PAR Technology Corporation
Q2 2009 Earnings Call Transcript

Published: 11 Nov 2008

[Operator:]

Good day, ladies and gentlemen, and welcome to the 3PAR second quarter fiscal 2009 earnings conference call. My name is Katie and I’ll be your coordinator for today. (Operator instructions) I would now like to turn the call over to the company. Please proceed.

[Unidentified Company Speaker:]

Good evening and welcome to 3PAR’s fiscal year 2009 second 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 Exchange Act of 1934 as amended. These forward-looking statements include among others, statements about our financial projections and growth trends for the third quarter and full year of fiscal 2009 and beyond, as well as financial projections and growth trends for the overall storage market and segments thereof. Anticipated impact and effectiveness of our market business and investment strategies, anticipated market share opportunities and diversification of our customer base, anticipated demand for our storage solution and reception of our value proposition as well as adoption trends in our customer markets. All of these forward-looking statements involve known and unknown risks and uncertainties and important factors that may cause our actual results, levels of activity, performance or achievement 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 quarterly report on Form 10-Q for the quarter ended June 30, 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 September 30, 2008 which will be filed with the SEC in November. These factors may cause our results to differ materially from the forward-looking statements we make on this conference call. We cannot guarantee future results, levels of activity, performance, or achievements. Our future results will depend on numerous factors including among other 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 that 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 www.3par.com under press releases and have furnished to the SEC on Form 8-K. We encourage listeners to review these items. With that, I’d now like to turn the call over to David Scott, CEO of 3PAR. David?

[David Scott:]

