Riverbed Technology 10-K 2013
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the year ended December 31, 2012
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number: 001-33023
Riverbed Technology, Inc.
(Exact name of registrant as specified in its charter)
199 Fremont Street
San Francisco, CA 94105
(Address of principal executive offices, including zip code)
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
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 checkmark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File Required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
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
As of June 30, 2012, the last business day of our most recently completed second fiscal quarter, the aggregate market value of the voting stock held by non-affiliates was $1,505,063,639 based on the number of shares held by non-affiliates of the registrant as of June 30, 2012, and based on the reported last sale price of common stock on June 30, 2012. This calculation does not reflect a determination that persons are affiliates for any other purposes.
Number of shares of common stock outstanding as of February 7, 2013: 163,364,718.
Documents Incorporated by Reference: Portions of the registrant’s proxy statement relating to its 2013 annual meeting of stockholders are incorporated by reference into Part III of this Annual Report on Form 10-K where indicated.
RIVERBED TECHNOLOGY, INC.
YEAR ENDED December 31, 2012
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Riverbed Technology provides solutions to the fundamental challenges facing IT in a dynamic and connected world: speed and reliability. Historically, computing across WANs has been plagued by poor performance, IT complexity and high cost. Our product portfolio enables organizations to optimize their IT infrastructure and get maximum return from their network, storage, and application investments. We do this by providing solutions that diagnose and cure IT performance issues. Riverbed’s complete family of performance products includes solutions for branch offices, mobile workers, private data centers, private clouds and cloud computing.
As business has become more complex, so have the needs of enterprise IT. Recognizing this, we have expanded our product line beyond pure WAN optimization to include application-aware network performance management (NPM), application performance management (APM), virtual application delivery controllers (ADCs), web content optimization (WCO), and storage delivery.
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:
Extending Performance Beyond Traditional WAN Optimization
In February 2009, we acquired Mazu Networks, Inc. (Mazu), which became the foundation for our Cascade product line. In October 2010, we acquired CACE Technologies, Inc. (CACE), which complemented the capabilities of our existing Cascade offerings. Our Cascade products allow us to meet enterprise and service provider customer demands by extending our suite of WAN optimization products to include global application performance, reporting, and analytics.
In 2010, we introduced solutions for the public cloud, including a cloud-intelligent WAN optimization solution and a cloud storage gateway targeting backup and improved disaster recovery (DR) readiness. By extending our award-winning acceleration and deduplication capabilities to cloud storage, we provide organizations with a fast, secure, and cost-efficient method to eliminate antiquated tape based data protection systems, reduce backup costs by 30% to 50% and improve DR readiness, without changes in the existing infrastructure.
In November 2010, we acquired Global Protocols LLC (Global Protocols), which added SkipWare technology to our WAN optimization and will bolster our leadership position in delivering optimization solutions for satellite networks.
In July 2011, we acquired Zeus Technology Ltd. and Aptimize Ltd., which became the Stingray product line. The Stingray ADC family is used by enterprises and large-scale web organizations to improve application performance and to manage the delivery of complex, business-critical web services. Its virtual ADC (vADC) and WCO capabilities give Riverbed customers an asymmetric performance solution.
In February 2012, we introduced Granite™ edge virtual server infrastructure (edge-VSI), radically changing how storage is deployed and managed in the branch office. In essence, it does for edge servers what virtual desktop infrastructure (VDI) did for desktops: it allows IT to consolidate and manage all edge servers in the data center. But unlike VDI, edge-VSI does this while delivering 20-50% lower total cost of ownership (TCO). With Granite, global enterprises can achieve complete consolidation of edge applications, servers, and storage to the data center, while delivering services to the edge of the enterprise as if they were local. The technology is complementary to wide area network (WAN) optimization, accelerating performance for applications and use cases not addressed by any WAN optimization approach today.
In December 2012, we acquired OPNET Technologies, Inc. OPNET is a provider of application and NPM solutions. The products address APM; NPM; network engineering, operations, and planning; and network research and development. OPNET customers include corporate enterprises, government and defense agencies, network service providers, and network equipment manufacturers. Its software products and related services are designed to help customers make better use of resources, reduce operational problems, and improve competitiveness. Through this acquisition we established ourselves as the leader in the converging APM and NPM markets. OPNET is now being integrated with the Riverbed Cascade business, which is now called Riverbed Performance Management.
Steelhead Product Family (WAN Optimization)
Our Steelhead appliances consist of our proprietary software that is delivered as appliances on a purpose-built hardware-computing platform, and as software for end users for public and private cloud environments. We sell different Steelhead appliances to address the needs of customers ranging from small office deployments to large headquarters and data center locations. The U.S. list prices for our Steelhead appliances currently range from $1,995 to $234,995. In 2010, we introduced the Steelhead 7050 appliance, and Virtual Steelhead and Cloud Steelhead appliances. The Steelhead 7050 appliance combines new levels of bandwidth and TCP session scalability with solid-state drives and 10 Gigabit Ethernet targeted to large data centers and private cloud environments. Virtual Steelhead provides all the functionality of our appliances, in a software-based virtual appliance designed for private cloud environments. Cloud Steelhead delivers our WAN optimization functionality specifically for public cloud environments. In 2012, we announced Steelhead CX models, which accelerate a broad range of applications that are critical to business. Through a combination of data reduction, TCP and UDP optimization, and application-level protocol optimization, they deliver dramatic performance increases across the WAN for all TCP and UDP applications. That year we also announced the integration of VMware vSphere into new Steelhead EX model appliances. The integration provides organizations with a single platform for simplified, centralized management of distributed virtual services at a lower total cost of ownership. When combined with the Granite edge-VSI, the integrated solution allows organizations to leverage the investments they have made in the data center and extend control and policy boundaries to the edge of the network.
Riverbed Virtual Services Platform (VSP)
Riverbed VSP is a virtualized, extensible data services platform that allows customers to deploy best-of-breed edge services that formerly required dedicated servers as virtual appliances. Customers can deploy these virtual appliances directly on Steelhead EX appliances to further minimize the hardware infrastructure footprint at the branch office, thereby reducing operational overhead, effectively creating a branch office box (BOB).
VSP runs in a dedicated partition on Riverbed Steelhead EX series appliances to give organizations the opportunity to consolidate services onto a high-performance branch office box. VSP is built with VMware vSphere market leading virtualization technology to run instances of a company's existing services or to take advantage of applications compatible with VMware vSphere hypervisor. Using this approach, IT leaders can virtualize their edge services at all of their branch offices without having to deploy and maintain standalone servers to run applications.
Consolidating and virtualizing with the Riverbed Steelhead EX series streamlines operations, helps cut costs, simplifies management, and enables more agile service delivery.
Steelhead Mobile software enables faster application performance and better support for mobile workers. With Steelhead Mobile software, companies of any size can give mobile workers LAN-like access to corporate files and applications no matter where they are in the world. Steelhead Mobile software overcomes the challenges that plague remote users, including variable locations, inconsistent links, and high-latency environments, and it does so seamlessly and transparently. This results in higher productivity and more efficient operations, access, and performance anywhere. The base list price of our SMC is currently $14,995. The Steelhead Mobile Controller-Virtual Edition (SMC-VE) is a software only version of the SMC and currently has a base list price of $5,995.
With Virtual Steelhead appliances, WAN optimization now extends to deployments where physical hardware may not be conveniently suited. Military deployments, for example, typically use ruggedized, custom hardware on which running a virtual machine is more convenient. Space-limited scenarios, such as mobile news vans or construction trailers, may also require a form factor that is free from the physical limitations of hardware appliances.
Cloud Steelhead appliance extends Riverbed WAN optimization to a solution that is purpose-built for public cloud computing environments. Public, private, and hybrid cloud environments all face the performance limitations inherent in today's applications and networks. In order for enterprises to maximize the flexibility and cost savings of the public cloud they must overcome the same latency and bandwidth constraints that challenge distributed IT infrastructure environments. Cloud Steelhead appliance offers a number of features to help ensure a smooth transition and user experience. It is available on a subscription basis, with monthly fees starting as low as $250 per month.
Central Management Console (CMC)
The Riverbed CMC provides centralized configuration, monitoring and control, which simplifies the process of deploying and managing Steelhead products that are distributed across a WAN. With this turnkey solution, businesses can easily configure, monitor, report on, and upgrade groups of Steelhead appliances and Virtual Steelhead - all through one web-based interface. The U.S. list prices of CMC appliances and CMC-VE currently range from $4,995 to $49,995.
The Interceptor appliance provides high scalability and availability for sites with multiple Steelhead appliances and extends the scaling and high-availability capabilities of Steelhead appliances to meet the requirements of the largest and most complex enterprise networks and data center environments. The Interceptor appliance allows these organizations to scale their WAN optimization solutions to support hundreds of thousands of end users, and scale up to optimize very high-bandwidth network connections in the data center. The U.S. list price of our Interceptor appliance is currently $34,995.
Granite Product Family (Storage Delivery)
Granite appliances allow IT to consolidate servers and storage from branch offices back to the data center without compromising branch application performance by enabling storage to be decoupled from its server over thousands of miles of distance and work as if the storage were local to the server. The user gets uncompromised performance, while IT management is able to manage, backup, provision, patch, expand, protect the data for its far-flung enterprise all within the four walls of the data center. Granite appliances reduce operational burden on IT managers while increasing their control over the infrastructure-all at a lower total cost of ownership.
Steelhead EX + Granite appliances are available in a range of models to suit the needs of any office. Granite requires two components: Granite Edge, an in-built service running on a Steelhead EX + Granite appliance in the branch office, and Granite Core, a physical or virtual appliance deployed alongside the Steelhead appliance and storage arrays in the data center.
Cascade Product Family (Network Performance Management)
Cascade appliances help organizations manage, secure and optimize the availability and performance of global applications. While our Cascade product line integrates closely with the Steelhead WAN optimization solution, it also offers compelling benefits for customers who have not yet deployed WAN optimization. Cascade products offer superior application-aware NPM, so managers can resolve network and application performance problems before they impact the business. Users can discover, monitor, and troubleshoot critical services, get accurate data for strategic IT projects, and communicate performance results clearly to the business, while lowering IT management costs. Cascade products combine flow-based and packet-based monitoring for a complete view of the environment, and integrate seamlessly with Wireshark software, the most widely used open source network analysis tool.
Customers achieve the greatest value and return on investment when deploying the entire Cascade family, which combines sophisticated end-to-end, service-level monitoring with high-speed, high-fidelity packet capture and analysis for both broad and deep network performance monitoring and analysis. However, Cascade Shark appliance with Cascade Pilot software can be deployed as standalone network troubleshooting solutions, while Cascade Profiler and Cascade Gateway appliances provide robust, end-to-end network monitoring.
Cascade Profiler appliance is the centralized analysis and reporting console for the Cascade family, correlating information collected by Cascade Shark, Cascade Gateway, Cascade Sensor and even Steelhead products to provide centralized monitoring, analysis and reporting of network and application performance problems. Cascade Profiler enables enterprises to proactively monitor and troubleshoot application and network, automate discovery and dependency mapping, plan for capacity planning and WAN optimization, and assure a consistent and reliable end-user experience.
The Cascade Gateway appliance collects flow data (NetFlow, sFlow, J-Flow, IPFIX and other popular flow statistics) from network infrastructure devices and sends it to Cascade Profiler for analysis, providing cost-effective, enterprise-wide, behavior-based network monitoring.
The U.S. list prices of Cascade appliances currently range from $36,995 to $185,000.
Cascade Shark appliances deliver scalable, high-performance continuous packet capture and long-term storage, enabling real-time and back-in-time forensic analysis and reporting of network and security events. Cascade Shark appliances are typically deployed wherever detailed and historical back-in-time analysis is needed, such as within the datacenter, headquarters or key branch offices, and can be used as an integral part of the Cascade visibility solution or as a standalone troubleshooting solution.
A software version of Cascade Shark that has been virtualized to run on VMware ESX environments, Cascade Shark Virtual Edition (VE) taps into the virtual switch in the ESX hypervisor to monitor the performance of all inter-VM traffic and send data to Cascade Profiler for analysis and reporting and/or to continuously capture packets and store them on the local server or on a storage area network (SAN) for back-in-time analysis with Cascade Pilot.
The Cascade Sensor appliance performs deep packet inspection to supplement flow-based data with Layer 7 application classification, end-user experience and performance metrics.
Virtualized software that runs on the RSP on Steelhead appliances, Cascade Sensor-VE is functionally similar to Cascade Sensor, except that it lacks Layer-7 application identification capabilities.
Cascade Pilot is a robust analysis console that enables users to quickly analyze multi-terabyte packet recordings on remote Cascade Shark appliances and Steelhead products without having to transfer large packet captures files across the network.
All Steelhead models (Steelhead, Virtual Steelhead, Cloud Steelhead and Steelhead Mobile) can provide remote site visibility to Cascade via flow export, packet inspection (Sensor-VE) and packet capture.
Cascade Express appliances bring the same revolutionary approach to application-aware NPM for the large enterprise to the small and medium enterprise in a flexible form designed to grow with the needs of the business and provide ease of use and deployment.
OPNET Product Family (Application Performance Management)
OPNET products use a variety of advanced technologies to support the analysis of application, network, and server performance under a wide range of current and planned or modeled operating conditions. Many OPNET software products share a significant amount of core software based on an open architecture. OPNET software architecture enables us to create new software more efficiently, to foster interoperability of OPNET software products, and to provide interfaces to a wide range of external data sources including third party management tools and network topology, traffic, and configuration information. OPNET also delivers extensive cross-product integration, to enable users to realize added value when products are deployed together.
The following sections summarize the OPNET software product portfolio by target market:
Primary Target Market: Enterprise IT (Corporate and Government/Defense)
AppCapacity Xpert, formerly called IT Guru Systems Planner, was introduced in December 2006. It provides capacity planning for servers, including planning for migration from physical-to-virtual server environments.
AppInternals Xpert was first introduced in December 2004. AppInternals Xpert delves into the complex software frameworks and operating systems of modern servers to extract large amounts of performance and forensic data to support all aspects of APM from the server perspective. AppInternals Xpert can provide analysis for any type of application, but particularly excels in Java and .NET environments. It continuously monitors thousands of system and application metrics and automatically detects and ranks performance and behavior anomalies. Its patented correlation technology automatically reveals relationships among metrics, highlighting the corresponding causal connections between components, resources, and code-level behavior in order to perform root cause analysis. It can assemble a complete picture of a transaction's path across tiers for near real-time and historical analysis.
AppMapper Xpert was introduced in January 2011. AppMapper Xpert automatically produces run-time application maps, identifying the underlying application components and infrastructure components that enable a production application. This dynamic model of the application, captured at the time of execution, is essential for troubleshooting application performance problems. It also provides critical information to improve a host of other operational workflows, such as configuration and change management, and datacenter virtualization and consolidation. AppMapper Xpert provides visibility into the interaction between applications and the underlying infrastructure, enabling IT organizations to effectively assess and respond to events and conditions that affect application service levels.
AppResponse Xpert, previously called Ace Live, was introduced in December 2007. AppResponse Xpert is an appliance-based solution that continuously monitors and analyzes end-user experience for all users and transactions. The solution also supports in-depth monitoring and analysis of the underlying network, a domain that is vital to comprehensive APM. AppResponse Xpert leverages the central role of the network in transporting transaction data to obtain vital information about relationships among clients and servers, and also among server tiers. This information is useful for performance analysis and troubleshooting in AppResponse Xpert and also for application discovery and dependency mapping functions performed by AppMapper Xpert. On-board analytics extract transactions from application flows and break down application response time, identifying which parts of the infrastructure are contributing most to delays. Add-on modules provide analytics for Citrix-hosted applications, database transactions, voice over IP, or VOIP, and NetFlow.
AppSQL Xpert was introduced in September 2010. AppSQL Xpert provides deep visibility into database performance through real-time monitoring of a broad range of metrics, with drilldowns to fine-grained forensic database transaction data for troubleshooting. It performs detailed tracking of database usage for trending and performance optimization. It also detects database policy violations, such as unauthorized access and suspicious usage patterns. AppSQL Xpert provides analysis of database performance while offering an agentless approach that imposes zero overhead on database operation.
