PAR Technology Corporation
Q4 2008 Earnings Call Transcript

Published: 19 May 2008

[Operator:]

Good day, ladies and gentlemen, and welcome to the fiscal fourth quarter 2008 3PAR Inc. earnings release conference call. My name is [Stacy] and I will be your moderator for today. (Operator Instructions) I would now like to turn the presentation over to 3PAR. Please proceed.

[Unidentified Company Representative:]

Good afternoon and welcome to 3PAR's fourth quarter and year end 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 first 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 SEC, including but not limited to those set forth in our quarterly report on Form 10-Q for the quarter ended December 31, 2007. Additional risk factors and other information you should consider will also be set forth in our annual report on Form 10K for the year ended March 31, 2008, which will be filed with the SEC in June 2008. These factors may cause our results to differ materially from the forward-looking statements we make in this conference call. We cannot guarantee future results, levels of activity, performance or achievements. Our future results will depend on numerous factors including, among others, the impact of macroeconomic trends on information technology spending, market acceptance of our utility storage solutions, and competitive practices in our industry. These forward-looking statements are made only as of today's date and we expressly disclaim any obligation to update or revise the information contained in the forward-looking statements. Please also note that this conference call will provide listeners with certain financial metrics determined on a nonGAAP basis for a comparison to previous quarters and the previous fiscal year and for our outlook for the current quarter. These fiscal metrics, together with a reconciliation to comparable GAAP financial measures, are contained in today's financial results press release, which we have posted on our website at Investor Relations on www.3par.com under Press Releases and have furnished to the SEC on Form 8-K. We encourage listeners to review these items. And with that, I'd now like to turn the call over to David Scott, CEO of 3PAR. David?

[David C. Scott:]

Good afternoon and thanks for joining us for our fourth quarter fiscal year 2008 earnings call. Let's start with the highlights. We're delighted to report revenue of $35.5 million, 204% higher than our revenue in this period a year ago and a sequential increase of 15%. 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, or vendor specific objective evidence, 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. This revenue is being recognized on a ratable basis over the life of the software support associated with those contracts, which was primarily for three years at the time. As a result, this quarterly revenue growth rate may not be meaningful as it does not reflect an applestoapples comparison. Notwithstanding that change, this top line result significantly exceeded our published estimates. We're particularly happy about our sequential growth as we achieved this result on top of an unusually strong third quarter and during a period when negative financial news and weak economic data have caused some to report softness in the March quarter. In this quarter we achieved a gross margin of 34.6% and our net loss narrowed to $1.2 million. This was better than Wall Street's consensus estimate of a net loss of $1.9 million. For the full fiscal year of 2008 we achieved a gross margin of 35.3% and a net loss of $10.1 million. This quarter and for the first time, we were at breakeven on a nonGAAP EPS basis. We achieved this milestone ahead of both our and Wall Street's expectations. The consensus estimate for our nonGAAP EPS this quarter was a loss of $0.02. Similarly, our GAAP EPS was better than expected at negative $0.02 compared to consensus estimates of negative $0.03. For the full fiscal year of 2008, we reported nonGAAP EPS of negative $0.19 and a GAAP EPS of negative $0.30. These results demonstrate our continued business strength as 3PAR takes market share from major incumbents even in the face of declining macroeconomic conditions. We believe this is clear measurable evidence that in challenging times customers are even more willing to find new ways to save money on storage. Our growing customer base recognizes that it makes no sense to continue writing oversized checks to their traditional suppliers for underutilized disk capacity and expensive professional services. I'd like to talk about a few other accomplishments in the quarter. These include our strategic penetration of cloud computing, how we continue to deliver utility computing solution leadership, and the increase in our business momentum both here in the U.S. and internationally. As we stated before, our largest customer segment is the business-to-business external service providers. This category includes companies offering software as a service, managed hosting, and business services over the Internet via cloud computing. This segment continued to perform strongly for 3PAR and grew from 30% to 40% of our business in the March quarter. We had strategic wins at two major new North American managed hosters, including Computer Sciences Corporation, continuing our rapid penetration in this segment. These organizations are at the forefront of a major wave transition occurring in the IT world towards the delivery of enterprise IT as a utility service. They're choosing 3PAR utility storage because of the system's unique combination of agility and efficiency within a Tier 1 platform. Even with unpredictable and diverse customer workloads, this agility lets service providers get their customers up and running faster, accelerating the time in which they can recognize revenue and receive cash. And service providers can reduce their cost by leveraging both the efficiency of our thin provisioning, snapshot and thin replication capabilities as well as our smart self-managing InForm operating software. This allows service providers to increase their cost competitiveness by driving down capital expenditures, [flow] space consumption, as well as power and people costs. 3PAR utility storage is making them more agile and cost efficient and therefore more competitive. As the service providers who are existing customers grow their business and add new customers, they need more storage and they generate even more repeat business for 3PAR. We estimate that there may be more than 3,000 enterprises hosted on 3PAR utility storage at businesstobusiness service providers. The strength of our repeat business rate - 83% this quarter - should be seen in this light. These numbers support our belief that 3PAR is extremely well positioned to take advantage of the trend toward cloud computing and the delivery of enterprise IT as a utility service. This is a trend we believe will continue to progress strongly over the next few years. Most customers are striving to achieve more with less. Last quarter, 3PAR continued to demonstrate how it can leverage its unique InSpire Architecture to that end with the announcement of its Nearline for Online solution. In traditional architectures, SATA disk drives are used for nearline applications like disk-to-disk backup, archiving and file system applications that typically have limited performance requirements. They're rarely used for performance-demanding Tier 1 online applications because of their limited ability to drive IOs and the length of time it takes to rebuild a failed SATA drive. 3PAR's architecture overcomes these limitations. The result is that with our Nearline for Online solution, customers can now run many online applications on cheaper SATA drives whereas they would require more expensive solutions from our major traditional competitors. In short, with 3PAR, customers can achieve more with less. The ratio of our Fibre Channel to SATA disk capacity in our booked orders was approximately 50

