Isilon Systems Q1 2008 Earnings Call Transcript

| About: Isilon Systems, (ISLN)

Isilon Systems (ISLN) Q1 2008 Earnings Call May 7, 2008 5:00 PM ET

Executives

Sujal Patel- President and CEO

Rosemary Moonheart- Director of Investor Relations

Bill Richter- VP of Finance and Interim CFO

Analysts

Kathryn Huberty- Morgan Stanley

Thomas Curlin- RBC Capital Markets

David Bailey- Goldman Sachs

Sid Parakh- McAdams, Wright & Ragen

Aaron Schwartz- JP Morgan

Glenn Hanus- Needham & Company

Clay Sumner- Friedman, Billings & Ramsey

Aaron Rakers- Wachovia

Wendy Abramowitz- Argus Research

Operator

Good evening, Ladies and Gentlemen, and welcome to the first quarter 2008 for Isilon Systems financial results conference call. My name is J.D. and I will be your conference coordinator today. (Operator Instructions) I will now turn your call over to Rosemary Moonheart, Director of Investor Relations.

Rosemary Moonheart

Thank you J.D. Good afternoon everyone, and thanks for joining us today. The speakers on our call will be Sujal Patel, our President and CEP; and Bill Richter, our Vice President of Finance and Interim CFO. As you know, there is important information to review before I turn the call over to Sujal. On this conference call we will be referencing both GAAP and non-GAAP financial measures. We provided GAAP and non-GAAP reconciliation in the press release we issued today announcing for Q1 results. The Press Release is available on the home page of the Investor Relations section of our website at www. Isilon.com\company. The webcast of this call will be archived in the same section. In addition, our recording of the conference call will be available later this evening through midnight Eastern time through May 21st. Details on the playback are in the same press release.

During this conference call, we will be making forward-looking statements about our business and expectations for the future. These forward-looking statements are subject to risks, uncertainties, and assumptions. If the risks or uncertainties ever materialize, or the assumptions prove incorrect, our actual results may differ materially from those identified by our forward-looking statements. For a detailed description of these risks, uncertainties, and assumptions, please read our annual report on Form 10K for the fiscal year ended December 31st, 2007 and our other filings with the Securities and Exchange Commission. Isilon assumes no obligation and does not intend to update these forward looking statements. And now I will turn the call over to Sujal.

Sujal Patel

Thank you Rosemary. Good afternoon and thank you for joining us today. I am encouraged by our first quarter results. Despite the challenges of the last few quarters, we saw some real underlying strength in our business, marked in particular by strong repeat purchases from existing customers and good management of operating expenses. I am now going to turn the call over to Bill to go over our financial results, and then I will discuss a number of factors that impacted our first quarter results, and provide you with my perspective on our progress.

Bill Richter

Thanks, Sujal. Today I will start with an overview of the first quarter performance and then review the numbers. As we said in our last call, at this time we are not providing quantitative revenue or EPS guidance. Before I go on, let me remind you that when we review gross margin and operating expenses, we are speaking on non-GAAP terms, which excludes stock-based compensation. We believe that excluding these expenses gives our management and investors a better indication of our operating results.

Now let’s move on to the numbers. Total revenue in the first quarter was $24.1 million, up 35% from $17.8 million in the first quarter of last year. Sequentially, total revenue was down 9%, from $26.6 million in the fourth quarter of 2007. As we said on the call in April, we expected a sequential decline. As we pointed out, there were three factors that would affect the revenue trend:

First, Q4 included an additional $1.5 million in revenue that moved in from previously restated periods.

Second, Q1 is a seasonally slower quarter due to our customers capital spending and budgeting cycles.

And third, we believe the uncertainties surrounding the audit committee review process did impact our ability to close sales, particularly with first-time customers.

You will see this reflected in the number of new customers, which at 51 declined sequentially as well as year-over-year.

As Sujal noted, sales from our existing customer base were particularly strong in Q1, and in fact we posted record reorders. We also continued to see the diversification in our revenue base, and for the third consecutive quarter no customer represented 10% or more of revenue. While there were no 10% customers, we did have a pick up in larger deals in the range of $500,000 to $2.5 million.

Software came in at 9% of total revenue, or about $2.2 million compared with 6% a year ago, and 11% last quarter. To some extent software as a percentage of total revenue tracks with number of new customers, and overall product mix. Software sales momentum is a core part of our model, and a key focus of our sales team.