AppSensor Xpert was introduced as APM Element Insight in June 2010. AppSensor Xpert uses remote instrumentation interfaces, such as SNMP to capture performance information from infrastructure components, which may otherwise be difficult to access, including servers, application components, network devices, and vendor-specific management systems. AppSensor Xpert supplies this data, on both a historical and real-time basis, to the rest of OPNET's APM solution suite for a more complete picture of end-to-end application performance.
AppTransaction Xpert, formerly called ACE Analyst, was first introduced in May 2000. AppTransaction Xpert is a powerful tool for detailed analysis of individual transactions. In today's complex application architectures, a single transaction can involve many tiers and require thousands of messages to traverse the network. This solution, which processes and merges traces taken in the production environment, makes extensive use of visualization and
analytics to accelerate troubleshooting in production, as well as pre-deployment testing and prediction. In production, the combination of AppResponse Xpert and AppTransaction Xpert provides a seamless workflow that spans monitoring, alerting, triage, root cause diagnosis, and remediation guidance. In pre-deployment, AppTransaction Xpert is our solution for application network readiness testing.
IT Guru Network Planner was first introduced in August 1998 as IT Guru. IT Guru Network Planner provides predictive network capacity planning and design optimization, as well as validation of network configuration changes.
IT Sentinel was first introduced in August 2004. IT Sentinel provides automatic and continuous network configuration integrity and security auditing, and proactive change validation.
nCompass for Enterprises was first introduced in September 2003 as NETCOP. It provides enterprises with centralized, real-time visibility of network topology, traffic, and status in a single, integrated view. nCompass for Enterprises provides a unified view to quickly recognize the impact of network events, and assisted troubleshooting to rapidly resolve problems.
VNE Server was first introduced in June 2002. VNE Server, or Virtual Network Environment Server, automatically maintains a detailed, near real-time data model of the production IT network. VNE Server includes a suite of adapters that obtain topology, traffic, and other information from network devices as well as a broad range of third-party data sources. VNE Server automates the data collection process for other OPNET products, including IT Guru Network Planner and SP Guru Network Planner. VNE Server capabilities are included in IT Sentinel and SP Sentinel.
Primary Target Market: Network Service Providers (both Commercial and Government/Defense)
SP Guru Network Planner was first introduced in June 2001. SP Guru Network Planner is built on the IT Guru Network Planner product, and contains analytics that are valuable to service providers for planning, network design optimization, and validation of configuration changes. SP Guru Network Planner includes modeling and analysis technologies for IP, MPLS, and ATM networks, and when combined with SP Guru Transport Planner, provides a single environment for network-level and optical transport-level analysis.
SP Guru Transport Planner, formerly WDM Guru, was first introduced in December 2001. SP Guru Transport Planner is an optical network-planning product for designing resilient, cost-efficient optical networks. SP Guru Transport Planner is also sold to network equipment manufacturers.
nCompass for Service Providers was first introduced in September 2003 as NETCOP. nCompass for Service Providers provides centralized, real-time visibility of network topology, traffic, and status in a single, integrated view. nCompass for Service Providers provides a unified view to quickly recognize the impact of network events, and assisted troubleshooting to rapidly resolve problems.
SP Sentinel was first introduced in August 2004. SP Sentinel provides automated and continuous network configuration integrity and security auditing for service providers, and proactive change validation.
AppResponse Xpert is for service providers who deliver managed network and data center services to enterprises to ensure application performance.
Primary Target Market: Network R&D Organizations (Defense and Equipment Manufacturers)
OPNET Modeler was OPNET's first product, introduced in 1987. OPNET Modeler is a network modeling and simulation product. It enables users to evaluate how networking equipment, communications technologies, systems, and protocols will perform under simulated network conditions.
Modeler Wireless Suite is based on OPNET Modeler, and incorporates additional functionality germane to wireless network R&D organizations.
Modeler Wireless Suite for Defense is based on OPNET Modeler, and incorporates additional functionality that supports unique network R&D undertaken by the defense community.
We develop and sell a variety of software modules that provide additional functions to our application and network management software products.
Stingray Product Family (Application Delivery Control)
Riverbed Stingray is a software-based ADC designed to deliver faster and more reliable access to public web sites and private applications. Stingray frees applications from the constraints of legacy, proprietary, hardware-based load balancers, which enables them to run in any physical, virtual or cloud environment.
Stingray Traffic Manager software provides complete control over user traffic, allowing administrators to accelerate, optimize, and secure key business transactions. With Stingray Traffic Manager, applications can run in any environment-physical, virtual, or cloud-and migrate and scale on demand. One of the fastest software-based ADCs on the market, Stingray Traffic Manager powers some of the most popular sites on the web.
Stingray™ Application Firewall is a sophisticated, application-aware, web application firewall for deep application security that protects against known and unknown attacks at the application layer, secures applications, and meets compliance requirements with confidence.
Stingray™ Aptimizer software is a web accelerator that dynamically groups activities for fewer long distance round trips. Stingray Aptimizer software compresses images to maximize available bandwidth, increases caching for faster repeat visits, and prioritizes actions to provide the best possible response time for loading web pages on any browser.
Whitewater Product Family (Cloud Backup)
Whitewater is a cloud storage appliance, designed to accelerate, deduplicate, secure, and store backup data sets in the public cloud. Whitewater appliances are available as physical and virtual appliances with list prices starting at $7,995.
Whitewater Cloud Storage appliances
Whitewater appliances are deployed in customer data centers or remote offices and provide a gateway to the public cloud that greatly improves data transmission speeds, security, and disaster recovery (DR) readiness while reducing cloud storage costs. Whitewater cloud storage appliances allow organizations to reap the benefits of the public cloud's scalability, flexibility and pay-per-use pricing model without changes to their existing data protection infrastructure. Whitewater appliances connect all popular backup applications to the leading public cloud storage vendors such as Amazon, AT&T, Nirvanix, Rackspace and Windows Azure. Leveraging industry-leading Riverbed WAN optimization, sub-file deduplication, intelligent local data cache, and strong encryption of data in motion and at rest, Whitewater appliances make public cloud storage a cost-effective and easy to implement solution for any organization.
Virtual Whitewater appliances
Whitewater appliances virtual edition provide all the functionality of a physical Whitewater appliance in a software form factor. This product, targeted at customers with virtualized environments and remote offices, offers increased flexibility for deployment for organizations of all sizes.
We are widely recognized as both the pioneer and leader in the WAN optimization category, but our broad range of technologies powers a full portfolio of interoperable performance products that integrate into virtually any enterprise network.
Riverbed Optimization System (RiOS)
The Riverbed Optimization System (RiOS) is our proprietary software platform that provides the core intelligence and essential functionality for our Steelhead products. To achieve performance improvements across a broad range of applications, RiOS integrates four key sets of technologies: data streamlining, transport streamlining, application streamlining and management streamlining.
Our data streamlining technologies address bandwidth limitations in existing networks. Our patented approach can be applied to all data and applications that run over TCP to reduce bandwidth consumption by dramatically reducing the need to send the same data multiple times over the WAN. Data streamlining also supports the classification of individual data packets for quality-of-service and route control.
In a non-optimized WAN setting, each time data is requested by a remote user, all of the data must be sent across the WAN, regardless of whether identical data (or an insignificantly modified version of the data) has previously been sent. In wide-area distributed computing environments where Steelhead products have been deployed, all of the requested data must be sent across the WAN only the first time data is requested by a user, at which time that data is stored by the Steelhead products on both sides of the network. In subsequent requests, redundant data segments will not be sent regardless of what application is requesting the data or which user is making the request. The detection of repetitive data patterns is very granular, with a typical segment of data being approximately 100 bytes. This fine level of granularity enables Steelhead products to detect tiny changes in files, e-mails, web pages and other application data, sending only those changes across the WAN.
Each end-user request for data is sent directly to the intended authoritative application server as opposed to a cache that typically utilizes a copy of the data. Our Steelhead product intercepts the server response, identifies redundant data patterns and then sends only the new segments across the WAN to the end-user. All of the existing segments are represented by references that point to those already existing segments stored on the end-user side of the WAN connection. In this way, significantly less traffic needs to be sent to deliver large amounts of data to the end-user. In addition, this approach eliminates data consistency issues inherent in cache-based approaches.
Transport streamlining enhances the performance of the TCP protocol by increasing the amount of data carried per TCP round trip, thereby reducing the number of round trips required to move a given amount of data over the WAN. We accomplish this by both increasing the default TCP payload and by filling the window with references to data rather than actual data.
We also enhance TCP performance by reducing the time associated with creating new TCP connections (especially for small, short-lived transfers), adapting transfer parameters based on real-time network characteristics and assigning priority for necessary packet resends due to packet loss. A component of transport streamlining, High Speed TCP, also addresses the TCP chattiness and latency that is particularly pronounced in high-speed connections (for example, OC-12 (622 Mbps)). Another component of transport streamlining, MXTCP, is designed to address private networks with packet loss.
Application streamlining provides a further mechanism to enhance the performance of specific applications. Many applications were designed for use over a LAN and require hundreds to thousands of interactions between client and server to execute even simple requests, such as opening a file. By understanding the semantics of particular application protocols, Steelhead products reduce chattiness, collapsing hundreds of client-server interactions into a few round trips over the WAN.
While most important business applications that run over TCP immediately benefit from data streamlining and transport streamlining, application streamlining enables us to add additional acceleration for specific applications. We have built specific Application Streamlining modules that support file, e-mail, web, ERP, database application, and thin client protocols (CIFS, MAPI, HTTP, Oracle Forms, SSL, Lotus Notes, NFS and MS-SQL, Citrix, and others). We have also built special modules to address protocol inefficiencies for common storage back-up and replication applications. We believe these applications are especially inefficient in wide-area distributed computing. We have designed our architecture to enable additional application streamlining modules to be incorporated easily over time.
Management streamlining allows for simplified implementation and administration of our Steelhead products. Unlike alternative approaches, which usually require changes to clients, servers, routers and switches or the addition of an overlay network of tunnels, Steelhead products are designed for transparent installation in existing IT infrastructure with minimal administration. The auto-discovery capabilities of RiOS allow our Steelhead products to identify automatically all Steelhead products on the WAN, typically without the need to reconfigure any network
infrastructure. Our products automatically intercept WAN traffic without any further configuration requirements to applications, clients or other network infrastructure, while allowing non-optimized traffic to simply pass through.
RiOS provides IT administrators with simplified management of Steelhead products through Command Line Interface (CLI), Graphical User Interface (GUI), and an optional CMC.
Other key elements of management streamlining include touch-less configuration options, over-the-wire software upgrades for Steelhead products, singular and grouped appliance management and customizable reporting analytics.
Edge Virtual Server Infrastructure (Edge-VSI)
Granite products enable users and applications in branch office locations to write to and access centrally managed storage while maintaining local disk performance. Granite products enable faster branch access to data center deployed Storage Area Networks (SANs), and it effectively eliminates the IT organizations' need to provision and maintain dedicated storage resources in branch offices.
Consolidate Servers and Storage from Branch Offices back to the Data Center
Granite is deployed in conjunction with Riverbed Steelhead appliances and consists of two components:
Granite Core - a physical or virtual appliance that resides in the data center alongside centralized storage
Granite Edge - a module that runs on a Steelhead EX appliance in the branch office
Granite Core mounts iSCSI LUNs provisioned in the data center and shares the storage resources with branch offices running the Granite Edge module. Granite Edge virtually presents one or more iSCSI targets in the branch which can be utilized by services and systems running both within the Riverbed Virtual Services Platform (VSP) as well as externally to the Steelhead EX appliance. Granite Core inspects mounted file systems and is able to proactively stream data to the branch. This capability allows data from centralized storage to be available wherever and whenever it is needed. Through asynchronous block-based write acceleration, Granite Edge ensures that data created in branch office locations is securely stored in the data center.
Application-aware Network Performance Management (NPM)
Collection of Performance Data
Our Cascade software collects performance data from sources across the network, including switches, routers and WAN optimization devices. This includes flow records, Layer 7 application data, and data about optimized links. All information is collected without any server-side agents or modifications to corporate applications.
Performance Metrics and Behavioral Analytics
Cascade products present the information collected from the network as a collection of useful metrics on application and network performance. It feeds these metrics into a behavioral analytics model, which learns the typical performance of applications and alerts an operator whenever performance deviates in a meaningful way from its learned “normal”.
Discovery and Dependency Mapping
Discovery and dependency mapping allows operators involved with performance troubleshooting, as well as IT consolidation initiatives, to rapidly understand all the components and associated interdependencies that are necessary for the delivery of an application to an end user.
Cloud Storage Appliances
Whitewater appliances significantly reduce the volume of data traversing networks and cut the cost of data backup and DR by reducing both the cost of storage consumed and the bandwidth requirements for moving backup data into and out of the cloud. Whitewater gateways are designed around the need for maintaining the highest data integrity, while at the same time delivering the performance and costs that companies need in such a backup and DR solution. Whitewater gateways are file based data deduplication storage devices with CIFS and NFS connectivity to backup applications, and cloud storage connectivity to a variety of class leading cloud storage providers.
Leading Deduplication and Replication Capabilities
Data is ingested into Whitewater gateways using multiple gigabit Ethernet connections, and is in-line deduplicated, compressed, and encrypted before it is written to the Whitewater local cache and asynchronously replicated via secure SSL connections to cloud storage. Whitewater gateways protect data using class leading deduplication technologies, utilizing scalable and cost effective cloud storage to provide long term data storage for backup data, and implementing a local disk cache for immediate restore needs.
Application Delivery Controller
Our Stingray product line is software-based. The ADC family is used by enterprises and large-scale web organizations to improve application performance and to manage the delivery of complex, business-critical web services. Stingray Traffic Manager software provides data-center based performance optimization, server offload, application reliability, WCO, and application firewall capabilities. It also provides robust scripting capabilities that allow enterprises to customize functionality based on their own business requirements.
TrafficScript Customization Language for Fine-grained Control
TrafficScript is a sophisticated programming language integrated within the core of Stingray Traffic Manager that enables high performance, highly configurable control of traffic management policies. TrafficScript rules can control all aspects of how traffic is managed and can choose when and where to apply request rate shaping, bandwidth shaping, routing, compression, and caching to prioritize the most valuable users and deliver the best possible levels of service.
WAN Optimization Industry Background
The Need for WAN Optimization
A common misconception is that increasing or optimizing bandwidth alone can adequately reduce the inefficiencies and performance problems inherent in wide-area distributed computing. It may allow an organization to increase the amount of data that can traverse a WAN at a given point in time, however, it may not address application performance problems resulting from the distance between locations across a WAN and from network and application protocol inefficiencies. Inadequate bandwidth is only one of three interrelated causes of performance problems. We believe that these problems can best be solved by simultaneously addressing all three root causes: software application protocol inefficiencies, transport network protocol inefficiencies, and insufficient or unavailable bandwidth.
Unlike alternative approaches, Steelhead products simultaneously address these root causes across a broad range of applications. They utilize proprietary software to improve the performance of applications and access to data over distance by reducing:
Steelhead products are used at both ends of a WAN connection and are designed to be more easily and transparently integrated into existing networks than alternative products. They address a broad range of widely used software applications, are scalable across networks of all sizes, and address the wide-area distributed computing needs of every major industry.
The WAN optimization market provides global access to data and applications across WANs with local area network LAN-like performance. The WAN optimization market is large and growing. The key drivers of demand in this market are; the increasingly geographically distributed nature of organizations and employees; the transition towards cloud storage and computing; the growing business dependence on application performance and real-time access to data; the increasing desirability of IT infrastructure consolidation in order to achieve compelling cost reductions or organizational efficiencies; and, management and data protection benefits.
Increasingly Distributed Organizations and Workforces
Organizations are becoming more geographically distributed, with businesses becoming more global by expanding into new markets, migrating manufacturing facilities to lower-cost locations, and outsourcing certain
business processes. In addition, existing enterprises continue to expand their geographic scope through mergers, acquisitions, partnerships, and joint ventures.
