Compellent Technologies, Inc. Q4 2009 Earnings Call Transcript

| About: Compellent Technologies, (CML)

Compellent Technologies, Inc. (NYSE:CML)

Q4 2009 Earnings Call Transcript

February 11, 2010 4:30 pm ET

Executives

Jenifer Kirtland – IR

Phil Soran – Chairman, President & CEO

Jack Judd – CFO

Analysts

Katy Huberty – Morgan Stanley

Mark Kelleher – Brigantine Advisors

Jason Ader – William Blair

Alex Kurtz – Merriman & Company

Jayson Noland – Robert W. Baird

Glenn Hanus – Needham & Company

Nahab Toski [ph] – Technology Insight Research [ph]

Aaron Rakers – Stifel Nicolaus

Rajesh Ghai – ThinkEquity

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Compellent fourth quarter 2009 financial results conference call. At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator instructions) I would now like to turn the conference over to our host, Jenifer Kirtland of EVC Group. 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 fourth 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 quarterly report on Form 10-Q for the quarter ended September 30, 2009, 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 is 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, Jenifer; and thanks everyone for joining us today on our 2009 fourth quarter earnings call. With me is Jack Judd, our Chief Financial Officer.

Fourth quarter finish was strong and capped another great year for Compellent. As organizations continue to focus on increasing efficiency they are asking for IT solutions that can intelligently manage their data and make it easier for them to respond to changing conditions. Compellent’s innovative Fluid Data architecture is helping customers solve these data storage challenges, reduce their search spending, and simplify data management. Our success is demonstrated in our fourth quarter financial results.

Revenue was up 35% from the prior year to a record $36.3 million. Compared to the third quarter, revenue grew 13%, our 17th consecutive quarter of growth. GAAP net income was $1.3 million or $0.04 per share and non-GAAP net income was $2.4 million or $0.07 per share, excluding the effects of stock based compensation expense.

Cash and investments totaled $123.8 million at the end of December, an increase of $23.6 million during 2009. Our deferred revenue increased by $6.4 million, which is 20% than at the end of the third quarter.

Jack and I just returned from investor meetings and analyst conferences and there are some several common themes in the questions that are asked. I thought it would be productive to address four of them in my comments.

So for the first question, did we see a fourth quarter budget flush?

We did not see end users “getting rd” of excess budget with unplanned purchases, but we did see end users with approved projects and budgets making buying decision. So the orders we received were earned over the preceding months.

Second question, has there been increased pricing pressure affecting gross margins?

Storage is always a competitive sell. We did not see any significant changes from previous quarters in terms of competitive pricing pressure. Our gross margins were lower than the third quarter, which, as we indicated during the last call, they were exceptionally high. But in general, margins do fluctuate from quarter to quarter, but fourth quarter margins remained squarely within our business model.

Some factors that caused margins to vary include, conscious decisions to win key footprints, lower priced entry systems, deferred revenue, and supplier costs. We did not see any significant directional changes that would cause us to adjust our business model.

Third question, how do you balance the need for – to invest for top line and maximizing profitability?

At this stage of our development, we will always focus on top line growth as a priority. Our revenue growth is outpacing the competition and we’ve become known as one of fastest-growing tech companies. And because of our differentiated business model of virtual manufacturing, 100% channel sales, and leveraging the industry standard hardware, we’ve proven profitability and leverage in our business. As we told you during our third quarter call, our plan was to invest extra money for sales and marketing to help fuel our future growth and we did it.

Our near term tactical goal is to be the fastest growing profitable storage vendor. Our long term goal is to be a growth company with best in the industry operating margins/

And final question, did you experience supply constraints?

Well, suppliers did indicate they experienced constraints in the fourth quarter, but our business was not impacted. We were able to avoid supply problems with our strong forecasting.

Now, more about the business. This is a great quarter for new customer growth. I was really pleased with both the quantity and the quality of these new users. We added 185 new end user customers to end 2009 with a total of 1812 distinct end users. This means we added 534 new end users in 2009 alone.

