Q1 2013 Earnings Call Transcript
Transcript Call Date 04/29/2013

Operator: Good afternoon. My name is Ginger and I will be your conference operator today. At this time, I would like to welcome everyone to the Riverbed First Quarter 2013 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you.

Ms. Renee Lyall, Director of Investor Relations, you may begin your conference.

Renee Lyall - IR: Thank you, Ginger. Welcome to our conference call for the first quarter of 2013. The speakers today are Jerry Kennelly, President and CEO; Ernie Maddock, Chief Financial Officer; and Eric Wolford, President of the Products Group.

Jerry will provide an overview of the business for the quarter and then Eric will talk about our markets and the opportunity as we look ahead. Ernie will review our first quarter results in greater detail and then Jerry will finish with our second quarter guidance and closing remarks.

A press release detailing our first quarter results was distributed today at approximately 1.05 pm Pacific Time over Business Wire. The press release is also available on our website at riverbed.com. This conference call is being webcast live at riverbed.com/investors and will be archived on our website for the next 12 months on the quarterly earnings and events pages.

Our discussion today will include forward-looking statements, including statements regarding our products, product roadmaps and technologies, our markets performance, revenue growth, operating synergies, strategies, repayment of outstanding debt and our financial outlook.

Forward-looking statements are only predictions and involve risks and uncertainties that may cause our actual results to differ materially from those expressed or implied by these statements. Factors that may affect our results are summarized in our quarterly release and described in detail in our SEC filings. Forward-looking statements are made as of today's date only and Riverbed disclaims any obligation to update any forward-looking statements.

Unless otherwise stated, financial information discussed on today's conference call is presented on a non-GAAP basis. Non-GAAP items are described and reconciled to GAAP results in today's press release and in a supplemental reconciliation available on the Investor Relations' portion of our website. Any future products, features or related specifications that may be referenced during today's call are for informational purposes only and are not commitments to deliver any technology or enhancements. Riverbed reserves the right to modify or cancel future product plans at any time.

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

Jerry M. Kennelly - Chairman and CEO: Thank you, Renee, and good afternoon to everyone. Before we begin, I want to welcome Ernie Maddock to the Riverbed team as our new CFO. Today is actually his first full day at the Company and he is hitting the ground running. Ernie joins Riverbed at an important time in our evolution as a company. We had a run rate to achieve more than $1 billion in revenue this year. Our transition to be a multiproduct company and even a more strategic partner to our customers is well underway. Ernie's years of experience will be of tremendous benefit to us as we move forward.

For the call today, Ernie will review Q1 financials, but as it's his first day, I will give the guidance myself this one time only. This is also a good opportunity to recognize two additions to our Board of Directors; Kim Stevenson, the CIO of Intel, and Satya Nadella, the President of Microsoft Servers and Business. I'm also pleased to congratulate David Wu who led design and development for Riverbed's most innovative products including Steelhead and Granite and was promotioned to Chief Technology Officer.

Our first quarter revenue was $253 million, growing 38% compared to the first quarter of 2012. OPNET generated $52 million for the quarter, slightly higher than the guidance we provided. Excluding OPNET, revenue grew 10% over the prior year. We experienced year-over-year growth across all of our major product lines, geographies and most verticals.

WAN optimization revenue increased 6% over last year and the market expanding products outside of OPNET and WAN optimization generated more than 40% year-over-year growth. Still, our Q1 results were below our expectations. The government vertical was most notably below our original forecast, with particular weakness due to sequestration.

Generally, the economy is mixed and we're seeing more softness internationally and transactions took longer to close in the first quarter. All that said, we saw several positive trends over the past few months. Sales of our new CX and EX Steelhead platforms continue to grow and now represent almost 80% of WAN optimization sales. We continue to see a large percentage of remote sites choosing the more powerful EX platform, which includes the virtual services, our VFP running the VMware ESX server.

These customers are choosing the EX appliance because they are consolidating more services within the branch and likely centralizing more assets to the data center. Steelhead was designed and built to be an extensible and multifunctioning platform. Granite is a good example of this and it is an ambitious extension to traditional WAN optimization. Customers continue to show overall enthusiasm for the product. We added 29 new Granite customers in the first quarter. If you didn't listen to our live simulcast of the Granite even we hosted two weeks ago in New York, I encourage you listen to the replay available on our IR website. End user customers, our partner EMC and an IDC industry expert discuss in great detail the tremendous benefit of this revolutionary product.

Stingray is also showing good traction and we are seeing customers embrace our more flexible cloud-enabled ADC offering. As an example, a major web retailer made the decision to host their external customer-efficient website in the cloud because of Stingray. In doing so, they were able to replace their current content delivery network with Riverbed because Stingray in combination with their cloud service provider delivered better performance at a much lower cost.

Turning to Riverbed Performance Management or RPM, the integration OPNET is progressing on schedule. Our experience with customers and partners in the first quarter reinforces our decision to move more aggressively into performance management. By combining Cascade and OPNET, we've created a unique solution that provides a holistic view of application performance, including the end-user experience, application transaction, and underlying infrastructure and network performance management.

Our RPM solution allows IT to detect and resolve problems before they impact the users' experience. This combined functionality is uniquely compelling in the market for network management.

We continue to work diligently to combine the two organizations into a single, unified team. We've made significant progress with systems integration, and this month in April, we combined the Cascade and OPNET sales team to create a unified customer-facing organization for RPM. The RPM sales team will work with the core Riverbed sales team to collectively win customer opportunities.

