Islon Systems Q2 2009 Earnings Transcript

Islon Systems, Inc (ISLN)

Q2 2009 Earnings Call

July 30, 2009 05:00 PM ET

Executives

Chris Blessington - Senior Director Marketing and Communications

Sujal Patel - President and Chief Executive Officer

Bill Richter - Chief Financial Officer

Analysts

Kathryn Huberty - Morgan Stanley

Amit Daryanani - RBC Capital Markets

Glenn Hanus - Needham & Company

Presentation

Operator

Good day, ladies and gentlemen. And welcome to the Isilon Systems 2009 Second Quarter Financial Results Conference Call. My name is Melanie, and I'll be your coordinator today. At this time all participants are in listen-only mode. We will conduct a question-and-answer session at the end of this conference. (Operator Instructions). As a reminder today's call is being recorded.

I would now like to turn the call over to Mr. Chris Blessington, Senior Director of Marketing and Communications. Please proceed.

Chris Blessington

Thanks, Melanie. Good afternoon, everyone. The purpose of our call today is to discuss results for the second quarter of fiscal year 2009. With me this afternoon are Isilon's CEO; Sujal Patel and CFO, Bill Richter. Following their prepared remarks, we will open the call up to questions. If you haven't seen a copy of today's press release announcing these results, it's available on the Investor Relations section of our website at www.isilon.com/company. A recording of this conference call will be available on the website later this evening through midnight Eastern Time on August 6th. Details on the playback are included in the press release mentioned earlier.

On this conference call, we will be referencing both GAAP and non-GAAP financial measures. When we review gross margin, operating expense, operating loss and net and net loss, we may be speaking in non-GAAP terms, which excludes stock-based compensation restructuring charges. We believe that excluding these expenses gives our management and investors a better indication of our operating results.

During this conference call, we will make forward-looking statements about our business and expectations for the future. These forward-looking statements are subject to risks, uncertainties and assumptions. If the risks or uncertainties ever materialize, or the assumptions prove incorrect, our actual results may differ materially from those expressed or implied by our forward-looking statements. These and other important risk factors and assumptions are detailed in documents field with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the year ended December 31, 2008 and other filings. These risk factors and assumptions could cause actual results to vary from expectations. The company makes no commitment to revise or update any forward-looking statements, in order to reflect subsequent events or circumstances.

And with that, I will now turn the call over to Sujal.

Sujal Patel

Thanks, Chris. Good afternoon, everyone. And thanks for joining us today. Before I share my thoughts on our business progress in Q2, I would like to ask Bill, to start off by providing a review of our Q2 financial results. Bill?

Bill Richter

Thanks, Sujal and good afternoon to everyone on the call. I'll start my financial review with the income statement, then provide a few highlights on Isilon's balance sheet and cash flows, and then conclude with some comments on how we expect to run the business in Q3.

As a remainder, when I discuss gross margin and operating expenses, I will be speaking in non-GAAP terms. Starting with the income statement; Q2, 2009 total revenue was 29 million, up 8% sequentially and 3% over the second quarter of last year. Weak macroeconomic conditions continue to continue to present a challenging selling environment. But overall, we are pleased with our team's ability to continue to win business and take market-share. Let me give you some detail on our Q2 revenue.

Geographically, the breakdown was 71%, North America and 29%, International. Our International business made up most of the sequential gains in second quarter revenue, particularly the Asia Pacific territory. On North America and EMEA were about flat with Q1. Having said that from an order trend perspective, North America was strongest followed by Asia while EMEA continue to be challenging.

In Q2, sales through channel partners contributed 57% of total revenue; up from 51% in Q1. In North America, sales through channel partners contributed 45% of revenue; up from 37% in Q1 and up from 30% in the fourth quarter of last year. You've heard us talk a lot about moving to more leveraged sales model. And in that regard, we're encouraged with the progress we've seen as far.

Sujal will share some more color on our channel initiatives in a few minutes.

Software application sales represented 10% of our total revenue mix in Q2; compared with 9% last quarter and 8% in Q2 of 2008. We acquired 57 new customers in Q2; representing 24% of revenue in the quarter. In absolute dollars, new customer revenue grew from 4.1 million in Q1 to 6.8 million in Q2. Let me move on to gross margin; total gross margin was 57.3% versus 40.5% last quarter and 57% in the second quarter of last year.

