Riverbed Technology, Inc. - FORM 10-Q

Attached files

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EX-31.2 - SECTION 302 CFO CERTIFICATION - Riverbed Technology, Inc.	dex312.htm
EX-31.1 - SECTION 302 CEO CERTIFICATION - Riverbed Technology, Inc.	dex311.htm
EX-32.1 - SECTION 906 CEO AND CFO CERTIFICATION - Riverbed Technology, Inc.	dex321.htm

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, 2009

¨	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 ¨ 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.

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 22, 2009 was: 69,203,865.

Riverbed Technology, Inc.

INDEX


		Page No.
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets as of September 30, 2009 and December 31, 2008	3
	Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2009 and September 30, 2008	4
	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2009 and September 30, 2008	5
	Notes to Condensed Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	36

Item 4.	Controls and Procedures	36

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	37

Item 1A.	Risk Factors	37

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	49

Item 6.	Exhibits	50

Item 1.

Financial Statements

RIVERBED TECHNOLOGY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

As of September 30, 2009 and December 31, 2008

(in thousands)


	September 30, 2009			December 31, 2008
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	75,709		$	95,378
Marketable securities		221,058			172,398
Trade receivables, net of allowances of $1,527 and $770 as of September 30, 2009 and December 31, 2008, respectively		47,099			46,839
Inventory		12,100			10,637
Deferred tax assets		8,730			6,185
Prepaid expenses and other current assets		15,169			12,605

Total current assets		379,865			344,042

Fixed assets, net		21,810			21,993
Goodwill		11,711			—
Intangibles, net		20,584			—
Deferred tax assets, non-current		35,360			27,033
Other assets		5,115			5,449

Total assets	$	474,445		$	398,517

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	21,267		$	18,290
Accrued compensation and benefits		19,766			13,137
Other accrued liabilities		26,583			13,342
Deferred revenue		58,472			45,194

Total current liabilities		126,088			89,963

Deferred revenue, non-current		17,561			12,967
Other long-term liabilities		2,892			1,758

Total long-term liabilities		20,453			14,725

Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.0001 par value – 30,000 shares authorized, no shares outstanding		—			—
Common stock; $0.0001 par value – 600,000 shares authorized; 69,194 and 69,145 shares issued and outstanding as of September 30, 2009 and December 31, 2008, respectively		343,637			315,882
Accumulated deficit		(15,781	)		(21,934	)
Accumulated other comprehensive income (loss)		48			(119	)

Total stockholders’ equity		327,904			293,829

Total liabilities and stockholders’ equity	$	474,445		$	398,517

See Notes to Condensed Consolidated Financial Statements.

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,
	2009			2008			2009			2008
Revenue:
Product	$	69,543		$	65,238		$	190,322		$	185,574
Support and services		32,506			21,309			90,925			55,547

Total revenue		102,049			86,547			281,247			241,121

Cost of revenue:
Cost of product		14,982			16,653			43,776			45,153
Cost of support and services		9,410			7,174			27,385			20,151

Total cost of revenue		24,392			23,827			71,161			65,304

Gross profit		77,657			62,720			210,086			175,817

Operating expenses:
Sales and marketing		44,192			34,855			127,003			100,992
Research and development		17,302			14,582			50,368			43,278
General and administrative		9,297			10,419			27,382			29,925
Other charges		—			11,000			—			11,000
Acquisition-related costs (credits)		(3,008	)		—			(4,447	)		—

Total operating expenses		67,783			70,856			200,306			185,195

Operating income (loss)		9,874			(8,136	)		9,780			(9,378	)

Other income, net		141			1,287			824			5,059

Income (loss) before provision for income taxes		10,015			(6,849	)		10,604			(4,319	)
Provision for income taxes		4,546			5,574			4,451			8,335

Net income (loss)	$	5,469		$	(12,423	)	$	6,153		$	(12,654	)

Net income (loss) per common share:
Basic	$	0.08		$	(0.17	)	$	0.09		$	(0.18	)

Diluted	$	0.08		$	(0.17	)	$	0.09		$	(0.18	)

Shares used in computing net income (loss) per common share:
Basic		69,370			71,005			69,035			70,915
Diluted		71,968			71,005			71,040			70,915

See Notes to Condensed Consolidated Financial Statements.

RIVERBED TECHNOLOGY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)


	Nine months ended September 30,
	2009			2008
Operating Activities:
Net income (loss)	$	6,153		$	(12,654	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		10,376			5,739
Stock-based compensation		40,431			38,157
Excess tax benefit from employee stock plans		(1,694	)		(1,427	)
Deferred taxes		(10,019	)		—
Changes in operating assets and liabilities:
Trade receivables		1,608			5,521
Inventory		(1,017	)		(7,720	)
Prepaid expenses and other current assets		(2,128	)		(4,870	)
Accounts payable		2,398			1,599
Accruals and other current liabilities		8,603			14,503
Acquisition-related contingent consideration		(4,947	)		—
Income taxes payable		6,562			4,762
Deferred revenue		17,073			17,385

Net cash provided by operating activities		73,399			60,995

Investing Activities:
Capital expenditures		(7,173	)		(10,761	)
Purchase of available for sale securities		(244,208	)		(264,179	)
Proceeds from maturities of available for sale securities		181,761			143,102
Proceeds from sales of available for sale securities		13,500			39,803
Acquisitions, net of cash and cash equivalents acquired		(20,469	)		—

Net cash used in investing activities		(76,589	)		(92,035	)

Financing Activities:
Proceeds from issuance of common stock under employee stock plans, net of repurchases		15,512			9,119
Payments for repurchases of common stock		(29,016	)		(24,992	)
Payments of debt		(5,004	)		—
Excess tax benefit from employee stock plans		1,694			1,427

Net cash used in financing activities		(16,814	)		(14,446	)

Effect of exchange rate changes on cash and cash equivalents		335			(169	)

Net decrease in cash and cash equivalents		(19,669	)		(45,655	)
Cash and cash equivalents at beginning of period		95,378			162,979

Cash and cash equivalents at end of period	$	75,709		$	117,324

See Notes to Condensed Consolidated Financial Statements.

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 a comprehensive solution to the fundamental problems of wide-area distributed computing. Our products enable our customers simply and efficiently to improve the performance of their applications and access to their data over wide area networks (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, 2009, the condensed consolidated statements of operations for the three and nine months ended September 30, 2009 and September 30, 2008, and the condensed consolidated statements of cash flows for the nine months ended September 30, 2009 and September 30, 2008 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, 2008.

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, 2009, and our results of operations and cash flows for the three and nine months ended September 30, 2009 and September 30, 2008. All adjustments are of a normal recurring nature. Certain prior period amounts have been reclassified to conform to the current period presentation. Specifically, service inventory as of December 31, 2008 in the amount of $5.9 million has been reclassified from Other long-term assets to Prepaid expenses and other current assets on our condensed consolidated balance sheet. In addition, the increase in Other assets of $1.4 million for the nine months ended September 30, 2008 has been reclassified from investing activities to operating activities on our condensed consolidated statement of cash flows. The results for the three and nine months ended September 30, 2009 are not necessarily indicative of the results to be expected for any subsequent quarter or for the fiscal year ending December 31, 2009.

Other than the adoption of the provisions of Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 805, Business Combinations, and ASC Topic 350, Intangibles – Goodwill and Other, there have been no significant changes in our accounting policies during the three and nine months ended September 30, 2009, as compared to the significant accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2008.

We have evaluated subsequent events through October 30, 2009, which is the date these condensed consolidated financial statements were issued.

Use of Estimates

GAAP requires us to make certain estimates and judgments that can affect the reported amounts of assets and liabilities as of the date of the 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 allowance for doubtful accounts, inventory valuation, our warranty liability, the accounting for income taxes including the determination of the timing of the release of our valuation allowance related to certain deferred tax asset balances, the accounting for business combinations 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 consolidated financial statements will be affected.

Revenue Recognition

Our software is generally integrated on appliance hardware and is essential to the functionality of the product. As a result, we account for revenue in accordance with ASC Topic 985, Software, for all transactions involving the sale of software. We

RIVERBED TECHNOLOGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

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

Product revenue consists of revenue from sales of our appliances and software licenses. Product sales include a perpetual license to our software. Product revenue is generally recognized upon transfer of title at shipment, assuming all other revenue recognition criteria are met. Shipping charges billed to customers are included in product revenue and the related shipping costs are included in cost of product revenue. Product revenue on sales to channel partners is recorded once we have received persuasive evidence of an end-user and all other revenue recognition criteria have been met.

Substantially all of our product sales have been sold in combination with support services, which consist of software updates and support. 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. Support includes access to technical support personnel and content via the internet and telephone. Support services also include an extended warranty for the repair or replacement of defective hardware. Revenue for support services is recognized on a straight-line basis over the service contract term, which is typically one year.

We use the residual method to recognize revenue when a product agreement includes one or more elements to be delivered at a future date and vendor specific objective evidence (VSOE) of the fair value of all undelivered elements exists. Through September 30, 2009, in virtually all of our contracts, the only element that remained undelivered at the time of delivery of the product was support and updates. Under the residual method, the fair value of the undelivered elements 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 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 element for which we do not have a fair value is support, revenue for the entire arrangement is bundled and recognized ratably over the support period. VSOE of fair value for elements of an arrangement is based upon the normal pricing and discounting practices for those services when sold separately, and VSOE for support services is measured by the renewal rate offered to the customer.

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 60 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.

Stock-Based Compensation

We estimated the fair value of stock options granted using the Black-Scholes option-pricing formula and a single option award approach. 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 option, the expected volatility of the price of our common stock, risk free interest rates and expected dividend yield of our common stock. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally four years.

On September 20, 2006, the effective date of the registration statement relating to our initial public offering (IPO), we implemented the Purchase Plan, which has a two year offering period and two purchases per year. The fair value of shares granted under the Purchase Plan is amortized over the two year offering period. Under the Purchase Plan, employees may purchase shares of common stock through payroll deductions at a price per share that is 85% of the lesser of the fair market value of our common stock as of the beginning of an applicable offering period or the applicable purchase date, with purchases generally every six months.

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 future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. 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.

RIVERBED TECHNOLOGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

As part of the process of preparing our 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 management estimates and assumptions in preparing our income tax provision including forecasted annual income.

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 foreign 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. The valuation allowance primarily relates to deferred tax assets established in purchase accounting. Any subsequent reduction of that portion of the valuation allowance and the recognition of the associated tax benefits will be recorded to our provision for income taxes.

As part of our accounting for business combinations, a portion of the purchase price was allocated to goodwill and intangible assets. Amortization expenses associated with acquired intangible assets are generally not tax deductible; however, deferred taxes have been recorded for non-deductible amortization expenses as a part of the purchase price allocation. In the event of an impairment charge associated with goodwill, such charges are generally not tax deductible and would increase the effective tax rate in the quarter any impairment is recorded.

