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RVBD > SEC Filings for RVBD > Form 10-K on 14-Feb-2014All Recent SEC Filings

Show all filings for RIVERBED TECHNOLOGY, INC.

Form 10-K for RIVERBED TECHNOLOGY, INC.


14-Feb-2014

Annual Report


Item 7. 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 Annual Report on Form 10-K. The information in this Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. 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, including statements under the headings "The Riverbed Strategy," "Major Trends Affecting our Financial Results" and statements regarding our revenue, gross margin, expenses, and future liquidity requirements. For example, words such as "may," "will," "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 Annual Report on Form 10-K in the section titled "Risk Factors" and the risks discussed in our other SEC filings. We undertake no obligation to publicly release any revisions to or otherwise update the forward-looking statements after the date of this Annual Report on Form 10-K.
Overview
We were founded in May 2002 by experienced industry leaders with a vision to improve the performance of wide-area distributed computing. We began commercial shipments of our Steelhead products in May 2004 and have since sold our products to approximately 25,000 customers worldwide, including customers resulting from acquisitions. We have two product lines:

         Application Acceleration product line, which includes our wide area
          network (WAN) optimization products, including Steelhead and Granite,
          our Stingray virtual application delivery controllers (ADCs), and our
          Whitewater cloud storage delivery products; and


         Performance Management product line, which includes our
          application-aware network performance management (NPM), application
          performance management (APM), network engineering, operations and
          planning (NEOP), and network simulation and modeling products. The
          Performance Management product line combines our former Cascade
          products and the products acquired from OPNET Technologies, Inc.
          (OPNET).

We are headquartered in San Francisco, California. Our personnel are located throughout the U.S. and in more than 35 countries worldwide. We expect to continue to add personnel in the U.S. and internationally to provide additional geographic sales, research and development, general and administrative and technical support coverage.
The Riverbed Strategy
Our goal is to develop solutions that are widely recognized as the preeminent performance and efficiency standard for organizations of all sizes and geographies. Key elements of our strategy include:
Enhance our customers' performance - Riverbed is the performance company. Our vision is to provide the most complete platform for location independent computing to ensure flawless application performance and the best user experience. This will allow customers to turn distance and location into competitive advantage by letting business objectives - not technical constraints - drive where and how applications and data are hosted and delivered for optimal business performance. Our vision focuses on the intersection of applications, networks, and storage, and brings customers a single, unified view of performance in their distributed environment.

Maintain and extend our technological advantages - We believe that we offer the broadest ability to enable rapid and reliable access to applications and data for our customers. We intend to enhance our position as a leader and innovator in the WAN optimization, branch converged infrastructure, application delivery controller and performance management markets. We also intend to continue to sell new capabilities, such as our solutions oriented toward cloud environments, into our installed base and to new customers. Continuing investments in research and development are critical to maintaining our technological advantage.

Transform from a single-product to platform company - We have introduced enhancements to our product capabilities in order to address our customers' size and application requirements. We have also


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introduced new products to extend our market and utilize our technology platform to extend our capabilities.
Extend our technology partner ecosystem - We work with a broad and diverse ecosystem of partners to extend the value of our platform and deliver a range of implementation, integration and value added services. We have enhanced our product capabilities via integration of and interoperability with partner technologies.

Increase market awareness - To generate increased demand for our products, we will continue to market the effectiveness of our comprehensive IT performance solutions.

Scale our sales force and distribution channels - We sell our products directly through our sales force and indirectly through channel partners. We intend to leverage, innovate and grow our sales force and our indirect channels to extend our geographic reach and market penetration.

Enhance and extend our support and services capabilities - On an ongoing basis, we plan to enhance and extend our support and services capabilities to continue to support our growing global customer base. For example, in March 2013, we launched Splash, a new feature-rich community site for customers.

