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Compellent Technologies, Inc. (NYSE:CML)

Q2 2008 Earnings Call Transcript

August 5, 2008 5:00 pm ET

Executives

Jenifer Kirtland – EVC Group

Phil Soran – Chairman, President and CEO

Jack Judd – CFO

Analysts

Katy Huberty – Morgan Stanley

Andrew Nowinski – Piper Jaffray

Tom Curlin – RBC

Eric Martinuzzi – Craig-Hallum Capital

Glenn Hanus – Needham & Company

Alex Kurtz – Merriman Curhan Ford & Co.

Douglas Reid – Thomas Weisel Partners

Clay Sumner – Friedman, Billings, Ramsey Group

Operator

Good afternoon ladies and gentlemen, thank you for standing by. Welcome to the Compellent Technologies second quarter 2008 conference call. During today's presentation, all parties will be in a listen-only mode. Following today’s presentation, the conference will be open for questions. If you do have a question, please press the star followed by the one on your push button phone. If you would like to withdraw that question, please press the star followed by the two. If you are using speaker equipment today, it will be necessary to lift the handset before pressing the numbers. This conference is being recorded today, Tuesday August 5, 2008.

At this time, I would like to turn the conference over to Jenifer Kirtland with the EVC Group. Please go ahead.

Jenifer Kirtland

Thank you, Operator, and good afternoon everyone. Thank you for joining us for the Compellent conference call and webcast to review financial results for the second quarter of 2008. 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 Form 10-K for the year ended December 31, 2007, under the heading "Risk Factors." Copies of these filings are available online from the SEC or on Compellent's Web site. These forward-looking statements are not guarantees of future performance and speak only as of the date hereof, and except as required by law, Compellent disclaims any obligation to update these forward-looking statements to reflect future events or circumstances. In addition, during today's discussion, management will comment on both actual results and certain non-GAAP results. Reconciliation of actual results with these non-GAAP results are provided in today's earnings release, which is available on our Web site at www.compellent.com.

And with that, I'll turn the call over to Phil Soran, President and CEO of Compellent.

Phil Soran

Well, thank you Jennifer and thank you all for joining us for our second quarter 2008 earnings call. With me today is Jack Judd, our Chief Financial Officer.

Compellent reported another quarter of strong financial results reflecting a growing global demand for our feature-rich, easy-to-use storage solution that provides the lowest total cost of ownership and energy efficiency in the industry. Our financial results continued to demonstrate solid revenue generation, margin expansion, expense management and progress towards profitability. We also made significant progress in expanding our brand awareness across the world, our channel partnerships and industry alliances. With these achievements, we believe that Compellent is well positioned for long-term growth and has emerged as an established leader in virtualized data storage.

I would like to highlight some of the recent financial results that we delivered this quarter. Our second quarter revenue increased 74% from the prior year to a record $21 million. Sequential quarterly revenue growth was 15% over the first quarter, this is our 11th consecutive quarterly increase. Our net loss is $0.02 per share, and our net loss excluding stock option compensation was only $66,000.

There were a number of other important achievements I would like to highlight. On the patent front, we received our first two US patents. We are especially excited about the first, which is part of our automated tiered storage feature, Data Progression. This validates Compellent’s unique ability to automatically optimize data placement and management within the volume. The benefit for end users is a significantly more efficient, cost-effective approach to data storage and the fulfillment of the promise of ILM or information lifecycle management. We believe this to be a must-have feature for the virtualized data center of today and tomorrow.

The second patent for instant data fusion technology which is part of the foundation for our Data Instant Replay and Remote Instant Replay features. It involves the manipulation of data address mapping to accomplish point in time copies. This allows for more effective space utilization and easier disaster recovery. We have many other additional patents pending in the US and several international filing outstanding as we seek to further protect our unique intellectual property.

Let’s look at the customer front and some of the customer and sales highlights. We recently announced our 1000 end-user customer, the global and sports and entertainment leader IMG. This is a Marquee world brand. After reviewing several legacy and next generation systems IMG chose the Compellent stand for its ease of use, virtualization and disaster recovery capabilities. The company will be replacing a competitive stand with Compellent in London, Florida, New York and Sydney and anticipate additional worldwide locations as part of a new global virtual data center. Another great competitive win was the Orlando Magic. We’ll be making a run for the NBA championship in a new all digital arena starting its data on a Compellent stand.