We are seeing positive customer synergies with OPNET, Cascade and Steelhead. We believe this early traction is the sign of bigger deals to come as we continue to educate our partners, expand our cross-training and cross-selling and elevate our sales efforts within the IT organization.

I will go through our second quarter guidance later on the call, but I know there are many questions about the slowing of WAN optimization revenue growth for both Riverbed and the market. The market dynamics have changed since we first invented WAN optimization more than 10 years ago. The market today is almost $1.6 billion in annual sales and Riverbed is half of that market.

In the short-term, we believe factors including slower government business and a generally softer economy are impacting sales. In a better macro environment, we believe our growth will increase. This quarter, (offering) evidence of that as our most mature enterprise market, the United States was the best performing geography. But beyond just the current external macro, we strongly believe that the future can hold good growth for Riverbed.

We will target growth in two fundamental ways; first, by increasing the penetration of Steelhead by building on the extensibility and multi-functionality of the platform as we have already started with Granite. Eric will speak to this in a moment. And second, as a company, we will continue to diversify beyond just WAN optimization. Our success this quarter with (other) revenue totally 32% of the total bodes well for the future.

I will now hand the call over to Eric, who oversees product engineering and marketing to talk more about our product direction and strategy.

Eric Wolford - President, Products Group: Thanks Jerry. As you know, key initiatives in IT are to virtualize, consolidate and secure data in a private, public or more often hybrid cloud environment, and the need to accomplish this without impacting the end-user's ability to access applications and data. Essentially, IT is required to transform application delivery, the data center and the network infrastructure and do it in a way that is invisible to the users.

Ultimately, for users accessing data, it's all about performance and Riverbed allows IT to deliver consistently high performance with our suite of products. RPM is the diagnostic tool that monitors and troubleshoots application performance. The other products in our platform, Steelhead WAN optimization, Granite Storage Delivery and Stingray Application Delivery Control accelerate performance and facilitate consolidation. By focusing on all aspects of performance, Riverbed provides customers one-stop shopping, which is a competitive advantage for us that we are not yet fully realizing.

Looking ahead, we want Riverbed Technology in every data center, every remote site and we have a strategy to help get us there. In its early adoption stage, WAN optimization was often tactically sold to solve acute pain points, including bandwidth limitations and the inefficiencies of application protocols like MAPI and CIFS.

Steelhead is still purchased for these reason today, but for us to increase penetration of our technology, we need to build on the extensibility and multi-functionality of the Steelhead performance platform and we need to sell all of our performance solutions more strategically as critical enablers of the transformation of the data center network infrastructure.

We have already taken steps toward delivering a multifunctioning edge appliance that includes adding Riverbed Performance Management, packet capture and the virtual services platform. These efforts are being well received by the market and will be further extended with the integration of OPNET. Granite is another big step in our strategy to extend the reach of the Riverbed performance platform.

As Jerry said, we're seeing tremendous customer and partner interest in Granite. I think a couple of important statistics that reinforce our strategy are first the 25% of Granite customers are net new to Riverbed; and second, approximately 40% of the Granite installations are to sites where Steelhead had not yet been previously deployed. Before the end of this year, we will add new functionality to the Steelhead to address the increasing demand of direct to net, driven by the prevalence of SaaS adoption. I wanted to give you some sense of the potential and opportunity we have in front of us. With more than 200,000 Steelhead units shipped, we have a strong piece of real estate at remote sites that can be leveraged by our vision for a converged and multifunctioning edge infrastructure. We will talk more about product direction on future calls.

I will now turn the call over to Ernie to discuss our first quarter results.

Ernest E. Maddock - EVP and CFO: Thanks Eric. Before I begin my prepared remarks, I'd like to convey how pleased I am to be joining Riverbed. It's exciting to be joining a dynamic and growing company with an industry-leading team whose products and solutions are so critical to the infrastructure and applications on which governments and enterprises rely.

Now let's go through the financials. As a reminder, our Q1 results include a full quarter of OPNET, and unless stated otherwise, the numbers I'll discuss are non-GAAP. Our first quarter revenue was $253 million, up 38% year-over-year, including OPNET at $52 million. Excluding OPNET, revenue increased 10% year-over-year.

First quarter product revenue was $148 million, or 59% of total sales, representing an increase of 26% over the year ago period. Support and service revenue was $105 million in the first quarter, representing 41% of total sales and growing 58% over the prior year. Of total revenue in the first quarter, WAN optimization represented 68%, Performance Management was 27% and ADC was 5%.

Turning to distribution, 79% of our Q1 revenue came from indirect channels while 21% was sold direct. Two distributors contributed more than 10% to revenue in the quarter with Arrow contributing 15% and Avnet contributing 11%. We had no 10% end user customers in the first quarter. Relative to year-on-year comparatives, we saw growth across all major geographies. The Americas represented 65% of total revenue, EMEA, 23% and APJ, 12%.

Looking at verticals, as Jerry said earlier, the government vertical was weaker than we initially forecast contributing a lesser percentage to total revenue in the year ago period. Financial services, professional services, manufacturing, technology and government, each contributed 10% or more to revenue in the quarter.

