Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number: 001-33023

 

 

Riverbed Technology, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   03-0448754

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification Number)

199 Fremont Street

San Francisco, California 94105

(Address of Principal Executive Offices including Zip Code)

(415) 247-8800

(Registrant’s Telephone Number, Including Area Code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x   Accelerated filer ¨    Non-accelerated filer ¨   Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange

Act).    Yes  ¨    No  x

The number of shares of the registrant’s common stock, par value $0.0001, outstanding as of October 19, 2011 was: 155,019,028.

 

 

 


Table of Contents

RIVERBED TECHNOLOGY, INC.

INDEX

 

          Page No.
  

PART I. FINANCIAL INFORMATION

  
Item 1.   

Financial Statements (Unaudited)

   3
   Condensed Consolidated Balance Sheets as of September 30, 2011 and December 31, 2010    3
  

Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2011 and 2010

   4
   Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and 2010    5
   Notes to Condensed Consolidated Financial Statements    6
Item 2.   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   22
Item 3.   

Quantitative and Qualitative Disclosures About Market Risk

   33
Item 4.   

Controls and Procedures

   33
   PART II. OTHER INFORMATION   
Item 1.   

Legal Proceedings

   34
Item 1A.   

Risk Factors

   34
Item 2.   

Unregistered Sales of Equity Securities and Use of Proceeds

   47
Item 6.   

Exhibits

   48

 

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Table of Contents
Item 1. Financial Statements

RIVERBED TECHNOLOGY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

As of September 30, 2011 and December 31, 2010

(in thousands, except par value)

 

     September 30,
2011
    December 31,
2010
 
     (Unaudited)        

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 153,856      $ 165,726   

Short-term investments

     321,829        259,245   

Trade receivables, net of allowances of $1,522 and $1,402 as of September 30, 2011 and December 31, 2010, respectively

     70,614        50,726   

Inventory

     15,399        15,180   

Deferred tax assets

     17,034        20,832   

Prepaid expenses and other current assets

     30,191        30,958   
  

 

 

   

 

 

 

Total current assets

     608,923        542,667   
  

 

 

   

 

 

 

Long-term investments

     83,575        76,169   

Fixed assets, net

     27,745        21,522   

Goodwill

     117,689        25,653   

Intangibles, net

     73,449        30,789   

Deferred tax assets, non-current

     45,728        35,775   

Other assets

     22,577        3,506   
  

 

 

   

 

 

 

Total assets

   $ 979,686      $ 736,081   
  

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Current liabilities:

    

Accounts payable

   $ 37,419      $ 27,015   

Accrued compensation and benefits

     32,393        32,915   

Other accrued liabilities

     48,026        18,813   

Deferred revenue

     114,425        89,026   
  

 

 

   

 

 

 

Total current liabilities

     232,263        167,769   
  

 

 

   

 

 

 

Deferred revenue, non-current

     33,295        26,511   

Other long-term liabilities

     21,833        4,381   
  

 

 

   

 

 

 

Total long-term liabilities

     55,128        30,892   
  

 

 

   

 

 

 

Commitments and contingencies

    

Stockholders’ equity:

    

Preferred stock, $0.0001 par value – 30,000 shares authorized, no shares outstanding

     —          —     

Common stock and additional paid-in capital; $0.0001 par value – 600,000 shares authorized; 155,014 and 150,868 shares issued and outstanding as of September 30, 2011 and December 31, 2010, respectively

     633,028        518,052   

Retained earnings

     62,962        19,309   

Accumulated other comprehensive income (loss)

     (3,695     59   
  

 

 

   

 

 

 

Total stockholders’ equity

     692,295        537,420   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 979,686      $ 736,081   
  

 

 

   

 

 

 

See Notes to Condensed Consolidated Financial Statements.

 

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Table of Contents

RIVERBED TECHNOLOGY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(Unaudited)

 

     Three months ended
September 30,
     Nine months ended
September 30,
 
     2011     2010      2011      2010  

Revenue:

          

Product

   $ 132,061      $ 102,841       $ 361,073       $ 262,083   

Support and services

     57,722        44,965         162,568         124,373   
  

 

 

   

 

 

    

 

 

    

 

 

 

Total revenue

     189,783        147,806         523,641         386,456   
  

 

 

   

 

 

    

 

 

    

 

 

 

Cost of revenue:

          

Cost of product

     26,968        21,889         74,386         57,133   

Cost of support and services

     17,998        12,878         49,633         36,476   
  

 

 

   

 

 

    

 

 

    

 

 

 

Total cost of revenue

     44,966        34,767         124,019         93,609   
  

 

 

   

 

 

    

 

 

    

 

 

 

Gross profit

     144,817        113,039         399,622         292,847   
  

 

 

   

 

 

    

 

 

    

 

 

 

Operating expenses:

          

Sales and marketing

     70,208        56,517         195,029         158,575   

Research and development

     30,999        21,951         89,250         61,500   

General and administrative

     15,353        12,078         43,949         34,393   

Acquisition-related costs

     2,732        —           4,124         2,725   
  

 

 

   

 

 

    

 

 

    

 

 

 

Total operating expenses

     119,292        90,546         332,352         257,193   
  

 

 

   

 

 

    

 

 

    

 

 

 

Operating income

     25,525        22,493         67,270         35,654   
  

 

 

   

 

 

    

 

 

    

 

 

 

Other income (expense), net

     (151     384         688         683   
  

 

 

   

 

 

    

 

 

    

 

 

 

Income before provision for income taxes

     25,374        22,877         67,958         36,337   

Provision for income taxes

     6,049        8,967         24,305         14,790   
  

 

 

   

 

 

    

 

 

    

 

 

 

Net income

   $ 19,325      $ 13,910       $ 43,653       $ 21,547   
  

 

 

   

 

 

    

 

 

    

 

 

 

Net income per common share:

          

Basic

   $ 0.12      $ 0.10       $ 0.28       $ 0.15   
  

 

 

   

 

 

    

 

 

    

 

 

 

Diluted

   $ 0.12      $ 0.09       $ 0.26       $ 0.14   
  

 

 

   

 

 

    

 

 

    

 

 

 

Shares used in computing net income per common share:

          

Basic

     155,367        145,978         153,981         143,662   

Diluted

     167,031        157,930         166,920         153,546   

See Notes to Condensed Consolidated Financial Statements.

 

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RIVERBED TECHNOLOGY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

     Nine months ended
September 30,
 
     2011     2010  

Operating Activities:

    

Net income

   $ 43,653      $ 21,547   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     16,477        11,388   

Stock-based compensation

     68,000        50,496   

Deferred taxes

     (6,463     (10,267

Excess tax benefit from employee stock plans

     (34,482     (9,600

Changes in operating assets and liabilities:

    

Trade receivables

     (15,892     4,792   

Inventory

     (219     (3,603

Prepaid expenses and other assets

     (14,405     (3,377

Accounts payable

     7,982        12,906   

Accrued and other liabilities

     6,354        14,385   

Acquisition-related contingent consideration

     1,552        (5,249

Income taxes payable

     42,546        8,355   

Deferred revenue

     32,184        21,492   
  

 

 

   

 

 

 

Net cash provided by operating activities

     147,287        113,265   
  

 

 

   

 

 

 

Investing Activities:

    

Capital expenditures

     (12,017     (7,876

Purchase of available for sale securities

     (504,074     (430,659

Proceeds from maturities of available for sale securities

     294,511        307,970   

Proceeds from sales of available for sale securities

     135,926        40,862   

Acquisitions, net of cash and cash equivalents acquired

     (120,179     —     
  

 

 

   

 

 

 

Net cash used in investing activities

     (205,833     (89,703
  

 

 

   

 

 

 

Financing Activities:

    

Acquisition-related contingent consideration

     —          (9,909

Proceeds from issuance of common stock under employee stock plans, net of repurchases

     41,996        40,504   

Cash used to net share settle equity awards

     (10,088     (2,300

Payments for repurchases of common stock

     (20,017     —     

Excess tax benefit from employee stock plans

     34,482        9,600   
  

 

 

   

 

 

 

Net cash provided by financing activities

     46,373        37,895   
  

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents

     303        129   
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     (11,870     61,586   

Cash and cash equivalents at beginning of period

     165,726        67,749   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 153,856      $ 129,335   
  

 

 

   

 

 

 

See Notes to Condensed Consolidated Financial Statements.

 

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RIVERBED TECHNOLOGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Organization

Riverbed Technology, Inc. was founded on May 23, 2002 and has developed innovative and comprehensive solutions to the fundamental problems associated with IT performance across wide area networks (WANs). Our products enable our customers to simply and efficiently improve the performance of their applications and access to their data over WANs, and provide global application performance, reporting and analytics.

Significant Accounting Policies

Basis of Presentation

The condensed consolidated financial statements include our accounts and the accounts of our wholly-owned subsidiaries. Intercompany transactions and balances have been eliminated. The accompanying condensed consolidated balance sheet as of September 30, 2011, the condensed consolidated statements of operations for the three and nine months ended September 30, 2011 and September 30, 2010, and the condensed consolidated statements of cash flows for the nine months ended September 30, 2011 and September 30, 2010 are unaudited. The accompanying statements should be read in conjunction with the audited consolidated financial statements and related notes contained in our Annual Report on Form 10-K for the year ended December 31, 2010.

The accompanying condensed consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (GAAP) pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). They do not include all of the financial information and footnotes required by GAAP for complete financial statements. We believe the unaudited condensed consolidated financial statements have been prepared on the same basis as the audited financial statements and include all adjustments necessary for the fair presentation of our balance sheet as of September 30, 2011, and our results of operations for the three and nine months ended September 30, 2011 and September 30, 2010, and cash flows for the nine months ended September 30, 2011 and September 30, 2010. All adjustments are of a normal recurring nature. The results for the nine months ended September 30, 2011 are not necessarily indicative of the results to be expected for any subsequent quarter or for the year ending December 31, 2011.

There have been no significant changes in our accounting policies during the nine months ended September 30, 2011, as compared to the significant accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2010.

Use of Estimates

Our condensed consolidated financial statements are prepared in accordance with GAAP. These accounting principles require us to make certain estimates and judgments that can affect the reported amounts of assets and liabilities as of the date of the condensed consolidated financial statements, as well as the reported amounts of revenue and expenses during the periods presented. Significant estimates and assumptions made by management include the determination of the fair value of stock awards issued, the relative selling price of our products and services for revenue recognition, the allowance for doubtful accounts, inventory valuation, the accounting for income taxes and the accounting for acquisition-related contingent consideration. We believe that the estimates and judgments upon which we rely are reasonable based upon information available to us at the time that these estimates and judgments were made. To the extent there are material differences between these estimates and actual results, our condensed consolidated financial statements will be affected.

Effective November 8, 2010, we completed a two-for-one stock split of our outstanding shares of common stock. Accordingly, we have retroactively displayed the effect of the change in our condensed consolidated financial statements.

Subsequent Events

We have evaluated subsequent events through the date these condensed consolidated financial statements were issued.

Revenue Recognition

We recognize revenue when all of the following have occurred: (1) we have entered into a legally binding arrangement with a customer; (2) delivery has occurred; (3) customer payment is deemed fixed or determinable and free of contingencies and significant uncertainties; and (4) collection is reasonably assured.

 

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The majority of our product revenue includes hardware appliances containing software components that function together to provide the essential functionality of the product. Therefore, our hardware appliances are considered non-software deliverables. Most non-software products and services qualify as separate units of accounting because they have value to the customer on a standalone basis and our revenue arrangements generally do not include a general right of return relative to delivered products. We account for non-software arrangements with multiple deliverables, which generally include support services sold with each of our hardware appliances, using the relative selling price method under the revenue recognition guidance for multiple deliverable arrangements.

Our product revenue also includes revenue from the sale of stand-alone software products. Stand-alone software may operate on our hardware appliance, but is not considered essential to the functionality of the hardware. Stand-alone software products generally include a perpetual license to our software. Stand-alone software sales are subject to the industry specific software revenue recognition guidance.

Certain arrangements with multiple deliverables may have stand-alone software deliverables that are subject to the software revenue recognition guidance along with non-software deliverables. The revenue for these multiple deliverable arrangements is allocated to the stand-alone software deliverables as a group and the non-software deliverables based on the relative selling prices of all of the deliverables in the arrangement.

The amount of product and services revenue recognized for arrangements with multiple deliverables is impacted by our valuation of relative selling prices. We apply the selling price hierarchy using vendor specific objective evidence (VSOE) when available, third-party evidence of selling price (TPE) if VSOE does not exist, and estimated selling price (ESP) if neither VSOE nor TPE is available.

VSOE of fair value for elements of an arrangement is based upon the normal pricing and discounting practices for a deliverable when sold separately, and VSOE for support services is further measured by the renewal rate offered to the customer. In determining VSOE, we require that a substantial majority of the selling prices fall within a reasonably narrow pricing range, generally evidenced by a substantial majority of such historical stand-alone transactions falling within a reasonably narrow range of the median rates. In addition, we consider major service groups, geographies, customer classifications, and other variables in determining VSOE.

We are typically not able to determine TPE for our products or services. TPE is determined based on competitor prices for similar deliverables when sold separately. Generally, our go-to-market strategy differs from that of our peers and our offerings contain a significant level of differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, we are unable to reliably determine what similar competitor products’ selling prices are on a stand-alone basis.

When we are unable to establish the estimated stand-alone value of our non-software deliverables using VSOE or TPE, we use ESP in our allocation of arrangement consideration. The objective of ESP is to determine the price at which we would transact a sale if the product or service were sold on a stand-alone basis. We determine ESP for a product or service by considering multiple factors including, but not limited to, cost of products, gross margin objectives, pricing practices, geographies, customer classes and distribution channels.

For stand-alone software sales, we recognize revenue based on software revenue recognition guidance. Under the software revenue recognition guidance, we use the residual method to recognize revenue when an agreement includes one or more elements to be delivered at a future date and VSOE of the fair value of all undelivered elements exists. In the majority of our contracts, the only element that remains undelivered at the time of delivery of the product is support services. Under the residual method, the fair value of the undelivered stand-alone software which is typically support services is deferred and the remaining portion of the contract fee is recognized as product revenue. If evidence of the fair value of one or more undelivered stand-alone software elements does not exist, all revenue is generally deferred and recognized when delivery of those elements occurs or when fair value can be established. When the undelivered stand-alone software for which we do not have VSOE of fair value is support, revenue for the entire arrangement is bundled and recognized ratably over the support period.

For our non-software deliverables, we allocate the arrangement consideration based on the relative selling price of the deliverables. For our hardware appliances we use the ESP of the deliverable. For our support and services, we generally use VSOE as our relative selling price. When we are unable to establish VSOE for our support and services, we use ESP in our allocation of arrangement consideration. We regularly review VSOE and ESP. As our go-to-market strategies evolve, we may modify our pricing practices in the future, which could result in changes in selling prices, including both VSOE and ESP.

For sales to direct end-users and channel partners, including value-added resellers, value-added distributors, service providers, and systems integrators, we recognize product revenue upon delivery, assuming all other revenue recognition criteria are met. For our hardware appliances, delivery occurs upon transfer of title and risk of loss, which is generally upon shipment. It is our practice to identify an end-user prior to shipment to a channel partner. For end-users and channel partners, we generally have no significant obligations for future performance such as rights of return or pricing credits. A portion of our sales are made through distributors under agreements allowing for stocking of our products in their inventory, pricing credits and limited rights of return for stock rotation. Product revenue on sales made through these distributors is initially deferred and revenue is recognized upon sell-through as reported by the distributors to us. Shipping charges billed to customers are included in product revenue and the related shipping costs are included in cost of product revenue.

 

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Support and services consist of support services, professional services, and training. Support services include repair and replacement of defective hardware appliances, software updates and access to technical support personnel. Software updates provide customers with rights to unspecified software product upgrades and to maintenance releases and patches released during the term of the support period. Revenue for support services is recognized on a straight-line basis over the service contract term, which is typically one to three years. Professional services are recognized upon delivery or completion of performance. Professional service arrangements are typically short term in nature and are largely completed within 90 days from the start of service. Training services are recognized upon delivery of the training.

Our fees are typically considered to be fixed or determinable at the inception of an arrangement, generally based on specific products and quantities to be delivered. Substantially all of our contracts do not include rights of return or acceptance provisions. To the extent that our agreements contain such terms, we recognize revenue once the acceptance provisions or right of return lapses. Payment terms to customers generally range from net 30 to 75 days. In the event payment terms are provided that differ from our standard business practices, the fees are deemed to not be fixed or determinable and revenue is recognized when the payments become due, provided the remaining criteria for revenue recognition have been met.

We assess the ability to collect from our customers based on a number of factors, including credit worthiness of the customer and past transaction history of the customer. If the customer is not deemed credit worthy, we defer revenue from the arrangement until payment is received and all other revenue recognition criteria have been met.

Inventory Valuation

Inventory consists of hardware and related component parts and is stated at the lower of cost (on a first-in, first-out basis) or market. A portion of our inventory relates to evaluation units located at customer locations, as some of our customers test our equipment prior to purchasing. Inventory that is obsolete or in excess of our forecasted demand is written down to its estimated realizable value based on historical usage, expected demand, and with respect to evaluation units, the historical conversion rate, the age of the units, and the estimated loss of utility. Inherent in our estimates of market value in determining inventory valuation are estimates related to economic trends, future demand for our products, the timing of new product introductions and technological obsolescence of our products. Inventory write-downs are recognized as cost of product and amounted to $1.6 million and $1.1 million in the three months ended September 30, 2011 and 2010, respectively, and $4.8 million and $3.6 million in the nine months ended September 30, 2011 and 2010, respectively.

Service Inventory

We hold service inventory that is used to repair or replace defective hardware reported by our customers who purchase support services. We classify service inventory as Prepaid expenses and other current assets. At September 30, 2011 and December 31, 2010, our service inventory balance was $8.7 million and $7.0 million, respectively.

Warranty Reserve

Upon shipment of products to our customers, we provide for the estimated cost to repair or replace products that may be returned under warranty. Our warranty period is typically 12 months from the date of shipment to the end-user customer for hardware and 90 days for software. For existing products, the reserve is estimated based on actual historical experience. For new products, the warranty reserve is based on historical experience of similar products until such time as sufficient historical data has been collected for the new product. The following is a summary of the warranty reserve activity for the nine months ended September 30, 2011 and 2010:

 

      Nine months ended
September 30,
 

(in thousands)

   2011     2010  

Beginning balance

   $ 1,329      $ 701   

Additions charged to operations

     1,355        992   

Warranty costs incurred

     (1,334     (585
  

 

 

   

 

 

 

Ending balance

   $ 1,350      $ 1,108   
  

 

 

   

 

 

 

 

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Stock-Based Compensation

Stock-based awards granted include stock options, restricted stock units (RSUs), and stock purchased under our Employee Stock Purchase Plan (the Purchase Plan). Stock-based compensation cost is measured at the grant date, based on the fair value of the awards, and is recognized as expense over the requisite service period only for those equity awards expected to vest. The fair value of the RSUs is determined based on the stock price on the date of grant. We estimated the fair value of stock options, including options to purchase stock under our Purchase Plan, using the Black-Scholes model. This model utilizes the estimated fair value of common stock and requires that, at the date of grant, we use the expected term of the grant, the expected volatility of the price of our common stock, risk-free interest rates and expected dividend yield of our common stock. The fair value is amortized on a straight-line basis over the requisite service periods of the awards, which is generally three to four years for stock options and six months to two years for options to purchase stock under our Purchase Plan.

