Compellent Technologies, Inc. Q2 2009 Earnings Call Transcript

Jul.29.09 | About: Compellent Technologies, (CML)

Compellent Technologies, Inc. (NYSE:CML)

Q2 2009 Earnings Call Transcript

July 29, 2009 4:30 pm ET

Executives

Jenifer Kirtland – IR, EVC Group

Phil Soran – Chairman, President and CEO

Jack Judd – CFO

Analysts

Katy Huberty – Morgan Stanley

Alex Kurtz – Merriman Curhan Ford

Eric Martinuzzi – Craig-Hallum

Aaron Rakers – Stifel Nicolaus

Amit Daryanani – RBC Capital Markets

Aaron Puni [ph] – Great Plain Advisors [ph]

Andrew Nowinski – Piper Jaffray

Paul Mansky – Canaccord Adams

Brent Bracelin – Pacific Crest Securities

Jason Nolan – Robert W. Baird

Glenn Hanus – Needham & Company

Rajesh Ghai – ThinkEquity

Doug Reid – Thomas Weisel Partners

Gabe Lowy – Noble Research

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Compellent Q2 2009 earnings conference call. (Operator instructions) This conference is being recorded today, Wednesday, July 29, 2009.

I would now like to turn the conference over to Jenifer Kirtland. Please go ahead.

Jenifer Kirtland

Thank you, operator, and thank you for joining the Compellent conference call and webcast to review financial results for the second quarter of 2009.

Before we get started, during the course of this conference call, we will make projections and may make other statements about Compellent's business that are forward-looking and are subject to many risks and uncertainties that could cause actual results to differ materially from expectations.

A detailed discussion of the risks and uncertainties that affect our business is contained in Compellent's filings with the SEC, including its annual report on Form 10-K for the year ended December 31, 2008, under the heading Risk Factors. Copies of these filings are available online from the SEC or on Compellent's website. These forward-looking statements are not guarantees of future performance and speak only as of the date hereof; and except as required by law, Compellent disclaims any obligation to update these forward-looking statements to reflect future events or circumstances.

In addition, during today's discussion, management will comment on both actual results and certain non-GAAP results. Reconciliation of actual results with these non-GAAP results are provided in today's earnings release, which is available on our website at compellent.com.

And now, I would like to turn the call over to Phil Soran, President and CEO of Compellent. Phil?

Phil Soran

Well, thank you, Jennifer; and thanks to everyone for joining us on our 2009 second-quarter earnings call. With me today is Jack Judd, our Chief Financial Officer.

There was a lot of change in our industry. Every day, we hear companies offering new products and services to simplify IT management and reduce their overall costs. However, it is really entrepreneurs and small companies, not the big ones, that are driving innovation and efficiency in the marketplace, and will lead this global economy out of the recession.

When we started Compellent, we had a vision for our business, sales strategy, and a product that can scale without limit. We believe enterprises should have affordable access to easy-to-administer storage management. Now, even in an economic environment that continues to be challenging, our vision remains unchanged and has found its mark among customers of all sizes.

I'm very pleased to report that our business continues to gain excellent momentum, and the last three months marked a record quarter for Compellent. Our product and business model continued to deliver new enterprise customer orders and strong sales growth.

Revenue grew 37% from the second quarter of 2008 to $28.7 million. This represents a 2% sequential quarterly increase over the first quarter of 2009, and our 15th consecutive quarter of revenue growth.

Non-GAAP net income, excluding stock compensation expense, was $1.5 million or $0.05 a share, up from a non-GAAP loss of $66,000 in last year's second quarter.

Internationally, our business grew 79% from Q2 last year and 29% sequentially.

This past quarter, we generated positive cash flow of $1.4 million and ended June with a record amount of cash on the balance sheet. We have been able to maintain a balance between expense management and investing for our future growth, while still generating a profit.

Last quarter, I characterized our sales performance as hitting lots of signals. In the second quarter, in addition to many average-sized orders, we had several full homeruns, that has helped us drive results. At the same time, our strategy of driving large enterprise storage features down to smaller customers with entry-level bundles has also paid off. These starting configurations, using our standard hardware and software, were an attractive solution for IT managers struggling with reduced budgets. We believe that these smaller footprints will grow over time and help us continue to grow our upgrade revenue stream.

During the second quarter, we added 115 new end-user accounts for a total of 1,491 at the end of June. Some of our new midsized enterprise accounts include the Lewis Energy Group in San Antonio, Texas; the City of Houston; and Appleton Papers in Wisconsin. One example of a homerun new enterprise accounts in Q2 was Savvis, a leading managed computing and network infrastructure provider. The new growth from small to large enterprises highlights the scalability of our product and the flexibility of our sales channel and virtual manufacturing model.

While the economy remains challenging, we did see increasing market stability during the quarter, especially in June. End-user customers became reengaged, interested in discussing new projects and committing funds for storage. Our business efficiency and momentum makes us optimistic that we can continue both sequential and annual growth, while most of our competitors have been declining.

There is a sharp focus on efficiency and cost savings within IT organizations, and they are realizing that efficient, scalable virtual storage, such as Compellent’s, is the future of the storage industry. We are getting more and more attention because of our unique ability to manage customers’ data automatically and move it between virtualized tiers of storage to the right place at the right time.

