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3PAR Inc. (NYSE:PAR)

F1Q10 Earnings Call Transcript

August 03, 2009 at 4:30 pm ET

Executives

David Scott - President and Chief Executive Officer

Adriel Lares - Chief Financial Officer and Vice President of Finance

Analysts

Mark Kelleher - Brigantine Advisors LLC

Aaron Rakers - Stifel Nicolaus

David Bailey - Goldman Sachs

Alex Kurtz - Merriman Curhan Ford & Co.

Paul Mansky - Canaccord Adams

Brian Freed - Morgan Keegan

Rajesh Ghai - ThinkEquity LLC

Jayson Noland - Robert W. Baird & Co., Inc.

Douglas Reid - Thomas Weisel Partners

Glenn Hanus - Needham & Company

Kaushik Roy - Wedbush Morgan Securities, Inc.

Operator

Good day ladies and gentlemen and welcome to the first fiscal quarter 2010 3PAR Incorporated earnings conference call. My name is Wayne and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference.

(Operator Instructions) I would now like to turn this presentation over to your host for today's call, 3PAR Incorporated. Please proceed.

Adriel Lares

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 second quarter and full year of fiscal 2010 and beyond, as well as financial projections and growth trends for the overall storage market and segments thereof including the development of the cloud computing market, the potential impact of our market, business and investment strategies on our business, management's current views concerning anticipated market share opportunities and anticipated demand for our storage solution and adoption trends in our customer markets.

All of these forward-looking statements involve known and unknown risks, uncertainties and other important factors that may cause our actual results, levels of activity, performance or achievements 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. These risk factors are included in our Annual Report on Form 10-K for the year ended March 31st, 2009.

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 June 30th, 2009, which will be filed with the SEC in August 2009. These factors may cause our results to differ materially from any forward-looking statements we make in 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 revise the information contained 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 both for a 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 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 would now like to turn the call over to David Scott, CEO of 3PAR. David?

David Scott

Good afternoon. Today we are announcing a full year result for our first quarter of fiscal year 2010. We achieved revenue of $44.5 million, up approximately 4% year-over-year and down 8% sequentially. I would note that since our July 14th preannouncement, the subsequent reported result of other enterprise club, high and the storage vendors, has confirmed the weakness of this segment of the market in the June quarter.

In fiscal Q1, we achieved the gross margin of 65.3% demonstrating healthy customer recognition of a few more with less value proposition despite an increasingly aggressive competitive pricing environment. In addition to achieving a strong gross profit result, we also effectively managed our operating expense in the first quarter which showed a sequential reduction of $1.6 million. These two factors allowed us to minimize the effect of our revenue shortfall on earnings.

As a result, we were able to deliver net income of $41,000 on a non-GAAP basis, a better profit performance than we had projected back on July 14th. This has allowed us to report non-GAAP earnings per share of $0.0 including expenses related to stock options of GAAP net loss for this quarter with $1.8 million or negative $0.03 per share.

I would like to focus on a few other aspects of our performance over the recent months including new customer wins, recognition achieved through industry awards, key new hires and the latest program enhancements associated with our focus on the cloud computing segment.

We have recently announced key new wins in the internet segment including TheLadders.com, a leading job search website, as well as Tickets.com, a leading online ticket reservation company. In addition, we made the first public announcement of a new F-Class customer, Managed Healthcare Associate, a leading provider of services that will turn site healthcare providers that include group purchasing, managed drug benefit and pharmaceutical data services.

We are extremely happy at how rapidly the F-Class has ramped since its introduction at the end of March. We are also pleased that the 3PAR T-Class with Thin Built In which has just celebrated its first year of general availability was recognized last quarter as a winner of the Best Products and Services of 2009 Award by the Networks Products Guide.

In addition, 3PAR's long term customer service was recognized as the first managed service provider to be awarded the Best of Software as a Service Showplace Award from ThinkStrategy, a strategic consulting services company. Service runs many different cloud and utility service offerings on 3PAR utility storage including Best Software as a Service offering.

We continue to strengthen the executive team at 3PAR. We recently announced that Whitney Tomlin has joined us as the new Vice President of Sales through our North American region replacing RJ Weigel who had earlier had taken on the worldwide sales role. Whitney was previously a highly respected regional Vice President of Sales at NetApp and has subsequently spent time as the North American Vice President of Sales at SunPower. His addition demonstrates our continued ability to attract top talents to our sales executive ranks.

In addition, I am pleased to announce that Rusty Walther has joined us as our Global Vice President of Customer Services. Rusty joined us from a short stint at Data Domain preferring to join a company at a similar stage of development than completely transition to EMC. For over four years until the end of April, Rusty was the Vice President of Global Support for NetApp. We feel extremely fortunate to have attracted an executive with such tremendous experience to 3PAR as we scale the Company through its next phase of development.

