3PAR Inc. F3Q09 (Qtr End 12/31/08) Earnings Call Transcript

Jan.29.09 | About: PAR Technology (PAR)

3PAR Inc. (NYSE:PAR)

F3Q09 Earnings Call Transcript

January 29, 2009 at 4:30 pm ET

Executives

David Scott – President and CEO

Adriel Lares – CFO and VP of Finance

Analysts

Mark Kelleher - Canaccord Adams

Brian Freed - Morgan Keegan

Rajesh Ghai - ThinkEquity

Alex Kurtz - Merriman Curhan Ford

Bill Shope - Credit Suisse

Kaushik Roy - Pacific Growth Equities

Amit Daryanani - RBC Capital Markets

[Unidentified Analyst]

[Mark Boulter] - Bluefin

Operator

Good day, ladies and gentlemen, and welcome to the fiscal third quarter 2009 3PAR incorporated earnings conference call. My name is Melanie and I will be your coordinator today. At this time our participants are on only listen mode. We will conduct the question and answer session at the end of this conference.

(Operator instructions) I would now like to turn the call over to 3PAR management. Go ahead.

Adriel Lares

Thank you Melanie. Good evening and welcome to 3PAR’s fiscal year 2009 third quarter earnings release conference call. This conference call will include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities Exchange Act of 1934 as amended.

These forward-looking statements will include among others, statements about our financial projections and growth trends for the fourth quarter and full year of fiscal 2009 and beyond, as well as financial projections and growth trends for the overall storage market and segments thereof.

The potential impact and effectiveness of our market business and investment strategies, management current views concerning anticipated market share opportunities and the impact of diversification of our customer base, anticipated demand for our storage solution and adoption trend in our customer markets

All of these forward-looking statements involve known and unknown risks and uncertainties and important factors that may cause our actual results, levels of activity, performance or achievement or those in our industry to differ from those expressed or implied by the statements we make.

In evaluating these forward-looking statements you should specifically consider various risk factors including the risk factors detailed from time to time in our filings with the Securities and Exchange Commission. This risk factors are included in our Annual report on report on Form 10-Q for the year-ended March 31st 2008 and our quarter report on Form 10-Q for the quarter ended September 30th 2008.

Additional risk factors and other information you should consider will also be set forth in our quarterly report on Form 10-Q for the quarter ended December 31st , 2008 which will be filed with the SEC in February 2009. These factors may cause our results to differ materially from the forward-looking statements we may make on this conference call.

We cannot guarantee future results, levels of activity, performance, or achievements. Our future results will depend on numerous factors including, among others, the impact of macroeconomic trends on information technology spending, market acceptance of our utility storage solutions, and competitive practices in our industry.

These forward-looking statements are made only as of today’s date and we expressly disclaim any obligation to update or revive the information contain in any forward looking statements

Please also note that this conference call will provide listeners with certain financial metrics determined on a non-GAAP basis for both the comparison to previous quarters and the previous fiscal year and for our outlook for the current quarter.

These financial metrics, together with a reconciliation to our comparable GAAP financial measures, are contained in today’s financial results press release, which we have posted on our website at Investor Relations, on www.3par.com under Press Releases and are furnished to the SEC on Form 8-K. We encourage listeners to review these items.

I’d now like to turn the call over to David Scott, CEO of 3PAR. David?

David Scott

Good evening and thanks for joining us for our third quarter fiscal year 2009 earnings call. We are delighted to report revenue of $48.2 million, 57 % higher than our revenue in this period a year ago, and 7% sequential increase.

We continue to deliver strong result and take market share at the significant rate in spite of the unprecedented economic condition. In fiscal Q3, we achieved the gross margin of 64.5% showing the customers maintain a demonstrable belief in our demo with less value proposition. As we move to a more cautious spending starts in light of the macro economic environment we manage to deliver excellent cost control.

So, in addition to achieving a strong gross profit result we also maintained flat expense structure this quarter. As a result we are able to deliver a net income of $2.3 million on a non-GAAP basis. This allowed us to report our non-GAAP earnings per share of $0.04 significantly exceeding our own expectations.

We delivered $461,000 in GAAP net income for a GAAP EPS including expenses related to stock options of $0.01 per share. The overall spending environment proves to be more uncertain and less predictable as the December quarter progressed. As we have reiterated on a number of occasions, we do not believe that bookings recorded as a specific point in time such as at the end of the quarter are necessarily sound indicators of our future revenue performance.

This is the reason we do not report either bookings or backlog numbers in our earnings calls. As an example of this, we saw clear evidence of increased turbulence in our bookings performance towards the end of the quarter. There was a pronounced increase in last minute decisions by customers and prospects to defund or defer previously planned and budgeted projects. Yet, as a counter to that trend we had seen an unusual and extremely strong start to bookings performance in January as well as the very healthy pipeline of opportunity. This contradictory sign post result in much less certain visibility and we expect this weakened visibility to remain unchanged at least through the first half of this calendar year.