[Adriel G. Lares:]

Good afternoon, and let me add my welcome to David. Thanks for joining us. As David mentioned, we are very pleased to report revenue of $35.5 million for this quarter, an increase of 204% over the same quarter a year ago and a 15% increase over the $30.8 million we reported last quarter. Of this total, product revenue accounted for $32.8 million or 93% of total revenue, an increase of 191% over our product revenue recognized in the same quarter a year ago and a 13% increase from product revenue recognized last quarter. Support revenue totaled $2.6 million, 7% of total revenue and an increase of 581% over support revenue recognized in the same quarter a year ago and a 47% increase from last quarter. For the full fiscal year of 2008 we reported total revenue of $118 million, an increase of 78% from last fiscal year. Of this total, produce revenue accounted for $111.7 million or 95% of total revenue, an increase of 72% from last fiscal year. Support revenue accounted for $6.3 million, an increase of 432% from last fiscal year. As David has mentioned earlier, as a result of our revenue recognition accounting change in March 2007, periodtoperiod revenue growth rates may not be meaningful as they do not represent a complete applestoapples comparison. However, starting with the first quarter of fiscal 2009 going forward, review comparisons on a periodtoperiod basis should be meaningful because for all the periods we expect to have VSOE of the fair value of our software support offering. In terms of new and repeat business [inaudible], 83% of total revenue in this quarter and 79% of total revenue for fiscal 2008 came from customers who had purchased from us previously. If we remove the portion of review contributed by software contract renewals, our repeat revenue for this quarter and the fiscal 2008 was 75% and 74% respectively. Again, this high rate of repeat business is in line with our expectations and further demonstrates the strength of our value proposition. I also want to reinforce again, as I did last quarter and on our road show, that we have a large and diversified customer base spread across a broad range of industries and sectors. For both this quarter and fiscal year 2008, we did not have a single customer accounting for more than 10% of our total revenue. Turning to the geographic view, we generated 17% of revenue from customers outside the U.S. compared to 21% last quarter. As we said last quarter, we continue to expect our international sales will contribute in the midteens percentage of our total revenue on an annual basis for the next couple of years. 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 42 productive account executives compared to 38 at the end of the December quarter. If you recall, we define an account executive to be productive if the account executive has been employed with us for more than six months. Additionally, 17% of our orders received this quarter included [inaudible]. The average number of transactions per productive AE for the quarter was 6.9 as compared to an average of 8.4 transactions in the previous quarter. Orders received during the quarter exceeding $1 million together were a total of $12.5 million as compared to $10.1 million in the previous quarter. Looking forward to fiscal year 2009, we continue to expect the total average dollar value of orders received by a productive account executive in a quarter to be approximately $1 million. Moving on down the P&L, cost of goods sold was $12.5 million and accounted for 35% of revenue, allowing us to achieve a gross margin of 64.6% compared to 65.1% in the previous quarter. As we have said previously, we continue to believe our gross margins to be currently at an unsustainably high level. We continue to expect it to trend toward a long-term target of 62% to 64% although we won't necessarily arrive there in a steady progression. As we also said, we expect our gross 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 $25.3 million in the quarter or 71% of revenue, compared to $19 million or 163% of revenue in the same quarter a year ago and $22.4 million or 73% of revenue in the previous quarter. For fiscal year 2008 our operating expenses totaled $89 million or 75% of revenue compared to $58.7 million or 89% of revenue in the previous fiscal year. We remain on track towards our long-term operating margin target and are confident that we will achieve the target by the end of fiscal year 2011. Within operating expenses, R&D expenses rose to $9 million from $8.2 million in the same quarter a year ago and $8.3 million in the previous quarter. The increase in absolute R&D expenses from last quarter to this quarter primarily reflects increased hiring and prototype expenses. For fiscal year 2008, our R&D expenses were $34.1 million, an increase of 39%, from $24.5 million reported for the previous fiscal year. We plan to continue to invest heavily in our research and development efforts. We are convinced that R&D investments are necessary to maintain and improve our technology advantage and will lead to sustainable long-term rewards. Sales and marketing expenses rose to $13.1 million from $8.9 million in the same quarter a year ago and the $11.8 million we reported in the previous quarter. The main contributor to the increase was sales commission expense related to end-of-year accelerators. Since the accelerated commissions are based on full year achievements, they are only recognized in the fourth