3PAR Inc. F1Q09 (Qtr End 06/30/08) Earnings Call Transcript

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 |  About: PAR Technology Corporation (PAR)
by: SA Transcripts

3PAR Inc. (NYSE:PAR)

F1Q09 Earnings Call

July 31, 2008 4:30 pm ET

Executives

David Scott - President, Chief Executive Officer and Director

Adriel Lares - Chief Financial Officer and Vice President of Finance

Analysts

Kaushik Roy - Pacific Growth Equities

Alex Kurtz - Merriman Curhan Ford

Clay Sumner - FBR

Thomas Curlin - RBC

Brent Bracelin - Pacific Crest Securities

Aaron Rakers - Wachovia

Mark Kelleher - Canaccord Adams

David Bailey - Goldman Sachs

Unidentified Analyst

Operator

Good day, ladies and gentlemen, and welcome to the first quarter fiscal 2009 3PAR earnings conference call. My name is Tina and I will be your coordinator for today. (Operator Instructions)

I would now like to turn the presentation over to the company.

Unidentified Corporate Representative

Good afternoon and welcome to our fiscal year 2009 first quarter earnings release conference call. This conference call will include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities and Exchange Act of 1934 as amended.

These forward-looking statements include, among others, statements about our financial projections for the second quarter and full year of fiscal 2009, as well as financial projections and growth trends for the overall storage market and segments thereof, anticipated demand for our storage solution, and adoption trends in our customers markets.

All of these forward-looking statements involve known and unknown risks, uncertainties and important factors that may cause our actual results, levels of activity, performance or achievements, or those in our industry to differ from those expressed or implied by the statements we make.

In evaluating these forward-looking statements, you should specifically consider various risk factors, including the risk factors detailed from time to time in our filings with the Securities and Exchange Commission, including, but not limited to, those set forth in our annual report on Form 10-K for the fiscal year ended March 31, 2008.

Additional risk factors and other information you should consider will also be set forth in our quarterly report on Form 10-Q for the quarter ended June 30, 2008, which will be filed with the SEC in August.

These factors may cause our results to differ materially from the forward-looking statements we make on this call. We cannot guarantee future results, levels of activity, performance or achievements.

Our future results will depend on numerous factors including, among others, the impact of macroeconomic trends on information technology spending; market acceptance of our utility storage solutions; and competitive practices in our industry.

These forward-looking statements are made only as of today’s date and we expressly disclaim any obligation to update or revise the information contained in them.

Please also note this conference call will provide listeners with certain financial metrics determined on a non-GAAP basis, both for a comparison to previous quarters and the previous fiscal year and for our outlook for the current quarter.

These financial metrics, together with a reconciliation to comparable GAAP financial measures, are contained in today’s financial results press release, which we have posted on our website at Investor Relations on 3par.com surprisingly under Press Releases, and have furnished to the SEC on Form 8-K. We encourage listeners to review these items.

I’d now like to turn the call over to David Scott, CEO of 3PAR.

David Scott

Good afternoon and thanks for joining us for our first quarter fiscal year 2009 earnings call. Let’s start with the highlights. We’re delighted to report revenue of $43 million, 80% higher than our revenue in this period a year ago and a sequential increase of 21%.

Please note that out of the $39.9 million of product revenue, $2.2 million reflects a one-time accelerated recognition of deferred revenue related to the establishment of VSOE for ratable revenue deferred from our March 2007 quarter.

Without this one-time revenue recognition of deferred ratable revenue, we would have reported total revenue of $40.7 million, 71% higher than our revenue in this period a year ago, and a sequential increase of 15%.

In this quarter, we achieved gross margin of 65% and for the first time a GAAP profit of $678,000; excluding the impact of the $2.2 million one-time revenue recognition, we would have reported a GAAP loss $827,000.

This quarter we also increased our profit on a non-GAAP EPS basis to $0.03 per share; excluding the impact of the $2.2 million one-time revenue recognition we would have reported a non-GAAP EPS of $0.01 per share.

Our GAAP EPS was a positive $0.01 per share; excluding the impact of the $2.2 million one-time revenue recognition our GAAP EPS would have been a negative $0.01.

These results show that 3PAR continues to grow its market share despite tighter budget in a slower economy. Our business may not prove to be completely recession proof, but at this stage we believe, based on our results, that the economic environment is clearly favoring solutions like 3PAR’s that demonstrate strong return on investment and lower total cost of ownership.

Also I am pleased to announce today that our Board of Directors has approved an investment of up to $10 million for the purchase of shares of 3PAR common stock in the open market under new buyback program.

The approval of this repurchase program by the Board demonstrates the commitment 3PAR had to increase shareholder value. We believe our common stock is an attractive value at recent trading prices and the deployment of some of 3PAR’s capital into this investment is warranted.

Moving on, I would like talk about a few other recent achievements in the areas of international expansion, expanding our solution integration for virtualized utility computing environments; bringing an innovative new environmental program to the market; as well as the detailing our continued success with new customers and partners.

Last week we publicly announced in Japan that ITOCHU Techno-Solutions Corporation known as CTC and 3PAR have signed an agreement that CTC to resell the 3PAR InServ platform into the Japanese market.

Since CTC is the largest independent storage provider in Japan, we believe this partnership has the potential to be an extremely important extension of our channel in that country.

This quarter we also announced a reseller relationship with SYSDBA in South Africa. Our international expansion efforts in Europe and other parts of Asia Pacific continued with our first customer wins in China and the Netherlands. We now have sold 3PAR InServ platforms into 18 countries worldwide.