This ability to dynamically move data at the block level is one important differentiation of our solution from competitive offerings. Customers are growing tired of storage solutions with stagnant storage management, forklift upgrades, and complex, difficult to manage bolt-on features. Our dynamic storage solutions fit well with emerging trends in the data center, like solid-state drives and the creation of private and public clouds. We see this in our strong order flow, awards, and coverage within the business and financial media like Investors Business Daily, Financial Times UK, BusinessWeek, and even Jim Cramer's Mad Money.

The excitement of our end-user base and channel community was reflected in attendance at C-Drive, which is our annual customer and partner event held in May. This year, a record 405 business partners, end-users, and members of the media and industry analyst committee attended the four-day conference. Even though many organizations have frozen or reduced their travel budgets, our C-Drive event still grew attendance by 31% over last year.

We see strong third-party recognition of our company, products, and customer support that has really made us a breakthrough brand in the storage industry. We did extremely well once again in the TheInfoPro Storage Wave 12 study. It is a survey of medium and large enterprise customers and their storage vendor experiences. We received the highest scores and indexes that measure product quality and service of any SAN provider, including a perfect 100 rating, which is a strong testament to the reliability, support, and innovation we have strived to provide our end-user customers. When congratulating our team on the score of 100, I jokingly told them, we can do better next time.

Also this year, we were named as one of two pilots for the Microsoft Worldwide Partner of the Year Award for advanced storage infrastructure solutions. In June, we were named the world's fastest growing block-based external storage company for the third year in a row, according to Gartner.

We continue to grow outside the US and formally launched our business in France and Italy in the second quarter.

We received several awards from top-tier industry publications, including, CRN’s Channel Chief’s 2009 award, ComputerWorld's Top Green IT Organization 2009 award, and the Network Computing 2009 award for our customer, the London Borough of Hillingdon.

While we continue to hire smartly to position ourselves for future growth, we also focus internally on processes and systems to ensure that we can continue to grow revenue, while still keeping our OpEx growth in check.

And I would like to just take a few minutes on this call to highlight some of the enhancements we have made in sales operations over the years that are helping us scale efficiently. For instance, way back in 2003, before we even received our first purchase order, we implemented a sophisticated, integrated CRM and ERP system based on Microsoft technologies. Our business partner (inaudible) registration system is fully integrated with our manufacturing forecasting system, which helps us provide very accurate forecast to our hardware suppliers, keeping inventory levels among the lowest in the industry.

Quote Center, our real-time online quoting tool, allows business partners to configure custom configurations 24 hours a day and provides us with excellent visibility on the status of end-user customer transactions. By implementing business intelligence systems and workflow automation, we have been able to keep our sales operation and headcount flat over the past year, while experiencing hyper revenue and order growth.

We launched the new Compellent customer portal during Q2, which provides quick and easy access to the information that our end-user customers desire, such as a knowledge base for self-help technical information, up-to-date status on their support calls to Compellent support, and a user form to be able to connect with other Compellent customers worldwide.

I would like to thank the Compellent team and our business partners, who continue to move the company forward. We are very fortunate to work with such a committed, dedicated group of individuals. I appreciate your efforts in executing another great quarter of growth and profitability for Compellent. I would also like to thank our end-users for the confidence they have shown in us.

I would now like to turn over the call to Jack to provide a more detailed look at the second-quarter financials and offer outlook on the third-quarter of 2009.

Jack?

Jack Judd

Thanks, Phil. During the second quarter, revenue grew $7.7 million to $28.7 million or 37% of the growth rate in prior year's second quarter. Sequentially, revenue grew $643,000 or 2%, our 15th consecutive quarter of sequential growth. We continue to grow in international markets, as revenue increased to $5.7 million in the second quarter compared to $3.2 million the year before. International revenue was 20% of total revenue in the second quarter.

Our end-users, at the end of the quarter, totaled 1,491, compared to 972 one year earlier, and 1,376 at the end of March. Measured on a year-to-date basis, our revenue from existing end-users was 49% of product revenue and new end-users made up 51% of product revenue.

Our gross margin increased to 53.7% in the second quarter of 2009, compared to 52.8% in the first quarter this past year. During the quarter, product margin was 49.2% and support services margin was 64.6%. Our average selling price of a system returned to levels similar to 2008. While we generally believe these average selling price metrics can be misleading, this is another sign that selling processes are returning to more normal levels.

Operating expenses increased to $15.5 million in the second quarter of 2009, from $12.6 million one year earlier as we continued to build infrastructure in sales and marketing and invest in our technology. This 23% increase in operating expenses compares very favorably to our 37% increase in revenue. This expense leveraging its possible because of both our business model advantages and our dedicated workforce, that continues to market and efficiently deliver outstanding products to our business partners and end users.

We continue to grow our employee headcount. At June 30, we employed 340 employees compared to 258 one year earlier and 317 at the end of the prior quarter. Almost 75% of our new hires are in sales and engineering.

Net income for the second quarter of 2009 was $247,000 or $0.01 per share, compared to a net loss of $603,000 or a minus $0.02 per share during the second quarter of 2008. Excluding the effect of stock-based compensation, our non-GAAP net income for the second quarter was $1.5 million or $0.05 per share, compared with a non-GAAP net loss of $66,000 or $0.00 per share the previous year.

Our balance sheet remained very strong. We ended the quarter with $104.6 million in cash and investments. Our balance sheet includes $28.6 million in deferred revenue, an increase of $8 million from December 2008 and $4.4 million from March 2009.

Our days sales outstanding increased by 16 days this past quarter, reflecting the timing of revenue within the quarter.