Accounting for Income Taxes

We use the asset and liability method of accounting for income taxes. Under this method, income tax expenses or benefits are recognized for the amount of taxes payable or refundable for the current year and for deferred tax liabilities and assets for the expected tax consequences of temporary differences between the tax bases of assets and liabilities for financial reporting purposes and amounts recognized for income tax purposes. The measurement of current and deferred tax assets and liabilities are based on provisions of currently enacted tax laws. The effects of future changes in tax laws or rates are not contemplated.

As part of the process of preparing our condensed consolidated financial statements, we are required to estimate our income tax expense and tax contingencies in each of the tax jurisdictions in which we operate. This process involves estimating current income tax expense together with assessing temporary differences in the treatment of items for tax purposes versus financial accounting purposes that may create net deferred tax assets and liabilities. We rely on estimates and assumptions in preparing our income tax provision.

We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including geographic distribution of our worldwide earnings, expectations of future taxable income, and the carryforward periods available to us for tax reporting purposes, as well as other relevant factors. We may establish a valuation allowance to reduce deferred tax assets to the amount we believe is more likely than not to be realized. Due to inherent complexities arising from the nature of our businesses, future changes in income tax law, or variances between our actual and anticipated operating results, we make certain judgments and estimates. Therefore, actual income taxes could materially vary from these estimates.

We are subject to periodic audits by the Internal Revenue Service and other taxing authorities. These audits may challenge certain tax positions we have taken, such as the timing and amount of deductions and allocation of taxable income to the various tax jurisdictions. The accounting for income tax contingencies may require significant management judgment in estimating final outcomes. Actual results could differ materially from these estimates and could significantly affect the effective tax rate and cash flows in future years. We have elected to record interest and penalties in the financial statements as a component of income taxes.

Goodwill, Intangible Assets and Impairment Assessments

Goodwill represents the excess of the purchase price of an acquired business over the fair value of the underlying net tangible and intangible assets. Goodwill is tested for impairment at least annually (more frequently if certain indicators are present). In the event that we determine that the carrying value of the reporting unit to which the goodwill is allocated is less than the reporting unit’s fair value, we will incur an impairment charge for the amount of the difference during the quarter in which the determination is made.

Intangible assets that are not considered to have an indefinite life are amortized over their useful lives. Each period we evaluate the estimated remaining useful life of purchased intangible assets and whether events or changes in circumstances warrant a revision to the remaining period of amortization. The carrying amounts of these assets are periodically reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable. Recoverability of these assets is measured by comparison of the carrying amount of each asset to the future undiscounted cash flows the asset is expected to generate. In the event that we determine certain assets are not fully recoverable, we will incur an impairment charge for those assets or portion thereof during the quarter in which the determination is made.

 

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Comprehensive Income

Comprehensive income consists of the following:

 

      Three months ended
September 30,
     Nine months ended
September 30,
 

(in thousands)

   2011     2010      2011     2010  

Net income

   $ 19,325      $ 13,910       $ 43,653      $ 21,547   

Change in net unrealized gains (losses) on investments, net of tax

     (140     55         (78     104   

Change in foreign currency translation adjustment, net of tax

     (4,110     456         (3,676     128   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total comprehensive income

   $ 15,075      $ 14,421       $ 39,899      $ 21,779   
  

 

 

   

 

 

    

 

 

   

 

 

 

The change in foreign currency translation adjustment, net of tax, for the three and nine months ended September 30, 2011, is primarily due to the fluctuation of exchange rates on a U.S. dollar-denominated liability for the acquisition-related contingent consideration on our UK subsidiary.

Concentrations of Risk

Financial instruments that are potentially subject to concentrations of credit risk consist primarily of cash, cash equivalents, marketable securities, and trade receivables. Investment policies have been implemented that limit investments to investment grade securities. The average portfolio maturity is currently less than a year. The risk with respect to trade receivables is mitigated by credit evaluations we perform on our customers and by the diversification of our customer base. No customer represented more than 10% of our trade receivable balance at September 30, 2011 and December 31, 2010. One value-added distributor represented more than 10% of our revenue for the three and nine months ended September 30, 2011. No customer represented more than 10% of our revenue for the three and nine months ended September 30, 2010.

We outsource the production of our inventory to third-party manufacturers. We rely on purchase orders or long-term contracts with our contract manufacturers. At September 30, 2011, we had no long-term contractual commitment with any manufacturer; however, we did have a 90 day commitment totaling $9.9 million.

Recent Accounting Pronouncements

In September 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-08, Intangibles—Goodwill and Other (Topic 350)—Testing Goodwill for Impairment (ASU 2011-08), to simplify how entities, both public and nonpublic, test goodwill for impairment. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. We are currently evaluating the impact of our pending adoption of ASU 2011-08 on our consolidated financial statements.

In May 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (Topic 820)—Fair Value Measurement (ASU 2011-04), to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. GAAP and International Financial Reporting Standards. ASU 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements particularly for level 3 fair value measurements (as defined in Note 4 below). ASU 2011-04 is effective for us in fiscal 2012 and should be applied prospectively. We are currently evaluating the impact of our pending adoption of ASU 2011-04 on our consolidated financial statements.

In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220)—Presentation of Comprehensive Income (ASU 2011-05), to require an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of equity. ASU 2011-05 is effective for us in fiscal 2013 and should be applied retrospectively. We are currently evaluating the impact of our pending adoption of ASU 2011-05 on our consolidated financial statements.

2. ACQUISITIONS

Fiscal 2011 Acquisitions

Zeus Technology, Ltd.

In July 2011, we acquired the outstanding securities of Zeus Technology, Ltd. (Zeus). The acquisition expanded our products and technology to compete in the virtual application delivery controller (ADC) market. Zeus pioneered the development of software-based highly scalable ADCs that deliver high-performance software-based load balancing and traffic management solutions for virtual and cloud environments. We have included the financial results of Zeus in our consolidated financial statements from the acquisition date.

 

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Pursuant to the share purchase agreement with Zeus we made payments totaling $104.2 million in cash for all of the outstanding securities of Zeus on July 19, 2011. In addition, we will potentially make additional payments (“acquisition-related contingent consideration”) totaling up to $27.0 million in cash, based on achievement of certain bookings targets related to Zeus products for the period from July 20, 2011 through July 31, 2012 (the “Zeus Earn-Out period”). In addition, we may pay up to $3.0 million as an incentive bonus to former employees of Zeus, based on achievement of certain bookings targets related to Zeus products for the Zeus Earn-Out period.

Preliminary Fair Value of Consideration Transferred

The total acquisition date fair value of the consideration transferred was estimated at $118.8 million, which included the initial payments totaling $104.2 million in cash, of which $20.1 million was paid to escrow to secure the seller’s indemnification obligations, $1.0 million to be paid upon finalization of the closing balance sheet and net working capital statement, and the estimated fair value of acquisition-related contingent consideration to be paid to Zeus shareholders totaling $13.5 million. The total acquisition date fair value of consideration transferred is estimated as follows:

 

(in thousands)

      

Payment to Zeus shareholders

   $ 105,243   

Acquisition-related contingent consideration

     13,543   
  

 

 

 

Total acquisition date fair value

   $ 118,786   
  

 

 

 

We recognized a liability of $13.5 million for the acquisition date fair value of the acquisition-related contingent consideration based on the probability of achievement of the bookings target. Any change in the fair value of the acquisition-related contingent consideration subsequent to the acquisition date, including changes from events after the acquisition date, such as changes in our estimate of the bookings targets, will be recognized in earnings in the period the estimated fair value changes. The fair value estimate is based on the probability weighted bookings to be achieved over the Zeus Earn-Out period. Actual achievement of bookings below $25.0 million would reduce the liability to zero and achievement of bookings of $40.0 million or more would increase the liability to $27.0 million. A change in fair value of the acquisition-related contingent consideration could have a material effect on the statement of operations and financial position in the period of the change in estimate. During the three month period ending September 30, 2011, we recorded an expense of $0.6 million due to the passage of time and the discount used for the fair value of acquisition-related contingent consideration.

We estimated the fair value of the acquisition-related contingent consideration using a probability-weighted discounted cash flow model. This fair value measurement is based on significant inputs not observed in the market and thus represents a Level 3 measurement. Level 3 instruments are valued based on unobservable inputs that are supported by little or no market activity and reflect our own assumptions in measuring fair value. The estimated fair value of acquisition-related contingent consideration of $13.5 million includes amounts to be distributed directly to shareholders, discounted at 17.5%, but excludes a fair value estimate of $1.7 million to be paid to former employees of Zeus. As of September 30, 2011, there were no significant changes in the estimated fair value of the contingent consideration recognized as a result of the acquisition of Zeus.

At the acquisition date, we estimated the fair value of an incentive bonus to be paid to the former employees of Zeus (Zeus incentive bonus) to be $1.7 million. This fair value was also estimated using a probability-weighted discounted cash flow model on the achievement of the bookings target. No liability for the Zeus incentive bonus was recorded as of the acquisition date, as this component is considered compensatory and is being recognized as compensation cost in operating expense ratably over the service period from July 20, 2011 to July 31, 2012.

In addition, we signed retention agreements for certain key employees of Zeus totaling $1.2 million, which will be recognized as compensation expense ratably over the two year period following the acquisition date.

Preliminary Allocation of Consideration Transferred

Under the acquisition method of accounting, the identifiable assets acquired and liabilities assumed were recognized and measured as of the acquisition date based on their estimated fair values as of the July 19, 2011, the acquisition date. The excess of the acquisition date fair value of consideration transferred over estimated fair value of the net tangible assets and intangible assets was recorded as goodwill.

 

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Based on their estimated fair values, we have preliminarily recorded $82.4 million of goodwill, $47.8 million of identifiable intangible assets, including $2.6 million of in-process technology, $7.7 million of deferred tax liabilities and $3.7 million of net other tangible liabilities. These estimated fair values were based upon a preliminary valuation and our estimates and assumptions are subject to change as we obtain additional information for our estimates during the measurement period, which is up to one year from the acquisition date. The primary areas of the estimated fair values that are not yet finalized relate to income taxes and residual goodwill.

The following table summarizes the estimated fair values of the assets and liabilities assumed at the acquisition date. Estimates of both current and non-current deferred tax assets are subject to change, pending the finalization of certain tax returns.

 

(in thousands)

      

Cash and cash equivalents

   $ 1,450   

Accounts receivable

     3,784   

Other tangible assets

     371   

Intangible assets

     47,800   
  

 

 

 

Total identifiable assets acquired

     53,405   

Accounts payable and other liabilities

     9,351   

Long-term deferred tax liabilities

     7,709   
  

 

 

 

Total liabilities assumed

     17,060   
  

 

 

 

Net identifiable assets acquired

     36,345   

Goodwill

     82,441   
  

 

 

 

Net assets acquired

   $ 118,786   
  

 

 

 

Intangible Assets

In our determination of the fair value of the intangible assets we considered, among other factors, the best use of acquired assets, analyses of historical financial performance and estimates of future performance of Zeus’s products. The fair values of identified intangible assets were calculated using an income approach and estimates and assumptions provided by Zeus’s and our management. The rates utilized to discount net cash flows to their present values were based on a weighted average cost of capital of 14%. This discount rate was determined after consideration of the rate of return on debt capital and equity that typical investors would require in an investment in companies similar in size and operating in similar markets as Zeus.

Intangible assets acquired resulting from the Zeus acquisition as of September 30, 2011 are as follows:

 

(in thousands)

   Useful life      Gross Fair
Value
     Accumulated
Amortization
    Net Book
Value
 

Existing technology and patents

     5 years       $ 25,900         (793   $ 25,107   

Patents

     5 years         5,500         (177     5,323   

Maintenance agreements

     5 years         13,300         (429     12,871   

Customer relationships

     3 years         1,500         (81     1,419   

Trademarks

     3 years         300         (16     284   

In-process technology

     N/A         1,300           1,300   
     

 

 

    

 

 

   

 

 

 
      $ 47,800       $ (1,496   $ 46,304   
     

 

 

    

 

 

   

 

 

 

The above table includes $1.3 million of Existing technology and patents that was reclassified from in-process technology upon reaching technical feasibility.

We determined the useful life of intangible assets based on the expected future cash flows associated with the respective asset. Existing technology is comprised of products that have reached technological feasibility and are part of Zeus’s product line. In-process technology assets represent efforts spent through the acquisition date on projects that had yet to reach technical feasibility. Patents are related to the design and development of Zeus’s products and this proprietary know-how can be leveraged to develop new technology and products and improve existing products. Customer relationships and maintenance agreements represent the underlying relationships and agreements with Zeus’s installed customer base. Trademarks represent the fair value of the brand and name recognition associated with the marketing of Zeus’s products and services. Amortization of existing technology and patents is included in cost of revenue, and amortization expense for customer relationships and trademarks is included in operating expenses.

 

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The expected future amortization expense related to the above intangible assets is as follows:

 

Fiscal Year

   In thousands  

2011 (remaining three months ending December 31)

   $ 2,385   

2012

     9,540   

2013

     9,540   

2014

     9,295   

2015

     8,940   

2016 and thereafter

     5,304   
  

 

 

 

Total amortization expense resulting from Zeus acquisition

     45,004   
  

 

 

 

In-process technology

     1,300   
  

 

 

 

Total Zeus intangible assets, net

   $ 46,304   
  

 

 

 

Actual amortization expense may differ from the amounts above due to, among other things, impairments, accelerated amortization and fluctuations in foreign currency exchange rates.

Goodwill

Of the total estimated purchase price, $82.4 million was allocated to goodwill, which represents the excess of the purchase price of an acquired business over the fair value of the underlying net tangible and intangible assets. The goodwill balance is primarily attributed to assembled workforce, expected synergies and expanded network opportunities when integrating Zeus’s technology with our current product offerings. All of the goodwill is expected to be deductible for federal and state income tax purposes. As of September 30, 2011, there was no change in the recognized amounts of goodwill resulting from the acquisition of Zeus.

Deferred Revenues

In connection with the purchase price allocation, we estimated the fair value of the service obligations assumed from Zeus as a consequence of the acquisition. The estimated fair value of the service obligations was determined using a cost build-up approach. The cost build-up approach determines fair value by estimating the costs relating to fulfilling the obligations plus a normal profit margin. The sum of the costs and operating profit approximates, in theory, the amount that we would be required to pay a third party to assume the service obligations. The estimated costs to fulfill the service obligations were based on the historical direct costs and indirect costs related to Zeus’s service agreements with its customers. Direct costs include personnel directly engaged in providing service and support activities, while indirect costs consist of estimated general and administrative expenses based on normalized levels as a percentage of revenue. Profit associated with selling efforts was excluded because Zeus had concluded the selling efforts on the service contracts prior to the date of our acquisition. The estimated research and development costs associated with support contracts have not been included in the fair value determination, as these costs were not deemed to represent a legal obligation at the time of acquisition. We recorded $1.7 million of deferred revenue to reflect the estimate of the fair value of Zeus’s service obligations assumed.

Results of Operations

The revenue and operating loss of Zeus, which was included in our consolidated condensed statement of operations from the acquisition date to the period ending September 30, 2011, was $2.8 million and $3.3 million, respectively. The results of operations of Zeus pre-acquisition were not significant, and therefore no pro forma results of operations were presented separately.

Aptimize Ltd.

In July 2011, we acquired the outstanding securities of Aptimize Ltd. (Aptimize) to expand our product offerings. We have included the financial results of Aptimize in our consolidated results from the acquisition date. This acquisition was not significant, and therefore the pro forma results of operations have not been presented.

Pursuant to the share purchase agreement with Aptimize we made payments totaling $17.3 million in cash for all of the outstanding securities of Aptimize. In addition, we will potentially make additional payments (acquisition-related contingent consideration) totaling up to $17.0 million in cash to be paid to Aptimize shareholders, based on achievement of certain bookings targets related to Aptimize products for the period from September 1, 2011 through September 30, 2012 (the Aptimize Earn-Out period).

Based on their estimated fair values, we have preliminarily recorded $13.0 million of goodwill, $4.7 million of identifiable intangible assets, $0.2 million of deferred tax liabilities and $0.1 million of net tangible assets.

 

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These estimated fair values were based upon a preliminary valuation and our estimates and assumptions are subject to change as we obtain additional information for our estimates during the measurement period, which is up to one year from the acquisition date. The primary areas of the estimated fair values that are not yet finalized relate to income taxes and residual goodwill.

Pre-Acquisition Contingencies

We have evaluated and continue to evaluate pre-acquisition contingencies related to our 2011 acquisitions that existed as of the respective acquisition dates. If these pre-acquisition contingencies that existed as of the acquisition date become probable in nature and estimable during the remainder of the measurement period, amounts recorded for such matters will be made in the measurement period and, subsequent to the measurement period, in our results of operations.

Fiscal 2010 Acquisitions

During the fourth quarter of fiscal 2010, we acquired CACE Technologies, Inc. (CACE) and Global Protocols, LLC (GP) to expand our product offerings. We have included the financial results of these companies in our consolidated results from their respective acquisition dates. Combined, the total fair value of the consideration transferred for these acquisitions was $26.8 million, which was paid in cash. Based on their estimated fair values, we recorded $13.8 million of goodwill, $16.8 million of identifiable intangible assets, including $3.3 million of in-process technology, $3.3 million of deferred tax liabilities and $0.5 million of net tangible liabilities.

Acquisition-related Costs

Acquisition-related costs include transaction costs, integration-related costs and changes in the fair value of the acquisition-related contingent consideration. During the three and nine months ended September 30, 2011, we recorded transaction costs, such as legal, accounting, valuation and other professional services of $1.0 million and $2.4 million, respectively; and integration-related costs of $1.1 million, related to the acquisitions of Zeus and Aptimize, and an expense of $0.6 million related to change in fair value of the acquisition-related contingent consideration to be paid directly to the Zeus shareholders. During the nine months ended September 30, 2010, we recorded an expense of $2.7 million related to change in fair value of the acquisition-related contingent consideration to be paid directly to the Mazu shareholders.