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 and age of the units. 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 reflected as cost of product and amounted to $0.6 million and $3.3 million in the three months ended September 30, 2009 and 2008, respectively, and $3.6 million and $4.8 million in the nine months ended September 30, 2009 and 2008, 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. If actual product failure rates, repair rates or any other post sales support costs differ from these estimates, revisions to the estimated warranty liability would be required.

The following is a summary of the warranty reserve activity for the nine months ended September 30, 2009 and 2008.


	Nine months ended September 30,
(in thousands)	2009			2008
Beginning balance	$	1,205		$	1,089
Additions charged to operations		656			1,569
Warranty costs incurred		(442	)		(1,244	)
Adjustments related to pre-existing warranties		(755	)		—

Ending balance	$	664		$	1,414

Deferred Inventory Costs

When our products have been delivered, but the product revenue associated with the arrangement has been deferred as a result of not meeting certain revenue recognition criteria, we also defer the related inventory costs for the delivered items. Deferred inventory costs amounted to $1.5 million and $2.2 million at September 30, 2009 and December 31, 2008, respectively, and are included in Prepaid expenses and other current assets in the condensed consolidated balance sheets.

RIVERBED TECHNOLOGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Service Inventory

We hold service inventory that is used to repair or replace defective hardware reported by our customers who purchase support services. Service inventory consists of hardware and related component parts and is stated at lower of cost (on a first-in, first-out basis) or market. We classify service inventory as Prepaid expenses and other current assets and we recognize the utilization of service inventory as a charge against cost of support and services revenue in the period in which it occurs. At September 30, 2009 and December 31, 2008 our service inventory balance was $6.3 million and $5.9 million, respectively. In the three months ended September 30, 2009 and 2008, we recognized $0.5 million, to cost of support and services relating to service inventory. In the nine months ended September 30, 2009 and 2008, we recognized $2.3 million and $1.3 million, respectively, to cost of support and services relating to service inventory.

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.

Comprehensive Income (Loss)

Comprehensive income (loss) consists of the following:


	Three months ended September 30,						Nine months ended September 30,
(in thousands)	2009			2008			2009			2008
Net income (loss)	$	5,469		$	(12,423	)	$	6,153		$	(12,654	)
Change in net unrealized losses on investments, net of tax		(40	)		(76	)		(175	)		(196	)
Change in foreign currency translation adjustment, net of tax		128			(251	)		342			(169	)

Total comprehensive income (loss)	$	5,557		$	(12,750	)	$	6,320		$	(13,019	)

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 and the average portfolio maturity to six months or less. 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 revenue for the three and nine months ended September 30, 2009 and 2008.

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, 2009, we had no long-term contractual commitment with any manufacturer; however, we did have a 90-day commitment totaling $13.0 million.

Recent Accounting Pronouncements

Effective January 1, 2009, we adopted ASC Topic 805, Business Combinations. Under ASC Topic 805, an acquiring entity is required to recognize all the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. It further requires that acquisition-related costs be recognized separately from the acquisition and expensed as incurred; that restructuring costs generally be expensed in periods subsequent to the acquisition date; that changes in the estimated fair value of contingent consideration after the initial measurement on the acquisition date be recognized in earnings in the period of the change in estimate; and changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period be recognized as a component of provision for taxes. In addition, acquired in-process research and development is capitalized as an intangible asset and amortized over its estimated useful life. See Note 2 for a description of our acquisition of Mazu Networks, Inc.

RIVERBED TECHNOLOGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Effective January 1, 2009, we adopted ASC Topic 350, Intangibles – Goodwill and Other, which amends the factors considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. ASC Topic 350 requires an entity to consider its own assumptions about renewal or extension of the term of the arrangement, consistent with its expected use of the asset. The adoption did not have a material impact on our condensed consolidated financial statements.

Effective January 1, 2009, we adopted ASC Topic 820, Fair Value Measurements. ASC Topic 820 delayed the effective date of its application for all non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until the beginning of the first quarter of fiscal 2009. The adoption of ASC Topic 820 did not have a material impact on our condensed consolidated financial statements.

In April 2009, ASC Topic 825, Financial Instruments, was issued, which requires disclosures about the fair value of our financial instruments for which it is practicable to estimate that value, whether recognized or not recognized in the balance sheets, in the interim reporting periods as well as in the annual reporting periods. In addition, ASC Topic 825 requires disclosures of the methods and significant assumptions used to estimate the fair value of those financial instruments. ASC Topic 825 was effective for us beginning April 1, 2009, and its adoption was not material to our condensed consolidated financial statements.

In May 2009, ASC Topic 855, Subsequent Events, which establishes general standards of accounting for, and requires disclosure of, events that occur after the balance sheet date but before financial statements are issued or are available to be issued. We adopted the provisions of ASC Topic 855 for the quarter ended June 30, 2009. This pronouncement does not have a material effect on our condensed consolidated financial statements.

In June 2009, ASC Topic 105-Generally Accepted Accounting Principles was issued, which supersedes all then-existing non-SEC accounting and reporting standards. All other non-grandfathered, non-SEC accounting literature not included in the Codification will become non-authoritative. ASC Topic 105 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. This pronouncement does not have an impact on our consolidated financial statements.

In October 2009, FASB issued Accounting Standards Update (ASU) No. 2009-14, Topic 985: Certain Revenue Arrangements That Include Software Elements (a Consensus of the FASB Emerging Issues Task Force Issue (EITF)). ASU No. 2009-14 modifies ASC 985-605, Software Revenue, such that the following products would be considered non-software deliverables and therefore excluded from the scope of ASC 985-605:

•

Tangible products that contain software elements and non-software elements that function together to deliver the tangible product’s essential functionality.

•

Undelivered elements that are essential to the above described tangible product’s functionality.

We expect that most of our products will be considered non-software deliverables and excluded from the scope of Statement of Position (SOP) 97-2, Software Revenue Recognition.

In October 2009, FASB issued ASU No. 2009-13, Revenue Recognition (Topic 605): Multiple Deliverable Revenue Arrangements (a Consensus of the FASB EITF). ASU No. 2009-13 modifies ASC 605-25, Revenue Recognition – Multiple-Element Arrangements (formerly EITF 00-21). ASU No. 2009-13 requires an entity to allocate the revenue at the inception of an arrangement to all of its deliverables based on their relative selling prices. This guidance eliminates the residual method of allocation of revenue in multiple deliverable arrangements and requires the allocation of revenue based on the relative-selling-price method. The determination of the selling price for each deliverable requires the use of a hierarchy designed to maximize the use of available objective evidence including, VSOE, third party evidence of selling price (TPE), or estimated selling price (ESP).

ASU No. 2009-13 and ASU No. 2009-14 must be adopted no later than the beginning of our fiscal year 2011 and early adoption is allowed and may be adopted either under the prospective method, whereby all revenue arrangements entered into, or materially modified after the effective date or under the retrospective application to all revenue arrangements for all periods presented. An entity may elect to adopt ASU No. 2009-13 and ASU No. 2009-14 in a period other than their first reporting period of a fiscal year under the prospective method but must adjust the revenue of prior reported periods such that all new revenue arrangements entered into, or materially modified, during the fiscal year of adoption are accounted for under this guidance.

RIVERBED TECHNOLOGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

We expect to adopt these pronouncements in the first quarter of fiscal 2010 under the prospective method. The adoption of these pronouncements may have a material effect on our revenue and financial position in the period of adoption, however, we have not yet been able to quantify the effect.

The adoption of ASU No. 2009-13 and ASU No. 2009-14 will allow the separation of deliverables under more arrangements which may result in less revenue deferral. For such arrangements, the application of the relative-selling price method of allocating the revenue of an arrangement and the elimination of the residual method of allocation may result in a different reallocation of revenue from product revenue, which is recognized upon delivery, to support revenue, which is recognized ratably over the support period.

2. ACQUISITION

We acquired Mazu Networks, Inc. (“Mazu”) on February 19, 2009 (the “acquisition date”), by means of a merger of a wholly-owned subsidiary with and into Mazu, such that Mazu became a wholly-owned subsidiary of ours. The results of Mazu’s operations have been included in the consolidated financial statements since the acquisition date. We acquired Mazu, among other reasons, to meet enterprise and service provider customer demands by extending our suite of WAN optimization products to include global application performance, reporting and analytics. The estimated acquisition date fair value of consideration transferred, assets acquired and the liabilities assumed for Mazu are presented below and represent our best estimates.

Fair Value of Consideration Transferred

Pursuant to the merger agreement we made payments totaling $23.1 million in cash for all of the outstanding securities of Mazu promptly following the closing. In addition, we will potentially make additional payments (“acquisition-related contingent consideration”) totaling up to $22.0 million in cash, based on achievement of certain bookings targets related to Mazu products for the one-year period from April 1, 2009 through March 31, 2010 (the “Earn-Out period”), with up to $16.6 million to be paid to Mazu shareholders and up to $5.4 million to be paid to former employees of Mazu as an incentive bonus provided generally that such former Mazu employees are employees of Riverbed at the time the acquisition-related contingent consideration is earned.

The total acquisition date fair value of the consideration transferred was estimated at $33.0 million, which included the initial payments totaling $23.1 million in cash, of which $3.5 million was paid to escrow to secure the seller’s indemnification obligations, and the estimated fair value of acquisition-related contingent consideration to be paid to Mazu shareholders totaling $9.9 million. The total acquisition date fair value of consideration transferred was estimated as follows:


(in thousands)
Payment to Mazu shareholders	$	23,051
Acquisition-related contingent consideration		9,909

Total acquisition-date fair value	$	32,960

A liability was recognized for an estimate of 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 Earn-Out period. Actual achievement of bookings below $16.0 million would reduce the liability to zero and achievement of bookings of $35.0 million or more would increase the liability to $16.6 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 and nine month periods ending September 30, 2009, we recorded a gain of $3.0 million and $5.8 million, respectively, due to our change in estimate of fair value of acquisition-related contingent consideration.

Allocation of Consideration Transferred

The identifiable assets acquired and liabilities assumed were recognized and measured as of the acquisition date, February 19, 2009, based on their estimated fair values. 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.

RIVERBED TECHNOLOGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

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	$	2,582
Accounts receivable		2,569
Other tangible assets		1,481
Intangible assets		23,500

Total identifiable assets acquired		30,132

Accounts payable and other liabilities		(2,379	)
Loan payable		(5,004	)
Deferred revenue		(1,500	)

Total liabilities assumed		(8,883	)

Net identifiable assets acquired		21,249

Goodwill		11,711

Net assets acquired	$	32,960

Intangible Assets

Management engaged a third-party valuation firm to assist in the determination of the fair value of the 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 Mazu’s products. The fair values of identified intangible assets were calculated using an income approach and estimates and assumptions provided by Mazu’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 19%. 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 Mazu. The following table sets forth the components of identified intangible assets associated with the Mazu acquisition and their estimated useful lives:


(in thousands)	Useful life	Fair Value
Existing technology	5 years	$	12,100
Patents	5 years		2,700
Maintenance agreements	5 years		6,100
Customer contracts	5 years		2,000
Trademarks	3 years		600

Total intangible assets		$	23,500

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 Mazu’s product line. There were no in-process research and development assets as of the acquisition date. Patents are related to the design and development of Mazu’s products and this proprietary know-how may be leveraged to develop new technology and products and improve existing products. Customer contracts represent the underlying relationships and agreements with Mazu’s installed customer base. Trademarks represent the fair value of the brand and name recognition associated with the marketing of Mazu’s products and services. Amortization of existing technology and patents is included in cost of product revenue, and amortization expense for customer relationships and trademarks is included in operating expenses.