quarter of the fiscal year. Therefore, this increase in sales commissions is a once a year seasonal factor. For fiscal year 2008, our sales and marketing expenses were $45.3 million, an increase of 61% from $28.1 million reported in the previous fiscal year. G&A expenses were $3.1 million compared to $1.9 million in the same quarter a year ago and $2.3 million in the last quarter. For fiscal year 2008, G&A expenses were $9.7 million, an increase of 59% from $6.1 million reported in fiscal 2007. The bulk of the increase reflects incremental expenses related to our compliance with public company standards. We would expect this number will remain at this new higher level as we have planned to continue to make investments in order to maintain compliance with the regulations and reporting obligations that being a public company entails. Our stock-based compensation expense rose to $1.2 million this quarter compared to $425,000 in the same quarter a year ago, but stayed flat from the previous quarter. For fiscal year 2008, our stock-based compensation expense rose to $3.6 million compared to $1.8 million reported in the previous fiscal year. We expect our option-based compensation expense to trend up incrementally from this higher level going forward. As a result of these elements we just discussed, our non-GAAP operating loss for this quarter was $1.1 million as compared to a loss of $11.5 million in the same quarter a year ago and a loss of $1.1 million in the previous quarter. Our non-GAAP operating loss for fiscal year 2008 was $8.4 million as compared to $14.7 million last year. Our GAAP operating loss for this quarter was $2.4 million as compared to a GAAP operating loss of $11.9 million in Q4 of 2007 and a loss of $2.3 million in the third quarter. Our GAAP operating loss for fiscal year 2008 was $12 million as compared to $16.4 million in the previous fiscal year. Our tax expense in this quarter was $52,000. We expect our tax expense to continue to be at this level over the next few quarters given our significant net operating loss carryforwards. Our non-GAAP net income for the quarter was a positive $60,000 compared to an $11.3 million net loss in the same quarter a year ago and a $664,000 net loss in the previous quarter. Our non-GAAP net loss for fiscal year 2008 was $6.5 million as compared to a loss of $13.7 million in the previous fiscal year. The GAAP net loss for the quarter was $1.2 million as compared to an $11.7 million net loss in the same quarter last year and a $1.9 million loss last quarter. Our GAAP net loss for fiscal year 2008 was $10.1 million as compared to a loss of $15.5 million last fiscal year. We are pleased to report breakeven earnings per share on a non-GAAP EPS basis for the quarter on 63 million weighted average diluted shares outstanding, ahead of our internal expectations and compared to a negative $0.02 in the previous quarter on 39.8 million weighted average basic shared. GAAP EPS for the quarter was negative $0.02 compared to a negative $0.05 in the previous quarter. Our non-GAAP EPS for fiscal year 2008 was negative $0.19 on 34.1 million weighted average basic shares outstanding compared to negative $0.77 in the previous fiscal year on 17.7 million weighted average basic shares. Just a reminder, the difference between our GAAP results and non-GAAP results is stock-based compensation expense and is reconciled in the exhibits attached to our press release available on the IR portion of our website. As of March 31, 2008 cash, cash equivalents and marketable securities totaled $115.6 million. We had $97.6 million in cash as of March 31, 2008. On a worldwide basis, 3PAR employed 451 full-time employees as of March 31, 2008, up from 426 full-time employees as of December 31, 2007 and 312 full-time employees as of March 31, 2007. With that, let me turn to our outlook for fiscal 2009 and remind you that we are not offering quarterly EPS guidance. We expect revenue to be between $161 million and $168 million for fiscal 2009 and between $35 million and $36 million for the first quarter. Our first quarter revenue guidance reflects our continuing cautiousness given market turbulence and uncertainty surrounding the macroeconomic environment. We expect non-GAAP EPS on a weighted average fully diluted share count for the full year to be between positive $0.05 and positive $0.10. This guidance presumes a gross margin of 62% to 64% and that we will continue to improve our operating leverage with operating expenses as a percentage of revenue for the full year to be between 64% and 66%, though this may fluctuate between these boundaries for a particular quarter. We continue to expect a 40% to 45% long-term revenue growth rate over the next three years. Of course, this assumes that we do not see a substantial worsening of macroeconomic conditions. I am very pleased with our performance this quarter, what we are reporting today, as well as in the fiscal year 2008. I would also like to emphasize 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 maintain or increase our growth rate and benefit our business from a long-term perspective. As a final housekeeping detail and to head off the barrage of incoming phone calls, I would like to update everyone on the expiration date of our lockup related to our IPO last November. The lockup expires on May 24, meaning shares subject to the underwriting lockup will effectively be eligible for trading on May 27. With that, let me turn it back to David.

