and $120 million. Q4 operating margin is expected to be about 28%.

Earnings per share in the fourth quarter is expected to be around $0.29 based on approximately 164 million shares outstanding and a 27% to 28% tax rate.

I'll now turn the call back over to Jerry for his closing remarks.

Jerry M. Kennelly

Thank you, Randy. The Riverbed strategy is driven by a single focal point, to provide our customers the best performance. We enable IT to centralized servers, storage and applications to the data center to support a more secure architecture at a lower total cost without sacrificing the users' experience. We truly believe we are one of the best positioned IT vendors today. We look forward to our next update in January.

Now the call -- operator can now open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question for today will come from the line of Alex Henderson with Needham.

Alexander B. Henderson - Needham & Company, LLC, Research Division

With some commentary here about some large orders in the month of September. So could you talk a little bit about the linearity and the visibility on the macro conditions? And I just have to ask, the map on the deferred revenue didn't add up, so could you just give us that one more time? I thought I heard $61 million in deferred from the Juniper stuff, which obviously is more than the sequential increase.

Jerry M. Kennelly

So yes, so linearity was in our normal range. It wasn't driven differently this quarter than what's normal. The number of large deals, it was also in our normal range. We came through the macro, as well as anybody, and we're able to make our guidance nicely.

Randy S. Gottfried

Okay. Let me take some of the other part. So on the deferred revenue, we had mentioned that more than $61 million from Juniper is in our deferred balance at the end of the September quarter. In that transaction, we -- it's a $75 million deal, we received $65 million. There's another $10 million that comes next year. We recognized about $4 million in the quarter.

Alexander B. Henderson - Needham & Company, LLC, Research Division

Well, I guess, shouldn't that be -- it's up more than $35 million -- it was only up about $30 million. So how does...

Randy S. Gottfried

The short-term and long-term, it was up about 3% quarter-on-quarter, about 21% -- 22% year-on-year, it's up 4% quarter-on-quarter, up about 22% year-on-year excluding the Juniper piece.

Operator

Our next question will come from the line of Jason Ader with William Blair.

Jason Ader - William Blair & Company L.L.C., Research Division

I just wanted to get a sense on the breakdown on the business. The federal was up, I guess, less than normal from Q2 to Q3, but you had a strong Q2. Could you give us a sense of how the federal business is looking both for what happened in Q3, the outlook for Q4 and then next year? And then on the enterprise side, it seems like you had a good sequential growth there but you guided quite well for Q4. So is there something going on there just in terms of you're expecting kind of a normal seasonal flush on the enterprise side and you have -- is there any comment you can give on bookings relative to revenue for enterprise?

Jerry M. Kennelly

Jason, basically, we had a really nicely balanced quarter. The government year-to-date is 16% of our revenue, enterprise year-to-date is about 14% of our revenue, matching our 50% growth so far this year. We've actually gotten better linearity in our government business, where it's not all just bunched in the third quarter, we had a great Q2 and a nice strong Q3. We've actually penetrated more and more of the federal agencies as sort of their standard for this product. And all of the federal agencies have a mandate to go to Cloud data center for the government. So the linearity over the course of the year has improved. And sort of the broad base of agencies we have to sell into has improved. So we had a nicely balanced business between both enterprise and government.

Randy S. Gottfried

I have to clarify just one statistic. Growth year-to-date in enterprise and government, the government was up year-to-date about 15%, enterprise up about 14%.

Jason Ader - William Blair & Company L.L.C., Research Division

And as for the federal -- and for Q4, Jerry, do you feel pretty good about federal as well?

Jerry M. Kennelly

We don't give per vertical guidance for Q4, but we've already had a year of dealing with crappy budgets in government, and we came out ahead. So we don't know what will happen in Q4, but the guidance we do is relatively normal in that regard.

Jason Ader - William Blair & Company L.L.C., Research Division

Enterprise?

