Shares were absolutely crushed today, down 29%, in the wake of the WAN optimization specialist's first-quarter earnings report, as revenue came in on the low end of Riverbed's already soft guidance that it issued last time around. Is today's sell-off an overreaction, or is there cause for concern?
First, the figures
Starting with the digits, non-GAAP revenue added up to $183 million, on the low end of the $183 million to $187 million forecast that Riverbed had previously provided, and also short of the Street consensus of $186.5 million. Adjusted earnings per share were just as expected at $0.20, the midpoint of guidance and exactly on target with the market's estimates.
The first quarter is typically a seasonally difficult one, and adding a major product transition made it even tougher.
Next quarter's guidance also came in leaving a little to be desired, with second-quarter sales expected to be between $193 million and $197 million and earnings per share in the ballpark of $0.21 and $0.22. That's light of the $202 million in sales and $0.24 that analysts are looking for in the coming quarter.
An arrow through my heart
Now that we have the numbers squared away, what's causing the weakness? One thing that presents a bit of a challenge in trying to reinvigorate sales growth is that Riverbed relies heavily on its indirect sales channel, so its destiny is literally in the hands of others. Indirect sales chalked up 94% of the quarter's revenue. That kind of figure has long been the status quo, but it could help Riverbed to grow its direct sales channel.
Two distribution partners in particular comprise a large portion of sales: Arrow Electronics and Avnet. Arrow was responsible for 17% of total revenue, with Avnet pitching in just over 10%.
CEO Jerry Kennelly specifically mentioned that its sales execution could be better, starting by improving its channel structure. He outlined Riverbed's multi-pronged approach:
At the channel level, we need to better educate, better train, and better recruit partners. Internally, we need to better align sales structure processes and incentives. And at the customer level, we need better targeting and marketing.
We are taking steps to address these challenges. We recently hired a chief marketing officer. In the first quarter, we began our performance Summit World Tour, a global roadshow to educate partners and customers about the performance platform.
Missing out on international
As fellow Fool Eric Bleeker and I were discussing last night, Riverbed's international growth could also see some improvement, especially as other IT-centric players are finding success there. For example, EMC (NYSE: EMC ) just reported earnings, with Asia-Pacific and Japan jumping 20% to an all-time record high in the region. Fellow networking player F5 Networks (Nasdaq: FFIV ) similarly cited Japan as one of its strongest geographies for bookings growth.
The Summit World Tour was announced in February and will include more than 50 conferences around the world to spread the word. Last night's release shows just how important this initiative is.
WAN optimization remains a key niche market in data-center infrastructure. The market is expected to grow to $1.3 billion by year's end. Riverbed is guiding full-year 2012 revenue to grow by 15%, which loosely implies that it should capture at least 40% of the market when you look at its product revenue and assume that WAN optimization continues to drive roughly 90% of sales.
In contrast, networking giant Cisco Systems (Nasdaq: CSCO ) doesn't focus as much on WAN optimization. It doesn't break out specific numbers for this segment but instead bundles them into its "Other" product category, which altogether accounted for just 3% of its product sales last quarter. In dollar terms, that added up to $287 million, but only a fraction of that figure is WAN optimization.
Rival Blue Coat Systems, which was recently taken private, is regrouping for another push after replacing its CEO last August and naming a new COO last month. Silver Peak is also trying to challenge Riverbed's dominance, recently joining Riverbed as a "leader" in Gartner's magic-quadrant report on the sector.
Riverbed of the future
Riverbed is undergoing a broader transition from a single-product company to a multiproduct one, and it's running into the expected types of growing pains in the process. Growth has predictably begun to decelerate as the company grows its revenue base, prompting Riverbed to look for additional catalysts. The tricky part is that deceleration and a price-to-earnings ratio upwards of 70 (before today's plunge) don't play nice together.
The company is getting into application delivery controllers, or ADCs, and expects healthy growth this year in that area. ADCs contributed just 4% of revenue this quarter, although F5 is the leader in the ADC market, and you can expect solid defense there.
Time to sell?
I've been a shareholder for quite some time, and I'm the first to admit that it seems Riverbed is in a rough patch right now. The past two quarters haven't been kind and the next one might not be either, but Riverbed still maintains leadership in a growing market.
If the company can successfully overcome the current speed bumps with product transitions and growing pains related to becoming a multiproduct company, then today's plunge represents an opportunity for those who have faith.
By its own admission, Riverbed needs to improve execution, but I'm not selling my shares. This long-term story is far from over.
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