The advantages of our virtual manufacturing model continues. Even with our revenue gains, our inventories are 6% lower at June 2009 than one year earlier.

I would now like to provide some guidance on the coming quarter. As Phil highlighted earlier, we are gaining confidence that customer buying patterns are strengthening from earlier this year and this can be seen in the growth of our current pipeline and our registered deal activity. Our current forecast is for revenue to be between $30 million and $32 million. This will mark our 16th consecutive quarter of revenue growth. We expect to continue to invest in our technology and sales teams, so as a result, our operating costs in the third quarter will increase from second-quarter spending by approximately 10%. We have set stock compensation costs to be approximately $1.4 million in the third quarter.

That concludes our formal remarks.

Now, operator, could you please open the call for Q&A?

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from the line of Katy Huberty with Morgan Stanley. Please go ahead.

Katy Huberty – Morgan Stanley

Hi, there. Good afternoon, congrats on another great quarter, guys.

Phil Soran

Thank you, Katy.

Katy Huberty – Morgan Stanley

Can you help us reconcile the contraction in product revenues sequentially, especially in light of higher ASPs, higher new customer accounts, and obviously, very strong growth in deferred revenue and services?

Phil Soran

Well, I think that it's all of those reasons. It isn't any one situation. It has a lot to do with how customers come to us and about ties and deals. I don't think there is anything really too significant that anybody should take forward that our product revenue relatively flat from quarter to quarter. And I think it is a real good metric for us that we increased revenue overall in the quarter from the prior quarter.

Katy Huberty – Morgan Stanley

And on that front, is it fair to say that the higher DSOs and higher payables suggest maybe some strength at the start of the September quarter?

Phil Soran

That is an interesting way to look at it. I think I would prefer to say that I think you can see that we had an awful lot of revenue in the month of June.

Katy Huberty – Morgan Stanley

Okay. And then perhaps one of the most telling metrics is the new customer revenue, which topped 50% up from last quarter. Assuming this stabilization turns into a full recovery, when do you think or do you think you can get back to new customer revenue running at 60% of total?

Phil Soran

I think that the number will come down towards the amount that you just said, over the course of the year. I think earlier in the year, especially the first quarter, your business tends to be more from your existing customer base versus finding new customers, as it takes time for budgets to be approved and it is for customers to make final buying decisions, once their budgets do become active. I think when you see the third and fourth quarters, especially the fourth quarter; I think that quarter will be dominated by business from new customer bases versus upgrades, which is really how it happened last year. We are excited about all the new customers we got and that was an encouraging number.

Katy Huberty – Morgan Stanley

Okay. I will leave the floor.

Phil Soran

Thanks a lot.

Operator

Thank you. Our next question comes from the line of Alex Kurtz with Merriman Curhan Ford. Please go ahead.

Alex Kurtz – Merriman Curhan Ford

Hey, guys. Great quarter. I had two quick questions for you.

Number one, your largest competitor is starting to make more noise about storage tiering in a box and rolling out some more advanced technologies than they have in the past with some of their legato products. Where you think the market and sort of looking forward over the next couple of quarters, how are you going to combat that, because that has been one of your biggest differentiators thus far?

Phil Soran

Well, first of all, I think the fact that you talked about is a compliment to us, that they are hearing enough from their customers. Couple of things here, we have had our dynamic block architecture kind of as an architectural advantage from inception and in kind of a way, it is integrated or a system we think will continue to be an advantage, even if others tried to do tiering and now we do as the block level very unique. Frankly, we have not heard much from our customer base about those features some of the competitors and I don't think they are really even shipping right now. So I think we have a significant architectural advantage that will continue into the future.

Alex Kurtz – Merriman Curhan Ford

All right. And just looking at your channel programs, I would be interested to hear your commentary about what kind of partners this quarter really drove business, and if you were to invest in incremental dollar, would it be going to sort of the larger national partners or the more regional guys? And then, I will go back into the queue. Thanks.

Phil Soran

So that one there, Alex, I would kind of actually go both. I mean, the strength of our channel is that we try to create a level playing field for both large players and smaller resellers, and frankly, we have gotten a lot of attainment from both sides there. So we made some significant investments in our channel developer program in the first quarter, we talked about that in the last call, and we are seeing some of the benefits of that and some of it is with the large players and some of it is frankly with the smaller regional players. And I think both of them are kind of key to our future. They tend to get kind of a different customer set and bring different value to the table and I think we got the folks on both of them, frankly, and both contributed.

Alex Kurtz – Merriman Curhan Ford

So if the investment is going to be made, it is going to be made at both levels?

Phil Soran

Correct.

Alex Kurtz – Merriman Curhan Ford

Thank you.

Phil Soran

Now what we do is – the way we always look at it is that we want to invest in those who are investing in us. So, if they are small but they are very focused on us, that is worth an investment from us. And if they are large and they can provide some focus on us, that is worth some investment from us. The ones we are really not going to spend the time on is those who are – we are just a nice addition to a line card. Those are the ones that we will eventually call out of our program.

Alex Kurtz – Merriman Curhan Ford

Okay. Thanks, guys.

Phil Soran

You are welcome.

Operator

Thank you. Our next question is from the line of Eric Martinuzzi with Craig-Hallum. Please go ahead.

Eric Martinuzzi – Craig-Hallum

Thanks, and congrats on the strong quarter. The services revenue, really strong growth there, both sequentially and year-over-year. I know in some tech companies there is almost a service catch-up as customers get invoices and pay those, you can't recognize revenue. My question is, what is a normalized starting point here for June, and what should we expect as far as sequentially in September?