As you recall, we reported a non-cash inventory write-down in the first quarter, which lowered margin by about 14 percentage points.

Even excluding the impact of the write-down, margins improved almost 3, 4 percentage points sequentially. In Q2, products margin was 59.3%; up from 43.7% last quarter and about flat with product margin in the second quarter of last year. Services margin was 51.2%; up from 31.2% last quarter and 46.2% in the second quarter of last year.

Again, the non-cash inventory write-down that occurred in Q1, impacted both product and service margins by 14 percentage points. Compared to Q1 and excluding the impact of the write-down, product margin improve a 180 basis points and service margin improved 520 basis points. These factors -- these three factors drove the overall increase in gross margins.

First, customers continue to see great value in Isilon's scale-out NAS solutions and our filed organization did a nice job, holding the line on discounting even in highly competitive deal. Second; our operations team began executing our cost savings programs in our own supply chains. And third; our services organization continues to deliver higher level of customer service, while keeping the lid on top. These factors taking together, drove gross margins to equal our previous company record set in Q3 of last year.

Moving on to operating expenses; excluding the impact of our previously announced restructuring plan and stock-based compensation, our Q2, 2009 operating expenses totaled 18.8 million, compared to 19.9 million last quarter and 21 million in the second quarter of 2008.

In our last call, we had indicated that restructuring charges could as high as 850,000. The actual result of 357,000 came in lower than initial estimates for couple of reasons. First; some of these severances included in our original forecast were recorded in the respective operating expense lines rather than in restructuring as the individuals replaced or expected to be replaced within a relatively short period of time. And second some of the plant costs were shifted from head count to non head count expenses.

Substantially all of the $357,000 charge reported in Q2 was paid out of cash during the quarter. In terms of savings, we said our plan would reduced the operating expense run rate by about 1 million per quarter.

As you can see by the sequential quarterly decline in operating expenses, we were able to achieve the full savings in Q2, which was faster than we had initially expected.

At $18.8 million, our operating expense structure is as low as it's been in two years. Q2 non-GAAP net loss per share, which excludes the impact of the restructuring charges and stock-based compensation was $0.03. This compares with a non-GAAP net loss per share of $0.14 last quarter and $0.07 in the second quarter of last year.

As a reminder, Q1 net loss per share included $0.06 of loss per share related to the non-cash inventory write-down. In Q2, non-GAAP net loss per share improved by $0.05, when you back out the impacts of Q1 write-down.

For Q3, -- let me move on and make a few comments on our balance sheet cash flows. We ended Q2 with 75.5 million in cash, cash equivalent and marketable securities; compared with 76.3 million at the end of last quarter and up from 75.1 million a year ago.

During Q2, our operations used about 670,000 in cash. In the trailing four quarters, Islion has been about breakeven from the free cash flow perspective; demonstrating high working capital and cost control.

Total deferred revenue was 30 million, up from 28.8 million last quarter and DSOs were 48 days; up slightly from 45 days last quarter.

Before I pass the call back to Sujal, I want to discuss our financial outlook. For Q3, we do expect to experience the typical seasonality that summer quarter tends to bring. From a planning perspective, you can expect us to keep our operating expense structure in the low $19 million range.

While there are some early signs of economic recovery; so far in Q3, we continue to see a difficult selling environment with IT budgets reduced relative to last year. Longer-term, we continue to target non-GAAP breakeven at around 35 million of revenue with gross margins in the mid to high 50s. As we grow the 35 million of revenue, there will be some incremental OpEx investments particularly in the R&D and sales and marketing organizations. Given what we see in the IT spending environments and the trends across our business, we anticipate reaching non-GAAP profitability sometime in 2010.

With that I'll turn the call back to Sujal.

Sujal Patel

Thanks, Bill. As we are all aware, challenging global macroeconomic conditions have put a significant downdrafts on IT venders. In light to that reality, I'm pleased that we were able to deliver solid second quarter results, and encouraged with the progress I see across the range of other important financial and operational areas.