Goodwill

Of the total estimated purchase price, $11.7 million was allocated to 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 business an addition to our product portfolio and not an additional reporting unit or operating segment. Goodwill is tested for impairment at least annually (more frequently if certain indicators are present). In the event that management determines that the value of goodwill has become impaired, we will incur an accounting charge for the amount of impairment during the fiscal quarter in which the determination is made. None of the goodwill is expected to be deductible for income tax purposes. As of September 30, 2009, there was no change in the recognized amounts of goodwill resulting from the acquisition of Mazu.

RIVERBED TECHNOLOGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Deferred Revenue

In connection with the allocation of consideration transferred, we estimated the fair value of the service obligations assumed from Mazu 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 Mazu’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 Mazu 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 $1.5 million of deferred revenue to reflect the estimate of the fair value of Mazu’s service obligations assumed.

Pre-Acquisition Contingencies

We have evaluated and continue to evaluate the pre-acquisition contingencies related to Mazu that existed as of the acquisition date. Certain pre-acquisition contingencies related to the Mazu final income tax return remain uncertain, however, we do not expect any resulting adjustments for such matters to be significant and any amounts will be recorded as an adjustment to goodwill. If any non-income tax-related pre-acquisition contingencies that existed as of the acquisition date become probable in nature and estimable, amounts for such matters will be recorded in our results of operations.

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 fair value of the acquisition-related contingent consideration to be distributed directly to the Mazu selling shareholders was originally estimated at the acquisition date to be $9.9 million. As of September 30, 2009, the estimated fair value of the acquisition-related contingent consideration liability was reduced to $4.1 million, primarily due to a reduction in the probability-weighted bookings estimate, discounted at 13%. The reduction in our fair value estimate resulted in a net gain of $3.0 million and $5.8 million for the three and nine months ended September 30, 2009, respectively, which was recorded in Acquisition-related costs in the Condensed Consolidated Statement of Operations.

The fair value of acquisition-related contingent consideration to be paid to the former employees of Mazu, originally estimated at $3.8 million at the acquisition date, is considered compensatory and will be recognized as compensation cost recorded in operating expense over the Earn-Out period, provided that such former Mazu employees are employees of Riverbed at the time the acquisition-related contingent consideration is earned. As of September 30, 2009 the estimated fair value of the acquisition-related contingent consideration to be paid to the former employees of Mazu was reduced to $1.6 million from $2.7 million as of June 30, 2009, due to a reduction in the probability-weighted bookings estimate.

The following table shows the compensation costs of the acquisition-related contingent consideration to be paid to the former employees of Mazu recognized in operating expenses in the three and nine month periods ended September 30, 2009, respectively:


(in thousands)	Three months ended September 30, 2009		Nine months ended September 30, 2009
Sales and marketing	$	2	$	358
Research and development		2		316
General and administrative		—		197

Total other acquisition-related compensation costs	$	4	$	871

RIVERBED TECHNOLOGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Acquisition-related Costs

Acquisition-related costs recognized during the three and nine months ended September 30, 2009 include changes in the fair value of the acquisition-related contingent consideration, transaction costs and integration-related costs. During the three months ended September 30, 2009, we recorded a net gain of $3.0 million related to change in fair value of the acquisition-related contingent consideration to be paid directly to the Mazu shareholders. During the nine months ended September 30, 2009, we recorded a net gain of $4.4 million, which included the cumulative changes in fair value of the acquisition-related contingent consideration to be paid directly to the Mazu shareholders of $5.8 million, partially offset by transaction costs such as legal, accounting, valuation and other professional services of $0.6 million and integration-related costs of $0.8 million.

The following table summarizes the acquisition-related costs recognized in the three and nine months ended September 30, 2009:


(in thousands)	Three months ended September 30, 2009			Nine months ended September 30, 2009
Transaction costs	$	—		$	595
Severance		—			412
Integration costs		—			364

Change in fair value of acquisition-related contingent consideration		(3,008	)		(5,818	)

Acquisition-related costs (credits)	$	(3,008	)	$	(4,447	)

Results of Operations

The amount of revenue and operating loss of Mazu included in our condensed consolidated statement of operations for the three months ended September 30, 2009 and from the acquisition date to the period ending September 30, 2009 were as follows:


(in thousands)	Three months ended September 30, 2009			Nine months ended September 30, 2009
Revenue	$	1,734		$	4,564
Operating loss	$	(3,489	)	$	(8,135	)

Pro Forma Results for Mazu Acquisition

The following table presents our pro forma results (including Mazu) for the three and nine months ended September 30, 2009 and 2008 as though the companies had been combined as of the beginning of each of the periods presented. The pro forma information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of each period presented. The pro forma results presented include acquisition-related costs, amortization charges for acquired intangible assets, eliminations of intercompany transactions, adjustments to interest expense and related tax effects.


	Three months ended September 30,					Nine months ended September 30,
(in thousands)	2009		2008			2009		2008
Total revenue	$	102,049	$	90,349		$	282,762	$	251,725
Operating income (loss)	$	8,155	$	(9,695	)	$	6,999	$	(14,099	)

3. NET INCOME (LOSS) PER COMMON SHARE

Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of vested common shares outstanding during the period. Diluted net income (loss) per common share is computed by giving effect to all potential dilutive common shares.

RIVERBED TECHNOLOGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

The following table sets forth the computation of net income (loss) per share:


	Three months ended September 30,					Nine months ended September 30,
(in thousands, except per share data)	2009		2008			2009		2008
Net income (loss)	$	5,469	$	(12,423	)	$	6,153	$	(12,654	)

Weighted average common shares outstanding - basic		69,370		71,005			69,035		70,915
Dilutive effect of employee stock plans		2,598		—			2,005		—

Weighted average common shares outstanding - diluted		71,968		71,005			71,040		70,915

Basic net income (loss) per share	$	0.08	$	(0.17	)	$	0.09	$	(0.18	)

Diluted net income (loss) per share	$	0.08	$	(0.17	)	$	0.09	$	(0.18	)

The following weighted average outstanding options and RSUs 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)	2009	2008	2009	2008
Stock options and awards outstanding:
In-the-money awards	—	2,169	—	2,999
Out-of-the-money awards	5,875	9,547	9,138	8,301

Total potential shares of common stock excluded from the computation of earnings per share	5,875	11,716	9,138	11,300

Stock options outstanding with an exercise price lower than our average stock price for the periods presented, RSUs and Plan Shares (“In-the-money awards”) that would otherwise have a dilutive effect under the treasury stock method, are excluded from the calculations of the diluted loss per share in periods with a loss since the effect in such periods would have been anti-dilutive.

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

RIVERBED TECHNOLOGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

4. FAIR VALUE OF ASSETS AND LIABILITIES

As of September 30, 2009, the fair value measurements of our cash and cash equivalents, marketable securities, and acquisition-related contingent consideration consisted of the following:


(in thousands)	Total		Level 1		Level 2		Level 3
Assets:
Corporate bonds and notes	$	20,096	$	—	$	20,096	$	—
Money market funds		49,722		49,722		—		—
Cash		5,891		—		—		—

Total Cash and cash equivalents	$	75,709	$	49,722	$	20,096	$	—

Corporate bonds and notes	$	26,894	$	—	$	26,894	$	—
U.S. government backed securities		35,717		35,717		—		—
U.S. government-sponsored enterprise obligations		151,734		—		151,734		—
FDIC-backed certificates of deposit		6,713		6,713		—		—

Total Marketable securities	$	221,058	$	42,430	$	178,628	$	—

Liabilities:

Acquisition-related contingent consideration	$	4,962	$	—	$	—	$	4,962

As of December 31, 2008, the fair value measurements of our cash and cash equivalents, and marketable securities consisted of the following:


(in thousands)	Total		Level 1		Level 2		Level 3
Assets:
Corporate bonds and notes	$	16,783	$	—	$	16,783	$	—
Money market funds		73,877		73,877		—		—
Cash		4,718		—		—		—

Total Cash and cash equivalents	$	95,378	$	73,877	$	16,783	$	—

Corporate bonds and notes	$	33,487	$	—	$	33,487	$	—
U.S. government backed securities		69,829		69,829		—		—
U.S. government-sponsored enterprise obligations		69,082		—		69,082		—

Total Marketable securities	$	172,398	$	69,829	$	102,569	$	—

RIVERBED TECHNOLOGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

As of September 30, 2009 and December 31, 2008, the marketable securities are recorded at amortized cost which approximates fair market value. All investments mature in one year or less.


(in thousands)	Fair Value		Unrealized Gains		Unrealized Losses
Corporate bonds and notes	$	22,551	$	21	$	—
Corporate bonds and notes		4,343		—		(7	)
U.S. government-sponsored enterprise obligations		137,484		164		—
U.S. government-sponsored enterprise obligations		14,250		—		(8	)
U.S. government backed securities		33,725		24		—
U.S. government backed securities		1,992		—		(2	)
FDIC-backed certificates of deposit		3,362		2		—
FDIC-backed certificates of deposit		3,351		—		(9	)

Total marketable securities at September 30, 2009	$	221,058	$	211	$	(26	)

Corporate bonds and notes	$	33,487	$	39	$	—
U.S. government-sponsored enterprise obligations		52,815		203		—
U.S. government-sponsored enterprise obligations		16,267		—		(28	)
U.S. government backed securities		65,839		259		—
U.S. government backed securities		3,990		—		(1	)

Total marketable securities at December 31, 2008	$	172,398	$	501	$	(29	)

Proceeds from the sales of available-for-sale securities were zero and $15.8 million in the three months ended September 30, 2009 and 2008, respectively. Proceeds from the sales of available-for-sale securities were $13.5 million and $39.8 million in the nine months ended September 30, 2009 and 2008, respectively. Gross realized gains or losses recorded on those sales during these periods were insignificant in the three and nine months ended September 30, 2009 and 2008.

Net unrealized holding gains and (losses), net of tax, on available-for-sale securities in the amount of $0.1 million and $0.3 million as of September 30, 2009 and December 31, 2008, respectively, have been included in accumulated other comprehensive income (loss).

We evaluate investments with unrealized losses to determine if the losses are other than temporary. The gross unrealized losses were primarily due to changes in interest rates. We have determined that the gross unrealized losses at September 30, 2009 are temporary. In making this determination, we considered the financial condition and near-term prospects of the issuers, the magnitude of the losses compared to the investments’ cost, the length of time the investments have been in an unrealized loss position and our intent and ability to hold the investment to maturity. Investments with unrealized losses have been in an unrealized loss position for less than a year.