Overall gross margin in the first quarter was 53.7%, up 80 basis points sequentially. Product margins were 57.4 %, basically flat with Q4. While product margins were flat sequentially, you may remember that we had some inventory write-down from the fourth quarter. Excluding those write-downs, core product margins actually ticked down a few percentage points. A number of factors impacted our product margins in the quarter, including the level of software sales, product mix, and the timing of COGS reductions.

That last point, COGS reductions, deserves a little more detail. As you can see on our balance sheet, inventory grew by $3 million from Q4. The transitioning or contract manufacturers from [inaudible] to Flextronics, while simultaneously moving from the I series to the X series product platform, contributed to lower inventory turns. In the storage business, declining inventory turn has a direct impact on gross margins.

While we expect inventory levels to continue to grow with our overall business, we anticipate inventory turns to start to increase in Q2. Service margin was 36.9% compared to 28.4 % at Q4 of 2007. This is a sizeable increase, but we don’t think of it as a trend in the near term. We are absorbing some of the investments we have made in the past, but still expect service margins to fluctuate as we continue to build our customer service and support structure.

Now, moving on to operating expenses. In the first quarter, total operating expense was $22.4 million, compared with $21.6 million in Q4. OpEx in both Q1 of 2008 and Q4 of 2007, include professional service fees and expenses related to the audit committee review. In Q1 of 2008, this expense was $2.8 million and is included in G&A expense on both a GAAP and non-GAAP basis. The Q4 expense was $1.5 million. In total, the audit review cost $4.3 million, and will continue to affect our cash flows from operations through the second quarter of this year.

Excluding the cost of the audit committee review, our operating expenses declined sequentially from Q4. This reflects our strong focus on aligning expenses with revenue, and good fiscal responsibility in managing costs. Sequentially we increased our R&D spend about 8% as planned. We will continue to invest in our technology and &D expense will increase in total dollars, but decrease as a percentage of revenue in the latter half of the year.

Sales and Marketing expense declined sequentially from Q4, reflecting lower variable costs associated with a slower quarter, as well as some efficiencies gained in the organization. As a percentage of revenue, Sales and Marketing expense still increased, but at a slower rate than what we have seen in the past. Excluding the audit committee review cost, G&A expense was essentially flat from Q4 of 2007 to Q1. Loss from operations in Q4 was $10.8 million, compared with $8 million in the first quarter of last year. On a non-GAAP basis, loss from operations was $9.5 million compared with $7.5 million in Q1 of 2007. The primarily reason for the widening loss on a GAAP and non-GAAP basis was the $2.8 million in costs associated with the audit committee review.

Net loss for the first quarter of 2008 was $10.1 million, or $.16 per share, compared with net loss of $6.9 million, or $.11 per share in the first quarter of last year. Non-GAAP net loss for Q1 of 2008 was $8.8 million, or $.14 per share, compared with $6.4 million, or $.11 per share a year ago. As I mentioned earlier, expenses related to audit committee review impacted our net loss by $.04 per share on a GAAP and on a non-GAAP basis.

Let me end with a few highlights from the balance sheet. We ended Q1 with $78.6 million in cash, cash equivalents, and marketable securities. Sequentially, deferred revenue increased 13.1% to $20.6 million from $18.2 million in Q4. And, in Q1, DSO’s dropped 66 days from 68 days in Q4. With this, I will now turn the call back over to Sujal.

Sujal Patel

As I look more closely at the dynamics of our Q1 business, I want to highlight a number of factors that impacted our financial results. Let me begin by discussing two key components driving Isilons long term growth. New customer acquisition, and repeat purchases from existing customers.

First, new customer acquisition. As Bill discussed, Isilons acquisition of new customers was down in the first quarter. I believe there are two converging factors driving the decline. A seasonally slower Q1 and heightened uncertainty due to Isilons audit committee review. While the audit committee review was completed by the end of Q1, we anticipate that the related business headwinds could take some time to dissipate. In contrast to new customer acquisition, repeat purchases from existing customer reach an all-time high, in both absolute dollars and in percentage terms. Repeat purchases were up 21% sequentially from Q4, and were up 67% compared to the first quarter of 2007. We believe this metric underscores Isilons strong value proposition, and in particular the modular pay-as-you-grow capability unique to our clustered storage architecture. Once our customers have experienced the business benefits of our products and technology first-hand they remain extremely loyal. This is a consistent and on-going trend in our business.