We closed the second quarter with 972 end-user customers. This is a 17% increase from the end of March. Our customers continued to gain industry recognition for their innovative use of Compellent Technology. Munder Capital Management won IDG’s computer awards’ Best Practices and Infrastructure Management Award. The $35.7 billion investment firm was honored for its implementation of Compellent stand as the foundation for its business continuity strategy.

On the international front, our relationships with our channel sales partners are excellent and we continue to gain traction with international business partners. International revenue grew approximately 100% year over year led by strong growth in the United Kingdom. We launched our United Kingdom operation a year ago and focused on building relationships and driving brand awareness. We have been very pleased with the results. Samples of our UK end users include the comic relief, which is a well-known charity that uses comedy and entertainment to raise money to fight poverty. the Royal Horticultural Society which houses over 200,000 images on its Compellent stand, in the London Borough at Hillingdon, which uses Compellent virtualization as the center piece to a governmental green initiative.

We recently cited new business partners in the BENELUX region of Europe and are already achieving sales momentum of customers like (inaudible) Group, an insurance claims and services provider. One new important international business partner for Compellent is Inter Access, an IT service provider with over 20 years of experience providing complex IT solutions to commercial and government clients in the BENELUX region of Europe. Even though Inter Access has been selling competitive server and storage products, they recently added us to their portfolio because we are (inaudible) to differentiate their overall solution and lower total cost of ownership for their customers. They told us that the combination of Compellent storage with Blade servers is a great way to help the end users in Europe implement a truly virtual data center.

We currently have our presence in 23 countries in North America, Europe, Asia, Australia and Africa. In May, we hosted our Annual C Drive Conference for customers, end users, and business partners. This year was bigger than ever with almost 300 attendees from across the world including industry analysts and reporters. The sessions were designed for open collaboration among participants, and they allow end users and our channel partners to share best practices. The feedback of our business partners and end users is a key strategy in planning future products and services.

Another highlight of the quarter was receiving Microsoft’s Storage Partner of the Year Award. This was especially significant as we competed against other finalists Hewlett-Packard, HP and NetApp. This award is a strong validation point for our end-user prospects and business partners.

These are only a few of our recent highlights. After just nine months as a publicly traded company, we have made enormous strides as an organization. Today, we have 258 employees, an established growing end-user base, a large business partner network and a financial model that can drive more on the bottom line as the business scales. We remain very optimistic about the outlet for continued growth in the storage market and especially for vendors who can offer IT managers options that reduce cost and energy consumption. According to Robert W Baird & Company’s Q2 Enterprise VAR Survey, storage and server virtualization are expected to be the strongest areas of spending in the second half of 2008. This survey also shows Q3 ‘08 expectations are better than they were for Q2 ’08. The excellent results entertained Maxis analysts’ optimism towards storage spending.

Before I finish, I just want to make a few comments here and say a few things about the product announcements that DMC made today, their new announcements here. Once again, it kind of shows that maybe others have been leaders in the innovation space for many years now. There is a lot of (inaudible) announcement and it once again highlights they have a model based architecture. We have a single model that can scale from the smaller system to the larger system with no rip and replace forklift upgrades. Also we continued to have our Dynamic Block Architecture as a unique differentiator in the industry. Things like thin provisioning being snapped on after the fact [ph] is a little bit different than building it from the beginning. It wasn’t too long for the DMCs to say they don’t recommend thin provisioning, that’s something to be afraid of. Here we have had for it almost five years.

We also announced some technology drive spin downs. Our Dynamic Block Architecture can reduce power consumption by almost 90% over legacy systems. Spin down a few drives in a segmented fashion only provides a little bit of the benefit of redo with our Dynamic Block Architecture and at best it is across all the data that might be stored in our Compellent SAN. So, I think we still have a significant lead, there are features that no one else has such as Data Progression for our block level automated tiered storage, fast track, thin import, thin replication and the list goes on and there are many other developments in operation right now in our labs to extend that significant lead we already have.