Moving on to costs and expenses, product gross margin was 81.6% in Q1; and support and service gross margin was 75% bringing our Q1 total gross margin to 78.8% and total operating expenses were $146 million, both within our targeted range. Operating margin for the quarter was 21% and consistent with guidance and interest expense was $6.3 million in the first quarter. Our tax rate was 17%, somewhat lower than we forecast given the lower revenue, as well as the geographic mix of that revenue.

As we said in our Q4 call, Q1 benefited from the retroactive 2012 R&D tax credit extension and in the second quarter, we will revert to a higher tax rate of between 26% and 27%. Net income was $39 million or $0.23 per diluted share within our guided range. We ended March with 2,614 total employees compared to 2,566 at December 31.

Moving to the balance sheet and cash flow, which are predominantly GAAP, March quarter cash flow from operations was $43 million and free cash flow was $38 million. We ended the March quarter with total assets of $2 billion while cash and investments totaled $503 million.

During the quarter, we repurchased 1.6 million riverbed shares for approximately $25 million. 113 million remains on the buyback. We also voluntarily repaid $50 million of debt and the remaining debt balance is $522 million. Given this balance, our interest expense in the second quarter will be between $5 million and $6 million.

In the first quarter, day sales outstanding were 36 days compared to 43 days in the prior quarter and inventory totaled $27 million as of March 31, compared to $24 million at December 31. Total deferred revenue was $296 million, up 9% sequentially.

I'll now turn the call back over got Jerry to provide our second quarter guidance.

Jerry M. Kennelly - Chairman and CEO: Thank you, Ernie. While we're positive about our overall business opportunity as a leader in application performance, the global spending environment is mixed and we're assuming that sales cycles remain elongated and that federal spending remains somewhat muted for at least for the first half of the year. Given that, we're taking a prudent and cautious approach to our guidance.

As a reminder, our guidance is non-GAAP. Our core Riverbed business excluding OPNET is forecasted to grow 6% to 7% sequentially from $201 million in Q1 to between $213 million and $216 million in Q2. However, OPNET revenue is expected to decline sequentially and contribute between $42 million and $46 million in their seasonally weaker June quarter will also be their sales integration quarter where for the first time they move on to our comp plan, their territories and quotas are readjusted, they begin working with our channel, and with the Riverbed sales and marketing team. We believe seasonality, integration, and federal spending weakness will have a temporary impact on OPNET sales, but we expect positive growth in Q3 and Q4 as we progress through the integration.

Combined, our total revenue in the second quarter is expected to be in the range of $255 million to $260 million, and we expect better growth in the second half of the year, particularly if the economy broadly improves.

Gross margins should be about flat. We're forecasting second quarter operating expense to be between $146 million and $148 million. Operating margin is expected be between 21% and 22%. The Q2 tax rate is targeted to be between 26% and 27%. Earnings per share for the second quarter is expected to be $0.21 to $0.22 based on approximately 169 million shares outstanding.

To summarize, we have a path to become a dramatically larger and even more strategic supplier to customers across the globe. With over 23,000 customers already depending on our products, and a growing portfolio of critical technologies, we think we're well-positioned for the future.

Our goal is to focus on what we can control and execute each quarter to continue to move forward.

With that, let me open it up to questions through Ginger, our operator. Ginger?

Transcript Call Date 04/29/2013

Operator: Sanjiv Wadhwani, Stifel Nicolaus.

Sanjiv Wadhwani - Stifel Nicolaus & Company, Inc.: A question either for Ernie or Jerry, I just wanted to clarify that the guidance that was given post Q4 for Q1 was a non-GAAP guidance, which sort of included that deferred revenue adjustment.

Jerry M. Kennelly - Chairman and CEO: That's correct. That was non-GAAP guidance.

Sanjiv Wadhwani - Stifel Nicolaus & Company, Inc.: And then a broader question, Jerry, I know you talked about sort of the slowdown in the WAN optimization market. I'm just trying to get to the bottom of, what do you think is causing that slowdown? Is it some changes that have happened in sort of the way MAPI and CIFS are behaving, or is there some other stuff going on that has led to that slowdown? Any color there would be helpful.

Jerry M. Kennelly - Chairman and CEO: Yeah, I'll say a few words and maybe I'll let Eric say a few words too. I mean, it has slowed down to mid-upper single-digits, that's for sure. The core sale of the product to be bandwidth and MAP optimization; it's still a big good market, but it caps out at penetration rate of the customers; that's in 15% to 20% range and that's why we started this program several years ago to see if we could get even penetration, get up to the 40%, 50% at the big customers and to do that, you have to have a more extended functionality where it's an architectural design to put Steelhead in as many of your branches as possible. And so, Granite is the start of that architectural design, where if you buy into the premise of handling your remote stores that way instead of only putting the Steelhead branches that have a bad WAN link, you'll put it almost at every branch where that's your architectural approach to your storage. And so Eric alluded, there's other things that we're coming that are similar architectural choices about the way you operate at the branch level. That can again extend that penetration above the 20% rate. The core business hasn't gone away. We've gotten bigger, we're at a $1 billion now. We're finishing our 11th year. We started year 12 next month and so you have to – the history of Silicon Valley is that you have to have products coming all the time to expand the markets. We've worked hard at that, number one, and then number two, we're now longer only do optimization, we have these synergistic additional products that are very important and be diversified. But we think we can make the WAN op business strong. We think it has a future, it's not dead. It can offer good growth in the future. So, I actually feel pretty good about our future. We got to get through 2013. Hopefully the second half is better. I think it can be, and these things we have in the works will start panning out. We could just be screaming in 2014.