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 by integrating performance acceleration and performance management solutions, 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, storage delivery, APM, NPM, and ADC markets, our ability to continue to attract new customers in those markets and our ability to generate additional sales from existing customers. Our growth in support and services revenue is dependent upon increasing the number of products under support contracts, which is dependent on both growing our installed base of customers and renewing existing support contracts. Our future profitability and rate of growth will be directly affected by the continued acceptance of our products in the marketplace, as well as the timing and size of orders, product mix, average selling prices and costs of our products and general economic conditions. Our ability to 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 typically personnel costs. Personnel costs consist of salaries, benefits and incentive compensation for our employees, including commissions for sales personnel and stock-based compensation. Revenue
Our revenue has grown rapidly since we began shipping products in May 2004, increasing from $2.6 million in 2004 to $1.0 billion in 2013. Revenue grew by 24% in 2013 from $836.9 million in 2012. We believe that our revenue growth is a positive sign that our products, support and services have a significant value proposition to our customers and that the markets that we compete in are still expanding. In 2013, revenue has been favorably impacted by $159.9 million as compared to 2012 related to our acquisition of OPNET in December 2012. Costs and Expenses
Operating expenses consist of sales and marketing, research and development, general and administrative expenses, and acquisition-related costs. Operating expenses from our OPNET acquisition, including acquisition related amortization of acquired intangibles of $48.4 million and acquisition and integration related costs of $18.3 million, are the most significant contributor to the increase in operating expenses in 2013 as compared to 2012. Personnel-related costs, including stock-based compensation, are the most significant component of each of these expense categories. Increased personnel-related costs were also the most significant driver behind the increase in costs and operating expenses in 2012 as compared to 2011. The increase in personnel-related costs reflects our investment in supporting our increased revenue and expanding our product offerings through strategic transactions. The timing and number of additional hires has and could materially affect our operating expenses, both in dollar amount and as a percentage of revenue, in any particular period.


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Stock-based Compensation Expense
Stock-based compensation expense and related payroll taxes were $92.8 million,
$92.5 million, and $97.2 million in the years ended December 31, 2013, 2012 and
2011 respectively. We expect to continue to incur increasing stock-based
compensation expense as we expect stock-based compensation to continue to play
an important part in the overall compensation structure for our employees.
Stock-based compensation expense and related payroll tax was as follows:

                                                          Year ended December 31,
(in thousands)                                       2013           2012           2011
Cost of product                                  $    1,241     $    1,011     $    1,075
Cost of support and services                          9,015          7,080          7,001
Sales and marketing                                  41,752         36,639         38,249
Research and development                             26,157         29,734         29,599
General and administrative                           14,636         18,007         21,275
Total stock-based compensation expense and
related payroll taxes                            $   92,801     $   92,471     $   97,199

Acquisitions
On December 18, 2012, we completed our acquisition of OPNET to extend our NPM business into the APM market. The addition of OPNET's broad-based family of APM products and Network Engineering, Operations and Planning (NEOP) products enhance our position in the NPM and APM markets and enables us to provide customers with an integrated solution that both monitors and accelerates network and application performance. The total acquisition date fair value of consideration transferred was $980.2 million, which included cash payments of $857.0 million, common stock issued of $122.6 million and the fair value of options assumed of $0.6 million.
During the year ended December 31, 2013, the OPNET acquisition contributed $159.9 million in revenue as compared to $5.5 million for the year ended December 31, 2012. The revenues of OPNET are included in our consolidated results for the periods presented subsequent to the acquisition date and are part of our Performance Management product line. Included in total Cost of product revenue for the year ended December 31, 2013 was OPNET acquisition-related intangible amortization of $32.9 million. Included in total operating expenses for the year ended December 31, 2013 was OPNET acquisition-related intangible amortization of $48.4 million.
During the first quarter of 2012, we purchased certain assets of Expand Networks Ltd. (Expand), including its intellectual property for $6.5 million. During fiscal 2011, we acquired Zeus Technology Ltd. (Zeus) and Aptimize Ltd. (Aptimize) to expand our product offerings in the virtual ADC and web content optimization markets. Combined, the total acquisition date fair value of consideration transferred was approximately $136.7 million. Seasonality
Our operating results may be affected by seasonal buying patterns. Historically, we have experienced a stronger seasonal revenue cycle in the fourth fiscal quarter and lowest in our first fiscal quarter.

Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP). These accounting principles require us to make certain estimates and judgments that can affect the reported amounts of assets and liabilities as of the date of the 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.