The following table summarizes the acquisition-related costs recognized in the three and nine months ended September 30, 2011 and 2010:

 

     Three months ended
September 30,
     Nine months ended
September 30,
 

(in thousands)

   2011      2010      2011      2010  

Transaction costs

   $ 968       $ —         $ 2,360       $ —     

Integration costs

     1,133         —           1,133         —     

Change in fair value of acquisition-related contingent consideration

     631         —           631         2,725   
  

 

 

    

 

 

    

 

 

    

 

 

 

Acquisition-related costs

   $ 2,732       $ —         $ 4,124       $ 2,725   
  

 

 

    

 

 

    

 

 

    

 

 

 

3. NET INCOME PER COMMON SHARE

Basic net income per common share is computed by dividing net income by the weighted average number of vested common shares outstanding during the period. Diluted net income per common share is computed by giving effect to all potential dilutive common shares, including stock awards. The following table sets forth the computation of income per share:

 

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     Three months ended
September 30,
     Nine months ended
September 30,
 

(in thousands, except per share data)

   2011      2010      2011      2010  

Net income

   $ 19,325       $ 13,910       $ 43,653       $ 21,547   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average common shares outstanding - basic

     155,367         145,978         153,981         143,662   

Dilutive effect of employee stock plans

     11,664         11,952         12,939         9,884   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average common shares outstanding - diluted

     167,031         157,930         166,920         153,546   
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic net income per share

   $ 0.12       $ 0.10       $ 0.28       $ 0.15   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted net income per share

   $ 0.12       $ 0.09       $ 0.26       $ 0.14   
  

 

 

    

 

 

    

 

 

    

 

 

 

Stock options outstanding with an exercise price higher than our average stock price for the periods presented, represent out-of-the-money awards and are excluded from the calculations of the diluted net income per share since the effect would have been anti-dilutive under the treasury stock method.

The following weighted average outstanding options were excluded from the computation of diluted net income per common share for the periods presented because including them would have had an anti-dilutive effect:

 

     Three months ended
September 30,
     Nine months ended
September 30,
 

(in thousands)

   2011      2010      2011      2010  

Total potential anti-dilutive shares of common stock

     3,300         2,176         1,819         4,938   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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4. FAIR VALUE OF ASSETS

As of September 30, 2011, the fair value measurements of our cash, cash equivalents and investments and acquisition-related contingent consideration consisted of the following:

 

(in thousands)

   Total      Level 1      Level 2      Level 3  

Assets:

           

Corporate bonds and notes

   $ 27,290       $ —         $ 27,290       $ —     

U.S. government-sponsored enterprise obligations

     13,700         —           13,700         —     

Money market funds

     41,656         41,656         —           —     

Cash

     71,210         —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total cash and cash equivalents

   $ 153,856       $ 41,656       $ 40,990       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Corporate bonds and notes

   $ 88,912       $ —         $ 88,912       $ —     

U.S. government backed securities

     39,740         39,740         —           —     

U.S. government-sponsored enterprise obligations

     264,793         —           264,793         —     

FDIC-backed certificates of deposit

     11,959         —           11,959         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ 405,404       $ 39,740       $ 365,664       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities:

           
  

 

 

    

 

 

    

 

 

    

 

 

 

Acquisition-related contingent consideration

   $ 15,215       $ —         $ —         $ 15,215   
  

 

 

    

 

 

    

 

 

    

 

 

 

As of December 31, 2010, the fair value measurements of our cash, cash equivalents and investments consisted of the following:

 

(in thousands)

   Total      Level 1      Level 2      Level 3  

Assets:

           

Corporate bonds and notes

   $ 7,746       $ —         $ 7,746       $ —     

U.S. government backed securities

     4,999         4,999         —           —     

U.S. government-sponsored enterprise obligations

     78,186         —           78,186         —     

Money market funds

     52,438         52,438         —           —     

Cash

     22,357         —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total cash and cash equivalents

   $ 165,726       $ 57,437       $ 85,932       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Corporate bonds and notes

   $ 113,179       $ —         $ 113,179       $ —     

U.S. government backed securities

     27,620         27,620         —           —     

U.S. government-sponsored enterprise obligations

     189,100         —           189,100         —     

FDIC-backed certificates of deposit

     5,515         —           5,515         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ 335,414       $ 27,620       $ 307,794       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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The following tables present the gross unrealized gains and gross unrealized losses as of September 30, 2011 and December 31, 2010:

 

(in thousands)

   Fair Value      Unrealized
Gains
     Unrealized
Losses
 

Corporate bonds and notes

   $ 53,438       $ 20       $ —     

Corporate bonds and notes

     35,474         —           (34

U.S. government backed securities

     39,740         56         —     

U.S. government-sponsored enterprise obligations

     91,279         57         —     

U.S. government-sponsored enterprise obligations

     173,514         —           (70

FDIC-backed certificates of deposit

     10,040         1         —     

FDIC-backed certificates of deposit

     1,919         —           (1
  

 

 

    

 

 

    

 

 

 

Total investments at September 30, 2011

   $ 405,404       $ 134       $ (105
  

 

 

    

 

 

    

 

 

 

Corporate bonds and notes

   $ 70,082       $ 81       $ —     

Corporate bonds and notes

     43,097         —           (31

U.S. government backed securities

     27,620         67         —     

U.S. government-sponsored enterprise obligations

     83,978         56         —     

U.S. government-sponsored enterprise obligations

     105,122         —           (96

FDIC-backed certificates of deposit

     1,925         5         —     

FDIC-backed certificates of deposit

     3,590         —           (9
  

 

 

    

 

 

    

 

 

 

Total investments at December 31, 2010

   $ 335,414       $ 209       $ (136
  

 

 

    

 

 

    

 

 

 

We have evaluated our investments as of September 30, 2011 and have determined that no investments with unrealized losses are other-than-temporarily impaired. No investments have been in a continuous loss position greater than one year.

Cash, Cash Equivalents and Investments

Cash and cash equivalents consist primarily of highly liquid investments in money market mutual funds, government-sponsored enterprise obligations, treasury bills, commercial paper and other money market securities with remaining maturities at date of purchase of 90 days or less. The carrying value of cash and cash equivalents at September 30, 2011 and December 31, 2010 was $153.9 million and $165.7 million, respectively. The carrying value approximates fair value at September 30, 2011 and December 31, 2010.

Investments, which are classified as available for sale at September 30, 2011, are carried at fair value, with the unrealized gains and losses, net of tax, reported as a separate component of stockholders’ equity. Investments consist of government-sponsored enterprise obligations, treasury bills, FDIC-backed certificates of deposit and corporate bonds and notes. The fair value of our investments is determined as the exit price in the principal market in which we would transact. Level 1 instruments are valued based on quoted market prices in active markets and include treasury bills and money market funds. Level 2 instruments are valued based on quoted prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency and include corporate bonds and notes, government-sponsored enterprise obligations and FDIC-backed certificates of deposit. Level 3 instruments are valued based on unobservable inputs that are supported by little or no market activity and reflect our own assumptions in measuring fair value. As of September 30, 2011 and December 31, 2010 we had no marketable securities valued as Level 3 instruments. As of September 30, 2011 and December 31, 2010, the investments are recorded at amortized cost, which approximates fair market value. Generally, our investments have maturity dates up to two years from our date of purchase and active markets for these investments exist.

Restricted Cash

Pursuant to certain lease agreements, we are required to maintain cash reserves, classified as restricted cash. Long-term restricted cash totaled $2.6 million at September 30, 2011 and December 31, 2010. Long-term restricted cash is included in Other assets in the condensed consolidated balance sheets and consists primarily of funds held as collateral for letters of credit for the security deposit on the leases of our corporate headquarters and is restricted until the end of the lease terms on July 31, 2014.

Acquisition-related Contingent Consideration

We estimated the fair value of the acquisition-related contingent consideration using a probability-weighted discounted cash flow model. This fair value measure was based on significant inputs not observed in the market and thus represents a Level 3

 

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instrument. Level 3 instruments are valued based on unobservable inputs that are supported by little or no market activity and reflect our own assumptions in measuring fair value

5. INVENTORY

Inventories consist primarily of hardware and related component parts and evaluation units located at customer locations, and are stated at the lower of cost (on a first-in, first-out basis) or market. Inventory is comprised of the following:

 

(in thousands)

   September 30,
2011
     December 31,
2010
 

Raw materials

   $ 1,226       $ 1,751   

Finished goods

     11,095         10,645   

Evaluation units

     3,078         2,784   
  

 

 

    

 

 

 

Total inventory

   $ 15,399       $ 15,180   
  

 

 

    

 

 

 

6. GOODWILL

Goodwill

Goodwill represents the excess of the purchase price of an acquired business over the fair value of the underlying net tangible and intangible assets. We consider the acquired businesses additions to our product portfolio and not additional reporting units or operating segments. We record goodwill adjustments pursuant to changes to net assets acquired during the measurement period, which is generally up to one year from the date of acquisition. The portion of goodwill associated with the acquisitions of Zeus and Global Protocols is deductible for federal and state income tax purposes.

Goodwill consisted of the following:

 

(in thousands)

      

Balance at December 31, 2010

   $ 25,653   

Additions resulting from acquisitions

     95,413   

Other adjustments

     (575

Foreign currency impact

     (2,802
  

 

 

 

Balance at September 30, 2011

   $ 117,689   
  

 

 

 

7. DEFERRED REVENUE

Deferred revenue consisted of the following:

 

(in thousands)

   September 30,
2011
     December 31,
2010
 

Product

   $ 6,322       $ 6,766   

Support and services

     141,398         108,771   
  

 

 

    

 

 

 

Total deferred revenue

   $ 147,720       $ 115,537   
  

 

 

    

 

 

 

Reported as:

     

Deferred revenue, current

   $ 114,425       $ 89,026   

Deferred revenue, non-current

     33,295         26,511   
  

 

 

    

 

 

 

Total deferred revenue

   $ 147,720       $ 115,537   
  

 

 

    

 

 

 

Deferred product revenue relates to arrangements where not all revenue recognition criteria have been met. Deferred support revenue represents customer payments made in advance for support contracts. Support contracts are typically billed on a per annum basis in advance and revenue is recognized ratably over the support period. Deferred revenue, non-current consists primarily of customer payments made in advance for support contracts with terms of more than 12 months.

8. GUARANTEES

Our agreements with customers, as well as our reseller agreements, generally include certain provisions for indemnifying customers and resellers and their affiliated parties against liabilities if our products infringe a third party’s intellectual property rights.

 

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To date, we have not incurred any material costs as a result of such indemnifications and have not accrued any liabilities related to such obligations in our condensed consolidated financial statements.

As permitted or required under Delaware law and to the maximum extent allowable under that law, we have certain obligations to indemnify our officers, directors and certain key employees for certain events or occurrences while the officer, director or employee is or was serving at our request in such capacity. These indemnification obligations are valid as long as the director, officer or employee acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal proceeding, had no reasonable cause to believe his or her conduct was unlawful. The maximum potential amount of future payments we could be required to make under these indemnification obligations is unlimited; however, we have a director and officer insurance policy that mitigates our exposure and enables us to recover a portion of any future amounts paid.

9. LEASE COMMITMENTS

We lease our facilities under non-cancelable operating lease agreements. Future minimum commitments for these operating leases in place as of September 30, 2011 with a remaining non-cancelable lease term in excess of one year are as follows:

 

(in thousands)

   September 30,
2011
 

2011 (the three months ending December 31)

   $ 2,403   

2012

     9,964   

2013

     10,454   

2014

     9,299   

2015

     5,686   

2016 and thereafter

     22,746   
  

 

 

 

Total

   $ 60,552   
  

 

 

 

The terms of certain lease agreements provide for rental payments on a graduated basis. We recognize rent expense on a straight-line basis over the lease period and have accrued for rent expense incurred but not paid. Rent expense under operating leases was $2.9 million and $2.3 million for the three months ended September 30, 2011 and 2010 and $8.1 million and $6.5 million for the nine months ended September 30, 2011 and 2010, respectively.

 

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10. COMMON STOCK

Stock-Based Compensation Expense

The following table summarizes stock-based compensation expense for stock options, RSUs and the Purchase Plan recorded in our condensed consolidated statement of operations for the three and nine months ended September 30, 2011 and 2010:

 

     Three months ended
September 30,
     Nine months ended
September 30,
 

(in thousands)

   2011      2010      2011      2010  

Cost of product

   $ 247       $ 128       $ 733       $ 383   

Cost of support and services

     1,587         1,359         4,853         3,978   

Sales and marketing

     8,742         7,235         26,896         21,086   

Research and development

     6,817         4,759         20,167         13,809   

General and administrative

     5,111         3,850         15,351         11,240   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 22,504       $ 17,331       $ 68,000       $ 50,496   
  

 

 

    

 

 

    

 

 

    

 

 

 

Share-Based Payments Valuation Assumptions

The fair value of options granted was estimated at the date of grant using the following assumptions:

 

     Three months ended
September 30,
     Nine months ended
September 30,
 
     2011      2010      2011      2010  

Employee Stock Options

           

Expected life in years

     4.2         4.5         4.2         4.5   

Risk-free interest rate

     1.0%         1.4%         1.0-1.7%         1.4-2.2%   

Volatility

     67%         52%         62%-67%         52%   

Weighted average fair value of grants

   $ 14.12       $ 8.11       $ 16.05       $ 6.48   

The fair value of Purchase Plan shares granted was estimated at the date of grant using the following assumptions:

 

     Three and nine months ended
September 30,
 
     2011      2010  

Purchase Plan

     

Expected life in years

     0.5-2.0         0.5-2.0   

Risk-free interest rate

     0.1%-0.6%         0.2%-0.8%   

Volatility

     49%-51%         44%-67%   

Weighted average fair value of grants

   $ 12.40       $ 6.07   

Stock Options

As of September 30, 2011, total compensation cost related to stock options granted to employees and directors but not yet recognized was $50.4 million, net of estimated forfeitures. This cost will be recognized on a straight-line basis over the remaining weighted-average service period. Amortization in the three months ended September 30, 2011 and 2010 was $7.3 million and $9.2 million, respectively. Amortization in the nine months ended September 30, 2011 and 2010 was $24.6 million and $27.9 million, respectively.

As of September 30, 2011, 9,093,000 shares were available for grant under the 2006 Equity Incentive Plan. As of September 30, 2011, 2,152,000 shares were available for grant under the 2006 Director Option Plan. As of September 30, 2011, 1,229,000 shares were available for grant under the 2009 Inducement Equity Incentive Plan.

Stock Purchase Plan

As of September 30, 2011, there was $8.6 million of total compensation cost, net of estimated forfeitures, left to be amortized under our Purchase Plan, which will be amortized over the remaining Purchase Plan offering period. Amortization in the three months

 

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ended September 30, 2011 and 2010 was $2.0 million and $1.4 million, respectively. Amortization in the nine months ended September 30, 2011 and 2010 was $6.2 million and $5.3 million, respectively.

As of September 30, 2011, 1,513,000 shares were available under the Purchase Plan.

Restricted Stock Units

As of September 30, 2011, total unrecognized compensation cost related to non-vested RSUs to employees and directors was $92.3 million, net of estimated forfeitures. This cost will be recognized over the remaining weighted-average service period. Amortization in the three months ended September 30, 2011 and 2010 was $13.2 million and $6.7 million, respectively. Amortization in the nine months ended September 30, 2011 and 2010 was $37.2 million and $17.3 million, respectively.

Share Repurchase Program

On August 19, 2011, our Board of Directors authorized a Share Repurchase Program (the “Program”), which authorizes us to repurchase up to $150.0 million of our outstanding common stock. The Program does not require us to purchase a minimum number of shares, and may be suspended, modified or discontinued at any time without prior notice. For the three and nine months ended September 30, 2011, we repurchased 874,321 shares of common stock under this Program on the open market for an aggregate purchase price of $20.0 million, or a weighted average of $22.89 per share. The timing and amounts of these purchases were based on market conditions and other factors, including price, regulatory requirements and capital availability. The share repurchases were financed by available cash balances and cash from operations. The maximum dollar value of shares of common stock that remain available for purchase under the Program is $130.0 million.

For the three and nine months ended September 30, 2010, no shares of common stock were repurchased under a Share Repurchase Program.

11. INCOME TAXES

Our effective tax rate was 23.8% and 39.2% for the three months ended September 30, 2011 and 2010, respectively, and 35.8% and 40.7% for the nine months ended September 30, 2011 and 2010, respectively. Our income tax provision consists of federal, foreign, and state income taxes. The provision for income taxes for the three months ended September 30, 2011 and 2010 was $6.0 million, and $9.0 million, respectively. The provision for income taxes for the nine months ended September 30, 2011 and 2010 was $24.3 million, and $14.8 million, respectively.

Our effective tax rate differs from the federal statutory rate due to state taxes and significant permanent differences. Significant permanent differences arise primarily from taxes in foreign jurisdictions with a tax rate different than the U.S. federal statutory rate, stock-based compensation expense, research and development (R&D) credits, certain acquisition related items, the amortization of deferred tax charges related to our intercompany sale of intellectual property rights, and the benefits from a change in tax status of our United Kingdom (UK) subsidiaries.

During the quarter ended September 30, 2011, our UK subsidiaries made an election to change their tax status to an entity that is disregarded for federal and state income tax purposes. As a result of the change in tax status, we recorded a deferred tax benefit of $3.6 million to record certain deferred tax assets resulting from the change.

We recorded a deferred charge during the nine months ended September 30, 2011 related to the deferral of income tax expense on intercompany profits that resulted from the sale of our intellectual property rights outside of North and South America to our Singapore subsidiary. The deferred charge is included in the Prepaid expenses and other current assets and the Other assets lines of the condensed consolidated balance sheets in the amounts of $5.6 million and $18.2 million, respectively. The deferred charge will be amortized as a component of income tax expense over the five-year economic life of the intellectual property.

During the nine months ended September 30, 2011, we increased our liability for unrecognized income tax benefits by $10.5 million to $17.4 million for tax positions related to the current year. The unrecognized tax benefits that, if recognized, would impact the effective tax rate were $16.0 million as of September 30, 2011.

12. SEGMENT INFORMATION

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. Our chief operating decision maker is our Chief Executive Officer. Our Chief Executive Officer reviews financial information presented on a consolidated basis, accompanied by information about revenue by geographic region for purposes of allocating resources and evaluating financial performance. We have one business segment and there are no segment managers who are held accountable for operations, operating results and plans for levels or components below the consolidated unit level. Accordingly, we are considered to be in a single reporting segment and operating unit structure.

 

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Revenue by geography is based on the billing address of the customer. The following table sets forth revenue by geographic area.

Revenue

 

     Three months ended
September 30,
     Nine months ended
September 30,
 

(in thousands)

   2011      2010      2011      2010  

United States

   $ 106,326       $ 80,839       $ 293,181       $ 202,970   

Europe, Middle East and Africa

     49,847         38,405         128,924         106,660   

Rest of the World

     33,610         28,562         101,536         76,826   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

   $ 189,783       $ 147,806       $ 523,641       $ 386,456   
  

 

 

    

 

 

    

 

 

    

 

 

 

13. LEGAL MATTERS

On June 1, 2011, we served Silver Peak Systems, Inc. with a lawsuit, filed in the United States District Court for the District of Delaware, alleging infringement of certain patents. The lawsuit seeks unspecified damages and injunctive relief. On July 22, 2011, Silver Peak Systems denied the allegations and requested declaratory judgments of invalidity and non-infringement.