Tight financial controls and an ongoing commitment to building operating leverage have enabled us to maintain our steady progress towards profitability. Our gross margin was 57.3%; represents Isilon's high water (ph) metric and was made possible by two key things.

First; our ability to demonstrate real and meaningful business value for customers and second, by significant improvements in our supply chain and services operations. While I take a moment and thank Mary Godwin, our VP of Operations and Bill ... our VP of Global Customer Service; for there leadership in bringing about these advances.

As Bill mention, our percentage of sales the channel was 57% for the second quarter; an improvement over Q1 to 51%. This growth achieved with no negative impact to gross margin, reflects the steady progress ... Isilon made since stepping into drive our channel operations late last year.

In addition, ... team signed 24 new sales partners in Q2, building out our sales capacity in some important critical market and horizontal applications. In our recent call, I said clear that meaningful progress in our channel operations would take sometime. And I want reiterate that now. But I'm encouraged by the early signs we're seeing. Expected to more as lenders team broaden the scope to directly address global channel opportunities going forward. Concurred with that focus on our international channel operations, senior VP of worldwide field operations Steve Fitz (ph) now with the four quarter under his belt, has taken steps to upgrade its international senior leadership team.

As a result, we've announced new sales leaders for EMEA and Japan on July 15th. ... and EMEA firmly had its U.K and Ireland sales for net up, and Tim Goodwin who led our ... sales efforts in Japan. Each brings to Isilon proven histories of delivering rapid revenue growth for International market. We fully recognize the significant market opportunity that exist for Isilon globally, and I expect that with George's strong leadership, of our global sales operation, we'll have progress to record in the near-term.

Let me take a moment to provide an update on new customer acquisitions. I was encouraged to see that the number ticked up from 48 new customers in Q1 to 57 new customers in Q2. But I am even more pleased that quarterly revenue from those new customers totaled 24%; up from 15% in Q1. With that said, I want to be clear that we still have a lot of work to do here, but I like the plan that we have in place. I'm encouraged with it's executions as far and look forward to building on these early but promising results.

Islion continued to demonstrate strength in a range of vertical markets in Q2. Life sciences in media, entertainment are among them. In life sciences for example; several different divisions of Merck are now driving significant application performance improvement with Islion scale-out NAS. The Merck high throughput screening group for example, which conducted a variety of biochemical, genetic and pharmacological test as a part of their drug discovery process is using Islion to accelerate molecular screening and ... sequencing runs. With Isilon, Merck HCF (ph) can now store a sequencing and screening data on a single high-performance, highly scalable share pool of storage; accelerating both the runs and sales, and the analysis of the ... data.

The result; ... scientific information in shorter time to market. Another Q2 customer, The New York Time (ph) is using Isilon as a center of depository for it's entire range of video content; enabling it to consolidate a massive database of video files into an easily scalable shared pool of storage.

With Isilon IQ, the New York Times has significantly increased the efficiency and easy use to the accessing video calls for research, as well as accelerating the process of streaming those videos to their range of online properties.

These another Q2 customers had enabled Isilon to cross the 1000 customer in threshold, a traditional milestones for technology companies and another indication of our leadership of the scale-out NAS category.

All of Isilon's customers have a couple of important things in common. Each and everyone of them understand the business agility enabled by Isilon's industry leading scalability performance and ease of use. In addition, I understand the value that sense from our rapid rate of meaningful product innovation.

During the second quarter, we continued that history of innovation with several important products announcements; all aimed at broadening our addressable opportunities in the enterprise. Our new backup accelerators; speeds backup and restore -- and simplifies backup management; overcoming one of the most significant challenges associated with building out and maintaining large scale-out NAS environments. The latest generation of our visionary operating system 1FS5.5 extends Isilon's efficiency, scalability and data protection capability to new industry leading levels, and a significant upgrade to our SyncIQ software application dramatically reduces the type acquired for enterprises to replicate data for business continuance, disaster recovery and other machine critical purposes.

As an example; Howard Medical School one of the countries foremost research and educational organizations and our new Q2 customer; exemplifies our ability to address a broader range of enterprise names.