Randy S. Gottfried

Everything's baked into the guidance that we gave. In general, we entered Q4 with a very solid funnel across the business, across all the verticals. And I think judging by the performance in Q3, which happened to be pretty good for enterprise, we're encouraged going to the end of the year. Everything, though, is baked into the guidance we gave.

Jerry M. Kennelly

Our customer base, the Fortune 500, the Global 2000 of the world is moving forward. They have their IT plans, they're doing their deployments, mostly business as usual for people who are trying to bring out the IT of the future and find the kind of cost saving ROI initiatives that they've been working on for years.

Operator

Our next question will come from the line of Ryan Hutchinson with Lazard Capital Markets.

Ryan Hutchinson - Lazard Capital Markets LLC, Research Division

I guess my question here maybe is on product mix. The clarification, just on the CX, EX, and in June, you talked about the mix being 50-50 split between CX, EX in the 50 series. And so the question was, I guess, is that consistent? I think you said greater than 50%. Is that for total units or just the split between those 2 product lines? And then part of that would just be metrics around Granite. I know you talked -- touched on it a little bit, but any specific metrics with respect to Granite, maybe how it's comparing to some of the other product lines, whether it's Whitewater or so on and so forth, that would be helpful.

Eric S. Wolford

Hey, Ryan, it's Eric. I'll try to take your questions. Yes, there's a number of statistics that are CX, EX-related and there's different questions. There's new platforms as a -- as compared to old, so the CX, EX are new platforms as a -- as compared to the platforms they replaced or that -- and in that ratio, over half of our business for comparable models is the new platform as opposed to the old platforms. In terms of the ratio between CX and EX themselves, how much, what percent of the CX, EX of the new platforms are EX. That number has increased from last quarter, it was in the 30s, low 30s, to now it's approaching 40%. So the EX percent of the new models is on the rise. And then with regard to Granite, yes, Granite is doing great. The second full quarter. I mean it's early, so obviously the results aren't material, but we feel great about its growth trajectory in terms of real results. We can compare it to the Steelhead's growth after first couple of quarters. It feels like it's there or better than that. And so we feel very good about Granite.

Operator

Our next question will come from the line of Ittai Kidron with Oppenheimer.

Ittai Kidron - Oppenheimer & Co. Inc., Research Division

I wanted to dig in into your core WAN optimization product family. I'm looking at the product splits that you have. It looks like your core product is now, like on a 3-, 4-year deceleration, if I look at the sequentials this year in your September quarter versus in the last 2, 3. And I'm just trying to get a much better understanding as we look at the company over the next year, how do we think about growth in your core market? Where do you see the -- how do you see the potential growth of the industry, yours relative to the industry? And I think I'm just trying to get my hands around what is the real growth in the market here going forward. It looks like it's decelerating.

Jerry M. Kennelly

I'll tell you, some would say you get the law of big numbers but -- and if you look at the full year comparison, Q1, as I remember, it was weak and then we had a very strong Q3 last year. But the truth is, we grew in the WAN products, 77% quarter-on-quarter, which is a 28% to 30% annualized growth number. Now we're not projecting that as our full year growth for next year, but the product remains a solid hitter. It's still a high percentage of our revenue. It's still very critical to every IT initiative people have for global IT and private Cloud centers and public centers. And we keep the product constantly fresh with new capabilities, new performance, and the competitors continue to drop to the wayside. And we continue to be the best game in town for this very critical technology. So yes, the growth isn't what it was in 2004 when it was 3,000%, but it's a very solid product and a very solid growth.

Ittai Kidron - Oppenheimer & Co. Inc., Research Division

Can you talk about in the quarter -- if you can give us some feel as to -- and nothing ever works to plan, right, but it looks like as a whole, you've delivered a great quarter. Can you give us some color on what, in your opinion, worked better than your expectations heading to the quarter versus slightly below your expectations in the quarter?