Another factor underscoring my confidence is the record number of large deals we saw in the first quarter. Several deals in excess of $1 million came from Fortune 500 Companies, demonstrating Isilons deepening penetration into enterprise accounts and larger, mission critical applications. Given both the increase in large deals, and the strength of our repeat purchases from existing customers, I am encouraged by Isilons long-term growth prospects.

As covered on our last conference call, we are executing against an operating plan that strikes a balance between investing in future growth, and steadily improving the operating leverage in our business. As Bill discussed earlier, we decreased our total operating expenses in Q1, excluding the audit committee review cost, while at the same time increasing investment in Research and Development. Although it is still early days, I view this as an important step in our path to profitability.

Now I want to take a moment and highlight some of our business accomplishments from the quarter. In January of 2008, Isilon launched the X Series Clustered Storage System. That provides 100 times the scalability, and 20 times the performance of traditional NAS and SAN storage systems. The X Series, which provides 60% greater performance and 20% greater power efficiency than our previous platforms, was designed to serve as a core component of the next generation data center, and as a result, more than 100 customers have already adopted the X Series in just the first few months of its release. And I want to emphasize, we are just getting warmed up. You can expect to see major new products and innovation coming from Isilon coming later in 2008.

Also in the first quarter, Garner research position Isilon as a visionary in the Gartner Magic Quadrant for mid-range and high-end NAS solutions. This was the first time that Gartner recognized Isilon, and clustered storage, in a Magic Quadrant. It reflects strong external validation of Isilons ascension into the mainstream enterprise storage market.

I view these as important factors underscoring our expanding leadership and momentum in the clustered storage sector, and we are 100% focused on advancing Isilons business execution to capture the significant market opportunity that lies ahead.

After my first full quarter as Isilons President and CEO, I want to highlight four main areas of accomplishment in our business operations. To begin, I have been focused on building out Isilons leadership team into a world-class organization. In the first quarter, we announced the appointment of Brett Helsel as our Senior Vice President of Engineering. We also announced the appointment of Paul Rutherford, who had previously been running engineering, to the role of Chief Technology Officer. Prior to joining Isilon, Brett’s background included serving as Senior Vice President of Product Development and Chief Technology Officer at F Five Networks, where he was part of the original management team that built the company into a global leader. Brett’s short time at Isilon has already affected positive change in our organization, and he reflects the caliber of senior executive leadership that I’m amassing to drive the next critical stage of our expansion and growth.

The second key area of focus was strengthening our field operations in North America, by far our largest market. Under Steve Fitz, Isilons Senior Vice President of World Wide Field Operations, we have made a number of important leadership additions to our sales organizations, with the goal of improving productivity and growth. We also realigned our service organization under Steve to improve the customer experience, beginning with their introduction to Isilon through product deployment, and into post sales and support.

Third, a key focus is to contain the growth of our operating expenses while making appropriate investments to capture the market opportunity and drive the company into long-term value. In the first quarter, we made some initial advances to contain costs and you should expect to see continued progress here. Most critically, I have focused and galvanized the company around our customers, making our customers successful, and fanatical about Isilons products and our company, will continue to drive our long-term success. And I believe we are already seeing positive signs of this cultural focus.

You can expect that I, and our management team, will continue to be laser-focused on these key areas of our business, to drive Isilons long-term growth and value. With this, Bill and I are happy to take your questions.

Question-and-Answer Session

Operator

The first call comes from Katy Huberty of Morgan Stanley. Please go ahead.

Kathryn Huberty- Morgan Stanley

Sujal, if I just rewind to last month, during the initial conference call post-investigation, it sounded like you were concerned that sequential decline in March could be far worse than what you saw in 2007. Can you help us understand what allowed you to hit a more normal seasonal trend?

Sujal Patel

Your question, as I understood it, was related to whether we saw a more normal trend with respect to seasonality in Q1 based on the message from the last conference call. If you remember back to the last call, we had talked about the fact that our revenue would be sequentially down but would be double-digit growth off of our Q1 2007. And I think that the positive effect that we saw during Q1 2008 was really a strong pattern of reorders from our existing customers. That strong pattern, coupled with large deals, really enabled us to still deliver a good result here.

Kathryn Huberty- Morgan Stanley

Can you just walk us through what linearity looked like in the quarter, and maybe touch on at what point did you see some of the delays in new orders? Was that late in the quarter, or did you see that pattern throughout?