Transition Towards Cloud Architecture
Organizations have begun transitioning towards either public or private cloud architecture in order to achieve greater financial efficiency, elastic resource provisioning, and automation of IT management. This transition, however, typically reduces application performance by moving data and applications further away from end users, and also taxes network resources by more frequently migrating large amounts of data across the network.
Organizations are Increasingly Dependent on Timely Access to Critical Data and Applications
Application performance and effective access to data are critical to executing, maintaining, and expanding business operations. Employees are increasingly dependent on a wide array of software applications to perform their jobs effectively, such as email, document management, enterprise resource planning, and customer relationship management.
Benefits of IT Infrastructure Consolidation
As organizations have become more geographically distributed, installing and managing IT infrastructure has become increasingly costly and complex. Accordingly, IT managers often seek to consolidate IT infrastructure resources into headquarters or centralized data center locations, which can provide a number of benefits, including:
Despite these benefits, many organizations have foregone or delayed consolidation projects because of network performance and manageability problems.
Wide-Area Distributed Computing Challenges
Technological advances in computing, networking, semiconductor, and storage technologies have improved users' ability to access data and use applications rapidly across their LANs and store enormous amounts of information economically. However, these same applications and storage technologies, which were often designed to operate optimally on LANs, perform slowly across WANs and frequently exhibit the following performance challenges:
Although many companies have attempted to solve these problems solely by adding bandwidth, addressing their technical root causes can best solve them:
Limitations of Alternative Approaches
Historically, organizations have implemented partial solutions in attempting to improve the performance of wide-area distributed computing, including:
The Riverbed WAN Optimization Solution
Steelhead products broadly address the core causes of poor performance of wide-area distributed computing: latency and protocol chattiness, bandwidth limitations, data growth, and limited visibility. By simultaneously addressing these causes, we are able to significantly improve the performance of applications and access to data across WANs and enable the consolidation of costly IT infrastructures. RiOS simultaneously addresses the fundamental performance limitations of distributed computing environments.
Through the application of our proprietary technology, our WAN optimization solution simultaneously addresses each of these root causes of poor WAN performance:
or minimize the amount of data that needs to be stored. Our products detect requests for redundant information and send very little more than the data that has actually been modified over the WAN.
When combined, these key technologies allow us to deliver significant benefits to our customers, including the ability to:
Steelhead products are designed to be easily and transparently deployed into our customers' networks. They are also designed for easy management, scalability across networks of all sizes, and for the wide-area distributed computing needs of every major industry.
Our products have been sold to over 22,000 customers worldwide in every major industry, including manufacturing, finance, technology, government, architecture, engineering and construction, professional services, utilities, healthcare and pharmaceuticals, media and retail. Our products are deployed in a wide range of organizations, from large global organizations with hundreds or thousands of locations to smaller organizations with few locations. As of December 31, 2012, one value-added distributor, Avent, Inc. (Avnet), accounted for 10% of our trade receivable balance. As of December 31, 2011, one value-added distributor, Arrow Electronics, Inc. (Arrow), accounted for 14% of our trade receivable balance. During the year ended December 31, 2012, two value-added distributors, Arrow and Avnet, accounted for 17% and 11%, respectively, of our consolidated revenue. During the years ended December 31, 2011 and 2010, one value-added distributor, Arrow, accounted for 15% and 10%, respectively, of our consolidated revenue. We believe it is unlikely that the loss of any of our channel partners would have a long term material adverse effect on our consolidated net revenues as we believe end-users would likely
purchase our products from a different channel partner. However, a loss of any one of these channel partners could have a material adverse impact during the transition period.
Our distribution agreements with Arrow and Avnet are ordinary course of business relationships. The agreements are non-exclusive distribution agreements subject to successively renewable annual terms and are cancellable by us and Arrow and/or Avnet, as applicable, for convenience upon 30-days' prior notice. The agreements do not obligate us to sell a major part of our goods or services, nor does it require Arrow and/or Avnet to buy any of our products; rather, the agreements set forth only the terms to which a sale will be subject if and when a customer places a purchase order with Arrow and/or Avnet, as applicable, for specified products.
Backlog represents the customer orders that have yet to be fulfilled or invoiced. As of December 31, 2012 and 2011, backlog was not material.
Sales and Marketing
We sell our products and support through channel partners and our field sales force:
With the ability to foster a strong, collaborative sales engagement environment between us and our partners, the Riverbed Partner Network (RPN) delivers a coverage model that optimizes our customer’s ability to acquire and implement our solutions in the manner that best fits its needs — through either value added resellers, systems integrators or service providers. We derived 95% of our revenue through indirect channels in 2012.
Our marketing activities include an integrated strategy comprised of lead generation, advertising, website operations, direct marketing, public relations, technology conferences and trade shows.
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.
See Item 1A, “Risk Factors,” for a discussion of risks related to our sales and marketing efforts.
Support and Services
We offer tiered customer support programs depending upon the service needs of our customers’ deployments. Support contracts provide customers the right to receive unspecified software product upgrades, maintenance releases issued when and if available during the support period and hardware repair. Product support includes internet access to technical content, as well as telephone, internet and email access to technical support personnel. Support contracts typically have a one-year term. We have support centers in New York, Bethesda, the San Francisco Bay Area, Amsterdam, London, Singapore, Sydney and Tokyo, which enable us to respond at all times. As we expand, we plan to continue to hire additional technical support personnel to service our growing international customer base.
Primary product support for customers of our channel partners is often provided by the partners themselves and we provide back-up support.
Our product sales include a warranty on hardware and software. Hardware is typically warranted against material defects for 12 months. Software is typically warranted to meet published specifications for a period of 90 days.
Research and Development
Continued investment in research and development is critical to our business. To this end, we have assembled a team of engineers with expertise in various fields, including networking, applications, storage and systems management. We have invested significant time and financial resources into the development of our products. We plan to expand our product offerings and solutions capabilities in the future and plan to dedicate significant resources to these continued research and development efforts. Further, as we expand internationally
and into different sectors, we may incur additional costs to conform our products to comply with local laws or local product specifications.
Research and development expenses were $146.1 million, $123.0 million, and $87.1 million in 2012, 2011 and 2010, respectively.
We outsource manufacturing of all hardware products. Our manufacturers provide us with limited warranties to cover general product failures, and all our larger manufacturing partners provide specific quality control processes and replacement cycle time commitments. In addition, the lead times associated with certain components are lengthy and consequently make rapid changes in quantity requirements and delivery schedules difficult. Although we outsource manufacturing operations for cost-effective scale and flexibility, we perform rigorous quality control testing intended to ensure the reliability of our products once deployed. We provide long-term forecasts to our manufacturing partners and we maintain oversight of their supply chain activities.
Shortages in components that we use in our products are possible and our ability to predict the availability of such components may be limited. Some of these components are available only from single or limited sources of supply. Our ability to deliver products to our customers in a timely manner would be adversely impacted if we needed to qualify replacements for any of a number of the components used in our products.
We outsource our logistics functions to third parties. These third parties ship our products on our behalf and perform certain other shipping and product integration capabilities.
The WAN optimization market is highly competitive and continually evolving. We believe we compete primarily on the basis of offering a comprehensive WAN optimization solution that broadly addresses the root causes of poor performance of wide-area distributed computing. We believe other principal competitive factors in our market include product performance, ability to deploy easily into existing networks and ability to remotely manage products. We believe that our solution performs better than competitive products as measured by a broad range of metrics encompassing application performance, compression ratios and data transfer times. Our ability to sustain such a competitive advantage depends on our ability to achieve continuous technological innovation and adapt to the evolving needs of our customers.
We believe we are currently the only provider of a comprehensive WAN optimization solution. However, a large number of vendors have made acquisitions to enter the WAN optimization market and continue to invest in this area.
Our primary competitors include Cisco Systems, Silver Peak Systems, Blue Coat Systems, and Citrix Systems. We also face competition from a large number of smaller private companies and new market entrants.
We believe that we compete favorably in each of the sub-segments of WAN optimization in addition to being the only provider of a comprehensive WAN optimization solution. As we have a purpose-built architecture, compared to many vendors’ attempts to combine separate technology elements, we believe we have a significant advantage in performance, ease-of-use, and ability to scale to large numbers of locations and employees.
We have received broad industry recognition for our innovative technology. For six consecutive years, InfoWorld has named the Riverbed Steelhead appliances as a Product of the Year. Since 2007, we have been positioned by Gartner in the Leaders’ Quadrant of the “WAN Optimization Controller (WOC)" Magic Quadrant, authored by Joe Skorupa and Severine Real, and most recently published in January 2012. This Gartner report positions vendors in one of four quadrants — Leaders, Challengers, Visionaries and Niche Players — based on the companies’ vision and ability to execute on that vision. In 2012 we were positioned by Gartner in the Visionary quadrant of the 2012 "Application Delivery Controllers (ADC)" Magic Quadrant by Joe Skorupa, Neil Rickard, and Bjarne Munch, and the in the Leaders quadrant of the 2012 "Application Performance Monitoring" Magic Quadrant authored by Jonah Kowall and Will Capelli. Riverbed’s WAN optimization solutions have received industry recognition from Forrester Research, IDC, NetworkWorld, The Wall Street Journal, eWeek, Storage Magazine, Network Computing and Byte & Switch, among others.
We also compete in the NPM and APM markets with our Riverbed Performance Management product line. Our primary competitors in this market are Netscout Systems, Computer Associates (NetQos) and Compuware.
Our Stingray product line competes in the vADC market. Our primary competitors in this market are F5 Networks, Citrix Systems, Cisco Systems and Radware.
See Item 1A, “Risk Factors,” for further discussion of risks regarding competition.
Our success as a company depends upon our ability to protect our core technology and intellectual property. To accomplish this, we rely on a combination of intellectual property rights, including patents, trade secrets, copyrights and trademarks, as well as customary contractual protections.
Our worldwide patent portfolio includes one hundred twenty three issued U.S. patents and thirty five issued foreign patents. Patents generally have a term of twenty years from their priority date, which is generally either the date they were initially filed or the filing date of the earliest patent from which priority is claimed. Our issued patents will expire in 2020 through 2029. U.S. patent filings are intended to provide the holder with a right to exclude others from making, using, selling or importing in the U.S. the inventions covered by the claims of granted patents. We also have U.S. provisional and non-provisional patent applications pending, as well as counterparts pending in other jurisdictions around the world. 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. Our granted patents, and to the extent any future patents are issued, any such future patents, may be contested, circumvented or invalidated over the course of our business, and we may not be able to prevent third parties from infringing these patents. In addition, the laws of certain countries do not protect our proprietary rights to the same extent as do the laws in the U.S. Therefore, the exact effect of having a patent cannot be predicted with certainty.
Our registered trademarks in the U.S. include, but are not limited to, Riverbed, Steelhead, RiOS, Cascade, Stingray, OPNET, Whitewater, and Wireshark. We additionally have registered trademarks in selected foreign jurisdictions. We also have a number of trademark applications pending, in the U.S. as well as in other jurisdictions.
In addition to the foregoing protections, we generally control access to and use of our proprietary software and other confidential information through the use of internal and external controls, including contractual protections with employees, contractors, customers and partners. Our software is also protected by U.S. and international copyright laws.
We also incorporate third-party software programs into our products pursuant to license agreements. For example, we embed technology from VMware into our Steelhead appliances to provide the virtualization in our RSP or VSP. Any disruption in our access to any of these software programs could result in significant delays in our product releases and could require substantial effort to locate or develop a replacement program.
See Item 1A, “Risk Factors,” for discussion of risks related to protecting our intellectual property.
As of December 31, 2012, we had 2,566 employees in offices in all major geographies, including 683 from the OPNET acquisition. Of these, 1,128 were engaged in sales and marketing, 794 in research and development, 340 in support and services, 272 in general and administration and 32 in manufacturing. None of our U.S. employees are represented by labor unions; however, in certain international subsidiaries, workers councils represent our employees. We consider current employee relations to be good.
Riverbed Technology, Inc. was incorporated in Delaware in May 2002. We operate internationally primarily through a number of wholly owned subsidiaries that are designed primarily to support our sales, marketing and support activities outside the United States. A summary of our financial information by geographic location is found in Note 16, “Segment Information,” in the Notes to Consolidated Financial Statements. We have a single operating segment and substantially all of our operating assets are located in the United States.
Our Internet address is www.riverbed.com. There we make available, free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (SEC). Our SEC reports can be accessed through the investor relations section of our website. The information found on our website is not part of this or any other report we file with or furnish to the SEC.
Unless the context otherwise requires, in this Annual Report on Form 10-K, the terms "Riverbed," "the Company," "we," "us," and "our" refer to Riverbed Technology, Inc. and its subsidiaries.
Set forth below and elsewhere in this Annual Report on Form 10-K, 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 Annual Report on Form 10-K 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 volatile U.S., European and global economic environment, and any of which may cause our stock price to fluctuate. As a result, comparing our operating results on a period-to-period basis may not be meaningful. You should not rely on our past results as an indication of our future performance. In addition, revenues in any quarter are largely dependent on customer contracts entered into during that quarter. Historically, the amount of customer orders that have not been shipped as of the end of a fiscal year has not been material. Moreover, a significant portion of our quarterly sales typically occurs during the last month of the quarter, and sometimes within the last few weeks or days of the quarter. As a result, our quarterly operating results are difficult to predict even in the near term and a delay in an anticipated sale past the end of a particular quarter may negatively impact our results of operations for that quarter, or in some cases, that year. A delay in the recognition of revenue, even from just one account, may have a significant negative impact on our results of operations for a given period. If our revenue or operating results fall below the expectations of investors or securities analysts or below any guidance we may provide to the market, as has occurred recently and at other times in the past, or if the guidance we provide to the market falls below the expectations of investors or securities analysts, as has occurred recently and at other times in the past, the price of our common stock could decline substantially. Such a stock price decline could occur, and has occurred recently and at other times 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:
Adverse economic conditions make it difficult to predict revenues for a particular period and may lead to reduced information technology spending, which would harm our business and operating results. In addition, turmoil in credit markets during economic downturns increases our exposure to our customers' and partners' credit risk, which could result in reduced revenue or increased write-offs of accounts receivable.
Our business depends on the overall demand for information technology, and in particular for WAN optimization, and on the economic health and general willingness of our current and prospective customers, both enterprises and government organizations, to make capital commitments. These government organizations include non-U.S. as well as U.S. federal, state and local organizations. In some quarters, sales to government organizations have represented, and may in the future represent, a significant portion of overall sales. If the conditions in the U.S. and global economic environment, including the economies of any international markets that we serve, remain uncertain or continue to be volatile, or if they deteriorate further, our business, operating results, and financial condition would likely be materially adversely affected. For example, U.S. government deficit spending and debt levels, as well as actions taken by the U.S. Congress relating to these matters, could negatively impact the U.S. and global economies and adversely affect our financial results. In addition, our financial results could be negatively impacted by the continuing uncertainty surrounding, or any deterioration relating to, the debt levels or growth prospects for Eurozone economies.
Economic weakness, customer financial difficulties and constrained spending on IT initiatives have resulted, and may in the future result, in challenging and delayed sales cycles and could negatively impact our ability to forecast future periods. In addition, the markets we serve are emerging and the purchase of our products involves material changes to established purchasing patterns and policies. The purchase of our products is often discretionary and may involve a significant commitment of capital and other resources. In addition, our operating expenses are largely based on anticipated revenue trends and a high percentage of our expenses are, and will continue to be, fixed in the short-term. Uncertainty about future economic conditions makes it difficult to forecast operating results and to make decisions about future investments. Weak or volatile economic conditions would likely harm our business and operating results in a number of ways, including information technology spending reductions among customers and prospects, longer sales cycles, lower prices for our products and services and reduced unit sales. A reduction in information technology spending could occur or persist even if economic conditions improve. In addition, any increase in worldwide commodity prices may result in higher component prices and increased shipping costs, both of which may negatively impact our financial results.