In spite of this caution return, we were encouraged by the performance we continue to deliver in this economic climate and believe we had every opportunity to weather the storm as well as or even better than many of our competitors. I would like to talk about a few other elements of our business that have been important in the last few months including business trends within our target markets, recognition for the 3PAR utility storage platform and progress in Asia Pacific.

First, I would like to announce that we have now served more that 1,000 systems to over 400 customers. This is a tremendous milestone for the Company. We were also encouraged by the healthy balance of revenues between new and repeat businesses during this quarter, 80% of our business came from existing accounts and 20% from new customers and I am pleased to say that the business to business service provider market continue to deliver strong business performance for 3PAR in the December quarter.

The B2B segment retained its position as our largest segment in the mid to high 30 percentage points of revenue and we announced greater intensity earlier this week as the latest managed service provider to adopt 3PAR utility storage. We have maintained our view that shared cloud computing IT infrastructure services have a good probability of being beneficiaries of the economic slowdown. We believe the pressure on traditional enterprise cap expending may accelerate the move to subscription-based model.

For the second quarter in a row, we saw strong sequential revenue growth in financial services. That we were able to see sustained growth in such a stressed industry segment might provide further evidence what our value proposition is strongly as these customers need to find ways to save money and may appear to become increasingly aware that they can save money by using 3PAR as an alternative to EMC and HTF.

From a product prospective, 41% of the disks customers ordered in this quarter were near line and 59% by the channel as compared to 52% and 48% respectively in the previous quarter. This result was more demonstration of the strength of demand for the high performance by the channel disk technology rather than weakness in near line.

We did see an unexpected drop in our [14:00] connect rate to 9% of bookings for the quarter. We will be monitoring this closely to see whether the signals are of greater interests in spite the channel resonates as the longest term direction chosen by customers persist in our enterprise data centers.

In the most recent Wave 11 Winter 2008 surveys conducted by the InfoPro, an independent research organization, and leading supplier of market intelligence for the IT industry, we were pleased to see that the 3PAR in storage array was rated the most exciting product in use. This result was achieved by our high-end S800 platform in their Fortune 1000 survey and by our midrange E-200 platform in the survey of mid-sized enterprises.

We believed that this particular result is important for 2 distinct reasons. First, it highlights the advantage of the breadth of our unified utility storage product line and its applicability to a large range of businesses but of more importance we would note that it’s possible for many products to develop an exciting reputation. Good marketing can achieve this by itself but to be voted the most exciting product in use is a mark that can only be earned once the rubber has hit the road in real life production.

The new T-class platform announced last September continue to ramp well during this quarter. We believe that it has provided our sales force with significant competitive advantages. One such advantage is its industry leading performance as evidenced by the T-class storage performance counsel benchmark. Another is the promise of its thin built- in AC capability that is designed to help customers perform such as thin liposuction on their existing in-store base of the incumbent storage equipment, this is part of our overall start thin get thin state and strategy.

The past few months have brought us some solid progress in Asia Pacific. We won our first footprint at Agoda, the South East Asian hotel and travel booking website and now a subsidiary of priceline.com. We also had an important new customer win at Alibaba, the e-Bay equivalent in China and last week Computer World China voted the 3PAR key class storage server as their Product of the Year. We continued our channel build out in the region, having just announced an agreement with PTC to sell and support 3PAR utility storage in South East Asia including Singapore, Malaysia and Indonesia and we saw a record number of new customer wins in Japan as our investments in channel development in the region starts to pay dividends.

We are encouraged by the growth opportunity that the Asia Pacific region represents. With that let me hand over to Adriel Lares, our CFO to go through the financial results for this quarter in detail.

Adriel Lares

Good afternoon and let me add my welcome to David’s. Thanks for joining us. As David mentioned we are very pleased to report revenue of $48.2 million for the quarter ended December 31st , an increase of 57% for the same quarter a year ago and a 7% increase of the $45.1 million we recorded in the pervious quarter. Of this total, product revenue accounted for $43.7 million or 91% of total revenue, an increase of 51% over our product revenue recognized in the same quarter a year ago and a 6% increase from product revenue recognized in the previous quarter.

Support revenue total 4.4 million, 9% of total revenue, an increase of 147% over support revenue recognized in the same quarter a year ago and a 20% increase from the previous quarter. In terms of the split between new and repeat business, 80% of total revenue in this quarter came from customers who have purchased from us previously as compared to 79% in the previous quarter.

We believe that 20% of revenue representing new business reflects 3PAR’s continued market penetration excluding revenue attributable to Software [17:57] our repeat revenue for this quarter was 70% as compared to 71% in the previous quarter. This quarter, no single customer accounted for more than 10% of our total revenue although our customer concentration will fluctuate quarter over quarter as result of factors, such as when we receive orders and when we install systems, we expect to continue expanding our customer base with for further reduce customer concentration over time.