[David C. Scott:]

Thanks, Adriel. We're very pleased with our performance this quarter. We've achieved a key milestone by achieving breakeven on a non-GAAP EPS basis. We remain focused on moving the business towards our long-term operating model while investing to be sure that we're well positioned for long-term growth. We believe that the trends towards delivering enterprise IT as a utility service using cloud computing as well as the growing imperative for customers to achieve more with less strongly favors 3PAR's existing value proposition. And with that, let me turn it over to the operator to poll for questions. Thank you, Operator.

[Operator:]

(Operator Instructions) Your first question comes from David Bailey - Goldman Sachs.

[David Bailey:]

A couple of questions, if I could. You mentioned the macro conditions when you gave your Q1 or your March quarter targets - or your June quarter targets, sorry about that. Can you talk a little bit about any changes that you're seeing in bookings, either the amount or the linearity because of the macroeconomic?

[David C. Scott:]

I think we are primarily looking to just be cautious in terms of the continuing economic news that we're picking up and sensitive to some of the softness that has been reported in some other enterprise players. Our business through last quarter, as you can see, remains strong, even in the face of concerns that were expressed at the turn of the year. But we think it's important to remain cautious. There is just too much news out there to ignore.

[David Bailey:]

And then the second question is your internal inventory and accounts receivable both grew at about twice the rate of our sequential revenue growth in the March quarter; can you help us understand what caused the increases, and how do you expect DSOs and inventories to trend in the June quarter?

[Adriel G. Lares:]

With respect to inventory, we actually had a transition in our manufacturing facility where we expanded our facilities to a much larger facility. In doing that, we sort of bulked up on inventory a bit here at the end of the quarter to make sure we had both inventory in our current location as well as in the new location. As it relates to accounts receivable, I'm not sure that there's too much of a trend there to see other than I think deferred revenue went up a little bit. But other than that, I don't see anything unusual about it at this point.

[David Bailey:]

And is most of the inventory, then, in work in process or is it in finished goods?