On August 17, 2011, Silver Peak Systems amended its counterclaims against us, alleging infringement by Riverbed of certain patents. The lawsuit seeks unspecified damages and injunctive relief. On September 20, 2011, we denied Silver Peak Systems’ allegations and requested declaratory judgments of invalidity and non-infringement.

At this time we are unable to estimate any range of reasonably possible loss relating to these actions. Discovery is ongoing, and trial is currently scheduled to begin on July 29, 2013. We believe that we have meritorious defenses to the counterclaims against us, and we intend to vigorously contest these counterclaims.

From time to time, we are involved in various legal proceedings, claims and litigation arising in the ordinary course of business. There are no currently pending legal proceedings at September 30, 2011 that, in the opinion of management, would have a material adverse effect on our financial position, results of operations or cash flows.

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this Form 10-Q. The information in this Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Such forward-looking statements include statements related to: our business and strategy, trends affecting our business and financial results, international expansion plans, growth of our revenue, costs and expenses (including sales and marketing expenses), our share repurchase program, and our acquisitions. Such statements are based upon current expectations that involve risks and uncertainties. Any statements contained herein that are not statements of historical facts may be deemed to be forward-looking statements. For example, words such as “may,” “will,” “could,” “should,” “estimates,” “predicts,” “potential,” “continue,” “strategy,” “believes,” “anticipates,” “plans,” “expects,” “intends” and similar expressions are intended to identify forward-looking statements. Our actual results and the timing of certain events may differ significantly from the results discussed in the forward-looking statements. Factors that might cause or contribute to such a discrepancy include, but are not limited to, those discussed elsewhere in this Form 10-Q in the section titled “Risk Factors” and the risks discussed in our other SEC filings. We disclaim any obligation to publicly release any revisions or updates to the forward-looking statements after the date of this Form 10-Q.

Overview

We were founded in May 2002 by experienced industry leaders with a vision to improve the performance of wide-area distributed computing. Having significant experience in caching technology, our executive management team understood that existing approaches failed to address adequately all of the root causes of this poor performance. We determined that these performance problems could be best solved by simultaneously addressing inefficiencies in software applications and wide-area networks (WANs) as well as insufficient or unavailable bandwidth. This innovative approach served as the foundation of the development of our products. We began commercial shipments of our products in May 2004 and have since sold our products to over 16,000 customers worldwide. We offer several product lines including Steelhead appliances, Central Management Console, Interceptor, Steelhead Mobile optimizing traffic over the wide area network, our Whitewater product line addressing the cloud storage acceleration market, our Cascade products focusing on application performance, reporting and analytics in the network performance management (NPM) market, and the Zeus and Aptimize products directed at the software-based load balancing and traffic management solutions for virtual and cloud environments in the application delivery controller (ADC) market and web content optimization, respectively.

 

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We are headquartered in San Francisco, California. Our personnel are located throughout the U.S. and in approximately thirty countries worldwide. We expect to continue to add personnel in the U.S. and internationally to provide additional geographic sales, research and development, general and administrative and technical support coverage.

Company Strategy

Our goal is to establish our solutions as the preeminent performance and efficiency standard for organizations relying on wide-area distributed computing. Key elements of our strategy include:

Maintain and extend our technological advantages

We believe that we offer the broadest ability to enable rapid, reliable access to applications and data for our customers. We intend to enhance our position as a leader and innovator in the WAN optimization market. We also intend to continue to sell new capabilities, such as our new cloud solutions, into our installed base. Continuing investments in research and development are critical to maintaining our technological advantage.

Enhance and extend our product lines

We plan to introduce enhancements to our product capabilities in order to address our customers’ size and application requirements. We also plan to introduce new products to extend our market and utilize our technology platform to extend our capabilities.

Riverbed is a leader in the WAN optimization market through our Steelhead product line. Our Steelhead appliances consist of our proprietary software that is delivered as appliances on a purpose-built hardware computing platform, and as software for end users for public and private cloud environments. We sell different Steelhead appliances to address the needs of customers ranging from small office deployments to large headquarters and data center locations. In addition to WAN optimization functionality, Steelhead appliances support the RSP, a virtualized environment within Steelhead appliances upon which third-party applications can be installed.

In 2009, we added the Cascade product line through our acquisition of Mazu Networks (Mazu). The Cascade product line helps organizations manage, secure and optimize the availability and performance of global applications. The acquisition allows us to meet enterprise and service provider customer demands by extending our suite of WAN optimization products to include global application performance, reporting and analytics.

In 2010, we introduced our Whitewater product that is engineered for the public cloud. Our Whitewater product is a cloud storage accelerator, designed to accelerate, de-duplicate, and secure data that is to be stored in the public cloud.

In July 2011, we announced the acquisitions of Zeus Technology, Ltd. (Zeus) and Aptimize Ltd. (Aptimize) which expanded our products and technology to compete in the virtual application delivery controller (ADC) market. Zeus pioneered the development of software-based highly scalable ADCs that deliver high-performance software-based load balancing and traffic management solutions for virtual and cloud environments. Aptimize is a market leader in web content optimization, an innovative new technology area that allows customers to deliver both internal web applications, like SharePoint, and external web applications, like e-commerce websites, much faster.

Increase market awareness

To generate increased demand for our products, we will continue promoting our brand and the effectiveness of our comprehensive WAN optimization solution.

Scale our sales force and distribution channels

Growth in revenue and increase in market share are key goals for us. We intend to expand our direct sales force and leverage our indirect channels to extend our geographic reach and market penetration. We sell our products directly through our sales force and indirectly through channel partners. We derived 95% of our revenue through indirect channels in the first nine months of 2011. We expect revenue from channel partners to continue to constitute a substantial majority of our future revenue.

 

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Enhance and extend our support and services capabilities

On an ongoing basis, we plan to enhance and extend our support and services capabilities to continue to support our growing global customer base. Our support organization goals include providing customers with the highest service levels in the industry for hardware replacement and software support. Our sales organization is focused on maintaining a high rate of service contract renewals on our existing customer base. Our professional services team is focused on developing and distributing training programs directed at our partners, and expanding our professional service offering.

Major Trends Affecting Our Financial Results

Company outlook

We believe that our current value proposition, which enables customers to improve the performance of their applications and access to their data across WANs, while also offering the ability to simplify IT infrastructure and realize significant capital and operating cost savings, should allow us to continue to grow our business. Our product revenue growth rate will depend significantly on continued growth in the WAN, NPM and ADC markets, and our ability to continue to attract new customers in that market and generate additional sales from existing customers. Our growth in support and services revenue is dependent upon increasing the number of products under support contracts, which is dependent on both growing our installed base of customers and renewing existing support contracts. Our future profitability and rate of growth will be directly affected by the continued acceptance of our products in the marketplace, as well as the timing and size of orders, product mix, average selling prices and costs of our products and general economic conditions. Our ability to grow and maintain profitability in the future will also be affected by the extent to which we must incur additional expenses to expand our sales, support, marketing, development, and general and administrative capabilities to grow our business. The largest component of our expenses is personnel costs. Personnel costs consist of salaries, benefits and incentive compensation for our employees, including commissions for sales personnel and stock-based compensation.

Revenue

Our revenue has grown rapidly since we began shipping products in May 2004, increasing from $2.6 million in 2004 to $551.9 million in 2010. Revenue grew by 35% in the nine months ended September 30, 2011 to $523.6 million from $386.5 million in the nine months ended September 30, 2010. We believe that our revenue growth in 2009 and 2010, during periods in which the global macroeconomic environment negatively impacted many businesses, is a positive sign that our products have a significant value proposition to our customers and that the WAN optimization market is still expanding.

Costs and Expenses

Operating expenses consist of sales and marketing, research and development, general and administrative expenses, and acquisition-related costs. Personnel-related costs, including stock-based compensation, are the most significant component of each of these expense categories. As of September 30, 2011, we had 1,554 employees, an increase of 34% from 1,161 employees at September 30, 2010. The increase in employees is the most significant driver behind the increase in costs and operating expenses from the nine months ended September 30, 2010 to the nine months ended September 30, 2011. The increase in employees was required to support our increased revenue and is due, in part, by our acquisitions during the period. The timing and number of additional hires has and could materially affect our operating expenses, both in absolute dollars and as a percentage of revenue, in any particular period.

Stock-based Compensation Expense

Stock-based compensation expense and related payroll taxes were $22.7 million and $17.8 million in the three months ended September 30, 2011 and 2010, respectively, and $71.9 million and $52.0 million in the nine months ended September 30, 2011 and 2010, respectively. We expect to continue to incur significant stock-based compensation expense and anticipate further growth in stock-based compensation expense as our employee base grows because we expect stock-based compensation to continue to play an important part in the overall compensation structure for our employees.

 

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Stock-based compensation expense and related payroll tax was as follows:

 

(in thousands)

   Three months ended
September 30,
     Nine months ended
September 30,
 
   2011      2010      2011      2010  

Cost of product

   $ 250       $ 137       $ 804       $ 403   

Cost of support and services

     1,604         1,404         5,208         4,086   

Sales and marketing

     8,832         7,449         28,527         21,770   

Research and development

     6,904         4,923         21,594         14,256   

General and administrative

     5,148         3,934         15,767         11,494   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation expense and related payroll taxes

   $ 22,738       $ 17,847       $ 71,900       $ 52,009   
  

 

 

    

 

 

    

 

 

    

 

 

 

Acquisitions

Combined, the total acquisition date fair value of consideration transferred was approximately $136.3 million, which included initial payments of $121.5 million in cash, of which $22.8 million was paid to escrow to secure the sellers’ indemnification obligations, $0.8 million paid upon the final Aptimize closing balance sheet, $1.0 million to be paid upon finalization of the Zeus closing balance sheet and the estimated fair value of acquisition-related contingent consideration of $14.6 million. Also included in the initial payments were $1.6 million of prepaid compensation costs. We preliminarily recorded $95.4 million of goodwill, $52.5 million of identifiable intangible assets, including $2.6 million of in-process technology, deferred tax liabilities of $7.9 million and $3.7 million of net other tangible liabilities related to these acquisitions. The results of operations of these companies are included in our condensed consolidated results for the period subsequent to the acquisition date. In the nine months ended September 30, 2011, we recognized $2.8 million in revenue, from the sale of these acquired companies’ products and services and we recognized $6.8 million of operating expenses, which included $1.7 million of acquisition-related intangible amortization, $0.2 million of stock-based compensation costs and $0.8 million of acquisition-related compensation costs.

During fiscal 2010, we acquired two companies to expand our product offerings. These acquisitions were not significant, individually or in the aggregate. Combined, the total purchase price for these acquisitions was approximately $26.8 million, which was paid in cash. We recorded $13.8 million of goodwill, $16.8 million of identifiable intangible assets, including $3.3 million of in-process technology intangible assets, $3.3 million of deferred tax liabilities, and $0.5 million of net tangible liabilities. The results of operations of these companies are included in our condensed consolidated results for the period subsequent to the acquisition date. In the nine months ended September 30, 2011, we recognized $10.4 million in revenue, from the sale of these acquired companies’ products and services and we recognized $7.4 million of operating expenses, which included $3.0 million of acquisition-related intangible amortization, $0.8 million of stock-based compensation costs and $2.1 million of acquisition-related costs, including retention bonuses.

Critical Accounting Policies and Estimates

Our condensed consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP). These accounting principles require us to make certain estimates and judgments that can affect the reported amounts of assets and liabilities as of the date of the condensed consolidated financial statements, as well as the reported amounts of revenue and expenses during the periods presented. We believe that the estimates and judgments upon which we rely are reasonable based upon information available to us at the time that these estimates and judgments are made. To the extent there are material differences between these estimates and actual results, our condensed consolidated financial statements could be adversely affected.

The accounting policies that reflect our more significant estimates, judgments and assumptions and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following: revenue recognition, accounting for business combinations, stock-based compensation, accounting for income taxes, inventory valuation and allowances for doubtful accounts. Please refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for our year ended December 31, 2010 for a more complete discussion of our critical accounting policies and estimates including revenue recognition, goodwill, intangible assets and impairment assessments, stock-based compensation, accounting for income taxes, inventory valuation and allowances for doubtful accounts. Our critical accounting policies have been discussed with the Audit Committee of the Board of Directors. We believe there have been no material changes to our critical accounting policies and estimates during the three and nine months ended September 30, 2011, compared to those discussed in our Form 10-K for the year ended December 31, 2010.

 

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Results of Operations

Revenue

We derive our revenue from sales of our appliances and software licenses and from support and services. Product revenue primarily consists of revenue from sales of our Steelhead, Cascade and ADC products and is typically recognized upon shipment. Support and services revenue includes unspecified software license updates and product support. Support revenue is recognized ratably over the contractual period, which is typically one year. Service revenue includes professional services and training, which to date has not been significant, and is recognized as the services are performed.

 

     Three months ended
September 30,
     Nine months ended
September 30,
 

(in thousands)

   2011      2010      2011      2010  

Total Revenue

   $ 189,783       $ 147,806       $ 523,641       $ 386,456   

Total Revenue by Type:

           

Product

   $ 132,061       $ 102,841       $ 361,073       $ 262,083   

Support and services

   $ 57,722       $ 44,965       $ 162,568       $ 124,373   

% Revenue by Type:

           

Product

     70%         70%         69%         68%   

Support and services

     30%         30%         31%         32%   

Total Revenue by Geography:

           

United States

   $ 106,326       $ 80,839       $ 293,181       $ 202,970   

Europe, Middle East and Africa

   $ 49,847       $ 38,405       $ 128,924       $ 106,660   

Rest of the World

   $ 33,610       $ 28,562       $ 101,536       $ 76,826   

% Revenue by Geography:

           

United States

     56%         55%         56%         53%   

Europe, Middle East and Africa

     26%         26%         25%         28%   

Rest of the World

     18%         19%         19%         19%   

Total Revenue by Sales Channel:

           

Direct

   $ 7,068       $ 7,721       $ 25,028       $ 23,999   

Indirect

   $ 182,715       $ 140,085       $ 498,613       $ 362,457   

% Revenue by Sales Channel:

           

Direct

     4%         5%         5%         6%   

Indirect

     96%         95%         95%         94%   

Quarter Ended September 30, 2011 Compared to the Quarter Ended September 30, 2010: Product revenue increased by 28% in the three months ended September 30, 2011 as compared to the three months ended September 30, 2010, due primarily to an increase in unit volume from increasing sales to existing customers and the addition of new customers. We believe the market for our products has grown due to increased market awareness of WAN optimization and an increase in distributed organizations, which increases dependence on timely access to data and applications.

Substantially all of our customers purchase support when they purchase our products. Support and services revenue increased 28% in the three months ended September 30, 2011 as compared to the three months ended September 30, 2010. As our customer base grows, we expect our revenue generated from support and services to increase; however, we expect the renewal rate of support contracts by existing customers to remain level.

In the three months ended September 30, 2011, we derived 96% of our revenue from indirect channels compared to 95% for the three months ended September 30, 2010. We expect indirect channel revenue to continue to be a substantial majority of our revenue.

We generated 44% of our revenue in the three months ended September 30, 2011 from international locations, compared to 45% in the three months ended September 30, 2010. We continue to expand into international locations and introduce our products in new markets and expect international revenue to increase in dollar amount over time.

Nine Months Ended September 30, 2011 Compared to the Nine Months Ended September 30, 2010: Product revenue increased by 38% in the nine months ended September 30, 2011 over the same period in the prior year due primarily to an increase in unit volume from sales to new customers and additional purchases by existing customers.

Support and services revenue increased by 31% in the nine months ended September 30, 2011 over the same period in the prior year due to higher first year support sales from higher product sales and the continued renewal of support contracts by our existing customers.

 

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Cost of Revenue and Gross Margin

Cost of product revenue consists of the costs of the appliance hardware, manufacturing, shipping and logistics costs, expenses for inventory obsolescence, warranty obligations and amortization of acquisition-related intangibles. We utilize third parties to assist in the design and manufacture of our appliance hardware, embed our proprietary software and perform shipping logistics. Cost of support and service revenue consists of personnel costs of technical support and professional services personnel, spare parts and logistics services. As we expand internationally and into other sectors, we may incur additional costs to conform our products to comply with local laws or local product specifications. In addition, as we expand internationally, we will continue to hire additional technical support personnel to support our growing international customer base.

Our gross margin has been and will continue to be affected by a variety of factors, including the mix and average selling prices of our products, new product introductions and enhancements, the cost of our appliance hardware, expenses for inventory obsolescence and warranty obligations, cost of support and service personnel, and the mix of distribution channels through which our products are sold.

 

      Three months ended
September 30,
     Nine months ended
September 30,
 

(in thousands)

   2011      2010      2011      2010  

Revenue:

           

Product

   $ 132,061       $ 102,841       $ 361,073       $ 262,083   

Support and services

     57,722         44,965         162,568         124,373   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

     189,783         147,806         523,641         386,456   
  

 

 

    

 

 

    

 

 

    

 

 

 

Cost of revenue:

           

Cost of product

     26,968         21,889         74,386         57,133   

Cost of support and services

     17,998         12,878         49,633         36,476   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total cost of revenue

     44,966         34,767         124,019         93,609   
  

 

 

    

 

 

    

 

 

    

 

 

 

Gross profit

   $ 144,817       $ 113,039       $ 399,622       $ 292,847   
  

 

 

    

 

 

    

 

 

    

 

 

 

Gross margin for product

     80%         79%         79%         78%   

Gross margin for support and services

     69%         71%         69%         71%   

Total gross margin

     76%         76%         76%         76%   

Quarter Ended September 30, 2011 Compared to the Quarter Ended September 30, 2010: The total cost of revenue increased $10.2 million, or 29.3%, in the three months ended September 30, 2011 compared to the three months ended September 30, 2010. The cost of product sold increased $5.1 million, or 23.2%, primarily due to an increase in unit volume associated with higher revenue. Cost of support and services revenue increased $5.1million, or 39.8%, as we added more technical support headcount domestically and abroad to support our growing customer base. Technical support and services headcount was 191 employees, including seven acquired company employees, as of September 30, 2011 compared to 159 employees as of September 30, 2010.

Gross margins remained at 76% in the three months ended September 30, 2011 as compared to the three months ended September 30, 2010. Product gross margins increased to 80% in the three months ended September 30, 2011 from 79% in the three months ended September 30, 2010 as a result of volume leverage and favorable product mix. Gross margins for support and services decreased slightly to 69% due to certain redundant transportation and warehousing costs as we converted to a new logistics provider.

Nine Months Ended September 30, 2011 Compared to the Nine Months Ended September 30, 2010: The total cost of revenue increased $30.4 million, or 32.5%, in the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010. The increase in cost of product revenue of $17.3 million, or 30.2%, was due primarily to increased unit volume associated with higher revenue. Cost of support and services revenue increased $13.2 million, or 36.1%, due to increased personnel related costs as a result of increased headcount.

Gross margins remained at 76% in the nine months ended September 30, 2011 as compared to the nine months ended September 30, 2010. Product gross margins increased to 79% in the nine months ended September 30, 2011 from 78% in the nine months ended September 30, 2010 as a result of volume leverage and favorable product mix. Gross margins for support and services decreased slightly to 69%.