Cash, Cash Equivalents and Marketable Securities

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, 2009 and December 31, 2008 was $75.7 million and $95.4 million, respectively, and approximates fair value.

Marketable securities, which are classified as available for sale at September 30, 2009, are carried at fair value, with the unrealized gains and losses reported as a separate component of stockholders’ equity. Marketable securities consist of government-sponsored enterprise obligations, treasury bills, FDIC-backed certificates of deposit and corporate bonds and notes. The fair value of our marketable securities 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, money market funds, and FDIC-backed certificates of deposit. 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 and government sponsored enterprise obligations. 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. We have no marketable securities valued as Level 3 instruments.

Restricted Cash

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. Current restricted cash totaled $0.1 million at September 30, 2009 and December 31, 2008. Long-term restricted cash totaled $3.5 million at September 30, 2009 and December 31, 2008. 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. The long-term restricted cash is restricted until the end of the lease terms on August 30, 2010 and July 31, 2014.

RIVERBED TECHNOLOGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

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. 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 change. Therefore, the reduction in our fair value estimate described above in Note 2 resulted in a net gain of $3.0 million and $5.8 million for the three and nine months ended September 30, 2009.

The following table represents a reconciliation of the change in the fair value measurement of the acquisition-related contingent consideration for the three and nine months ended September 30, 2009:


(in thousands)	Three months ended September 30, 2009			Nine months ended September 30, 2009
Beginning balance	$	7,966		$	—
Acquisition date fair value measurement		—			9,909
Acquisition-related compensation expense		4			871
Adjustments to fair value measurement		(3,008	)		(5,818	)

Ending balance	$	4,962		$	4,962

5. INVENTORY

Inventory consists primarily of hardware and related component parts and is 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, 2009		December 31, 2008
Raw materials	$	778	$	544
Finished goods		7,397		7,545
Evaluation units		3,925		2,548

Total inventory	$	12,100	$	10,637

6. GOODWILL AND INTANGIBLE ASSETS

Goodwill

Goodwill, which is allocated to our one reporting unit, represents the excess of the purchase price of Mazu over the fair value of the underlying net assets acquired. Goodwill at September 30, 2009 was $11.7 million.

RIVERBED TECHNOLOGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Intangible Assets

Intangible assets consisted of the following:


		September 30, 2009
(in thousands)	Useful life	Gross		Accumulated Amortization			Net
Existing technology	5 years	$	12,100	$	(1,477	)	$	10,623
Patents	5 years		2,700		(329	)		2,371
Maintenance agreements	5 years		6,100		(744	)		5,356
Customer contracts	5 years		2,000		(244	)		1,756
Trademarks	3 years		600		(122	)		478

Total intangible assets		$	23,500	$	(2,916	)	$	20,584

Estimated future amortization expense related to the above intangible assets at September 30, 2009 is as follows:


Fiscal Year	In thousands
2009 (the three months ending December 31)	$	1,195
2010		4,780
2011		4,780
2012		4,608
2013 and thereafter		5,221

Total	$	20,584

7. OTHER ACCRUED LIABILITIES

Other accrued liabilities consisted of the following:


(in thousands)	September 30, 2009		December 31, 2008
Deferred rent liability	$	5,573	$	4,783
Acquisition-related contingent consideration		4,962		—
Other accrued liabilities		16,048		8,559

Total other accrued liabilities	$	26,583	$	13,342

8. DEFERRED REVENUE

Deferred revenue consisted of the following:


(in thousands)	September 30, 2009		December 31, 2008
Product	$	3,966	$	4,987
Support and services		72,067		53,174

Total deferred revenue	$	76,033	$	58,161

Reported as:
Deferred revenue, current	$	58,472	$	45,194
Deferred revenue, non-current		17,561		12,967

Total deferred revenue	$	76,033	$	58,161

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 annual 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 of customer payments made in advance for support contracts with terms of more than 12 months.

RIVERBED TECHNOLOGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

9. 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. 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.

10. 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, 2009 with a remaining non-cancelable lease term in excess of one year are as follows:


(in thousands)	September 30, 2009
2009 (the three months ending December 31)	$	1,988
2010		6,644
2011		7,774
2012		6,726
2013 and thereafter		8,714

Total	$	31,846

The terms of certain lease agreements provide for rental payments on a graduated basis. We recognize rent expense on the straight-line basis over the lease period and have accrued for rent expense incurred but not paid. Rent expense under operating leases was $2.1 million and $1.8 million for the three months ended September 30, 2009 and 2008, respectively, and $6.1 million and $5.2 million for the nine months ended September 30, 2009 and 2008, respectively.

On September 26, 2006, we entered into an Agreement of Sublease (Sublease) for our corporate headquarters, and on March 21, 2007 entered into another lease agreement to expand our corporate headquarters as well as extend the term of the existing Sublease. The terms of the leases are from February 1, 2007 and March 31, 2007, respectively, to July 31, 2014, with two five year renewal options. The aggregate minimum lease commitment for the combined leases is $17.5 million and is included in the table above. We have entered into two letters of credit totaling $3.0 million to serve as the security deposit for the leases, which is included in other assets in the condensed consolidated balance sheet.

On February 29, 2009, we entered into a lease agreement for office space in Boston, Massachusetts. The term of the lease is five years, with one five year renewal option, commencing on March 1, 2009. The aggregate minimum lease commitment is $1.9 million and is reflected in the table above.

During the quarter ended June 30, 2009, we entered into two lease agreements for co-location space. Each of the leases extends five years with an aggregate minimum commitment totaling $4.8 million, which is reflected in the table above.

11. COMMON STOCK

In July 2002, our Board of Directors adopted the 2002 Stock Plan (the “2002 Plan”). In April and May 2006, our Board of Directors approved the 2006 Equity Incentive Plan (the “2006 Plan”), the Purchase Plan and the 2006 Director Stock Option Plan (the “2006 Director Plan”), which became effective upon our IPO. In September 2006, all shares of common stock available for grant under the 2002 Plan transferred to the 2006 Plan.

RIVERBED TECHNOLOGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

In February 2009, our Board of Directors adopted the 2009 Inducement Equity Incentive Plan (the “2009 Plan”). The objective of the 2009 Plan is to provide incentives to attract, retain, and motivate eligible persons whose potential contributions are important to promote our long-term success and the creation of stockholder value. The 2009 Plan is intended to comply with NASDAQ Rule 4350(i)(1)(A)(iv), which governs granting certain awards as a material inducement to an individual entering into employment with us. The 2009 Plan may be used for new hire equity grants should the Board of Directors determine to do so in the future.

Valuation Assumptions

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


	Three months ended September 30,				Nine months ended September 30,
	2009		2008		2009	2008
Employee Stock Options (1)
Expected life in years		4.5		4.5	4.5	4.5
Risk-free interest rate		2.0%		3.1%	1.5% - 2.0%	2.6% - 3.1%
Volatility		52%		50%	50% - 52%	50% - 51%
Weighted average fair value of grants	$	9.63	$	6.82	$6.58	$7.02

(1)	Assumptions used in 2008 exclude assumptions related to the modification accounting associated with the Tender Offer. Such assumptions include an expected life of 2.5 years to 3.6 years, a risk-free interest rate of 2.4% to 2.6% and a volatility of 48% to 49%.


	Three and nine months ended September 30,
	2009	2008
Purchase Plan
Expected life in years	0.5-2.0	0.5-2.0
Risk-free interest rate	0.3%-0.9%	1.7%-2.6%
Volatility	77%-83%	47%-53%
Weighted average fair value of grants	$8.62	$5.33

The expected term represents the period that stock-based awards are expected to be outstanding. For the three and nine months ended September 30, 2009 and 2008, we have elected to use the simplified method of determining the expected term of stock options due to our insufficient historical exercise data. The computation of expected volatility for stock options for the three and nine months ended September 30, 2009 and 2008 is based on the historical volatility of comparable companies from a representative peer group selected based on industry, financial and market capitalization data. The computation of expected volatility for the Purchase Plan for the three and nine month period ended September 30, 2009 is based on our historical volatility. Management estimated expected forfeitures and is recognizing compensation costs only for those equity awards expected to vest.

Stock Options

Options issued under our stock option plans are generally for periods not to exceed 10 years and are issued with an exercise price equal to the market value of our common stock on the date of grant, as determined by the last sale price of such stock on the Nasdaq Global Select Market. Options typically vest either 25% of the shares one year after the options’ vesting commencement date and the remainder ratably on a monthly basis over the following three years, or ratably on a monthly basis over four years. Options granted under the 2002 Plan prior to May 31, 2006 have a maximum term of ten years, and beginning May 31, 2006 have a maximum term of seven years. Options granted under the 2006 Plan have a maximum term of seven years. Options granted under the 2006 Director Plan prior to March 4, 2008 have a maximum term of ten years, and options granted beginning March 4, 2008 have a maximum term of seven years.

In the first quarter of 2009, we granted options under the 2009 Plan to purchase 0.4 million shares of common stock to Mazu employees that joined us following the closing of the merger.

As of September 30, 2009, total compensation cost related to stock options granted to employees and directors but not yet recognized was $67.6 million, net of estimated forfeitures of $14.2 million. 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, 2009 and 2008 was $9.7 million and $9.6 million, respectively. Amortization in the nine months ended September 30, 2009 and 2008 was $29.2 million and $27.3 million, respectively.

RIVERBED TECHNOLOGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

During the second quarter of 2008, we filed a Tender Offer Statement on Schedule TO with the SEC pursuant to which we extended an offer to non-section 16 reporting employees to exchange up to an aggregate of 5,511,495 options to purchase shares of our common stock, whether vested or unvested. Options granted prior to May 1, 2008 with an exercise price greater than 120% of the closing market price on April 30, 2008 were eligible to be tendered pursuant to the offer. The closing market price on April 30, 2008 was $13.67. In accordance with the Tender Offer (the “TO”), the number of new options issued was based on an exchange ratio of 0.85 new shares for each share exchanged based on the number of options tendered. A total of 5,246,325 options were tendered and cancelled, and a total of 4,459,392 options were granted on May 30, 2008 at $17.95 per share. The new options retained the vesting schedule of the options exchanged. The TO was subject to modification accounting whereby the total compensation cost measured at the date of modification was the portion of the grant-date fair value of the original award for which the requisite service was expected to be rendered (or has already been rendered) at that date plus the incremental cost resulting from the modification. The incremental cost resulting from the modification is measured as the excess of the fair value of the modified award over the fair value of the original award immediately before its terms are modified. The incremental fair value of $5.5 million for the new awards was computed using an expected life of 2.5 years to 3.6 years, a risk-free interest rate of 2.4% to 2.6% and a volatility of 48% to 49%. The $407,000 incremental fair value of the vested awards was recognized as compensation expense on the modification date in 2008. The $5.1 million incremental fair value of the unvested awards is being amortized over the remaining service period.