Bill Richter

I’ll take that, and I’ll start with your second question first. In terms of the pattern of elongated sales cycles I would say that it wasn’t any particular concentration in any one month, it was really throughout the quarter. And in terms of your first question, sales linearity, we don’t give out the specific percentages month-by-month, but what I will tell you is that overall we did see some improvement in our linearity, and you can see that reflected in the sequential decline in DSOs.

Operator\

The next question comes from Tom Curlin of RBC. Please proceed.

Thomas Curlin- RBC Capital Markets

Do you feel like you are any closer to being able to provide forward guidance, or is there a timeline for that over the next few quarters? Just any update on a level of conviction on y our pipeline that would allow you to start doing that again.

Bill Richter

As we said, we are not providing any quantitative guidance on Q2 or for the rest of the year. And we constantly evaluate it, and we will certainly let you know when we change our strategy there. What I will say, is that Q2 is seasonally stronger than Q1. That seasonally stronger quarter as we expect it is tempered to some extent by the headwinds that take some time to dissipate after the audit committee investigation terminated, and also to the extent that macro-economic factors effect our business going forward. And it is just hard to tell.

Thomas Curlin- RBC Capital Markets

On the field operations efforts. How far along do you think you are with that process qualitatively, do you think that from an HR perspective that is done by the middle of this year, or is going to take another year to get to where you want to be with that structure?

Sujal Patel

I think the way that I look at it is that, we as a company, like all high-growth companies, are in a constant state of evaluating our structure and bringing in senior talent, and ensuring that we have the right team to capitalize on the opportunity in front of us. I certainly feel like that we have made some significant progress in respect to leadership hires, both in North America as well as some internationally. And I feel confident about that new team’s capability moving forward.

Operator

The next questions is from David Bailey, of Goldman Sachs. Please proceed.

David Bailey- Goldman Sachs

I was wondering if you would help us understand what percentage of your revenue in the quarter came from repeat customers, at least qualitatively, and where you expect that mix to be longer-term.

Bill Richter

Around 25% of the revenue came from new customers and around 75% was from repeat. Long term, we would like to see that at 50-50.

David Bailey- Goldman Sachs

On the second one, just to follow-up on the macro question, can you comment on any changes you have seen in the macro environment, particularly on the pricing side?

Sujal Patel

With respect to Q1, we didn’t see any particular impact with respect to the macroeconomic environment, and in particular we didn’t see any particular impact in pricing. It is going to be difficult for us going forward to determine the extent of the macroeconomic environment on our results, but certainly it makes us a little cautious, but we haven’t seen any particular impact with respect to pricing.

Operator

The next question comes from Sid Parakh with McAdams Wright Ragen. Please proceed.

Sid Parakh- McAdams Wright Ragen

A quick question on repeat customers. Once you sign on a new customer, subsequent to them signing up how many quarters do they make purchases, and what is the total value of purchases as a component of their initial purchase? I am trying to get a sense to how much they buy over time.

Bill Richter

That is a good question. We certainly believe that one of the most important things about our business model is that new customers that we acquire become significant repeat order customers for us over time. The time period and the frequency of the purchases varies from customer to customer. We see some customers who will step in and repurchase the next quarter after their initial purchase, and then continue on a quarterly basis, and I would say more often we see two quarters go by before the second purchase from our new customers, but the pattern from there varies. We have customers who buy from us on a monthly basis, leveraging our unique pay-as-you-grow architecture, and then we have some who buy based on budgetary constraints and buy in a more lumpy pattern.

Sid Parakh- McAdams Wright Ragen

Say I spend $10,000 the first time I make a purchase. Over time do I spend $100,000 or do I spend $50,000.

Bill Richter

When we think about our average deal size, it is always for our company been in the low six digits, and that is pretty consistent whether we are talking about a first purchase from an existing customer, or we are talking about a repeat order from a customer. So I would say that there is a wide degree of variability, but that the average is pretty much the same.

Sid Parakh- McAdams Wright Ragen

One of the things that you have talked about it how the investigation is hurting you guys in the market place because some customers probably stepped back and said “let’s wait and watch”, or do you think that they have just gone away and the pipeline, as a result, has seen more churn?