Over the last few months we have expanded our integration plans with VMware, as we continue to build out what we believe to be the strongest virtualized utility computing platform in the industry.

3PAR participated in VMware’s introduction of its Site Recovery Manager solution with the announcement of the 3PAR Replication Adapter. This product integrates VMware’s Site Recovery Manager with 3PAR’s Remote Copy replication facility to provide an end-to-end disaster recovery solution for utility computing IT architectures.

This can form the basis of resilient cloud computing delivery models for service providers, as well as enabling self service computing for large scale enterprises and government organizations.

In addition, we recently announced the 3PAR Thin Copy Desktop solution for VMware’s Virtual Desktop Infrastructure, which lets customers provision hundreds of high performance virtual desktops that consume only a fraction of the bandwidth and storage capacity that would otherwise have to be used with traditional storage approaches.

This integrated solution extends utility computing based IT architectures to efficiently handle the user interface for both self-service and cloud computing models.

We continue to encourage environmental responsibility, most recently with a new program called the 3PAR Virtual Technology Incentive Program or V-TIP. It combines the efficiency-related benefits of 3PAR utility storage and our previously announced carbon-neutral storage program with new financial incentives from selected utilities companies.

As part of this V-TIP program, the Pacific Gas and Electric utility, PG&E, in recognition of 3PAR’s energy-saving storage virtualization and thin provisioning technology, now offers energy rebates to qualifying 3PAR customers in Northern California.

Customers now have an even greater financial incentive to be environmentally conscious. We are actively exploring extending this program into areas served by other utilities.

During this quarter, we maintained our momentum in cloud computing with Terremark, a leading managed hosting provider, announcing that 3PAR utility storage was the foundation for its new Infinistructure Utility Computing platform that offers shared infrastructure services.

We also became a strategic supplier to DataPipe, another leading hosting service provider.

In addition, after thorough competition, we were awarded a win as the new operational standard for all mid-tier storage at Salesforce.com an acknowledged leader in the SaaS segment, as well as the new standard platform for all engineering and development within the account.

We also announced customer success stories, with NASA Ames Kepler project to search for new earth-like planets; NewsGator, a SaaS pioneer in Really Simple Syndication, or RSS technology for the web; and Demand Media, a Web 2.0 social media company.

Our repeat business from existing customers continued to be extremely healthy, with 81% of our business in the first fiscal quarter coming from existing customers, excluding support-related revenue. In addition, we had excellent success with new business wins this quarter.

Before turning to Adriel for the details of the financial results, I would like to congratulate the 3PAR team for their continued dedication to helping the company scale rapidly this quarter.

This included a seamless transition of our manufacturing function to a new and larger facility at the beginning of this June quarter. It takes significant focus, commitment and hard work to deliver great results.

Now to Adriel, our CFO to go through the financial results for this quarter in detail.

Adriel Lares

Good afternoon and let me add my welcome to David: thanks for joining us. As David mentioned we’re very please to report revenue of $43 million for this quarter, an increase of 80% over the same quarter a year ago and a 21% increase over the $35.5 million we reported last quarter.

Of this total, product revenue accounted for $39.9 million or 93% of total revenue, an increase of 73% over our product revenue recognized in the same quarter a year ago and a 23% increase from product revenue recognized last quarter.

Support revenue totaled $3 million, 7% of total revenue and an increase of 342% over support revenue recognized in the same quarter a year ago, and a 15% increase from last quarter.

As David has mentioned earlier, out of the $39.9 million product revenue, $2.2 million reflects a one-time accelerated recognition of deferred revenue related to the establishment of VSOE or vendor specific objective evidence for the ratable revenue deferred from our March 2007 quarter.

You may recall that we transitioned our software warranty model to a software support model in March 2007. With that change, because we had not established VSOE of the fair value of our new software support offering, we deferred revenue from product sales with software support in the month of March 2007.

Prior to this quarter, this revenue had been recognized on a ratable basis over the life of the software support associated with those contracts, which were primarily for three years at that time.

However, in reviewing our VSOE data point this quarter we have determined that we have established VSOE of fair value on our software support offering based on actually renewal data points.

As a result, we did an one-time revenue recognition of the deferred revenue balance related to the March 2007 ratable revenue in the amount $2.2 million. Without this one-time recognition of $2.2 million deferred revenue, we would have reported a total product revenue of $37.7 million, an increase of 63% over the same quarter a year ago, and a 15% increase over the product revenue recognized last quarter.

Our total revenue would have been $40.7 million for this quarter, an increase of 71% over the same quarter a year ago, and a 15% increase over the total revenue recognized last quarter.

In terms of new and repeat business split, 88% of total revenue in this quarter came from customers who had purchased from us previously. If we remove the portion of revenue contributed by software contract renewals, our repeat revenue for this quarter was 81%.

Again, this high rate of repeat business is in line with our expectation and further demonstrates the strength of our value proposition.

This quarter we had one customer that accounted for more than 10% of our total revenue. Although our customer concentration may fluctuate quarter-over-quarter as a result of factors such as timing of orders received and/or installed, we continue to expand our large customer base which is well diversified across a broad range of industries and sectors.