In addition using Isilon IQ to power of massive Linux compute cluster, running a variety of proprietary applications that analyze biomedical data, Howard Medical School is utilizing the latest version of SinkIQ to replicate data across two Isilon clusters for disaster recovery purposes.

With Isilon, HMS has dramatically simplified its storage infrastructure to increase application performance, decreased cost and accelerate it's leading edge biomedical research. All of the new products we launched in the first half of 2009, broadened our footprint with a new an existing enterprise customers to maximize the applications and work flows we can effectively address. That part of the development strategy is producing real results as we begin to see and when deal that we do not complete for in the past. Enterprise storage consolidation, traditional math home (ph) directories, business analytics and most notably, virtualized environments.

One example of Isilon's growing strength and supporting virtualized environment, is a large Midwestern and insurance and financial services company, with demanding desktop and back office requirements. By effectively supporting the ... applications by the demotions and utility like distributed resource schedule, Isilon significantly lowered the customers CapEx investment, ensured the highest levels of data protection and decreased OpEx by providing a single point of management for both; there virtualized and non- virtualized environments.

Virtualization is a key area with strong growth potential for Isilon And you should expect to see us much more directly engaged in this opportunities going forward.

As we all know, cutting edge products and highly flexible platforms alone will not enable us to maximize the opportunity we have for us. We must effectively execute it as a business, and we are.

Our continued progress on EPS and the fact that our Q2 operating expenses were more than a $1 million lower than Q1 and $2.2 million lower than Q2 of last year; demonstrates that we have continued to make significant progress on our cost structure. But not at the expense of product innovation and leadership.

In light of the fact that first half of 2009 has presented a very challenging macroeconomic climate, I am encouraged by our ability to deliver year-over-year revenue growth by simultaneously making significant progress towards profitability. These results demonstrates the value of our products and technology, our improving business execution and the passion and commitment on the Isilon team.

I'd like to thank the Isilon team, both our employees and our partner network for their hard work and dedication in the first half of the year. With that, Bill and I are happy to take your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions). And our question comes from the line of Kathryn Huberty with Morgan Stanley. Go ahead.

Kathryn Huberty - Morgan Stanley

Thanks. Good afternoon, guys. Given, North America orders did improve sequentially and there some sign that IT spending is stabilizing domestically. Is it said or assume that that business will grow sequentially in September?

Bill Richter

Kathryn, you're right as you play out. I mean from the order trend perspective, North America did grow.. And so that is a decently leading indicator of how Q3 will go. But it's hard to say how that shapes up overall for the revenue line for the full quarter.

Kathryn Huberty - Morgan Stanley

And then does it relates to the growth in Asia sequentially in June? Was that a number of deals that made up the growth or were there a couple of large deals that run the business?

Bill Richter

It was really, I won't say a couple of large deals. But it was a smaller number of medium size deals. And it's particularly out of the Asia-Pacific region, which is a small territory for us, and the business tends to be brought here.

Kathryn Huberty - Morgan Stanley

Okay. And then are there any upcoming headwinds on the cost side that would prohibit a linear improvement in profitability over the next two to four quarters.

Bill Richter

Well, let me answer like this Kathryn. We're committed to continuing to generate leverage in the business. And so as revenue scales, our operating expense structure will scale. But obviously we're working to let it scale at a lower rate in order to drive profitability. And in terms of what happens in any one quarter, depends on the specific dynamic. But we like the model that we put in place.

Kathryn Huberty - Morgan Stanley

And the plans is to moderate investment along with revenue growth?

Sujal Patel

Absolutely.

Kathryn Huberty - Morgan Stanley

Okay. Thanks so much. Great job on cost this quarter guys.

Bill Richter

Thank you.

Sujal Patel

Thanks Kathryn.

Operator

Our next question comes from the line of Amit Daryanani with RBC Capital Markets. Go ahead.

Amit Daryanani - RBC Capital Markets

Thanks. Good afternoon, guys. Sujal, just a question I guess on the channel side, you guys obviously made a lot of progress this quarter. Can you just talk about what the long-term targets are with regards to the channel as a percentage of sales internationally and domestically? And what are -- there is no margin impact yet. Do you think there would be any in the foreseeable future?