Randy S. Gottfried

I'll take a stab, and Jerry can add some color as well. I'd say, in general, we came in what we expected. So there are no great surprises. U.S. and especially U.S. enterprise came in a bit better so we are pleased by the strength there. Europe, despite the summer months in Europe, actually held up quite well. All the product lines came in pretty much what we had hoped at. Clearly, we wish we had done better in Asia Pacific, and we're focused on that as we look for an opportunity for improvement in the future. But in general, I think we executed reasonably well, and coming out of the quarter and coming into the fourth, we see the best funnel we've ever seen.

Operator

[Operator Instructions] Our next question will come from the line Subu Subrahmanyan with TheJudaGroup.

Natarajan Subrahmanyan - TheJudaGroup, Research Division

Just to take another stab at the WAN optimization market growth rate, if you don't mind. For the first 3 quarters of the year, your year-over-year comp is about 9% growth and the other areas have been driving faster growth. So can you talk about kind of bigger picture longer-term growth rates, is this from slowing to a low double-digit growth rate, any kind of broader growth rate that you can throw around that big piece of your business?

Eric S. Wolford

So yes, this is Eric. So we -- as Jerry -- I'll reiterate a little bit of what Jerry said, that the WAN optimization market sequentially, which is what we see right in front of us, which is the quarter that we just did and the one that's right in front of us, looks very good and very strong and enabled us to produce the results in the numbers and allow us to give the guidance that we're giving. So WAN optimization is a key part of Riverbed's growth strategy. Now in addition to that, obviously, we are seeking growth from these new investments we're making in other product areas, like application performance management, network performance management, that area as well as application delivery controllers. So we do want to augment growth from those other product areas and expand our market, all centered on performance. But as we look forward, WAN optimization, the stuff that's right in front of us, looks like it's growing, and it's growing very nicely.

Natarajan Subrahmanyan - TheJudaGroup, Research Division

And Eric, could you put that in context of competitive position, which maybe your largest competitor not as focused on this market, where you think share is, and directionally, if there's a share gain opportunity there?

Eric S. Wolford

Yes, sure. So I think our share is about half of the market, and so there's another half to go after. I think probably, Gartner reported I think 11%, around 11% is a bunch of very small players. Cisco has about 22%, and then there is the Silver Peak, Citrix Blue Coat combination which are on the single digits. So you add all that up and there's -- we're at 50%. Do I think there's an opportunity for share gain? Yes, there's no question there's an opportunity for share gain. We've seen comparable companies to us in size get into the 60s, and we would aspire to do that as well.

Operator

Our next question will come from the line of Brent Bracelin with Pacific Crest Securities.

Brent A. Bracelin - Pacific Crest Securities, Inc., Research Division

I wanted to kind of take a look at, we look at your guidance here for December quarter, you guided to 5% to 8% sequential growth. If I compare that with going into December a year ago, I think you guided to 4% to 6% sequential growth. So clearly, you're slightly more optimistic going into this quarter and obviously saw a nice healthy rebound, and Americas is up 14% sequentially. But as you compare kind of going into this December versus last December, industry-wide there's arguably some more questions with Intel and IBM having some issues late in the quarter. How would you compare and contrast what you're seeing now going into this December quarter versus a year ago? Is it really the new product cycle that's giving you the optimism? Help us kind of understand why you're slightly more optimistic going into this December quarter versus a year ago?

Randy S. Gottfried

In general -- this is Randy. In general, if you look at just the midpoint of guidance, the range over the past few years has been about 2% to 6%, where at the midpoint, we're at the higher end of the quarter-on-quarter guidance. We come up with the guidance the same way every time. We look at the pipeline, bottoms up. We look at close rates. We look at a variety of different factors to come up with what we think is the right number. We're encouraged by what we saw coming out of this quarter. I mean, last year, we had a pretty incredible Q3. So the Q3 to Q4 comp was a tough one last year. That's not to say this, this one's a layup either. But in general, we feel pretty good about the business, and everything we know is really baked into that guidance.