Restricted Stock Units

In the first quarter of 2009, we granted RSUs covering 2.1 million shares of common stock to our employees under the 2006 Plan, which included performance-based RSUs to eligible executives covering 1.8 million shares of common stock and 0.3 million time-based RSUs. We expense the cost of RSUs, which is determined to be the fair market value of the shares of our common stock at the date of grant, ratably over the service period.

The number of performance-based RSUs that vest is variable based upon meeting certain annual performance targets, and require the eligible executives to be employed by us for up to three years from the date of grant. We estimated stock compensation expense for our performance share awards based on the probability-weighted estimate of achieving the annual performance target and only recognized expense for the portions of such awards estimated to be earned and vested. In connection with the performance-based RSUs, we recorded stock compensation expense in operating expenses in the amount of $0.7 million and $1.6 million, for the three and nine months ended September 30, 2009, respectively. Any change in the estimate of the number of performance-based RSUs to be earned will result in an adjustment to the cumulative compensation expense in the period of the change in estimate.

RSUs generally vest over a period of three to four years from the date of grant. Until vested, RSUs do not have the voting rights of common stock and the shares underlying the awards are not considered issued and outstanding. As of September 30, 2009, total unrecognized compensation cost related to non-vested RSUs to employees and directors but not yet recognized was $22.1 million, net of estimated forfeitures of $4.8 million. This cost will be recognized over the remaining weighted-average service period. Amortization in the three months ended September 30, 2009 and 2008 was $2.2 million and $0.7 million, respectively. Amortization in the nine months ended September 30, 2009 and 2008 was $5.2 million and $1.2 million, respectively.

As of September 30, 2009, 2,001,276 shares were available for grant under the 2006 Plan and the 2006 Director Plan. As of September 30, 2009, 1,145,100 shares were available for grant under the 2009 Plan.

Stock Purchase Plan

The Purchase Plan became effective on the effective date of the registration statement relating to our IPO. Under the Purchase Plan, employees may purchase shares of common stock through payroll deductions at a price per share that is 85% of the lesser of the fair market value of our common stock as of the beginning of an applicable offering period or the applicable purchase date, with purchases generally every six months. Employees’ payroll deductions may not exceed 15% of their compensation. Employees may purchase up to 2,000 shares per purchase period provided that the value of the shares purchased in any calendar year does not exceed IRS limitations.

As of September 30, 2009, there was $7.0 million, net of estimated forfeitures, left to be amortized under our Purchase Plan, which will be amortized over the remaining Purchase Plan offering period, which is 16 months. Amortization in the three months ended September 30, 2009 and 2008 was $1.8 million and $2.2 million, respectively. Amortization in the nine months ended September 30, 2009 and 2008 was $5.1 million and $8.2 million, respectively.

As of September 30, 2009, 1,355,660 shares were available for future issuance under the Purchase Plan.

RIVERBED TECHNOLOGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Share Repurchase Program

On April 21, 2008, our Board of Directors authorized a Share Repurchase Program (the “Program”), which authorizes us to repurchase and retire up to $100.0 million of our outstanding common stock during a period not to exceed 24 months from the Board authorization date. The Program does not require us to purchase a minimum number of shares, and may be suspended, modified or discontinued at any time. For the three months ended September 30, 2009, we repurchased 621,908 shares of common stock under this Program on the open market for an aggregate purchase price of $12.2 million, or an average of $19.63 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 $21.0 million

12. INCOME TAXES

Our effective tax rate was 45.4% and (81.4%) for the three months ended September 30, 2009 and 2008, respectively, and 42.0% and (193.0%) for the nine months ended September 30, 2009 and 2008, respectively. Our income tax provision consists of federal, foreign, and state income taxes.

Our effective tax rate differs from the federal statutory rate due to state taxes and significant permanent differences. Significant permanent differences arise primarily from stock-based compensation expense, research and development (R&D) credits, and certain acquisition related items.

As part of our accounting for the acquisition of Mazu, we established deferred tax assets for federal net operating loss carryforwards and R&D credit carryforwards that are subject to limitation under Section 382 of the Internal Revenue Code. Accordingly, we recorded a valuation allowance of $9.2 million related to a portion of the federal net operating loss carryforwards and R&D credit carryforwards that we do not expect to be realized. Any subsequent reduction of the valuation allowance and the recognition of the associated tax benefits will be recorded to our provision for income taxes.

13. 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 activity 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.

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)	2009		2008		2009		2008
United States	$	58,264	$	54,289	$	156,208	$	142,386
Europe, Middle East and Africa		25,747		20,476		75,019		59,369
Rest of the World		18,038		11,782		50,020		39,366

Total revenue	$	102,049	$	86,547	$	281,247	$	241,121

14. LEGAL MATTERS

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, 2009 that, in the opinion of management, might 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 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 and statements related to growth of our revenue and sales and marketing expenses. 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 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 (WAN), 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 approximately 7,000 customers worldwide. We now offer several product lines including Steelhead^® appliances, Central Management Console, Interceptor, Steelhead Mobile and Cascade products.

We are headquartered in San Francisco, California. Our personnel are located throughout the United States and in over twenty-five countries worldwide. We expect to continue to add personnel in the United States 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 solution 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 into our installed base. Continuing investments in research and development are critical to maintaining our technological advantage.

Enhance and extend our product line

We plan to introduce new models of our current products as well as enhancements to their 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.

In August 2007, we began selling our Steelhead Mobile product line, which includes a software client version of our Steelhead appliances, which delivers local area network (LAN)-like application performance to any employee laptop, whether on the road, working from home or connected wirelessly in the office.

In February 2008, we announced the introduction of the Riverbed Services Platform (RSP), which enables the delivery of virtualized edge services without the need to deploy additional physical servers at remote or branch offices. RSP allows customers to deploy services from an array of vendors on Steelhead appliances in a self-contained partition to minimize the hardware infrastructure footprint at the branch office.

In August 2008, we introduced the 50 series models of our Steelhead appliances. The 50 series models represent the next generation of our Steelhead appliances.

In February 2009, we acquired Mazu Networks, Inc. (“Mazu”). Mazu 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 with the Cascade product line.

In October 2009, we introduced the Central Management Console – Virtual Edition (CMC-VE) designed for managed service providers (MSPs). The new capabilities of CMC-VE allow MSPs to reduce operational costs, improve visibility, easily scale and flexibly allocate management licenses to enterprise customers through its new multi-tenant capabilities. CMC-VE runs on VMWare ESX, and MSPs can run it on any existing server that has capacity.

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 distribution channels

We intend to leverage and expand our indirect channels to extend our geographic reach and market penetration. We sell our products directly through our sales force and indirectly through resellers. We have derived 92% of our revenue through indirect channels in the first nine months of 2009. We expect revenue from resellers to continue to constitute a substantial majority of our future revenue. During 2009, we added 280 new reseller partners, four large systems integrators and 15 managed service providers. Also in 2009, we expanded our direct sales force presence in two new countries.

Enhance and extend our support and services capabilities

We plan to enhance and extend our support and services capabilities to continue to support our growing global customer base. In 2008, we increased our sales focus on service contract renewals on our existing customer base, we developed and distributed training programs directed at our partners, and expanded 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 optimization market, 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, growing our installed base of customers and increasing our renewal rate of 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 achieve 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.

Macroeconomic Environment

During 2008 the domestic and international economic environment turned sharply negative, with most developed countries, including the U.S., falling into economic recessions. Credit markets and bank lending contracted suddenly in the third quarter of 2008 making credit generally harder to obtain for most businesses and consumers. Commodity prices declined sharply in the second half of 2008 as demand for commodities decreased. This resulted in a sharp reduction in consumer spending in the second half of 2008. This macroeconomic environment caused the growth trend in corporate spending on IT infrastructure to slow in 2008 and through 2009 continues to be uncertain.

Revenue

Our revenue has grown rapidly since we began shipping products in May 2004, increasing from $2.6 million in 2004 to $333.3 million in 2008. Revenue grew by 41% in 2008 to $333.3 million from $236.4 million in 2007. Revenue grew by 17% in the first nine months of 2009 to $281.2 million from $241.1 million in the first nine months of 2008.

Costs and Expenses

Operating expenses consist of sales and marketing, research and development and general and administrative expenses. Personnel-related costs, including stock-based compensation, are the most significant component of each of these expense categories. As of September 30, 2009 we had 996 employees, which included approximately 60 employees that joined as a result of the Mazu acquisition in the first quarter of 2009, an increase of 22% from the 814 employees at September 30, 2008. The increase in employees is the most significant driver behind the increase in costs and operating expenses. The increase in employees was required to support our increased revenue. The timing of additional hires has affected, 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 was $14.0 million and $13.1 million in the three months ended September 30, 2009 and 2008, respectively, and $40.7 million and $38.3 million, in the nine months ended September 30, 2009 and 2008, 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.


(in thousands)	Three months ended September 30,				Nine months ended September 30,
	2009		2008		2009		2008
Stock-based compensation and related payroll taxes:
Cost of product	$	120	$	54	$	330	$	131
Cost of support and services		1,121		1,126		3,283		3,476
Sales and marketing		6,285		5,931		18,380		17,912
Research and development		3,627		3,431		10,363		9,950
General and administrative		2,798		2,534		8,393		6,838

Total stock-based compensation expense and related payroll taxes	$	13,951	$	13,076	$	40,749	$	38,307

Acquisition of Mazu

On February 19, 2009, we acquired Mazu Networks, Inc. We made an initial payment totaling $23.1 million in cash; and potentially will make additional payments totaling up to $22.0 million in cash based on achievement of certain bookings targets for the one-year period from April 1, 2009 through March 31, 2010. The fair value of the acquisition-related contingent consideration to be distributed directly to shareholders, originally estimated at the acquisition date at $9.9 million, discounted at 13%, was included in the purchase price of Mazu. As of September 30, 2009, the estimated fair value of the contingent consideration recognized as a result of the acquisition of Mazu was reduced to $4.1 million, due to a reduction in management’s estimate of the probability-weighted bookings, discounted at 13%. Any subsequent change in the estimated fair value of the acquisition-related contingent consideration will also be recognized in earnings in the period of the change in estimate. The change in the estimated fair value of the acquisition-related contingent consideration resulted in a net gain of $3.0 million and $5.8 million for the three and nine months ended September 30, 2009, respectively. The estimated fair value of the acquisition-related contingent consideration to be paid to former employees of Mazu is considered compensatory and will be recognized over the service period from February 19, 2009 to March 31, 2010. During the three months ended September 30, 2009, the acquisition-related compensation expense was offset by the reduction in the estimated fair value of the acquisition-related contingent consideration. We recognized $0.9 million of acquisition-related compensation expense in the nine month periods ended September 30, 2009.

The results of operations of Mazu are included in our consolidated results for the period subsequent to the acquisition date of February 19, 2009. In the three months ended September 30, 2009, we recognized $1.7 million in revenue from Mazu products and services, recorded $4.1 million in operating expenses, which includes the costs of assuming 60 former Mazu employees. In the nine months ended September 30, 2009, we recognized $4.6 million in revenue from Mazu products and services and recorded $9.8 million in operating expenses.