So, with that I want to close here by just saying that we have worked really hard to ensure that Compellent has the resources and infrastructure to take advantage of its opportunity and we are proud of our progress. And I would really like to sincerely thank our employees and business partners for another great quarter of execution.

Now, I would like to turn the call over to Jack for a more detailed look at our second quarter financial results and third quarter and full-year 2008 guidance. Jack?

Jack Judd

Thank you, Phil. I am excited about taking everyone through our second quarter results. Revenue grew $8.9 million to $21 million, or 74% from the prior year’s second quarter. Compared to the first quarter of 2008, revenue grew $2.7 million or 15%. We continued to grow in international markets. International revenue increased to $3.2 million in the second quarter, approximately 100% more than the previous year. Our end users at the end of the quarter totaled $972 compared to $554 one year earlier. Our revenue from existing end users measured on a year-to-date basis was 41% of product revenue and new end users made up 59% of product revenue. This combination of new end users in our current base coming back for upgrades and additional systems makes the Compellent story exciting.

Our gross margin increased to 54.1% in the second quarter of 2008 compared to 47.8% in the same quarter last year and 52.2% in the first quarter of 2008. The largest increase was from support and services margin from 39.5% in the second quarter of 2007 to 59.6% in the second quarter of 2008 primarily due to the leveraging of our Copilot support group. This recurring services revenue provides stability and predictability to our financial model and illustrates the high level of customer satisfaction that our Copilot Services organization provides.

Operating expenses increased to $12.6 million in the second quarter of 2008 from $7.8 million one year earlier, as we continued to build infrastructure in all areas, especially our sales and marketing teams. Our total employee count at the end of June was 258 compared to 212 and 172 at the end of December 2007 and June 2007 respectively. Our net loss on a GAAP basis for the second quarter of 2008 was $603,000 or $0.02 per share compared to $1.9 million or $0.45 per share in the previous year. Excluding the effective stock-based compensation, our net loss for the second quarter was $66,000 compared with a net loss of $1.8 million in the previous year.

We ended the quarter with $92.9 million in cash and investments. Our balance sheet includes $15.6 million of deferred revenue, an increase of $3.1 million from March 2008 and $5.1 million from December 2007. The growth in deferred revenue reflects both the increase in new end users choosing three year main in its contracts and the almost 100% renewal rates of our current end-user base. Our ageing [ph] and our accounts receivable remained steady with the prior quarter end. Our inventories are higher as a result of an increase in field service parts and increases in evaluations systems of potential new end users. Our strategy of virtual manufacturing continues to deliver value as our low cost of inventories lead the industry.

Our guidance for the next quarter and for the end of the year is quite strong. We continued to see strong demand for our products and support services. Our pipeline remains strong and continues to grow. We, therefore, currently expect revenue to increase to approximately $22 million in the third quarter of 2008 compared to $13.4 million in the same quarter of 2007. For all of 2008, revenue is forecasted to be between $85 million and $86 million. Gross margins will be between 52% and 53% for 2008. We anticipate that the company will achieve GAAP profitability in the second half of this year.

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

Question-and-Answer Session

Operator

Thank you sir. Ladies and gentlemen, at this time we will begin the question-and-answer session. (Operator Instructions) Our first question comes from the line of Katy Huberty with Morgan Stanley. Please go ahead.

Katy Huberty – Morgan Stanley

How much help if any –

Phil Soran

Katy, you are a little soft, can you get a little closer to the mike?

Katy Huberty – Morgan Stanley

Yes, can you hear me?

Phil Soran

Yes.

Katy Huberty – Morgan Stanley

Sorry about that.

Phil Soran

Start again though, I didn’t hear you.

Katy Huberty – Morgan Stanley

Congrats on the continued execution, another great quarter. How much help if any did you get from component pricing on the product margin front and what other factors drove that line item this quarter?

Phil Soran

Well, a couple of things that factor and there is a little bit of effect from improved buying capability, second of all is just a little bit larger systems have helped there too and then also our service and support margins went up.