[Adriel G. Lares:]

The other matter, just to get to your question there, is also we have a safety stock program that we just initiated which also increased that a little bit. And then to address your question, you said is it mostly in finished goods?

[David Bailey:]

Yes.

[Adriel G. Lares:]

At this point I don't think there's any major things. It's probably mainly in manufacturing.

[Operator:]

Your next question comes from Mark Kelleher - Canaccord Adams.

[Mark Kelleher:]

Just to follow up on that last question a little bit, you mentioned the deferred revenue up a bit. Is that maintenance? What's boosting the deferred revenue?

[Adriel G. Lares:]

In deferred revenue there's two components. There's the short-term and the long-term. The short-term reflects those shipments that we have or orders that we have shipped, but we have not yet recognized revenue. Effectively, we have invoiced them but we haven't recognized revenue on them.

[Mark Kelleher:]

And can you talk a little bit about the competitive environment? Are you seeing different win rates? I know EMC has some new functionality out there. Anything different on that front?

[David C. Scott:]

We've seen absolutely no impact, Mark, in terms of kind of new EMC functionality in the kind of paradigm of the competitive deal structure we're seeing. I think the competitive environment has not changed significantly since last quarter.

[Mark Kelleher:]

And how about the financial sector? Are you seeing any particular weakness over there?

[David C. Scott:]

We've seen some of the kind of prospects that we've had go through weakening cycles, but our revenue this quarter in financial services was again robust.

[Operator:]

Your next question comes from Thomas Curlin - RBC Capital Markets.

[Thomas Curlin:]

It seems like you didn't have any 10% customers, but your average number of deals per rep was down so it seems like your, I guess, productivity, your deal sizes are up on a broad basis for the quarter. Is that a fair assessment of what happened during the quarter?

[David C. Scott:]

I think pretty much it's a fair assessment of what's happened. I think the fluctuations in the number of transactions from a quarterly perspective, it's probably wrong to compare them quarter to quarter but map out how the trends have been over a longer period of time. And if you look at it over a longer period of time, you won't see it that substantially different from the trends.

[Thomas Curlin:]

And then, with the two controller product now out, how is that faring for you, and is it driving any change in the mix of competitive engagements, in other words, who you're seeing, who you're competing against in deals?

[David C. Scott:]

Because we tend to target large-scale enterprises and service providers and big government organizations and the E Class, which is the dual controller, is really a platform extension to address kind of remote sites and departmental opportunities, we tend not to have seen any change in the competitive environment. If you're asking do we see players like Compellent or EqualLogic, etc., the answer is no because really their focus is still on the small to medium size enterprises, and so there's very, very little overlap.

[Thomas Curlin:]

And then finally, just in terms of pipeline, the comments about macro seem appropriate and prudent but do you feel like the pipeline is reflecting that or are you taking a more conservative approach on close rates or is it just a purely sort of qualitative comment given anecdotal comments from the field?

[David C. Scott:]

I think it's really more of the latter, the qualitative comments. We suspect that for those vendors who have seen softness there will become kind of a level of increased desperation that occurs. And so in that environment you start to see stranger competitive dynamics that will occur, and you should be cautious in how you handle your outlook from that perspective. But I wouldn't say that there is anything from our existing pipeline that would indicate concerns on the macroeconomic condition.

[Operator:]

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

[Brent Bracelin:]

A couple of questions if you could here, David. The first question's really on the mix of revenue from existing customers. It certainly has increased here for three consecutive quarters. It implies you're doing a good job increasing the share with existing customers. And the flip side of that would suggest that revenue from new customers is down ticking here a little bit. How shall we think about that, and do those trends start to reverse themselves as you ramp up some of those new productive sales reps?

[David C. Scott:]

I would characterize it slightly differently, Brent. I was delighted by our new customer win rate last quarter, and it was very strong. And so I don't think - I think what you can reflect on is that we're continuing to plant new seeds for future repeat business growth very successfully as we continue to cultivate our existing customers, who tend to be large aggregators of storage demand.

[Brent Bracelin:]

And then wanted to ask a follow up on the service provider side, cloud computing side of the business, that was, what, 40% of the mix in Q4 and was it actually 30% in Q1, just to clarify?