Finally, I would like to note the recent announcement of Cloud Agile, a program directed at promoting the benefit of delivering enterprise IT as a utility service for partners of 3PAR. We believe that we are in the midst of major secular trends with cloud computing as an ultimate replacement of much of the information technology that is currently owned and operated by enterprises. We designed 3PAR utility storage with the unique combination of agility and efficiency which was among the two major requirements that cloud computing provides us success in the future.

This has led us to have taken a leadership position as a chosen platform to multi tenet enterprise class cloud computing offering in a number of major players in the segment. Four key cloud computing partners who offered their services across the world joined our Cloud Agile Program as charter members. They were Verizon Business, Terremark, DataPipe and Attenda. Partners in our Cloud Agile Program benefit from a number of program elements that include technology incentives in heart's technical and sales training, sales enablement and joint marketing activity that is designed to increase mutual sales and profitability.

We continue to look for ways to tighten our partnerships with the leading players in this increasingly important segment both today and into the future. Finally, let me give you an updated view of the segment demand picture we witnessed in the June quarter. Our sales in fiscal Q1 demonstrated the continuing strengthening in both financial services and government sectors as a percentage of our overall revenue performance. The strengthening government sales pushed up our percentage of business we conducted through an indirect retail of channel to 39% in the quarter including one 10% customer in the quarter, the FBI.

The business-to-business service provider segment was slightly weaker than in the previous three quarters but remained our largest segment in the 30% to 40% range of revenues. The internet segment remains steady sequentially. International business continues to perform better than we had expected at 20% of revenues.

Looking forward, we noted in our previous call that we saw a renewed weakness in demand towards the end of the first fiscal quarter. The weakness was broad based and appeared to be influenced significantly by renewed concerns around budget availability and larger enterprises and service providers. We did not see a reduction in the number of new customer wins we had in the June quarter compared with March and our success in this area remains very healthy.

However, we did see a tightening in average deal sizes for new business opportunities as pricing became very [fizz] where the major incumbents were attempting to protect their installed bases. In this economic environment, we believe that sales rep productivity is reducing for everyone selling it to the high-end storage business. From that perspective, we are reducing our forecast of bookings per productive account executive from about $1 million per quarter to a range of $850,000 to $900,000 per quarter.

Let me now turn the call over to Adriel Lares, our Chief Financial Officer, to go over our financial result in more detail. Adriel?

Adriel Lares

Good afternoon. As David mentioned for the first quarter ended June 30th, we reported revenues of $44.5 million representing an increase of 4% over the same quarter a year ago but an 8% decrease over the $48.5 million we recorded in the previous quarter. Of this total, product revenue accounted for $38.8 million or 87% of total revenue, a decrease of 3% over our product revenue recognized in the same quarter a year ago and a 10% decrease from product revenue recognized in the previous quarter.

Support revenue totaled $5.7 million, 13% of total revenue and an increase of 87% over support revenue recognized in the same quarter a year ago and a 10% increase from the previous quarter. In terms of the split between new and repeat business, 86% of total revenue in this quarter came from customers who had purchased from us previously as compared to 83% in the previous quarter. Although the 14% of revenue represented new business, it is slightly lower than what we have seen typically being contributed as we have noted in the past that this percentage can fluctuate given the timing and size of orders shipped we recognized in the quarter.

Excluding revenue attributable to software contract renewals, our repeat revenue for this quarter was 73%, the same as in the previous quarter. This quarter we had one customer that accounted for more than 10% of total revenue. Although our customer concentration will fluctuate quarter over quarter as a result of factors such as when we receive orders and when we install systems, we expect to continue expanding our customer base which will further reduce customer concentration over time.

Turning to the geographic view, we generated 20% of revenue from customers outside the US compared to 21% in the previous quarter. As we have said before, we expect that our international sales will contribute in the mid teens percentage of our total revenue for the next four to six quarters although the percentage may fluctuate quarter over quarter driven by factors such as the timing and size of orders we received and shipped.

At this point, let me also take a moment to provide you with some additional key metrics. At the end of the quarter, we had a total of 56 productive account executives compared to the 49 at the end of the previous quarter. If you recall, we define an account executive or AE to be productive if he or she has been employed with us for more than six months. The average number of transactions per productive AE for the quarter was 5.5 as compared to 5.1 in the previous quarter and the result was within the normal range of fluctuation.

Orders received during the quarter exceeding $1 million ticket together accounted for a total of $15.9 million as compared to $22.3 million in the previous quarter. Additionally, as David mentioned earlier as the result of the weakened demand picture in the first quarter, we are reducing our forecast for bookings per productive account AE from about $1 million per quarter to a range of $850,000 to $900,000 per quarter. As we get more information regarding the current demand environment, we will attempt to assess the impact to this productivity metric.

Moving on down the P&L, cost of good sold was $15.4 million and gross margin was 65.3% compared to the 65% in the previous quarter. As we have said previously, we continue to believe our gross margin is currently at unsustainably high level. In the past quarter, we saw increased pricing pressures from our competitors which may negatively impact our gross margin going forward.