Many of our customers and channel partners use third parties to finance their purchases of our products. Any freeze, or reduced liquidity, in the credit markets may result in customers or channel partners either delaying or entirely foregoing planned purchases of our products if they are unable to obtain the required financing. This would result in reduced revenues, and our business, operating results and financial condition would be harmed. In addition, these customers' and partners' ability to pay for products already purchased may be adversely affected by any credit market turmoil or an associated downturn in their own business, which in turn could harm our business, operating results and financial condition.
We face intense competition that could reduce our revenue and adversely affect our financial results.
The market for our products is highly competitive and we expect competition to intensify in the future. Other companies may introduce new products in the same markets we serve or intend to enter.
This competition could result, and has resulted in the past, in increased pricing pressure, reduced profit margins, increased sales and marketing expenses and failure to increase, or the loss of, market share, any of which would likely seriously harm our business, operating results and financial condition.
Competitive products may in the future have better performance, more and/or better features, lower prices and broader acceptance than our products. Many of our current or potential competitors have longer operating
histories, greater name recognition, larger customer bases and significantly greater financial, technical, sales, marketing and other resources than we do. Potential customers may prefer to purchase from their existing suppliers rather than a new supplier regardless of product performance or features. Currently, in the WAN Optimization market we face competition from a number of established companies, including Cisco Systems, Blue Coat Systems, Citrix Systems and F5 Networks. We also face competition from a large number of smaller private companies and new market entrants. In the Network Performance Management and Application Performance Management markets, our Riverbed Performance Management product line primarily competes with Netscout, Computer Associates (NetQos) and Compuware. As a result of our July 2011 acquisitions of Zeus and Aptimize, we face additional competition from F5 Networks and Citrix Systems.
We expect increased competition from our current competitors as well as other established and emerging companies if our market continues to develop and expand. For example, third parties currently selling our products could market products and services that compete with our products and services. In addition, some of our competitors have made acquisitions or entered into partnerships or other strategic relationships with one another to offer a more comprehensive solution than they individually had offered. We expect this trend to continue as companies attempt to strengthen or maintain their market positions in an evolving industry and as companies enter into partnerships or are acquired. Many of the companies driving this consolidation trend have significantly greater financial, technical and other resources than we do and are better positioned to acquire and offer complementary products and technologies. The companies resulting from these possible consolidations may create more compelling product offerings and be able to offer greater pricing flexibility, making it more difficult for us to compete effectively, including on the basis of price, sales and marketing programs, technology or product functionality. Continued industry consolidation may adversely impact customers' perceptions of the viability of smaller and even medium-sized technology companies and consequently customers' willingness to purchase from such companies. These pressures could materially adversely affect our business, operating results and financial condition.
We also face competitive pressures from other sources. For example, Microsoft has improved, and has announced its intention to further improve, the performance of its software for remote office users. Our products are designed to improve the performance of many applications, including applications that are based on Microsoft protocols. Accordingly, improvements to Microsoft application protocols may reduce the need for our products, adversely affecting our business, operating results and financial condition. Improvement in other application protocols or in the Transmission Control Protocol (TCP), the underlying transport protocol for most WAN traffic, could have a similar effect. In addition, we market our products, in significant part, on the anticipated cost savings to be realized by organizations if they are able to avoid the purchase of costly IT infrastructure at remote sites by purchasing our products. To the extent other companies are able to reduce the costs associated with purchasing and maintaining servers, storage or applications to be operated at remote sites, our business, operating results and financial condition could be adversely affected.
We rely heavily on channel partners to sell our products. Disruptions to, or our failure to effectively implement, develop and manage, our distribution channels and the processes and procedures that support them could harm our business.
Our future success is highly dependent upon establishing and maintaining successful relationships with a variety of channel partners, including value-added resellers, value-added distributors, service providers, and systems integrators. A substantial majority of our revenue (95% in 2012 and 96% in 2011) is derived from indirect channel sales and we expect indirect channel sales to continue to account for a substantial majority of our total revenue. We employ a two-tier distribution strategy, as part of a larger effort to scale our reach and better serve the needs of our channel. Our revenue depends in large part on the effective performance of these channel partners, and changes to our distribution model, the loss of a channel partner or the reduction in sales to our channel partners could materially reduce our revenues and gross margins. By relying on indirect channels, we may have little or no contact with the ultimate users of our products, thereby making it more difficult for us to establish brand awareness, ensure proper delivery and installation of our products, service ongoing customer requirements and respond to evolving customer needs. In addition, we recognize a large portion of our revenue based on a sell-through model using information regarding the end user customers that is provided by our channel partners. If those channel partners provide us with inaccurate or untimely information, the amount or timing of our revenues could be adversely impacted. For example, we have encountered delays with certain partners where internal processing issues have prevented that partner from providing a purchase order to us in a timely manner.
Recruiting and retaining qualified channel partners and training them in our technology and product offerings requires significant time and resources. These recruitment, retention and training efforts have assumed even
greater importance as we have evolved into a multi-product company. 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. In particular, training and educating our channel partners has become more complex as we have introduced products that extend beyond core WAN optimization. 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, product discounting, freight charges, or our introduction of new products or new product platforms or entry into new markets with different pricing and cost structures.
Any introduction of, and transition to, a new product line requires us to forecast customer demand for both legacy and new product lines for a period of time, and to maintain adequate inventory levels to support the sales forecasts for both product lines. If new product line sales, or product line sales in general, exceed our sales forecast, we could possibly experience stock shortages, which would negatively affect our revenues. If legacy product line sales, or product lines sales in general, fall short of our sales forecast, we could have excess inventory, as has occurred from time to time. Any inventory charges would negatively impact our product gross margins.
Our sales cycles can be long and unpredictable, and our sales efforts require considerable time and expense. As a result, our revenue is difficult to predict and may vary substantially from quarter to quarter.
The timing of our revenue is difficult to predict. Our sales efforts involve educating our customers about the use and benefit of our products, including their technical capabilities and potential cost savings to an organization. Customers typically undertake a significant evaluation process that has in the past resulted in a lengthy sales cycle, in some cases over twelve months. Also, as our channel model distribution strategy evolves, utilizing value-added resellers, value-added distributors, systems integrators and service providers, and as the breadth of our product offerings increases, the level of variability in the length of sales cycle across transactions may increase and make it more difficult to predict the timing of many of our sales transactions. We spend substantial time and money in our sales efforts without any assurance that these endeavors will produce any sales. Even after making the decision to purchase, customers may deploy our products slowly and deliberately. In addition, product purchases are frequently and increasingly subject to budget constraints, multiple approvals, and unplanned administrative, processing and other delays.
Customers may also defer purchases as a result of anticipated or announced releases of new products or enhancements by our competitors or by us. For example, in the first quarter of 2012 and in prior periods we have experienced delays in customer purchasing cycles in response to our introduction of new products or product transitions; we expect that this trend will continue in the future. Product purchases may be, and in the recent past have been, delayed by the volatile U.S. and global economic environment, which introduced additional risk into our ability to accurately forecast sales in a particular quarter. If sales expected from a specific customer for a particular quarter are not realized in that quarter or at all, revenue will be harmed and we may miss our stated guidance for that period.
If we do not successfully anticipate market needs and develop products and product enhancements that meet those needs, or if those products do not gain market acceptance, our business and operating results will be harmed.
We may not be able to anticipate future market needs or be able to develop new products or product enhancements to meet such needs, either on a timely basis or at all. For example, our failure to address additional application-specific protocols, particularly if our competitors are able to provide such functionality, could harm our business. In addition, our inability to diversify beyond our current product offerings could adversely affect our business. Any new products or product enhancements that we introduce, including by way of acquisitions, may not achieve any significant degree of market acceptance or be accepted into our sales channel by our channel partners, which would adversely affect our business and operating results. In addition, the introduction of new products or product enhancements may shorten the life cycle of our existing products, or replace sales of some of our current products, thereby offsetting the benefit of even a successful product introduction, or may cause customers to defer purchasing our existing products in anticipation of the new or enhanced products, any of which could adversely affect our business and operating results.
Acquisitions could disrupt our business and cause dilution to our stockholders.
During 2012 we acquired OPNET Technologies, Inc. and certain assets of Expand Networks Ltd. In prior years we acquired Mazu Networks, Inc., CACE Technologies, Inc., Global Protocols LLC, Zeus Technology Ltd. and Aptimize Ltd. Also in 2012 we entered into multiple agreements contemporaneously with Juniper Networks, Inc. (Juniper) pursuant to which we acquired certain rights and licenses to Juniper's WX WAN optimization product line, entered into a technology integration agreement to integrate our Steelhead® Mobile technology into the Juniper Networks® Junos® Pulse client to enable a mobile acceleration solution for mobile phones and tablets, and granted Juniper a source code license for our application delivery controller (ADC) technology and related tools with rights to modify, create and distribute their own ADC product. In the future we may acquire other businesses, products or technologies. Our ability as an organization to integrate acquisitions is unproven. Any acquisitions that we complete may not ultimately strengthen our competitive position or achieve our goals, or the acquisition may be viewed negatively by customers, financial markets or investors. In addition, we may encounter difficulties in integrating personnel, operations, technologies or products from the acquired businesses and in retaining and motivating key personnel from these businesses. We may also encounter difficulties in maintaining uniform standards, controls, procedures and policies across locations, or in managing geographically or culturally diverse locations. We may experience significant problems or liabilities associated with acquired or integrated product quality or technology. Acquisitions may disrupt our ongoing operations, divert management from day-to-day responsibilities and increase our expenses. Acquisitions may reduce our cash available for operations and other uses and could result in an increase in amortization expense related to identifiable assets acquired, potentially dilutive issuances of equity securities or the incurrence of debt. Certain of these risks relating specifically to our December 2012 acquisition of OPNET, including risks relating to our borrowing $575 million pursuant to the terms of a senior credit facility, are set forth in the section titled “Risks Related to Our Acquisition of OPNET Technologies”.
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 use of Riverbed-designed content in our hardware platforms has increased our susceptibility to scarcity or delivery delays for custom components within our systems. Shortages in components that we use in our products have occurred recently and may occur in the future and our suppliers' ability to predict the availability of such components may be limited. For example, the flooding in Thailand affected the availability of disk drive components and, consequently, increased our costs in procuring those components. Some components that we use are available only from limited sources of supply. In addition, the lead times associated with certain components are lengthy and preclude rapid changes in quantity requirements and delivery schedules. The unavailability of any
component that is necessary to the proper functioning of our appliances would prevent us from shipping products. Any inability to ship our products in a timely manner would delay sales and adversely impact our revenue, business, operating results and financial condition.
Any growth in our business or the economy is likely to create greater pressures on us and our suppliers to project overall component demand accurately and to establish optimal component inventory levels. In addition, increased demand by third parties for the components we use in our products may lead to decreased availability and higher prices for those components. We carry limited inventory of our product components, and we rely on suppliers to deliver components in a timely manner based on forecasts we provide. We rely on both purchase orders and long-term contracts with our suppliers, but we may not be able to secure sufficient components at reasonable prices or of acceptable quality, which would seriously impact our ability to deliver products to our customers and, as a result, adversely impact our revenue.
If we fail to accurately predict our manufacturing requirements, we could incur additional costs or experience manufacturing delays, which would harm our business. We are dependent on contract manufacturers, and changes to those relationships, expected or unexpected, may result in delays or disruptions that could harm our business.
We depend on independent contract manufacturers to manufacture and assemble our products. We rely on purchase orders or long-term contracts with our contract manufacturers. Some of our contract manufacturers are not obligated to supply products to us for any specific period, in any specific quantity or at any specific price. Our orders may represent a relatively small percentage of the overall orders received by our contract manufacturers from their customers. As a result, fulfilling our orders may not be considered a priority by one or more of our contract manufacturers in the event the contract manufacturer is constrained in its ability to fulfill all of its customer obligations in a timely manner. We provide demand forecasts and purchase orders to our contract manufacturers. To the extent that any such demand forecast or purchase order is binding, if we overestimate our requirements, the contract manufacturers may assess charges or we may have liabilities for excess inventory, each of which could negatively affect our gross margins. Conversely, because lead times for required materials and components vary significantly and depend on factors such as the specific supplier, contract terms and the demand for each component at a given time, if we underestimate our requirements, the contract manufacturers may have inadequate materials and components required to produce our products, which could interrupt manufacturing of our products and result in delays in shipments and deferral or loss of revenue.
Although the contract manufacturing services required to manufacture and assemble our products may be readily available from a number of established manufacturers, it is time-consuming and costly to qualify and implement contract manufacturer relationships. Therefore, if one or more of our contract manufacturers suffers an interruption in its business, or experiences delays, disruptions or quality control problems in its manufacturing operations, or we choose to change or add additional contract manufacturers, our ability to ship products to our customers would be delayed and our business, operating results and financial condition would be adversely affected.
In addition, a portion of our manufacturing is performed overseas and is therefore subject to risks associated with doing business in other countries.
We are dependent on various information technology systems, and failures of or interruptions to those systems could harm our business.
Many of our business processes depend upon our information technology systems (IT), the systems and processes of third parties, and on interfaces with the systems of third parties. For example, our order entry system provides information to the systems of our contract manufacturers, which enables them to build and ship our products. If those systems fail or are interrupted, or if our ability to connect to or interact with one or more networks is interrupted, our processes may function at a diminished level or not at all. This would harm our ability to ship products, and our financial results would likely be harmed.
In addition, reconfiguring our IT systems or other business processes in response to changing business needs, or in connection with integrating acquired businesses, including our recent acquisition of OPNET, 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, we are currently engaged in patent infringement litigation against Silver Peak Systems, in which both we and Silver Peak Systems assert patent infringement by the other party. Intellectual property litigation has resulted, and may in the future result, in substantial costs and diversion of management resources, and may in the future harm our business, operating results and financial condition. Furthermore, many of our current and potential competitors have the ability to dedicate substantially greater resources to enforce their intellectual property rights than we do. Accordingly, despite our efforts, we may not be able to prevent third parties from infringing upon or misappropriating our intellectual property.
Claims by others that we infringe their proprietary technology could harm our business.
Our industry is, and any industry or market that we may enter in the future may be, characterized by the existence of a large number of patents and frequent claims and related litigation regarding patent and other intellectual property rights. In the ordinary course of our business, we are involved in disputes and licensing discussions with others regarding their claimed proprietary rights and we cannot assure you that we will always successfully defend ourselves against such claims. Third parties have claimed and may in the future claim that our products or technology infringe their proprietary rights. For example, in the third quarter of 2011, Silver Peak Systems alleged that we infringe certain of its patents. We expect that infringement claims may increase as the number of products and competitors in any of our markets increases and overlaps occur. In addition, as we have gained greater visibility and market exposure as a public company, we face a higher risk of being the subject of intellectual property infringement claims. Any claim of infringement by a third party, even those without merit, could cause us to incur substantial legal costs defending against the claim, and could distract our management from our business. Furthermore, we could be subject to a judgment or voluntarily enter into a settlement, either of which could require us to pay substantial damages. A judgment or settlement could also include an injunction or other court order that could prevent us from offering our products. In addition, we might elect or be required to seek a license for the use of third-party intellectual property, which may not be available on commercially reasonable terms or at all, or if available, the payments under such license may harm our operating results and financial condition. Alternatively, we may be required to develop non-infringing technology, which could require significant effort and expense and may ultimately not be successful. Any of these events could seriously harm our business, operating results and financial condition. Third parties may also assert infringement claims against our customers and channel partners. Any of these claims would require us to initiate or defend potentially protracted and costly litigation on their behalf, regardless of the merits of these claims, because we generally indemnify our customers and channel partners from claims of infringement of proprietary rights of third parties. If any of these claims succeed, or if we voluntarily enter into a settlement, we may be forced to pay damages on behalf of our customers or channel partners, which could have a material adverse effect on our business, operating results and financial condition.
Our international sales and operations subject us to additional risks that may harm our operating results.