Turning to the geographic view, we generated 8% of revenue from customers outside the U.S. compared to 17% last quarter. As we said in the previous quarters, we continue to expect our international sales will contribute into the mid-teens percentage of our total revenue on an annual basis over the next couple of years, although this percentage may fluctuate quarter-over-quarter as a result of factors such as timing of orders received and/or shipped.

At this point, let me also take a moment to provide you with a few key metrics related to our orders received in the quarter. At the end of the quarter, we had a total of 44 productive account executives, compared to 42 at the end of last quarter.

If you recall, we define an account executive to be productive if he or she has been employed with us for more than six months. The average number of transactions per productive AE for the quarter was 7.3, as compared to an average of 6.9 transactions in the previous quarter.

Orders received during the quarter exceeding $1 million together accounted for a total of $6.6 million as compared to $12.5 million in the previous quarter. For the rest of fiscal 2009, we continue to expect the average total dollar value of orders received by productive AE in a quarter to be approximately $1 million.

Moving on down the P&L, cost of goods sold was $15 million and gross margin was 55%, compared to 64.6% last quarter.

As we have said previously, we continue to believe our gross margin is currently at an unsustainably high level. We continue to expect it to trend toward a long term target range of 62% to 64% level, although we won’t necessarily arrive there in a steady progression.

As we also have said each quarter, we expect our margins will fluctuate significantly, potentially on a quarter-to-quarter basis as a result of factors such as the timing of received orders and the product mix installed in a particular quarter.

Operating expenses totaled $27.8 million in the quarter or 65% of revenue, compared to $20.3 million or 85% of revenue in the same quarter a year ago, and $25.3 million or 71% of revenues in the prior quarter.

We are very pleased with this result and it continues to demonstrate our ability to improve operating efficiency. We remain on track towards our long-term operating margin target and are confident that we will achieve that target by the end of fiscal year 2011.

Within operating expenses, R&D expenses rose to $10.2 million from $7.8 million in the same quarter a year ago and $9 million in the prior quarter. The increase in absolute R&D expenses from last quarter to this quarter primarily reflects increased hiring and prototype expenses.

We plan to continue to invest heavily in our research and development efforts. We are convinced that R&D investments are necessary to maintain or improve our technology advantage and will lead to sustainable long-term awards.

Sales and marketing expenses rose to $14.3 million from $10.5 million in the same quarter a year ago, and $13.1 million we reported in the prior quarter. The main contributor to the increase was hiring; higher sales commission expenses, the result of significant revenue growth in the previous quarter; and seasonal events such as the sales pick up meeting.

G&A expenses were $3.4 million compared to $2.1 million in the same quarter a year ago and $3.1 million in the last quarter. The bulk of the increase reflects increased hiring in our finance and accounting departments, and incremental expenses related to our compliance with public company standards.

Our stock-based compensation expenses rose to $1.3 million this quarter compared to $540,000 in the same quarter a year ago and $1.2 million in the previous quarter. We expect our option-based compensation expenses to trend up incrementally from this higher level going forward.

As a result of these elements we just discussed, we are pleased to report, for the first time in our history, positive non-GAAP and GAAP operating income.

Our non-GAAP operating income for this quarter was $1.4 million, as compared to a loss of $4.3 million in the same quarter a year ago and a loss of $1.1 million in the previous quarter.

Our GAAP operating income for this quarter was $95,000 as compared to a GAAP operating loss of $4.8 million in the same quarter a year ago and a loss of $2.4 million in the previous quarter.

Our tax expense in this quarter was $170,000. We expect our tax expense to continue to be at this low level over the next few quarters given our significant net operating loss carry forward.

Our non-GAAP net income for the quarter was $2 million compared to $4.1 million net loss in the same quarter a year ago, and $60,000 non-GAAP net income in the previous quarter.

For the first time, we are reporting a positive GAAP net income. The GAAP net income for the quarter was $678,000, as compared to a $4.7 million net loss in the same quarter last year and a $1.2 million net loss in the previous quarter.

Excluding the impact of the previously discussed $2.2 million one-time revenue recognition, our non-GAAP net income for the quarter would have been $460,000 compared to a $4.1 million non-GAAP net loss in the same quarter a year ago and a $60,000 non-GAAP net income in the previous quarter.

The GAAP net loss for the quarter would’ve been $827,000 as compared to a $4.7 million net loss in the same quarter a year ago, and a $1.2 million net loss in the previous quarter.

We are pleased to report our non-GAAP EPS of $0.03 for the quarter on 63 million weighted average diluted shares outstanding, compared to breakeven in the previous quarter on 63 million weighted average diluted shares outstanding.

GAAP EPS for the quarter was a positive $0.01, compared to a negative $0.02 in the previous quarter.

Excluding the impact of the $2.2 million one-time revenue recognition, our non-GAAP EPS would’ve been a positive $0.01 per share for the quarter on 63 million weighted average diluted shares outstanding, compared to breakeven in the previous quarter on 63 million weighted average diluted shares outstanding.

GAAP EPS for the quarter would have been a negative $0.01 compared to a negative $0.02 in the previous quarter.

Just a reminder, the difference between our GAAP results and non-GAAP results is stock-based compensation expense and as reconciled in the exhibits attached to our press release available on the IR portion of our website.

As of June 30, cash, cash equivalents and marketable securities totaled $107.7 million. We had $115.6 million cash as of March 31, 2008.

On a worldwide basis, 3PAR employed 492 employees as of June 30, 2008, up from 451 full-time employees as of March 31, 2008 and 352 full-time employees as of June 30, 2007.