Good afternoon and thank you for joining us for our second quarter fiscal year 2009 earnings call. We’re pleased to report revenue of $45.1 million, 61% higher than our revenue in this period a year ago, and 5% higher than the previous quarter. The 5% sequential increase was particularly impressive given that we had accelerated a significant amount of revenue into our first fiscal quarter from the rest of the year including the quarter which we are reporting today. This top line result exceeded our guidance and we believe this trend demonstrates continued strength in our customer markets and demand for our products. In fiscal Q2 we achieved a gross margin of 65.2%. I’m pleased that we continue to be able to maintain these gross margins levels. It’s an important measure of our customer’s view of the value that we deliver to their organizations. We delivered net income of $520,000 on a non-GAAP basis excluding stock-based compensation expenses. This result translated into a non-GAAP EPS of $0.01. We achieved this in spite of substantial headwinds in the other income line including negative currency effects and substantial reductions in net interest income. Our GAAP EPS including expenses related to stock options was negative $0.02 a share. I’d like to talk about a few other achievements in the quarter in the areas of our new platform rollout, continued innovation and the build-out of our business both domestically and internationally. We announced our new T-class InServ storage server in September which we’ve been successfully shipping since the beginning of that quarter. This new platform reinforced our leadership position as the fastest storage array in the industry as independently audited by the Storage Performance Council under its SPC-1 benchmark. The T-class delivers approximately two to three times the performance of the S-class platform that it replaces and we’ve been delighted by its rate of uptake within our customer base. We’ve also been extending our leadership in thin provisioning innovation with our "Start Thin, Get Thin, Stay Thin strategy". Thin provisioning 1.0 was about starting thin applied to new applications that were being deployed. Thin provisioning 2.0 is about getting thin to extend the benefit to existing data volumes that were created using traditional fat provisioning techniques. The T-class platform included our new Gen3 Asic with a thin built-in zero detection design. It enabled efficient and non-disrupted fat to thin data migrations. This capability can let customers efficiently migrate petabytes of bloated fat data volumes from our competitors existing installed bases on to 3PAR, delivering them a substantial return on investment. This is an example of our intent to differentiate in both software and hardware. And we intend to continue innovating at a rapid pace. The next phase, thin provisioning 3.0 is about staying thin. A previous limitation of thin provisioning was that physical storage capacity can become trapped when used with file systems that are subject to significant file deletion over time. If the file system does not reuse the storage capacity immediately it can cause written utilization efficiency on the storage array to drop. Two weeks ago we announced a partnership with Symantec on a joint thin reclamation ATI to address this challenge. With thin reclamation, Symantec’s file systems can signal the unused storage blocks associated with deleted files and 3PAR systems will be able to reuse those blocks. Rather than having to purchase more storage, this freed storage capacity can then be used for other applications resident on the 3PAR storage array. Our leadership in thin provisioning has received ever greater industry attention. Last quarter 3PAR received the 2008 Frost & Sullivan North American Technology Innovation Award. This award was in recognition of the revolutionary impact of 3PAR’s thin provisioning technology on the storage industry. Thin provisioning is also being recognized for its extremely positive impact on energy efficiency and 3PAR customer, Hilton Grand Vacations, was recently chosen by Storage Networking World in conjunction with Computer World and the Storage Networking Industry Association to receive the award for return on investment and best practices in green computing. We believe our comprehensive Start Thin, Get Thin, Stay Thin strategy will enhance both our competitive leadership and our reputation for ongoing platform innovation. Over the last few months we’ve continued our integration within the broader storage and virtualization ecosystems. We announced a cooperative support agreement with Microsoft for Hyper-V, participation in the Oracle Unbreakable Limits program as well as support for Symantec’s SmartMove technology. Our customers can benefit from better integrated 3PAR solutions as they build out their utility and cloud computing infrastructures. Internationally, we recently announced new partnerships with Databasement, a storage systems integrator, who will represent 3PAR utility storage offerings in the Netherlands, Germany, and Spain as well Knitlogix, a storage reseller who will distribute the InServ platform in India. Turning to the economy, we’ve been monitoring the demand environment closely given recent developments. To date we’ve witnessed what we could consider very moderate impacts to spending patterns on 3PAR storage. We’ve seen a handful of instances where customer budgets have been reduced as a precaution. However to date, this behavior has been more than offset by increased prospect interest in 3PAR’s value proposition and in offerings. We think this interest is being spurred by the compression of IT budgets in response to the economic slowdown. We’ve seen companies who may previously not have considered moving away from their relationships with their incumbent storage providers begin to explore the benefits of 3PAR utility storage. It has now become extremely important for them to maximize storage utilization and reduce their total cost of ownership. We believe our value proposition that lets customers achieve more with less, less capital costs, less operating costs for power, pooling and floor space and less administrative overhead is attracting and resonating with prospects. As evidence of this we’ve seen strong new customer adoption of 3PAR last quarter with new business representing 21% of revenue