In the years ended December 31, 2012, 2011, and 2010, we derived 45%, 45% and 47%, respectively, of our revenue from customers outside the U.S. We have personnel in numerous countries worldwide. We expect to continue to add personnel in additional countries. Our international sales and operations makes us subject to various U.S. and international laws and regulations, including those relating to antitrust, data protection, and
business dealings with both commercial and governmental officials and organizations. Our international sales and operations subject us to a variety of additional risks, including:
As we continue to expand our business globally, our success will depend, in large part, on our ability to anticipate and effectively manage these and other risks associated with our international sales and operations. Our failure to manage any of these risks successfully, or to comply with these laws and regulations, could harm our operations, reduce our sales and harm our business, operating results and financial condition. For example, in certain foreign countries, particularly those with developing economies, certain business practices that are prohibited by laws and regulations applicable to us, such as the Foreign Corrupt Practices Act, may be more commonplace. Although we implement policies and procedures with the intention of ensuring compliance with these laws and regulations, our employees, contractors and agents, as well as channel partners involved in our international sales, may take actions in violation of our policies. Any such violation could have an adverse effect on our business and reputation.
Some of our business partners also have international operations and are subject to the risks described above. Even if we are able to successfully manage the risks of international operations, our business may be adversely affected if our business partners are not able to successfully manage these risks.
Foreign currencies periodically experience rapid fluctuations in value against the U.S. dollar. Any foreign currency devaluation against the U.S. dollar increases the real cost of our products to our customers and partners in foreign markets where we sell in U.S. dollars, which has resulted in the past and may result in the future in delayed or cancelled purchases of our products and, as a result, lower revenues. In addition, this increase in cost increases the risk to us that we will be unable to collect amounts owed to us by such customers or partners, which in turn would impact our revenues and could materially adversely impact our business and financial results. Any devaluation may also lead us to more aggressively discount our prices in foreign markets in order to maintain competitive pricing, which would negatively impact our revenues and gross margins. Conversely, a weakened U.S. dollar could increase the cost of local operating expenses and procurement of raw materials to the extent we purchase components in foreign currencies.
Starting in the first quarter of fiscal 2012, we entered into forward contracts designated as cash flow hedges to protect against foreign currency exchange rate risks. The effectiveness of our hedges depends on our ability to accurately forecast expenses denominated in non-US dollar currencies. As a result, we could incur significant losses from our hedging activities if our forecasts are incorrect. In addition, our hedging activities may be ineffective or may not offset any or more than a portion of the adverse financial impact resulting from currency variations. Gains or losses associated with hedging activities also may impact our profitability.
International customers may also require that we localize our products. The product development costs for localizing the user interface of our products, both graphical and textual, could be a material expense to us if the software requires extensive modifications. To date, such changes have not been extensive, and the costs have not been material.
We are investing in engineering, sales, marketing, services and infrastructure, and these investments may achieve delayed or lower than expected benefits, which could harm our operating results.
We intend to continue to add personnel and other resources to our engineering, sales, marketing, services and infrastructure functions as we focus on developing new technologies, growing our market segment, capitalizing on existing or new market opportunities, increasing our market share, and enabling our business operations to meet anticipated demand. We are likely to recognize the costs associated with these investments earlier than some of the anticipated benefits, and the return on these investments may be lower, or may develop more slowly, than we expect. If we do not achieve the benefits anticipated from these investments, or if the achievement of these benefits is delayed, our operating results may be adversely affected.
If we lose key personnel or are unable to attract and retain personnel on a cost-effective basis, our business would be harmed.
Our success is substantially dependent upon the performance of our senior management and key technical and sales personnel. 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. For the year ended December 31, 2012, our research and development expenses were $146.1 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, both organically and through acquisitions of complementary businesses and technologies, including our December 2012 acquisition of OPNET, and anticipate that further significant expansion will be required. This growth is expected to continue to place significant demands on our management, infrastructure and other resources. To manage our growth, we 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.
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 WAN optimization products will become less effective.
Our WAN optimization 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 WAN optimization products to reduce such redundancy depends on our products' ability to recognize the data being requested. Our WAN optimization 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 WAN optimization products. For those organizations that elect to encrypt their data transmissions from the end-user to the server in a format that we are not able to decrypt, our WAN optimization products will offer limited performance improvement unless we are successful in incorporating additional functionality into our products that address those encrypted transmissions. Our failure to provide such additional functionality could limit the growth of our business and harm our operating results.
If our products do not interoperate with our customers' infrastructure, installations could be delayed or cancelled, which would harm our business.
Our products must interoperate with our customers' existing infrastructure, which often have different specifications, utilize multiple protocol standards, deploy products from multiple vendors, and contain multiple generations of products that have been added over time. If we find errors in the existing software or defects in the hardware used in our customers' infrastructure or problematic network configurations or settings, as we have in the past, we may have to modify our software or hardware so that our products will interoperate with our customers' infrastructure. In such cases, and others, our products may be unable to provide significant performance improvements for applications deployed in our customers' infrastructure. These issues could cause longer installation times for our products and could cause order cancellations, either of which would adversely affect our business, operating results and financial condition. In addition, government and other customers may require our products to comply with certain security or other certifications and standards. If our products are late in achieving or fail to achieve compliance with these certifications and standards, or our competitors achieve compliance with these certifications and standards, we may be disqualified from selling our products to such customers, or at a competitive disadvantage, which would harm our business, operating results and financial condition.
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 broader product offering than ours may be able to offer concessions that we are not able to match because we currently offer a relatively focused line of products and have fewer resources than many of our competitors. If organizations are reluctant to add network infrastructure products from new vendors or otherwise decide to work with their existing vendors, our business, operating results and financial condition will be adversely affected.
Our products are highly technical and may contain undetected software or hardware errors. These errors, and any related claims against our products, could cause harm to our reputation and our business.
Our products, including software product upgrades and releases, are highly technical and complex and, when deployed, are critical to the operation of many networks. Our products have contained and may contain undetected errors, defects or security vulnerabilities. In particular, new products and product platforms may be subject to increased risk of hardware issues. Some errors in our products may be discovered only after a product has been installed and used by customers. Some of these errors may be attributable to third-party technologies incorporated into our products, which makes us dependent upon the cooperation and expertise of such third parties for the
diagnosis and correction of such errors. The diagnosis and correction of third-party technology errors is particularly difficult where our product features the RSP or VSP, because it is not always immediately clear whether a particular error is attributable to a technology incorporated into our product or to third-party software deployed by our customers on our product. In addition, where we have incorporated technology from a third-party, the solutions may be more complex and may lead to new technical errors that may prove difficult to diagnose and support. Any delay or mistake in the initial diagnosis of an error will result in a delay in the formulation of an effective action plan to correct such error. Any errors, defects or security vulnerabilities discovered in our products after commercial release could result in loss of revenue or delay in revenue recognition, loss of customers and increased service and warranty cost, any of which could harm our reputation, business, operating results and financial condition. Any such errors, defects or security vulnerabilities could also adversely affect the market's perception of our products and business. In addition, we could face claims for product liability, tort or breach of warranty, including claims relating to changes to our products made by our channel partners. Our contracts with customers contain provisions relating to warranty disclaimers and liability limitations, which may not be upheld. Defending a lawsuit, regardless of its merit, is costly and may divert management's attention and harm the market's perception of us and our products. In addition, if our business liability insurance coverage proves inadequate or future coverage is unavailable on acceptable terms or at all, our business, operating results and financial condition could be adversely impacted.
Our use of open source and third-party software could impose limitations on our ability to commercialize our products.
We incorporate open source software into our products. Although we monitor our use of open source closely, the terms of many open source licenses have not been interpreted by U.S. courts, and there is a risk that such licenses could be construed in a manner that could impose unanticipated conditions or restrictions on our ability to commercialize our products. We could also be subject to similar conditions or restrictions should there be any changes in the licensing terms of the open source software incorporated into our products. In either event, we could be required to seek licenses from third parties in order to continue offering our products, to re-engineer our products or to discontinue the sale of our products in the event re-engineering cannot be accomplished on a timely or successful basis, any of which could adversely affect our business, operating results and financial condition.
We also incorporate certain third-party technologies, including software programs, into our products and may need to utilize additional third-party technologies in the future. However, licenses to relevant third-party technology may not continue to be available to us on commercially reasonable terms, or at all. Therefore, we could face delays in product releases until equivalent technology can be identified, licensed or developed, and integrated into our current products. These delays, if they occur, could materially adversely affect our business, operating results and financial condition. We currently use third-party software programs in our appliance and software products, some of which are currently available from only one vendor. Any disruption in our access to these or other software programs or third-party technologies could result in significant delays in our product releases and could require substantial effort to locate or develop a replacement program. If we decide in the future to incorporate into our products any other software program licensed from a third party, and the use of such software program is necessary for the proper operation of our products, 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 export controls of the U.S. and other countries and may be exported outside the U.S. and other countries only with the required level of export license or through an export license exception, because we incorporate encryption technology into our products. In addition, various countries regulate the import of certain encryption technology and have enacted laws that could limit our ability to distribute our products or could limit our customers' ability to implement our products in those countries. Changes in our products or changes in regulations may increase the cost of building and selling our products, create delays in the introduction of our products in international markets, prevent our customers with international operations from deploying our products throughout their global systems or, in some cases, prevent the export or import of our products to certain countries altogether. Any change in regulations, shift in approach to the enforcement or scope of existing regulations, or change in the countries, persons or technologies targeted by such regulations, could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential customers with international operations. We must comply with various and increasing environmental regulations, both domestic and international, regarding the manufacturing and disposal of our products. For example, we must comply with Waste Electrical and Electronic Equipment Directive laws, which are being adopted by certain European Economic Area countries on a country-by-country basis. Failure to comply
with these and similar laws on a timely basis, or at all, could have a material adverse effect on our business, operating results and financial condition. This would also be true if we fail to comply, either on a timely basis or at all, with any U.S. environmental laws regarding the manufacturing or disposal of our products. Any decreased use of our products or limitation on our ability to export or sell our products would harm our business, operating results and financial condition.
Our sales to the United Stated government customers subject us to special risks that could adversely affect our business.
We sell our products directly or indirectly to the United States government and, in connection with such sales, we must comply with complex federal procurement and related laws and regulations, which may impose added costs on our business. For the year ended December 31, 2012, approximately 11% of our sales constituted sales made directly or indirectly to the United States government. The federal government audits and reviews the performance of federal contractors regarding contract terms, pricing practices, cost structure, and compliance with applicable laws, regulations and standards. Such an audit could result in an adverse finding, including a finding that we overcharged the government or failed to comply with applicable laws, regulations and standards. If a government audit or other investigation results in an adverse finding or uncovers improper or illegal activities, we may be required to restate previously reported operating results or we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines, and suspension or debarment from doing business with United States federal government agencies. We could face additional expense and delay if any of our competitors, or competitors of the prime contractors to which we serve as subcontractors, protest or challenge contract awards made to us or to our prime contractors pursuant to competitive bidding. In addition, United States government contracts contain provisions and are subject to laws and regulations that provide government customers with rights and remedies not typically found in commercial contracts; these remedies include rights to terminate for convenience on short notice, reduce or modify contracts or subcontracts, and claim rights in products and technology produced by us.
We compete in rapidly evolving markets and have a limited operating history, which makes it difficult to predict our future operating results.
We were incorporated in May 2002 and shipped our first Steelhead appliance in May 2004. We have a limited operating history and offer a focused line of products in an industry characterized by rapid technological change. It is very difficult to forecast our future operating results. You should consider and evaluate our prospects in light of the risks and uncertainty frequently encountered by companies in rapidly evolving markets characterized by rapid technological change, changing customer needs, increasing competition, evolving industry standards and frequent introductions of new products and services. As we encounter rapidly changing customer requirements and increasing competitive pressures, we likely will be required to reposition our product and service offerings and introduce new products and services. We may not be successful in doing so in a timely and appropriately responsive manner, or at all. Furthermore, many of our target customers have not purchased products similar to ours and might not have a specific budget for the purchase of our products and services. All of these factors make it difficult to predict our future operating results.
We incur significant costs as a result of operating as a public company, and our management devotes substantial time to new compliance initiatives.
We incur significant legal, accounting and other expenses as a public company, including costs resulting from regulations regarding corporate governance practices and costs relating to compliance with Section 404 of the Sarbanes-Oxley Act. For example, the listing requirements of the Nasdaq Stock Market's Global Select Market require that we satisfy certain corporate governance requirements relating to independent directors, audit and compensation committees, distribution of annual and interim reports, stockholder meetings, stockholder approvals, solicitation of proxies, conflicts of interest, stockholder voting rights and codes of conduct. In addition, the Dodd-Frank Wall Street Reform and Consumer Protection Act contains various provisions applicable to the corporate governance functions of public companies. Our management and other personnel devote a substantial amount of time to these compliance initiatives. Moreover, these rules and regulations have increased our legal and financial compliance costs and will make some activities more time-consuming and costly. For example, these rules and regulations could make it more difficult for us to attract and retain qualified persons to serve on our Board of Directors, our board committees or as executive officers.
While we believe that we currently have adequate internal controls over financial reporting, we are exposed to risks from legislation requiring companies to evaluate those internal controls.
The Sarbanes-Oxley Act requires that we test our internal controls over financial reporting and disclosure controls and procedures. In particular, for the year ended December 31, 2012, we performed system and process evaluation and testing of our internal controls over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Our compliance with Section 404 requires that we incur substantial expense and expend significant management time on compliance-related issues. Moreover, if we are not able to comply with the requirements of Section 404 in the future, or if we or our independent registered public accounting firm identify deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses, the market price of our stock may decline and we could be subject to sanctions or investigations by the Nasdaq Stock Market's Global Select Market, the SEC or other regulatory authorities, which would require significant additional financial and management resources.
Changes in financial accounting standards may cause adverse unexpected revenue fluctuations and affect our reported results of operations.
A change in accounting policies can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective. New pronouncements and varying interpretations of existing pronouncements have occurred with frequency and may occur in the future. Changes to existing rules, or changes to the interpretations of existing rules, could lead to changes in our accounting practices, and such changes could adversely affect our reported financial results or the way we conduct our business.
We are required to expense equity compensation given to our employees, which has reduced our reported earnings, will harm our operating results in future periods and may reduce our stock price and our ability to effectively utilize equity compensation to attract and retain employees.
We historically have used stock options, restricted stock units (RSU), and an employee stock purchase plan as significant components of our employee compensation program in order to align employees' interests with the interests of our stockholders, encourage employee retention, and provide competitive compensation packages. The compensation charges that we are required to record related to these equity awards have reduced, and will continue to reduce, our reported earnings, will harm our operating results in future periods, and may require us to reduce the availability and amount of equity incentives provided to employees, which could make it more difficult for us to attract, retain and motivate key personnel. Moreover, if securities analysts, institutional investors and other investors adopt financial models that include stock option expense in their primary analysis of our financial results, our stock price could decline as a result of reliance on these models with higher expense calculations.
We may have exposure to greater than anticipated tax liabilities.
Our provision for income taxes is subject to volatility and could be adversely affected by nondeductible stock-based compensation, changes in the research and development tax credit laws, earnings being lower than anticipated in jurisdictions where we have lower statutory rates and being higher than anticipated in jurisdictions where we have higher statutory rates, transfer pricing adjustments, not meeting the terms and conditions of tax holidays or incentives, changes in the valuation of our deferred tax assets and liabilities, changes in actual results versus our estimates, or changes in tax laws, regulations, accounting principles or interpretations thereof. In addition, like other companies, we may be subject to examination of our income tax returns by the U.S. Internal Revenue Service and other tax authorities. While we regularly assess the likelihood of adverse outcomes from such examinations and the adequacy of our provision for income taxes, there can be no assurance that such provision is sufficient and that a determination by a tax authority will not have an adverse effect on our results of operations.
If we fail to successfully manage our exposure to the volatility and economic uncertainty in the global financial marketplace, our operating results could be adversely impacted.
We are exposed to financial risk associated with the global financial markets, including volatility in interest rates and uncertainty in the credit markets. Our exposure to market rate risk for changes in interest rates relates primarily to our $575 million senior credit facility and our investment portfolio. The primary objective of our investment activities is to preserve principal, maintain adequate liquidity and portfolio diversification while at the same time maximizing yields without significantly increasing risk. However, the valuation of our investment portfolio is subject to uncertainties that are difficult to predict. Factors that may impact its valuation include changes to credit ratings of the securities that we hold, interest rate changes, the ongoing strength and quality, and recent instability, of the global credit market, and liquidity. If the carrying value of our investments exceeds the fair value, and the decline in fair value is deemed to be other-than-temporary, we will be required to write down the value of our
investments. Additionally, instability and uncertainty in the financial markets, as has been recently experienced, could result in the incurrence of significant realized or impairment losses associated with certain of our investments, which would reduce our net income.