Further, as we have also said each quarter, we expect our margins may fluctuate potentially on a quarter-to-quarter basis as the result of factors such as the timing of received orders, the product mix installed on particular quarter and the performance of the US dollar and currency trading relative to foreign currencies. Hence, we continue to expect our gross margin will trend toward our long term target range of 62% to 64% and do not expect to arrive at that target range in a steady progression.

Operating expenses totaled $31.1 million in the quarter or 70% of revenue compared to $27.8 million or 64.8% of revenue in the same quarter a year ago and $32.7 million or 67.5% of revenue in the prior quarter.

Within operating expenses, R&D expenses rose to $11.6 million from $10.2 million in the same quarter a year ago but declined from $12.6 million in the prior quarter. The decrease in absolute R&D expenses from last quarter primarily reflects decrease in program spending and a reduction in compensation expense accruals.

Sales and marketing expenses rose to $15.6 million from $14.3 million in the same quarter a year ago and declined from $15.7 million we reported in the prior quarter. The primary contributor to the decrease from last quarter was lower sales commission expense as the result of the sequential decline in revenue.

G&A expenses were $3.9 million compared to $3.4 million in the same quarter a year ago and $4.3 million in the previous quarter. The decrease from last quarter primarily reflects the lower compensation expense accrual and lower bad debt expense.

Our stock-based compensation expense rose to $1.8 million this quarter compared to $1.3 million in the same quarter a year ago and $1.8 million in the previous quarter. The primary contributor to the slight increase in this quarter was new option grants through the quarter. We expect our stock-based 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 loss for this quarter was $248,000 as compared to a net income of $1.4 million in the same quarter a year ago and an operating income of $690,000 in the previous quarter.

Our GAAP operating loss for this quarter was $2.1 million as compared to a GAAP operating income of $95,000 in the same quarter a year ago and an operating loss of $1.2 million in the previous quarter.

Our net interests and other income for this quarter was $377,000 as compared to $753,000 in the same quarter a year ago and $355,000 in the previous quarter. The sequential increase on our net other income was primarily driven by a foreign currency gain incurred on the re-measurement of our British pound accounts receivable on the US consolidated balance sheet and an offset by 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 conscious 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 in our investment portfolio will be at the very low level for the near future.

Our tax expense in this quarter was $87,000. We expect our tax expense to continue to be at this low level over the next few quarters given our significant net operating loss carry forwards. Our non-GAAP net income for the quarter was $41,000 compared to a $2 million net income in the same quarter a year ago and $906,000 non-GAAP net income in the previous quarter. Our GAAP net loss for the quarter was $1.8 million as compared to a $678,000 net income in the same quarter last year and a net loss of $907,000 in the previous quarter.

We are pleased to report a non-GAAP EPS of positive $0.00 for the quarter on 64 million weighted average diluted shares outstanding compared to a $0.01 in the previous quarter on 63 million weighted average diluted shares outstanding. GAAP EPS for the quarter was a negative $0.03 compared to a negative $0.01 in the previous quarter. Just as a reminder, the difference between our GAAP result and non-GAAP result is stock-based compensation expense and as reconciled on the exhibits attached to our press release which is available on the IR portion of our website.

As of June 30, 2009, cash, cash equivalents and marketable securities totaled $96.7 million. We had $103.8 million in cash as of March 31st, 2009. On a worldwide basis, 3PAR employed 614 full time employees as of June 30, 2009, up from 591 full time employees as of March 31st, 2009 and 492 full time employees as of June 30, 2008.

With that, let me turn to our outlook for fiscal 2010 and remind you that we do not provide quarterly EPS guidance. We are reiterating the forward guidance that we gave on our July 14th conference call and continue to expect our fiscal year of 2010 revenues to be between $190 million and $205 million.

For our fiscal year 2010 non-GAAP EPS, we expect it to be between $0.00 and positive $0.10 on a weighted average fully diluted share count basis. Implied in this revived yearly guidance of the weakened demand environment witnessed in the first quarter, our reduced visibility is reflected in an expanded range for both our revenue and non-GAAP EPS.

Turning to the September quarter, our revenue forecast for fiscal Q2 is still between $43 million and $47 million. We note again that we do not expect overall expense levels to decline between the first and second fiscal quarters.

Finally, I would like to express my appreciation to all of the 3PAR employees who contributed to the quarterly sequential expense reduction from our fiscal fourth quarter of 2009 to our first fiscal quarter of 2010. In this difficult macro environment, we recognize that although we believe our value proposition provides the best opportunity to take market share today, we must do so in an expense efficient manner.

With that, let me turn it back to David.

David Scott

Thanks Adriel. Although last quarter was the most difficult quarter we have experienced to date as a public company, it is easy to miss our relative performance against our primary competition. Accounting for the $2.2 million that were accelerated into the June 2008 quarter one year ago because of the [PSOE_26.5] related issue, 3PAR's real growth rate would have been about 9% year over year. This is less than we would have liked but should be put in the context of the other high end storage vendors.