Sujal Patel

Bill, let me tackle the first part of that question. So the first thing to remember when you look at our channel percentage overall, is that the vast majority of our international business is done through the channel. And so it is very close to 100% of our business. And so as we continue to diversify and we move towards more Isilon's footprint, North America and International business, that's going to drive the channel. When you look what that means from an end result standpoint, we certainly believe that we should be able to drive 18% of our business through the channel and that's the direction that we are going.

The other piece of your question was related to margin. And what we've been finding in the first half of this year as we begun to rollout new channel programs in North America, we found that really there is no gross margin pressure that's being placed on us relative to engaging the channel in opportunities. Our channel partners are sophisticated towards resellers and integrators. They understand how to sell value. They're selling a complete solution off and that we are pleased of. And what we're finding is often means that we can protect our price point better than we would be able to in some cases with our direct sales force.

Amit Daryanani - RBC Capital Markets

Great. And then just some questions on the gross margins. Sujal, you talked about sort of you had high water market; 57.3%. Just looking at how sustainable these margins are at these levels, especially assuming the software mix remain there on 10%. Is there most of these margins running down a little?

Sujal Patel

So, as I mentioned in the prepared remarks, we were definitely pleased with progress in gross margins and bringing the back up to our water mark of 57.3%. Gross margins from where they are today to our long-term business model obviously, we'll probably have a little bit of lumpiness up and down there. But we continue to believe that our target business model has our gross margins in the low 60s and that includes both progress on our product margin side as well as on service side.

Amit Daryanani - RBC Capital Markets

Got it. And just finally for me, could you just talk about what percent of the system shipments we did in Q2 are from the new products at X and NL series?

Bill Richter

Amit, we don't break out the specific product lines. What I will tell you on that is that our NL product picked up very quickly and are selling very well. The X series is pushing us into a lot of new enterprise work flows that really broadened our applicability and broadened the types of applications we are going after and. And so it's pick up is a little bit slower. But I was pleased with it's contribution as well in the future.

Amit Daryanani - RBC Capital Markets

Great. Thanks a lot. And good job in the quarter, guys.

Bill Richter

Thanks, Amit.

Operator

Our next question comes from the line of Erin Raker (ph) with Stifel Nicolaus. Go ahead.

Unidentified Analyst

Yeah. Thanks guys. Couple of question as well. I guess I want to dive a little bit deeper in the gross margin line. It looks like product gross margin at 59% was down a bit sequentially. Given the answer to the prior question, do you believe that that gross margin trends up from here? I'm just trying to understand how we kind of sustain this 57% type gross margin going forward. Is that really the driver you see gross margin on the product side trend up?

Bill Richter

Yeah. And Amit -- or -- sorry, Erin, the -- I mean, gross margin, we are pleased with ... from a product standpoint, particularly given the pricing environment that's out there right now. We -- everyone of the deal that we win, goes at our existing cap, new accounts are in competitive engagements. And for large incumbent vendors are often employing very severe pricing tactics. So overall given the environment, we were pleased with where the margin number was. In terms of how to progress going forward, as midst of software sales improvement, we do feel like overtime that makes a ... as we have a greater percentage of customers that have come on board more recently. And then also we are continuing to work our supply chain and find ways of lowering our costs.

And Erin, just Q1, just to clarify the numbers for you here; so product margins on a non-GAAP basis in Q2 was 59.3%. Those are a 180 basis point improvement sequentially from Q1 and roughly flat year-over-year of about 30 basis points.

Unidentified Analyst

Okay. Fair enough. And then I guess two other questions. I appreciate the kind of color on next quarter, how do you guys typically characterize typical seasonal quarter? I mean, we've seen obviously some lumpiness in your business, how do you guys think about typical seasonality?

Sujal Patel

Yeah. I mean, Erin Q3 for us tend to be a slow quarter. So first of all that EMEA is the slowest market in the third quarter. And EMEA will be finest in the U.S. as well, particularly in August and early September when the technology buyers are literally out on vacation. So in terms of what exactly that means to the revenue lines; you really have to think about it in terms of our back dynamic, the seasonality dynamic in terms of how it's coupled of with the overall macro economy. So we're not giving any more on indication of what we've already said. But we do expect seasonality can impact the business in some way.