If we need additional capital in the future, it may not be available to us on favorable terms, or at all.
We have historically relied on outside financing and cash flow from operations to fund our operations, capital expenditures and expansion, most recently through establishment of a $575 million senior secured term loan facility to facilitate our acquisition of OPNET. 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 our current senior secured term loan facility contain certain covenants that limit future borrowings and require that certain payments, investments and acquisitions meet defined leverage ratios, and any additional financing may place additional 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, break-ins or terrorism.
Our main operations, including our primary data center, are located in the San Francisco Bay Area, a region known for seismic activity. A significant natural disaster, such as an earthquake, fire or a flood, could disrupt our operations and therefore harm our business, operating results and financial condition. A natural disaster could also impact our ability to manufacture and deliver our products to customers, or provide support to our customers, any of which would harm our business, operating results and financial condition. In addition, our servers are vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems, which could result in the theft of intellectual property, customer information or other sensitive data. Any of these incidents could result in both legal and reputational costs. Natural disasters, acts of unrest or terrorism or war could also cause disruptions in our or our customers' business, our domestic and international markets, or the economy as a whole. To the extent that such disruptions result in delays or cancellations of customer orders or the deployment of our products, our business, operating results and financial condition would be adversely affected.
Risks Related to Our Acquisition of OPNET Technologies
The integration of the businesses and operations of Riverbed and OPNET involves risks, and the failure to integrate successfully the businesses and operations in the expected time frame may adversely affect our future results.
Any failure to meet the challenges involved in integrating the operations of Riverbed and OPNET successfully or to otherwise realize any of the anticipated benefits of the acquisition of OPNET could harm our results of operations. Our ability to realize the benefits of the acquisition will depend in part on the timely integration of organizations, operations, procedures, policies and technologies, as well as the harmonization of differences in the business cultures of the two companies and retention of key personnel. The integration of the companies will be a complex, time-consuming and expensive process that, even with proper planning and implementation, could significantly disrupt our business. The challenges involved in this integration include the following:
We may not successfully integrate the operations of Riverbed and OPNET in a timely manner, or at all. If we fail to manage the integration of these businesses effectively, our growth strategy and future profitability could be negatively affected, and we may fail to achieve the intended benefits of the acquisition.
We may not realize the anticipated benefits of the acquisition of OPNET.
We are acquiring OPNET to realize certain anticipated benefits. Our ability to realize these anticipated benefits depends, in part, on our ability to successfully combine the businesses of Riverbed and OPNET. We may not realize the anticipated benefits to the extent, or in the time frame, anticipated. The anticipated benefits are necessarily based on projections and assumptions, and assume, among other things, a successful integration of OPNET's business with our Cascade product line. If we do not realize the anticipated benefits, our growth strategy and future profitability could be negatively affected.
We have taken on significant debt to finance the OPNET acquisition, which will decrease our business flexibility and increase our interest expense.
In connection with the acquisition of OPNET, we incurred approximately $575 million of debt. This debt, together with certain covenants imposed on us in connection with incurring this debt, will, among other things, reduce our flexibility to respond to changing business and economic conditions and will increase our interest expense. Our ability to pay interest and repay the principal for our indebtedness is dependent upon our ability to manage our business operations, generate sufficient cash flows to service such debt and the other factors discussed in this section. There can be no assurance that we will be able to manage any of these risks successfully. We may also need to refinance a portion of our outstanding debt as it matures. There is a risk that we may not be able to refinance existing debt or that the terms of any refinancing may not be as favorable as the terms of our existing debt. Furthermore, if prevailing interest rates or other factors at the time of refinancing result in higher interest rates upon refinancing, then the interest expense relating to that refinanced indebtedness would increase. In addition, changes by any rating agency to our outlook or credit rating could negatively affect the value of both our debt and equity securities and increase the interest amounts we pay on outstanding or future debt. These risks could adversely affect our financial condition and results of operations.
The completion of the acquisition may cause customers or suppliers to terminate their relationships with us.
Certain of our customers or suppliers may be uncertain about the combined company or may have prior experience with OPNET that causes such customers or suppliers to be dissatisfied with OPNET. Likewise, certain customers or suppliers of OPNET may be uncertain about the combined company or may have prior experience with us that causes such customers or suppliers to be dissatisfied with us. This uncertainty or dissatisfaction may cause such customers or suppliers to terminate their existing relationships with or seek to change their existing agreements with us. These decisions could have an adverse effect on our business.
Uncertainty following the acquisition may cause customers, suppliers and channel partners to delay or defer decisions concerning us and adversely affect our business, financial condition and operating results.
Uncertainty following the acquisition of OPNET may cause customers, suppliers and channel partners to delay or defer decisions concerning us or our products, which could negatively affect our business. Customers, suppliers and channel partners may also seek to change existing agreements with us as a result of the acquisition. Any delay or deferral of those decisions or changes in existing agreements could adversely affect our business.
Failure to retain key employees could diminish the anticipated benefits of the acquisition.
The success of the acquisition of OPNET will depend in part on the retention of personnel critical to the business and operations of the combined company due to, for example, their technical skills or management expertise. Employees and consultants may experience uncertainty about their future roles with us until clear strategies are announced or executed. Riverbed and OPNET, while similar, do not have the same corporate cultures, and some employees or consultants may not want to work for the combined company. In addition, competitors may recruit employees during our integration of OPNET. If we are unable to retain personnel that are critical to the successful integration and future operation of the combined companies, we could face disruptions in our operations, loss of existing customers, key information, expertise or know-how, and unanticipated additional recruiting and training costs. In addition, the loss of key personnel could diminish the anticipated benefits of the acquisition of OPNET.
Our acquisition of OPNET could trigger certain provisions contained in OPNET's agreements with third parties that could permit such parties to terminate those agreements.
OPNET may be a party to agreements that permit a counter-party to terminate an agreement or receive payments because the acquisition would cause a default or violate an anti-assignment, change of control or similar clause in such agreement. If this happens, we may have to seek to replace that agreement with a new agreement or make additional payments under such agreement. However, we may be unable to replace a terminated agreement on comparable terms or at all. Depending on the importance of such agreement to our business, the failure to replace a terminated agreement on similar terms or at all, and requirements to pay additional amounts, may increase the costs to us of operating the combined business.
Risks Related to Ownership of Our Common Stock
The trading price of our common stock has been volatile and is likely to be volatile in the future.
The trading prices of the securities of technology companies, including our own, have been highly volatile. Further, our common stock has a limited trading history. Since our initial public offering in September 2006 through December 31, 2012, our stock price, after adjusting for our 2:1 stock split in the form of a stock dividend effected in November 2010, has fluctuated from a low of $3.55 to a high of $44.70. The market price of our common stock has at times reflected a higher multiple of expected future earnings than many other companies. As a result, even small changes in investor expectations regarding our future growth and earnings, whether as a result of actual or rumored financial or operating results, changes in the mix of products and services sold, acquisitions, industry changes, or other factors, could result in, and have recently resulted in, significant fluctuations in the market price of our common stock.
Factors that could affect the trading price of our common stock include, but are not limited to:
If the market for technology stocks or the stock market in general experiences loss of investor confidence, the trading price of our common stock could decline for reasons unrelated to our business, operating results or financial condition. The trading price of our common stock might also decline in reaction to announcements by, or events that affect, other companies in our industry, or the trading price might decline in reaction to events that affect the stock market generally even if these announcements or events do not directly affect us. Each of these factors, among others, could cause our stock price to decline. Some companies that have had volatile market prices for their securities have had securities class actions filed against them. If such a suit were filed against us, regardless of its merits or outcome, it could result in substantial costs and divert management's attention and resources.
If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.
The trading market for our common stock will continue to depend in part on the research and reports that securities or industry analysts publish about us or our business. If we do not continue to maintain adequate research coverage or if one or more of the analysts who covers us downgrades our stock or publishes inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts ceases coverage of our company or fails to publish reports on us regularly, demand for our stock could decrease, which could cause our stock price and trading volume to decline.
Anti-takeover provisions in our charter documents and Delaware law could discourage, delay or prevent a change in control of our company and may affect the trading price of our common stock.
We are a Delaware corporation and the anti-takeover provisions of the Delaware General Corporation Law may discourage, delay or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder, even if a change in control would be beneficial to our existing stockholders. In addition, our restated certificate of incorporation and amended and restated bylaws contain provisions that may discourage, delay or prevent a change in our management or control over us that stockholders may consider favorable.
We lease approximately 102,358 square feet of office space in San Francisco, California pursuant to a lease that expires in 2014. In February 2012, we entered into a lease for approximately 167,000 square feet of office space in San Francisco, California for our new worldwide corporate headquarters. Upon acquisition of OPNET Technologies, Inc., we assumed approximately 82,000 square feet of office space in Bethesda, MD held under two leases. These leases expire in 2016 and 2021. In addition, we lease approximately 67,000 square feet of office space in Sunnyvale, California pursuant to leases that expires in 2021. We maintain support centers in New York, the San Francisco Bay Area, Amsterdam, London, Singapore, Sydney and Tokyo, and sales offices in multiple locations worldwide. We believe that our current facilities are suitable and adequate to meet our current needs, and we intend to add new facilities or expand existing facilities as necessary.
On June 1, 2011, we served Silver Peak Systems, Inc. with a lawsuit, filed in the United States District Court for the District of Delaware, alleging infringement of certain patents. The lawsuit seeks unspecified damages and injunctive relief. On July 22, 2011, Silver Peak Systems denied the allegations and requested declaratory judgments of invalidity and non-infringement.
On August 17, 2011, Silver Peak Systems amended its counterclaims against us, alleging infringement by Riverbed of three US patents: 7,630,295, titled “Network Device Continuity”; 7,945,736, titled “Dynamic Load Management of Network Memory”; and 7,948,921, titled “Automatic Network Optimization.” The patents purport to cover certain features offered on the Riverbed Steelhead products. Silver Peak seeks unspecified damages and a permanent injunction prohibiting Riverbed from offering those features. On September 20, 2011, we denied Silver Peak Systems’ allegations and requested declaratory judgments of invalidity and non-infringement.
On December 21, 2011, we amended our lawsuit against Silver Peak Systems to allege infringement of an additional patent.
At this time we are unable to estimate any range of reasonably possible loss relating to these actions. Discovery is ongoing, and trial of our claims against Silver Peak Systems is currently scheduled to begin on September 30, 2013. Trial of Silver Peak Systems' claims against us is currently scheduled to begin on March 24, 2014. We believe that we have meritorious defenses to the counterclaims against us, and we intend to vigorously contest these counterclaims.
In connection with our July 2011 acquisition of the outstanding securities of Zeus Technology Limited (Zeus), the share purchase agreement provided for certain additional potential payments (acquisition-related contingent consideration) totaling up to $27.0 million in cash, based on achievement of certain bookings targets related to Zeus products for the period from July 20, 2011 through July 31, 2012 (the Zeus Earn-Out period). The share purchase agreement also provided for a potential $3.0 million payment as an incentive bonus to former employees of Zeus, based on achievement of certain bookings targets related to Zeus products for the Zeus Earn-Out period.
In October 2012 we served the representative of the Zeus shareholders, as lead defendant and proposed defendant class representative for all other similarly situated former shareholders of Zeus, with a lawsuit, filed in the Superior Court of the State of California, for declaratory relief. The lawsuit seeks declaratory judgment that, among other things, (a) Riverbed is not in breach of the share purchase agreement, and (b) Riverbed does not owe any acquisition-related contingent consideration under the share purchase agreement because the necessary conditions precedent to the payment of acquisition-related contingent consideration did not occur. In November 2012, the representative of the Zeus shareholders filed a cross-complaint against Riverbed and Riverbed Technology Limited in the Superior Court of the State of California. The cross-complaint claims breach of contract and breach of the covenant of good faith and fair dealing, and seeks declaratory judgment that Riverbed has breached the share purchase agreement and that the entire $27.0 million in contingent consideration is payable to Zeus shareholders. We believe that the contention of the representative of the Zeus shareholders is without merit and intend to vigorously defend our determination.
In November 2012 we received a grand jury subpoena issued by the United States District Court for the Eastern District of Virginia. The subpoena requests documents related to certain federal government contracting matters, including a $19 million transaction involving the sale of our products and services by a Riverbed reseller to an agency of the federal government in 2009. We are cooperating fully with this inquiry.
From time to time, we are subject to various legal proceedings, claims and litigation arising in the ordinary course of business. We do not believe we are party to any currently pending legal proceedings the outcome of which would have a material adverse effect on our financial position, results of operations or cash flows.
There can be no assurance that existing or future legal proceedings arising in the ordinary course of business or otherwise will not have a material adverse effect on our financial position, results of operations or cash flows.
Market Information for Common Stock
Our common stock has traded on Nasdaq under the symbol “RVBD” since our initial public offering on September 20, 2006, first on the Nasdaq Global Market and, since January 1, 2008, on the Nasdaq Global Select Market. Prior to our initial public offering, there was no public market for our common stock.
The following table sets forth for the indicated periods the high and low sales prices of our common stock as reported by the Nasdaq Global Select Market.
The last reported sale price for our common stock on the Nasdaq Global Select Market was $15.92 per share on February 14, 2013.
We have never paid any cash dividends on our common stock. Our board of directors currently intends to retain any future earnings to support operations and to finance the growth and development of our business and does not intend to pay cash dividends on our common stock for the foreseeable future. Any future determination related to our dividend policy will be made at the discretion of our board of directors.
As of February 7, 2013, there were 220 registered stockholders of record of our common stock. Because many of our shares of common stock are held by brokers or other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by the record holders.
Stock Performance Graph
The graph set forth below compares the cumulative total stockholder return on our common stock between December 31, 2007 and December 31, 2012, with the cumulative total return of (i) the Nasdaq Computer Index and (ii) the Nasdaq Composite Index, over the same period. This graph assumes the investment of $100 on December 31, 2007 in our common stock, the Nasdaq Computer Index and the Nasdaq Composite Index, and assumes the reinvestment of dividends, if any. We have never paid dividends on our common stock and have no present plans to do so. The graph assumes the initial value of our common stock on December 31, 2007 was the closing sales price of $13.37 per share.
The comparisons shown in the graph below are based upon historical data and are not intended to suggest future performance. This performance graph shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the Exchange Act), or incorporated by reference into any filing of ours under the Securities Act of 1933, as amended, or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.
Recent Sales of Unregistered Securities
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
Share Repurchase Program
On August 19, 2011, our Board of Directors authorized a Share Repurchase Program (the Program), which authorizes us to repurchase up to $150.0 million of our outstanding common stock. On May 17, 2012, our Board of Directors approved a $150.0 million increase to the Program. The Program does not require us to purchase a minimum number of shares, and may be suspended, modified or discontinued at any time without prior notice. During the three months ended December 31, 2012, no shares were purchased in open market transactions under the Program. During the twelve months ended December 31, 2012, we repurchased 7,376,859 shares of common stock under the Program on the open market for an aggregate purchase price of $127.1 million, or a weighted average of $17.24 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 $137.8 million, subject to the terms under our credit agreement.
The following selected consolidated financial data should be read in conjunction with our audited consolidated financial statements and related notes thereto and with Management’s Discussion and Analysis of Financial Condition and Results of Operations, which are included in this Annual Report on Form 10-K. The consolidated statement of operations data for the years ended December 31, 2012, 2011 and 2010, and the selected consolidated balance sheet data as of December 31, 2012 and 2011 are derived from, and are qualified by reference to, the audited consolidated financial statements included in this Annual Report on Form 10-K. The
consolidated statement of operations data for the years ended December 31, 2009 and 2008, and the consolidated balance sheet data as of December 31, 2010, 2009 and 2008 are derived from audited consolidated financial statements, which are not included in this Annual Report on Form 10-K.