Operator: Jayson Noland, Robert W. Baird & Co., Inc.

Jayson Noland - Robert W. Baird & Co., Inc.: I wanted to ask about the guidance Jerry, are you assuming any revenue synergy meaning our OPNET people selling Steelhead, Riverbed people selling OPNET and are you applying RPM quota to both sides of the house?

Jerry M. Kennelly - Chairman and CEO: It's a great question. So, we are applying RPM quota, so all of Cascade and OPNET people will have a total quota that includes both Cascade and OPNET, and then the core team will have a quota that includes RPM revenue and they won't care whether it's Cascade or OPNET. They will just get comped in that. So, the comp will extend the (craft), the entire sales force. But again, we did what we said we were going to do, was leave it alone for Q1, let them finish out their fiscal year, finish out their comp plans, drive their pipeline as it was, that worked as we hoped, you are now sort of in the uncertain territory where we have to do these things, we have to put them together. It's the right thing to do. The future of that is quite bright, but it has – it just injects some uncertainty into our second quarter, and that's just the way it is. It's like sometimes you take a half step back, so you can take two steps forward, and that's what happens when you make a big acquisition.

Jayson Noland - Robert W. Baird & Co., Inc.: Are you assuming any revenue synergy for Q2, or is that still more of a calendar '14 thing?

Jerry M. Kennelly - Chairman and CEO: That's more later, I'd say. Q2 will depend on current pipeline.

Operator: Alex Henderson, Needham.

Alex Henderson - Needham: I was wondering if you could talk a little bit about the geographic (split). It's a little hard to look at when you're dealing with the acquisition in there. Can you talk about what the core business did on individual geographies, what the percentages might have looked like if OPNET wasn't in there just so we can have a apples-to-oranges comparisons?

Jerry M. Kennelly - Chairman and CEO: Yeah, so, without OPNET, the Americas were the winner. They did 16% year-on-year growth. EMEA and APJ were both more challenged. EMEA grew 2% year-on-year. It had strength in places but it had pockets of weakness, so it was a mix story with EMEA. APJ was basically up slightly – essentially flat, up slightly year-over-year. And so, APJ, we've been fiddling with, and, in fact, our Head of Worldwide Sales, Dave, is in Singapore this week making the final energies for our – put our new Head of Asia Sales in place probably within the next six weeks at the latest. Our new Head of China started April 17 and so we're kind of reworking the whole APJ, but we're on it right now and hope to have all those personnel transitions done before the end of this quarter.

Alex Henderson - Needham: Can you just give us the enterprise and commercial in the same context; enterprise commercial versus Fed.

Jerry M. Kennelly - Chairman and CEO: Let's see what – so without governments, we don't actually break out Fed separately, but without government, the U.S. enterprise was up 19% year-over-year and so that's one of the things that…

Eric Wolford - President, Products Group: So, Alex, that's non-OPNET, Riverbed core, U.S. enterprise is a real bright spot and was up 19%.

Operator: Jess Lubert, Wells Fargo Securities.

Jess Lubert - Wells Fargo Securities: I wanted to follow-up on the OPNET integration and I was hoping you could discuss to what degree you're seeing sales force distractions that may have impacted the quarter and/or the outlook? And then can you help us understand the ongoing investment requirements needed to get the channel and sales force up to speed on the new products, how that's going so far and if sales ramp-up in the second half of the year, how should we be thinking about leverage?

Jerry M. Kennelly - Chairman and CEO: So OPNET, so we basically left the OPNET sales force alone during the first quarter and the fact they came in over guidance, and they had one of their best quarters ever. So we didn't see that distraction. But we believe there will be some distraction in Q2 and that's part of our guidance because when you change territory, sales manager, partners, quotas, comp plan; it all has to be done and you have to pick a quarter to do it and that's this quarter. But as you go back to the original thesis of why we bought OPNET, we can remember they were heavy in the U.S. and very heavy in government. They were weaker in enterprise, they were weaker in Europe, they were weaker in Asia, and they were weaker in a channel model because they are mostly a direct end user company. So we think our global footprint with our channel partners worldwide, our ability to extend the market in Europe, extend the market in Asia gives them the benefit of a larger sales organization and a bigger brand. It's part of the thesis, and once we get past Q2, and perhaps we will see what happens in Q3. It's a win both in terms of distribution upside and synergy, as well as the product synergy where we are now in the market with the only combined end-to-end network performance management combined with application performance management product. So, we still think the thesis is right. We still think the win is there. I think our ability to take market share in that market will be good. We have to get through the near term integration.

Jess Lubert - Wells Fargo Securities: Then can you just follow-up on the incremental investment needed to make that happen in the second half and how we should be thinking about the investment requirements and how that translates to leverage, as we get into Q3 and Q4?

Jerry M. Kennelly - Chairman and CEO: The expense run rate to make all that happen is already in place, and so it's a reallocation of resources that will not be incremental investment.

Operator: Jason Ader, William Blair.

Jason Ader - William Blair: Jerry, can you just tell us how much of the – you think was the number for government. You said it was slightly below as a percentage. Could you give us maybe a sense of how much of the sequential decline?