EMC Symmetrix product line was reported to be down 28% year over year. Hitachi Storage Systems business was reported down 19% year over year and IBM disk storage business was reported down 20% year over year. Viewed from this perspective, it is clear that 3PAR continued to take market share.

We are not immune from the impacts of the economic downturn; we continue to be a beneficiary of the trends toward storage optimization technology. In the last quarter, we also passed our 10 year anniversary in business. We have always been subject to those skeptical that the market would accept a new high-end storage vendor against robust incumbent competition. I want to thank the 3PAR team for their skill and determination in overcoming those who would doubt over the last decade.

By focusing on the new architectural and technology needs of customers as the evolution towards virtualized utility computing architectures to take place, 3PAR has placed itself in a tremendous position to take advantage of the cloud computing wave. One where existing enterprise incumbency is likely to be of little value.

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

Question-and-Answer Session

Operator

(Operator's instruction) Your first question comes from the line of Mark Kelleher - Brigantine Advisors LLC.

Mark Kelleher - Brigantine Advisors LLC

I wanted to focus on the step up in account execs. It seems like a fairly meaningful sequential jump there. Can you talk about the trends there and maybe connected to that, can you talk about the sales cycles whether those are extending and lastly, when do you think you can get to that AE productivity number that you talked about? It does not look like, if I do the math that it will in the September quarter.

David Scott

First of all, the step up to 66 productive account executives is really a reflection of the hiring situation we face back in December 2008. If you remember that time after the slowdown in September, hiring conditions became much easier. Previous to that, in the year there were a lot of vendors who early on in the year had been hiring aggressively and so the competition for good productive account executives was very difficult. But we kind of made the investment in the December quarter and you are seeing those come through right now.

The trends in sales rep productivity that we reflected in our reduced forecast for $850,000 to $900,000 in bookings per quarter per productive account executive really reflect the sluggishness that we started to see in the economic condition and we expect that that rate of sales rep productivity to be in place for some time depending on how the economy turns, that could bounce back over time as well.

Mark Kelleher - Brigantine Advisors LLC

And the sales cycles, are they extending?

David Scott

Sales cycles have extended mainly to do with budgetary restriction. At the end of last quarter from the demand perspective, we simply saw customers who had projected that they would place orders decide to hold on over into the next quarter or even beyond because they were concerned about the way their own business opportunities were panning out.

So from that perspective, we have seen sales cycles expand. There had been a couple of cases where we have also seen sale cycle expand because of competitive activity. Interestingly enough not associated with EMC's V-Max but we have noticed that IBM has seem to accelerate the number of free giveaways of their XIV product that they are using for evaluation and that is increasing some sales cycles there.

Operator

Your next question comes from the line of Aaron Rakers - Stifel Nicolaus.

Aaron Rakers - Stifel Nicolaus

I guess I want to dive a little bit more into the competitive question. You guys, I think last quarter I had mentioned that you are or when you preannounced, you had mentioned that you really have not seen much of the V-Max product to date. Can you help us maybe dive a little bit deeper in terms of what you have seen from them competitively to date and what potentially the new FASP technology means competitively for you guys relative to EMC?

David Scott

Yes, absolutely Aaron. So, first of all, my comment about not seeing a lot of EMC V-Max hold in North America, we had account maybe a handful of accounts where we saw V-Max being bid competitively against 3PAR and so it had a very, very low presence during the June quarter.

As far as FASP is concerned and that software we have not seen any impact on our sales cycles from it. It is clear to us that probably the second and third phases of the FASP software development are what are really required to make solid state disk technology a really meaningful technology in most large scale enterprises in the service providers and so it is kind of a wait and see until things are delivered and it is becoming more and more the case that EMC is having to kind of forward announce new product cycles, something that we have tried to avoid where possible.

Aaron Rakers - Stifel Nicolaus

Fair enough and then if I can ask the following question, when you look at your productive account exec role here going forward, how do we think about that given the trend upward here which is around, in this most recent quarter?

David Scott

I think for a number of factors that the trend was a fairly significant jump. I would not expect you to see anywhere near that growth rate continuing. If you like it was more of a catch up from what we had previously expected to achieve before.

Aaron Rakers - Stifel Nicolaus

And then final question for me on the gross margin front, I know longer term you have always kind of thrown up the target of 62% to 64%. Do you see, I guess as you are given the competitive landscape, has that kind of timeframe of what you would characterize as a longer trend to that level, has that changed at all since what you have seen over the last couple of months competitively?

David Scott

Well, I think we have definitely seen an increase in pricing aggressiveness particularly from EMC in the last few months. We see it impact us mainly in EMC's installed base where we are actually trying to compete and unseat them and they come back with extremely aggressive pricing to protect their installed base and as we want to get in, we have to be extremely aggressive as well.

A visibility to that competitive environment, we think that is one more indicator that leads us to believe that the 62% to 64% gross margin goes, which I indicated, is likely to be met over time.