Sujal Patel

When we look at it, I think we look at it in two ways. Certainly the headwinds that we faced in Q1 had some impact, and that impact is caused by our customers and the uncertainties that is raised in their minds, as well as the fact that some of our competitors may have used it as a temporal advantage, as a competitive sales tactic against us. We certainly saw the effect of that with respect to lengthening of certain sales cycles with new customers, as well as we did lose some deals while we are trying to acquire new customers. That effect is an effect that we can quantify and we feel. We also think that there is an effect that impacted our ability to build pipeline through Q4 and maybe to a little bit greater degree Q1. But that is a lot harder for us to quantify since it is really at the mouth of the funnel.

Sid Parakh- McAdams Wright Ragen

But can you at least say qualitatively whether it is bigger than the last quarter or bigger than the third quarter of last year, or any sense of how it is trending?

Sujal Patel

Certainly it is a key metric that we track, and we look forward to making good progress on it. We don’t talk about the relative strength of the pipeline from quarter to quarter.

Sid Parakh- McAdams Wright Ragen

OK. That’s fine. The final question from me, what kind of cash levels are you more comfortable with? Cash has gone down about $14 million in the last two quarters. I am trying to figure out what is a level that you are comfortable with.

Bill Richter

Two factors really impacted our cash balance in Q1. The first was the costs of professional service fees related to the audit committee review, and even though that review is over, the cash outflows from that will to some extent continue through Q2.

The other factor affecting cash balance in Q1 was the growth in inventory. We discussed those on the prepared remarks and we expect both of those factors, the cost of the audit committee review and the growth of inventory to be temporary and to subside in the next couple of quarters. We have over $75 million in cash, cash equivalents, and marketable securities and are very comfortable with the financial resources we have at our disposal to advance the business.

Sid Parakh- McAdams Wright Ragen

In Q2 how much of an affect should we expect from the professional fees?

Bill Richter

We are not providing guidance on cash flows for the out quarters.

Operator

The next question is from Aaron Schwartz of JP Morgan. Please proceed.

Aaron Schwartz- JP Morgan

I had a question about the repeat business. In the last couple of quarter you have talked about adoption of the IQ 200 system putting some pressure on transaction side. I am wondering if that had reversed, or if you could characterize the repeat business. Is it just more volume of the low end, or if you saw your installed base move up the product spectrum to where you saw a little better ASPs?

Sujal Patel

What I heard what the relative impact of the IQ 200 with respect to reorders from our existing customers. One of the things I think I mentioned on the last call is that the IQ 200 we introduced a couple of years ago, was a product that could be sold at the street for $20-$30,000 at street level, and would allow customers an entry into the clustered storage space. I think if you look at our business going forward, the IQ 200 is going to be a less and less important part of our business, as we continue to penetrate larger enterprise accounts and continue to see larger and larger deals being the more predominant type of deal that we go after. When we look at the IQ 200 trends I think it did help the new customer acquisition a bit, but it really didn’t help us in terms of accelerating our channel sales, nor did it really help us in terms of bringing in large deals over time.

Aaron Schwartz- JP Morgan

And on the software business, it seemed like a very strong number considering the slow-down in new customers. Can you talk about the software tie ratio and apps between the new customer base and the install base? Did they really come back, and did you see a higher application tie ratio or can you provide some metrics around that?

Bill Richter

I won’t give you quantitative metrics, but let me try and give you some color. Our new customers tend to attach their deals with software at a higher rate than our existing customers, for a variety of reasons, and we saw that in Q1. The number of new customers was down, and that brought our software percentage down a couple of points from Q4. If you take a step back and look at it in absolute terms, in absolute dollars from Q1 of last year to Q1 of this year, the software dollars are up over 100%, and we are pleases with that. It remains a core part of our operating model, our sales team is focused on it, and I think our goal as a management team is to drive that percentage up going forward.

Aaron Schwartz- JP Morgan

Is it fair to assume that you have a shot at a better tie rate with new customers than going back into the install base and up-selling applications?

Bill Richter

We do both, but as I just mentioned, the attach rate with new customers is higher.

Operator

The next question is from Glenn Hanus with Needham & Company. Please proceed.

Glenn Hanus- Needham & Company

Maybe you could comment on the developments on the competitive front? I think we talked about net apps showing up more than EMC, any changes in tactics out there, and behavior? Thank you.