Jerry M. Kennelly - Chairman and CEO: I can give you the Riverbed only. The Riverbed was, it was 14% of revenue this quarter. Last year it was 17%. So, that 3% drop basically is 85% of our shortfall this quarter which is interesting and someone understandable given the sequestration. I have gone into April numbers, and $5.5 million of those deals that have been committed and forecast for March had actually come in and booked now which is fantastic. So, it wasn't just smoke up there, and the business was really there and it just got deferred.

Jason Ader - William Blair: Just on that government outlook, how do you expect the year to play out? I mean, it seems like you are being fairly conservative for June, but would you expect September to be lighter than normal seasonally just given the issues going on in the government right now?

Jerry M. Kennelly - Chairman and CEO: It's hard to say that, Jason. We saw some March stuff shift to June. There'll probably be some June stuff that shifts into September. The government is learning as we go along. They will get some sort of budget in place and the agencies will be hell-bent to get it all spent by September 30 particularly in this environment. So, I can tell you better when we get to the end of June, but I think it will get better, is my sense, because that's what we're feeling from both our Fed team and what we're seeing in bookings already in April for that business.

Operator: Amitabh Passi, UBS.

Amitabh Passi - UBS: Jerry, just looking at the data from OPNET over the last four to five years, it seems like this year you're seeing a rather large decline from March to June. I know you attributed it to seasonality, but it seems like it's not really borne out into data the past few years. Wondering if there's anything else going on there that you think might be explaining the March to June quarter decline in OPNET?

Jerry M. Kennelly - Chairman and CEO: Absolutely, that's an excellent question. They always have some dip. This dip is bigger for the – they have the seasonality dip, but in addition, we have the integration which is huge. It's a huge disruption to the business, number one. And number two, it's the federal and spending environment. So those two things together, why we're guiding to a bigger than usual dip for OPNET. Three things; seasonality, federal, and integration risk.

Amitabh Passi - UBS: And then just as a follow-up, how should we think about your priorities for use of cash? Looks like this quarter you paid down debt and bought back stock. Do you think it'll be some balance of both or we prioritize debt pay-down?

Jerry M. Kennelly - Chairman and CEO: You know what, we have a – as a company, we have an extremely strong cash flow or like a cash machine. So we take a look at the cash flow that comes in each quarter. We look at our cash balances and then we look at – if we paid on debt, we benefit future EPS. But at the same time, we also look to see our stock – right now, I think our stock is seriously undervalued and I would guess we would be active first in repurchasing stock, and put debt second this time.

Operator: Rod Hall, JPMorgan.

Rod Hall - JPMorgan: I just had a couple of questions, first of all, I wanted to see if you guys – I don't think I heard the CX, EX percentage out at the branch offices, so I don't know if you guys could give that again, I think you said more than 50% of last time. So if I just missed it, I apologize for that.

Eric Wolford - President, Products Group: Yeah, it's over 80%, Rod.

Rod Hall - JPMorgan: Over 80%, okay, thanks Eric. And then I wanted to ask, I thought this FlyScript's announcement was pretty interesting, and I wanted, Eric, maybe could you talk a little bit about what you guys are doing with developer support? Are you going to – are you guys spending money there, or is it just your ongoing normal developer support process that would support the rollout of that? And if you could give us anymore color on how it's going, that will be interesting as well?

Eric Wolford - President, Products Group: Sure, sure, yeah. FlyScript and Splash; Splash is the community side. FlyScript is kind of the developer interface and tools that they can use to customize their deployments of Riverbed performance platform. So, there's not incremental investments, that's not in our run rate first, Rod, but in terms of us prioritizing where we do spend the money in our run rate, yes, there is incremental inside of the run rate, right, spend on this developer platform. And that's because we have a firm belief in the long run infrastructure that was once rigid will be more and more programmable. So we have honed in on restful APIs across our platform with libraries and toolkits and scripts in a community that we're going to develop and foster. So, this is a very important part of our going forward story.

Rod Hall - JPMorgan: Then Eric, I wanted to follow, you said, you got 200,000 Steelheads deployed in the field, just back to the Granite, what proportion of those are penetrated now with Granite? Can you give us any idea and how many of them do you think actually, could eventually, roll over realistically?

Eric Wolford - President, Products Group: That's a good question. So, from the call, one of the stats we gave was that about 40% of the Granite boxes into remote sites were going into remote sites where there wasn't a Steelhead. Do you follow-me? So, one of the whole goals is to increase our penetration into remote sites and we think thus far through that process we have discovered that Granite is a great way to get Riverbed logoed boxes or technology, can be software as well, into locations where we otherwise weren't, and so we are starting to see that. Obviously the balance of them, the 60% are going into places where people are upgrading their Steelhead, and instead of upgrading Steelheads to just a Steelhead they are upgrading it to a Granite box with a Steelhead inside, if you will, and typically they have to buy a bigger box when they do that because they need more storage in that box. So, they will often size up one or two sizes of boxes because of the additional storage requirements.

Rod Hall - JPMorgan: I was going to say, if you don't like of the 200,000 of the Steelheads that are out there though, do you have any – is there still a lot – I assume there is still a lot of penetration that go far, but are we like…?

Eric Wolford - President, Products Group: Oh, enormous. Enormous, yeah. It's a sliver of that right now; so, yes.

Operator: Alex Kurtz, Sterne Agee.

Alex Kurtz - Sterne Agee: You guys have talked a lot about concerns around sequester impacting the government business. How do you guys differentiate sort of saturation within the government agencies versus the budget issues? I mean, you guys have been shipping into government for many years. I'm sure it's not a new concept of technology to manage the federal agencies. So, is this something about the federal pipeline looking in the back half that leads you to that commentary?