The following table summarizes the amortization of intangibles recognized in the three and nine months ended September 30, 2009:


(in thousands)	Three months ended September 30, 2009		Nine months ended September 30, 2009
Cost of product	$	740	$	1,806
Sales and marketing		455	$	1,110

Total amortization of intangibles	$	1,195	$	2,916

The following table summarizes the acquisition-related contingent consideration to be paid to the former Mazu employees recognized in operating expenses, and the acquisition-related costs for the three and nine months ended September 30, 2009:


(in thousands)	Three months ended September 30, 2009			Nine months ended September 30, 2009
Sales and marketing	$	2		$	358
Research and development		2			316
General and administrative		—			197

Total other acquisition-related compensation costs		4			871

Acquisition-related costs (credits)		(3,008	)		(4,447	)

Total	$	(3,004	)	$	(3,576	)

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with United States 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 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 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, stock-based compensation, accounting for business combinations, 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 fiscal year ended December 31, 2008 for a more complete discussion of our critical accounting policies and estimates. 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, 2009, compared to those discussed in our Form 10-K for the year ended December 31, 2008, except as discussed below.

Business Combinations

In our business combinations, we are required to recognize the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. The purchase price allocation process requires management to make significant estimates and assumptions, especially at acquisition date with respect to intangible assets, estimated contingent consideration payments and pre-acquisition contingencies.

Although we believe the assumptions and estimates we have made have been reasonable and appropriate, they are based in part on historical experience and information obtained from the management of the acquired company and are inherently uncertain. Examples of critical estimates in valuing the estimated contingent consideration and certain of the intangible assets we have acquired or may acquire in the future include but are not limited to:

•

estimated fair value of the acquisition-related contingent consideration, which is performed using a probability-weighted discounted cash flow model based upon the expected achievement of performance targets;

•

future expected cash flows from product sales, support agreements, consulting contracts, other customer contracts and acquired developed technologies and patents; and

•

discount rates.

Unanticipated events and circumstances may occur which may affect the accuracy or validity of such assumptions, estimates or actual results. Additionally, 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 of the estimated fair value change. A change in fair value of the acquisition-related contingent consideration could have a material affect on the statement of operations and financial position in the period of the change in estimate.

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 our single reporting unit 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.

Results of Operations

Revenue

We derive our revenue from sales of our appliances and software licenses and from support and services. Product revenue typically recognized upon shipment. Support obligations include technical assistance, unspecified software license updates and defective hardware replacement. 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,
(dollars in thousands)	2009		2008		2009		2008
Total Revenue	$	102,049	$	86,547	$	281,247	$	241,121
Total Revenue by Type:
Product	$	69,543	$	65,238	$	190,322	$	185,574
Support and services	$	32,506	$	21,309	$	90,925	$	55,547
% Revenue by Type:
Product		68%		75%		68%		77%
Support and services		32%		25%		32%		23%
Total Revenue by Geography:
United States	$	58,264	$	54,289	$	156,208	$	142,386
Europe, Middle East and Africa	$	25,747	$	20,476	$	75,019	$	59,369
Rest of the World	$	18,038	$	11,782	$	50,020	$	39,366
% Revenue by Geography:
United States		57%		63%		56%		59%
Europe, Middle East and Africa		25%		24%		27%		25%
Rest of the World		18%		13%		17%		16%
Total Revenue by Sales Channel:
Direct	$	6,640	$	5,649	$	22,637	$	21,003
Indirect	$	95,409	$	80,898	$	258,610	$	220,118
% Revenue by Sales Channel:
Direct		7%		7%		8%		9%
Indirect		93%		93%		92%		91%

Quarter Ended September 30, 2009 Compared to the Quarter Ended September 30, 2008: Product revenue increased by 7% in the three months ended September 30, 2009 as compared to the three months ended September 30, 2008 due primarily to an increase in unit volume. Service revenue increased by 53% in the quarter ended September 30, 2009 as compared to the same quarterly period in the prior year. Substantially all of our customers purchase support when they purchase our products. The increase in support and services revenue on an absolute basis and as a percentage of total revenues is a result of increased product and first year support sales combined with the continued sales focus on increasing the renewal rate of support contracts by existing customers. As our customer base grows, we expect the proportion of revenue generated from support and services to increase.

In the three months ended September 30, 2009, we derived 93% of our revenue from indirect channels. We expect indirect channel revenue to continue to be a significant portion of our revenue.

We generated 43% of our revenue from international locations in the three months ended September 30, 2009 compared to 37% in the three months ended September 30, 2008. 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, 2009 Compared to the Nine Months Ended September 30, 2008: Product revenue increased by 3% in the nine months ended September 30, 2009 over the same prior year period due primarily to an increase in unit volume.

Support and services revenue increased in the nine months ended September 30, 2009 by 64% over the same period in the prior year as a result of our continued focus on increasing the rate of support renewal contracts.

Cost of Revenue and Gross Margin

Cost of product revenue primarily consists of the costs of appliance hardware, manufacturing, shipping and logistics costs and expenses for inventory obsolescence, amortization of certain intangibles, and warranty obligations. Cost of support and service revenue consists of salary and related costs of technical support and professional services personnel, spare parts and logistics services.


	Three months ended September 30,				Nine months ended September 30,
(dollars in thousands)	2009		2008		2009		2008
Revenue:
Product	$	69,543	$	65,238	$	190,322	$	185,574
Support and services		32,506		21,309		90,925		55,547

Total revenue		102,049		86,547		281,247		241,121

Cost of revenue:
Cost of product		14,982		16,653		43,776		45,153
Cost of support and services		9,410		7,174		27,385		20,151

Total cost of revenue		24,392		23,827		71,161		65,304

Gross profit	$	77,657	$	62,720	$	210,086	$	175,817

Gross margin for product		78%		74%		77%		76%
Gross margin for support and services		71%		66%		70%		64%
Total gross margin		76%		72%		75%		73%

Quarter Ended September 30, 2009 Compared to the Quarter Ended September 30, 2008: Cost of product decreased primarily due to lower product costs of $0.8 million from a change of product mix towards the 50 series models, lower shipping costs of $0.2 million, and lower write-downs of inventory of $2.7 million, partially offset by higher unit sales volume, higher manufacturing overhead from higher personnel costs of $0.5 million, increased costs due to royalty arrangements of $0.7 million, and amortization of intangible assets of $0.7 million. Product gross margins increased as lower inventory write-downs and favorable product mix more than offset the increases in manufacturing overhead, royalty arrangements and amortization of intangible assets.

Cost of support and services increased, as we added technical support headcount domestically and abroad to support our growing customer base. Technical support and services headcount was 130 employees as of September 30, 2009 compared to 100 employees as of September 30, 2008. Support and services gross margins increased as new service contracts and service contract renewals more than offset the costs related to increased technical support headcount.

Nine Months Ended September 30, 2009 Compared to the Nine Months Ended September 30, 2008: Cost of product decreased primarily due to lower product costs of $3.1 million from a change of product mix towards the 50 series models and lower write-downs of inventory of $1.2 million, partially offset by increased amortization of intangible assets of $1.8 million, and higher manufacturing overhead from higher personnel costs of $1.5 million. Product gross margins increased as lower inventory write-downs and favorable product mix more than offset the increases in manufacturing overhead and amortization of intangible assets.

Cost of support and services increased, as we added technical support headcount domestically and abroad to support our growing customer base. Support and services gross margins increased as a result of revenues increasing at a higher rate than support and services costs associated with increased headcount.

Sales and Marketing Expenses

Sales and marketing expenses primarily include personnel costs, sales commissions, marketing programs and facilities costs.


	Three months ended September 30,				Nine months ended September 30,
(dollars in thousands)	2009		2008		2009		2008
Sales and marketing expenses	$	44,192	$	34,855	$	127,003	$	100,992
Percent of total revenue		43%		40%		45%		42%

Quarter Ended September 30, 2009 Compared to the Quarter Ended September 30, 2008: Sales and marketing expenses increased by $9.3 million, or 27%, primarily due to an increase in the number of sales and marketing employees, as sales and marketing headcount grew to 464 employees as of September 30, 2009 from 379 employees as of September 30, 2008, including 31 Mazu employees. The increase in employees resulted in higher salary expense and employee related benefits. Additionally, commission expense increased in the three months ended September 30, 2009 as compared to the three months ended September 30, 2008 due to increased revenue and personnel. Salaries and related benefits, bonuses and commissions accounted for $4.6 million, marketing related activities accounted for $0.8 million, facilities and information technology expenses accounted for $0.9 million, travel and entertainment expenses accounted for $0.6 million, and bad debt expense accounted for $0.3 million of the $9.3 million increase in sales and marketing expenses. Stock-based compensation, which was $6.3 million in the three months ended September 30, 2009 compared to $5.9 million in the three months ended September 30, 2008, accounted for an increase of $0.4 million in sales and marketing expenses. In addition, the third quarter of 2009 includes acquisition-related expenses for the amortization of intangibles of $0.5 million.

We plan to continue to make investments in sales and marketing with the intent to add new 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 grow 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.

Nine Months Ended September 30, 2009 Compared to the Nine Months Ended September 30, 2008: The increase in sales and marketing expenses of $26.0 million was primarily due to an increase in the number of sales and marketing employees. The increase in employees resulted in higher salary expense and employee related benefits. Additionally, commission expense increased in the nine months ended September 30, 2009 as compared to the nine months ended September 30, 2008 due to the increase in revenue and additional personnel. Salaries and related benefits, bonuses and commissions accounted for $14.6 million, marketing related activities accounted for $3.0 million, facilities and information technology expenses accounted for $1.5 million, outside services expenses accounted for $2.1 million, travel and entertainment expenses accounted for $0.7 million, and bad debt expense accounted for $1.0 million of the $26.0 million increase in sales and marketing expenses. Stock-based compensation, which was $18.2 million in the nine months ended September 30, 2009 compared to $17.9 million in the nine months ended September 30, 2008, accounted for an increase of $0.3 million in sales and marketing expenses. In addition, the nine months ended September 30, 2009 includes acquisition-related expenses for the amortization of intangibles of $1.1 million and compensation expense of $0.4 million related to the acquisition-related contingent consideration to be paid to former employees of Mazu.

Research and Development Expenses

Research and development expenses primarily consist of personnel costs and facilities costs. We expense research and development expenses as incurred.