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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 including the fair value measurement of contingent consideration, goodwill, intangible assets and impairment assessments, accounting for income taxes, and inventory valuation. Our critical accounting policies have been discussed with the Audit Committee of the Board of Directors. Revenue Recognition
We recognize revenue when all of the following have occurred: (1) we have entered into a legally binding arrangement with a customer; (2) delivery has occurred; (3) customer payment is deemed fixed or determinable and free of contingencies and significant uncertainties; and (4) collection is reasonably assured.
The majority of our product revenue includes hardware appliances containing software components that function together to provide the essential functionality of the product. Therefore, our hardware appliances are considered non-software deliverables. Most non-software products and services qualify as separate units of accounting because they have value to the customer on a standalone basis and our revenue arrangements generally do not include a general right of return relative to delivered products. We account for non-software arrangements with multiple deliverables, which generally include support services sold with each of our hardware appliances, using the relative selling price method under the revenue recognition guidance for multiple deliverable arrangements.
Our product revenue also includes revenue from the sale of stand-alone software products. Stand-alone software may operate on our hardware appliance, but is not considered essential to the functionality of the hardware. Stand-alone software products generally include a perpetual license to our software. Stand-alone software sales are subject to the industry specific software revenue recognition guidance.
Certain arrangements with multiple deliverables may have stand-alone software deliverables that are subject to the software revenue recognition guidance along with non-software deliverables. The revenue for these multiple deliverable arrangements is allocated to the stand-alone software deliverables as a group and the non-software deliverables based on the relative selling prices of all of the deliverables in the arrangement.
The amount of product and services revenue recognized for arrangements with multiple deliverables is impacted by our valuation of relative selling prices. We apply the selling price hierarchy using vendor specific objective evidence (VSOE) when available, third-party evidence of selling price (TPE) if VSOE does not exist, and estimated selling price (ESP) if neither VSOE nor TPE is available.
VSOE of fair value for elements of an arrangement is based upon the normal pricing and discounting practices for a deliverable when sold separately, and VSOE for support services is measured by the renewal rate offered to the customer. In determining VSOE, we require that a substantial majority of the selling prices fall within a reasonably narrow pricing range, generally evidenced by a substantial majority of such historical stand-alone transactions falling within a reasonably narrow range of the median rates. In addition, we consider major service groups, geographies, customer classifications, and other variables in determining VSOE.
We are typically not able to determine TPE for our products or services. TPE is determined based on competitor prices for similar deliverables when sold separately. Generally, our go-to-market strategy differs from that of our peers and our offerings contain a significant level of differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, we are unable to reliably determine what similar competitor products' selling prices are on a stand-alone basis.
When we are unable to establish the estimated stand-alone value of our non-software deliverables using VSOE or TPE, we use ESP in our allocation of arrangement consideration. The objective of ESP is to determine the price at which we would transact a sale if the product or service were sold on a stand-alone basis. We determine ESP for a product or service by considering multiple factors including, but not limited to, cost of products, gross margin objectives, pricing practices, geographies, customer classes and distribution channels.
For stand-alone software sales, we recognize revenue based on software revenue recognition guidance. Under the software revenue recognition guidance, we use the residual method to recognize revenue when an agreement includes one or more elements to be delivered at a future date and VSOE of the fair value of all undelivered elements exists. In the majority of our contracts, the only element that remains undelivered at the time of delivery of the product is support services. Under the residual method, the fair value of the undelivered stand-alone software, which is typically support services, is deferred and the remaining portion of the contract fee is recognized as product revenue. If evidence of the fair value of one or more undelivered stand-alone software elements does not exist, all revenue is generally deferred and recognized when delivery of those elements occurs