Brent A. Bracelin - Pacific Crest Securities, Inc., Research Division

How much would you attribute to the product cycle?

Jerry M. Kennelly

Our product portfolio is also larger at this point than it was. We have the new versions of Steelhead, the new data center versions of Steelhead. The ADC business is bigger and more robust than it was last year. And then our Cascade business, and we had a year now the complete integration of the Shark and pilot technologies we bought with CACE Technologies into the core Cascade product, and all those things seem to be firing well.

Operator

Our next question will come from the line of Amitabh Passi with UBS.

Amitabh Passi - UBS Investment Bank, Research Division

When we think about the dynamics around your margin, your margins came in really strong both on the product and services side. So I'm just wondering if you could help us understand the puts and takes this quarter. And for next quarter, would you expect another $4 million of revenue recognition from Juniper?

Randy S. Gottfried

Yes, let me take those different parts. But I would say, in general, yes, we are very pleased by the gross margin and operating margin profile in the third quarter. For the full gross margins, we got a little bit of wind at our back in that drive prices have moderated somewhat. We also had -- with a little more inventory and with the product transition more behind us, some of our logistics costs were a bit more in check in the third quarter than as we went through that transition earlier this year. There's always a bit of a range depending on product mix and channel mix, but I think most of the gains are sustainable. We're thinking roughly flattish product gross margins going in to the end of the year. Service gross margins, as I mentioned, will probably go back to a more typical 73% to 75% gross margin number. We got a little bit behind on hiring in the services groups that we expect to catch up on as we going into the end of the year. And the depot and logistics and some of the other parts of the services organization, a lot of those variables sort of aligned to yield some especially good profitability. And I expect to catch up a little bit more in the fourth quarter. But we're encouraged by what we saw, and I think we've made, overall, some improvement from where we were.

Amitabh Passi - UBS Investment Bank, Research Division

And just on Juniper, for next quarter, another $4 million?

Randy S. Gottfried

Still roughly $4 million.

Operator

Our next question will come from the line of Alex Kurtz with Sterne Agee.

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

NetScout reported earlier today, and they commented on, in the federal space, some of these larger strategic multiyear deals were not getting funded. And I wonder if, is Riverbed still fairly transactional in nature and you can sort of avoid some of those big decisions on some multiyear projects? Is that sort of the difference that you see between yourselves and sort of a multiyear multimillion-dollar NetScout type of deal? Any kind of color and that will be helpful.

Eric S. Wolford

Yes, sure. Yes, with -- this is Eric. With regard to federal, there's no question that projects that are multiyear get funded if they involved cost take-out or improving IT efficiency. They're all about taking cost out, right, especially in civilian agencies. And so what the Cascade product line is doing in conjunction with the Steelhead product line, and we're kind of doing a solution sell to customers, is we're selling both of them together in order to help people to help the federal agencies to consolidate, to take costs out, to consolidate data centers, consolidate locations, and those multiyear projects are being supported. So it is a little bit of a different story, and we did have, in our Cascade business unit, a very strong quarter in the government.

Operator

Our next question will come from the line of Kent Schofield with Goldman Sachs.

Kent Schofield - Goldman Sachs Group Inc., Research Division

A couple of product questions, if I could. With the Steelhead 150 and some of the lower price models that you have out there, how are you seeing adoption in terms of further penetrating accounts? And then on the CX versus EX, is there a meaningful gross margin difference between the 2 platforms?

Eric S. Wolford

Yes, this is Eric again. On the first part of your question, yes, penetration into existing accounts is a huge part of our sales effort and sales push. We get more revenue every quarter from our existing customers than we do from new customers. So there is lots of market opportunity in those existing customers and we are laser-like focused on getting that in. The models are definitely a part of that story, but it's not just that, it's all aspects. The data centers are changing, so you need different models for data centers. Remote offices are changing, so you need different models for remote offices. And laptops are changing, so you need different models for that change. So you need to have that comprehensive approach in order to get that penetration, and so that's what is helping to enable the penetration. Then with regard to CX and EX, we have pretty standard ranges of gross margin profitability and both of them fit within our normal and expected range.