	Three months ended September 30,				Nine months ended September 30,
(dollars in thousands)	2009		2008		2009		2008
Research and development expenses	$	17,302	$	14,582	$	50,368	$	43,278
Percent of total revenue		17%		17%		18%		18%

Quarter Ended September 30, 2009 Compared to the Quarter Ended September 30, 2008: Research and development expenses increased by $2.7 million, or 19%, in the three months ended September 30, 2009 compared to the three months ended September 30, 2008 due to an increase in personnel and facility-related costs as a result of research and development headcount increasing to 270 employees as of September 30, 2009 from 234 employees as of September 30, 2008, including 24 Mazu employees. Salaries, bonuses and related benefits accounted for $1.7 million, and facilities-related costs accounted for $0.5 million of the $2.7 million increase in research and development expenses. Stock-based compensation, which was $3.6 million in the three months ended September 30, 2009 compared to $3.4 million in the three months ended September 30, 2008, accounted for $0.2 million of the increase in research and development expenses. We plan to continue to invest in research and development as we develop new products and make further enhancements to existing models.

Nine Months Ended September 30, 2009 Compared to the Nine Months Ended September 30, 2008: Research and development expenses increased by $7.1 million in the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008 due to an increase in personnel and facility-related costs. Salaries, bonuses and related benefits accounted for $5.1 million, and facilities-related costs accounted for $0.6 million of the $7.1 million increase in research and development expenses. Stock-based compensation, which was $10.3 million in the nine months ended September 30, 2009 compared to $9.9 million in the nine months ended September 30, 2008, accounted for $0.4 million of the increase in research and development expenses. Acquisition-related expenses for the compensation expense related to the acquisition-related contingent consideration to be paid to former employees of Mazu were $0.3 million in the nine months ended September 30, 2009.

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,
(dollars in thousands)	2009		2008		2009		2008
General and administrative expenses	$	9,297	$	10,419	$	27,382	$	29,925
Percent of total revenue		9%		12%		10%		12%

Quarter Ended September 30, 2009 Compared to the Quarter Ended September 30, 2008: General and administrative expenses decreased by $1.1 million, or 11%, in the three months ended September 30, 2009 compared to the three months ended September 30, 2008 due to a decrease in legal fees incurred to defend intellectual property (IP) litigation that was settled in the third quarter of 2008, offset by an increase in personnel costs, primarily as a result of headcount increasing to 114 employees as of September 30, 2009 from 95 employees as of September 30, 2008. Of the $1.1 million decrease in general and administrative expenses, legal fees decreased $2.0 million offset by an increase in salaries, bonuses and related benefits of $0.6 million. Legal fees associated with the IP litigation were $2.0 million in the quarter ended September 30, 2008 but no significant fees were incurred in the quarter ended September 30, 2009. Stock-based compensation, which was $2.8 million in the three months ended September 30, 2009 compared to $2.5 million in the three months ended September 30, 2008, accounted for $0.3 million of the offsetting increase in general and administrative expenses.

Nine Months Ended September 30, 2009 Compared to the Nine Months Ended September 30, 2008: The decrease in general and administrative expenses for the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008 is due to a decrease in legal fees incurred to defend IP litigation that was settled in the third quarter of 2008, offset by an increase in personnel costs. Of the $2.5 million decrease in general and administrative expenses, professional service fees decreased $6.2 million offset by an increase in salaries, bonuses and related benefits of $1.8 million. Professional service fees decreased primarily due to a reduction in legal fees of $5.0 million. Legal fees associated with IP litigation were $4.3 million in the nine months ended September 30, 2008. Tax advisory fees decreased by $0.8 million. Stock-based compensation, which was $8.3 million in the nine months ended September 30, 2009 compared to $6.8 million in the nine months ended September 30, 2008, accounted for approximately $1.5 million of the offsetting increase in general and administrative expenses.

Acquisition-Related Costs

Acquisition-related costs include changes in the fair value of the acquisition-related contingent consideration, transaction costs and integration-related costs.

The estimated fair value of acquisition-related contingent consideration as of the acquisition date to be distributed directly to shareholders was recognized as part of the purchase price of Mazu. Changes in the fair value of this liability are recognized in earnings as acquisition-related costs in the period of the change in estimate. The fair value estimate is based on a discounted probability weighted bookings amount. Actual achievement of bookings below $16.0 million would reduce the liability to zero and achievement of bookings of $35.0 million or more would increase the liability to $16.6 million. The achievement of actual bookings could be different than our estimates and could have a material effect on the fair value of the acquisition-related contingent consideration which will be recognized in earnings in the period of the change in estimate.

The fair value of the acquisition-related contingent consideration to be distributed directly to shareholders, originally estimated at the acquisition date at $9.9 million, discounted at 13%, excluded the fair value estimate of $3.8 million to be paid to former employees of Mazu. As of September 30, 2009, the estimated fair value of the contingent consideration recognized as a result of the acquisition of Mazu was reduced to $4.1 million from our acquisition date estimated fair value of $9.9 million, primarily due to a reduction in the probability-weighted bookings estimate. 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.

During the three months ended September 30, 2009, we recorded a gain of $3.0 million related to change in fair value of the acquisition-related contingent consideration to be paid directly to the Mazu shareholders. During the nine months ended September 30, 2009, we recorded a net gain of $4.4 million, including $5.8 million related to change in fair value of the acquisition-related contingent consideration to be paid directly to the Mazu shareholders, partially offset by transaction costs such as legal, accounting, valuation and other professional services of $0.6 million and integration-related costs of $0.8 million.

The following table summarizes the acquisition-related costs, including changes in the estimated fair value of the acquisition-related contingent consideration to be distributed directly to shareholders of Mazu, transaction costs and integration-related costs, recognized in the three and nine months ended September 30, 2009.


(in thousands)	Three months ended September 30, 2009			Nine months ended September 30, 2009
Transaction costs	$	—		$	595
Severance		—			412
Integration costs		—			364

Change in fair value of acquisition-related contingent consideration		(3,008	)		(5,818	)

Acquisition-related costs (credits)	$	(3,008	)	$	(4,447	)

Quarter Ended September 30, 2009:

Nine Months Ended September 30, 2009:

As of September 30, 2009, the estimated fair value of the acquisition-related contingent consideration to be distributed directly to shareholders, which was recognized as a result of the acquisition of Mazu was reduced to $4.1 million from our acquisition date estimated fair value of $9.9 million, due to a reduction in the probability-weighted bookings estimate. The reduction in our fair value estimate resulted in a net gain of $5.8 million for the period. In addition, in the first quarter of 2009 we incurred transaction costs such as legal, accounting, valuation and other professional services of $0.6 million and integration-related costs of $0.8 million

Other Income, Net

Other income, net consists primarily of interest income and foreign currency exchange losses.


(dollars in thousands)	Three months ended September 30,						Nine months ended September 30,
(dollars in thousands)	2009			2008			2009			2008
Interest income	$	413		$	1,507		$	1,591		$	5,440
Other		(272	)		(220	)		(767	)		(381	)

Total other income, net	$	141		$	1,287		$	824		$	5,059

Quarter Ended September 30, 2009 Compared to the Quarter Ended September 30, 2008: Other income, net, decreased in the three months ended September 30, 2009 due to decreased interest income on cash and marketable securities balances as a result of declining interest rates. Weighted average interest rates applicable to our cash and marketable securities balances decreased to 0.6% in the three months ended September 30, 2009 compared to 2.2% in the three months ended September 30, 2008. Other expense primarily represents foreign exchange losses on foreign currency denominated liabilities. The increase in other expense is a result of the decline of the U.S. dollar relative to other major foreign currencies in the quarter.

Nine Months Ended September 30, 2009 Compared to the Nine Months Ended September 30, 2008: Other income, net, decreased in the nine months ended September 30, 2009 due to decreased interest income on cash and marketable securities balances as a result of declining interest rates. Weighted average interest rates applicable to our cash and marketable securities balances decreased to 0.8% in the nine months ended September 30, 2009 compared to 2.8% in the nine months ended September 30, 2008. Other expense primarily represents foreign exchange losses on foreign currency denominated liabilities. The increase in other expense is a result of the decline of the U.S. dollar relative to other major foreign currencies in the nine months ending September 30, 2009.

Provision for Income Taxes

The provision for income taxes for the three months ended September 30, 2009 and 2008 was $4.5 million, and $5.6 million, respectively, and $4.5 million, and $8.3 million for the nine months ended September 30, 2009 and 2008, respectively. Our income tax provision consists of federal, foreign, and state income taxes. Our effective tax rate was 45.4% and (81.4%) for the three months ended September 30, 2009 and 2008, respectively, and 42.0% and (193.0%) for the nine months ended September 30, 2009 and 2008, respectively.

Our effective tax rate for the three and nine months ended September 30, 2009 is higher when compared to the same period in the prior year primarily due to a valuation allowance recorded on our federal and state deferred tax assets in the prior year that is no longer required in the current year and a legal settlement paid in the prior year that resulted in a net loss before taxes.

We expect our effective tax rate in 2009 to fluctuate on a quarterly basis. The effective tax rate could be affected by 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.

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. The valuation allowance primarily relates to deferred tax assets established in purchase accounting. Any subsequent reduction of that portion of the valuation allowance and the recognition of the associated tax benefits will be recorded to our provision for income taxes.

Liquidity and Capital Resources


	As of September 30,			As of December 31,
(in thousands)	2009			2008
Working capital	$	253,777		$	254,079
Cash and cash equivalents	$	75,709		$	95,378
Marketable securities	$	221,058		$	172,398

	Nine months ended September 30,
(in thousands)	2009			2008
Cash provided by operating activities	$	73,399		$	60,995
Cash used in investing activities	$	(76,589	)	$	(92,035	)
Cash used in financing activities	$	(16,814	)	$	(14,446	)

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.

Marketable securities consist of government sponsored enterprise obligations, treasury bills and corporate bonds and notes. The fair value of marketable securities is determined as the exit price in the principal market in which we would transact. The fair value of our marketable securities has not materially fluctuated from historical cost. The accumulated unrealized losses on marketable securities recognized in accumulated other comprehensive loss in our stockholders’ equity is $0.1 million. The recent volatility in the credit markets has increased the risk of material fluctuations in the fair value of marketable securities.

Cash and cash equivalents, and marketable securities increased by $29.0 million in the nine month period ended September 30, 2009 to $296.8 million. Cash provided by operating activities of $73.4 million was partially offset by significant cash expenditures in the nine months ended September 30, 2009, including $29.0 million in share repurchases, $20.5 million paid for the acquisition of Mazu, net of cash acquired and $5.0 million used to pay down debt acquired in the acquisition of Mazu.

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. Current restricted cash totaled $0.1 million at September 30, 2009 and December 31, 2008, and long-term restricted cash totaled $3.5 million at September 30, 2009 and December 31, 2008. 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 August 30, 2010 and July 31, 2014.

We have significant international sales costs and derive approximately 44% of our revenues outside the U.S. Our sales contracts are principally denominated in United States dollars and therefore changes in foreign exchange rates have not 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.

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 cash flows from sales personnel. In addition, operating cash flows for the nine months ended September 30, 2009 includes the change in acquisition-related contingent consideration of $4.9 million.