Phil Soran

I think that our maintenance programs and our professional services revenue will continue to increase quarter over quarter, and a lot of it has to do with not only new system sales that we are making to first-time customers, but the almost 1,500 customers that are going to be going to renewal programs with our maintenance, and we continue to have almost 100% renewal rate. So a good hunk of that increase in revenue is a reflection of the systems that we sold one year ago.

Eric Martinuzzi – Craig-Hallum

Okay. But that is a pretty substantial jump; we are up almost 20%, 25% there from Q1 to Q2. I understand the sequential growth, but any greater clarity than that?

Phil Soran

I think it would be a reflection of really good maintenance programs and up selling an awful lot of maintenance services for all different products that we deliver with our stamp.

Eric Martinuzzi – Craig-Hallum

Okay. And then the domestic channel, I know you have focused on your international growth, but are there other ongoing efforts domestically that you could talk about as far as really getting out in the market and expanding your domestic footprint?

Phil Soran

Well, the biggest one is – I will go over a couple of things there, Eric. Number one, we talked about this in the first quarter call, but one thing we invested in this year and you kind of have to be very strategic with your hiring and where you are going to put the focus, but we hired a territory we call channel development managers, whose only job is to go out and develop the channel partners that we have and their investing in us, like I talked about earlier, and then also to find other partners in key areas that we need additional coverage. So that is pretty strong investment we have there and we have four in the domestic and one internationally there.

Second of all, we have – so we did that, we also – lot of investment in trade shows, PR efforts, that kind of stuff just to get that breakthrough brand message out in the market a lot more. So second quarter was one of those, and then frankly, a big investment in the second quarter was C-Drive. To put that on, some think it is funded, but it cost us a lot of money, but boy, that is some of the best money we have spent. To get 405 people to come here and spend days with you, learning your message and understand that better. So a lot of efforts on that channel development stuff, I can't emphasize better than that.

Eric Martinuzzi – Craig-Hallum

Okay. And one last housekeeping question. You have got a pretty nice run in the stock here. What is a good weighted average share count to use for Q3, Jack?

Jack Judd

I think that we disclosed that in our press release, $30 million – just a second, let me look this up. $32,840,000 in Q2, and on a year-to-date basis, it would be just slightly less than that.

Eric Martinuzzi – Craig-Hallum

I am just saying for Q3, sometimes that – are you moving it up?

Jack Judd

(inaudible) million in Q3.

Eric Martinuzzi – Craig-Hallum

Okay, thanks.

Operator

Thank you. Our next question comes from the line of Aaron Rakers with Stifel Nicolaus. Please go ahead.

Aaron Rakers – Stifel Nicolaus

Yes, thanks, guys. A couple of questions. Well, I guess building on the earlier question, as we move forward here, given the strength that you're seeing in your support and services line, any thoughts with regard to how you expect the mix between product and service revenue and then kind of taking it to next step, how maybe we should think about that. Well, it looks to be a still very strong service gross margin line here going forward.

Phil Soran

Well, I think you have a couple questions there, Aaron, so I think I will take them one at a time. Let us compare maybe with what happened this past quarter with what we have given for guidance in the coming quarter. I would expect that as our revenue increases next quarter from the current quarter, that more of the revenue increase will flow through product than support and services than what happened in the previous quarter. So in other words, I think that the increase in revenue experienced in the second quarter in support services and maintenance programs will not be duplicated to that extent in the next quarter. And as we go forward, I expect the margins that we earn on that line should be quite consistent, that is what we have had in the past quarter.

Aaron Rakers – Stifel Nicolaus

Okay, very good.

Phil Soran

And the rest are on margins.

Aaron Rakers – Stifel Nicolaus

A couple of other questions. And on – I know you guys again highlighted international growth, but if I look at the domestic growth here this quarter, on a year-over-year basis, it looks like it is kind of slow to the lowest level that we have seen, actually down a bit on a sequential basis. So was there any – is that more or less just a macro impact there, are you seeing more competition on that front, I'm just kind of – you know, is there any trend to kind of grab onto in that North America seeing some moderation to that year-over-year growth trend?

Phil Soran

I wouldn't try to grab onto anything. You know, we're forecasting sequential growth and we think a lot will come from the domestic market. So I wouldn't grab onto that. We did have nice international orders in Canada during the quarter, which really helped that international growth. But I wouldn’t grab onto anything there and – you know, it is just competitive out there and when there is a piece of storage business on the opportunity list, I think it seems like a lot of competitors are going after it, but I don't think that will change or whatever. But we think we have some advantages with our cost-effective storage and stuff. But I wouldn't pick up any big trend on that one there, other than – you know you win where you win the deals, right?

Jack Judd

And I think, again, we have to remember that the third quarter is a quarter that is a little bit tougher internationally because of Europe being shut down for vacations. But I think you will see more of the growth in the quarter being domestic than it was here in this past quarter.

Aaron Rakers – Stifel Nicolaus

Okay. Final question on – first time I have heard you guys mentioned Savvis, obviously as a new customer win. Can you help us understand where you are at? Obviously, we have seen one of your competitors being well positioned within Savvis. Any color on where you are necessarily positioned within Savvis?

Phil Soran

Well, I would like to just leave the out there at we have a nice wind at Savvis and we're doing business with them and we will try to give more color on that as we go into the future, when we kind of do something jointly with them.