The new mid-size enterprise customers were The Minnesota Twins, a Major League baseball franchise and the likely 2010 World Series winner; The Texas Lottery; Radiology Limited, which is a large diagnostic imaging services company based in Tucson; and Texas First Bank.

In addition, more large enterprises are choosing Compellent Fluid Date storage because of our significant efficiency advantages. Some brand names you might recognize that joined the Compellent user family include The Blackstone Group, Canadian Tire Financial Services, Manpower, two state Blue Cross organizations, TrueValu, and The China National Offshore Oil Company.

Also, during 2009, we set a goal to come up with a new way to tell the Compellent story that is just as innovative as our product and business model. In the past, our sales people and channel partners talked about the myriad of different features and benefits that we deliver. Customers were asking for a concise way to describe all of this Compellent differentiation. They want to start a new conversation bout data. They know competitor systems treat data as a static thing, frozen in place after its initial storage.

We believe data should be actively, intelligently, and automatically managed throughout its life cycle and change in business conditions. We call this Fluid Data and we believe it’s the future of data storage. You’d like to see our customers describe Fluid Data, log on to Youtube and search on Fluid Data from Compellent. I think you’ll enjoy it.

Innovation behind our Fluid Data enterprise storage continues to receive recognition from the industry. We are especially proud to win the 2010 InfoWorld Technology of the Year award for the third consecutive time. Quoting InfoWorld’s test center, what Compellent does better than the other vendors is provide great ease of use in all the performance you could ask for at very moderate prices. In Compellent’s Storage Center, wizards make everyday tasks simple enough for untrained administrators to do.

Other winners this year included Intel, Microsoft, Cisco, VMware, Citrix, Sun, Apple, and Amazon, putting us in very, very good company. We also won the Best Channel Vendor for 2009 from Business Solutions magazine. And we were avoided Deloitte Technology Fast 500 award for being one of the fastest growing companies in North America.

We demonstrated our technology leadership once again with the launch of Storage Center 5, our fifth generation release. Some of Storage Center 5’s new features include portable volume, which reduces time, cost, and complexity of data application in disaster recovery situation. Scalable SAS, which lowers the disk cost for remote replication and automated tiering while providing enterprise performance, other innovative features such as automated tiered storage with RAID 6 protection, Virtual Ports I/O technology, and Server Mapping for automated deployment of virtual servers through an easy-to-use interface. Many of these features were added in direct response to feedback we received from end users as well as our growing family of channel partners.

I am very optimistic about the outlook for our continued growth and profitability in 2010. We are very well positioned in a growing storage market with innovative products, an experienced team, and a strong balance sheet necessary to take advantage of the opportunities ahead. We will continue to invest for the future while delivering great results for our employees, partners and shareholders.

I really want to thank the Compellent team and our business partners for their hard work and dedication in once again helping us achieve record fourth quarter and full year results. I would also like to extend my appreciation to our end user customers for their confidence in Compellent.

Well, now I would like to turn the call over to Jack to provide a more detailed look at our financial results for the fourth quarter and our outlook for the first quarter of 2010. Jack?

Jack Judd

Thanks, Phil. Our fourth quarter like all of 2009 was strong. During the fourth quarter, revenue increased 35% from the fourth quarter of 2008 and 13% from the third quarter of 2009 to $36.3 million.

We continue to grow international markets. International revenue increased to $6.4 million in the fourth quarter of 2009 compared to $4.7 million the year before. International revenue was 18% of total revenue for the fourth quarter.

Our end users at the end of the quarter totaled 1812 compared to 1278 one year earlier. Measured on a year-to-date basis, our revenue from existing end users was 47% of product revenue and new end users made up 53% of product revenue.