[David C. Scott:]

Yes, it went up from 30% to 40%. So that area of our business grew very strongly from quarter to quarter sequentially.

[Brent Bracelin:]

So if you look at the momentum there and if I looked at revenue outside of that category, it would imply that revenue outside of that category would be kind of flat to down sequentially. As you think about revenue outside of the service provider category, what are you seeing there? Are there any customers kind of pausing here in the short run, and what are the dynamics in that segment outside of the service provider category?

[David C. Scott:]

Sure. I think I already mentioned it on the call but financial services was robust and fundamentally was continuing to kind of perform and grow at the rate of the overall business. I think in the last quarter whether, if there was some weakness, it was slightly less as a percentage of revenue in the government space and maybe slightly lighter in the Internet Web 2.0 space. But I don't see any kind of particular signs that that is a problem area developing.

[Brent Bracelin:]

And then back to the service provider business. Obviously, it's 40% of the mix today. You signed it sounded like two large customers. One was CSC. What was the other new customer there, and then what do you think that business could be in fiscal 2009 here. Could it be half of the business? How much momentum do you have on that service provider side?

[David C. Scott:]

I would have given you the other customer's name if I could have given you the other customer name, but I can't at this stage. Hopefully at a latter stage we will be able to. But I called out the macro trend that we are seeing towards cloud computing and the delivery of enterprise IT as a utility service for good reason. We have a strong sense that this is a rapidly growing evolution of the way enterprises are looking to source their core IT infrastructure. We believe that it's very similar to kind of Nicholas Carr's discussion of how electricity moved from kind of generating in local factories, you know, with water wheels or whatever, to getting your electricity via a grid and a utility service. And we think that kind of macro trend appears to be playing out in the area of infrastructure IT. We've tried to position our platform to be optimized for utility computing infrastructures which, by definition, are going to be at the heart of these new utility service models going forward. By securing that position, we think we're going to be able to ride the wave. And although I'm not prepared to put any goals on the percentage of our business it's likely to be in the future, we certainly see it's a strong trend. And if that trend outgrows the rest of the market, we would expect it therefore to be reflected in our own future financial performance.

[Brent Bracelin:]

And my last question - I'll cede the floor - really had to do with the HP, VMware, kind of 3PAR partnership, 3cV. You talked about Hilton as a new customer win there as part of that program, but could you give us a little more insight or color on how close you're working with the HP c-Class, how close you're working with VMware, and then kind of quantify how much interest is there in kind of a bundled kind of blueprint solution?

[David C. Scott:]

Well, there's definitely interest in the solution blueprint. The beauty of kind of shared virtualized infrastructure is it's not like the old model where you used to buy an SAP application. You bought all the servers, the storage and the application and some professional services all from one vendor, a systems integrator or [inaudible]. People build out these shared virtualized infrastructures themselves because they are technology integrators, whether you're a large-scale service provider or a large financial services organization acting as an internal service bureau, and so you don't need a single go-to-market channel for its delivery. Now on the other half of your question, we clearly continue to work very closely with probably more VMware than necessarily with HP because the integration that happens between server and storage tends to happen more at the kind of operating system level.

[Operator:]

Your next question comes from Alfredo Pinero - Thomas Weisel Partners.

[Alfredo Pinero:]

My question is about gross margins. Is there anything that you saw in the quarter, some of the levers that helped you achieve about the 65% gross margins for the quarter? And also is there anything that is giving you confidence to achieve the range of guidance of the gross margins you gave for the next fiscal year?

[Adriel G. Lares:]

As it relates to the gross margin, we're just looking in the past what fluctuates gross margin a bit and the way that we price our disk drives. We price our software on a license to use per disk drive so the larger the system that we recognize in a particular quarter, there's sort of a bump or an increase in gross margins for that particular quarter. So we happened to have larger systems that were recognized in this past quarter. But we sill maintain our sort of 62% to 64% long-term operating model. And it has fluctuated in the past so we're cautious about that and just want to make sure that models don't get too aggressive when it comes to pushing up the gross margin. But we still feel confident about the 62% to 64% long-term model and especially as it relates to the fiscal year 2009 guidance.

[David C. Scott:]

And just to add, Alfredo, why we believe that to be the case, I think there are two factors. I think the competitive environment is likely to strengthen over time with more price competition. And also, if you look at the cost of commodities, I think there is clearly the potential for kind of increases in cost of goods sold over time for which we're somewhat cautious.