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.
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 over 22,000 customers worldwide, including customers resulting from acquisitions. We offer several product lines including Steelhead appliances directed at the WAN optimization market, Cascade products in the network performance management (NPM) market, our Stingray product line which competes in the virtual application delivery controller (ADC) market, and our Whitewater cloud storage gateway directed at the cloud back up and disaster recovery solution market.
We are headquartered in San Francisco, California. Our personnel are located throughout the U.S. and in more than thirty-five 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:
channel partners. We intend to expand our direct sales force and leverage our indirect channels to extend our geographic reach and market penetration.
Major Trends Affecting Our Financial Results
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, NPM, application performance management and the virtual ADC markets, and our ability to continue to attract new customers in those markets and generate additional sales from existing customers. Our growth in support and services revenue is dependent upon increasing the number of products under support contracts, which is dependent on both growing our installed base of customers and renewing existing support contracts. Our future profitability and rate of growth will be directly affected by the continued acceptance of our products in the marketplace, as well as the timing and size of orders, product mix, average selling prices and costs of our products and general economic conditions. Our ability to 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.
Our revenue has grown rapidly since we began shipping products in May 2004, increasing from $2.6 million in 2004 to $836.9 million in 2012. Revenue grew by 15% in 2012 from $726.5 million in 2011. We believe that our revenue growth is a positive sign that our products have a significant value proposition to our customers and that the markets that we compete in are still expanding.
Costs and Expenses
Operating expenses consist of sales and marketing, research and development, general and administrative expenses, and acquisition-related costs. Personnel-related costs, including stock-based
compensation, are the most significant component of each of these expense categories. As of December 31, 2012, including more than 650 employees hired in connection with our acquisition of OPNET Technologies, Inc. (OPNET), we had 2,566 employees, an increase of 59% from the 1,610 employees at December 31, 2011. Our increasing employee headcount remains the most significant driver behind the increase in costs and operating expenses in 2012. The increase in employees reflects our investment in supporting our increased revenue and expanding our product offerings through strategic transactions, including OPNET. The timing of additional hires and material acquisitions has and could materially affect our operating expenses, both in absolute dollars and as a percentage of revenue, in any particular period.
Stock-based Compensation Expense
Stock-based compensation expense and related payroll taxes were $92.5 million, $97.2 million, and $73.9 million in the years ended December 31, 2012, 2011 and 2010 respectively. We expect to continue to incur significant stock-based compensation expense and anticipate further growth in stock-based compensation expense as our employee base grows because we expect stock-based compensation to continue to play an important part in the overall compensation structure for our employees.
Stock-based compensation expense and related payroll tax was as follows:
On December 18, 2012, we completed our acquisition of OPNET to extend our NPM business into the application performance management (APM) market. The addition of OPNET's broad-based family of APM products enhances our position in the NPM market and enables us to provide customers with an integrated solution that both monitors network and application performance and also accelerates it. The total acquisition date fair value of consideration transferred was approximately $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. The revenue and operating loss of OPNET, which was included in our consolidated statement of operations from the acquisition date to December 31, 2012, was $5.5 million and $6.5 million, respectively.
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. and Aptimize Ltd., 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, which included initial payments of $121.5 million in cash, of which $22.8 million was placed in escrow to secure the sellers’ indemnification obligations, $0.8 million was paid upon delivery of the final Aptimize closing balance sheet, $1.4 million was paid upon the finalization of the Zeus closing balance sheet and the estimated fair value of acquisition-related contingent consideration of $14.6 million. Also included in the initial payments were $1.6 million of prepaid compensation costs. We recorded $95.8 million of goodwill, $52.5 million of identifiable intangible assets, including $2.6 million of in-process technology, deferred tax liabilities of $7.9 million and $3.7 million of net other tangible liabilities related to these acquisitions. The results of operations of these companies are included in our consolidated results for the period subsequent to the respective acquisition dates. In the year ended December 31, 2011, we recognized $6.8 million in revenue from the sale of these acquired companies’ products and services and we recognized $19.0 million of operating expenses, which included $4.3 million of acquisition-related intangibles amortization, $1.0 million of stock-based compensation costs and $1.3 million of acquisition-related compensation costs.
During fiscal 2010, we acquired two companies to expand our product offerings. These acquisitions were not significant, individually or in the aggregate. Combined, the total purchase price for these acquisitions was approximately $26.8 million, which was paid in cash. We recorded $13.8 million of goodwill, $16.8 million of identifiable intangible assets, including $3.3 million of in-process technology intangible assets, $3.3 million of deferred tax liabilities, and $0.5 million of net tangible liabilities. The results of operations of these companies are included in our consolidated results for the period subsequent to the respective acquisition dates. In the year ended December 31, 2010, we recognized $1.1 million in revenue from the sale of these acquired companies’ products and services, and we recognized $2.9 million of operating expenses, which included $0.6 million of acquisition-related intangible amortization, $0.6 million of transaction and integration costs, $0.5 million of acquisition-related compensation costs, and $0.2 million of stock-based compensation costs.
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.
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, goodwill, intangible assets and impairment assessment, accounting for business combinations, accounting for income taxes, derivative financial instruments, and inventory valuation. Our critical accounting policies have been discussed with the Audit Committee of the Board of Directors.
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 further measured by the renewal rate offered to the customer. In determining VSOE, we require that a substantial majority of the selling prices fall within a reasonably narrow pricing range, generally evidenced by a substantial majority of such historical stand-alone transactions falling within a reasonably narrow range of the median rates. In addition, we consider major service groups, geographies, customer classifications, and other variables in determining VSOE.
We are typically not able to determine TPE for our products or services. TPE is determined based on competitor prices for similar deliverables when sold separately. Generally, our go-to-market strategy differs from that of our peers and our offerings contain a significant level of differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, we are unable to reliably determine what similar competitor products’ selling prices are on a stand-alone basis.
When we are unable to establish the estimated stand-alone value of our non-software deliverables using VSOE or TPE, we use ESP in our allocation of arrangement consideration. The objective of ESP is to determine the price at which we would transact a sale if the product or service were sold on a stand-alone basis. We determine ESP for a product or service by considering multiple factors including, but not limited to, cost of products, gross margin objectives, pricing practices, geographies, customer classes and distribution channels.
For stand-alone software sales, we recognize revenue based on software revenue recognition guidance. Under the software revenue recognition guidance, we use the residual method to recognize revenue when an agreement includes one or more elements to be delivered at a future date and VSOE of the fair value of all
undelivered elements exists. In the majority of our contracts, the only element that remains undelivered at the time of delivery of the product is support services. Under the residual method, the fair value of the undelivered stand-alone software, which is typically support services, is deferred and the remaining portion of the contract fee is recognized as product revenue. If evidence of the fair value of one or more undelivered stand-alone software elements does not exist, all revenue is generally deferred and recognized when delivery of those elements occurs or when fair value can be established. When the undelivered stand- alone software for which we do not have VSOE of fair value is support, revenue for the entire arrangement is bundled and recognized ratably over the support period.
For our non-software deliverables, we allocate the arrangement consideration based on the relative selling price of the deliverables. For our hardware appliances we use the ESP of the deliverable. For our support and services, we generally use VSOE as our relative selling price. When we are unable to establish VSOE for our support and services, we use ESP in our allocation of arrangement consideration. We regularly review VSOE and ESP. As our go-to-market strategies evolve, we may modify our pricing practices in the future, which could result in changes in selling prices, including both VSOE and ESP.
For sales to direct end-users and channel partners, including value-added resellers, value-added distributors, service providers, and systems integrators, we recognize product revenue upon delivery, assuming all other revenue recognition criteria are met. For our hardware appliances, delivery occurs upon transfer of title and risk of loss, which is generally upon shipment. It is our practice to identify an end-user prior to shipment to a channel partner. For end-users and channel partners, we generally have no significant obligations for future performance such as rights of return or pricing credits. 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. 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 75 days. In the event payment terms are provided that differ from our standard business practices, the fees are deemed to not be fixed or determinable and revenue is recognized when the payments become due, provided the remaining criteria for revenue recognition have been met.
We assess the ability to collect from our customers based on a number of factors, including credit worthiness of the customer and past transaction history of the customer. If the customer is not deemed credit worthy, we defer revenue from the arrangement until payment is received and all other revenue recognition criteria have been met.
Stock-based awards granted include stock options, restricted stock units (RSUs), and stock purchased under our Employee Stock Purchase Plan (the Purchase Plan). Stock-based compensation cost is measured at the grant date, based on the fair value of the awards, and is recognized as expense over the requisite service period only for those equity awards expected to vest.
The fair value of the RSUs is determined based on the stock price on the date of grant. 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. During the first three quarters of 2010, we elected to use the simplified method of determining the expected term of stock options due to insufficient historical exercise data as a publicly traded company. For the years ended December 31, 2012 and 2011 and during the fourth quarter of 2010, we determined that we had sufficient historical information to use a method based on historical exercise patterns and post vesting termination behavior, which we believe is more representative of our expected term.
During the first three quarters of 2010, the computation of our expected volatility for stock options was based on the historical volatility of comparable companies from a representative peer group selected based on industry, financial and market capitalization data, due to insufficient historical volatility data as a publicly traded company. For the years ended December 31, 2012 and 2011 and during the fourth quarter of 2010, we determined that we had sufficient historical volatility data to use a blended historical and implied volatility. The computation of expected volatility for the Purchase Plan for the years ended December 31, 2012, 2011 and 2010 is based on our historical volatility.
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 be recognized as a component of provision for taxes. In addition, the fair value of in-process research and development 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:
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 during the fourth quarter (more frequently if certain indicators are present). In the event that we determine that the fair value of our single 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 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.
Recoverability of indefinite lived intangible assets is measured by comparison of the carrying amount of the asset to the future discounted cash flow the asset is expected to generate. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired assets. We did not recognize any material goodwill or intangible asset impairment charges in the years ended December 31, 2012, 2011 or 2010.
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.
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 estimates and assumptions in preparing our income tax provision.
We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent earnings experience by jurisdiction, expectations of future taxable income, and the carryforward periods available to us for tax reporting purposes, as well as other relevant factors. We establish a valuation allowance to reduce deferred tax assets to the amount we believe is more likely than not to be realized. Due to inherent complexities arising from the nature of our businesses, future changes in income tax law, or variances between our actual and anticipated operating results, we make certain judgments and estimates. Therefore, actual income taxes could materially vary from these estimates.
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.
We are subject to periodic audits by the Internal Revenue Service and other taxing authorities. These audits may challenge certain tax positions we have taken, such as the timing and amount of deductions and allocation of taxable income to the various tax jurisdictions. Income tax contingencies are accounted for in accordance with authoritative guidance, and may require significant management judgment in estimating final outcomes. Actual results could materially differ from these estimates and could significantly affect the effective tax rate and cash flows in future years.
Derivative Financial Instruments
We use derivative instruments to manage our short-term exposures to fluctuations in foreign currency exchange rates, which exist as part of ongoing business operations. Our general practice is to hedge a majority of transaction exposures denominated in British pounds, Euros, Australian dollars and Singapore dollars. These instruments have maturities between one to three months in the future. We do not enter into any derivative instruments for trading or speculative purposes.
We account for our derivative instruments as either assets or liabilities on the balance sheet and carry them at fair value. Gains and losses resulting from changes in fair value are accounted for depending on the use of the
derivative and whether it is designated and qualifies for hedge accounting. Derivatives that qualify for hedge accounting are initially included in Accumulated other comprehensive income (loss) and subsequently reclassified into earnings upon the occurrence of the forecasted transactions to which they hedge. Derivatives that do not qualify for hedge accounting are adjusted to fair value each period through earnings.
Inventory consists of hardware and related component parts and is stated at the lower of cost (on a first-in, first-out basis) or market. A portion of our inventory relates to evaluation units located at customer locations, as some of our customers test our equipment prior to purchasing. Inventory that is obsolete or in excess of our forecasted demand is written down to its estimated realizable value based on historical usage, expected demand, and with respect to evaluation units, the historical conversion rate, the age of the units, and the estimated loss of utility. Inherent in our estimates of market value in determining inventory valuation are estimates related to economic trends, future demand for our products, the timing of new product introductions and technological obsolescence of our products. Inventory write-downs are recognized as cost of product and amounted to approximately $6.7 million, $7.1 million and $4.8 million for the years ended December 31, 2012, 2011 and 2010, respectively.
Results of Operations
We derive our revenue from sales of our appliances and software licenses and from support and services. Product revenue primarily consists of revenue from sales of our Steelhead, Cascade and Stingray products and is typically recognized upon delivery. Support and services revenue includes unspecified software license updates and product support. Support revenue is recognized ratably over the contractual period, which is typically one year. Service revenue includes professional services and training, which to date has not been significant, and is recognized as the services are performed.
December 31, 2012 Compared to 2011: Product revenue increased by 9% in 2012 due primarily to an increase in unit volume from increasing sales to existing customers and the addition of new customers. We believe the market for our products has grown due to increased market awareness of WAN optimization services by increasingly distributed organizations, which increases dependence on timely access to data and applications. Acquisitions in 2012, including OPNET in December 2012, which added $5.5 million in revenue, or 5%, of revenue growth over 2011. As of December 31, 2012, our products had been sold to over 22,000 customers, including OPNET customers, compared to approximately 17,000 as of December 31, 2011.
Substantially all of our customers purchase support when they purchase our products. Support and services revenue increased 28% in 2012 as compared to 2011. Support and services revenue as a percentage of total revenues increased over the prior year as our install base grew and the renewal rate of support contracts by existing customers remained stable. As our customer base grows, we expect our revenue generated from support and services to increase; however, we expect the renewal rate of support contracts by existing customers to remain level.
We generated 45% of our revenue in the both years ended December 31, 2012 and 2011 from international locations. 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.
2011 Compared to 2010: Product revenue increased by 32% in 2011 due primarily to an increase in unit volume from increasing sales to existing customers and the addition of new customers. Acquisitions in 2011 added $6.8 million in revenue, or 1%, of revenue growth over 2010. As of December 31, 2011, our products had been sold to over 17,000 customers, compared to approximately 9,200 as of December 31, 2010.
Support and services revenue increased 31% in 2011 as compared to 2010 which is consistent with our growth in product revenue. Support and services revenue as a percentage of total revenues remained relatively consistent with the prior year as our renewal rate of support contracts by existing customers remained stable.
We generated 45% of our revenue in the year ended December 31, 2011 from international locations, compared to 47% in the year ended December 31, 2010.
Cost of Revenue and Gross Margin
Cost of product revenue consists of the costs of the appliance hardware, manufacturing, shipping and logistics costs, expenses for inventory obsolescence, warranty obligations and amortization of acquisition-related intangibles. We utilize third parties to assist in the design of and to manufacture our appliance hardware, embed our proprietary software and perform shipping logistics. Cost of support and service revenue consists of personnel costs of technical support and professional services personnel, spare parts and logistics services. As we expand internationally and into other sectors, we may incur additional costs to conform our products to comply with local laws or local product specifications. In addition, as we expand internationally, we will continue to hire additional technical support personnel to support our growing international customer base.
Our gross margin has been and will continue to be affected by a variety of factors, including the mix and average selling prices of our products, new product introductions and enhancements, the cost of our appliance hardware, expenses for inventory obsolescence and warranty obligations, cost of support and service personnel, and the mix of distribution channels through which our products are sold.
December 31, 2012 Compared to 2011: The total cost of product revenue increased $19.3 million, or 18%, in the year ended December 31, 2012 compared to the year ended December 31, 2011. The cost of product sold increased $6.2 million, or 9%, primarily due to an increase in the cost of product sold associated with greater volume of products shipped for higher revenue. The cost of product revenue increase was also attributable to increased amortization of acquisition-related intangible assets of $6.2 million, $3.5 million related to increased shipping costs consistent with our higher volume and $1.1 million due to increased cost of hard-drives.