Our gross margin was 52.9% in the fourth quarter of 2009 compared to 54.9% in the fourth quarter of 2008. During the current quarter, product margin was 48% and support and services margin was 66.1%. Our margins have varied considerably during 2009 from 57.2% to 52.8%. This is caused by many factors including significant discounts can be necessary to acquire strategic end users, our revenue recognition practices require us that all discounts are allocated to product revenue. If initial sales to end users include multi-year maintenance contracts, this can reduce margins due to discounting practices. And finally, our tactical pricing of entry-level systems to guide end users who in future periods will purchase upgrades.

Operating expenses increased to $18.3 million in the fourth quarter of 2009 from $14.1 million one year earlier. This 30% increase in operating expenses compared favorably to our 35% in revenue and represents both our strategic initiative to add quality people that help grow revenue and engineering talent that expands our technology advantage.

We continue to grow our employee headcount. At the end of 2009, we employed 387 employees compared to 290 one year earlier and 360 at the end of the prior quarter.

GAAP net income for the fourth quarter of 2009 was $1.3 million or $0.04 per share consistent with the fourth quarter of 2008. Excluding the effect of stock based compensation, our non-GAAP net income for the fourth quarter was $2.4 million or $0.07 per share compared to non-GAAP net income of $2 million or $0.06 per share the previous year.

Our balance sheet remains strong. We ended the quarter with $123.8 million cash and investments, an increase of $23.6 million from the end of 2008. Our positive cash flows during the year come from both our operations and $10.7 million of net proceeds from our follow-on offering completed this past November. Our balance sheet includes $38.2 million of deferred revenue, an increase of $17.6 million from December 2008.

This strong increase in deferred revenue is due to excellent renewals of our maintenance programs from our current end users and more of our new end users choosing multi-year maintenance programs.

Our days sales outstanding is consistent with the prior quarter although our ageing has improved. Our increase in our AR balance is a reflection of both the timing of revenue and the amount of prepaid maintenance contracts billed, but not yet paid.

I would now like to provide some guidance on the coming quarter. As Phil highlighted earlier, we see strength in our markets. We continue to see strong growth in our current pipeline and our registered deal activity. Our current revenue forecast range for first quarter 2010 is $35 million to $37 million. Due to continued investments in talent during the first quarter of 2010, we anticipate that our operating expenses will grow 8% to 10% from fourth quarter spending.

During the first quarter of 2010 we expect gross margins will be higher than the just completed fourth quarter, but throughout 2010 gross margins will continue to fluctuate, but remain within our long term goals. We expect stock compensation costs to be approximately $1.5 million in the first quarter. Capital spending will be higher in 2010 than 2009 as we invest in equipment for our software development labs. We will continue to monitor for the appropriate time to bring our tax net operating loss into income. Until that point, our income tax rate will be approximately 10%. Once the capitalization of the value of our NOL occurs, we expect our tax rate to be 35%. Finally, and as always, Compellent remains focused on generating profits and cash while making the investments required to maximize our future growth potential.

That concludes our formal remarks. Now, operator, could you please open the call for questions and answers?

Question-and-Answer Session

Operator

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

Katy Huberty – Morgan Stanley

Hi, good afternoon guys. You mentioned several factors that creates volatility on the gross margin line quarter to quarter, can you just rank the factors in order of magnitude that hit the product margin sequentially this quarter?

Phil Soran

Well, the two big ones are probably footprint deals we did and then also the margins you get on entry-level deals, which you saw the result was we are able to get a lot of new end users that will grow in the future and get good margins in the future.

Katy Huberty – Morgan Stanley

Okay.

Phil Soran

The deferred revenue is probably little less, but it does more product margin early on, but long term it helps margin also, reduced revenue risk in the future.

Katy Huberty – Morgan Stanley

Okay. So would you characterize the footprint deals that came this quarter as a new trend that you will see every quarter from hereon out and that’s where the best opportunities lie from here, or do you think it was somewhat onetime in nature?

Phil Soran

Well, I don’t if I call it onetime in nature, but I would say it’s – it won't be continual further. I mean we did guide there is a little bit of improved margins in the next quarter. So, it’s opportunistic and you take advantage of the opportunity when it faces you.