Sales and Marketing Expenses

Sales and marketing expenses represent the largest component of our operating expenses and include personnel costs, sales commissions, marketing programs and facilities costs. Marketing programs are intended to generate revenue from new and existing customers, and are expensed as incurred. We plan to continue to make investments in sales and marketing with the intent to add new

 

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customers and increase penetration within our existing customer base by increasing the number of sales personnel worldwide, expanding our domestic and international sales and marketing activities, increasing channel penetration, building brand awareness and sponsoring additional marketing events. We expect future sales and marketing expenses to continue to increase and continue to be our most significant operating expense. Generally, sales personnel are not immediately productive and sales and marketing expenses do not immediately result in increased revenue. Hiring additional sales personnel reduces short-term operating margins until the sales personnel become productive and generate revenue. Accordingly, the timing of sales personnel hiring and the rate at which they become productive will affect our future performance.

 

     Three months ended
September 30,
     Nine months ended
September 30,
 

(in thousands)

   2011      2010      2011      2010  

Sales and marketing expenses

   $ 70,208       $ 56,517       $ 195,029       $ 158,575   

Percent of total revenue

     37%         38%         37%         41%   

Quarter Ended September 30, 2011 Compared to the Quarter Ended September 30, 2010: Sales and marketing expenses increased by $13.7 million, or 24.2%, in the three months ended September 30, 2011 compared to the three months ended September 30, 2010 primarily due to increases in personnel costs of $9.2 million. The increase in personnel costs, which include salaries, commissions, bonuses and related benefits and stock-based compensation, was primarily due to headcount increasing to 714 employees, including 51 acquired company employees, as of September 30, 2011 from 536 employees as of September 30, 2010. Intangibles amortization and acquisition-related bonuses contributed $0.6 million and $0.7 million, respectively, to the increase in sales and marketing expense.

Nine Months Ended September 30, 2011 Compared to the Nine Months Ended September 30, 2010: The increase in sales and marketing expenses for the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010 of $36.5 million, or 23.0%, is primarily due to increases in personnel costs of $24.6 million, increases in marketing costs of $2.3million and increases in travel and entertainment expenses of $3.0 million. Intangibles amortization contributed to $0.8 million of the increase in sales and marketing expense.

Research and Development Expenses

Research and development (R&D) expenses primarily include personnel costs and facilities costs. We expense R&D costs as incurred. We are devoting substantial resources to the continued development of additional functionality for existing products and the development of new products. We intend to continue to invest significantly in our R&D efforts because we believe they are essential to maintaining our competitive position. Investments in R&D personnel costs are expected to increase in dollar amount.

 

     Three months ended
September 30,
     Nine months ended
September 30,
 

(in thousands)

   2011      2010      2011      2010  

Research and development expenses

   $ 30,999       $ 21,951       $ 89,250       $ 61,500   

Percent of total revenue

     16%         15%         17%         16%   

Quarter Ended September 30, 2011 Compared to the Quarter Ended September 30, 2010: R&D expenses increased by $9.0 million, or 41.2%, in the three months ended September 30, 2011 compared to the three months ended September 30, 2010 primarily due to increases in personnel costs of $6.0 million, facilities and information technology costs of $0.4 million, and acquisition-related bonuses of $0.8 million. The increase in personnel costs, which include salaries, bonuses and related benefits and stock-based compensation, was primarily due to headcount increasing to 444 employees, including 34 acquired company employees, as of September 30, 2011 from 314 employees as of September 30, 2010. In addition, during the three months ended September 30, 2011, we recorded legal fees pursuant to the Silver Peak Systems litigation to R&D expenses, which may become more significant in future periods.

Nine Months Ended September 30, 2011 Compared to the Nine Months Ended September 30, 2010: The increase in R&D expenses for the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010 of $27.7 million, or 45.1%, is primarily due to an increase in personnel costs of $17.4 million, outside services of $2.5 million and facilities and information technology costs of $1.5 million. Acquisition-related bonuses contributed to $1.7 million of the increase in research and development expense.

 

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General and Administrative Expenses

General and administrative expenses consist primarily of compensation for personnel and facilities costs related to our executive, finance, human resources, information technology and legal organizations, and fees for professional services. Professional services include legal, audit and information technology consulting costs.

 

     Three months ended
September 30,
     Nine months ended
September 30,
 

(in thousands)

   2011      2010      2011      2010  

General and administrative expenses

   $ 15,353       $ 12,078       $ 43,949       $ 34,393   

Percent of total revenue

     8%         8%         8%         9%   

Quarter Ended September 30, 2011 Compared to the Quarter Ended September 30, 2010: General and administrative expenses increased by $3.3 million, or 27.1%, in the three months ended September 30, 2011 compared to the three months ended September 30, 2010 due to an increase in personnel costs of $2.4 million. The increase in personnel costs, which include salaries, bonuses and related benefits and stock-based compensation, was primarily due to headcount increasing to 174 employees, as of September 30, 2011 from 133 employees as of September 30, 2010.

Nine Months Ended September 30, 2011 Compared to the Nine Months Ended September 30, 2010: The increase of $9.6 million, or 27.8%, in general and administrative expenses for the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010 is primarily due to an increase in personnel costs of $6.6 million and outside services of $0.9 million.

Acquisition-Related Costs

Acquisition-related costs include changes in the fair value of the acquisition-related contingent consideration, transaction costs and integration-related costs, which are summarized as follows:

 

     Three months ended
September 30,
     Nine months ended
September 30,
 

(in thousands)

   2011      2010      2011      2010  

Transaction costs

   $ 968       $ —         $ 2,360       $ —     

Integration costs

     1,133         —           1,133         —     

Change in fair value of acquisition-related contingent consideration

     631         —           631         2,725   
  

 

 

    

 

 

    

 

 

    

 

 

 

Acquisition-related costs

   $ 2,732       $ —         $ 4,124       $ 2,725   
  

 

 

    

 

 

    

 

 

    

 

 

 

Quarter Ended September 30, 2011 Compared to the Quarter Ended September 30, 2010: The acquisition-related costs recorded in the three months ended September 30, 2011 include $2.1 million of transaction and integration costs related to acquisitions completed during the third quarter of 2011. There were no acquisition-related costs recorded in the three months ended September 30, 2010.

Nine Months Ended September 30, 2011 Compared to the Nine Months Ended September 30, 2010: The acquisition-related costs recorded in the first nine months of 2011 include $3.5 million of transaction and integration costs related to acquisitions completed during the third quarter of 2011. The acquisition-related costs recorded in the first nine months of 2010 include changes in the fair value of the acquisition-related contingent consideration. The final liability for contingent consideration relating to the Mazu acquisition, which was determined pursuant to the achievement of certain bookings targets through March 31, 2010, was paid during the third quarter of 2010. During the nine months ended September 30, 2010, we recognized $2.7 million of acquisition-related costs due to the change in fair value of acquisition-related contingent consideration to be distributed directly to the Mazu shareholders.

Other Income (Expense), Net

Other income (expense), net consists primarily of interest income on our cash and investments, interest expense, and foreign currency exchange gains and losses. Cash has historically been invested in highly liquid investments such as time deposits held at major banks, commercial paper, U.S. government agency discount notes, money market mutual funds and other money market securities with average portfolio maturities at the date of purchase less than one year.

 

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     Three months ended
September 30,
     Nine months ended
September 30,
 

(in thousands)

   2011     2010      2011     2010  

Interest income

   $ 351      $ 371       $ 1,220      $ 853   

Other

     (502     13         (532     (170
  

 

 

   

 

 

    

 

 

   

 

 

 

Total other income (expense), net

   $ (151   $ 384       $ 688      $ 683   
  

 

 

   

 

 

    

 

 

   

 

 

 

Quarter Ended September 30, 2011 Compared to the Quarter Ended September 30, 2010: Other income (expense), net decreased in the three months ended September 30, 2011 compared to the three months ended September 30, 2010 primarily due to increased foreign exchange losses related to the revaluation of the acquisition-related contingent consideration. Weighted average interest rates applicable to our cash and investment balances decreased to 0.3% in the three months ended September 30, 2011 compared to 0.4% in the three months ended September 30, 2010.

Nine Months Ended September 30, 2011 Compared to the Nine Months Ended September 30, 2010: Other income (expense), net, was flat in the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010. Weighted average interest rates applicable to our cash and investment balances remained at 0.3% in the nine months ended September 30, 2011 and 2010. Other expense primarily represents foreign exchange losses on foreign currency denominated liabilities.

Provision for Income Taxes

The provision for income taxes for the three months ended September 30, 2011 and 2010 was $6.0 million and $9.0 million, respectively. Our income tax provision consists of federal, foreign, and state income taxes. Our effective tax rate was 23.8% and 39.2% for the three months ended September 30, 2011 and 2010, respectively, and 35.8% and 40.7% for the nine months ended September 30, 2011 and 2010, respectively.

Our effective tax rate differs from the federal statutory rate due to state taxes and significant permanent differences. Significant permanent differences arise primarily from taxes in foreign jurisdictions with a tax rate different than the U.S. federal statutory rate, stock-based compensation expense, R&D credits, certain acquisition related items, the amortization of deferred tax charges related to our intercompany sale of intellectual property rights, and the benefits from a change in tax status of our United Kingdom (UK) subsidiaries.

During the quarter ended September 30, 2011, our UK subsidiaries made an election to change their tax status to an entity that is disregarded for federal and state income tax purposes. As a result of the change in tax status, we recorded a deferred tax benefit of $3.6 million to record certain deferred tax assets resulting from the change.

We recorded a deferred charge during the nine months ended September 30, 2011 related to the deferral of income tax expense on intercompany profits that resulted from the sale of our intellectual property rights outside of North and South America to our Singapore subsidiary. The deferred charge is included in the Prepaid expenses and other current assets and the Other assets lines of the condensed consolidated balance sheets in the amounts of $5.6 million and $18.2 million, respectively. The deferred charge will be amortized as a component of income tax expense over the five year economic life of the intellectual property.

Our effective tax rate for the three months ended September 30, 2011 is lower when compared to the same period in the prior year primarily due to the income tax benefits recorded in the current year that result from a change in tax status of our UK subsidiaries for federal and state income tax purposes.

Our effective tax rate in 2011 and in future periods may fluctuate on a quarterly basis. The effective tax rate could be affected by the geographic distribution of our worldwide earnings or losses, our stock-based compensation expense, changes in the valuation of our deferred tax assets, changes in actual results versus our estimates, or changes in tax laws, regulations, accounting principles, or interpretations thereof. Additionally, in the future our effective rate will likely decrease as a result of our entering into an intercompany research and development program with our Singapore subsidiary and a tax holiday in Singapore.

We record a valuation allowance to reduce our deferred tax assets to the amount we believe is more likely than not to be realized. In assessing the need for a valuation allowance, we have considered our historical levels of income and expectations of future taxable income. In determining future taxable income, we make assumptions to forecast federal, state and international operating income, the reversal of temporary differences, and the implementation of any feasible and prudent tax planning strategies. The assumptions require significant judgment regarding the forecasts of taxable income, and are consistent with our forecasts used to manage our business.

We occasionally record valuation allowances for deferred tax assets established in purchase accounting. In the future, we may conclude that it is more likely than not that the deferred tax assets will be realized based on expectations of taxable income and other

 

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factors. This would result in a reduction of the valuation allowance and a decrease to income tax expense for the period such determination is made.

In the year ended December 31, 2010, management concluded that a valuation allowance was needed on our California income tax credit carryforwards. Due to a change in our forecasted income allocated to California for tax years after 2010, it is more likely than not that the California income tax credit carryforwards will not be utilized in the foreseeable future. Accordingly, we have established a 100% valuation allowance against the California tax credit carryforwards.

During the nine months ended September 30, 2011, we increased our liability for unrecognized income tax benefits by $10.5 million to $17.4 million for tax positions related to the current year. The unrecognized tax benefits that, if recognized, would impact the effective tax rate were $16.0 million as of September 30, 2011.

We are subject to potential income tax audits on open tax years by any taxing jurisdiction in which we operate. The taxing authorities of the most significant jurisdictions are the United States Internal Revenue Service, California Franchise Tax Board and HM Revenue and Customs in the UK and the Inland Revenue Authority of Singapore. We do not anticipate any material adjustments to our tax provisions relating to previously filed tax returns. The statute of limitations for federal, state, UK and Singapore tax purposes are generally three, four, one and four year(s) respectively; however, we continue to carryover tax attributes prior to these periods for federal and state purposes, which would still be open for examination by the respective tax authorities. Accordingly, years 2004 through 2010 are open to tax examinations for federal and state purposes.

Liquidity and Capital Resources

 

(in thousands)

   As of
September 30,
2011
    As of
December 31,
2010
 

Working capital

   $ 376,660      $ 374,898   

Cash and cash equivalents

   $ 153,856      $ 165,726   

Short and long-term investments

   $ 405,404      $ 335,414   
     Nine months ended  
     September 30,  

(in thousands)

   2011     2010  

Cash provided by operating activities

   $ 147,287      $ 113,265   

Cash used in investing activities

   $ (205,833   $ (89,703

Cash provided by financing activities

   $ 46,373      $ 37,895   

Cash and Cash Equivalents

Cash and cash equivalents consist of money market mutual funds, government-sponsored enterprise obligations, treasury bills, commercial paper and other money market securities with remaining maturities at date of purchase of 90 days or less.

Short and long-term investments consist of government-sponsored enterprise obligations, treasury bills and corporate bonds and notes. The fair value of investments is determined as the exit price in the principal market in which we would transact. The fair value of our investments has not materially fluctuated from historical cost. The accumulated unrealized losses, net of tax, on investments recognized in accumulated other comprehensive income (loss) in our stockholders’ equity as of September 30, 2011 is $0.1 million. The recent volatility in the credit markets has increased the risk of material fluctuations in the fair value of investments.

Cash and cash equivalents, short-term investments and long-term investments increased by $58.1 million in the nine months ended September 30, 2011 to $559.3 million.

Pursuant to certain lease agreements and as security for our merchant services agreement with our financial institution, we are required to maintain cash reserves, classified as restricted cash. Long-term restricted cash totaled $2.6 million at September 30, 2011 and December 31, 2010. Long-term restricted cash is included in Other assets in the condensed consolidated balance sheets and consists primarily of funds held as collateral for letters of credit for the security deposit on the leases of our corporate headquarters and is restricted until the end of the lease terms on July 31, 2014.

Since the fourth quarter of 2004, we have expanded our operations internationally. Our sales contracts are principally denominated in U.S. dollars and therefore changes in foreign exchange rates have not materially affected our cash flows from operations. As we fund our international operations, our cash and cash equivalents are affected by changes in exchange rates. To date, the foreign currency effect on our cash and cash equivalents has not been material.

 

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Cash Flows from Operating Activities

Our largest source of operating cash flows is cash collections from our customers. Our primary uses of cash from operating activities are for personnel related expenditures, product costs, outside services, and rent payments. Our cash flows from operating activities will continue to be affected principally by the extent to which we grow our revenue and spend on hiring personnel in order to grow our business. The timing of hiring sales personnel in particular affects cash flows as there is a lag between the hiring of sales personnel and the generation of revenue and related cash flows from their sales efforts.

Cash provided by operating activities was $147.3 million in the nine months ended September 30, 2011 an increase of $34.0 million compared to $113.3 million in the nine months ended September 30, 2010. The increase in cash flow from operating activities was primarily due to an increase in cash flow of $23.6 million from operations after adjusting for non-cash items, primarily related to an increase in cash used for excess tax benefits from employee stock plans, and a $10.4 million increase from the change in operating assets and liabilities, primarily increases in income taxes payable and deferred revenues offset by trade receivables and other assets.

Cash Flows used in Investing Activities

Cash flows used in investing activities primarily relate to acquisitions, purchases of investments, net of sales and maturities and capital expenditures.

Cash used in investing activities increased by $116.1 million to $205.8 million in the nine months ended September 30, 2011 compared to $89.7 million in the nine months ended September 30, 2010. The increase in cash used in investing activities is primarily due to payments for acquisitions totaling $120.2 million.

Cash provided by Financing Activities

Cash provided by financing activities in the nine months ended September 30, 2011 totaled $46.4 million and consisted of proceeds from the issuance of common stock of $42.0 million and excess tax benefit from employee stock plans of $34.5 million offset by cash used to net share settle equity awards of $10.1 million and cash used to repurchase shares of $20.0 million.

We believe that our net proceeds from operations, together with our cash balance at September 30, 2011, will be sufficient to fund our projected operating requirements for at least the next 12 months. Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities, the timing and extent of expansion into new territories, the timing of introductions of new products and enhancements to existing products, and the continuing market acceptance of our products. In the future, we may enter into other arrangements for potential investments in, or acquisitions of, complementary businesses, services or technologies, which could require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all.

Contractual Obligations

The following is a summary of our contractual obligations as of September 30, 2011:

 

     Total      Remaining
three
months of
2011
     2012      2013      2014      2015      Thereafter  
     (in thousands)  

Contractual Obligations

                    

Operating leases

   $ 60,552       $ 2,403       $ 9,964       $ 10,454       $ 9,299       $ 5,686       $ 22,746   

Purchase obligations (1)

   $ 10,415         10,406         9         —           —           —           —     

Acquisition-related contingent consideration

   $ 15,215         —           15,215         —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual obligations

   $ 86,182       $ 12,809       $ 25,188       $ 10,454       $ 9,299       $ 5,686       $ 22,746   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Represents amounts associated with agreements that are enforceable, legally binding and specify terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of payment. Obligations under contracts that we can cancel without a significant penalty are not included in the table above.

Off-Balance Sheet Arrangements

At September 30, 2011 and December 31, 2010, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes, nor did we have any undisclosed material transactions or commitments involving related persons or entities.

 

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Other

At September 30, 2011 and December 31, 2010, we did not have commercial commitments under lines of credit, standby repurchase obligations or other such debt arrangements.

Recent Accounting Pronouncements

See Note 1 of “Notes to Condensed Consolidated Financial Statements” for recent accounting pronouncements that could have an effect on us.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Foreign Currency Risk

Our sales contracts are principally denominated in U.S. dollars and therefore our revenue and receivables are not subject to significant foreign currency risk. We do incur certain operating expenses in currencies other than the U.S. dollar and therefore are subject to volatility in cash flows due to fluctuations in foreign currency exchange rates, particularly changes in the British pound, Euro, Australian dollar and Singapore dollar. To date, we have not entered into any hedging contracts because exchange rate fluctuations have had minimal impact on our operating results and cash flows. In addition, sales would be negatively affected if we chose to more heavily discount our product price in foreign markets to maintain competitive pricing.

Pursuant to the acquisition of Zeus, we recorded a U.S. dollar-denominated liability of $13.5 million for the acquisition-related contingent consideration on our UK subsidiary. This liability is subject to fluctuations in foreign currency exchange rates, which could have a negative impact on our statement of operations.