Also as David has mentioned earlier, our Board of Directors has approved a stock-buyback program under which we are authorized to repurchase up to $10 million worth of our common stock in the open market. We believe that the recent trading price of our common stock present an attractive opportunity for the investment of some of our capital.

With that, let me turn to our outlook for fiscal 2009 and remind you that we are not offering quarterly EPS guidance. We are raising our full year 2009 revenue expectation to be between $156 million and $171 million from the range between $161 and $168 million that was provided in the last quarter’s earnings call.

For the second quarter of fiscal 2009, we expect revenues to be between $40.5 million and $41.5 million. Our flattish second quarter revenue guidance, assuming that we have not had the one-time accelerated revenue recognition of $2.2 million deferred revenue, reflects our continuing cautiousness given market turbulence and uncertainties surrounding the macroeconomic environment.

We’re also raising our full year fiscal 2009 non-GAAP EPS expectation on a weighted average fully diluted share count basis to be between positive $0.06 and positive $0.10 from the range between $0.05 and $0.10 that was provided in the last quarter’s earnings call.

This guidance presumes a gross margin of 62 to 64% that we will continue to improve operating leverage with operating expenses as a percentage of revenue for the full year to be between 64 and 66%, though this may fluctuate beyond these boundaries for a particular quarter.

We continue to expect a 40 to 45% long-term revenue growth rate through our fiscal year 2011. Of course, this assumes we did not see a substantial worsening of macroeconomic conditions.

I’m very pleased with our performance in the quarter we are reporting today. Having said that I would like to reiterate that in the event that we overachieve revenue guidance and/or gross margin expectations, we will reinvest the additional profits primarily into the sales force and engineering.

We believe this strategy will allow us to reduce risk associated with achieving our long-term growth rate and potentially increase it. We believe this will benefit our business and shareholders from a long-term perspective.

With that, let me turn it back to David.

David Scott

Thanks, Adriel. We’re delighted by the continuing strength of our business results as we put more quarters under our belt as a public company.

In the tough high-end storage market competing against well-entrenched competitors and navigating in uncertain economic climate, we’re still being able to grow the business at over 70% year-over-year, as well as increasing our EPS performance substantially.

Our continued storage leadership with Green IT initiatives, virtualized infrastructure and utility computing appears to be increasingly well recognized. And we feel that the business outlook continues to look promising as we continue into the second quarter of our fiscal year.

And with that let me turn it over to the operator to poll for questions. Thank you.

Question-and-Answer Session

Operator

Your first question is from the line of David Bailey - Goldman Sachs.

David Bailey - Goldman Sachs

Great, thank you very much. Could you talk a little bit about your AE hiring expectations between now and end of the fiscal year and maybe how that compares to when you came into calendar 2008?

David Scott

David, from an AE hiring perspective, I think we’ve previously given guidance, so if you look at our long-term growth rate of 40 to 45%, we intend to be at a higher productive kind of AEs or ramp productive AEs at that rate.

Obviously, our growth this quarter wasn’t as great as we would have hoped it to be, but I think that’s a result of a very competitive hiring climate right now in the storage industry. But it’s an area of focus for us and we believe that clearly there is an opportunity to continue to hire aggressively.

David Bailey - Goldman Sachs

But do you think you could get to that 40 to 45% by the end of the year?

David Scott

Our commitments that we reiterated here is the goal of achieving 40 to 45% revenue growth rate on a compound basis through fiscal year 2011. So, yes we do believe we can achieve it.

David Bailey - Goldman Sachs

No, I meant on the hiring side.

David Scott

Yes.

David Bailey - Goldman Sachs

Okay, and then does your target for the year of $166 to $171 million. Does that include the $2.2 million?

David Scott

Yes.

David Bailey - Goldman Sachs

Okay, and then finally, could you talk a little bit about your cash flow expectations, and your priorities? Obviously you announced the buyback today, but what are your other cash priorities?

Adriel Lares

From a cash perspective, the buyback is included in our current cash projections internally for the company, but we have no other uses for that cash, other than the fact that we’re going to continue to invest into R&D from a capital expense perspective, by buying our own systems.

David Bailey - Goldman Sachs

Thank you.

Operator

Your next question comes from the line of Mark Kelleher - Canaccord Adams.

Mark Kelleher - Canaccord Adams

Thanks. Congratulations on a great quarter. Can you just talk about international a little bit? I know it varies, but it seems to have dropped off in the quarter. What are the things that are affecting that international number?

David Scott

The international number, Mark, is small in relationship to the overall size of the business and can fluctuate heavily dependent on timing of shipments and revenue recognition. The quarter was slightly weaker than we had expected it to be, but we’re also in the middle of a transition of our partnership in Japan.

As I think I talked about in my commentary, we’ve just announced a relationship with CTC in Japan. We believe that as that ramps up, we will see our international business from that perspective starting to grow again. There is a major opportunity there.

Obviously as we were changing out our channel there, we have one partner who is no longer aggressively moving forward with our channel in Japan, and CTC is replacing them.

Mark Kelleher - Canaccord Adams

Okay and the 10% customer, could you tell us what vertical that was in?

David Scott

Sure, it was in the Internet vertical.

Mark Kelleher - Canaccord Adams

Okay, and last question is just to follow up on that last question on the EPS guidance, does that include $0.01 or $0.03 from the June quarter?

Adriel Lares

That includes the $0.03 from the quarter.

Mark Kelleher - Canaccord Adams

Okay. Great, thanks.