Aaron Rakers – Stifel Nicolaus

Fair enough. Thank you.

Operator

Thank you. Our next question comes from the line of Amit Daryanani with RBC Capital Markets. Please go ahead.

Amit Daryanani – RBC Capital Markets

Thanks, congratulations on a good quarter, guys.

I had a quick question, just you know, you were talking about demand starting to stabilize and visibility again starting to improve. Are you seeing pricing starting to get a little bit easier in the marketplace as well right now?

Phil Soran

You broke up just a little bit there, are we seeing pricing get stabilized?

Amit Daryanani – RBC Capital Markets

Yes, I was just curious like given the fact we're starting to see demand stabilize a little bit here, are you seeing pricing pressure starting to ease up a little bit too in the marketplace?

Phil Soran

I think the pricing is still – the pricing pressure is still there. I mean, we were able to keep the margin flat, so I think that is possible. With this difficult economy, more storage is very competitive and I don't see that changing anytime soon. You know, things are stabilizing, but it is not like it is a booming economy, where people can’t get to all the deals or whatever. So it is more competitive than it was a year ago, and I don't think that thing is going to change anytime soon. You know, one thing that we were able to help customers out with this past quarter is to offer them 0% leases, which can help them get in affordably to cost-effective solutions. So that was a nice deal too.

Amit Daryanani – RBC Capital Markets

And then, just looking at the international markets, I mean you guys I think has a full rollout in France and Italy this quarter. Are there any other big parts of Europe where you do not have a presence, which you possibly are looking to roll out in the next few quarters?

Phil Soran

Yes, we could say to the folks that are out there, we will kind of wait till we publicly announce where it is. Now we are still selling in the other markets, but we haven't “officially rolled out”. So we did France and Italy so that those kind of formal weighted or formal PR launch or whatever, but we have sales in other countries that we haven't quite yet formally rolled out or whatever. So yes, we have got a lot of room for growth in the international markets and we will continue to do that strategically.

Amit Daryanani – RBC Capital Markets

Thanks a lot.

Phil Soran

You bet.

Operator

And your next question comes from the line of Aaron Puni [ph] with Great Plain Advisors [ph]. Please go ahead.

Aaron Puni – Great Plain Advisors

Hi, thanks. With the federal government stimulus and the government year end, do you expect the government revenue to be stronger in the September quarter than in past quarters?

Phil Soran

I hope we get a little more government business in the fiscal year and then stuff. You know, relatively, we still have a lot of room for growth in the government area, it takes a long time to crack that market and we have invested in that. So I think we'll see benefits from that in the future. It is not like it is going to be dramatically higher than it was in the past. So I think we should see that some benefit out of it. And you know, the stimulus dollars kind of helped, they added to it, it is tough to put your finger on it, I want a deal because of stimulus dollars, but hopefully we find more and more of those in the future.

Aaron Puni – Great Plain Advisors

And then were there any other particular verticals in the quarter that were – that sort of surprised you?

Phil Soran

(inaudible) Jack, the standard verticals, healthcare was good.

Jack Judd

Healthcare and financial services and education and (inaudible) for government. You know, we still have the same thing going on with all our verticals. We sell across all verticals successfully. We don't have a product that only is meant for one vertical. And even with any one vertical, we sell lots of customers within that vertical. So we really don't have any concentration going on right now.

Aaron Puni – Great Plain Advisors

All right. Thanks.

Phil Soran

Thanks, Aaron.

Operator

Thank you. Our next question comes from the line of Andrew Nowinski with Piper Jaffray. Please go ahead.

Andrew Nowinski – Piper Jaffray

Good afternoon, guys. Congrats to another nice quarter.

Phil Soran

Thank you.

Andrew Nowinski – Piper Jaffray

Just with regard to your entry level bundle, is that offering targeted at the new market segment, i.e., the small enterprise or is it more in response to a change in behavior from your midsized customers that perhaps aren't spending as much now?

Phil Soran

No, I wouldn't say really that is going after new markets. I just consider it a way to get at entry-level midsized enterprise accounts that have large growth potential (inaudible), I don't think it is necessarily a “new market”. But one of the challenges we have is we copied all the way down at that size, all the way up to the large enterprise customers and we just try to make it easier for people to get in the customer fold while we're doing that. And we kind of see a little bit of – we think it is better than our brick-based architecture, where we have a lot more scale to build in. If we can get that architecture down to that low-end guy, he can grow with us and realize the benefits of our scalable architecture.

Andrew Nowinski – Piper Jaffray

Got it, understood. And then, just on the competitive landscape, in that kind of customer pool, at that entry-level range, is it the same as your typical competitors in the midsize range?

Phil Soran

Yes, we hear some of the same names, you know, you do tend to see Dell is on the ecological solution more than they used to; and you see HP sell the left-hand solution more than they used to with their acquisitions. You know, (inaudible) and other products, so, with that you tend to see those offerings there more often.

Andrew Nowinski – Piper Jaffray

Okay. And then just maybe on a roadmap perspective, are Live Volumes still on track.

Phil Soran

So, on a roadmap, historically what we have done is talked a lot about – we tend to announce after we have a customers. So Live Volume is going through engineering right now, it is a real complex product right at the tail and we will start getting early user share in the next few weeks.

Andrew Nowinski – Piper Jaffray

Okay. And then just last question, maybe from a hardware perspective, is now that SSDs are out, is SAS and two terabyte drives on the roadmap for you guys?