Operator

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

David Bailey - Goldman Sachs

Just on the competitive environment still, given that IBM is being more aggressive with the trials of XIV and V-Max is likely to be a bigger presence going forward, should we expect the sales cycles to continue to lengthen over the next couple of quarters?

David Scott

I cannot give you a crystal ball on that David. I would suspect that they naturally should. Clearly both XIV and V-Max are very different architectures for IBM and EMC installed basis respectively and as they look to kind of evaluate whether they should migrate from their existing platforms to give you kind of platforms, it is going to take more time to evaluate. So, it would not surprise me to see sales cycles elongated.

David Bailey - Goldman Sachs

And you think that is reflected in the new productivity assessment that you have for your Account Executives?

David Scott

Yes, absolutely. I think the new productivity assessment reflects the economic sluggishness and economic sluggishness can easily be accentuated by the opportunity to evaluate new products. It becomes a very good decision criterion to give people an excuse to not buying now.

David Bailey - Goldman Sachs

And then your DSOs ticked up this quarter both on a quarter over quarter basis and year over year. How should we expect that to trend over the next couple of quarters?

Adriel Lares

I think in general, David this is Adriel, it has ticked up and I think part of that was also just sort of the linearity of shipments this quarter was tended to be sort of more backend loaded so when we are doing an invoice, and obviously came in at the end of the quarter which obviously impacted DSOs in standpoint and pushed up accounts receivable. We are certainly working on trying to get that down to its almost historical levels that we have seen but in this environment, I do not think that it is a surprise that it got to those levels.

Operator

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

Alex Kurtz - Merriman Curhan Ford & Co.

So, a couple of weeks ago, you talked about the site preparedness issues causing some of the delays and converting some of the backlog or some of the orders from the larger customers. What does that look like now couple of weeks later and what are you thoughts setting it to the September quarter on that issue?

David Scott

Well, some of the accounts with site preparedness impacted us have actually converted to revenue now. But some have not, and some may still not even in this quarter because where you have issues around PAR availability, it is a completely different set of the parties including local utilities that you are dependent on. So, there are some progresses being made but not necessarily as much as we had hoped.

Alex Kurtz - Merriman Curhan Ford & Co.

Okay, and David on just to the follow up to somebody's other question about longer sales cycles, is this sort of like the new kind of environment for you with XIV and V-Max getting it to the market a little bit more aggressively now? Should we just expect longer sales cycles for the foreseeable future or is there some point in time where you guys think you can turn the corner and start to improve the close rates?

David Scott

I think normally when you see kind of major architectural changes of your primary competition, it tends to last a couple of quarters as people get through that experience base with the new platforms and venting evolves back to normal. So, I only think this will be a two to three quarters normally if it turns out to be the case. I do not forget that the elongation in sales cycles both in part associated with competitive evaluations. I think it is far more to do with the economic conditions that the people are facing and their sluggishness on committing to expenditures.

Alex Kurtz - Merriman Curhan Ford & Co.

Okay and just looking to the September quarter, David, thinking about your installed base versus your net new business, what levels do you think it may play out in and what vertical do you think will be strong for you guys? Obviously government should be strong again in September naturally?

David Scott

Yes. We tend not to try and give too much direction as to where verticals will play out. The impact of the economic sluggishness was pretty broad base across all of the sectors that we support including even the service provider segment where there were examples. Where there was clearly business need but there was not short term budget availability at the end of the June quarter.

So, it is difficult given the demand position to forecast how the actual shares are going to shift through this quarter. I will say just as one exception from a bookings perspective, we did see a strong increasing contribution from the internet Web 2.0 space in the June quarter.

Operator

Your next question comes from the line of Paul Mansky - Canaccord Adams.

Paul Mansky - Canaccord Adams

Sorry for the direction for some of these questions but I just simply have to ask you, you have got seven incremental account executive teams. How many of those were most recently at Data Domain?

David Scott

I do not know, I am sorry to say, I can tell you that it is not as many as you would think it would be because some of them become productive account executives and have been on board for six months. That means that we hired them before the end of December last year. So, in terms of the people coming out from Data Domain, it is unlikely to be reflected in the result that we just posted.

Paul Mansky - Canaccord Adams

I apologize, wrong input, then if we are to look a slightly differently relative to roughly 20 or so incremental headcounts firm wide, do we see Data Domain popping up there just proportionate?

David Scott

Well, we just got our new VP of Worldwide Customer Services from Data Domain and we actually see it is a significant opportunity obviously; there are many people who joined Data Domain and get an opportunity that they do not have in a major incumbent competitor. So, I certainly believe they are maybe fertile hunting ground for us to attract the account executives though and I see it over time.

Paul Mansky - Canaccord Adams

Yes. Just on a housekeeping perspective, I do not know if I heard a reference to the interface distribution bookings, can you provide us an update on that?

Adriel Lares

Sure. The amount of sort of percentage of Fibre Channel orders was 64.8% and obviously then the Nearline was 35.2%. The connect rate for iscuzzy was 23%.