Katy Huberty – Morgan Stanley

Okay. And those opportunities would largely be in mid-and-large size enterprises and maybe some of the big cloud opportunities, is that fair?

Phil Soran

It will be those types of things; it will also be accounts where (inaudible) leads you to lots of other places that might take a little longer to enter.

Katy Huberty – Morgan Stanley

Okay. And then just lastly, Jack, it sounds like OpEx may grow faster than revenue in the first quarter, which makes sense just given seasonality of revenues early in the year. But if you think about the full year, would you expect OpEx to grow in line, faster or slower than revenue, just from a big picture standpoint for all of 2010?

Jack Judd

Slower than revenue.

Katy Huberty – Morgan Stanley

Okay, great, thanks guys.

Operator

Our next question comes from the line of Mark Kelleher with Brigantine Advisors. Please go ahead.

Mark Kelleher – Brigantine Advisors

Great, thanks. How about the distribution partners, can you talk about how that is going, how that is progressing?

Phil Soran

Yes, so first of all, last year we were able to – while the economy was tough – we were able to invest quite a bid in the – our channel program and – both in higher end channel development manager and recruiting of those and work with strategic partner and our venture partners. So, we really made a lot of progress and I think we also think that that investment will continue to pay. We’ve barely begun to see the results of that. I would like to say people always ask us do you need to keep recruiting more business partners and we do need to keep recruiting them but to double our revenue this year we would not need to double the number of partners, we need to double the mindshare of the ones we have. Now, international obviously the one that adds more people than you might domestically. But we continue to gain mindshare of our partners and we feel real good about that investment we made in the past.

Mark Kelleher – Brigantine Advisors

So the increase in OpEx this year wouldn’t necessarily include quite the level that you invested last year in the distribution channel. So, what you just said, was that right?

Phil Soran

I would say it grows slower than it did last year as far as the channel development part of the business.

Jack Judd

Our operating expenses naturally include many more expenses than just the amount of money we spend for our channel partners.

Mark Kelleher – Brigantine Advisors

Sure, great, thanks.

Phil Soran

Yes.

Operator

Our next question comes from the line of Jason Ader with William Blair. Please go ahead.

Jason Ader – William Blair

Thanks. I had two questions, one, can you explain the rise in DSOs over the last year, it looks like from Q4 of ’08 the days sales outstanding are up almost 30 days?

And then secondly, competitively, just wondering who are seeing more or less out there in the market?

Jack Judd

Well Jason as to your first point on the DSO our receivable balance includes an awful lot of market programs that have been sold to where we have not taken the income into income. So when you look at our accounts receivable balance, there certainly is an awful lot of monies due from customers that we had sold systems, but there is also money that’s sitting in deferred revenue. And so internally here we tend to look at our ageing as a more – a better item to look at. And our ageing has actually improved from earlier in 2009.

Phil Soran

And on the competitive front, we probably see the large vendors that you’d expect to see, large incumbent vendors like EMC, they are probably one, NetApp number two, and HP number three.

Jason Ader – William Blair

You are not seeing Dell any more or less?

Phil Soran

Yes, we – I would say on the Dell front we tend to see about the same we used to. I think the thing that’s changed with Dell is who they are representing. So in the past when you were up against Dell, you were primarily up against the Clarion [ph] products, and now you tend to see it’s coming half and half Clarion [ph] and EqualLogic product line. So the good news is that we got a lot of features that – which we’ve pioneered for many years that we have competitive advantage of those offerings.

Jason Ader – William Blair

Okay thanks.

Phil Soran

You bet.

Operator

Our next question comes from the line of Alex Kurtz with Merriman & Company. Please go ahead.

Alex Kurtz – Merriman & Company

Hey guys, can you hear me okay?

Phil Soran

You bet, Alex.

Alex Kurtz – Merriman & Company

So, if you look at the sales and marketing line this quarter, or actually in the fourth quarter, I mean as you shoot out the commissions, would you say that there was absolute dollar growth in terms of the (inaudible) you had to do clearly hit that 185 net new customers where a lot of the uptick in sales and marketing spends were this quarter?