Phil Soran

Yes, keep your eyes open for SAS, that is definitely a good technology. We have decided to do SAS as earlier versions of SAS had some scalability issues and we want to wait for versions that had to have the requirements we had for our customers. So keep your eyes open, we are real short-term on that. And then on the two terabyte drives, when they are ready for enterprise consumption, we will be right there, or shortly thereafter.

Andrew Nowinski – Piper Jaffray

Got it. Thanks. Keep up the good work.

Phil Soran

Thanks a lot.

Operator

Thank you. Our next question comes from the line of Paul Mansky with Canaccord Adams. Please go ahead.

Paul Mansky – Canaccord Adams

Yes, a lot of my questions have been asked and answered, so this may be just a few just by way of clarification.

On the product gross margin side, obviously a slight uptick on a sequential basis, but still fairly well off on kind of the historical trend line. Did I hear you correctly say that you expect them to remain at kind of these depressed levels vis-à-vis pricing for the foreseeable future?

Jack Judd

I don't know if I would characterize our margins as depressed. I still think that they are very good for our business and I still think overall, if you look at our overall margin, I think it is really good. I think you are seeing with our number that was this past quarter, 49.2%, you are definitely seeing price competitiveness in the market for which we have to react. I still think long term, we continue to be very positive and I still think, like I said last quarter, that we will see some improvement in margin as we go through the year. Maybe next quarter we will have more of a margin improvement than we just had.

Paul Mansky – Canaccord Adams

Right. What I'm trying to do is trying to get down to the bottom line, obviously. I heard you mention that OpEx was going to be up 10% sequentially, despite the fact that obviously you don't have your user conference this quarter and the product revenues, which are obviously lower margin than service are going to make up a greater percentage of the growth. So, maybe as we kind of think about that in the context of running a framework vis-à-vis operating margins and expectations for the upcoming quarter, it would be a little bit helpful.

Jack Judd

I don't know if I can say much more than I have already said on it. I do expect that margins will improve over the next two quarters and into 2010 and we will have to see what happens then in the next quarter.

Paul Mansky – Canaccord Adams

Okay, great. Thank you.

Operator

Thank you. Our next question comes from the line of Brent Bracelin with Pacific Crest Securities. Please go ahead.

Brent Bracelin – Pacific Crest Securities

Thank you. A couple of questions, if I could here. Phil, you started the call out talking about kind of this quarter having several homeruns versus last quarter, where you had more singles. Any other kind of homeruns that you can talk about, other than kind of Savvis that you have already mentioned? And then secondarily, did you recognize most of the revenue from some of the homerun wins this quarter or is that still yet to be recognized in Q3?

Phil Soran

So first, some of the homeruns, we have to kind of get their okay before you pass on their names and some of that, so I am going to hold off on that and some of them want to do more of a – give it some more time before we do the formal announcements over that. The nice thing about some of those customers is that yes, we did take some of the revenue there, but then those also tend to grow, so if we can deliver good solution to those people, that could be future revenues, but we did take some of the revenue in that quarter.

Jack Judd

None of the homeruns that we refer to were sold with acceptance criteria though that would indicate that we had future revenue recognition on.

Brent Bracelin – Pacific Crest Securities

Okay, fair enough. And then, Jack, I just wanted to follow up on the deferred revenue. You have certainly got a spike there. Would you attribute that mostly to kind of maintenance renewal contracts or is there contribution from kind of deferred product revenue that is in that – and contributed to that spike in deferred revenue as well?

Jack Judd

There really is no deferred product revenue; it would be unusual for us to characterize anything as deferred product. I think what you do see with some of our deferred revenue though, is that we are doing more longer-term maintenance fields than we would have done a year before. We are doing more three-year maintenance on initial system sales than we did before, and that is very much part of our strategy.

Brent Bracelin – Pacific Crest Securities

Okay, fair enough. And then, as you think about kind of Q3, clearly saw a spike in DSOs this quarter. You know, as you think about Q3, do you think the quarter could return back to more normal linearity or are you expecting and modeling a middle, kind of backend loaded kind of quarter?

Jack Judd

Probably a combination of the two. We think that buying patterns are becoming more normal, but I still think that September will be a big month. But probably percentage-wise, that is probably as much as it was in the second quarter.

Brent Bracelin – Pacific Crest Securities

And then as it relates to visibility, clearly you talked about a rebound in June, clearly you are guiding to sequential growth here more so than last quarter. Do you have more visibility and how confident are you in the sustainability of kind of the (inaudible) you see now?

Phil Soran

The best we have is a visibility over the pipeline. I kind of highlighted some of the sales operations advantages we have there and the nice thing is that gives us the visibility (inaudible). The visibility of the direct model with the economy is of a general model. So we are based a little bit on that visibility, and we see there when we came up with the revenue guidance.

Brent Bracelin – Pacific Crest Securities

Fair enough. My last question, as it relates to kind of these homerun opportunities. Would you attribute kind of the SSD functionality as helping drive some higher interest and some of these homerun opportunities or is it just kind of more maturing of the business model?

Phil Soran

I think it is more of the latter. I think it is just the acceptance of our – what we hear in the market from our customers. We have had very large customers with hundreds of terabytes installed for quite a while now and just that stability is showing and customers are hearing about it and that is getting us into those opportunities.

Now that being said, I think the promise of SSD is helping us with them and so what is best about the homeruns is because they bought SSD, I think it is more – the promise of SSD and the fact that we are able to implement that kind of architecture, using only up to 1/10 of the physical storage that other vendors have got to do, because we are a dynamic block architecture. That is something I think is attractive to customers when they look at our implementation and our architecture.