Operator

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

Brian Freed - Morgan Keegan

Really quick just to revisit the gross margin question, you guys talked about it, it might not be correct in both line; has anything changed in terms of your strategy and the pricing of very competitive deals with just like EMC or in the pricing provided to you by your contract manufacturing offering that gives you visibility in sustaining of that or is that fairly a long term?

David Scott

I believe it is more of a trajectory rather than any strategic shift. We have always stated that we are prepared to make investments to win new accounts and that continues to be our strategy. I indicated in my prepared remarks that we had seen a very healthy win rate of new customers in the quarter. I think that reflects our willingness to be aggressive but we did see overall average deal sizes decline in the new business space as the reflection of the competitive pricing pressures.

Brian Freed - Morgan Keegan

Okay and then the next question, in terms of deferred revenue you recovered slightly this quarter after last quarter but it still not as high as it has been in the earlier part of the last fiscal year. How should we be thinking of deferred revenue in terms of predictive nature, one and two, do you feel like the timing of shipments last quarter just took deferred revenue down ahead any influence on the shortfall?

David Scott

Well, there are a couple of things. First of all, we have always indicated publicly that you should be very careful of trying to takeaway any information from our deferred revenue picture because it does not necessarily take into account our overall backlog position or the demand position we face when we are giving new guidance. I think in the deferred revenue that we outlined and reported there are two effects that you should consider. One is the effect that we had a substantial amount of business that did not get converted into actual revenue in the June quarter because of site preparedness issue as we disclosed and obviously if those had been recognized as revenue, deferred revenue would have been down by that amount and I think if that had been the case, that weakening of deferred revenue would have been signaling this quarter of the weakening economic demand picture that we saw towards the end of June.

Brian Freed - Morgan Keegan

Okay great and then one final housekeeping item, in terms of total deals, just the number of deals not size, was that up sequentially?

Adriel Lares

Total deals greater than a million dollars, is that what you are referring to?

Brian Freed - Morgan Keegan

Yes, I guess so.

Adriel Lares

So, we reported the number of deals in total greater than a million dollars was $15.9 million. That is compared to $22.3 million in Q4 of fiscal year 2009.

Brian Freed - Morgan Keegan

Yes, I think you said something about 5.5 transactions per…

Adriel Lares

Yes, that is number of transactions per productive account executive is 5.5 and that is up from 5.1 in fiscal Q4 of 2009.

Operator

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

Rajesh Ghai - ThinkEquity LLC

A couple of questions on the competitive landscape, IBM on its earnings calls said that although the scales were down 20%, XIV is very strong and you had mentioned that IBM was giving away XIV in the past quarter. I was just curious, how many deals did that impact you and given that you were able to maintain your gross margin pretty steady, I am just assuming that you probably walked away from some deals. Can you give us some color on how the data systems, how many deals did that clearly affect you?

David Scott

Well, we saw competitive evaluations in just a couple of environments that caused kind of sales cycles delays. So I would not put it in the context of anything tremendously significant right now. From a pricing perspective as I indicated before, Rajesh, we definitely saw competitiveness from a pricing perspective particularly from EMC but from kind of all vendors in general in the June quarter and that led our average deal sizes for new business to come down during the quarter.

Rajesh Ghai - ThinkEquity LLC

Okay and in general, when you are talking to your customers, what does it mean to getting in terms of utilization rates that you can have with existing storage and if that could be, if that is high enough, do you see that as a leading indicator of pent up demand and higher storage market given that will be for few quarters?

David Scott

What we have seen as a trend amongst our customer base is that they have realized that they can run that 3PAR utility storage infrastructure at much higher rate of utilization than they believed were possible and we have seen them generally inching up. You might have had a very conservative company running maybe at 70% rate utilization and fluctuating between 70% and 80%. You may have seen kind of a less risk-averse company running between 80% and 90% and those two companies may have pushed out that that broad base range of utilization. They play at by 5% each point as an example in response to the economic condition because they know that if they push out the utilization rate they can delay the purchase of new upgrade capacity and I think that is just first of all an advantage for our customers in terms of their ability to really achieve tremendously high levels of rate utilization efficiency compared with our competitions in provisioning products.

But also it gives you some sense of the tools that the customers are using to delay purchase commitment.

Rajesh Ghai - ThinkEquity LLC

Okay, great. Just one question, can you clarify between quarters of current deferred revenue increase or decrease, what does it really mean? And I appreciate on putting up your question but I do not understand what takeaway from an increase and decrease in deferred revenue, current deferred revenue.

Adriel Lares

Well, let me give two definite examples. I just try to indicate that in the June quarter, if we had recognized the revenue that we have expected to recognize during the June quarter. We have seen deferred revenue overall go down because product deferred revenue would have gone down.