Turning to the geographic view, we generate 16% of revenue from customers outside the U.S., same as we reported in the previous quarter. As we said before, we expect that our international sales will contribute in the mid-teens percentage of our total revenue for the next 6 to 8 quarters although this percentage may fluctuate quarter over quarter driven by factors such as the timing of orders received and shipped.

As a result of higher international shipment activities and the continued decline in the value of the British pound and the euro against the U.S. dollar during the quarter, we incurred foreign exchange laws related to the re-measurement of our foreign currency account receivable on the consolidated balance sheet. We started implementing a hedging strategy in November against our third party British propositions in an effort to reduce the impact of foreign exchange volatility. At this point, let me also take a moment to provide you with a few key metrics related to our orders received in the quarter. At the end of the quarter, we had a total of 48 productive account executives compared to 46 at the end of the previous quarter.

If you recall we defined an account executive or AE to be productive if he or she has been employed with us for more than 6 months. The average number of transactions per productive AE for the quarter was 6.8 and this resulted within the normal range of fluctuation. Orders received during the quarter exceeding $1million, together, accounted for a total $8.3 million as compared to $5.8 million in the previous quarter. For the rest of fiscal year 2009, we continue to expect the average total dollar value of orders received by our productive AE in a quarter to be approximately $1 million.

Moving on down the P&L, cost of goods sold was $17.1 million and gross margin was 64.5% compared to 65.2% in the previous quarter. As we have said previously we continue to believe our gross margin is currently at an unsustainably high level. Although we continue to expect it to trend toward a long-term target range of 62% to 64%, we do not expect to arrive at that target range in a steady progression.

Further, as we have also said each quarter, we expect our margins will fluctuate significantly, potentially on a quarter-to-quarter basis as a result of factors such as the timing of received orders, the product mix installed in a particular quarter and the performance of the US dollar in currency trading relative to foreign currencies.

Operating expenses totaled $30.6 million in the quarter or 64% of revenue compared to $22.4 million or 73% of revenue in the same quarter a year ago and $30.9 million or 68% of revenue in the prior quarter. The decrease in our operating expense quarter-to-quarter was driven primarily by tighter expense control put in place during the quarter, including the 68 partial shutdown during the Christmas Holiday period. For the full year of 2009, we believe we are on track to achieve an operating expense ratio between 64% and 66% most likely at the upper end as we invest to take market share. In terms of the long-term operating model and based on what we have seen in the market to date, we still believe that we will achieve our long-term operating margin target by the end of fiscal year 2011.

Let me emphasize that although we are aware of the current macroeconomic challenges we continue to believe it presents an opportunity for us to continue to take market share from incumbent storage solution providers and other competitors based on the technical merits and capabilities of our storage solution and more importantly, our cost-saving value proposition.

Within operating expenses, R&D expenses rose to $11.5 million from $8.3 million in the same quarter a year ago, but declined from $12 million in the prior quarter. The decrease in absolute R&D expenses from last quarter primarily reflects the PTO accrual reversal benefit from the partial holiday shutdown offset by increased headcount.

We expect we can leverage R&D investments to enhance and expand the technology advantage we benefit from today and we believe that this will lead to long-term rewards for our customers and shareholders.

Sales and marketing expenses rose to $15.2 million from $11.8 million in the same quarter a year ago and the $15.1 million we reported in the prior quarter. The primary contributors to the increase were increased headcount and higher sales commissions expenses as a result of sequential revenue growth from the previous quarter.

G&A expenses were $3.9 million compared to $2.3 million in the same quarter a year ago and $3.7 million in the previous quarter. The increase primarily reflects a precautionary increase in our bad debt reserve.

Our stock-based compensation expenses rose to $1.9 million in this quarter compared to $1.2 million in the same quarter a year ago and $1.7 million in the previous quarter. The primary contributors to this increase were new option grants through the quarter. We expect our stock-based and compensation expenses to trend up incrementally from this higher level going forward.

As a result of these elements I just discussed, our non-GAAP operating income for this quarter rose to $2.4 million as compared to a loss of $1.1 million in the same quarter a year ago and an operating income of $291,000 in the previous quarter.

Our GAAP operating income for the quarter was $507,000 as compared to a GAAP operating loss of $2.3 million in the same quarter a year ago and an operating loss of $1.4 million in the previous quarter.

Our net interests and other income for this quarter was $47,000 as compared to $510,000 in the same quarter a year ago and $125,000 in the previous quarter. The sequential decline in our other income was primarily driven by a foreign currency loss incurred on the re-measurement of our British pound accounts receivable on the US consolidated balance sheet and lower interest income from our corporate cash investment portfolio.