Unidentified Analyst

Okay. Final question; as it pretends the competitive landscape, have you seen any early indications of looks to be NetApps data untapped (ph), is that overlays; and any thoughts on HPs recent acquisition of Ibrix?

Sujal Patel

So, with respect to NetApps ... we haven't yet seen of it in the field. We are expecting to see it by the end of the year. But to-date we haven't seen any of it. And our competition continues to be largely against NetApps and EMC; NetApps more often than EMC. And we feel very comfortable with our fifth generation technology in the lead that we over those two competitors. With HP and Ibrix, which you mentioned, our view that HP's purchased Ibrix; again demonstrate the important and strategic value of scale-out NAS. And I think it's all probably also an indication that HP want to satisfy with the technology side to acquired pimppolice over few years back to make their oneoff extreme data product. I would expect that over the course of the next year or two that more and more large incumbents are going to move into this space and really validate scale-out technologies. And like NetApp, I feel very comfortable with our technology lead giving that we spend nine years and five and five and half generations into our product line today.

Unidentified Analyst

Great. Thanks a lot.

Sujal Patel

Thanks.

Operator

Our next question comes from the line of ... with Think Equity. Go ahead.

Unidentified Analyst

Yeah. Thanks. Congratulations on the sequential growth. Just a couple of questions on the OpEx. In the past you've mentioned that you plan to keep OpEx flat going forward. Does that mean -- I'm just giving the math based on your gross margin this quarter and your OpEx. Your breakeven seems to have come down below 35 million, are you still seeking the stand on 35 million breakeven, or given that OpEx turn out to be lower than what you had projected last time. Does it come down below 35?

Sujal Patel

Sure. I mean, and actually during our prepared remarks I reiterated that we continue to see breakeven at the $35 million level. And there will some incremental operating expenses, investments in our operating expenses between now and 35 million. Those really come in the form of two areas. I mean, first, there is obviously some incremental variable extent associated with our sales and marketing functions as the revenue line grows. And then secondly, Isilon will continue to invest in our R&D organization to ensure that we have a growing technological advantage compared to the competition. So you can expect there to make investments there. Having said that, we are at the same time very committed to ensuring that we continue to generate leverage in the business, and so operating expenses will not grow faster than revenue.

Unidentified Analyst

Okay. Great. And going to the CapEx; CapEx actually contracted pretty sharp lead in the quarter, what do you expect for CapEx going forward for remainder of the year?

Sujal Patel

Sure. You're right. I mean, CapEx was considerably lower and sorry you're right CapEx was low in Q2. And that really a function of ... it's part belt tightening programs that we put into place.

In addition to optimizing our operating expense structure, we look very closely to optimizing our cash position. It's very important to us as the company and important to our customers as well. It's at a very low level now. I wouldn't expect it to remain at that low level. Having said that we have given, and are not giving a specific guidance on go forward CapEx.

Unidentified Analyst

Sure. And in terms of the fact that entire product (ph) is going to come out with -- they don't have Italy (ph) and then if you could please tell me the move in this space. What do you think as a long-term impact from the scaled NAS market? Do you see that kind of growing because there is so much more marketing air cover for these kind of solutions. And how do you see that impacting our business in general? Does it kind of increase competition or does it increase size of the market. Can you comment in general about how do you see this playing out going forward?

Sujal Patel

Yeah. It's really interesting question. I think the activity we've seen with NetApp, with EMC and Atmos, with I bricks (ph) and HP; all that activity we believe supports the notion that scale-out is the architecture of choice for the future of network storage. And I'm a big believer in that happened for nearly a decade now. And what I think we're going to see out there is we're going to see increased competition. But that increased competition for us is going to increase its attention to this new architecture in this space and ultimately I view it as a net positive. I never want to be alone in this space, otherwise probably not very important. And so we look forward to having these products in the marketplace, so we can compete on the merits of our technology and our business value proposition.

Unidentified Analyst

Great. And my last question, on Asia you saw a sequential improvement in performance. Was that a result of distribution expansion? You're expanding up new channel partners over that a function of demand improvement. And how do you see all of that is kind of trending forward, going forward for Asia as well as Europe? Thanks.