Jack Judd

Yes and I think there also has been a little bit of leveraging that goes on in our manufacturing team. As you sell more, you don’t tend to have to add as much cost, so there is some good overhead absorption going on also.

Katy Huberty – Morgan Stanley

As a follow up to the featured discussion around the new EMC product today, how important do you view solid state drives and see duplication technologies in your road map just given how much attention those technologies have received this year?

Phil Soran

Yes let’s first of all talk about the solid state area there. So, first of all, we have actually had solid state end customer installations for quite a while now. We only do it under a special bid situation. We found that at times it can be (inaudible) and it is not an inexpensive technology right now. So, we view that – there is a future for it in the right environments. So, we’ll continue to expand that. What you will see us do with solid state though is leverage our Dynamic Block Architecture and our Data Progression with that technology. It’s just another drive or storage for us, another tiered storage. So, some of the stuff we have got the patents for we’ll be able to get significant advantage over other vendors we think. On the data de-duplication front there, date de-duplication tends to be more tied to archived storage than more primary storage. But we have a lot of features in our product that does what I call data reduction which is basically minimize the amount of space that you have to use to store the amount of date you have. So, you know examples of your thin provisioning and how we do boot from SAN, I call it kind of de-dup boot where you have one copy of the OS where you might have 50 servers using that single copy, a lot of features like that that we do that tie into both our local storage and our application. So we’ll just continue to find the most efficient storage management techniques we can give to the customers so they can hopefully have the lowest total cost of ownership.

Katy Huberty – Morgan Stanley

Then lastly Jack, what sort of are the highest DSOs in the quarter sequentially?

Jack Judd

Our DSOs?

Katy Huberty – Morgan Stanley

Yes.

Jack Judd

I believe that they were 70 and 73 days. So some of the receivables, when you see a receivable balance, some of the dollars reflect when you sold the items in the quarter also.

Katy Huberty – Morgan Stanley

So fair to say that linearity was a little more backend loaded this quarter?

Jack Judd

Fractionally.

Katy Huberty – Morgan Stanley

Okay, thanks so much.

Operator

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

Andrew Nowinski – Piper Jaffray

Hi, big quarter guys, great job.

Phil Soran

Thanks Andrew.

Andrew Nowinski – Piper Jaffray

I just wanted to touch base on the product gross margins really improved, can you give some color on what’s kind of driving that?

Phil Soran

Well currently we said there are two big drivers, the service and support margins continue to increase. We did get once again some increased buying power with our volumes going up. Working larger deals has helped a little bit there also. And as Jack said, we are able to amortize some of the manufacturing costs over a larger revenue base.

Andrew Nowinski – Piper Jaffray

Okay got it. And then what about on existing customers, are you guys saying is it capacity expansion or additional sites from application kind of driving the growth in existing customers or revenue from existing customers?

Phil Soran

It is both of the above. So, we have a lot of customers that are now doing disaster recovery sites. They are talking to our references and find out that it is really easy to do, very quick to implement, and it is very functional how you do it. And then the other thing that is nice about the data storage business is people find ways to store more data, so there is capacity upgrade, software upgrades, all those things follow our favor. So, it was frankly from both.

Andrew Nowinski – Piper Jaffray

Got it. Then a last question, you said our linear areas are relatively unchanged, just wondering, if it is 50% the last month I guess, did you guys see a pretty significant business momentum coming out of the June quarter given that you are already in excess of 1000 customers?

Phil Soran

It’s what we see continue like we said in the comments there at the start of the quarter, the pipeline is growing we are optimistic about the future here and it is just kind of continuation of the second quarter momentum.

Jude Judd

The third quarter is always typically the slowest growth quarter in a fiscal year for us and for other companies in the technology business. So, that’s a reality of it also.

Andrew Nowinski – Piper Jaffray

Good. Thanks guys. Keep it up.

Operator

Thank you. Our next question is from the line of Tom Curlin with RBC. Please go ahead.

Tom Curlin – RBC

Hi. Congratulations on the upside execution.

Jack Judd

Thanks Tom.