compared with 12% in the previous quarter. Our financial services segment performance was also strong this quarter. This appears to be contrary to many investor expectations yet could be explained by an increased favoring of our value proposition. Our business-to-business service provider segment also delivered a strong quarterly performance. However, despite the positive business indicators we see, we also recognize that conditions could abruptly turn. We therefore remain extremely vigilant for signs that the broad economic slowdown may start to more negatively impact our future results. Though investing to support the rapid scaling of our business, we are also evaluating areas in which we can prudently control expenditures. Should we see any additional signs of the downturn affecting our business, we’re also prepared to act to reduce our costs. Lastly, I’d like to thank the 3PAR team. In this environment they continue to rise to the challenges associated with rapid scaling and I appreciate their continued commitment to our customers and our success. And with that, let me hand over Adriel Lares, 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’s. Thanks for joining us. As David mentioned, we are very pleased to report revenue of $45.1 million for the quarter ended September 30, an increase of 61% over the same quarter a year ago and a 5% increase over the $43 million we recorded in the previous quarter. Of this total, product revenue accounted for $41.4 million or 92% of total revenue, an increase of 55% over our product revenue recognized in the same quarter a year ago, and a 4% increase from product revenue recognized in the previous quarter. Support revenue totaled $3.7 million, 8% of total revenue and an increase of 208% over support revenue recognized in the same quarter a year ago and a 23% increase from the previous quarter. In terms of the split between new and repeat business, 79% of total revenue in this quarter came from customers who had purchased from us previously as compared to 88% in the previous quarter. As David mentioned previously, we believe the 21% of revenue representing new business reflects 3PAR’s continued market penetration. Excluding revenue attributable to software contract renewals, our repeat revenue for this quarter was 71% as compared to 81% in the previous quarter. This quarter no single customer accounted for more than 10% of total revenue. Although our customer concentration will fluctuate quarter-over-quarter as a result of factors such as when we receive orders and when we install systems, we expect to continue expanding our customer base which will further reduce customer concentration over time. Turning to the geographic view, we generated 16% of revenue from customers outside the US compared to 8% in the previous quarter. As we said before, we expect that our international sales will contribute in the mid-teens percentage of our total revenue on an annual basis for the next couple of years. Although this percentage may fluctuate quarter-over-quarter driven by factors such as the timing of orders received and shipped. As a result of higher international shipping activities and the sudden decline in the value of the British pound and the euro against the US dollar during the quarter, we incurred a revenue foreign exchange loss related to the re-measurement of our foreign currency accounts receivable on the consolidated balance sheet. 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 46 productive account executives compared to 44 at the end of the previous quarter. If you recall, we define an account executive or AE 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 8.5 as compared to an average of 7.3 transactions in the previous quarter. Orders received during the quarter exceeding $1 million together accounted for a total of $5.8 million as compared to $6.6 million in the previous quarter. For the rest of fiscal year 2009 we continue to expect the average total dollar value of our orders received by a productive AE in a quarter to be approximately $1 million. Moving on down the P&L, cost of goods sold was $15.7 million and gross margin was 65.2% compared to 65% in the previous quarter. As we have said previously we continue to believe our gross margin is currently at an unsustainably high level. Although we continue to expect it to trend toward a long-term target range of 62% to 64%, we do not expect it to arrive at that target range in a steady progression. Further as we have also 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, the product mix installed in a particular quarter and the performance of the US dollar in currency trading relative to foreign currencies. Operating expenses totaled $30.9 million in the quarter or 68% of revenue compared to $21.1 million or 75% of revenue in the same quarter a year ago and $27.8 million or 65% of revenue in the prior quarter. The increase in our operating expense quarter-to-quarter was driven primarily by investments in our sales force and engineering and higher stock-based compensation expenses. For the full year 2009 we continue to target that we will achieve operating expense as a percent of total revenue within the range of 64% to 66% but expect it to be at the upper end as we invest to take market share. In terms of the long-term operating model and based on what we have seen in the market to date, we still believe that we will achieve our long-term operating margin target by the end of fiscal year 2011. Let me emphasize that although we are aware of the current macroeconomic challenges we believe it presents an opportunity for us to continue to take market share from incumbent storage solution providers and other competitors based on the technical merits and capabilities of our storage solution and more importantly, our cost-saving value proposition. Therefore we believe that investments we make today will benefit our long-term business growth. Within operating expenses, R&D expenses rose to $12 million from $8.9 million in the same quarter a year ago and $10.2 million in the prior quarter. The increase in absolute R&D expenses from last quarter primarily reflects increased hiring and prototype expenses related to the introduction of our T-class storage arrays. We plan to continue to invest in our research and development efforts. We expect we can leverage R&D investments to enhance