Cash provided by operating activities increased to $73.4 million in the nine months ended September 30, 2009, compared to $61.0 million in the nine months ended September 30, 2008. An increase in net income increased cash flow from operations by $18.8 million, offset by an increase in deferred tax assets which decreased cash flow from operations by $10.0 million. Cash flow from operations includes significant non-cash operating items including stock-based compensation of $40.4 million and $38.2 million in the nine months ended September 30, 2009 and 2008, respectively, and depreciation and amortization of $10.4 million and $5.7 million in the nine months ended September 30, 2009 and 2008, respectively.

Cash Flows from Investing Activities

Cash flows used in investing activities primarily relate to investments in marketable securities, acquisitions and capital expenditures to support our growth.

Cash used in investing activities decreased in the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008 primarily due to lower purchases of marketable securities and capital expenditures, partially offset by $20.5 million paid for the acquisition of Mazu, net of cash and cash equivalents acquired of $2.6 million.

Cash Flows from Financing Activities

Cash used in financing activities was $16.8 million and $14.4 million in the nine months ended September 30, 2009 and 2008, respectively. Cash used for repurchases of common stock was $29.0 million in the nine months ended September 30, 2009 compared to $25.0 million in the nine months ended September 30, 2008; cash provided from the exercise of stock options was $15.5 million and $9.1 million in the nine months ended September 30, 2009 and 2008 respectively; and cash used to pay down the debt acquired in the acquisition of Mazu was $5.0 million in the nine months ended September 30, 2009.

On April 21, 2008, our Board of Directors authorized a Share Repurchase Program, which authorizes us to repurchase up to $100.0 million of our outstanding common stock during a period not to exceed 24 months from the Board authorization date. The Program does not require us to purchase a minimum number of shares, and may be suspended, modified or discontinued at any time. During the nine month period ended September 30, 2009, we repurchased 1,954,613 shares of common stock under this Program for an aggregate purchase price of $29.0 million, or an average of $14.84 per share. The maximum dollar value of shares of common stock that remain available for purchase under the Program is $21.0 million. The timing and amounts of these repurchases 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.

We believe that our net proceeds from operations, together with our cash and marketable securities balance at September 30, 2009, 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. We may enter into arrangements for potential investments in, or acquisitions of, complementary businesses, services or technologies, which also 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, 2009:


	Total		Remaining three months of 2009		2010		2011		2012		2013 and beyond
	(in thousands)
Contractual Obligations
Operating leases	$	31,846	$	1,988	$	6,644	$	7,774	$	6,726	$	8,714
Purchase obligations (1)	$	15,286		15,059		149		70		8		—
Acquisition-related contingent consideration	$	4,962		—		4,962		—		—		—

Total contractual obligations	$	52,094	$	17,047	$	11,755	$	7,844	$	6,734	$	8,714

(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, 2009 and December 31, 2008, 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.

Other

At September 30, 2009 and December 31, 2008, 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 United States 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 since 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.

Interest Rate Sensitivity

We had unrestricted cash and cash equivalents totaling $75.7 million and $95.4 million at September, 2009 and December 31, 2008, respectively. Cash and cash equivalents, which are held for working capital purposes, 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.

In addition, we had marketable securities totaling $221.1 million and $172.4 million at September 30, 2009 and December 31, 2008, respectively. Marketable securities 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. Declines in interest rates, however, will reduce future investment income. The recent volatility in the credit markets has caused a macro shift in investments into highly liquid short-term investments such as U.S. Treasury bills. This has caused a significant decline in short-term interest rates, which we expect will 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 of September 30, 2009, 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) as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act.

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, 2009, 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.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the third quarter of 2009 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

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 may 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 which are outside of our control, including the changing and recently volatile U.S. and global economic environment, 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 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:

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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;

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

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

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general economic conditions in our domestic and international markets;

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limited visibility into customer spending plans;

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changing market conditions, including current and potential customer consolidation;

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customer concentration;

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the timing of recognizing revenue in any given quarter as a result of software revenue recognition 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;

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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;

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

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

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

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

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

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

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

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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;

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

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our estimates of the fair value of acquisition-related contingent consideration may change significantly and could have a material effect on earnings; and

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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.

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 or financial condition.

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, we face competition from a number of established companies, including Cisco Systems, Blue Coat Systems, Juniper Networks, Citrix Systems, and F5 Networks. We also face competition from a large number of smaller private companies and new market entrants.

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.

Continued 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, the recent turmoil in credit markets increases our exposure to our customers’ and partners’ credit risk, which could result in reduced revenue or additional 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 to make capital commitments. If the conditions in the U.S. and global economic environment 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. Economic weakness, customer financial difficulties and constrained spending on IT initiatives have recently 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 market we serve is 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, such as occurred in 2008, 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, such as we have recently experienced, may result in customers or channel partners either delaying or entirely foregoing planned purchases of our products as 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 the credit market turmoil or an associated downturn in their own business, which in turn could harm our business, operating results and financial condition.

We rely heavily on indirect distribution partners to sell our products. Disruptions to, or our failure to effectively 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 indirect distribution partners, including value-added resellers and service providers. 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. Accordingly, our revenue depends in large part on the effective performance of these channel partners, and the loss of or reduction in sales to our channel partners could materially reduce our revenues. 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.

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, 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 exceed our sales forecast, we could possibly experience stock shortages, which would negatively affect our revenues. If legacy product line sales 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.

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.

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 increase in the 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 are possible and our and our suppliers’ ability to predict the availability of such components may be limited. Some of these components are available only from limited sources of supply. The unavailability of any of these components would prevent us from shipping products because each of these components is necessary to the proper functioning of our appliances. In addition, the lead times associated with certain components are lengthy and preclude rapid changes in quantity requirements and delivery schedules.

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.

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.

Some 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, 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.

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. 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 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. We expect that infringement claims may increase as the number of products and competitors in our market 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 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, 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, effort and money in our sales efforts without any assurance that our efforts 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. Beginning in early 2008 and continuing through the third quarter of 2009, product purchases have in some instances been delayed by the volatile U.S. and global economic environment, which has 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.

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

In the third quarter of 2009, we derived approximately 43% 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 subject us to a variety of risks, including:

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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;

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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;

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unfavorable changes in tax treaties or laws;

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increased exposure to foreign currency exchange rate risk; and

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reduced protection for intellectual property rights in some countries.

Recently, certain foreign currencies have experienced 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.

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 could harm our international operations, reduce our international sales and harm our business, operating results and financial condition.

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. 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 2009, our research and development expenses were $17.3 million, or approximately 17% 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.

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 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.

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’re 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. 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.

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, which 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.

We may engage in future acquisitions that could disrupt our business and cause dilution to our stockholders.

In February 2009, we acquired Mazu Networks, Inc. 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. 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 compete in rapidly evolving markets and have a limited operating history, which make 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.

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. In such 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 Steelhead appliances, our Interceptor appliances, our Central Management Console appliances, our Cascade appliances, and our Steelhead Mobile software client and controller. For example, in our Steelhead appliances, we use third-party software to configure a storage adapter for specific redundant disk setups as well as to initialize and diagnose hardware on certain models, and in our Central Management Console and Steelhead Mobile Controller appliances we use third-party software to help manage statistics and reporting. Each of these software programs is currently available from only one vendor. As a result, any disruption in our access to these software programs 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.

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 U.S. export controls and may be exported outside the U.S. 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 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. 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 control 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 control over financial reporting and disclosure controls and procedures. In particular, for the year ended December 31, 2008, we performed system and process evaluation and testing of our internal control over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal control 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 control 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.

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. In particular, in September 2009, the Financial Accounting Standards Board issued statements that change the way companies are required to account for revenue under multiple deliverable arrangements in their income statements. We plan to early adopt this statement in the first quarter of fiscal 2010.

One new standard changes the scope of ASC 985-605, Software Revenue Recognition (formerly SOP 97-2) and excludes certain products that were previously included in the scope. We expect that substantially all of our products will be considered non-software deliverables and excluded from the scope of ASC 985-605. The implementation of this new accounting standard may cause significant fluctuations in our reported revenue and may make forecasting revenue more difficult causing significant variances between our forecasted results and actual results. These new regulations frequently require significant judgments in their application, and are subject to numerous subsequent clarifications and interpretations, some of which may require changes in the way we recognize revenue and may require restatement of prior period revenue and results, either of which could adversely affect our reported results.

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 a significant component 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 Financial Accounting Standards Board has adopted changes that require companies to record a charge to earnings for employee stock option grants and other equity incentives. We adopted this standard effective January 1, 2006. By causing us to record significantly increased compensation costs, such accounting changes 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 future income taxes could be affected by disqualifying dispositions of stock from our employee stock purchase plan and stock options, by 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, by 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 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, the current instability and uncertainty in the financial markets 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.

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 or terrorism.

Our main operations, including our primary data centers, 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 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. Acts of terrorism or war could also cause disruptions in our or our customers’ business 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 have been highly volatile. Further, our common stock has a limited trading history. Since our initial public offering in September 2006 through September 30, 2009, our stock price has fluctuated from a low of $7.10 to a high of $52.81. 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 in the past 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;

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

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the gain or loss of significant customers;

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recruitment or departure of key personnel;

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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;

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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;

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

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

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

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an announced acquisition of or by a competitor; and

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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 events that affect other companies in our industry or the stock market generally even if these 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 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.

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.

Insiders have substantial control over us and will be able to influence corporate matters.

As of September 30, 2009, our directors and executive officers and their affiliates beneficially owned, in the aggregate, approximately 15.2% of our outstanding common stock. As a result, these stockholders will be able to exercise significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, such as a merger or other sale of our company or its assets. This concentration of ownership could limit your ability to influence corporate matters and may have the effect of delaying or preventing a third party from acquiring control over us.

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, 2009 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, 2009 – July 31, 2009	—	$	—	—	$	33,225,000
August 1, 2009 – August 31, 2009	478,076		19.74	478,076		23,789,000
September 1, 2009 – September 30, 2009	143,832		19.28	143,832		21,016,000

Total	621,908	$	19.63	621,908	$	21,016,000

(1)	On April 21, 2008, our Board of Directors authorized a Share Repurchase Program, which authorizes us to repurchase up to $100.0 million of our outstanding common stock during a period not to exceed 24 months from the Board authorization date.

(2)

During the third quarter of 2009, we repurchased 621,908 shares of common stock under this Program for an aggregate purchase price of approximately $12.2 million, or an average of $19.63 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.

Item 6.

Exhibits


Exhibit No.		Description

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.

The certification attached as Exhibit 32.1 that accompanies this Quarterly Report on Form 10-Q is 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.

(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 December 18, 2008.

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 30, 2009


RIVERBED TECHNOLOGY, INC.

By:		/s/ JERRY M. KENNELLY
		Jerry M. Kennelly
		President and Chief Executive Officer

Dated: October 30, 2009


RIVERBED TECHNOLOGY, INC.

By:		/s/ RANDY S. GOTTFRIED
		Randy S. Gottfried
		Chief Financial Officer

EXHIBIT INDEX


Exhibit No.		Description

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.

(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 December 18, 2008.

Riverbed Technology, Inc. - FORM 10-Q - October 30, 2009

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