Tom Curlin – RBC

The very strong new customer add in the quarter, are there any specific themes beyond just the core value prop that you guys are able to play to in this environment, for example the power element of the equation, is that becoming more prevalent?

Phil Soran

Yes, everybody has had this advantage on the energy front there. The green is kind of a fad marketing event but it is not a fad as far as the end users, and frankly the impact that it imports on the decision criteria of customers has moved up quite a bit. There is a little bit of locality based on that where you live in the country, it might be more important to New York City or Washington DC or something like that but it has definitely moved up and I think we have done a much better job of articulating our advantage and you know frankly we kind of joke now, our CTO Larry Aszmann, we now call him our CEO, our Chief Environmental Officer. He has kind of taken the banner and planted it really hard across both Web sites and Webinars and presentations and that type of thing. Actually it shows real numbers help with our Data Progression and thin provisioning we can actually cut power consumption to up to 90% because we are able to use higher capacity, lower power consuming drives to store more of the inactive data and we don’t overprovision storage, all those types of things have a big effect. So, it’s moved up quite a bit. I think we are also getting a little bit more of mind share of the business partners out there. So, we get a little bit higher percentage of their business which is a real positive for us. The other thing I hear from our customers is our brand, it is much more aware of, people are aware of Compellent, are hearing about us through lots of different means. We have had some good analyst coverage. The awards we have got this year, the Microsoft award, the SAN of the Year award, the Storage Magazine Quality Award all those things have kind of added up to giving us just a significant increase in momentum which is where a lot of the new end-user customers come from.

Tom Curlin – RBC

Can you give us the metrics on new partners in the quarter and maybe the mix of revenue from top 10 partners?

Phil Soran

We are kind of not disclosing the number of partners. We did increase the number of partners in the quarter and part of the reason is kind of a lot of things we say is if we are going to double our revenue we don’t necessarily need to double the number of partners. What we need to do is double the mindshare of the ones we have. Now as we do increase the mindshare, I’ll highlight a few of the international ones. We did have a nice increase on the number of partners and so we just don’t want to report on that right now Tom.

Tom Curlin – RBC

Okay and do you just feel like generally in this environment your value prop is getting more audience to some degree up the market as customers really focus on, well I’ll call it, payback period versus RLI, very payback oriented?

Phil Soran

I think that Baird survey was real indicative of it where the last thing they are going to cut is their storage budget because you can’t quit storage or data. So, that’s a positive for us on that front. It is not an optional item to spend on. The other thing that has really helped us I think is our marginality. So, you can start small if you don’t have the budget or if you want to cut a little bit and you can because our scalability unlike the – I talked about the EMC and how it is a very model-based architecture. Ours, it’s one model of Storage Center, you can start small and grow into it as the budget opens up or the economy turns around or whatever. So, that’s been positive and frankly in tough economic times you have got to find a different way to store data and you are not going to get this total cost ownership that is afforded with Dynamic Block Architecture until you start buying it. So with the combination that you have store more data then you need to do a better way of doing it, it actually I think helps our value proposition to sing a little bit sweeter tune.

Tom Curlin – RBC

Alright. Thanks very much.

Phil Soran

You bet.

Operator

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

Eric Martinuzzi – Craig-Hallum Capital

Thanks. I know you had two questions on the gross margins already but I do want to go back to them because I think they were so strong in Q2 and from what you talked about, it sounds like most of those things only get better as you grow, buying capacity, larger systems, service leverage what is it that ramps us down from the 34% that we have just put up to the 52% to 53% that you have talked about for the year?

Jack Judd

Well, partly the 52% to 53% will be a year-to-date measure versus a future quarter measure. So, you have got to kind of feed in how you think you are going to get to that. We anticipate in the future to continue to be competitive and to win deals and that is part of it. Also you have got to keep – we’ll get around and we will develop some professional services offering which will be some more hiring on that support and services margin. So, that will cap that down a little bit in the last half of the year also.

Phil Soran

Because it is flexibility of asset [ph] when you need to be.

Jack Judd

Right.