As we reported in the previous quarter earnings call, in light of the turmoil in the financial markets, we made a cautious decision to move the majority of our corporate cash assets into very short-term and liquid investments. As a result of this action we expect the yield on our investment portfolio will be at a very low level for the near future.

Our non-GAAP net income for the quarter was $2.3 million compared to $664,000 net loss in the same quarter a year ago and $520,000 non-GAAP net income in the previous quarter. Our GAAP net income for the quarter was $461,000 as compared to a $1.9 million net loss in the same quarter a year ago and a net loss of $1.2 million in the previous quarter.

We are pleased to report a non-GAAP EPS of $0.04 for the quarter on $63 million weighted average diluted shares outstanding compared to $0.01 in the previous quarter on $64 million weighted average diluted shares outstanding. GAAP EPS for the quarter was at positive $0.01 compared to a negative $0.02 in the previous quarter. Just a reminder, the difference between our GAAP results and non-GAAP results stock-based compensation expenses and is reconciled in the exhibits attached to our press release which is available on the IR portion of our website.

As of December 31st, 2008, cash, cash equivalents, and marketable securities totaled $100.6 million. This represents a $7.8 million decrease from the previous quarter. In this quarter we execute a portion of the $10 million stock repurchased program authorized by our Board in July of 2008. The total amount spent on a repurchased program during the quarter was $1.5 million.

As I mentioned before, we have moved the majority of our corporate cash investment portfolio to liquid and short term assets. At this point, our investment portfolio primarily consists of Treasury and agency money market funds, short-term agency paper, short term municipal bonds and high-quality short-term commercial paper.

On a worldwide basis, 3PAR employed 572 full-time employees as of December 31st, 2008 up from 533 full-time employees as of September 30, 2008 and 426 full-time employees as of December 31st, 2007.

With that, let me turn to our outlook for fiscal 2009 and remind you that we do not provide quarterly EPS guidance.

We are increasing our full year fiscal 2009 revenue expectations to be between $178 million and $184 million from the range of between $171 million and $179 million that was provided in the previous quarter’s earnings call. This full year revenue guidance equates into the fourth quarter revenue guidance of between $42 million and $48 million. We are aware of the continuing deterioration of the global economic situation and its impact on the visibility concerning our financial results. As a result, we believe it is prudent to widen our guidance range.

Before moving on to our fiscal 2009 non-GAAP EPS I think it was worth noting again that in the December quarter as we took a cautious stand given the economic environment, our expensive benefited from not only tight reductions in discretionary spending for our partial holiday shutdown and the delay in the start dates of new hires. Without these effects we expect our operating expenses to increase in the fiscal fourth quarter. That being said, we still expect for the full year operating expenses to be at the high end of either 64% at 66% of revenue that we previously provided.

Reflecting the continued prudence in our guidance we expect our full year fiscal 2009 non-GAAP EPS on a weighted average fully diluted share count basis to be between positive $0.06 and positive $0.08 from the range of between $0.05 and $0.09 that was provided in the prior quarter’s earnings call. We know the non-GAAP EPS to reflect our over achievement in the third quarter.

I am very pleased with our performance in the quarter particularly in light of global economic recession that is surrounding us. Having said that, I would like to reiterate that in the event that we over achieve revenue guidance, and/or gross margin expectations, we will invest the additional profits primarily into our sales force, customer services and engineering.

We believe this strategy will allow us to better take advantage of the opportunities the current economic environment presents us to help secure our long-term growth.

With that, let me turn it back to David.

David Scott

Thanks Adriel. We now understand that the recession officially started in December 2007, just a few weeks after our IPO. The calendar year 2008, we achieved $172 million in revenue and achieved profitability on a non-GAAP basis in our full calendar quarter. This represents the reported 81% revenue growth year-on-year that probably closed the mid-60s percentage points of growth when adjusted for the [BSLE 28.56] related revenue recognition policy change in the March quarter of 2007.

I am extremely proud of the commitment of the three part team that delivered great operating results to our shareholders through such unexpectedly trying times. Recently, we have expressed what we believe is the flawed hypothesis about customers’ refocusing their spending on major incumbent supplies, somewhat a few promiscuously described as a flight to quality. We believe there is stronger evidence of a flight to savings and the new vendors like 3PAR with innovative technologies can save money.

We believe this is being demonstrated by customers in three ways. First, their willingness to spend capital to save ongoing operating expenditures in power, cooling, flow space, people cost and professional services; second, they are increasing desire to buy the most deficient solutions possible when spending valuable capital with thin provisioning becoming a “must-haves”; and third, when capital is unavailable to increasingly favor the adoption of enterprise level cloud computing based services where 3PAR has a significant infrastructure presence.

We therefore remain confident that the trends toward cloud computing, virtualization and the need to do more with less should favor the 3PAR value proposition and allows the opportunity to continue to take market share.