But in the March quarter, we also reported that deferred revenue had gone down. But in that case, it was for very different reasons. We have been shipping out of our factories at a very high levels all the way through to the end of the quarter prioritizing upgrade shipments versus new system shipments and the decline in deferred revenue in the March quarter had nothing to do with any economic weakness that we saw because we actually saw a very strong demand picture in the March quarter.

So, I try to use this as an example that it is very difficult to look at our deferred revenue and out of that, whichever direction it goes, making clear cut assumptions of what is the driving factor. It tends to be different because of the combination of product and support deferred revenue that is included in that number.

Rajesh Ghai - ThinkEquity LLC

Great! And if you look at your Q2 guidance of $43 million to $47 million, have you relaxed your assumption in terms of how long it could take for typical customer to deploy? Are assumptions any different from to what you had in the previous the quarters?

Adriel Lares

We try to take into account all of the factors that we have been seeing develop in the market right now.

Rajesh Ghai - ThinkEquity LLC

Great! So the two to five months typical windows is that kind of relaxed or do you expect that…?

David Scott

Obviously, it is maybe slightly a little longer but we certainly take that into account and basically we look at that on a bottoms-up basis, so not just as an average that we were taking at the end of the quarter.

Operator

Your next question comes from the line of Jayson Noland.

Jayson Noland - Robert W. Baird & Co., Inc.

Just a housekeeping question, first, Adriel, the non-GAAP tax rate in the quarter and then expectations for this fiscal year.

Adriel Lares

So, for the tax rate, if you just look at that low amount, I think on just an absolute dollar basis it should not get much higher for the rest of the fiscal year. So, that percentage of non-GAAP at the top of my head I have it right here, but if you just look at the absolute dollar amount, it should be pretty consistent for the rest of the fiscal year.

Jayson Noland - Robert W. Baird & Co., Inc.

Okay. Just two more questions I guess a question on competitive dynamics by vertical. David, do you see differences, I guess, by vertical? Are your competitors fighting more in a certain area of the market or your solution that is suited for a certain area of the market and if so, does that impact the gross margin vertical?

David Scott

We see, I think, less competition in the business to business service provider segment where the four architectural advantages that we have are extremely significant. We see probably more competitive pressure in the internet Web 2.0 space where more platforms can position themselves as meeting need.

Jayson Noland - Robert W. Baird & Co., Inc.

Does that reflect the gross margin differences across verticals?

Adriel Lares

I do not think we have seen any substantial differences in gross margin by segment. They tend to be pretty consistent and they do fluctuate. So there is no low trajectory.

Jayson Noland - Robert W. Baird & Co., Inc.

Okay. Then last question for me, if you can just talk about your deal pipeline now relative to last year or last quarter, are some of these large deals still in there as your pipeline growing, as you see the deals get elongated and are delayed?

Adriel Lares

Yes, we definitely have seen our pipeline grow very significantly. A very significant growth in the early stages of the pipeline as well, as I think more and more customers are becoming aware with 3PAR and aware of the importance of trying to do more with less and optimizing the storage environment using highly efficient virtualized storage solutions.

And so, that is very encouraging trend that we spotted that I think is driven by the economic recession and leads us to continue to believe that we have a cyclical value proposition.

Operator

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

Douglas Reid - Thomas Weisel Partners

It looks like seven of the last quarters percent of sales from international sources has been above your targeted 15%. I am just wondering if you could remind us of your strategy for growth internationally and maybe highlight any relative strength by vertical geography in the markets outside the US?

Adriel Lares

We actually, Doug, indicated that we believe international revenues should be in the mid-teen as a percentage of overall revenue for a number of quarters. Quite awhile ago, we have said it was about six to eight quarters and for a number of quarters now we have been pushing through and we probably hit 20% now with two quarters slightly earlier than we had expected to.

And so, if we end up in the high teens from other couple of quarters, it will not surprise us at all. We think there is a major opportunity for us to grow our international business overtime. Some of the investments that we have been making in direct sales, in locations like the UK, Germany and Japan starting to sell as well as the expansion of the number countries where we have value added reseller partners leading the charge and we think all of that bodes well as for international revenue to become a larger and larger part of our overall revenue mix.

Douglas Reid - Thomas Weisel Partners

Okay. And then, in your prepared remarks, you highlighted the win with the F-Class. I wonder if you could share a little more color on the competitive dynamics, specifically around the F-Class and how that might be distinct from what you are seeing in the E-Class?

Adriel Lares

The F-Class has ramped tremendously well and we boarded out I think just an optimal point in time where budgets were coming under very severe contraction and this has allowed us to win a large number of deals with the F-Class without impacting the gross margins levels of the E400 which normally we would have to price down even more aggressively to meet customers budgetary availability.

So, the transition from the E to the F Class has almost completely taken place now with the exemption of a couple of units of E-Classes. So, we have been very, very pleased with the speed of the transition and the health of the transition.

Douglas Reid - Thomas Weisel Partners

Okay. I could just squeeze one more and then…, just on R&D, I think you mentioned source of a lower R&D, this quarter was a lower salary and then some cut on programs. I am wondering if you could talk about whether you are pausing some programs there or shifting direction or what you could add there on R&D program cuts.