[Alfredo Pinero:]

What was the direct versus indirect sales for the quarter, and is there any change in that segment?

[Adriel G. Lares:]

The direct sales for the quarter was 79% direct and 21% indirect. That's up from last quarter, where it was 66% direct and 34% indirect. This is more with what we thought is in line because we are a direct sale company. The 21% that's indirect is primarily those international locations that are nonEnglish speaking, nonnative English speaking, where we use resellers as well as those government entities that require a reseller that we sell through.

[Operator:]

(Operator Instructions) Your next question comes from Alex Kurtz - Merriman Curhan Ford & Co.

[Alex Kurtz:]

So just a couple quick questions with Adriel, then I'll jump over to David here. So Adriel, the services margin in the quarter, am I missing - it seems like it dipped a little bit in the quarter or maybe I'm miscalculating that.

[Adriel G. Lares:]

No, it came down a little bit. And, you know, we've talked about it in the past, that we expect the support margins to get into sort of the 70% level. We thought that sort of the high [inaudible] level was an unsustainable level, and I think this is more the level that you should see going forward.

[Alex Kurtz:]

So in the low 70s is sort of the target on that?

[Adriel G. Lares:]

Correct.

[Alex Kurtz:]

And the net interest income or sort of the net interest expense every quarter, should we be looking at $1.25 million going forward? Is that a good run rate?

[Adriel G. Lares:]

It's probably more like $700,000 to $800,000. You know, what we're experiencing this past quarter obviously is the rate decreases though we did have some higher rates in the money market funds in the earlier part of the quarter. But our Fed Chairman has certainly taken care of that.

[Alex Kurtz:]

And just to make sure, your gross margin guidance, that's non-GAAP, right?

[Adriel G. Lares:]

No, the - yeah, that's GAAP, actually. The 62% to 64% is GAAP.

[Alex Kurtz:]

So we just factor in a certain portion of your stock comp?

[Adriel G. Lares:]

Correct, which is relatively small in that area.

[Alex Kurtz:]

And David, if you look at your net new customers wins in the quarter, would you characterize those as branch office sort of secondary sites of larger enterprise customers or did you see actual wins in large core data center, where you're sitting next to large symmetric arrays?

[David C. Scott:]

The vast majority is core data center wins.

[Alex Kurtz:]

And as far as just, you hear a lot about elongation of the sales cycle, a lot more CIOs and CFOs getting involved. This is sort of the comments we heard from a lot of tech companies this quarter. Did you see similar types of trends with your customers? Obviously, you guys had a nice quarter, but are those some of the kind of things that you saw in the sales cycle?

[David C. Scott:]

In the last couple of weeks of the quarter I think it's accurate to characterize that every single deal that we thought was going to come in did come in. We saw nothing that pushed over the quarter boundary.

[Alex Kurtz:]

And any vertical internationally that sort of stood out to you this quarter or was it sort of in line with what you've seen in prior quarters?

[David C. Scott:]

Nothing unusual.

[Operator:]

Your last question comes from [Mitch] - Pacific Growth Technologies.

[Mitch:]

Just a quick question for you. You had said how the competitive environment is probably going to expand going forward. Any thoughts into moving kind of down market in terms of products or seeking out OEM relationships going forward?

[David C. Scott:]

There are always thoughts, Mitch, but no. Focus is the key to success, we believe, and our focus on kind of the high-end enterprise and service provider marketplace and government is where we will kind of remain fixed. And I think the increased competitiveness is more likely to be a response from the traditional major incumbents who were really used to dividing the pie three or four ways and now they'll start dividing the pie five ways.

[Mitch:]

Do you see the increased competitiveness as more of a pricing element or them developing more features to be more competitive?

[David C. Scott:]

I think it's mainly going to be around pricing competitiveness rather than feature based.

[Operator:]

There are no further questions in the queue.

[David C. Scott:]

Well with that, I just want to say thank you very much for joining us in our second earnings call following the IPO. We're again very pleased that it was a successful one. Thank you. We look forward to speaking with any of you later on during the quarter. Take care.

[Operator:]

Thank you for your participation in today's conference. This does conclude your presentation. You may disconnect.