Operator

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

Aaron Rakers - Wachovia

Congratulations on the quarter. First I’ll just ask on the prior question, the 10% customer, had that been a costumer in the past or is this a new customer for you?

David Scott

Yes, it was an existing customer.

Aaron Rakers - Wachovia

So a similar customer that was previously 10% within that vertical?

David Scott

Yes.

Aaron Rakers - Wachovia

Okay, perfect, and then last quarter I think you gave some color around possibly service provider as a vertical overall. Can you talk about how big that is as a percentage of your overall revenue?

David Scott

I think last quarter I talked about the business-to-business service providers growing from about 30% to 40% of our revenue. This quarter, if you exclude the impact of the very large Internet customer order, the change would not be significant from the direction that we had previously.

Aaron Rakers - Wachovia

Okay.

David Scott

It’s in the 30 to 40% range.

Aaron Rakers - Wachovia

Okay. And then federal government, I know you disclosed that in some filings, what was the contribution there?

David Scott

The federal government business I’d characterizes as okay.

Aaron Rakers - Wachovia

Okay. And then a final couple of things from me, housekeeping, you had in the past had talked about contribution between Fibre Channel and SATA, and then can you talk about the trend between repeat versus new customers? It looks like what you’ve disclosed, the new customer contribution, or revenue contribution, actually declined on a sequential basis.

David Scott

First of all, as far as the split between nearline and Fibre Channel from a bookings perspective, we saw it pretty much unchanged from last quarter, around 49% nearline; 51% Fibre Channel drive.

As far as the level of repeat business is concerned, yes, that continues to strengthen, and I think it gives you an insight into just the strength of our business model once we capture accounts.

We really end up planting, as we said before, these small seeds that subsequently give us very large ramp-rates for internal repeat business within those accounts.

I think last quarter, we referenced that we were delighted by the number of new customers we had won and that remains the case this quarters as well.

In term of the actual revenue from new customers, you are right, there was a slight sequential drop if you do the calculation between our fiscal Q4 and this last quarter, but it was nothing significant and certainly didn’t reflect a pattern of our new business accretion.

Aaron Rakers - Wachovia

Final question, can you characterize the competitive landscape now that we’ve seen EMC pushing its virtual provisioning within the DMX platform and it sounds like announcing the support for the CLARiiON box, may be as early as next week. Just what are you seeing from a competitive standpoint when I think about that new customer’s dynamic as well.

David Scott

From a competitive standpoint as far as EMC’s virtual provisioning impact, it’s been pretty much similar to the impact of Hitachi’s announcement of their Dynamic Provisioning which was their thin provisioning implementation, really not a lot. I think what is becoming clear to customers to do any thorough analysis of the capabilities, it’s as I said before.

The implementations that EMC and Hitachi have put together on DMX and the USP platform really don’t reflect the kind of ease of use, the kind of automation that is necessary to allow people to implement these products efficiently. You end up with what we called chubby provisioning that enhances operational overhead risk.

The great thing for us is that the major players that have endorsed the thin provisioning is really an important technology and now clearly because of our core architecture advantages, we’re able to demonstrate tremendous advantage here.

As the economic climate has worsened, the importance of reducing total cost of ownership has raised, and the value of our thin provisioning in terms of being able to not just reduce capital costs, but it reduced the cost of power, cooling, floor space, and now the additional financial incentives from things like our V-TIP program really makes the difference and enhances our value proposition.

Aaron Rakers - Wachovia

Thank you.

Operator

Your next question comes from the line of Brent Bracelin - Pacific Crest Securities.

Brent Bracelin - Pacific Crest Securities

Thank you. I have a couple questions here. First on the industry specific side, David, we’ve now seen a pretty healthy result out of IBM, EMC, and now 3PAR at the high-end of storage market.

Just trying to get your perspective on what’s going on there? Do you think we’re seeing upgrading of an aging installed base of high-end systems? Are you seeing customers decide to re-architect the data center and that’s why perhaps they are seeing resurgence here? What’s your best guess on why we’re seeing strength at the high-end here?

David Scott

I think there is a real driver towards improving efficiency through consolidation that’s occurring, and the type of consolidation that you achieve depends on effectively your strategy and how forward-looking you’re thinking.

Those people who are trying to get the maximum level of improvements in efficiency are really looking at virtualized infrastructures, from service to storage. They are looking at utility computing architectures, and we’re seeing the benefit of that in our growth rate as talked, around in the 70-80% range year-on-year.

For those people who are quite comfortable in getting there yet, you’ve got a different scenario of trying to eke out the improvements and efficiency you can get from consolidation using your existing vendors’ products.

I think you’re seeing that in the high-end results of companies like EMC, Hitachi, and IBM, where they have announced anywhere between I think 10 and 30% growth year-on-year for their high-end products.

Brent Bracelin - Pacific Crest Securities

Sure, thank you. That’s certainly helpful. Shifting gears, from a company-specific standpoint, if you look at the absolute value of large deals, $1 million-plus deals, it did decline in June from March, and from June of a year ago.

Obviously it didn’t impact the overall revenue business here that obviously was at record levels. But are you seeing a change in the buying behavior of your customers; are they buying smaller deals more frequently, what are you seeing there and how should we interpret that large deal mix going down here?

David Scott

So, importantly, I want to register that when we report that the amount of deal value we’re relating that’s over $1 million, we’re referring to bookings that we’re making in that first quarter and not to revenue. So there is no necessarily direct revenue impact. What it is, is a more of a forward looking indicator as to our business.