With that, let me turn it over to the operator to poll for questions. Thank you. Operator?

Question-and-Answer Session

Operator

(Operator instructions). Your first question comes from the line of Mark Kelleher - Canaccord Adams. Go ahead.

Mark Kelleher - Canaccord Adams

Congratulations on a good quarter on a tough environment. Can you maybe touch a little bit on your hiring trends, what you are looking to do, have that shifted at all as the visibility getting a little worse here?

David Scott

A strategy with slightly worse visibility and obvious times of increasing turbulence was to move to a more cautionary approach from our spending perspective and from that perspective we have really frozen hiring except for a number of key areas associated with sales and customer service in escalation support. Otherwise, we are continuing to maintain a cautionary approach until visibility gets markedly improved with lots of prudent stats.

Mark Kelleher - Canaccord Adams

Can we expect a couple of more account executive teams per quarter?

David Scott

We will continue to hire in the sales organization at this point in time. Yes.

Operator

Your next question comes from the line of Brian Freed - Morgan Keegan. Go ahead.

Brian Freed - Morgan Keegan

On the competitive front, EMC has been talking about the new DMX they have got coming out shortly; they have got IO base center provisioning. As you talked to the customers and they look to the offerings that the EMC placed is set to appear, what kind of response do you think you had or it has impact on your competitive differentiation?

David Scott

First of all, I can say that we have not had any visibility at all that we feel would affect us competitively to this new DMX. So, at this point in time it is a wait to see.

Brian Freed - Morgan Keegan

Secondly, if you are trying to look forward in terms of opportunities, yes, you have historically been very good in a Web 2.0 market. Are you seeing significant increases and penetration in the traditional markets as they become a little bit more flexible in their architectures and are there any customers designs that are tough on that side of things?

David Scott

In the traditional market space, I think financial service does not get more traditional and as I mentioned in my previous comments, we saw a very strong sequential revenue growth in financial services last quarter. Furthermore I can tell you that our bookings performance in terms of new orders was even stronger in financial services during the December quarter. We saw situations where customers clearly indicated to us and in this case was a new customer win in a major European kind of bank that they felt investing in a capital expenditure in 3PAR was going to allow them to substantially reduce their operating expenditures, which is a critical success factor for them moving forward and we are willing to adapt that over EMC which then incumbent supplier as the next generation platform. We also saw examples in financial services, again another major European institution where I understand all of their spending on EMC was frozen at the end of the last quarter and the early major expenditure on primary storage was with 3PAR as they look to make the most efficient use of capital expenditures as they could.

Operator

Your next question comes from the line of Rajesh Ghai - ThinkEquity. Go ahead.

Rajesh Ghai - ThinkEquity

I was looking at the ESBF as I encountered this number of transactions and revenue, so those things are a result of the fact that you are selling more 800s and was that a function of pricing? What is happening over there?

Adriel Lares

Whatever measurement that you can come to from a basic kind of calculation I would be very concern because it mixes a huge set of different elements in terms of upgrade transactions, new business transactions etc, but what I will say is that that we certainly did see a characterization where for some of our new customer win environments, we had larger overall deal sizes.

Rajesh Ghai - ThinkEquity

Here is the question that I have been getting recently about your revenue acquisition policy. You have conservative policy that has… so why exactly do you do that? Is there a risk involved that you have seen shipping and deployment or…?

Adriel Lares

We turn around and we recognize our revenue on installation and the reason we do that is that the accounting rules and regulations now require you to have established, some of what we call VSOE, on any services you are supplying with your offering and does include the installation services and so in fact until we have completed those installation services because we have not been able to establish VSOE on an independent basis. We have to defer revenue recognition until that point in time.

Rajesh Ghai – ThinkEquity

One last question. Compare that from XIV that have you have seen this quarter?

Adriel Lares

We have seen XIV sporadically in various deals, not as much as we would have expected. We fundamentally believe that the XIV platform has not necessarily been designed and optimized as a utility storage platform designed for utility computing environments and flexible workload consolidation, and so it maybe that there is somewhat of a mismatch of the type of opportunities that we are both coming going after. But we have not seen anything that gives us a view that is becoming a significant competitive threat in fact somewhat to the opposite of this stage.

Operator

Your next question comes from the line of David Bailey - Goldman Sachs. Go ahead.

David Bailey - Goldman Sachs

On the non-GAAP EPS target you are providing for the full year or actually I guess for Q4 of zero to negative $0.02. Is that a function of the OpEx increase or do you also expect gross margin to come down as well?

Adriel Lares

I think in general, it is a combination of just our general prudence in general, I mean as you can see from our revenue range that it does range from 42 to 48 for the quarter and so that is a sort of inclined those different types of scenarios as well as the OpEx increase as [38.41] to that that we will incur in the fourth quarter so it is going to take into account all of those factors.