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or when fair value can be established. When the undelivered stand-alone software for which we do not have VSOE of fair value is support, revenue for the entire arrangement is bundled and recognized ratably over the support period. For our non-software deliverables, we allocate the arrangement consideration based on the relative selling price of the deliverables. For our hardware appliances we use the ESP of the deliverable. For our support and services, we generally use VSOE as our relative selling price. When we are unable to establish VSOE for our support and services, we use ESP in our allocation of arrangement consideration. We regularly review VSOE and ESP. As our go-to-market strategies evolve, we may modify our pricing practices in the future, which could result in changes in selling prices, including both VSOE and ESP. For sales to direct end-users and channel partners, including value-added resellers, value-added distributors, service providers, and systems integrators, we recognize product revenue upon delivery, assuming all other revenue recognition criteria are met. For our hardware appliances, delivery occurs upon transfer of title and risk of loss, which is generally upon shipment. It is our practice to identify an end-user prior to shipment to a channel partner. For end-users and channel partners, we generally have no significant obligations for future performance such as rights of return or pricing credits. Shipping charges billed to customers are included in product revenue and the related shipping costs are included in cost of product revenue.
Support and services consist of support services, professional services, and training. Support services include repair and replacement of defective hardware appliances, software updates and access to technical support personnel. Software updates provide customers with rights to unspecified software product upgrades and to maintenance releases and patches released during the term of the support period on a when-and-if-available basis. Open-enrollment training services which are delivered on a when-and-if-available basis may be bundled with support services. Revenue for support services is recognized on a straight-line basis over the service contract term, which is typically one to three years. Professional services are recognized upon delivery or completion of performance. Professional service arrangements are typically short term in nature and are largely completed within 90 days from the start of service. Training services are recognized upon delivery of the training.
Our fees are typically considered to be fixed or determinable at the inception of an arrangement, generally based on specific products and quantities to be delivered. Substantially all of our contracts do not include rights of return or acceptance provisions. To the extent that our agreements contain such terms, we recognize revenue once the acceptance provisions or right of return lapses. Payment terms to customers generally range from net 30 to 90 days. In the event payment terms are provided that significantly differ from our standard business practices, the fees may be 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
Stock-based awards granted include stock options, restricted stock units (RSUs), and stock purchased under our Employee Stock Purchase Plan (the Purchase Plan). Stock-based compensation expense is measured at the grant date, based on the fair value of the awards, and is recognized as expense over the requisite service period only for those equity awards expected to vest.
The fair value of the RSUs is determined based on the stock price on the date of grant. The fair value of the RSUs is amortized on a straight-line basis over the requisite service periods of the awards, which is generally three to four years. We estimated the fair value of stock options and stock purchased under our Purchase Plan using the Black-Scholes model. This model utilizes the estimated fair value of common stock and requires that, at the date of grant, we use the expected term of the grant, the expected volatility of the price of our common stock, risk-free interest rates and expected dividend yield of our common stock. The fair value is amortized on a straight-line basis over the requisite service periods of the awards, which is generally three to four years for stock options, and six months to two years for stock purchased under our Purchase Plan. The expected term represents the period that stock options are expected to be outstanding. We estimated the expected term based on historical exercise patterns and post vesting termination behavior. We estimated the expected volatility of stock options using a blended historical and implied volatility data. The computation of expected volatility for the Purchase Plan is based on our historical volatility.


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Accounting for Business Combinations
In our business combinations, we are required to recognize all the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. Further, acquisition-related costs are recognized separately from the acquisition and expensed as incurred; restructuring costs are generally expensed in periods subsequent to the acquisition date; changes in the estimated fair value of contingent consideration after the initial measurement on the acquisition date are 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 are recognized as a component of provision for (benefit from) income taxes. In addition, the fair value of in-process research and development (R&D) is recorded as an indefinite-lived intangible asset until the underlying project is completed, at which time the intangible asset is amortized over its estimated useful life, or abandoned, at which time the intangible asset is expensed.
Accounting for business combinations requires management to make significant estimates and assumptions, including the acquisition date fair value of 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 management of the acquired company and are inherently uncertain. Examples of critical estimates in accounting for acquisitions include but are not limited to:

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


         the future expected cost to develop the in-process R&D into
          commercially viable products and the estimated cash flows from the
          products when completed;


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

the discount rates.

Unanticipated events and circumstances may occur which may affect the accuracy or validity of such assumptions, estimates or actual results. 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 fair value of our reporting unit is less than the reporting unit's carrying 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. On a periodic basis, 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 . . .

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