I would say that as we mature, it is becoming more and more obvious for customers buying into our technology for the first time, that they can take full advantage of the buy-just-in-time approach of our clustered architecture. They can start small and then grow very, very large within a single infrastructure.

I think when we weren’t very well known and people started to say, ‘well my first time buy may have to be of the same size as I buy from the EMC or Hitachi.’ Now they’re realizing that the first-time buy could be much lower, yet they scale just in time, and it’s a huge competitive advantage for us.

Brent Bracelin - Pacific Crest Securities

Okay, fair enough. Then as a follow-up to that, your guidance for the September quarter excluding the $2.2 million equates to flat-to-up September. Is that consistent with seasonal trends that you’ve seen in the past?

David Scott

I think if you look at our September revenue guidance, and you exclude the ratable revenue, you also have the impact from that large customer revenue that we refer to, the greater than 10% customer.

Some of that revenue we feel that was expected in the following quarter and got accelerated in, and therefore the resulting announcement of guidance in the flattish area of 40.5% to 41.5%, really reflects those two factors.

Brent Bracelin - Pacific Crest Securities

Okay, that’s helpful. My last question is really about Salesforce.com, obviously a customer that’s growing like a weed. One, was there any revenue you recognize from Salesforce in the quarter, and then two, as you think about that win, how competitive was the deal, and how important is that as a win for you going forward?

David Scott

First, we recognize no revenue from Salesforce.com in the quarter. That was a win that was awarded. Second, we feel it’s extremely important, because Salesforce.com, and your characterization, is growing like a weed, and it’s again, the SaaS segment, the Software as a Service segment, is one of three key segments in our business-to-business external service provider, kind of super segment if you like.

It’s a very important focus for us. We have a lot of customers in that space people, like Ariba, Symantec, with their Software as a Service offering and others, and gaining one of the premier accounts in this I think is just as significant as the position that we’ve established in the managed hosting segment.

Brent Bracelin - Pacific Crest Securities

Very helpful. Thank you.

Operator

Your next question is from the line of Thomas Curlin - RBC.

Thomas Curlin - RBC

Good afternoon and congratulations. A lot of questions have been asked on the business. Maybe a little bit on technology. Are you seeing at this point any real demand from customers to migrate their Fibre Channel infrastructure or connectivity over the Ethernet using FCoE, especially in that entrenchment to high-end Fibre Channel environment?

David Scott

The answer of that very quickly is none.

Thomas Curlin - RBC

Okay. That’s what I was expecting. Do you think that is a year out, two years out, three years out, or just no clue given to the recent status of that stuff?

David Scott

I remember back in the year 1999-2000, a great debate raging at the speed at which iSCSI would get adopted in the marketplace and I think…

Thomas Curlin - RBC

I remember that too.

David Scott

People were talking about it, is it going to be in a year or is it going to be in two year? As we all know it proved not to be the case until around the 2006 and 2007 timeframe; major changes in protocol in core data centers takes place much slower than people ever expect.

I think from that perspective Fibre Channel over Ethernet is an important strategic direction that I believe makes sense and will come but it don’t think it will become a really important element of major data centers until the 2010 timeframe.

Thomas Curlin - RBC

And is there emerging demand for 8 Gig Fibre Channel?

David Scott

The pressure to go from 2 to 4 was much greater than the pressure to go from 4 to 8.

Thomas Curlin - RBC

So, probably a slower adoption cycle there.

David Scott

I’d suspect so.

Thomas Curlin - RBC

Okay, and then iSCSI, are you seeing any pickup in interest there, may be at least for certain types of applications or, just how would you describe it?

David Scott

I think the interesting element of Fibre Channel over Ethernet is that ultimately that will probably be the primary target for most high performance data centers evolving from Fibre Channel. They will move from straight Fibre Channel to Fibre Channel over Ethernet.

I think in the large scale data centers iSCSI will still retain a place for connecting stranded service with relatively low IO requirements that maybe doesn’t make sense to put a Fibre Channel HBA in.

That’s really the only segment in the high-end enterprise data centers that I see iSCSI playing. Separately of course, in small to medium sized enterprises, who are just going to a SAN for the first time, I think there is a great strength of potential place for iSCSI in that segment today.

Thomas Curlin - RBC

All right. Thanks very much.

Operator

Your next question comes from the line of Clay Sumner - FBR.

Clay Sumner - FBR

Thanks very much, and congratulations. Just wanted to talk about the sales and marketing efforts, can you loosely describe how much of your sales and marketing efforts or budget focuses on new customer acquisition versus support of existing accounts? And is there any expectations that that mix might change?

David Scott

It has been on our strategy in the past for our sales force to primarily sell to both new accounts as well as to existing accounts. We have more recently, over the last couple of quarters started to focus certain account executives on expanding our presence in strategic accounts and really taking off of them the responsibility for going out and getting new business.

We think that’s the way of optimizing our penetration because I think we’ve talked about broadly, we have fairly low penetration in many of the large global 500 accounts who are our customers today and there’s a big opportunity to expand that.

I think there is a shift in our sales force focus that’s occurring towards hiring that kind of people who can expand within existing accounts that we’ve broken into but have huge potential opportunity.

From an overall sales and marketing perspective we have no plans that ease off our strategy of slowly aggregating new account wins that are the seeds for our future business growth. And we feel very, very comfortable with the rate of accretion of those wins today.