We expect cost of product revenue to increase substantially in 2013 and thereafter due to increased amortization of acquisition related intangible assets associated with our acquisition of OPNET. See Note 2 of “Notes to Consolidated Financial Statements” for more information regarding the expected future amortization expense of intangible assets relating to the OPNET acquisition.
Cost of support and services revenue increased $11.5 million, or 17%, as we added more technical support headcount domestically and abroad coupled with increases in freight, duties and taxes, and repair costs to support our growing customer base. Technical support and services headcount was 340 employees, which includes more than 100 employees from acquired companies, as of December 31, 2012 compared to 199 employees as of December 31, 2011.
Gross margins remained at 76% in the year ended December 31, 2012 compared to the year ended December 31, 2011. Product gross margins decreased to 77% in the year ended December 31, 2012 from 79% in the year ended December 31, 2011 as a result of an increase in amortization of acquisition-related intangible assets, and increased shipping costs related to new product introductions. Gross margins for support and services increased slightly to 72% in the year ended December 31, 2012 compared to 69% in the year ended December 31, 2011, primarily due to the elimination of certain redundant transportation and warehousing costs as we converted to a new logistics provider.
2011 Compared to 2010: The total cost of product revenue increased $23.2 million, or 28%, in the year ended December 31, 2011 compared to the year ended December 31, 2010. The cost of product sold increased $12.5 million, or 23%, primarily due to an increase in unit volume associated with higher revenue. The increase in cost of product revenue was also attributable to increased amortization of acquisition-related intangible assets of $6.0 million, increased expense for inventory obsolescence of $2.2 million, primarily due to excess inventory caused by anticipated new product introductions, $2.2 million related to increased personnel costs and $0.9 million due to increased cost of hard-drives in the fourth quarter of 2011 due to supply chain disruptions from flooding in Thailand.
Cost of support and services revenue increased $18.2 million, or 36%, as we added more technical support headcount domestically and abroad to support our growing customer base. Technical support and services
headcount was 199 employees as of December 31, 2011 compared to 169 employees as of December 31, 2010. In addition, cost of support and services increased $3.6 million due to higher transportation, warehousing and duties costs to support a larger customer base.
Gross margins remained at 76% in the year ended December 31, 2011 compared to the year ended December 31, 2010. Product gross margins increased to 79% in the year ended December 31, 2011 from 78% in the year ended December 31, 2010 as a result of volume leverage and favorable product mix. Gross margins for support and services decreased slightly to 69% in the year ended December 31, 2011 compared to 70% in the year ended December 31, 2010, primarily due to certain redundant transportation and warehousing costs as we converted to a new logistics provider.
Sales and Marketing Expenses
Sales and marketing expenses represent the largest component of our operating expenses and include personnel costs, sales commissions, marketing programs and facilities costs. Marketing programs are intended to generate revenue from new and existing customers, and are expensed as incurred. We plan to continue to make investments in sales and marketing with the intent to add new customers and increase penetration within our existing customer base by increasing the number of sales personnel worldwide, expanding our domestic and international sales and marketing activities, increasing channel penetration, building brand awareness and sponsoring additional marketing events. We expect future sales and marketing expenses to continue to increase and continue to be our most significant operating expense. Generally, sales personnel are not immediately productive and sales and marketing expenses do not immediately result in increased revenue. Hiring additional sales personnel reduces short-term operating margins until the sales personnel become productive and generate revenue. Accordingly, the timing of sales personnel hiring and the rate at which they become productive will affect our future performance.
December 31, 2012 Compared to 2011: Sales and marketing expenses increased by $56.0 million, or 21%, in the year ended December 31, 2012 compared to the year ended December 31, 2011, primarily due to increases in personnel costs of $33.1 million. The increase in personnel costs, which include salaries, commissions, bonuses and related benefits and stock-based compensation, was primarily due to sales and marketing headcount increasing to 1,128 employees, which includes more than 250 employees from acquired companies, as of December 31, 2012 from 736 employees as of December 31, 2011. The sales and marketing expense increase is further attributed to increased marketing-related activities of $5.9 million, higher travel and entertainment costs of $3.2 million, and increased facilities and IT related costs of $1.7 million. In addition, in the year ended December 31, 2012, amortization of acquisition-related intangibles and compensation expense of acquisition-related contingent consideration and bonuses accounted for $6.6 million of the increase.
2011 Compared to 2010: Sales and marketing expenses increased by $47.6 million, or 21%, in the year ended December 31, 2011 compared to the year ended December 31, 2010, primarily due to increases in personnel costs of $28.4 million. The increase in personnel costs, which include salaries, commissions, bonuses and related benefits and stock-based compensation, was primarily due to sales and marketing headcount increasing to 736 employees, which includes more than 50 employees from acquired companies, as of December 31, 2011 from 556 employees as of December 31, 2010. The sales and marketing expense increase is further attributed to higher travel and entertainment costs of $4.1 million, increased marketing-related activities of $3.8 million, and increased facilities and IT related costs of $1.3 million. In addition, in the year ended December 31, 2011, amortization of acquisition-related intangibles and compensation expense of acquisition-related contingent consideration and bonuses accounted for $1.7 million and $1.1 million of the increase, respectively.
Research and Development Expenses
Research and development (R&D) expenses primarily include personnel costs and facilities costs. We expense R&D expenses as incurred. We are devoting substantial resources to the continued development of additional functionality for existing products and the development of new products. We intend to continue to invest
significantly in our R&D efforts because we believe they are essential to maintaining our competitive position. Investments in R&D personnel costs are expected to increase in dollar amount.
December 31, 2012 Compared to 2011: R&D expenses increased by $23.1 million, or 19%, in the year ended December 31, 2012 compared to the year ended December 31, 2011, primarily due to increases in personnel costs of $16.4 million and a $2.8 million increase in facilities and information technology costs offset by a decrease in acquisition-related bonus of $1.1 million. The increase in personnel costs, which include salaries, bonuses and related benefits and stock-based compensation, was primarily due to R&D headcount increasing to 794 employees, which includes more than 240 employees from acquired companies, as of December 31, 2012 from 466 employees as of December 31, 2011. We plan to continue to invest in R&D as we develop new products and make further enhancements to existing products.
2011 Compared to 2010: R&D expenses increased by $35.8 million, or 41%, in the year ended December 31, 2011 compared to the year ended December 31, 2010, primarily due to increases in personnel costs of $22.7 million, and compensation expense of acquisition-related contingent consideration and bonuses of $1.9 million. The increase in personnel costs, which include salaries, bonuses and related benefits and stock-based compensation, was primarily due to R&D headcount increasing to 466 employees, which includes more than 30 employees from acquired companies, as of December 31, 2011 from 357 employees as of December 31, 2010.
General and Administrative Expenses
General and administrative (G&A) 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 outside legal, audit and information technology consulting costs.
December 31, 2012 Compared to 2011: G&A expenses increased by $0.9 million, or 1%, in the year ended December 31, 2012 compared to the year ended December 31, 2011, primarily due to an increase in personnel costs of $2.5 million and facilities and information technology costs of $0.9 million offset by a decrease in stock-based compensation of $3.3 million. The increase in personnel costs, which include salaries, bonuses and related benefits, was primarily due to G&A headcount increasing to 272 employees, which includes more than 60 employees from acquired companies as of December 31, 2012 from 179 employees as of December 31, 2011.
2011 Compared to 2010: G&A expenses increased by $12.3 million, or 26%, in the year ended December 31, 2011 compared to the year ended December 31, 2010, primarily due to an increase in personnel costs of $8.0 million. The increase in personnel costs, which include salaries, bonuses and related benefits and stock-based compensation, was primarily due to G&A headcount increasing to 179 employees as of December 31, 2011 from 136 employees as of December 31, 2010.
Acquisition-related costs include changes in the fair value of acquisition-related contingent consideration, transaction costs and integration-related costs. Transaction costs include advisory, legal and other professional fees. Integration related costs include integration project management consulting, acquired employee retention bonuses and one-time termination benefits, and other non-recurring, or redundant costs to integrate an acquired company into Riverbed's systems and operations. In 2013 we expect to incur significant costs associated with the integration of OPNET.
The following table summarizes the acquisition-related costs, including changes in the fair value of the acquisition-related contingent consideration, transaction costs and integration-related costs, recognized in the years ended December 31, 2012, 2011 and 2010:
Pursuant to the acquisition of OPNET, we incurred transaction costs and integration costs of $11.7 million and $1.5 million, respectively, which were included in our consolidated statement of operations for the year ended December 31, 2012. See Note 2 of "Notes to the Consolidated Financial Statements" for information regarding the change in fair value of acquisition-related contingent consideration.
Other Income (Expense), Net
Other income (expense), net consists primarily of interest income on our cash and marketable securities, interest expense, and foreign currency exchange losses. Cash has historically been invested in highly liquid investments such as time deposits held at major banks, commercial paper, U.S. government agency discount notes, money market mutual funds and other money market securities with maturities at the date of purchase of 90 days or less.
December 31, 2012 Compared to 2011: Other income (expense), net, decreased in the year ended December 31, 2012, primarily due to increased foreign exchange losses related to the revaluation of the acquisition-related transactions, and increased interest expense resulting from the debt incurred pursuant to the acquisition of OPNET offset by increased interest income on higher cash and investment balances in the year ended December 31, 2012 as compared to the year ended December 31, 2011. Weighted average interest rates applicable to our cash and investments balances remained consistent at 0.3% in the year ended December 31, 2012 compared to the year ended December 31, 2011.
2011 Compared to 2010: Other income, net, decreased in the year ended December 31, 2011, primarily due to increased foreign exchange losses related to the revaluation of the acquisition-related transactions offset by increased interest income on higher cash and investment balanced in the year ended December 31, 2011 as compared to the year ended December 31, 2010. Weighted average interest rates applicable to our cash and investments balances remained consistent at 0.3% in the year ended December 31, 2011 compared to the year ended December 31, 2010.
Provision for Income Taxes
The provision for income taxes was $39.4 million, $28.2 million, and $22.8 million for the years ended December 31, 2012, 2011, and 2010, respectively. Our income tax provision consists of federal, foreign, and state income taxes. Our effective tax rate was 42%, 31%, and 40%, for the years ended December 31, 2012, 2011, and 2010, respectively.
For the year ended December 31, 2012, our effective tax rate differs from the federal statutory rate due to state taxes and significant permanent differences. Significant permanent differences arose primarily from taxes in foreign jurisdictions with a tax rate different than the U.S. federal statutory rate, non-deductible stock-based compensation expense, the amortization of deferred tax charges related to our intercompany sale of intellectual
property rights, and non-deductible acquisition-related expenses. Our effective tax rate in 2012 was higher than 2011 primarily because of the reversal of a valuation allowance in the prior year, current year non-deductible acquisition costs, and lower R&D tax credit benefits in the current year due to the expiration of the federal R&D tax credit as of December 31, 2011 which had not been renewed as of December 31, 2012. These amounts were partially offset by the full year benefit of our tax holiday in Singapore.
For the year ended December 31, 2011, our effective tax rate differed from the federal statutory rate due to state taxes and significant permanent differences. Significant permanent differences arose primarily from the reversal of a valuation allowance, non-deductible stock-based compensation expense, R&D tax credits, the amortization of deferred tax charges related to our intercompany sale of intellectual property rights, the benefits from a change in tax status of our United Kingdom (UK) subsidiaries, and taxes in foreign jurisdictions with a tax rate different than the U.S. federal statutory rate. Our effective tax rate in 2011 was lower than 2010 primarily because of the reversal of a valuation allowance and the income tax benefits recorded that resulted from a change in tax status of our UK subsidiaries for federal and state income tax purposes. These benefits were partially offset by income tax expense on intercompany profits that resulted from the sale of our intellectual property rights outside of North and South America to our Singapore subsidiary.
For the year ended December 31, 2010, our effective tax rate differed from the federal statutory rate due to state taxes and significant permanent differences. Significant permanent differences arose primarily from non-deductible stock-based compensation expense, R&D tax credits and non-deductible acquisition-related expenses.
International revenues account for a significant portion of our total revenues, such that a material portion of our pretax income is earned and taxed outside the U.S. at rates lower than the U.S. statutory rate. The geographic mix of earnings in any particular fiscal year can have a significant impact on our provision for income taxes. The foreign jurisdiction with the most significant impact on our provision for foreign income taxes in the periods presented is Singapore.
International revenues account for a significant portion of our total revenues, such that a material portion of our pretax income is earned and taxed outside the U.S. at rates lower than the U.S. statutory rate. The geographic mix of earnings in any particular fiscal year can have a significant impact on our provision for income taxes. The foreign jurisdiction with the most significant impact on our provision for foreign income taxes in the periods presented is Singapore.
As of December 31, 2011, we reevaluated the need for a valuation allowance on certain federal net operating loss carryforwards and R&D credit carryforwards by considering positive and negative evidence as required by the related accounting guidance. As a result of this evaluation, we concluded that it is more likely than not that we will have sufficient future taxable income to utilize the net operating loss carryforwards and credit carryforwards. Accordingly, we reversed the valuation allowance and recorded an income tax benefit of $8.8 million in 2011.
Based on our forecasted income allocated to California for tax years after 2010, it is more likely than not the California income tax credits carryforwards will not be utilized in the foreseeable future. Accordingly, we have established a 100% valuation allowance against the tax credits. The amount of the valuation allowance against the California credits was $8.6 million and $6.1 million, net of federal benefits, for the years ended December 31, 2012 and 2011, respectively.
During the year ended December 31, 2011, we made an election to change the tax status of our UK subsidiaries to entities that are disregarded for federal and state income tax purposes. As a result of the change in tax status, we recorded a tax benefit of $2.9 million to record certain deferred tax assets resulting from the change.
We recorded deferred charges during the year ended December 31, 2011 related to the deferral of income tax expense on intercompany profits that resulted from the sale of our intellectual property rights (including intellectual property acquired during 2011) outside of North and South America to our Singapore subsidiary. The deferred charges are included in the Prepaid expenses and other current assets and the Other assets lines of the consolidated balance sheets in the amounts of $5.0 million and $10.5 million as of December 31, 2012, respectively, and $5.0 million and $15.6 million as of December 31, 2011, respectively. The deferred charges are amortized as a component of income tax expense over the five year economic life of the intellectual property.
Beginning in the year ended December 31, 2011, we are subject to a reduced income tax rate in Singapore as a result of certain employment and spending commitments. The reduced tax rate is effective through 2020. For
the year ended December 31, 2012, we realized a tax benefit of $3.8 million ($0.02 diluted net income per share). We realized no tax savings in the year ended December 31, 2011 because of net local tax losses.
During the year ended December 31, 2012, we reduced our current federal, foreign and state taxes payable by $20.2 million for the excess tax benefits from stock option exercises and other employee stock programs, offsetting additional paid-in capital. In addition, we have unrecorded excess tax benefits from stock option exercises and other employee stock programs of approximately $6.6 million as of December 31, 2012. These amounts will be credited to additional paid-in-capital when such amounts reduce cash taxes payable.
On January 2, 2013, the American Taxpayer Relief Act of 2012 (H.R. 8) was signed into law which retroactively extends the Federal research and development credit from January 1, 2012 through December 31, 2013. As a result, we will recognize the retroactive benefit of the Federal research and development credit of approximately $4.4 million as a discrete item in the first quarter of 2013, the period in which the legislation, including the reinstatement, was enacted.
We are subject to income tax in the U.S. as well as numerous state and foreign jurisdictions. With the exception of several states, we are no longer subject to federal, state and local income tax examinations for years before 2009, although carryforward attributes that were generated prior to 2009 may still be adjusted upon examination by the California Franchise Tax Board if the attributes either have been or will be used in a future period. In addition, we file tax returns in multiple foreign taxing jurisdictions. In our most significant foreign jurisdictions, the UK and Singapore, the open tax years range from 2008 to 2011.
Quarterly Results of Operations
The following table sets forth our unaudited quarterly consolidated statement of operations data for each of the eight quarters ended December 31, 2012. In management’s opinion, the data has been prepared on the same basis as the audited consolidated financial statements included in this Annual Report on Form 10-K, and reflects all necessary adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of this data. The results of historical periods are not necessarily indicative of the results of operations for a full year or any future period.