Bill Richter

Yeah. I think I'll take that, I think that when you look at Asia; we had entered Asia not too many quarter ago. And really it's in a very early stage, and so have a lot of small numbers. It has a big affect in Asia so I wouldn't read into it in terms of increase demand or increased distribution capacity. In terms of going forward, we do expect to see a improvement out of Europe. We made a leadership change there at the end of Q2 and expect to see some early signs of success there in the near-term.

And then as we start seeing the revenue level come up, both North America and Europe predominantly as the two largest regions that we sale into, then we'll continue with incremental investments for the top line.

Unidentified Analyst

Great. Thank you so much.

Operator

(Operator Instructions). And our next question comes from the line of Glenn Hanus with Needham. Go ahead.

Glenn Hanus - Needham & Company

Yeah. Good afternoon, guys. Could you comment a little bit on how you view your performance in Q2 versus your own expectations and comment on that in terms of like puts and takes on revenues and gross margins?

Bill Richter

Well, let me take a shot of that and then maybe Sujal will add color if he likes and -- I think when you're looking at the business, the ... will certainly continue to be very difficult for us in Q2. There was a lot of deals we're involved with. It disappeared because customer lost budget. And often time is the buyer that we've engaged with believes that these budgets are relatively lay in cycle. And then someway or above them, the deal disappears because of whatever type of budget cuts with the organization itself. From a revenue perspective, I think ... them more, but the economy is what it is. Having said that, for the rest of P&L, we are pleased with our gross margins that were right on plan. And we are very pleased with operating expenses. We are actually did I think a bit better than we had anticipated going into the quarter.

Sujal Patel

I think that -- the only color I might add is that Q2 was certainly difficult with budget constraints and with deal push outs. But I would say that there was a little bit of incremental stability relative to Q1 with that effect with even more pronounced.

Glenn Hanus - Needham & Company

And you sound a little maybe a little bit more cautious than few others just in terms of next quarter or so here. I mean, excuse me if that's a misinterpretation of your remarks. But it sound a little cautious on the environments relative to few other cause, do you think that's a function of the markets particularly you serve or something else?

Bill Richter

I want you that our performance will necessarily be all that different from the storage market in general. I wouldn't view that because of the market we sell into that there is going to be any difference. In fact, I think our performance proprietary (ph) be inline with that respect.

If you sensed any caution, I think it's just because there are so many different counter balancing forces at play in Q3. There is yet another quarter away from hopefully the deepest spot of the economic downturn. But it's seasonally slow quarter. But on the positive side, you might say that there is may be some pent up demand. So all these forces play against each other. And we are playing it cautious. I think that when you're coming out an environment like we saw in Q1 and Q2, I think it's prudent to manager your business in a conservative manner and ... top line.

Glenn Hanus - Needham & Company

And shifting gears a little bit, could you comment on just a little more deeply operationally on the channel side, kind of where you're at and how that build out as going, the changes you are making there and what specifically you're trying to accomplish in the next couple of quarters?

Bill Richter

Sure. So, as I think you folks will probably remember; we hired lenderd (ph) to run our worldwide channels organization at the end of last year. Lenderd spent something along the line for eight years of NetApp and grew their channel business from north of $100 million to over $2 billion. Lenderd has a great deal of expertise building out channels with strong storage centric cars, resellers and system integrators throughout the world. And so Lenderd focus to-date has really been on our North American channel business, signing up new partners rolling out a new a new channel program, which gives our partners both, high retain margin, but as well as the opportunity to focus on higher margin professional services business with which we don't compete with our partners. And so that's a huge positive for our partners, that's a differentiated offering. And from operating that has gotten a lot of partners very excited. As Lenderd ... his team build out here initially in North America and he's got the program going; he is now focused on continuing that success and rolling out program out globally initially starting with Europe and then moving to the Asia-Pacific region from there.

Glenn Hanus - Needham & Company

Okay. Thank you.

Operator

And there are no further questions at this time. I'd like to turn the call back over to Mr. Patel for closing remarks. Please proceed.

Sujal Patel

Thank you. Thanks very much to everyone for being on the call. And we look forward to updating you on Q3 in late October.

Operator

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

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