David Bailey - Goldman Sachs

And then just on the competitive side, have you started to see competitors bundle other offerings that they have with storage in order to provide lower price points for the bundled package and if you do start to see that working, what do you do to combat it..

Adriel Lares

We have seen certain examples where that has been used and the example is a fairly interesting because in a way what is being done demonstrates maybe the weakness of some of our incumbent competition’s offerings; for instance in one situation, I believe EMC offered 200 days of free consulting with their product. I am not quite sure we did well enough demonstrating that if you needed 200 days of free consulting to get the solution up and running what was the likely going operating expense to keep it running, maintain it and change it overtime.

So, we have seen evidence of some elements of bundling. Typically, most customers see through that and are really focused on looking at what delivers them the best overall total cost of ownership in primary storage and for those customers who have that sophistication, we find ourselves pretty much able to demonstrate the ability to save substantial amounts of money competitively.

Operator

Your next question comes from the line of Doug Reid - Thomas Weisel Partners LLC.

Doug Reid - Thomas Weisel Partners LLC

I wanted to ask if you can put a little more color on the composition of new customers by segment. You mentioned financial services are strong. It presented some strength there but stripping off financial services within new customers last quarter, where have you seen strength and if you could also talk about other strengths outside of financial?

David Scott

Sure. We secured a number of new managed service providers worldwide. In addition, in the B2B segment, we saw a lot of new software as service customers come on board. In addition to that, we are generally starting to penetrate other industries in the Global 1000 with fairly significant wins where we are effectively replacing kind of EMC's infrastructure in those accounts and we are starting to see increases, if you like in the other category as well.

Operator

Your next question comes from the line of Alex Kurtz - Merriman Curhan Ford.

Alex Kurtz - Merriman Curhan Ford

Congratulations guys on a strong bottom line execution. Just a follow up on the prior question, did the financial vertical go up as a percent of sales quarter over quarter?

David Scott

Yes.

Alex Kurtz - Merriman Curhan Ford

Do you guys care to share that?

David Scott

No. As you are aware, we tried a strategy. We gave you an indication of the size of our largest segment and we also try to give you an indication of the relative ordering of the segment. I would say right now that the traditional ordering that we have had, which is business to business service providers, being the largest segment holds through. The second segment now has always been the internet and the Web 2.0 players and the third, financial services and fourth, government. It has to be said that financial services is closing in on the number two spot.

Alex Kurtz - Merriman Curhan Ford

Just on the Web 2.0 customers, what do you see this quarter? Did you acquire new customers in that vertical or was it just additional spending from the install base there?

David Scott

We did acquire some new customers in that segment this quarter although I would say that if we were to say that we are seeing any weakness at all between the different segments that we focused on, the internet Web 2.0 space seems to be more cautious with its spending.

Alex Kurtz - Merriman Curhan Ford

Okay. And couple of days ago, VMware provided sort of a cautious, I look obviously on their March quarter, how is VMware driving your business right now and my follow up question is, do you feel like in the storage market, maybe some of the low hanging fruit on some of the storage, VMware-led storage deals are sort of coming to an end. It is getting a little bit more competitive for those VMware-types of deals.

David Scott

I do not think there is any change in the dynamic. We continue to see a very significant attach rate for, as you put it, VMware-led deals within our installed base. We do not see any signs of that changing. I think obviously everyone is jumping on the band wagon of trying to kind of reposition their product as being a perfect fit for VMware and it becomes fairly interesting to see how they position their product in that space and gives us the opportunity to really highlight the competitive advantages we have in performance space utilization and integration with disaster recovery solutions, integration with BDI and etc. So, yes there is a greater competition around. I think because bee is attracted to a honey pot.

Operator

Your next question comes from the line of Bill Shope - Credit Suisse.

Bill Shope - Credit Suisse

Can you give some more color on the T-class system performance in the quarter, in particular, can you give us any sense of upgrade activities in the installed base and was it significant over key system sales primarily driven by new installation?

David Scott

The T-system sales are driven both within our installed base and within new customers and clearly we are getting very rapidly through a transition between the EMC costs right now. It is being very rapid.

Bill Shope - Credit Suisse

Okay and can you give us any metrics if it is possible to help us understand how successful you have done it in provision with 2.0 or migrating capacity from competitors based under your platform?

David Scott

At this stage as I have indicated, team building basic capability and our T-class system is a pre-enabler for this nondestructive version of process in migration and as we announced at the time of the T-class, it is pending new version of operating system that provides a software complement to it. So at this stage, we are really seeding the ground for future migrations rather than, we did not give you any figures about something that is actually being accomplished.

Bill Shope - Credit Suisse

Okay, sorry about that. Now on the pricing side of the equation, looking at the competitive landscape outside of the bundling deals you talked about earlier, are you seeing any incremental change in aggressive pricing versus some of the aggression you noted last quarter?