Phil Soran

No with – I wouldn’t say there is an increase in (inaudible) there.

Alex Kurtz – Merriman & Company

Okay the growth sequentially is mostly around higher commissions?

Phil Soran

There are some commissions and also a little spend on some of the messaging we are working on and some programs like that, that will take off, provide some value long term.

Alex Kurtz – Merriman & Company

Okay. And so if you look out into the first half, you are obviously – EMC is coming out with their second version of SAS. It’s going to have block-level migration. So what’s the next big thing for you guys to just remain fresh and competitive with your partners and in the market, what do you guys – where you guys looking out and sort of keep differentiating yourselves?

Phil Soran

Yes, well first of all, you guys talking about – we think it’s kind of complementary that the competitors are validating our automated tiered storage, which we’ve kind of pioneered for the last five years here. And the nice thing – it’s actually – the more people talk about things like that, the more if you will actually look at how things are implemented (inaudible) advantage becomes more apparent to people. And just a good example of volume of movement it is more expensive and difficult to do and kind of indicative of our success, 81% of our upgrade capacity is Tier 3 disk which kind of shows that this automated tiering at the block level helps (inaudible). But we got a lot of features that we compete, win on, not just the (inaudible), but also a lot in feature end. Two things it will be based on is one is the 100% – the off the shelf hardware, which allows us to kind of have the future built in, future server connectivity options, future disk technologies where we can automatically just insert them side by side without having to change the model or upgrade to a future model or those types of things.

And then the second thing, keep leveraging our Fluid Data architecture, which allows us to kind of extend the data life cycle management that we are providing for end users, both on the front end and the back end. So customers have told us we love your product, just manage more of the life cycle of the data and that’s where you kind of see our direction going.

Alex Kurtz – Merriman & Company

Okay, thanks for that. And Jack, just to repeat, you said 105 tax rate for most of ’10, was that right?

Jack Judd

Yes.

Alex Kurtz – Merriman & Company

Okay. So then you guys are (inaudible) going into next fiscal year, but for this year 10% tax rate?

Jack Judd

Yes. In future quarters if the capitalization of our net operating loss appears imminent, I will give some direction on that in future calls.

Alex Kurtz – Merriman & Company

Okay, thanks guys.

Operator

Our next question comes from the line of Jayson Noland with Robert W. Baird. Please go ahead.

Jayson Noland – Robert W. Baird

Thank you, Phil, and I like the (inaudible) production there.

Phil Soran

Yes, thanks. I am aware everybody is laughing out there in the audience.

Jayson Noland – Robert W. Baird

Maybe an update on the hosted service provider market. Do you see the same competitor there? What sort of feature sets, why is Compellent winning and what do you see going forward from here?

Phil Soran

Yes, so first of all, we announce the Savvis deal last year and so – we have dozens of service providers that are customers and have been for quit a while. So that’s good market, so that’s a good market for us and it’s also one that we think is important in the future. It’s just another way of books selling stores to end users. What we see kind of there looking for, basically, cloud computing is kind of all about the – in which I kind of equate a little bit with the service providers there – it’s all about flexibility and it’s flexibility in cost, flexibility in geography, flexibility in quality of service, and flexibility in their offerings there. And if you think about our Fluid architecture that’s exactly what it does, it gives the flexibility in their location with things like live volume and our remote incident [ph] replay, flexibility in the quality of service with automated tiering, flexibility in cost that comes out of those things, and improvisioning [ph] so I think we got kind of the – the right kind of architecture for that market, which will be important to us in the future.

Jayson Noland – Robert W. Baird

Great. And last question from me, Jack, may be if you could characterize your pipeline of business now versus last year and how do close rates feel?

Jack Judd

Well I think our pipeline is significantly better than it would be a year ago. Our pipeline always tends to grow and it has a lot of quality accounts in it. We generally do not disclose the exact levels within the pipeline, but I think it’s an excellent pipeline. I don’t know if Phil you want to comment on that?