Bill Richter

When we look at Q1, I think that largely the competitive dynamics of our business were unchanged from what we saw in Q4, and we talked about it in April on our conference call. I don’t really think it has changed over the course of the last few quarters as well. When we are competing in field engagements we predominantly face Network Appliance and EMC as the two competitors that we compete against, and our win rates are vey high. It is interesting, whenever we compete against Network Appliance more often than not we are competing against their traditional, non-clustered, 7 G filers, but we are seeing instances of competition against their GX product which is their early release of their clustered offering. To give you an example, in Q4, we competed head-to-head against Network Appliance with a Fortune 100 company, and we won a deal that was over $1 million. It was a deal that was head-to-head against ONTAP GX. The thing that was interesting about that is it was not only an initial sale of over $1 million, but in Q1 we had another order which was roughly $.5 million from that same customer, so it shows the repeat business model as well.

The same sort of thing happens with EMC but for different reasons. With EMC we had an engagement in Q1 for example which was a large enterprise account, multi-million dollar win for us, and the real keys against EMC are the ability of our products to seamlessly integrate into the customers data center, and the fact that we provide a complete solution, end-to-end, from the hardware, to the network, to the operating systems, file system, as well as all the software as a single offering.

Glenn Hanus- Needham & Company

Any color around what is behind the increase in number of larger deals? Is this generated on how you are targeting certain customers, or what is underneath seeing this result, and as you indicated, you would expect to see more of that?

Sujal Patel

I think the reason we are seeing larger deals is because one of the very healthy trends that is occurring in our business is that we are continuing to penetrate more and more enterprise accounts, which are pushing us into core data center applications and mission critical applications. One of the things I will mention is related to the questions about software, is that the software applications we introduced in the latter half of 2006 and 2007, to some degree helped us to unlock that enterprise customer base, and we have been focused on building out our products and technology in our services support organization of our company in order to accelerate the penetration into those accounts. Those accounts have higher average deal sizes, there are more critical applications, and better margins as well. We view that as a really critical part of our growth strategy.

Glenn Hanus- Needham & Company

On the service gross margin, should we expect to see that come back down to the low 30 range as we go forward?

Bill Richter

We are not giving out any specific quantitative guidance on service margins. We have said that we see it in the high thirties and low forties, in the near to medium term, and from any quarter-to-quarter we expect it to fluctuate. Hopefully that gives you a little color on it.

Operator

Your next question will be from Clay Sumner with Friedman, Billings & Ramsey. Please proceed.

Clay Sumner- Friedman, Billings & Ramsey

Sujal could you talk about some of your verticals, and specifically if you could give us the percentage of revenue from the film vertical or from the Web 2.0 vertical?

Bill Richter

We don’t give exact percentages in terms of how our business breaks up against the various vertical markets. In Q1 we continued to see good winds across the range of vertical markets that we focus on, and continue to see Isilon as a company, and our products continue to penetrate the vertical markets that we entered over the course of the last few years in a significant way. One of the things that you may have seen just this week was that we had won an award from Bio IT as best storage system and it is just another indication of the heightened awareness of our company within certain vertical markets that we have been entering as well as our continued penetration into those verticals.

Clay Sumner- Friedman, Billings & Ramsey

There are several of the Web 2.0 storage offerings coming out, or said to be coming out, from some of the big vendors. HP launched one this week. I am wondering if it is slowing down some of the evaluations by some of the Web 2.0 type customers?

Bill Richter

With respect to the Web 2.0 vertical, which is just one segment of our business, we have not seen any significant slowing based on any data or early products from any of the emerging large vendors in the clustered space.

Clay Sumner- Friedman, Billings & Ramsey

Can you guys touch on head-count and maybe some of the recent trends there?

Bill Richter

For head-count take down a couple heads from Q4 and I think that reflects Sujal and my strong focus on operating proactivity and as the business grows we fully expect head-count to grow. We have said that we are going to focus on growing the R&D organization and continuing to invest in new technology, and head-count and sales and marketing will also grow, but at a slower rate.

Clay Sumner- Friedman, Billings & Ramsey

Lastly, on the Sales and Marketing sales force, can you say roughly what percentage of your sales force has been there less than six months, just to get an idea of where they are in the productivity curve?

Bill Richter

We don’t give out the exact measures in terms of who in the sales force is new, and who has been there a long time. I will say, as I mentioned in the prepared remarks, that we have made a lot of key leadership hires, and we have made some key hires that those facts that have trusted and worked with for a long time. As we look at ourselves as a real growth business, being able to absorb new hires and being able to ramp them up quickly is a key tenant that we have to be really good at and we have got a number of programs and initiatives in place to make sure that we can do that.