Eric Martinuzzi – Craig-Hallum Capital

Got you. And as far as other human capital issues, you have added a lot of heads this year, do you find yourself struggling to find the best qualified candidates or do you feel like you have got enough resumes out there to fill the spots you have got?

Phil Soran

Hiring is not our biggest challenge. We’re trying to cross the company there. I guess the best example I would use is we have not used a search firm for hire yet to date in the company. So, that is I think kind of the strongest statement, if we are having trouble we would have to use those types of resources. So, that’s a good indicator of it. The other thing we are seeing too is there is some discontent in other storage companies and they have heard about our positive and aggressive culture and so we tend to get proactive enquiries into Compellent for what positions we have. So, hopefully we can continue that and keep the culture up and keep the reputation of the company up so that those enquiries will keep coming.

Eric Martinuzzi – Craig-Hallum Capital

Okay. Then lastly a couple of housekeeping items here. Your cash from ops, if I am reading this right, you are basically breakeven on the cash from ops Jack, is that right?

Jack Judd

Yes, that would be exact. Cash flow is presented on a year-to-date basis.

Eric Martinuzzi – Craig-Hallum Capital

Okay. So the quarter was breakeven and the only burn was in Q1.

Jack Judd. Right. It’s about $1.2 million so far in fixed assets this year.

Eric Martinuzzi – Craig-Hallum Capital

Then the stock-based comp, I think you had it ramping up in the back half of the year, had been using $0.5 million per quarter, does that go up or does it stay about the same?

Jack Judd

I think that this coming quarter it’s going to be around $600,000. I think that it will still be in the range of $2.2 million to maybe $2.5 million this year in total. We will have to see how stock options are given, what the price of the stock is and all the other things that go into that calculation.

Eric Martinuzzi – Craig-Hallum Capital

Okay, it’s terrific. Thanks.

Operator

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

Glenn Hanus – Needham & Company

Good afternoon and congrats on the performance.

Phil Soran

Thanks Glenn.

Glenn Hanus – Needham & Company

Should we continue to think about the business model kind of invest any upside in revenues first in sales and marketing and then in R&D given the same basic message?

Phil Soran

I think we’ll continue to invest. As long as we deliver growth and stuff, we think that’s a prudent way to do it. We do want to still prove out the business model for profitability and showing that we can get there is obviously a significant goal for us there. But we will invest a lot of the upside we deliver to sales and marketing, R&D, and those types of strategic efforts.

Glenn Hanus – Needham & Company

On the competitive front, are you seeing price pressure from Dell-EqualLogic out there or any color on what you are seeing out of them?

Phil Soran

I think the pricing, the competitive pricing pressure were pretty similar to other quarters that we have seen before. So, once again our total cost of ownership gives us the advantage there. So, what we want to do is be price competitive but deliver the best value for the customer and it really wasn’t any different this quarter than others.

Glenn Hanus – Needham & Company

Just back on EMC there for a second, there was a response to a question there about doing some data movement capability within their tiering, it sounded somewhat similar to a feature you have, is that an accurate characterization, do you feel like what they presented in any way will slow you down at all?

Phil Soran

I think our Data Progression is very differentiated from what they are doing (inaudible) our hands on there and see what they announced their works and so there but we manage the data inside the volume, so we are doing it at a block level with that tiering is very differentiated in the industry and that’s what gives you the value of it because we are able to go so much more grander, the example of e-mail, you can have parts of the e-mail – one file will be on different tiers of storage, different rate levels, etc is powerful. And the other thing is as I indicated here in the conference call, we’ve also got a patent on this, how we do some of that stuff, so that’s a good competitive advantage also.

Glenn Hanus – Needham & Company

Right, okay, thank you very much.

Phil Soran

You bet.

Operator

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

Alex Kurtz – Merriman Curhan Ford & Co.

Thanks and congratulations guys, another good quarter.

Phil Soran

Hi Alex.

Alex Kurtz – Merriman Curhan Ford & Co.

The first question is this is the second conference call in a row where we are talking about larger deals, larger systems, are you shifting your focus among your core customers maybe up market a little bit and is that changing at all or is it just adding more capacity with the systems that you are selling?