Interest Rate Sensitivity

We had unrestricted cash and cash equivalents, and investments totaling $559.3 million and $501.1 million at September 30, 2011 and December 31, 2010, respectively. Cash and cash equivalents of $153.9 million and $165.7 million at September 30, 2011 and December 31, 2010, respectively, are held for working capital purposes and include highly liquid investments with a maturity of ninety days or less at the time of purchase. Cash equivalents consist primarily of money market mutual funds, government-sponsored enterprise obligations, treasury bills, and other money market securities. Investments of $405.4 million and $335.4 million at September 30, 2011 and December 31, 2010, respectively, consist of government-sponsored enterprise obligations, treasury bills, FDIC-backed certificates of deposit and corporate bonds and notes.

We do not enter into investments for trading or speculative purposes. Due to the high investment quality and relative short duration of these investments, we do not believe that we have any material exposure to changes in the fair market value as a result of changes in interest rates. The volatility in the credit markets in early 2009 caused a macro shift in investments into highly liquid short-term investments such as U.S. Treasury bills. This caused a significant decline in short-term interest rates, which reduced investment income. Further declines in interest rates may reduce future investment income. In addition, the volatility in the credit markets increases the risk of write-downs of investments to fair market value.

 

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We evaluated the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of September 30, 2011, the end of the period covered by this quarterly report on Form 10-Q. This controls evaluation was done under the supervision and with the participation of our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO).

Disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934, such as this quarterly report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed such that information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

Based upon the controls evaluation, our CEO and CFO have concluded that as of September 30, 2011, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission and to ensure that material information relating to us and our consolidated subsidiaries is made known to management, including the CEO and CFO.

 

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Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the second quarter of 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act). Internal control over financial reporting means a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Inherent Limitations of Internal Controls

Our management, including our CEO and CFO, does not expect that our disclosure controls and procedures or our internal controls over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

On June 1, 2011, we served Silver Peak Systems, Inc. with a lawsuit, filed in the United States District Court for the District of Delaware, alleging infringement of certain patents. The lawsuit seeks unspecified damages and injunctive relief. On July 22, 2011, Silver Peak Systems denied the allegations and requested declaratory judgments of invalidity and non-infringement.

On August 17, 2011, Silver Peak Systems amended its counterclaims against us, alleging infringement by Riverbed of certain patents. The lawsuit seeks unspecified damages and injunctive relief. On September 20, 2011, we denied Silver Peak Systems’ allegations and requested declaratory judgments of invalidity and non-infringement.

At this time we are unable to estimate any range of reasonably possible loss relating to these actions. Discovery is ongoing, and trial is currently scheduled to begin on July 29, 2013. We believe that we have meritorious defenses to the counterclaims against us and we intend to vigorously contest these counterclaims.

From time to time, we are subject to various legal proceedings, claims and litigation arising in the ordinary course of business. We do not believe we are party to any currently pending legal proceedings the outcome of which would have a material adverse effect on our financial position, results of operations or cash flows.

There can be no assurance that existing or future legal proceedings arising in the ordinary course of business or otherwise will not have a material adverse effect on our financial position, results of operations or cash flows.

 

Item 1A. Risk Factors

Set forth below and elsewhere in this Quarterly Report on Form 10-Q, and in other documents we file with the SEC, are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Quarterly Report on Form 10-Q and in our other public statements. Because of the following factors, as well as other variables affecting our operating results, past financial performance should not be considered as a reliable indicator of future performance and investors should not use historical trends to anticipate results or trends in future periods.

Risks Related to Our Business and Industry

Our operating results may fluctuate significantly, which makes our future results difficult to predict and could cause our operating results to fall below expectations or our guidance.

Our quarterly and annual operating results have varied significantly in the past and could vary significantly in the future, which makes it difficult for us to predict our future operating results. Our operating results may fluctuate due to a variety of factors, many of

 

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which are outside of our control, including the changing and volatile U.S., European and global economic environment, and any of which may cause our stock price to fluctuate. As a result, comparing our operating results on a period-to-period basis may not be meaningful. You should not rely on our past results as an indication of our future performance. In addition, revenues in any quarter are largely dependent on customer contracts entered into during that quarter. Moreover, a significant portion of our quarterly sales typically occurs during the last month of the quarter, and sometimes within the last few weeks or days of the quarter. As a result, our quarterly operating results are difficult to predict even in the near term and a delay in an anticipated sale past the end of a particular quarter may negatively impact our results of operations for that quarter, or in some cases, that year. A delay in the recognition of revenue, even from just one account, may have a significant negative impact on our results of operations for a given period. If our revenue or operating results fall below the expectations of investors or securities analysts or below any guidance we may provide to the market, as has occurred recently and at other times in the past, the price of our common stock could decline substantially. Such a stock price decline could occur, and has occurred in the past, even when we have met our publicly stated revenue and/or earnings guidance.

In addition to other risks listed in this “Risk Factors” section, factors that may affect our operating results include, but are not limited to:

 

   

fluctuations in demand, including due to seasonality, for our products and services. For example, many companies in our industry experience adverse seasonal fluctuations in customer spending patterns, particularly in the first and third quarters; we have experienced these seasonal fluctuations in the past and expect that this trend will continue in the future;

 

   

fluctuations in sales cycles and prices for our products and services;

 

   

reductions in customers’ budgets for information technology purchases and delays in their purchasing cycles;

 

   

general economic or political conditions in our domestic and international markets, in particular the recent deficit spending and government debt issues surrounding the U.S. and Eurozone economies;

 

   

limited visibility into customer spending plans;

 

   

changing market conditions, including current and potential customer consolidation;

 

   

customer or partner concentration. For example, one value-added distributor represented more than 10% of our revenue for the three and nine months ended September 30, 2011;

 

   

variation in sales channels, product costs or mix of products sold;

 

   

the timing of recognizing revenue in any given quarter as a result of revenue recognition accounting rules, including the extent to which sales transactions in a given period are unrecognizable until a future period or, conversely, the satisfaction of revenue recognition rules in a given period resulting in the recognition of revenue from transactions initiated in prior periods;

 

   

the sale of our products in the timeframes we anticipate, including the number and size of orders, and the product mix within any such orders, in each quarter;

 

   

our ability to develop, introduce and ship in a timely manner new products and product enhancements that meet customer requirements;

 

   

the timing and execution of product transitions or new product introductions, including any related or resulting inventory costs;

 

   

customer acceptance of new product introductions. For example, we recently introduced solutions for the public cloud, including a cloud-intelligent WAN optimization solution and a cloud storage accelerator targeting back-up and select archive workloads. These new products may not achieve any significant degree of market acceptance or be accepted into our sales channel by our channel partners. Furthermore, many of our target customers have not purchased products similar to these and might not have a specific budget for the purchase of these products;

 

   

our ability to successfully integrate any businesses that we acquire, especially where those acquisitions result in our entering new markets. For example, in July 2011 we acquired Zeus Technology Ltd., a company that delivers high-performance software-based load balancing and traffic management solutions for virtual and cloud environments, and Aptimize Ltd., a web content optimization company;

 

   

unpredictability in the development of core, new or adjacent markets, including the public cloud computing market and including any markets that we enter as a result of acquisitions;

 

   

the timing of product releases or upgrades by us or by our competitors;

 

   

any significant changes in the competitive dynamics of our markets, including new entrants or substantial discounting of products;

 

   

our ability to control costs, including our operating expenses and the costs of the components we purchase;

 

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any component shortages or price fluctuations in our supply chain. For example, the recent flooding in Thailand may affect the availability of disk drive components that we use in our products;

 

   

our ability to establish and maintain successful relationships with channel partners, and the effectiveness of any changes we make to our distribution model;

 

   

any decision to increase or decrease operating expenses in response to changes in the marketplace or perceived marketplace opportunities;

 

   

our ability to derive benefits from our investments in sales, marketing, engineering or other activities;

 

   

our ability to successfully work with partners on combined solutions. For example, where our product features the Riverbed Services Platform (RSP), we are required to work closely with our partners in product validation, marketing, selling and support;

 

   

volatility in our stock price, which may lead to higher stock compensation expenses;

 

   

unpredictable fluctuations in our effective tax rate due to disqualifying dispositions of stock from the employee stock purchase plan and stock options, changes in the valuation of our deferred tax assets or liabilities, changes in actual results versus our estimates, or changes in tax laws, regulations, accounting principles, or interpretations thereof; and

 

   

the effects of natural disasters, including any effects on our supply chain or on the willingness of our customers or prospective customers to make capital commitments.

Adverse economic conditions make it difficult to predict revenues for a particular period and may lead to reduced information technology spending, which would harm our business and operating results. In addition, turmoil in credit markets during economic downturns increases our exposure to our customers’ and partners’ credit risk, which could result in reduced revenue or increased write-offs of accounts receivable.

Our business depends on the overall demand for information technology, and in particular for WAN optimization, and on the economic health and general willingness of our current and prospective customers, both enterprises and government organizations, to make capital commitments. These government organizations include non-U.S. as well as U.S. federal, state and local organizations. In some quarters, sales to government organizations have represented, and may in the future represent, a significant portion of overall sales. If the conditions in the U.S. and global economic environment, including the economies of any international markets that we serve, remain uncertain or continue to be volatile, or if they deteriorate further, our business, operating results, and financial condition would likely be materially adversely affected. For example, U.S. government deficit spending and debt levels, as well as actions taken by the U.S. Congress relating to these matters, could negatively impact the U.S. and global economies and adversely affect our financial results. In addition, our financial results could be negatively impacted by the continuing uncertainty surrounding, or any deterioration relating to, the debt levels or growth prospects for Eurozone economies. Economic weakness, customer financial difficulties and constrained spending on IT initiatives have resulted, and may in the future result, in challenging and delayed sales cycles and could negatively impact our ability to forecast future periods. In addition, the markets we serve are emerging and the purchase of our products involves material changes to established purchasing patterns and policies. The purchase of our products is often discretionary and may involve a significant commitment of capital and other resources. In addition, our operating expenses are largely based on anticipated revenue trends and a high percentage of our expenses are, and will continue to be, fixed in the short-term. Uncertainty about future economic conditions makes it difficult to forecast operating results and to make decisions about future investments. Weak or volatile economic conditions would likely harm our business and operating results in a number of ways, including information technology spending reductions among customers and prospects, longer sales cycles, lower prices for our products and services and reduced unit sales. A reduction in information technology spending could occur or persist even if economic conditions improve. In addition, any increase in worldwide commodity prices may result in higher component prices and increased shipping costs, both of which may negatively impact our financial results.

Many of our customers and channel partners use third parties to finance their purchases of our products. Any freeze, or reduced liquidity, in the credit markets may result in customers or channel partners either delaying or entirely foregoing planned purchases of our products if they are unable to obtain the required financing. This would result in reduced revenues, and our business, operating results and financial condition would be harmed. In addition, these customers’ and partners’ ability to pay for products already purchased may be adversely affected by any credit market turmoil or an associated downturn in their own business, which in turn could harm our business, operating results and financial condition.

We face intense competition that could reduce our revenue and adversely affect our financial results.

The market for our products is highly competitive and we expect competition to intensify in the future. Other companies may introduce new products in the same markets we serve or intend to enter.

This competition could result, and has resulted in the past, in increased pricing pressure, reduced profit margins, increased sales and marketing expenses and failure to increase, or the loss of, market share, any of which would likely seriously harm our business, operating results and financial condition.

 

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Competitive products may in the future have better performance, more and/or better features, lower prices and broader acceptance than our products. Many of our current or potential competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical, sales, marketing and other resources than we do. Potential customers may prefer to purchase from their existing suppliers rather than a new supplier regardless of product performance or features. Currently, in the WAN Optimization market we face competition from a number of established companies, including Cisco Systems, Blue Coat Systems, Citrix Systems, Juniper Networks and F5 Networks. We also face competition from a large number of smaller private companies and new market entrants. In the Network Performance Management market, our Cascade product line primarily competes with Netscout, Computer Associates (NetQos) and OpNet. As a result of our July 2011 acquisitions of Zeus and Aptimize, we face additional competition from F5 Networks and Citrix Systems.

We expect increased competition from our current competitors as well as other established and emerging companies if our market continues to develop and expand. For example, third parties currently selling our products could market products and services that compete with our products and services. In addition, some of our competitors have made acquisitions or entered into partnerships or other strategic relationships with one another to offer a more comprehensive solution than they individually had offered. We expect this trend to continue as companies attempt to strengthen or maintain their market positions in an evolving industry and as companies enter into partnerships or are acquired. Many of the companies driving this consolidation trend have significantly greater financial, technical and other resources than we do and are better positioned to acquire and offer complementary products and technologies. The companies resulting from these possible consolidations may create more compelling product offerings and be able to offer greater pricing flexibility, making it more difficult for us to compete effectively, including on the basis of price, sales and marketing programs, technology or product functionality. Continued industry consolidation may adversely impact customers’ perceptions of the viability of smaller and even medium-sized technology companies and consequently customers’ willingness to purchase from such companies. These pressures could materially adversely affect our business, operating results and financial condition.

We also face competitive pressures from other sources. For example, Microsoft has improved, and has announced its intention to further improve, the performance of its software for remote office users. Our products are designed to improve the performance of many applications, including applications that are based on Microsoft protocols. Accordingly, improvements to Microsoft application protocols may reduce the need for our products, adversely affecting our business, operating results and financial condition. Improvement in other application protocols or in the Transmission Control Protocol (TCP), the underlying transport protocol for most WAN traffic, could have a similar effect. In addition, we market our products, in significant part, on the anticipated cost savings to be realized by organizations if they are able to avoid the purchase of costly IT infrastructure at remote sites by purchasing our products. To the extent other companies are able to reduce the costs associated with purchasing and maintaining servers, storage or applications to be operated at remote sites, our business, operating results and financial condition could be adversely affected.

We rely heavily on channel partners to sell our products. Disruptions to, or our failure to effectively implement, develop and manage, our distribution channels and the processes and procedures that support them could harm our business.

Our future success is highly dependent upon establishing and maintaining successful relationships with a variety of channel partners, including value-added resellers, value-added distributors, service providers, and systems integrators. A substantial majority of our revenue is derived from indirect channel sales and we expect indirect channel sales to continue to account for a substantial majority of our total revenue. We employ a two-tier distribution strategy as part of a larger effort to scale our reach and better serve the needs of our channel. Our revenue depends in large part on the effective performance of these channel partners, and changes to our distribution model, the loss of a channel partner or the reduction in sales to our channel partners could materially reduce our revenues and gross margins. By relying on indirect channels, we may have little or no contact with the ultimate users of our products, thereby making it more difficult for us to establish brand awareness, ensure proper delivery and installation of our products, service ongoing customer requirements and respond to evolving customer needs. In addition, we recognize a large portion of our revenue based on a sell-through model using information regarding the end user customers that is provided by our channel partners. If those channel partners provide us with inaccurate or untimely information, the amount or timing of our revenues could be adversely impacted. For example, we have encountered delays with certain partners where internal processing issues have prevented that partner from providing a purchase order to us in a timely manner.

Recruiting and retaining qualified channel partners and training them in our technology and product offerings requires significant time and resources. In order to develop and expand our distribution channel, we must continue to scale and improve our processes and procedures that support our distribution channel, including investment in systems and training, and those processes and procedures may become increasingly complex and difficult to manage. We have no minimum purchase commitments with any of our value-added resellers or other indirect distributors, and our contracts with these channel partners do not prohibit them from offering products or services that compete with ours. Our competitors may be effective in providing incentives to existing and potential channel partners to favor their products, to choose not to partner with us, or to prevent or reduce sales of our products. Our channel partners may choose not to offer our products exclusively or at all. If we fail to maintain successful relationships with our channel partners, fail to develop new relationships with channel partners in new markets or expand the number of channel partners in existing markets, fail to manage, train or motivate existing channel partners effectively or if these channel partners are not successful in their sales efforts, sales of our products would decrease and our business, operating results and financial condition would be materially adversely affected.

 

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We are susceptible to shortages or price fluctuations in our supply chain. Any shortages or price fluctuations in components used in our products could delay shipment of our products or increase our costs and harm our operating results.

Our use of Riverbed-designed content in our hardware platforms has increased our susceptibility to scarcity or delivery delays for custom components within our systems. Shortages in components that we use in our products have occurred recently and may occur in the future and our suppliers’ ability to predict the availability of such components may be limited. For example, the recent flooding in Thailand may affect the availability of disk drive components. Some components that we use are available only from limited sources of supply. In addition, the lead times associated with certain components are lengthy and preclude rapid changes in quantity requirements and delivery schedules. The unavailability of any component that is necessary to the proper functioning of our appliances would prevent us from shipping products. Any inability to timely ship our products would delay sales and adversely impact our revenue, business, operating results and financial condition.

Any growth in our business or the economy is likely to create greater pressures on us and our suppliers to project overall component demand accurately and to establish optimal component inventory levels. In addition, increased demand by third parties for the components we use in our products may lead to decreased availability and higher prices for those components. We carry limited inventory of our product components, and we rely on suppliers to deliver components in a timely manner based on forecasts we provide. We rely on both purchase orders and long-term contracts with our suppliers, but we may not be able to secure sufficient components at reasonable prices or of acceptable quality, which would seriously impact our ability to deliver products to our customers and, as a result, adversely impact our revenue.

We expect our gross margins to vary over time and our recent level of product gross margin may not be sustainable. In addition, our product gross margins may be adversely affected by our introductions of new products.

Our product gross margins vary from quarter to quarter and the recent level of gross margins may not be sustainable and may be adversely affected in the future by numerous factors, including but not limited to product or sales channel mix shifts, increased price competition, increases in material or labor costs, excess product component or obsolescence charges from our contract manufacturers, write-downs for obsolete or excess inventory, increased costs due to changes in component pricing or charges incurred due to

component holding periods if our forecasts do not accurately anticipate product demand, warranty-related issues, product discounting, freight charges, or our introduction of new products or new product platforms or entry into new markets with different pricing and cost structures.

Any introduction of, and transition to, a new product line requires us to forecast customer demand for both legacy and new product lines for a period of time, and to maintain adequate inventory levels to support the sales forecasts for both product lines. If new product line sales, or product line sales in general, exceed our sales forecast, we could possibly experience stock shortages, which would negatively affect our revenues. If legacy product line sales, or product line sales in general, fall short of our sales forecast, we could have excess inventory, as has occurred in prior quarters. Any inventory charges would negatively impact our product gross margins.

Our sales cycles can be long and unpredictable, and our sales efforts require considerable time and expense. As a result, our revenue is difficult to predict and may vary substantially from quarter to quarter.