Operator

Our next question will come from the line of Brian Modoff with Deutsche Bank.

Brian T. Modoff - Deutsche Bank AG, Research Division

First clarification, guys, can you give me the rundown again on the product side in terms of revenues by each of the categories? And then, Jerry, how do you think you're doing in the data center to data center WAN op markets from a market share standpoint? Do you think it's parroting what you've seen on the client server side, or do you think -- can you talk about that a little bit?

Jerry M. Kennelly

So why don't I give -- I'll give the proportion of total revenue. So WAN optimization was about 87% of the total, NPM was 8%, and ADC -- our ADC products were 5% of total. That includes $4 million from Juniper.

Eric S. Wolford

Brian, this is Eric. On the data center to data center, so you know we sell boxes, right? And when we sell big data center boxes, they can be put in data centers for hub and spoke, or they can be put in data centers for data center to data center. The way we are able to determine how much of it is data center to data center is by just asking customers. And when we ask them, we get back about 20% is a reasonable estimate, around there, is our data center to data center motivated purchasing. So you can work out the math from there. And if you work out the math from there and compare it to our competitors, you'll find we're probably -- in fact, we are the leader in the data center to data center space.

Operator

Our next question will come from the line of Daniel Ives with FBR.

Daniel H. Ives - FBR Capital Markets & Co., Research Division

Obviously 1Q, real tough quarter. Now you've had 2 strong quarters in a row, especially this one in a pretty tough [indiscernible]. I mean, are we now through the transition? I mean, now in hindsight when you look back, was it just some issues in the channel in terms of new product? I mean, what are you hearing from customers? What do you hear internally? Maybe we could kind of -- if you could look back in the last 9 months?

Jerry M. Kennelly

No, we are through the transition. Q1 is a seasonally softer quarter. It was a bit softer than we've seen, we didn't fall of a cliff or anything, and we have the new models out. The sales force is fired up. We have a great rolling thunder of product releases that's constant. We're selling higher at the customers. We are a more strategic partner at the CIO level. Our big channel partners are better educated, more critical to the [indiscernible] and our product is sold by AT&T, by Verizon, by IBM, by EMC, by the EDF group of HP, by Dimension Data and a whole host of others. So it's not little Riverbed out there alone walking into customers, we walk in holding the hands of BT or AT&T or IBM and these accounts. And we're just a key underlying infrastructure technology for all the trends of the future in IT, and we're the lead brand. We're the arms dealer to the whole industry for the critical facility. And so we've blown past Q1, and we're off and running.

Daniel H. Ives - FBR Capital Markets & Co., Research Division

Okay. But specifically in Europe, I mean, obviously, we actually had some issues there. You really strengthened the challenges, the -- some of the internal value. Do you think that's helped you versus Europe has obviously bid a lot of companies this quarter where Europe has been strong. And maybe you could just speak to that, that's my last one.

Jerry M. Kennelly

Sure. So sales is about the 2 "P"s, people and partners. And in Europe and in all our areas, we concentrate very much on who are the sales management we have, who are the sales reps we have and who are the channel and sales partners we have. And we work very hard on that. It's critical to us. We spent 1.5 years bolstering up Europe on all those fronts and it's paying off.

Operator

Our next question will come from the line of Sanjiv Wadhwani with Stifel, Nicolaus.

Sanjiv Wadhwani - Stifel, Nicolaus & Co., Inc., Research Division

I wanted to ask you a question on operating margins. You obviously are up to 29-ish percent. In September, I think your guidance called for about 28% in December. I'm just curious, are we looking at a level of high 20s now going forward in 2013? Or do you have some investments that you're contemplating, maybe on the sales and marketing side? Any color there will be helpful.