David Scott

Yes, I definitely saw in the turbulence at the end of the last quarter a hint of desperation. I think, some of the incumbent suppliers have their own, well at least of the major incumbent suppliers has their own disk drive business and it seemed very clear to us that maybe that this disk drive side of their business had a lot of extra capacity or a lot of extra spindles that they were willing to give away for free.

Operator

Your next question comes from the line of Kaushik Roy - Pacific Growth Equities.

Kaushik Roy - Pacific Growth Equities

As a follow up to Bill's question, help me understand this. In terms of pricing in Q4, calendar Q4, it was worse than Q3 or it was pretty much as you would have expected normal pricing one?

David Scott

I think it was characterized by there were certain deals where we saw very aggressive pricing activity but in terms of the overall pricing impact to us, we do not feel that there has been any significant impact over the normal quarter to quarter declines that we would expect to see. We sell on a value proposition of reducing overall total cost of ownership by up to 50% or more and when you take that strategy effectively, you can negate a lot of the pricing actions that occurs on a dollar per rule terabyte basis that our competitors demonstrate.

Kaushik Roy - Pacific Growth Equities

Is there any comment why their gross margins came down?

David Scott

Yes, I can, actually, in our S to T transition, we were still transition selling some S-systems to some T-systems. We had some inventory that we perceived that we probably would not use of S inventory and we actually wrote that down to the tune of approximately $600,000 to $800,000 which obviously hit the gross margin line which brought that margin down.

Kaushik Roy - Pacific Growth Equities

So for March quarter, you expect margins to be going up?

David Scott

I am not saying that. I am just saying that that was the impact for the December quarter that we experienced. We have only talked about that the 64% to 62% is our long term gross margin level and that is where we are sticking with.

Kaushik Roy - Pacific Growth Equities

And then it is interesting that, could you talk about life quality and you talked about flight to savings? So again in terms of composition, who are you seeing the most in terms of competition? Is it EMC or Hitachi or is NetApp? I mean, can you rank them a little bit maybe?

Adriel Lares

Absolutely. EMC by far is the number one competitor. Hitachi, number two. Probably, IBM number three, followed by HP, number four. NetApp is only in certain segments.

Kaushik Roy - Pacific Growth Equities

Last question, DSO has been up from 52 to 55, can you comment why and then, what are you expecting for March?

David Scott

Did you say they went up from, what to what?

Kaushik Roy - Pacific Growth Equities

Fifty two to fifty five nil.

David Scott

I have a slightly different calculation where there a lot much higher than that. I am not sure we have to find out how you do it and they were relatively flat from quarter. They went up slightly but I can tell you and from our calculation where they went up slightly, again, it was just we got this very large customers who although they are great to have as customers in terms of their credibility and their credit ratings and their cash, they can tend to put a little pressure on us from quarter to quarter especially at this macroeconomic environment. We have got that just they are putting pressure on us to delay payments.

Operator

Your next question comes from the line of Amit Daryanani - RBC Capital Markets.

Amit Daryanani - RBC Capital Markets

David, I just got a question for you talking about EMC being your largest competitor. In the past, you have seen them go to this DMX upgrade cycles and they are ready to go for one in spring or summer this year. Is the pricing being aggressive and do you suspect the pricing probably gets a little more aggressive this time given the macro environment?

David Scott

I am not certain that we have seen anything. It is two and a half years, almost three years now since we saw EMC trying to use price very aggressively directed against us and at that point in time, it backside very significantly because they used it in many of their largest accounts on a project basis where they would be pricing on a project basis at 50% less than the price of their newly agreed contractual price with those very large customers and very quickly, the customers kind of appear to turn around and say to EMC, "Look, if you are willing to price against 3PAR in this project at this level, I want that to be the new contractual price level." So that activity have directed price aggressiveness against 3PAR disappeared pretty quickly over couple of quarters and since then, we have not seen that activity. When we see it, it tends to just be more general kind of price aggressiveness. For instance not the quarter we just reported but the quarter before that, we certainly saw in the northeast and in New York, very specific, EMC price aggressiveness obviously I think in an area where they were extremely stressed to get to so many quotas, but nothing targeted against us as such.

Amit Daryanani - RBC Capital Markets

Got it and just in terms of polls rates at this point, do you know something in held in line with the stock level that is starting to slow down a little?

David Scott

No. I think that they were at historical level. What I would turn around and say is that the turbulence we saw and I discussed at the end of the last quarter with more in the form of people deciding not to go through and authorize to spending their budget at the end of December. Now, we got to work out what kind of effect that is. I mean one could have a hypothesis that it is a bit like a 9/11 effect where after September this year, everybody decided to freeze spending and they wanted to get into the new year and see what budgets look like and then free up spending and that would really demonstrate the pattern that we have seen. One of where there was more caution clearly towards the end of the year but then as soon as there was more clarity on budget, we have seen this very strong and very unusually strong start to bookings performance in January.