and expand the technology advantage we benefit from today and we believe this will lead to long-term rewards for our customers and shareholders. Sales and marketing expenses rose to $15.1 million from $9.9 million in the same quarter a year ago and the $14.3 million we reported in the prior quarter. The primary contributors to the increase were hiring and sales commissions expenses as a result of sequential revenue growth from the previous growth. G&A expenses were $3.7 million compared to $2.2 million in the same quarter a year ago and $3.4 million in the previous quarter. The bulk of the increase reflects increased hiring in our finance and accounting department and a precautionary increase in our bad debt reserve. Our stock-based compensation expenses rose to $1.7 million this quarter compared to $625,000 in the same quarter a year ago and $1.3 million in the previous quarter. The primary contributors to this increase were new option grants through the quarter and grants of restricted stock and unit awards. We expect our stock-based compensation expenses to trend up incrementally from this higher level going forward. As a result of these elements I just discussed our non-GAAP operating income for this quarter rose to $291,000 as compared to a loss of $1.8 million in the same quarter a year ago and an operating income of $1.4 million in the previous quarter. Our GAAP operating loss for the this quarter was $1.4 million as compared to a GAAP operating loss of $2.4 million in the same quarter a year ago and an operating income of $95,000 in the previous quarter. Our net other income for this quarter was $125,000 as compared to $115,000 in the same quarter a year ago and $753,000 in the previous quarter. The sequential decline in our net other income was primarily driven by a foreign currency loss incurred on the re-measurement of our British pound accounts receivable on the US consolidated balance sheet as well as a final balloon interest payment on our recently paid off loan. In light of the turmoil in the financial markets, during the quarter, we moved the majority of our corporate cash assets into very short-term and liquid investments. As a result of this action we expect the yield on our investment portfolio will be at a very low level for the near future. During the quarter we received a net tax credit of $104,000 as a result of a one-time tax benefit allowed by a new tax law through the government economic stimulus program. Looking forward we expect our tax expense to return to the normal level that we have seen prior to this quarter and to stay at that low level over the next few quarters given our significant net operating loss carry-forwards. Our non-GAAP net income for the quarter was $520,000 compared to a $1.7 million net loss in the same quarter a year ago and a $10 million non-GAAP net income in the previous quarter. Our GAAP net loss for the quarter was $1.2 million as compared to a $2.4 million net loss in the same quarter last year and net income of $678,000 in the previous quarter. We are pleased to report a non-GAAP EPS of $0.01 for the quarter on $64 million weighted average diluted shares outstanding compared to $0.03 in the previous quarter on $63 million weighted average diluted shares outstanding. GAAP EPS for the quarter was at negative $0.02 compared to a positive $0.01 in the previous quarter. Just a reminder, the difference between our GAAP results and non-GAAP results is stock-based compensation expenses and is reconciled in the exhibits attached to our press release which is available on the IR portion of our website. As of September 30, 2008, cash, cash equivalents, and marketable securities totaled $108.3 million. This represents a $579,000 net increase over the previous quarter. In this quarter we completely paid off our existing loan on the balance sheet and since September 30, 2008, are debt-free. As we have stated before during the quarter we moved our corporate cash investment portfolio to a more liquid and short-term assets. At this point our investment portfolio primarily consists of Treasury money market funds, short-term agency paper, and high-quality short-term commercial paper. On a worldwide basis, 3PAR employed 533 full-time employees as of September 30, 2008 up from 492 full-time employees as of June 30, 2008 and 370 full-time employees as of September 30, 2007. With that, let me turn to our outlook for fiscal 2009 and remind you that we do not provide quarterly EPS guidance. We are adjusting our full year fiscal 2009 revenue expectations to be between $171 million and $179 million from the range of between $166 million and $171 million that was provided in the previous quarter’s earnings call. Although we have not seen significant impacts of the current macroeconomic environment to our business, as we enter the next calendar year, further deterioration could change the situation. That being said we believe it is prudent to widen our guidance range. Based on visibility we have in this period of time, we expect revenue for the third quarter of fiscal 2009 to be between $43 million and $45 million. As we have discussed publicly in the past our flattish third quarter revenue guidance reflects the historical seasonality of our quarterly revenue trend. We expect our full year fiscal 2009 non-GAAP EPS on a weighted average fully diluted share count basis to between positive $0.05 and positive $0.09 from the range of between $0.06 and $0.10 that was in the prior quarter’s earnings call. We lowered the non-GAAP EPS range to reflect the more conservative corporate cash position that we expect to result in significantly lower interest income over the next few quarters as well as to reflect our general conservatism given the macroeconomic environment. We believe we can 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. I’m very pleased with our performance in the quarter particularly in light of the financial turmoil surrounding us. Having said that, I would like to reiterate that in the event that we over achieve revenue guidance, and/or gross margin expectations, we will invest the additional profits primarily into our sales force and engineering. We believe this strategy will allow us to better take advantage of the opportunities the current economic environment presents us to help secure our long-term growth. With that, let me turn it back to David.