Jerry M. Kennelly - Chairman and CEO: No, I don't think we're anywhere close to saturation point in government. They're huge, they're biggest buyer of technology in every country in the world. There's sequestration in the U.S., there's also austerity in Europe, so both those impacts. But there is plenty of landing spots for our technology, plenty of demand for it, they love it, it has a good ROI for the government agencies. We're landing government deals as we sit here. So, it's just budget and fighting and clarity, and something all the – it's not just Riverbed, every tech vendor is facing this, but there is plenty – there is no saturation involved.

Operator: Mark Sue, RBC Capital Markets.

Mark Sue - RBC Capital Markets: Jerry, just a question on integration. The last time you tried to combine the sales force, I don't think it worked out too well and you had to go back to the old way, where Steelhead just focused on Steelhead. So maybe some assurance to investors, the synergies planned, and why things will go more smoothly this time around? And then separately, if we talk about the (new) things that are hurting you, such as on the OPNET business, seasonality, federal and integration, do those things all turn positive by the time we finish the June quarter; any other drivers that will kind of get you to the return to growth in the back half of the year?

Eric Wolford - President, Products Group: Mark, this is Eric. I'll take the first part of that question. What gives us more confidence this time is because of the success we had integrating Cascade. So Cascade similarly was a Performance Management product that we brought in, in fact it was the first time we tried to bring in a new product, and we had a separate sales force. Then we had an overlay sales, and an integrated sales force. We went through this progression, and obviously the success of growth in Cascade turned out to be very good. We were able to leverage the big sales force and not continue to spend on overlay Cascade sales resources because our main sales force picked it up over the course of time. There's a lot of learning and training that goes on, but they were able to pick it up. So it was a success story. The idea is that with OPNET, they are an extension of that Performance Management story which is something that our core sales force is already somewhat familiar with doing. So, it's not hyper-spacing into a different world. It is instead just an extension of that which they did with Cascade, they will now do all the way up through application performance management, not just network performance management.

Jerry M. Kennelly - Chairman and CEO: Last time, basically we delayed too long; integrating was our biggest issue, wasn't that we did it and backed often. And once you get past (here), I really have to talk to you in June, or actually in July. Hopefully, we get past most of the big stuff, the big stuff is getting your territory, getting your quota, getting your comp plan, knowing who your manager is, meeting your channel partners. That will all have taken place, being cross-trained. That will all have taken place this quarter. So there will be some residual issues and as you get to try and (argue), it's possible, and so the big thing to do in a single quarter that I think will get through most of it at least by June.

Mark Sue - RBC Capital Markets: And if anything, from the seasonality should one view, by the time we will get to September, the heavy lifting should be behind us by that point.

Jerry M. Kennelly - Chairman and CEO: Correct.

Operator: Bill Choi, Janney.

Bill Choi - Janney: Clarification, because, I'm still trying to understand and reconcile the government exposure part. I had in my model that last year, on a standalone Riverbed basis to generate 13% of total sales from the government, you have sighted 17%, so maybe you could just double check the past and what did that U.S. government or the total government maybe declined year-over-year basis, and when you say the government accounted for 85% of the shortfall, is that versus the low end of the range you had given? And then I have a question.

Ernest E. Maddock - EVP and CFO: That would be versus the midpoint of the range we gave, and I think our vertical number is right, but we'll have to get back to offline and we can't push up and draw the papers here on the call.

Bill Choi - Janney: Then my question is really your strategy is to obviously increase the functionality on these branch office unit sand to drive penetration of that and when we kind of look at your strategy with Cisco's, you are there emulating what you are doing which is to include more application awareness, visibility, as well as WAN optimization built into the routers. I guess, I want to understand if you've seen Cisco by following on the strategy have a bigger impact in the current – in the quarter and in the current outlook? And they're doing it with some level of pricing discount, whether you've seen pricing be a potential tool set you could use to increase penetration?

Eric Wolford - President, Products Group: Bill, this is Eric. Yeah, no question, Cisco is our top competitor; has been, and I suspect will continue to be. In terms of our bottoms-up measurement of win rates, we did not see a change in what the norms are. Nine out of 10 times our sales force tells us when we compete with them we win, with all of the usual uncertainties in that number. In terms of their behavior, they are still committed to WAN optimization. I think they believe it's an important part of their strategy and story as well as they continue to invest in it. And we continue to compete in them, and yeah, they do at times give it away at either huge discounts or sometimes just bundle into the deal. If you're trying to do a big consolidation job though, unfortunately, just lowering the price doesn't work. You either have the ability to deliver on what the customer wants to do in consolidating their resources back to the data center or you can't. It's not just a compression bandwidth thing. It involves much heavier-lifting and heavier workload. So, we feel very good about competitive position relative to Cisco.

Jerry M. Kennelly - Chairman and CEO: And OPNET actually sold with Cisco and it runs well in their gear, as does the Stingray product also runs very well in Cisco gear. So, this is just business to us and we're happy to see our product get out there on whatever box possible.

Bill Choi - Janney: Did you see potentially the introduction of ISR-AX as one of the factors delaying the sales cycle as people evaluate this competitive solution?

Eric Wolford - President, Products Group: We did not in any aggregate sense. There might be a deal or two here or there, but not as a general trend.