Clay Sumner - FBR

Adriel, you don’t see any trajectory change in a level of sales spending to parallel that?

Adriel Lares

No, that’s all within our plan at this point.

Clay Sumner - FBR

Okay. And I would expect actually to see you increasing new customer acquisition and an era of tight budgets forcing folks to look at lower costs to manage.

Just curious about the rate of new customer adoption clearly you are seeing the strong increase in your existing customer business. Are you actually seeing an increase maybe in the number of customers, or you are just not showing up as an increase in the revenue because it’s starting small or…

David Scott

I think we’ve had very strong new customer acquisition from the win perspective in both of the last two quarters. Because of revenue recognition timing it may not have shown up so much in the last quarter’s results.

But I think that is one element to the effect and the second element to the effect is definitely people feel far more comfortable in buying smaller and then expanding substantially over time and that is the trend that’s just a benefit of our clustering architecture.

Clay Sumner - FBR

Right. As you become more mature over time and more internationally or geographically diversified, are you expecting services cost to increase maybe just having to support more service people or might have actually service costs actually decreased as a percentage of revenue if you keep expanding so significantly within your existing customer base?

Adriel Lares

Certainly one of our objective is to try to leverage as much of the infrastructure as we can and it’s no surprise that we’re targeting the major city centers such as the Bay Area and New York and those areas.

We’ll continue to do that because the more concentration we get of customers in those areas we can leverage those depots, but at this point I can’t promise that we’re going to get that leverage right away. But it’s something that we’re certainly going to be trying to do and emphasis going forward.

Clay Sumner - FBR

Thank you.

Operator

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

Alex Kurtz - Merriman Curhan Ford

Congratulations. The first question is on linearity in the quarter. Can you just give us an overview of that and specifically in June was the business momentum coming out of June into the next quarter?

Adriel Lares

I’ll answer the first part of the question and hand over the second part to David. But from a linearity perspective, from a revenue standpoint our revenue quarters are more linear than our orders that we receive.

Orders, just like every other storage company, come in right at on the last month of the quarter, but in general it’s a little bit more linear; I won’t say that its exactly linear but it’s more linear than it would otherwise normally be.

David Scott

And in terms of the outlook as we were taking orders into the end of the quarter, I’d once again say that we could see no clear signs of the macroeconomic impacts following through an impacting our own results, yet we keep waiting for the other shoe to drop.

Alex Kurtz - Merriman Curhan Ford

Okay, great. Then on the CTC announcement, I know your largest competitor has footprints there in that NEC and I was wondering if you look at that announcement, from CTC’s prospective, what were they trying to get out the partnership and how they are looking deploy 3PAR in the near term as far as winning in the marketplace there?

David Scott

I think CTC is seeing in the Japanese market right now a strong trend towards people looking at Green IT virtualized infrastructure utility computing and they believe that 3PAR was the best partner to spearhead their efforts in that direction along with a virtualization product that they provide as part of their overall solutions.

They really saw us as providing something that their existing suppliers couldn’t and they are, from an independent reseller perspective the largest independent resellers VMC network appliance Hitachi in Japan so they couldn’t find what they wanted from their existing partners.

Alex Kurtz - Merriman Curhan Ford

If I’m at CTC trying to sell storage how am I getting directed internally within CTC to look at 3PAR; maybe that relationship is too new to come to a conclusion on that?

David Scott

I think that you’d have to ask CTC that in all fairness, but clearly the great focus is looking at next generation data centers, Green IT, virtualized infrastructure and utility computing.

Alex Kurtz - Merriman Curhan Ford

Okay and on the dual controller, I just hear a lot of buzz of that doing very well in the marketplace. Has the kind of environment that you’re selling into change from last quarter on the types of customer that’s looking out it?

Are you getting any pulling into maybe mid-markets space or at least the high-end of the mid markets space on that product or is that still a branch office solution for you for a larger enterprise?

David Scott

I think we are getting pull for the product into that space but are very cautious about responding to that pull. We target only the customers we believe had very rapid growth rate. So, they tend to be in the Internet Web 2.0 space where there are small to medium sized businesses, but with a potential of very rapid growth in storage capacity requirements.

Again our dual control offerings is a good fit for them, as a low cost starting point. Most of these companies are characterized by the fact that they’re trying to make investments upfront. Their businesses haven’t yet taken off so, it’s cool, it’s cool, it’s cool and then there’s viral marketing, the campaign takes off and it goes scorchingly hot.

They need a platform that they can suddenly change directions, be very agile, respond to this huge business demand very quickly. That’s what we have proven our capability doing in account, after account, after account and our references really show that and give these customers confidence that this is right platform for them strategically to choose.

Alex Kurtz - Merriman Curhan Ford

Okay. So it sounds like maybe there is a little bit more pull but you’re trying to keep it within verticals that you’ve been focused on historically?

David Scott

That’s correct. We’re not trying to target a traditional small to medium businesses in more generic industries where they don’t expect to grow very fast.

Alex Kurtz - Merriman Curhan Ford

Okay. Adriel cash flow operations from the quarter; if you have that? And it looks like service margin was down sequentially. Is that right and if so, how should we be thinking about that on a go forward basis?

Adriel Lares

Operating cash flow, that was about $889,000 to the negative.

Then in terms of the services margins, I think I may have mentioned in the past, that we in a thought that the services margin were unsustainably high and that we thought would probably meander somewhere between 65 and 70%.