Brent Bracelin – Pacific Crest Securities

Very helpful. Thank you.

Operator

Thank you. Our next question comes from the line of Jason Nolan with Robert W. Baird. Please go ahead.

Jason Nolan – Robert W. Baird

Yes, thanks. Just a question on distribution first. I haven't heard you guys talk much about CBW, if you could just describe the relationship there and how important to CBW is your business?

Phil Soran

So CBW is a partner of ours. And a very important partner of ours and we are excited about it. And we will continue to invest in that one there.

Jason Nolan – Robert W. Baird

And the relationship with CBW between the standard borrower community?

Phil Soran

So what we try to do is have a level plain for all our partners and once again invest in those, invest in us, but have bills somewhere on a level plain so that they can deal with deal registration and items like that. So they are all strategic to us.

Jason Nolan – Robert W. Baird

That makes sense. And then just last question from me, just more broadly and related to some of the previous questions. We hear from resellers that Compellent does well in the SMB community because you are able to solve 95% of your customer’s problems with a single solution. So as you move up market here to the large enterprise, does the value proposition change or is it basically the same attraction?

Phil Soran

No, I think it's a real similar attraction. The only difference I'd say is that the advantages we provide with our architecture, the impact is actually greater the larger the customer gets. You know, if you just had a 5-terabyte system, tiered storage may have less impact rather than if you have a 105 terabytes of data to manage and you start to figure out, 80% to 90% of the data is inactive. When you got hundreds of terabytes, it's a lot of data; you can do some of the economies of scale on. So I think the story really resonates up and down the line and actually some of the benefits get accentuated the bigger they get.

Now, some of the other ones – the smaller ones, the automation and ease-of-use that really helps a small company that doesn’t have much resource to manage it and so that can be a – on the decisions factor, maybe they weigh things a little bit differently, but frankly the larger the customer is, the more the benefits play out for him.

Jason Nolan – Robert W. Baird

Thanks, Phil.

Phil Soran

You bet.

Operator

Thank you. Our next question comes from the line of Glenn Hanus with Needham & Company. Please go ahead.

Glenn Hanus – Needham & Company

Good afternoon and congrats, guys.

Phil Soran

Hi, Glenn.

Jack Judd

Hi, Glenn.

Glenn Hanus – Needham & Company

Yes, so could you maybe just expand on kind of high level here, where you are finding and continue to find the most promising kind of new opportunities for you guys? Is it more geography or underpenetrated verticals or deeper partner relations or – in certain regions perhaps or just kind of a combination of a lot of those things or some other factors?

Phil Soran

I find more of the peanut butter answer to this right across all of those things there. I – still the biggest challenge we have is that right now there is thousands of storage deals going down and how many of them are evaluating us? If they evaluate us, we do real well and the challenge we always have is how do we get to all of them and make them aware of us and that's why you have all of the focus on PR and branding and that breakthrough brand that I think we are getting more and more known for and then, the reach of your channel that – different channel players can get into – reach into different customers and how we do that. And we are starting to do more – some vertical shows. So you kind of – it's kind of across the board all the above rather than any one area standing out.

Glenn Hanus – Needham & Company

And how about – on the service provider side, what's your opportunity there? Great win at Savvis; does that represent a major new vertical for you? Do you – have you already penetrated that area much? What can we expect there going forward?

Phil Soran

Well, I – couple of things with the service providers. The whole virtualized storage and automation and tiered storage and all those benefits we just talked about on the last question really play strongly in those environments. They need all of those to really kind of offer kind of leading edge solutions to their customers. We've had service providers as customers for, I don’t know, four years now, I mean almost from day one. So it's not a new vertical for us.

I think we might be getting recognized by some of those players more and more because they've heard about us actually, frankly from some of their end-user customers. So we have a lot of – just on the call of the prospect in Europe that service provider, I'm really just raveling off lots of references where they check us out within the service provider space that are getting their benefits from us for many years now.

Glenn Hanus – Needham & Company

And maybe lastly, I mean I know you are mostly in the primary storage realm, but any thoughts on implications that the EMC-DDUP acquisition and channel fallout or anything that might impact you one way or the other as a result of that merger?

Phil Soran

No, we weren’t able to see any fallout yet. I – the first thing I'll do is really got to congratulate Frank Slootman and his team, I know all of the sales people there. Evident it was a really great company and they did really great job and is really, really need to see them get back kind of exit strategy there and then I see, frankly it provides – it validates the need for innovation in the storage market and it validates what they are doing on efficiency and the archive market. We’ve kind of dealing in the primary storage and I think it kind of just highlights that advantage and how viable people find it. So no real change though in the channel layout as of yet.

Glenn Hanus – Needham & Company

Okay. Thanks, guys.

Phil Soran

You bet.

Jack Judd

Thank you.

Operator

Thank you. Our next question comes from the line of Rajesh Ghai with ThinkEquity. Please go ahead.

Rajesh Ghai – ThinkEquity

Hi, good afternoon. Thanks for taking the questions. You mentioned, Phil, that you see EqualLogic and LeftHand in a lot more transactions. Can you comment on what sign is that, is that just an expansion of the distribution to more channel partners targeting the semi market? And also, can you talk about your win rate against them in this – in the latest quarter?