Randy S. Gottfried

Sure, so -- yes, as you mentioned, we gave guidance of 28% in the fourth quarter. Yes, we still aspire as a medium-term target to get to about 30% at some point. We are much -- our key focus, it really is around growing the absolute dollar profits, and that means growing the top line at a reasonably profitable level, but the percentage is a bit secondary to that. So I have to give you an unsatisfying answer but it depends. I think we're encouraged by the leverage you've seen in the business. I think clearly in Q3, we've demonstrated this is a great profitable business, but I don't foresee any big investment blip or anything like that but we're -- as we move through the course of the next quarters and year, we just want to make sure we're growing that top line sufficiently. We think there's a big untapped market potential, and we don't want -- we want to make sure we don't squeeze it too much, just getting a percentage higher.

Sanjiv Wadhwani - Stifel, Nicolaus & Co., Inc., Research Division

Got it. But there's no big spending wave or hiring wave on sales and marketing or anything like that contemplated, at least for the near-term?

Randy S. Gottfried

No great new wave of spending. We have the typical Q1 drop just because revenue drops off in the first quarter, while expenses are -- tend to be a little bit flattish or maybe even up slightly. But absent that, there's no general change in our spending approach.

Operator

Our next question will come from the line of Matt Robison with Wunderlich Securities.

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

Hoping you could comment a little bit on the Granite sales cycle and what you think the VMware integration is going to do for you there?

Eric S. Wolford

Matt, it's Eric. Yes, we think really good things. We know a lot of customers were very excited and eager and sort of anticipating, even some of them waiting for us to get that integration done so they can integrate vCenter and vSphere in the data center out to the Edge, and so that's what we have completed. Granite is in its life cycle, though. It's a brand-new technology, a brand-new approach. And it's very powerful, and we have some fantastic cheerleader customers and the word is getting out. And as I think I mentioned in a previous question, Matt, it does remind me of that Steelhead growth, that Steelhead ramp. Now we're only 2 quarters in, but it looks to be pattern matching to that growth curve.

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

Have you had enough transactions to kind of characterize the length of the sales cycle, or is it just varying widely at this point?

Eric S. Wolford

Yes, it's varying widely. But the sales cycle is -- and I guess the best answer right now is it's varying widely. You've got a handful of data points and you can tell a story amongst all of them. It's getting the understanding of, it's education first. People have to learn there's a new way to do something. And then after that, it actually hasn't been that long of a sales cycle, once you get past that education phase.

Operator

And at this time, we do have time for one more question, which will come from Bill Choi from Janney.

William H. Choi - Janney Montgomery Scott LLC, Research Division

I found Eric's comment about the Granite matching or being better than the Steelhead ramp, so I guess if we go all the way back to 2004, the pattern was 100,000, 800,000, 1.5 million, 1.9 million, and would you kind of endorse that it's growing faster than that?

Randy S. Gottfried

Yes, we're not going to do product specific breakouts, but you're on the right track.

William H. Choi - Janney Montgomery Scott LLC, Research Division

Okay, great. And then one last question was how is the CX, EX new Steelhead products mix shift matching up with the new products that you guys had launched back in 2008? Because I guess it being more than 50%, it seems fairly obvious after several quarters. So I just want to see if you guys are endorsing that this transition is largely done, and going forward, it's going to be pretty much all new products.

Jerry M. Kennelly

Yes, yes, yes. So the transition is proceeding how we expected it. The new models, though, we make available, there's an overlap period, which we do for convenience, because a lot of large customers have qualified and certified the older models and you've got to give them time to finish their buildouts and rollouts and not require them to recertify many of the larger companies. So but that end of sale window is coming to a close, and that will help to complete the transition. So it's living a -- its normal life cycle of transition.

Renee Lyall

Thank you for joining us on the call today. And if you have any questions, please direct them to Investor Relations. Have a good evening.

Operator

Ladies and gentlemen, thank you for your participation in today's conference call. You may now disconnect.

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