Phil Soran

Yes, this pipeline, I would just say in general a year ago the way to describe it is that at this point in time a year ago people had not approved their budgets. They were delaying purchases. They had not approved their budgets, and they didn’t get that done until March. They did not know what’s their budget. This year that’s not the case. I think their budgets are approved and they are cautious because the economy itself, they are trying to be efficient and they will be smart with their purchase, but they are in more of a normal business mode. So, it’s significantly better than it was a year ago.

Jayson Noland – Robert W. Baird

Thanks guys.

Operator

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

Glenn Hanus – Needham & Company

Yes, good afternoon guys. Jack, could you comment a little bit on the puts and takes on the service margin? And then in terms of the overall margin improvement should we expect that both in service and product going forward?

Jack Judd

I think you got two questions here. During the quarter, our service margin was a little bit lower than it was the previous quarter. It’s due to many reasons, some of it being, employee as especially on the profitable services side, and then somewhat it has to do with how much revenue that we might have sold [ph] in the quarter and how it gets deferred. I want to point out that the services margin is nice and high and well within the goals of our business.

And then the second question again, Glenn, was?

Glenn Hanus – Needham & Company

You talked about some sequential improvement in gross margin. Could you – would that be on both sides of the – both service and product?

Jack Judd

I would say that it’s more likely to be on product.

Glenn Hanus – Needham & Company

Okay, thank you.

Operator

Our next question comes from the line of Nahab Toski [ph] with Technology Insight Research [ph]. Please go ahead.

Nahab Toski – Technology Insight Research

Hey guys, I know Omar is a great catcher, not sure about (inaudible) you guys to the World Series there, but we’ll see. Anyhow, so with the all competitors coming out with some version of data tiering, clearly that should have raised their awareness of your solution, would you agree with that?

Phil Soran

Yes, first of all I will comment on the first one, yes, we have a lot of investors comment that we should actually take some of our cash and help sign (inaudible) that long term contract, but we are holding off on that. So–

No, on the serious side you hit it right on the nose there. It was interesting, another feature that we had is more exclusive based on the large incumbents was thin provisioning and one day we found is after all the other vendors start saying they had it, what happened is customers actually got more aware of how it worked and when they found out how competitive offering worked, they kind of came to the conclusion that many times they weren’t even going to use the thin provisioning. But when they saw how Compellent’s worked they said you know what I am talking to users. Therefore the large incumbent had a bit more disk drives to cover up the inefficiency of their implementation.

So, thus we actually then started getting the financial advantage, not just the feature to check market advantage. So I – we are already seeing some of that indication with the automated tiered storage that – we have been the pioneer for that for the last five years. We kind of came out with the term early on. We have bee shipping it for five years. And the more people talk about it – people are finding that they are getting pointed to hey, why not compare the leader in that space for automated tiered storage, it’s Compellent, and then they look a lot deeper how ours works and they get even more impressed. So, its’ kind of like if we buy ourselves (inaudible) some will hear some more. The more people yell and the more people find the automated tiering. So, you know this kind of commentary it works on all our models. It does – we only have one model. So, all of our customers from small to large were able to take advantage of it, not just a select few.

Nahab Toski – Technology Insight Research

Right, okay. Well on the flip side though, since you do have, is there going to be a digestion period for this new information out there or are you seeing no evidence of the digestion period?

Phil Soran

Digestion period for the competitors are probably is, for ours people have been digesting for five years.

Nahab Toski – Technology Insight Research

Okay, alright, so new prospective customers are not slowing down your buying cycle–

Phil Soran

No.

Nahab Toski – Technology Insight Research

Okay. Also, could you give us any information on what your top-10 channel concentration was?

Phil Soran

Well, yes, we came out in the – well, is it the secondary – we had some of those data there. I think and I believe didn’t we Jack?

Jack Judd

Well the top ten channel partners are around 35% of our business.