The timing of our revenue is difficult to predict. Our sales efforts involve educating our customers about the use and benefit of our products, including their technical capabilities and potential cost savings to an organization. Customers typically undertake a significant evaluation process that has in the past resulted in a lengthy sales cycle, in some cases over twelve months. Also, as our channel model distribution strategy evolves, utilizing value-added resellers, value-added distributors, systems integrators and service providers, the level of variability in the length of sales cycle across transactions may increase and make it more difficult to predict the timing of many of our sales transactions. We spend substantial time and money in our sales efforts without any assurance that these endeavors will produce any sales. Even after making the decision to purchase, customers may deploy our products slowly and deliberately. In addition, product purchases are frequently and increasingly subject to budget constraints, multiple approvals, and unplanned administrative, processing and other delays. Customers may also defer purchases as a result of anticipated or announced releases of new products or enhancements by our competitors or by us. Product purchases may be, and in the recent past have been, delayed by the volatile U.S. and global economic environment, which introduced additional risk into our ability to accurately forecast sales in a particular quarter. If sales expected from a specific customer for a particular quarter are not realized in that quarter or at all, revenue will be harmed and we may miss our stated guidance for that period.


Acquisitions could disrupt our business and cause dilution to our stockholders.

        In February 2009, we acquired Mazu Networks, Inc. In October 2010 and November 2010, we acquired CACE Technologies, Inc. and Global Protocols LLC, respectively. In July 2011, we acquired Zeus Technology Ltd. and Aptimize Ltd. In the future we may acquire other businesses, products or technologies. Our ability as an organization to integrate acquisitions is unproven. Any acquisitions that we complete may not ultimately strengthen our competitive position or achieve our goals, or the acquisition may be viewed negatively by customers, financial markets or investors. In addition, we may encounter difficulties in integrating personnel, operations, technologies or products from the acquired businesses and in retaining and motivating key personnel from these businesses. We may also encounter difficulties in maintaining uniform standards, controls, procedures and policies across locations, or in managing geographically or culturally diverse locations. We may experience significant problems or liabilities associated with acquired or integrated product quality or technology. Acquisitions may disrupt our ongoing operations, divert management from day-to-day responsibilities and increase our expenses. Acquisitions may reduce our cash available for operations and other uses and could result in an increase in amortization expense related to identifiable assets acquired, potentially dilutive issuances of equity securities or the incurrence of debt.

We rely on third parties to perform shipping and other logistics functions on our behalf. A failure or disruption at a logistics partner would harm our business.

Currently, we use third-party logistics partners to perform storage, packaging, shipment and handling for us. Although the logistics services required by us may be readily available from a number of providers, it is time-consuming and costly to qualify and implement these relationships. If one or more of our logistics partners suffers an interruption in its business, or experiences delays, disruptions or quality control problems in its operations, or we choose to change or add additional logistics partners, our ability to ship products to our customers would be delayed and our business, operating results and financial condition would be adversely affected.

 

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If we fail to accurately predict our manufacturing requirements, we could incur additional costs or experience manufacturing delays, which would harm our business. We are dependent on contract manufacturers, and changes to those relationships, expected or unexpected, may result in delays or disruptions that could harm our business.

We depend on independent contract manufacturers to manufacture and assemble our products. We rely on purchase orders or long-term contracts with our contract manufacturers. Some of our contract manufacturers are not obligated to supply products to us for any specific period, in any specific quantity or at any specific price. Our orders may represent a relatively small percentage of the overall orders received by our contract manufacturers from their customers. As a result, fulfilling our orders may not be considered a priority by one or more of our contract manufacturers in the event the contract manufacturer is constrained in its ability to fulfill all of its customer obligations in a timely manner. We provide demand forecasts and purchase orders to our contract manufacturers. To the extent that any such demand forecast or purchase order is binding, if we overestimate our requirements, the contract manufacturers may assess charges or we may have liabilities for excess inventory, each of which could negatively affect our gross margins. Conversely, because lead times for required materials and components vary significantly and depend on factors such as the specific supplier, contract terms and the demand for each component at a given time, if we underestimate our requirements, the contract manufacturers may have inadequate materials and components required to produce our products, which could interrupt manufacturing of our products and result in delays in shipments and deferral or loss of revenue.

Although the contract manufacturing services required to manufacture and assemble our products may be readily available from a number of established manufacturers, it is time-consuming and costly to qualify and implement contract manufacturer relationships.

Therefore, if one or more of our contract manufacturers suffers an interruption in its business, or experiences delays, disruptions or quality control problems in its manufacturing operations, or we choose to change or add additional contract manufacturers, our ability to ship products to our customers would be delayed and our business, operating results and financial condition would be adversely affected. In addition, a portion of our manufacturing is performed overseas and is therefore subject to risks associated with doing business in other countries.

We are dependent on various information technology systems, and failures of or interruptions to those systems could harm our business.

Many of our business processes depend upon our information technology systems (“IT”), the systems and processes of third parties, and on interfaces with the systems of third parties. For example, our order entry system provides information to the systems of our contract manufacturers, which enables them to build and ship our products. If those systems fail or are interrupted, or if our ability to connect to or interact with one or more networks is interrupted, our processes may function at a diminished level or not at all. This would harm our ability to ship products, and our financial results would likely be harmed.

In addition, reconfiguring our IT systems or other business processes in response to changing business needs may be time-consuming and costly. To the extent this impacted our ability to react timely to specific market or business opportunities, our financial results would likely be harmed.

 

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If we are unable to protect our intellectual property rights, our competitive position could be harmed or we could be required to incur significant expenses to enforce our rights.

We depend on our ability to protect our proprietary technology. We rely on trade secret, patent, copyright and trademark laws and confidentiality agreements with employees and third parties, all of which offer only limited protection. Despite our efforts, the steps we have taken to protect our proprietary rights may not be adequate to preclude misappropriation of our proprietary information or infringement of our intellectual property rights, and our ability to police such misappropriation or infringement is uncertain, particularly in countries outside of the U.S. Further, with respect to patent rights, we do not know whether any of our pending patent applications will result in the issuance of patents or whether the examination process will require us to narrow our claims, and even if patents are issued, they may be contested, circumvented or invalidated over the course of our business. The invalidation of any of our key patents could benefit our competitors by allowing them to more easily design products similar to ours. Moreover, the rights granted under any issued patents may not provide us with proprietary protection or competitive advantages, and competitors may in any event be able to develop similar or superior technologies to our own now or in the future. Protecting against the unauthorized use of our products, trademarks and other proprietary rights is expensive, difficult and, in some cases, impossible. Litigation has been necessary in the past and may be necessary in the future to enforce or defend our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. For example, in the third quarter of 2008 we settled a patent infringement lawsuit with Quantum Corporation where both we and Quantum asserted that the other party infringed a patent or patents. In addition, we are currently engaged in patent infringement litigation against Silver Peak Systems, in which both we and Silver Peak Systems assert patent infringement by the other party. Intellectual property litigation has resulted, and may in the future result, in substantial costs and diversion of management resources, and may in the future harm our business, operating results and financial condition. Furthermore, many of our current and potential competitors have the ability to dedicate substantially greater resources to enforce their intellectual property rights than we do. Accordingly, despite our efforts, we may not be able to prevent third parties from infringing upon or misappropriating our intellectual property.

Claims by others that we infringe their proprietary technology could harm our business.

Our industry is, and any industry or market that we may enter in the future may be, characterized by the existence of a large number of patents and frequent claims and related litigation regarding patent and other intellectual property rights. In the ordinary course of our business, we are involved in disputes and licensing discussions with others regarding their claimed proprietary rights and we cannot assure you that we will always successfully defend ourselves against such claims. Third parties have claimed and may in the future claim that our products or technology infringe their proprietary rights. For example, in the third quarter of 2008 we settled a patent infringement lawsuit with Quantum Corporation. In addition, in the third quarter of 2011 Silver Peak Systems alleged that we infringed certain of its patents. We expect that infringement claims may increase as the number of products and competitors in any of our markets increases and overlaps occur. In addition, as we have gained greater visibility and market exposure as a public company, we face a higher risk of being the subject of intellectual property infringement claims. Any claim of infringement by a third party, even those without merit, could cause us to incur substantial legal costs defending against the claim, and could distract our management from our business. Furthermore, we could be subject to a judgment or voluntarily enter into a settlement, either of which could require us to pay substantial damages. A judgment or settlement could also include an injunction or other court order that could prevent us from offering our products. In addition, we might elect or be required to seek a license for the use of third-party intellectual property, which may not be available on commercially reasonable terms or at all, or if available, the payments under such license may harm our operating results and financial condition. Alternatively, we may be required to develop non-infringing technology, which could require significant effort and expense and may ultimately not be successful. Any of these events could seriously harm our business, operating results and financial condition. Third parties may also assert infringement claims against our customers and channel partners. Any of these claims would require us to initiate or defend potentially protracted and costly litigation on their behalf, regardless of the merits of these claims, because we generally indemnify our customers and channel partners from claims of infringement of proprietary rights of third parties. If any of these claims succeed, or if we voluntarily enter into a settlement, we may be forced to pay damages on behalf of our customers or channel partners, which could have a material adverse effect on our business, operating results and financial condition.

Our international sales and operations subject us to additional risks that may harm our operating results.

In the third quarter of 2011, we derived approximately 44% of our revenue from customers outside the U.S. We have personnel in numerous countries worldwide. We expect to continue to add personnel in additional countries. Our international sales and operations makes us subject to various U.S. and international laws and regulations, including those relating to antitrust, data protection, and business dealings with both commercial and governmental officials and organizations. Our international sales and operations subject us to a variety of additional risks, including:

 

   

the difficulty and cost of managing and staffing international offices and the increased travel, infrastructure, legal and other compliance costs associated with multiple international locations;

 

   

difficulties in enforcing contracts and collecting accounts receivable, and longer payment cycles, especially in emerging markets;

 

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tariffs and trade barriers and other regulatory or contractual limitations on our ability to sell or develop our products in certain foreign markets;

 

   

the effects of any political instability on the general willingness of our current and prospective customers to make capital commitments;

 

   

unfavorable changes in tax treaties or laws;

 

   

increased exposure to foreign currency exchange rate risk; and

 

   

reduced protection for intellectual property rights in some countries.

As we continue to expand our business globally, our success will depend, in large part, on our ability to anticipate and effectively manage these and other risks associated with our international sales and operations. Our failure to manage any of these risks successfully, or to comply with these laws and regulations, could harm our operations, reduce our sales and harm our business, operating results and financial condition.

Some of our business partners also have international operations and are subject to the risks described above. Even if we are able to successfully manage the risks of international operations, our business may be adversely affected if our business partners are not able to successfully manage these risks.

Foreign currencies periodically experience rapid fluctuations in value against the U.S. dollar. Any foreign currency devaluation against the U.S. dollar increases the real cost of our products to our customers and partners in foreign markets where we sell in U.S. dollars, which has resulted in the past and may result in the future in delayed or cancelled purchases of our products and, as a result, lower revenues. In addition, this increase in cost increases the risk to us that we will be unable to collect amounts owed to us by such customers or partners, which in turn would impact our revenues and could materially adversely impact our business and financial results. Any devaluation may also lead us to more aggressively discount our prices in foreign markets in order to maintain competitive pricing, which would negatively impact our revenues and gross margins. Conversely, a weakened U.S. dollar could increase the cost of local operating expenses and procurement of raw materials to the extent we purchase components in foreign currencies.

International customers may also require that we localize our products. The product development costs for localizing the user interface of our products, both graphical and textual, could be a material expense to us if the software requires extensive modifications. To date, such changes have not been extensive, and the costs have not been material.

We are investing in engineering, sales, marketing, services and infrastructure, and these investments may achieve delayed or lower than expected benefits, which could harm our operating results.

We intend to continue to add personnel and other resources to our engineering, sales, marketing, services and infrastructure functions as we focus on developing new technologies, growing our market segment, capitalizing on existing or new market opportunities, increasing our market share, and enabling our business operations to meet anticipated demand. We are likely to recognize the costs associated with these investments earlier than some of the anticipated benefits, and the return on these investments may be lower, or may develop more slowly, than we expect. If we do not achieve the benefits anticipated from these investments, or if the achievement of these benefits is delayed, our operating results may be adversely affected.

If we lose key personnel or are unable to attract and retain personnel on a cost-effective basis, our business would be harmed.

Our success is substantially dependent upon the performance of our senior management and key technical and sales personnel. For example, we believe that our sales execution in the EMEA region in the second quarter of 2011 was negatively impacted by the absence of a dedicated senior sales executive for the region. Our management and employees can terminate their employment at any time, and the loss of the services of one or more of our executive officers or other key employees could harm our business. Our success also is substantially dependent upon our ability to attract additional personnel for all areas of our organization, particularly in our sales, research and development and customer service departments. Competition for qualified personnel is intense, and we may not be successful in attracting and retaining such personnel on a timely basis, on competitive terms, or at all. Additionally, fluctuations or a sustained decrease in the price of our stock could affect our ability to attract and retain key personnel. When our stock price declines, our equity incentive awards may lose retention value, which may negatively affect our ability to attract and retain such key personnel. If we are unable to attract and retain the necessary technical, sales and other personnel on a cost-effective basis, our business, operating results and financial condition would be adversely affected.

We may not generate positive returns on our research and development investments.

Developing our products is expensive, and the investment in product development may involve a long payback cycle or may not generate additional revenue at all. In the third quarter of 2011, our research and development expenses were $31.0 million, or approximately 16% of our total revenue. Our future plans include significant investments in research and development and related product opportunities. We believe that we must continue to dedicate a significant amount of resources to our research and development efforts to maintain our competitive position. These investments may take several years to generate positive returns, if ever.

 

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Our ability to sell our products is highly dependent on the quality of our support and services offerings, and our failure to offer high quality support and services would harm our operating results and reputation.

Once our products are deployed within our customers’ networks, our customers depend on our support organization to resolve any issues relating to our products. A high level of support is critical for the successful marketing and sale of our products. If we or our channel partners do not effectively assist our customers in deploying our products, succeed in helping our customers quickly resolve post-deployment issues, and provide effective ongoing support, it would adversely affect our ability to sell our products to existing customers and would harm our reputation with potential customers. In addition, as we expand our operations internationally, our support organization will face additional challenges, including those associated with delivering support, training and documentation in languages other than English. Any failure to maintain high quality support and services would harm our operating results and reputation.

If we fail to manage future growth effectively, our business would be harmed.

We have expanded our operations significantly since inception and anticipate that further significant expansion will be required. This future growth, if it occurs, will place significant demands on our management, infrastructure and other resources. To manage any future growth, we will need to hire, integrate and retain highly skilled and motivated employees. We will also need to continue to improve our financial and management controls, reporting systems and procedures. We have an enterprise resource planning software system that supports our finance, sales and inventory management processes. If we were to encounter delays or difficulties as a result of this system, including loss of data and decreases in productivity, our ability to properly run our business could be adversely impacted. If we do not effectively manage our growth, our business would be harmed.

If we do not successfully anticipate market needs and develop products and product enhancements that meet those needs, or if those products do not gain market acceptance, our business and operating results will be harmed.

We may not be able to anticipate future market needs or be able to develop new products or product enhancements to meet such needs, either on a timely basis or at all. For example, our failure to address additional application-specific protocols, particularly if our competitors are able to provide such functionality, could harm our business. In addition, our inability to diversify beyond our current product offerings could adversely affect our business. Any new products or product enhancements that we introduce, including by way of acquisitions, may not achieve any significant degree of market acceptance or be accepted into our sales channel by our channel partners, which would adversely affect our business and operating results. In addition, the introduction of new products or product enhancements may shorten the life cycle of our existing products, or replace sales of some of our current products, thereby offsetting the benefit of even a successful product introduction, or may cause customers to defer purchasing our existing products in anticipation of the new or enhanced products, any of which could adversely affect our business and operating results.

Organizations are increasingly concerned with the security of their data, and to the extent they elect to encrypt data being transmitted from the point of the end user in a format that we’re not able to decrypt, rather than only across the WAN, our products will become less effective.

Our products are designed to remove the redundancy associated with repeated data requests over a WAN, either through a private network or a virtual private network (VPN). The ability of our products to reduce such redundancy depends on our products’ ability to recognize the data being requested. Our products currently detect and decrypt some forms of encrypted data. Since most organizations currently encrypt most of their data transmissions only between sites and not on the LAN, the data is not encrypted when it passes through our products. For those organizations that elect to encrypt their data transmissions from the end-user to the server in a format that we are not able to decrypt, our products will offer limited performance improvement unless we are successful in incorporating additional functionality into our products that address those encrypted transmissions. Our failure to provide such additional functionality could limit the growth of our business and harm our operating results.

If our products do not interoperate with our customers’ infrastructure, installations could be delayed or cancelled, which would harm our business.

Our products must interoperate with our customers’ existing infrastructure, which often have different specifications, utilize multiple protocol standards, deploy products from multiple vendors, and contain multiple generations of products that have been added over time. If we find errors in the existing software or defects in the hardware used in our customers’ infrastructure or problematic network configurations or settings, as we have in the past, we may have to modify our software or hardware so that our products will interoperate with our customers’ infrastructure. In such cases, and others, our products may be unable to provide significant performance improvements for applications deployed in our customers’ infrastructure. These issues could cause longer installation times for our products and could cause order cancellations, either of which would adversely affect our business, operating results and financial condition. In addition, government and other customers may require our products to comply with certain security or other certifications and standards. If our products are late in achieving or fail to achieve compliance with these certifications and standards, or our competitors achieve compliance with these certifications and standards, we may be disqualified from selling our products to such customers, or at a competitive disadvantage, which would harm our business, operating results and financial condition.

 

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If functionality similar to that offered by our products is incorporated into existing network infrastructure products, organizations may decide against adding our products to their network, which would harm our business.

Other providers of network infrastructure products, including our partners, are offering or announcing functionality aimed at addressing the problems addressed by our products. For example, Cisco Systems incorporates WAN optimization functionality into certain of its router blades. The inclusion of, or the announcement of intent to include, functionality perceived to be similar to that offered by our products in products that are already generally accepted as necessary components of network architecture or in products that are sold by more established vendors may have an adverse effect on our ability to market and sell our products. Furthermore, even if the functionality offered by other network infrastructure providers is more limited than our products, a significant number of customers may elect to accept such limited functionality in lieu of adding appliances from an additional vendor. Many organizations have invested substantial personnel and financial resources to design and operate their networks and have established deep relationships with other providers of network infrastructure products, which may make them reluctant to add new components to their networks, particularly from new vendors. In addition, an organization’s existing vendors or new vendors with a broad product offering may be able to offer concessions that we are not able to match because we currently offer a focused line of products and have fewer resources than many of our competitors. If organizations are reluctant to add network infrastructure products from new vendors or otherwise decide to work with their existing vendors, our business, operating results and financial condition will be adversely affected.

Our products are highly technical and may contain undetected software or hardware errors. These errors, and any related claims against our products, could cause harm to our reputation and our business.