Adriel Lares

We are basically looking at every area of spend with respect to R&D and so we are trying to assess whether some projects get delayed a little bit but obviously, we are trying to maintain as much as we can in order to maintain the headcount that we believe we need for the longer term.

Operator

Your next question comes from the line of Glenn Hanus - Needham & Company.

Glenn Hanus - Needham & Company

Compelling under call, you talked a little bit about [Savis]. Can you talk about your relative position in [Savis] versus the other players there?

David Scott

Sure. Glenn, Savis has been customer of ours for six years now and our utility storage platform is the basis to a wide range of different utility in the class competing services that they offer. Those include their utility computer offering which is based on general. Their dedicated cloud offering which is based on kind of dedicate VMware on HP furthers the opened cloud computer offering which is shared VMware on HP, their intelligent hosting offering, their utility storage offering and their software as a service offering.

So, we have continued to expand our presence in a number of areas. It is true that they are talking about piloting; I believe the new private cloud computer offering which I think they are targeting towards Amazon and Google at the low end of expectations and that platform, I believe, is expected to be piloted on another storage vendor. [Savis] has for sometime had been interested in offering more than one storage vendor in the cloud offerings and this was an appropriate way of them implementing it. But we do not believe it will change our business opportunity and trajectory with the existing services or potentially new services that come along in the future.

Glenn Hanus - Needham & Company

And maybe lastly, the overall tone of business and demand, just given your guidance. I am just wondering on the margin, what has changed in the last three weeks if anything?

David Scott

I do not sense that anything has changed radically in either director, either much better or much worst. I think it is in a pretty steady state right now.

Operator

Your last question comes from the line of Kaushik Roy - Wedbush Morgan.

Kaushik Roy - Wedbush Morgan Securities, Inc.

Going back to the demand question, are you seeing a weakness in the storage market in general or specifically at the high end? I asked that because the EMC got [Audio Break]…

David Scott

The EMC guided… I think operator is trying to… I wonder if you can finally let him to re-ask the question. Operator, could you let Kaushik?

Operator

Sure. Next, question. Thank you. Mr. Roy, your line is open.

Kaushik Roy - Wedbush Morgan Securities, Inc.

David, can you hear me?

David Scott

Yes, we can now.

Kaushik Roy - Wedbush Morgan Securities, Inc.

My question was on the demand. Are you seeing weakness in the storage market in general or specifically at the high end? And I asked this because the EMC guided full year 2009 revenue above this reduction.

David Scott

Well, the first thing is that we really only play in the high end storage market. So, we are reflecting business that we see. If we look at all the vendors whose product lines operate at the lower end or below our range of offerings, it looks as if the market, the small to medium sized businesses and enterprises has not been affected. It is not just enterprise budgets or the budgets of large service providers.

So, I think it is something that we are seeing in the high end of the market primarily. The change in EMC’s guidance, obviously, you have to reflect the fact that they are in a broader segment of storage. They have Clarion and AX product lines go considerably further into the low end and whatever they may have signals as an increase in their guidance is obviously dependent on where that guidance was originally set and do not forget, they were down I think 25% year on year to Symmetrix in Q1 where we up 37%. In calendar Q2, we were up, as I mentioned, effectively 9% and EMC was down even more and EMC Symmetrix' product line down 28% year on year. So, it is clearly a differential growth rate that we are seeing and we are taking market share but undoubtedly the high end, I think, is suffering more than the low end or mid range.

Kaushik Roy - Wedbush Morgan Securities, Inc.

Can you quantify how much of the June quarter revenue mix was because of site preparedness or how much was it because of weakness in demand?

David Scott

That is a more complicated question only because it has got two steps to it. If we had been able to recognize revenue after completing installation of what we had expected to do, the change in the economic demand picture would not have affected our results. So we would have been able to meet our guidance with that.

Obviously, if demand had been strong during the June quarter, we might have been able to replace some of that revenue but we did not recognize because of site preparedness issue but unfortunately because the economic picture was much weaker and we saw demand weakening, we did not have that escape available to us.

Kaushik Roy - Wedbush Morgan Securities, Inc.

And last question, you mentioned F-Class doing very well. Can you give us the revenue split? Is it 10% or 20% of your overall product sales now?

David Scott

Yes, we do not breakdown the product line split since I think you know over our history as the public company, I think the important element though is that we design our product line so that they are gross margin neutral. So, we do not mind which way demand shifts.

Operator

And at this time, we have no additional questions. I will turn the call back over to the speakers for closing remarks.

Adriel Lares

Thanks everyone and we will see everyone else on the road. Bye-bye!

David Scott

Bye-Bye!

Operator

And we thank you. This concludes today's presentation. You may now disconnect. Have a great day.

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Source: 3PAR Inc. F1Q10 (Qtr End 08/03/09) Earnings Call Transcript

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