Nahab Toski – Technology Insight Research

Okay, alright, good.

Jack Judd

Which is by the way similar numbers to back quarters.

Nahab Toski – Technology Insight Research

Okay. My last question is that and EMC’s recent tech talk, they mentioned that V-Max, 50% of V-Max buyers were adopting the SAS [ph] technology. They didn’t give any indication on the Clarion. Are you seeing any evidence that they are pushing it hard on the Clarion at all or it’s just simply on their V-Max?

Phil Soran

Well, I mean, I really couldn’t comment if I could more on the V-Max I think than the Clarion because it’s – it was delayed a little bit there. But once again, it’s – no difference it’s been in the past on the competitive front. I think people are actually frankly appreciating our architecture a lot more, so they have been starting to talk about it.

Nahab Toski – Technology Insight Research

Okay, thanks a lot guys.

Phil Soran

You bet.

Operator

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

Aaron Rakers – Stifel Nicolaus

Yes, thanks guys.

Phil Soran

Hi, Aaron.

Aaron Rakers – Stifel Nicolaus

Hi guys. The first question from me would be back on the gross margin I know you guys said your gross margin would be up here into this next quarter. but I think maybe it would be helpful to understand the – is there any way to quantify the input to the gross margin pressure that you saw last quarter, be it – how do we think about maybe supply tightness et cetera, that’s having an impact that looks to lift here as we look forward?

Phil Soran

No, I would just say that there were some supply constraints that we were able to work around. That didn’t affect us. But, yes, with that, I think gross tend to be – it kind of held out a little bit. My comments that cost tend to stay flat where you tend to see a little bit of a steady decline, so that didn’t happen last quarter. We anticipate that would happen this quarter. So I think that will be a positive impact on that. But that was a real small piece of the margin. But the good news is some of the things that hit the margins are going to lead to positive in the future. Getting more entry configs on the footprints on the floor really helps and those upgrades tend to be higher margins. And then also against some of those key accounts we think will lead us to new opportunities too, so I think there is some good news in there.

Aaron Rakers – Stifel Nicolaus

So, let me ask it this way, so over the last couple of quarters, the margins obviously bounced around. Maybe on average it’s been somewhere in a 54-ish percent range. Is that the right range? What’s the right range to be thinking about for 2010 for you guys from a model perspective?

Jack Judd

I think that we are trying to say that the margin did bounce around an awful lot. I actually think the third quarter margin was probably higher than what we’ll experience long term in this business. But the numbers that we experienced last year are all within our business model. And what we are trying to make sure people understand is that that number that we had in the fourth quarter while lower it’s still within the range we need to be to hit our long term operating margin goals.

Aaron Rakers – Stifel Nicolaus

Okay. And that brings me to the next question. Can you I guess just to talk about those goals and any framework of revenue contribution it would take to – that you guys model out to be kind of at those goals?

Phil Soran

Yes, so first of all, it’s – obviously much larger than we are now, but – and we see those operating margins going into the high teens are best in the industry.

Aaron Rakers – Stifel Nicolaus

And at what revenue level do you think it takes to get there?

Jack Judd

I think that we would just say that it’s so ways away yet. I will still not be so exact where I would give you our ranges for that.

Aaron Rakers – Stifel Nicolaus

Okay, fair enough. And then final question would be, you mentioned obviously HP competition, which really is in a change, but in that has the competition that you’ve seen from HP for example LeftHand has that been changing? Have you seen more LeftHand in your competitive engagements because that seems like that’s been a part of the HP portfolio that they are starting to talk more about?

Phil Soran

Yes, I would say on the HP, similar to the Dell story and then the –we might see HP a little more I think probably because of some of the business partners that we’ve started to work with, used to sell HP, so we (inaudible) year or two ago. That being said now, the primary competitor we tend to see there is still the EVA and then our entry configurations we will see that the LeftHand. So, on a percentage basis, the LeftHand is definitely increasing, but EVA is still probably the primary competitor.