Operator: Erik Suppiger, JMP Securities.

Erik Suppiger - JMP Securities: A couple of questions, first off, some of the other networking vendors weakness on the service provider side and in case it's managed service providers, I'm wondering if you saw any of those issues? And then secondly in terms of the sales force, are you making any changes to quotas or what are you doing to try to keep some of the morale up within the sales organization?

Eric Wolford - President, Products Group: This is Eric, I'll take the first question. So just for everyone, clearly we don't – a big part of our businesses isn't selling our products as infrastructure to service providers for their own use in their network. Instead, we typically sell it as a managed service, and I'm talking specifically about WAN optimization as a managed service. So the end buyer is an enterprise. So our experience this quarter was that service providers were within their normal range of business in selling to enterprise as a managed service.

Jerry M. Kennelly - Chairman and CEO: We do have broad-based miss of our sales force of their quotas this quarter. It was pretty much – I'd say 85% of that was in the government vertical. And so, the morale in our sales force is pretty good; have just come from the quarterly business reviews and they were upbeat, and we have a pretty decent guidance for the Q1 to Q2 increase in our traditional business. So, we watch retention. We watch morale. We have a variety of tools to deal with that, but we don't have a downcast sales force by any means at all.

Operator: Daniel Ives, FBR Capital Markets.

Daniel Ives - FBR Capital Markets: When you were going over sales cycles in sort of post quarter, I mean you've obviously been through a bunch of different types of IT spending environment. What do you think is going on in terms of budget? I mean, do you think budgets are set late, digestion period obviously we know what's going on in federal, but maybe just talking down on federal, what are your thought compared to others cycles that you've seen?

Jerry M. Kennelly - Chairman and CEO: Q1 you see still some budgets not done yet in the enterprise and I think we did talk about the slightly longer sales cycles, some uncertainties. So, I believe that had some impact in Q1. The big successful business IT is a constant investment and it doesn't go away. So, not really – I think the budgets are written now and they are set for 2013, is my sense.

Daniel Ives - FBR Capital Markets: Just in terms of with OPNET, I mean just maybe you could talk about what you are hearing from customers or even from the channel in terms of potential cross-selling, I mean did you know, there is better education going on out there in terms of potential opportunities between two companies, maybe talk about that and then how their process can kind of develop over the next few quarters.

Eric Wolford - President, Products Group: So, this is Eric, I'll take a shot at that one. The first place we saw any indication of synergy is with our core sales force, meaningful programs out to the channel are just beginning right now. So, outside of Riverbed, out to the channel, that's just happening this quarter, because we let OPNET alone for calendar Q1 which was there fiscal Q4. So that's just happening. But with the core sales force, there is no question, the synergy opportunities are there in the funnel, with OPNET accounts that seem interested in looking at Steelhead, and Steelhead accounts or Cascade accounts that seem very interested in expanding with OPNET. So, in terms of core sales and OPNET sales collaboration opportunities, yes. We see those there with the outside channel. Yeah, I mean it is just starting right now.

Operator: Brian Modoff, Deutsche Bank.

Vijay Bhagavath - Deutsche Bank: Vijay Bhagavath calling on behalf of Brian. Two questions. First is help us understand non-GAAP revenues. Like to understand the split between GAAP and non-GAAP on the revenue line.

Jerry M. Kennelly - Chairman and CEO: Yeah, the difference is that non-GAAP includes the amortization of services revenue from an acquisition, which otherwise would be washed out at acquisition accounting. It's normal revenue. It's the revenue the Company would have recognized had it not been acquired that gets washed out when you do acquisition accounting.

Vijay Bhagavath - Deutsche Bank: And then the follow-on question Jerry is, in hindsight do you think OPNET was the correct strategy for the Company? I mean, you have $0.5 billion in debt. You still have integration (themes) with OPNET. This is versus five looking at security as the next phase growth opportunity. Any thoughts there on security versus performance management, as you know, the next pillar of growth opportunity for the Company.

Jerry M. Kennelly - Chairman and CEO: No, I absolutely think OPNET was the right thing to do. It's interesting that not every company will have a Steelhead. You can get a high percentage, a 100% of companies with networks need Performance Management and Performance Management is a leading sales through the rest of our product line, number one. Number two, we got a market leader – we got the Gartner Quadrant leader in technology in an important space. That had a sizeable run rate of revenue that was important with a good product and a worldwide and a strong distribution organization and a strong engineering organization that filled out our whole performance management play. When we first bought brought Mazu, it started the Cascade product line. The first two years, it grew but it didn't explode as it was missing the 100% functionality. You have to present the market with a whole product, and so Cascade started to grow when we bought the (case) product that added Shark and Pilot to it because then you had a more complete network performance management, and the last three years at Cascade have been fantastic because we added (EnCase). Now by adding in OPNET, that has the Application Performance Management, we're the only one who have the full gamut from end to end. The price we paid was reasonable. The asset we got was fantastic, and the position it gives us in the market is exactly right. So, I still feel very good about the OPNET acquisition. Not all that debt was fully acquisitions, some of that was simply to have excess balance of operating cash above and beyond what we needed for the acquisition. So, I would do it again. We have security, we have some security aspects in our product, our Stingray product. We bought a company called – they had brought a company called Art of Defence which has a very good…

Eric Wolford - President, Products Group: Web application firewall.