Amit Daryanani - RBC Capital Markets

Got it and could you just talk about rules of mix with direct versus indirect as the percent of sales?

Adriel Lares

The direct was about 69% and the indirect was about 31%. In the previous quarter, that was 73% and 27%, so in the ball parks of what they have been before.

Amit Daryanani - RBC Capital Markets

Can you talk about if you are using a buyback for one and a half million share, can you share if you guys bought back?

Adriel Lares

I believe it was around 227,000 shares.

Operator

Your next question comes from the line of [Unidentified Analyst].

[Unidentified Analyst]

Can you talk a little bit more about the mixture that you are seeing towards high end cyber channel drives away from data drives and what you think is it is bringing out and then, for the [54.55] drop off?

David Scott

As I tried to describe, Joel, in my comments before, it was a perceived weakness in near-line drives. It was just an excessive strength in the performance of cyber channel in the quarter where the number of [55.16] shut off very dramatic. We have penetration in accounts where performance is important and on our platform they can take advantage to be autonomic wide striping that we deliver to generate tremendous performance without having to go to expense of solid state disks technology, etc and I think there were some elements of that in the mix shift towards cyber channel.

As far as [Aiskasi] is concerned, that is very puzzling. The only thing that we can think of is that there is clearly more and more industry and customer discussion about the storage area and networking credit call of choice in large enterprise datacenters in the future over ethernet and I think for long time, [Aiskasi] was the only game in town over an ethernet fabric and now, it is becoming clearer I think to many people that maybe fiber channel ethernet could be the long term direction and if that is the case, we would speculate that that may lead people to focus less on [Aiskasi] in the segments that we target.

Now, that is not to say [Aiskasi] will not continue to have very strong kind of performance maybe in other segments like small to medium size businesses but we certainly are basically trying to understand if there is any significance to that trend or it is just a one off work.

[Unidentified Analyst]

Okay and then, solid state is something that you think would be compatible with your systems?

David Scott

Absolutely. We will be planning to support solid state in our platform. The reason we do not have till today is because of our wide striping weakening. We see tremendous [I Apps] performance out of wide striping with private channel drive without the expense of having to provide solid state disk. Many of our competitors who had to drive towards solid state disk in an earlier stage have to do that because they have naturally narrowly stripe architectures where the amounts of performance they can get to a volume out of ordinary five channel drive is simply insufficient in increasingly large number of application.

The problem obviously at this stage with solid state disk is it is still very expensive and is not kind of cost competitive compared with wide striping. The number of solutions where solid state disks other advantage which is latency is applicable to as remarkably small and still relatively insignificant.

Operator

Your last question comes from the line of [Mark Boulter] - Bluefin.

[Mark Boulter] - Bluefin

David and Adriel, I just wanted to get a feel when you discussed your target model in 2011, have you kind of opened up the aperture in terms of how you get there now that you have a costs side lever that you have not planned to use or is it really just kind of the progression to driving profitability or the marginal ramp cost space is relatively flat?

David Scott

From what we can see and we just registered with you the less certain visibility and the weakened visibility that we have but from what we can see, we still maintain our goal of achieving our target operating model by the March quarter of 2011 and that would represent between our IPO in that time of 40% to 45% take from a revenue perspective and achieving around probably the lower end of our 15% to 19% operating margin range. That still, at this stage, remains the goal that we are looking to achieve. Now obviously if a recession turns into a depression, every company cannot be immune from the effects of that and so we continue to look very closely but if the evidence of our countercyclical value proposition continues to grow and there is more and more evidence of that, clearly if we can continue to take market share and grow whereas the others either flat line or shrink, we feel that we will have a very strong opportunity to make these goals.

Right now, if you look at the reported quarters, IBM just reported that these systems shrunk 16% year on year and this is in the year where year ago, they had acquired XIZ so a tremendously surprising results kind of to me and even the EMC I think, Sometrics was down 9% year on year. Clarian maybe up 6% and we set that against our performance of growing 57% year over year. So it is clearly we are taking significant market share at this point in time.

[Mark Boulter] - Bluefin

Great, thank you. I missed all the questions but I wanted to see to what extent you are seeing customer shift from perhaps they purchased just once or twice a year and carry couple of quarters of storage inventory, are folks like that is shifting to making regular quarterly purchases of smaller amounts.

David Scott

Yes, I believe that that is absolutely a trend in upgrade business.

Operator

Ladies and gentlemen, that does conclude our Q&A session. I will turn the call back over to management for any closing remarks.

David Scott

Thank you very much for your time and we will see next quarter.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. That does conclude the presentation, you may disconnect. Have a wonderful day.

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