Our products, including software product upgrades and releases, are highly technical and complex and, when deployed, are critical to the operation of many networks. Our products have contained and may contain undetected errors, defects or security vulnerabilities. In particular, new products and product platforms may be subject to increased risk of hardware issues. Some errors in our products may be discovered only after a product has been installed and used by customers. Some of these errors may be attributable to third-party technologies incorporated into our products, which makes us dependent upon the cooperation and expertise of such third parties for the diagnosis and correction of such errors. The diagnosis and correction of third-party technology errors is particularly difficult where our product features the Riverbed Services Platform (RSP), because it is not always immediately clear whether a particular error is attributable to a technology incorporated into our product or to the third-party RSP software deployed on our product. In addition, our RSP solutions, because they involve a third-party, are more complex, and the solutions may lead to new technical errors that may prove difficult to diagnose and support. Any delay or mistake in the initial diagnosis of an error will result in a delay in the formulation of an effective action plan to correct such error. Any errors, defects or security vulnerabilities discovered in our products after commercial release could result in loss of revenue or delay in revenue recognition, loss of customers and increased service and warranty cost, any of which could harm our reputation, business, operating results and financial condition. Any such errors, defects or security vulnerabilities could also adversely affect the market’s perception of our products and business. In addition, we could face claims for product liability, tort or breach of warranty, including claims relating to changes to our products made by our channel partners. Our contracts with customers contain provisions relating to warranty disclaimers and liability limitations, which may not be upheld. Defending a lawsuit, regardless of its merit, is costly and may divert management’s attention and harm the market’s perception of us and our products. In addition, if our business liability insurance coverage proves inadequate or future coverage is unavailable on acceptable terms or at all, our business, operating results and financial condition could be adversely impacted.

Our use of open source and third-party software could impose limitations on our ability to commercialize our products.

We incorporate open source software into our products. Although we monitor our use of open source closely, the terms of many open source licenses have not been interpreted by U.S. courts, and there is a risk that such licenses could be construed in a manner that could impose unanticipated conditions or restrictions on our ability to commercialize our products. We could also be subject to similar conditions or restrictions should there be any changes in the licensing terms of the open source software incorporated into our products. In either event, we could be required to seek licenses from third parties in order to continue offering our products, to re-engineer our products or to discontinue the sale of our products in the event re-engineering cannot be accomplished on a timely or successful basis, any of which could adversely affect our business, operating results and financial condition.

We also incorporate certain third-party technologies, including software programs, into our products and may need to utilize additional third-party technologies in the future. However, licenses to relevant third-party technology may not continue to be available to us on commercially reasonable terms, or at all. Therefore, we could face delays in product releases until equivalent technology can be identified, licensed or developed, and integrated into our current products. These delays, if they occur, could materially adversely affect our business, operating results and financial condition. We currently use third-party software programs in our appliance and software products, some of which are currently available from only one vendor. Any disruption in our access to these or other software programs or third-party technologies could result in significant delays in our product releases and could require substantial effort to locate or develop a replacement program. If we decide in the future to incorporate into our products any other software program licensed from a third party, and the use of such software program is necessary for the proper operation of our appliances, then our loss of any such license would similarly adversely affect our ability to release our products in a timely fashion.

 

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We are subject to various regulations that could subject us to liability or impair our ability to sell our products.

Our products are subject to a variety of government regulations, including export controls, import controls, environmental laws and required certifications. For example, our products are subject to export controls of the U.S. and other countries and may be exported outside the U.S. and other countries only with the required level of export license or through an export license exception, because we incorporate encryption technology into our products. In addition, various countries regulate the import of certain encryption technology and have enacted laws that could limit our ability to distribute our products or could limit our customers’ ability to implement our products in those countries. Changes in our products or changes in regulations may increase the cost of building and selling our products, create delays in the introduction of our products in international markets, prevent our customers with international operations from deploying our products throughout their global systems or, in some cases, prevent the export or import of our products to certain countries altogether. Any change in regulations, shift in approach to the enforcement or scope of existing regulations, or change in the countries, persons or technologies targeted by such regulations, could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential customers with international operations. We must comply with various and increasing environmental regulations, both domestic and international, regarding the manufacturing and disposal of our products. For example, we must comply with Waste Electrical and Electronic Equipment Directive laws, which are being adopted by certain European Economic Area countries on a country-by-country basis. Failure to comply with these and similar laws on a timely basis, or at all, could have a material adverse effect on our business, operating results and financial condition. This would also be true if we fail to comply, either on a timely basis or at all, with any U.S. environmental laws regarding the manufacturing or disposal of our products. Any decreased use of our products or limitation on our ability to export or sell our products would harm our business, operating results and financial condition.

We compete in rapidly evolving markets and have a limited operating history, which makes it difficult to predict our future operating results.

We were incorporated in May 2002 and shipped our first Steelhead appliance in May 2004. We have a limited operating history and offer a focused line of products in an industry characterized by rapid technological change. It is very difficult to forecast our future operating results. You should consider and evaluate our prospects in light of the risks and uncertainty frequently encountered by companies in rapidly evolving markets characterized by rapid technological change, changing customer needs, increasing competition, evolving industry standards and frequent introductions of new products and services. As we encounter rapidly changing customer requirements and increasing competitive pressures, we likely will be required to reposition our product and service offerings and introduce new products and services. We may not be successful in doing so in a timely and appropriately responsive manner, or at all. Furthermore, many of our target customers have not purchased products similar to ours and might not have a specific budget for the purchase of our products and services. All of these factors make it difficult to predict our future operating results.

We incur significant costs as a result of operating as a public company, and our management devotes substantial time to new compliance initiatives.

We incur significant legal, accounting and other expenses as a public company, including costs resulting from regulations regarding corporate governance practices and costs relating to compliance with Section 404 of the Sarbanes-Oxley Act. For example, the listing requirements of the Nasdaq Stock Market’s Global Select Market require that we satisfy certain corporate governance requirements relating to independent directors, audit committees, distribution of annual and interim reports, stockholder meetings, stockholder approvals, solicitation of proxies, conflicts of interest, stockholder voting rights and codes of conduct. In addition, the recently passed Dodd-Frank Wall Street Reform and Consumer Protection Act contains various provisions applicable to the corporate governance functions of public companies. Our management and other personnel devote a substantial amount of time to these compliance initiatives. Moreover, these rules and regulations have increased our legal and financial compliance costs and will make some activities more time-consuming and costly. For example, these rules and regulations could make it more difficult for us to attract and retain qualified persons to serve on our Board of Directors, our board committees or as executive officers.

While we believe that we currently have adequate internal controls over financial reporting, we are exposed to risks from legislation requiring companies to evaluate those internal controls.

The Sarbanes-Oxley Act requires that we test our internal controls over financial reporting and disclosure controls and procedures. In particular, for the year ended December 31, 2010, we performed system and process evaluation and testing of our internal controls over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Our compliance with Section 404 requires that we incur substantial expense and expend significant management time on compliance-related issues. Moreover, if we are not able to comply with the requirements of Section 404 in the future, or if we or our independent registered public accounting firm identify deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses, the market price of our stock may decline and we could be subject to sanctions or investigations by the Nasdaq Stock Market’s Global Select Market, the SEC or other regulatory authorities, which would require significant additional financial and management resources.

 

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Changes in financial accounting standards may cause adverse unexpected revenue fluctuations and affect our reported results of operations.

A change in accounting policies can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective. New pronouncements and varying interpretations of existing pronouncements have occurred with frequency and may occur in the future. Changes to existing rules, or changes to the interpretations of existing rules, could lead to changes in our accounting practices, and such changes could adversely affect our reported financial results or the way we conduct our business.

We are required to expense equity compensation given to our employees, which has reduced our reported earnings, will harm our operating results in future periods and may reduce our stock price and our ability to effectively utilize equity compensation to attract and retain employees.

We historically have used stock options, restricted stock units (RSU), and an employee stock purchase plan as significant components of our employee compensation program in order to align employees’ interests with the interests of our stockholders, encourage employee retention, and provide competitive compensation packages. The compensation charges that we are required to record related to these equity awards have reduced, and will continue to reduce, our reported earnings, will harm our operating results in future periods, and may require us to reduce the availability and amount of equity incentives provided to employees, which could make it more difficult for us to attract, retain and motivate key personnel. Moreover, if securities analysts, institutional investors and other investors adopt financial models that include stock option expense in their primary analysis of our financial results, our stock price could decline as a result of reliance on these models with higher expense calculations.

We may have exposure to greater than anticipated tax liabilities.

Our provision for income taxes is subject to volatility and could be adversely affected by nondeductible stock-based compensation, changes in the research and development tax credit laws, earnings being lower than anticipated in jurisdictions where we have lower statutory rates and being higher than anticipated in jurisdictions where we have higher statutory rates, transfer pricing adjustments, not meeting the terms and conditions of tax holidays or incentives, changes in the valuation of our deferred tax assets and liabilities, changes in actual results versus our estimates, or changes in tax laws, regulations, accounting principles or interpretations thereof. In addition, like other companies, we may be subject to examination of our income tax returns by the U.S. Internal Revenue Service and other tax authorities. While we regularly assess the likelihood of adverse outcomes from such examinations and the adequacy of our provision for income taxes, there can be no assurance that such provision is sufficient and that a determination by a tax authority will not have an adverse effect on our results of operations.

If we fail to successfully manage our exposure to the volatility and economic uncertainty in the global financial marketplace, our operating results could be adversely impacted.

We are exposed to financial risk associated with the global financial markets, including volatility in interest rates and uncertainty in the credit markets. Our exposure to market rate risk for changes in interest rates relates primarily to our investment portfolio. The primary objective of our investment activities is to preserve principal, maintain adequate liquidity and portfolio diversification while at the same time maximizing yields without significantly increasing risk. However, the valuation of our investment portfolio is subject to uncertainties that are difficult to predict. Factors that may impact its valuation include changes to credit ratings of the securities that we hold, interest rate changes, the ongoing strength and quality, and recent instability, of the global credit market, and liquidity. If the carrying value of our investments exceeds the fair value, and the decline in fair value is deemed to be other-than-temporary, we will be required to write down the value of our investments. Additionally, instability and uncertainty in the financial markets, as has been recently experienced, could result in the incurrence of significant realized or impairment losses associated with certain of our investments, which would reduce our net income.

If we need additional capital in the future, it may not be available to us on favorable terms, or at all.

We have historically relied on outside financing and cash flow from operations to fund our operations, capital expenditures and expansion. We may require additional capital from equity or debt financing in the future to fund our operations or respond to competitive pressures or strategic opportunities. We may not be able to secure timely additional financing on favorable terms, or at all. The terms of any additional financing may place limits on our financial and operating flexibility. If we raise additional funds through further issuances of equity, convertible debt securities or other securities convertible into equity, our existing stockholders could suffer significant dilution in their percentage ownership of our company, and any new securities we issue could have rights, preferences and privileges senior to those of holders of our common stock. If we are unable to obtain adequate financing or financing on terms satisfactory to us, if and when we require it, our ability to grow or support our business and to respond to business challenges could be significantly limited.

 

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Our business is subject to the risks of earthquakes, fire, floods, pandemics and other natural catastrophic events, and to interruption by manmade problems such as computer viruses, break-ins or terrorism.

Our main operations, including our primary data center, are located in the San Francisco Bay Area, a region known for seismic activity. A significant natural disaster, such as an earthquake, fire or a flood, could disrupt our operations and therefore harm our business, operating results and financial condition. A natural disaster could also impact our ability to manufacture and deliver our products to customers, or provide support to our customers, any of which would harm our business, operating results and financial condition. In addition, our servers are vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems, which could result in the theft of intellectual property, customer information or other sensitive data. Any of these incidents could result in both legal and reputational costs. Natural disasters, acts of unrest or terrorism or war could also cause disruptions in our or our customers’ business, our domestic and international markets, or the economy as a whole. To the extent that such disruptions result in delays or cancellations of customer orders or the deployment of our products, our business, operating results and financial condition would be adversely affected.

Risks Related to Ownership of Our Common Stock

The trading price of our common stock has been volatile and is likely to be volatile in the future.

The trading prices of the securities of technology companies, including our own, have been highly volatile. Further, our common stock has a limited trading history. Since our initial public offering in September 2006 through September 30, 2011, our stock price, after adjusting for our 2:1 stock split in the form of a stock dividend effected in November 2010, has fluctuated from a low of $3.55 to a high of $44.70. The market price of our common stock has at times reflected a higher multiple of expected future earnings than many other companies. As a result, even small changes in investor expectations regarding our future growth and earnings, whether as a result of actual or rumored financial or operating results, changes in the mix of products and services sold, acquisitions, industry changes, or other factors, could result in, and have recently resulted in, significant fluctuations in the market price of our common stock.

Factors that could affect the trading price of our common stock include, but are not limited to:

 

   

variations in our operating results;

 

   

announcements of technological innovations, new services or service enhancements, strategic alliances or significant agreements by us or by our competitors;

 

   

the gain or loss of significant customers;

 

   

recruitment or departure of key personnel;

 

   

providing estimates of our future operating results, or changes of these estimates, either by us or by any securities analysts who follow our common stock, or changes in recommendations by any securities analysts who follow our common stock;

 

   

significant sales or purchases, or announcement of significant sales or purchases, of our common stock by us or our stockholders, including our directors and executive officers;

 

   

announcements by or about us regarding events or news adverse to our business;

 

   

market conditions in our industry, the industries of our customers and the economy as a whole;

 

   

adoption or modification of regulations, policies, procedures or programs applicable to our business;

 

   

an announced acquisition of or by a competitor; and

 

   

an announced acquisition of or by us.

If the market for technology stocks or the stock market in general experiences loss of investor confidence, the trading price of our common stock could decline for reasons unrelated to our business, operating results or financial condition. The trading price of our common stock might also decline in reaction to announcements by, or events that affect, other companies in our industry, or the trading price might decline in reaction to events that affect the stock market generally even if these announcements or events do not directly affect us. Each of these factors, among others, could cause our stock price to decline. Some companies that have had volatile market prices for their securities have had securities class actions filed against them. If such a suit were filed against us, regardless of its merits or outcome, it could result in substantial costs and divert management’s attention and resources.

 

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If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.

The trading market for our common stock will continue to depend in part on the research and reports that securities or industry analysts publish about us or our business. If we do not continue to maintain adequate research coverage or if one or more of the analysts who covers us downgrades our stock or publishes inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts ceases coverage of our company or fails to publish reports on us regularly, demand for our stock could decrease, which could cause our stock price and trading volume to decline.

Anti-takeover provisions in our charter documents and Delaware law could discourage, delay or prevent a change in control of our company and may affect the trading price of our common stock.

We are a Delaware corporation and the anti-takeover provisions of the Delaware General Corporation Law may discourage, delay or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder, even if a change in control would be beneficial to our existing stockholders. In addition, our restated certificate of incorporation and amended and restated bylaws contain provisions that may discourage, delay or prevent a change in our management or control over us that stockholders may consider favorable.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The following table summarizes the stock repurchase activity for the three months ended September 30, 2011 and the approximate dollar value of shares that may yet be purchased pursuant to our stock repurchase program:

 

Period

   Total Number
of Shares
Purchased (1)
     Average
Price Paid
per Share
     Total Number of
Shares
Purchased as
Part of Publicly
Announced
Program
     Maximum
Approximate Dollar
Value of Shares that
May Yet Be
Purchased Under
the Program (2)
 

July 1, 2011 – July 31, 2011

     —         $ —           —         $ —     

August 1, 2011 – August 31, 2011

     406,545         22.16         406,545         140,990,000   

September 1, 2011 – September 30, 2011

     467,776         23.53         467,776         129,983,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     874,321       $ 22.89         874,321       $ 129,983,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) On August 19, 2011, our Board of Directors authorized a Share Repurchase Program, which authorizes us to repurchase up to $150.0 million of our outstanding common stock. The Share Repurchase Program will expire in August 2013.
(2) During the third quarter of 2011, we repurchased 874,321 shares of common stock under this Program for an aggregate purchase price of approximately $20.0 million, or a weighted average of $22.89 per share. These shares were purchased in open market transactions. The timing and amounts of these purchases were based on market conditions and other factors including price, regulatory requirements and capital availability. The share repurchases were financed by available cash balances and cash from operations.

 

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Item 6. Exhibits

 

Exhibit No.

  

Description

    2.1    Share Purchase Agreement dated as of July 19, 2011, among Riverbed Technology, Inc. (as guarantor), Riverbed Technology Limited, a wholly-owned subsidiary of Riverbed Technology, Inc., the holders of securities of Zeus Technology Limited, and an agent for such holders. (3)
    3.1    Restated Certificate of Incorporation. (1)
    3.2    Amended and Restated Bylaws. (2)
    4.1    Form of Common Stock Certificate. (1)
  31.1    Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.2    Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32.1*    Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS*    XBRL Instance Document
101.SCH*    XBRL Taxonomy Extension Schema Document
101.CAL*    XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*    XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*    XBRL Taxonomy Extension Label Linkbase Document
101.PRE*    XBRL Taxonomy Extension Presentation Linkbase Document

 

(1) Incorporated by reference to Registrant’s Registration Statement on Form S-1 (No. 333-133437) filed with the SEC on April 20, 2006, as amended.
(2) Incorporated by reference to Registrant’s Current Report on Form 8-K (No. 001-33023) filed with the SEC on February 22, 2011.
(3) Incorporated by reference to Registrant’s Current Report on Form 8-K (No. 001-33023) filed with the SEC on July 25, 2011.
* Furnished and not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Riverbed Technology, Inc. under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date of this Quarterly Report on Form 10-Q, irrespective of any general incorporation language contained in such filing.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Dated: October 28, 2011

 

RIVERBED TECHNOLOGY, INC.

By:

  /s/ Jerry M. Kennelly
 

 

  Jerry M. Kennelly
  President and Chief Executive Officer

Dated: October 28, 2011

 

RIVERBED TECHNOLOGY, INC.

By:

  /s/ Randy S. Gottfried
 

 

  Randy S. Gottfried
  Chief Financial Officer

 

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EXHIBIT INDEX

 

Exhibit No.

  

Description

    2.1    Share Purchase Agreement dated as of July 19, 2011, among Riverbed Technology, Inc. (as guarantor), Riverbed Technology Limited, a wholly-owned subsidiary of Riverbed Technology, Inc., the holders of securities of Zeus Technology Limited, and an agent for such holders. (3)
    3.1    Restated Certificate of Incorporation. (1)
    3.2    Amended and Restated Bylaws. (2)
    4.1    Form of Common Stock Certificate. (1)
  31.1    Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.2    Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32.1*    Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS*    XBRL Instance Document
101.SCH*    XBRL Taxonomy Extension Schema Document
101.CAL*    XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*    XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*    XBRL Taxonomy Extension Label Linkbase Document
101.PRE*    XBRL Taxonomy Extension Presentation Linkbase Document

 

(1) Incorporated by reference to Registrant’s Registration Statement on Form S-1 (No. 333-133437) filed with the SEC on April 20, 2006, as amended.
(2) Incorporated by reference to Registrant’s Current Report on Form 8-K (No. 001-33023) filed with the SEC on February 22, 2011.
(3) Incorporated by reference to Registrant’s Current Report on Form 8-K (No. 001-33023) filed with the SEC on July 25, 2011.
* Furnished and not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Riverbed Technology, Inc. under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date of this Quarterly Report on Form 10-Q, irrespective of any general incorporation language contained in such filing.

 

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