Alex Kurtz - Merriman Curhan Ford

Okay, all right. Thanks a lot and congratulations.

Operator

Your next question is from the line Kaushik Roy - Pacific Growth Equities.

Kaushik Roy - Pacific Growth Equities

Thank you. Congratulations. In the past I think you have given the connect rate for iSCSI. Can you tell us what the iSCSI connect rate was?

Adriel Lares

Yes. It was around 18%.

Kaushik Roy - Pacific Growth Equities

Thank you. And on EPS for the full year, you’re guiding 6 to 10%. Is that GAAP or non-GAAP?

Adriel Lares

That’s $0.06 to $0.10.

Kaushik Roy - Pacific Growth Equities

$0.06 to $0.10 on a non-GAAP?

Adriel Lares

That’s correct; on a non-GAAP.

Kaushik Roy - Pacific Growth Equities

So if I take the mid point, which is $0.08 and you did $0.03 in non-GAAP in Q1, even if you do $0.03 for the next three quarters, I guess it’s $0.12. So does that mean that operating margins are coming down for the next few quarters?

Adriel Lares

Keep in mind Kaushik that the $0.03 that we achieved this quarter would have been $0.01 without the ratable revenue that got accelerated this quarter.

Kaushik Roy - Pacific Growth Equities

Okay. But you’re not expecting…?

Adriel Lares

If we take that out then we would have normally done $0.01 and you can figure out to yourself what you think we might have done over the next couple of quarters to get this $0.06 to $0.10 for the year.

Kaushik Roy - Pacific Growth Equities

But your revenues are not coming down; you’re growing at pretty good rate.

Adriel Lares

Right, we also said that we were guiding our revenues flattish from this past quarter to this quarter technically with the ratable revenues from a guidance perspective they’re actually slightly down. We say flattish because without that ratable revenue our revenue would have been $40.7 million and we guided $40.5 to $41.5 million.

Kaushik Roy - Pacific Growth Equities

Okay. Another clarification on gross margins, so for full year you’re guiding 64% to 66% on a non-GAAP basis is that correct?

Adriel Lares

We actually guided 62% to 64% on a GAAP basis. We didn’t given a non-GAAP guidance we just said 62% to 64%.

Kaushik Roy - Pacific Growth Equities

Can you comment what are your expectations for Q2 for gross margins?

Adriel Lares

We don’t guide that mainly because its unclear what the mix of products is going be in terms of the amount of the software composition and it could vary widely. So, we don’t give that guidance.

Kaushik Roy - Pacific Growth Equities

Okay. Thank you.

Operator

Your next question is from the line of Marc (inaudible) - (inaudible).

Unidentified Analyst

Looking forward to this buyback although I doubt you will be able to buy whole lot in $8 range given your results. Can you talk little bit about may be just directionally, unless you already you did, about the products deferred?

Adriel Lares

The deferred product revenue.

Unidentified Analyst

Yes.

Adriel Lares

Generally this quarter we’ve recognized where it basically accelerated what was on the balance sheet related to our deferral; last year it was March of 2007 when we switched to our software warranty model to a software maintenance model. It put on the books at that time about $6 million worth of business.

Then we were recognizing that $6 million of product revenue over approximately three years. We’ve been recognizing that little by little every quarter. This quarter we had enough data points from the VSOE perspective that it determined for us we had to actually accelerate that revenue in this quarter; that’s now off the books.

So effectively for this going forward from here it’s typical product software in the product revenue plus software maintenance that we’ll continue to layer in in the future.

Unidentified Analyst

Mostly what I am getting that is that was a drag on deferred revenue growth sequentially in the quarter pulling that out but if you take look at…

Adriel Lares

That’s true.

Unidentified Analyst

Is it growing similar to the pro forma revenue growth if you take out the first?

Adriel Lares

Yes. Without that the deferred revenue would have grown at around 14% without that ratable acceleration.

Unidentified Analyst

Great. And then with respect to your first guidance over the short-term, looking out a quarter, do you have the same kind of visibility that you typically do where a little bit more than half you basically have in hand, and then another one or two pieces are either shadow backlog plus new bookings, or how do you approach that in general?

Adriel Lares

In general of that particular quarter’s revenue 60% of it, it’s stuff that we see coming from backlog; there is another 20% in that quarter that potentially we think might fall in the following quarter or potentially to come into this quarter but we can’t quite see it yet.

Then that eventually falls in and then there was another 20% beyond that that is literally turns business and that turns business of that 20% is fairly linear to the quarter; we just get upgrade orders that we can turnaround fairly quickly and recognize revenue and that makes up the entirety of a quarter’s revenue.

Unidentified Analyst

Great, it sounds good. So raising guidance and keeping the OpEx levels similar obviously you have additional commission costs. But, how should I think of the additional spend in terms of is it accelerating existing projects and programs or does that allow you to start something completely new for calendar 2009, calendar 2010 results, that you hadn’t expect to start as early?

Adriel Lares

I think we also mentioned in the call, we are trying to reduce the risk of our long-term growth rate so many of the additional costs are there to strengthen the infrastructure of the company, whether it is strategic hires that we wouldn’t otherwise have hired or additional programs that actually leverage the current employee that we have.

So we trying to do everything we can here internally to strengthen the infrastructure again to make sure that we continue our long-term growth rate.

Unidentified Analyst

Great, thank you.

Operator

That concludes the Q&A session and concludes the conference. Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.

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