Aaron Rakers – Stifel Nicolaus

Perfect. Thanks guys.

Phil Soran

You bet.

Operator

Our next question comes from the line of Rajesh Ghai. Please go ahead.

Rajesh Ghai – ThinkEquity

Yes thanks. Just drilling a little bit deeper into the gross margin issue, so you mentioned that you had a higher number of footprint use and entry level deals that caused that gross margin to be a little lower. So what is different in these deals because if I – I notice that your new customer number hasn’t really declined, and actually gone up. So, I am just wondering, what is different in these deals than in the past? Is it environment, more competition, or is it customers still not willing to still trying to get more discounts out of you?

Phil Soran

No, so like I said, I think it’s real positive in here, so one nice thing is about our product is it’s able to bridge or it can actually from the entry to the enterprise with the same product, the same Storage Center product. So, let’s talk a little bit about the entry. If you are going to have a scalable product at the entry, you have to put the hardware infrastructure in there that’s capable of scaling. So with the cost of control type architecture you have to build that infrastructure upfront and then from then on its simple addition of disk and disk technology there. So you kind of set yourself for some long term savings where you kind of build up an enterprise infrastructure upfront. So therefore you have a little bit more hardware you have to buy which has a little lower margin.

On the higher end deals there is just some deals that you decide that this footprint is worth being aggressive on and you do it because you are going to get paid back long term, so once again I think there is a lot of opportunity there.

Rajesh Ghai – ThinkEquity

Given the likelihood of these deals or these kind of deals occurring in the future, what gives the confidence that you can – you mentioned some factors in terms what could increase the gross margin, but do you see a proportion of these first time deals and foot print deals kind of continuing to be the same going forward or declining as a percentage of total.

Phil Soran

I think it will be part of our life forever and I hope it is because of its momentum; it’s great to have them there. But the nice thing is once we have got them they tend to grow in a nice profitable fashion and we get a lot of upgrade business. So, getting new footprints is really positive I think.

Rajesh Ghai – ThinkEquity

Great. And international revenues have been up, you’ve been investing in the channel overseas and in sales people overseas. So that’s kind of held steady around the 17%, 18% mark and I am just curious – I know the international markets especially Europe has been – have been weak – as these markets become stronger, will you expect that percentage to increase in 2010 or do you think the total – as a total of the entire pie is – continues to be seen at the percentage level?

Phil Soran

Well two ways to look at that. On a real dollar basis, just take since the third quarter international revenue was up $1.4 million. So, that’s a nice increase. When you are growing the domestic place you are going on a percentage of a bigger number, so the percentage is tougher. So if you kind of look at it, we are investing in both markets, so it’s not like we are only investing in international, not domestic. So the growth in domestic is because the investment we are making there. So we’ll see both of them do it. We are trying to do the international smartly. We could spend a lot more money to get into a lot more countries and I don’t think we’d see the pay back, should I do in the smart fashion, which I think we are doing. So, once you get in and you can see continued growth on there from a real dollar point of view and long term you would see that percentage start going up as you start – penetrate more of the domestic market as the growth slows there a little bit.

Rajesh Ghai – ThinkEquity

Great. And one last question on the cash. Is there – is it going to change, is you position on the cash – I think it’s up to $123 million now. Are you going to continue to preserve cash or you now try to do a buyback at some point of time in the future?

Jack Judd

Our current strategy is continued cash flow positive and to keep the money on our balance sheet.

Rajesh Ghai – ThinkEquity

Great, thank you.

Operator

Ladies and gentlemen, that does conclude our question-and-answer session. Management, I will now turn it over to you for any closing remarks.

Phil Soran

Well we – I just want to thank once again our employees, business partners, and our end users for their support and then also the financial markets. And I guess you’ve been here from Minnesota we got a (inaudible) people back east riding the snow. So, we ask you to drive safe and take care and take some Aspirin when are you doing that shoveling. So, alright thanks everybody.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using ACT Teleconferencing. You may now disconnect.

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