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.

                                                      Three months ended         Nine months ended
(in thousands)                                           September 30,             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:

                                        Three months ended     Nine months ended
    (in thousands)                      September 30, 2009    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:

                                              Three months ended             Nine months ended
(in thousands)                                September 30, 2009             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.

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.

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       Nine months ended
                                            September 30,            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       Nine months ended
                                               September 30,            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 . . .