Clay Sumner- Friedman, Billings & /Ramsey

But the slow down in new customer acquisition you would not relate to currently having a larger percentage of new people?

Bill Richter

No, I would not make that correlation. I think that the new customer acquisition I think we relate it to both the seasonally slower nature of Q1 for our business as well as the headwinds that we face in the uncertainties of that cause with new customers that haven’t done business with us in the past.

Operator

The next question comes from Aaron Rakers from Wachovia. Please proceed.

Aaron Rakers- Wachovia

A couple of questions. First, can you give us an idea of how your performance played out across your channels in the quarter, direct versus indirect?

Bill Richter

Our channel percentage was roughly 50-50 this quarter, which is roughly consistent with what is has been in the last quarter or two.

Aaron Rakers- Wachovia

Also, I want to jump back and touch on the topic around larger deal flows. It would be helpful for us to understand on a relative basis if we are talking about deals in excess of $1 million, or the $4-6 range, or are you starting to see those materialize? Any kind of qualitative or quantitative direction would be helpful.

Bill Richter

We didn’t report any 10% customers during the quarter, and that is a lid for you if you will for the size of deals in the quarter. Just qualitatively we did see a nice uptick in the number of deals in the $.5 to $1.5 million range.

Aaron Rakers- Wachovia

A year ago we had two customers at more than 10% of revenue; can you update us on those customers? Are they still actively purchasing, or doing repeat business with you, or any color on what is going on within those legacy key customers?

Sujal Patel

Sure. If you look back four or five quarters, we had three 10% customers in various reporting periods: Kodak, Comcast, and XM Radio. One of the things we are very proud of is the fact that as Bill mentioned, we have grown our business and diversified our business significantly and over the course of the last three quarters we have not reported any 10% customers. All three of those customers continue to be good customers, in the last five or six months we have seen repeat orders from all of them, it is just that we have grown our business to the point where they don’t graduate to the 10% mark.

Aaron Rakers- Wachovia

Final question. In the transcript that you had, you will be making some major product announcements later this year. Should we think about those being more platform specific or are we going to get back to talking about rolling out a couple of new add-on software features? And that is really what we’re talking about, the drive that software contribution to the mid-teens that we had talked about several quarters ago.

Bill Richter

You are going to see that for us 2008 is going to be a year of really helping to push our platforms that are way beyond what they were at in 2007 and you saw the first part of that at the beginning of the year with the X Series launch and you will continue to see us make platform announcements. With respect to software, we have spent a significant amount of time and money for 2007 and 2007 expanding our software portfolio. We feel that we have a tremendous opportunity to leverage the software applications as well as drive deeper to implement new features and functions within those software apps and you will see us focus on that over the course of the next three to four quarters as opposed to introducing a lot of new software apps.

Aaron Rakers- Wachovia

And the final question for me. You mentioned EMC in terms of competitive engagements. You really talked about NetApp more so. Can you talk about when you compete against EMC what product platforms you are competing against, and whether you are starting to see, the [inaudible] the code name out in some customer engagements at this point?

Sujal Patel

Sure. When we compete against EMC we compete against a much wider range of products than when we compete against Network Appliance. And that’s because NetApp sells a complete solution. With EMC sometimes we see the EMC NAS product with their Clarion behind it. Sometimes we see Clarion with a server attached to it that might be running something like Linux. We have seen the Infiniflex from EMC both before it got the fancy brand name and before that, and with all of those we have a very strong [inaudible] especially with Infiniflex due to the complexity of the offering we are able to deliver very high win rates against it.

Operator

We have a question from the line of Wendy Abramowitz from Argus Research. Please proceed.

Wendy Abramowitz- Argus Research

Could you talk a little bit about your U.S. versus International business? I believe you said that most of your business came from North America this quarter, and if you are planning to expand internationally some more?

Bill Richter

About 1/3 of our revenue came from abroad. We are quite pleased to have that business in place and some of the investments we have made in the past are paying off. It’s a nice natural hedge against the U.S. economy. In terms of opening up new countries or new geographies there are no announcements to make on that right now.

Operator

There are no more questions at this time. I will turn it back to our CEO Sujal Patel.

Sujal Patel

I would like to thank everyone for being on the call. We look forward to updating you on our progress in July.

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