Jerry M. Kennelly - Chairman and CEO: Web application firewall. And actually the Mazu product itself started the life as a security product. So we have a couple of chips down in that. We're not saying we'll go in that space now, but that's another interesting space in the network world. So, we want to grow to be a provider of performance products in layers 4 through 7, and I think that strategy is working. It has little glitches here and there, but if you look at the overall trajectory, we just reported 38% growth and yes, we bought some of that growth, but we did buy it and we paid for it, and we deserve the credit for it. That's how every large company has done it, and we're no exception. And so I think we're on the right track.

Vijay Bhagavath - Deutsche Bank: Just a closing thought, in terms of the core business is now seeing 6%, 7% growth, any thoughts there on would we see this sort of a single digit growth pattern for the foreseeable future or you think there might be some catalyst in the horizon that could reaccelerate the core business?

Jerry M. Kennelly - Chairman and CEO: We grew in that core business through 9% last quarter. It would have grown 9% again this quarter had the sequestration not hit us. I think we talked about some of the catalysts that are coming.

Eric Wolford - President, Products Group: The obvious ones are an improved economic situation which includes the federal government, and the global spending environment for sure, but outside of that, extending the functionality to being a multi-product or a multi-function box at the edge that consolidates storage and addresses things like direct to net demand, provides a broader applicability of our Steelhead performance platform at the edge. Layered on top of that however, is an ability to do multiple products and the products outside of WAN optimization as we talked about those non-WAN op products, non-OPNET, they were growing at over 40%. So, we have some high growth adjacent businesses that are still performance businesses, but adjacent to WAN optimization that complement a WAN optimization business that has itself several growth levers in front of it.

Operator: Tal Liani, Bank of America Merrill Lynch.

Tal Liani - Bank of America Merrill Lynch: I have a question about the guidance. There is going to be sequential decline in OPNET, and you're guiding for a sequential increase in overall revenues. So, if I back out OPNET, there is actually quite a substantial sequential increase in the numbers ex-OPNET.

Jerry M. Kennelly - Chairman and CEO: Yes, 6% to 7%.

Tal Liani - Bank of America Merrill Lynch: The sequential increase is between 6% and 7%.

Eric Wolford - President, Products Group: For non-OPNET.

Jerry M. Kennelly - Chairman and CEO: For (non-OPNET).

Tal Liani - Bank of America Merrill Lynch: Non-OPNET, right, but the sequester is only kicking in next quarter; this coming quarter, not the previous quarter. This was more of an expectations quarter, but this quarter is the real cut. And the question is, what do you see outside of – so, I assume that federal could even further decline next quarter. And maybe you can correct me with what you're seeing right now, but if I take into account and if the logic is correct, it means that the sequential increase you expect in enterprise, ex-federal is actually much greater than the 7%. So, can you just discuss this? What is the risk (because) federal further declines and then what's the risk to your guidance if that's the case on the enterprise side?

Jerry M. Kennelly - Chairman and CEO: We don't split our guidance into government and enterprise, but let me say, the sequestration confusion on the agencies and their ability to issue purchase orders hit the hardest in Q1 in February and March. And so, yes, there is some dollar cut coming later in the year, but there's clarity about who has the dollars and how to spend them, and so I think the biggest impact was Q1. There will be a continued impacted and I'm not saying Federal is going to go off like a sky rocket, but our enterprise business particularly in the U.S. was quite strong in Q1. We have a good forecast out of Europe. We think our risk in Q2 is OPNET for integration and then, a little bit of issue internationally particularly in APJ, but overall our guidance contains everything we know, everything we've seen and we think it's correct.

Tal Liani - Bank of America Merrill Lynch: I have a second question not related on Granite. Can you discuss the applications that are being used for Granite? So you see pretty nice growth, and I'm wondering if there is any kind of single application running across your customers, if you can see a certain deployment case or its broader base?

Eric Wolford - President, Products Group: Yeah, for sure. This is Eric. There's three main drivers of sales. We can pretty much bucket every sale we've done so far into one of these three categories. The reason why the customer wrote the check for making the purchase, and the average deal size of these deals are definitely bigger than Steelhead deals. So they are bigger average deal size, and the reason why they are writing the check is for, either storage and server consolidation. They no longer want data to live in a remote site. So, they consolidate the server and the storage. The second reason is because they were motivated by backup consolidation. So they had a backup budget. They were going to do a backup refresh, and instead of doing a backup refresh, they consolidated everything back to the data center, and therefore didn't need any remote site backup. Or third, customers had motivation around getting data out of sensitive locations. So, I don't trust the locations where my data is resident, and I just want to get it out so that it's safe. So, data protection, get it out of you know places that are a little bit scary, and those are the three main reasons why people are purchasing.

Tal Liani - Bank of America Merrill Lynch: Any specific vertical that you see strength?

Eric Wolford - President, Products Group: It's very horizontal. I mean people deploy servers; companies deploy servers and storage and back-up across every major vertical. So, there is probably you know 15 different verticals that are represented in that customer base and there is not one that sort of the silver bullet shining star.

Jerry M. Kennelly - Chairman and CEO: There is a great length to the event on the IR site. You might take a look.

Renee Lyall - IR: Thanks everyone for joining us today and I'm sorry that we're out of time with some analysts still in the queue. If you have any question following the call today, please direct them to me and Investor Relations and have a nice evening.

Operator: Ladies and gentlemen, this does conclude today's conference call. Thank you for participating. At this time you may now disconnect.