Phil Soran

Yes, let's – so I think it's not that they are getting more partners I'd say. But – so a couple of things. Just, one is we have more partners now that sell both HP and us. So that right there is going to cause more – you are going to see it more often or whatever. And I also think that for those large providers, they – they're – let's say they are putting X ergs of energy into selling storage, they are still doing that but a larger percentage of that energy is being put – applied to the EqualLogic and the LeftHand solutions.

So as to the detriment of other solutions, I think they are soft. But the other nice thing as we might be seeing a little bit more is in replacing some of – I call it kind of brick remorse out there, I see a lit bit of that – that brick architecture. What some customers have told us is that the first one was good, the second one is okay, and the third might be too many in that scalability. So that also brings us into opportunities, people are finding that.

Rajesh Ghai – ThinkEquity

Okay. Just one question on support and services. As someone pointed out, it's been growing pretty rapidly. I know you don’t break out support and services in that line, but has there been a change in the contribution rate from support and services in that line? Has kind of services been growing faster than in the – over the past three quarters or what's been contributing to that increase? If could give the clarities, that'll be great.

Jack Judd

It's a great question and our professional services dollars is very similar in the second quarter than it was in the first quarter. We are putting an awful lot more emphasis and efforts into professional services and we expect an awful lot of good things to come in the future, but most of the revenue we are still recognizing on that is for our training services and for our installation services.

Rajesh Ghai – ThinkEquity

And going forward over the next few quarters, how do you see that trending?

Jack Judd

I expect it to go up a little bit each quarter.

Rajesh Ghai – ThinkEquity

Okay, great.

Jack Judd

We don’t expect it to double or triple in that sort of a time period.

Rajesh Ghai – ThinkEquity

Okay. And you mentioned that overseas contribution was up 22%. So that's a relative strength over what you had in the previous quarter. Was that strength reflected in Canada as you mentioned or was that in Europe that related to a distribution expansion you've done lately?

Jack Judd

I think that we did better across many international markets in the second quarter compared to the first quarter.

Rajesh Ghai – ThinkEquity

And Europe was weak for most of your competitors. I'm just wondering was that strength in Europe too or –?

Jack Judd

Yes.

Rajesh Ghai – ThinkEquity

Okay, great. And lastly, one housekeeping item, what should we assume as a tax rate going forward?

Jack Judd

I think a better way to say our taxes versus a rate at least in this current quarter is I would estimate the taxes next quarter will be around $200,000.

Rajesh Ghai – ThinkEquity

Okay. Thank you so much.

Phil Soran

Thank you.

Operator

Thank you. And our next question comes from the line of Doug Reid with Thomas Weisel Partners. Please go ahead.

Doug Reid – Thomas Weisel Partners

Thanks for taking my questions and congratulations on a great quarter.

Phil Soran

Thanks, Doug.

Jack Judd

Thank you.

Doug Reid – Thomas Weisel Partners

So just circling back to the issue of solid state to drive adoption, you mentioned in response to an earlier question that you are seeing a high level of interest and I think you shared some helpful data from your C-Drive survey as well highlighting that fact. But could you help us understand a little bit better the rate of adoption as revenued or rather of the new customers to get a sense of what the adoption rate is?

Phil Soran

Yes, it’s – we don’t break down that part on the product. Let me just give you a little bit color on that there. I would say the interest levels are very high and the adoption rate is starting to happen, it's not buzzed up at all, but the fact that we are able to do it and you can seamlessly upgrade to it later on. So a lot of customers will buy because of solid state even though they may not buy it on initial purchase. And like I said earlier that we are able to do it at one-tenth the cost of those competitive solutions is obviously a real advantageous for us there too.

So a little early to see the big revenue ramp from it. We got multiple customers using it and liking it and early results are really good. We had some users talk about the C-Drive, their experience with it and they are really, really excited about it and companies are getting excited by this, obviously the IOPS if they can get out of it, but some of the environmental impact, but another one that's really kind of exciting them is some of the response time and latency decrease we are able to get with that type of solution. So I think the pricing has got to come down a little bit more for you to see the huge revenue increases, but it sure is an interesting technology for the future.

Doug Reid – Thomas Weisel Partners

Okay, great. I mean, just some – back to the international growth, any difference in deal sizes between the international business and the U.S. business?

Jack Judd

Internationally, deals tend to be slightly larger than they are in the United States. International deals tend to be a little bit bigger.

Doug Reid – Thomas Weisel Partners

Okay, great. Thanks so much.

Operator

Thank you. And we have time for one more question. And the question is from the line of Gabe Lowy with Noble Research. Please go ahead.

Gabe Lowy – Noble Research

Hello, gentlemen. Nice quarter.

Phil Soran

Thank you, Gabe.

Gabe Lowy – Noble Research

At the risk of going back to the beginning of the bridge with a new bucket, paintbrush, they’ve all been answered. Thank you.

Phil Soran

Okay.

Operator

Thank you. And at this time, we have no further questions in the queue. Please go ahead.

Phil Soran

Well, we just want to thank everybody for the support and once again, I want to thank the team for just outstanding quarter, we are really excited and looking forward to provide innovation and results for the market and that concludes our remarks and we'll see you guys in three months with the next call. Thank you.

Operator

Thank you. Ladies and gentlemen, this concludes the Compellent Q2 2009 earnings conference call. If you would like to listen to a replay of today's conference, please dial 303-590-3030 or 1-800-406-7325 followed by pass code of 4110370. ACT would like to thank you for your participation and you may now disconnect.

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