Phil Soran

I am really glad you asked that question there. First of all, our target market has not changed, we really believe we have a leadership capability for what we call the mid-size enterprise that’s really our coveted sweet spot and we continue to do real well there and we don’t want to take our eye off that ball. That being said, I would tell you that there were some large enterprise accounts that realize the benefits of things like Data Progression and how we do our application and we have on limitations on things like snapshots and pre-allocation of storage, and how our thin provisioning works. We had one large customer I can think of that did a migration from one of those legacy systems and day one just a letter of thin import was able to save 70% of their capacity. So, those types of features are causing large enterprise customers to look at our solution and I really think that as our brand gets bigger, customers tend to be willing to buy bigger systems upfront as opposed to grow into them. So, they might buy with a lot more confidence because of the large number of end-user references that we have.

Alex Kurtz – Merriman Curhan Ford & Co.

But you would not say that you are aggressively trying to break into sort of the low end of the enterprise market which would suggest that maybe things are going to get more competitive, is that your strategy, right?

Phil Soran

I would indicate that our strategy is still the same. We are going after the mid-size enterprise and it turns out there are a lot of large enterprises like those same features and when we get those up we’ll go close those two. But (inaudible) mid size.

Alex Kurtz – Merriman Curhan Ford & Co.

So, would you say, maybe Jack has the number, your average deal size for net new customer, was that up quarter over quarter?

Jack Judd

We don’t track on our current basis deal size over average system. The average system is still a consistent number from quarter to quarter, there was no really movement in it. But I would say overall the average deal size is up but I don’t have any numbers to give you today.

Phil Soran

One of the effects Alex is that a lot of our customers are implementing the disaster recovery scenario on day one purchases.

Alex Kurtz – Merriman Curhan Ford & Co.

Right. So, there is follow on. Then the next question is what was the iSCSI in the quarter?

Phil Soran

Actually I didn’t figure that out. The buying gets pretty similar now if not even a little bit more in the past. You’ve talked about the 60% plus range of a mix of Fibre and iSCSI and I think the fight continues. We didn’t actually track it this quarter but we are seeing a large mix of it. They tend to buy both, they like that advantage of not getting locked in technologically. One of our advantages of being designed for persistence and not obsolescence is that you don’t have to pick and chose you can use both and it turns out – we find most customers actually have a fit for both those technologies.

Alex Kurtz – Merriman Curhan Ford & Co.

Okay, just two more quick questions, just back on the acceleration and net new customers that you added in the quarter, was there really a couple of different partners who really drove that for you? That was a significant uptick from the net new adds you did in the prior quarter, how should we think about that?

Jack Judd

I think that you always need to look at the new customer adds at the same time look at the amount of business that came from new versus existing customers and I think that you are going to see in the quarter that we had an uptick of new business as a percentage of our overall business compared to the first quarter and then that would tie in that we had more new customers in the quarter than we had in the first quarter. So, they are tied together. You are not really able to analyze either one of those numbers without looking at the other.

Alex Kurtz – Merriman Curhan Ford & Co.

Then finally just a comment on the CX4 release today, the CX4 is interesting here in the first couple of months that’s being released but I am more concerned for you guys about the CX3 and what is going to happen with pricing in the marketplace for that product as it gets kind of wiped over in the next year and change, any initial feedback from partners that are confronting that issue yet or is it just too soon to tell?

Phil Soran

Too soon to tell.

Alex Kurtz – Merriman Curhan Ford & Co.

Alright guys, thanks a lot.

Phil Soran

Thank you Alex.

Operator

Thank you. Our next question is from the line of Douglas Reid with Thomas Weisel Partners. Please go ahead.

Douglas Reid – Thomas Weisel Partners

Thanks and congratulations on the excellent execution.

Phil Soran

Thanks Doug.

Douglas Reid – Thomas Weisel Partners

Most of my questions have been answered but just quickly on the OpEx ramp in the second half, any reason why that would not be linear?

Jack Judd

I think it would be slightly less than linear in the last half because an awful lot of hires just are done earlier in the year versus later in the year. But we will continue to do hiring as people come to us and as markets open up and as we feel that making the add is good for our shareholders.

Douglas Reid – Thomas Weisel Partners

Okay and then back on the macro environment, are you seeing as you battled along for new customers any impact of the more cautious macro environment in terms of sales cycles stretching or any change in behavior from last quarter?

Phil Soran

I think it was similar to the comments we made last quarter, I would say it is quite similar to the first quarter actually the sales cycles and stuff we saw there. So, those were a little longer than they were in the past and we will be able to more than cover that up with increased mindshare and business partner coverage and pipeline stuff. Compared to a year ago, there is a little lengthening but I think we have been able to obviously grow through that with the increase in mindshare.

Douglas Reid – Thomas Weisel Partners

Okay great and once again congrats.

Phil Soran

You bet Doug.

Operator

Thank you (Operator instructions) our next question is from the line of Clay Sumner with FBR. Please go ahead.

Clay Sumner – Friedman, Billings, Ramsey Group

Thanks very much and congratulations from me as well.

Phil Soran

Thank you Clay.

Clay Sumner – Friedman, Billings, Ramsey Group

On inventory, I think I might have missed it, I think you said it went up primarily because of evaluation units, is that correct?

Jack Judd

It went up for two main reasons. One being is that as we expand nationally, it requires us to put an awful lot more spare parts in remote warehouses, and so that is a good hunk of the money. Then, I think also we also tend to have more inventories related to evaluations and demo systems and that would be higher than it was in the previous quarter.

Clay Sumner – Friedman, Billings, Ramsey Group

Okay great. The on the sales and marketing expense, do you guys plan on continuing to add expenses like kind of $500 million to $1 million per quarter level for the foreseeable future or are there any changes coming that might significantly accelerate or decelerate that level of investment?

Jack Judd

I think that we will continue to make investments at least as aggressive as we have in the past and as opportunities arise, we are going to take advantage of them. We think an awful lot of our business and we think there are lots of opportunities out there and we are going to go take advantage of them.

Clay Sumner – Friedman, Billings, Ramsey Group

Okay and then on the professional services, did you wind up adding to that in this quarter or is that something you are still planning for future quarters?

Jack Judd

We still have an awful lot to do to execute a more aggressive strategy on professional services. I do want to emphasize that we do have professional services. Nobody should walk away thinking that we don’t have significant efforts or significant results in that . We still so significant installs and significant training for our end users and our business partners and we expect that over time as we find people that can help build that business that we will expand those services.

Clay Sumner – Friedman, Billings, Ramsey Group

Okay. I was asking – I think last quarter you were saying that you expected to hire some professional service folks and that would bring service margins down in fact service margins went up dramatically. So, it displaces having hired as many as you had planned to, is that fair to say?

Phil Soran

If we just sell investment maybe also our Copilot Services had a margin increase also.

Clay Sumner – Friedman, Billings, Ramsey Group

Then a quick one, when you do start reporting GAAP profits, what do you expect the diluted share count to be?

Jack Judd

I think we have about 30.6 million shares outstanding right now and our options, the option pool, I’ll say the options is around 1.4 million shares.

Clay Sumner – Friedman, Billings, Ramsey Group

Okay great. Thanks very much.

Phil Soran

Thanks Clay.

Operator

Thank you. At this time there are no additional questions, I would like to turn it back to management for any closing remarks.

Phil Soran

I would just like to first of all once again thank our employees and business partners. We are really excited the way you really feel good about the results this quarter on a number of fronts from the visibility to the financial results to the progress we made and we want to thank our end-user customers also for ultimately it is you [ph] who make the decision out there. Thanks for the support of investors and employees and staff. Thanks a lot.

Operator

Thank you sir. Ladies and gentlemen, if you would like to listen to the replay of today’s conference, please dial 1 800 405 2236 or 303 590 3000 using the access code of 11 11 7355 followed by the pound key. This does conclude the Compellent Technology’s second quarter 2008 conference call. ACT would like to thank you for your participation. You may now disconnect.

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Source: Compellent Technologies, Inc. Q2 2008 Earnings Call Transcript
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