[David Scott:]

Thanks, Adriel. Almost one year after our idea of and despite unprecedented economic turbulence, I’m delighted that we’ve consistently met or exceeded our guidance over the last four quarters. We remain vigilant for signs that the economy will substantially change the trajectory of our business performance but have not seen any substantial impact so far. Though prudently cautious, we are also cognizant of our opportunities. We have a strong balance sheet with no debt. Customer trends towards the deployment of utility and cloud computing infrastructures may significantly favor our ongoing business performance. And with a solution that allows customers to achieve more with less, we believe that current economic conditions could present a unique opportunity for 3PAR to aggressively take market share. With that, let me turn it over to the operator to call for questions. Thank you.

[Operator:]

(Operator instructions) Your first question comes from the line of Tom Curlin from RBC. Please proceed.

[Tom Curlin:]

Hey, good afternoon and congratulations on another very good revenue quarter.

[David Scott:]

Thanks a lot.

[Tom Curlin:]

Are you seeing a meaningful change in competitive behavior out there in this environment, or, a fairly stable in that sense despite the macro stuff?

[David Scott:]

We’ve seen some very aggressive pricing action from EMC and IBM over the last couple of months. But mainly restricted to those two companies otherwise I wouldn’t say we’ve seen any substantial change.

[Tom Curlin:]

And how about HP in terms of the high-end stuff they resell?

[David Scott:]

I haven’t seen anything that I would know from HP.

[Tom Curlin:]

Okay and you mentioned the financial stuff holding up for you guys. You tend to have some larger deals so is that driven by one or two customers or is that fairly broad-based in terms of the contribution in the quarter and the pipeline and how it’s holding up for you?

[David Scott:]

It was actually fairly broad-based within the financial services industry. There was no really large, kind of, customer deals that we would call out of the norm.

[Tom Curlin:]

All right and then no 10% customers in the quarter from a pipeline perspective and the December quarter outlook, can you tell us if that includes a 10% plus type of assumption for any customer in the December quarter?

[David Scott:]

I can’t give you the granularity of whether that includes a 10% plus type of customer. I can tell you that our pipeline looks extremely healthy.

[Tom Curlin:]

And then just finally from me, in the internet segment, are there any pockets of that that you find to be more cautious than others? For example, let’s say internet customers that are focused very heavily on consumer or different types of consumer apps?

[David Scott:]

It’s difficult for us to discern that because the internet segment, the business to consumer service providers as we talk about internet web 2.0 is one of the most volatile segments from a quarter-to-quarter perspective both on revenue and a booking level. So it’s always challenging for us to determine simply from a quarter-to-quarter whether there’s any meaningful change. So I really can’t comment on that right now.

[Tom Curlin:]

Okay, all right. Thanks very much.

[David Scott:]

Thanks, Tom.

[Operator:]

Your next question comes from the line of Brent Bracelin from Pacific Crest. Please proceed.

[Brent Bracelin:]

Thank you. A couple questions here from me. I guess one, how much revenue is driven from the new platform in the quarter? And then kind of how fast do you think you’ll ramp as far as percent of the business over the next quarter or two? Two, salesforce.com, obviously big win there, have you started installing yet? Did you start to recognize revenue this quarter? Or does it come in next quarter? And then lastly, you did see a pretty healthy up-tick in revenue from new customers. Any verticals there that are stand-out where you’re having more success than any other verticals?

[David Scott:]

I wish you’d asked them one at a time, Brent. As far as the T-class, we were shipping the T-class from the beginning of the quarter that we’re reporting. We don’t breakdown our product line portfolio in general but I can tell you that we were very happy with the rate of uptake of the T-class and we continue to expect that trend to continue. I’m unaware, we tend not to talk about individual customers who have contributed to the revenue line right now. I think we’d have to go offline and find out whether salesforce.com did indeed increase, but I think as far as new customers overall we had a very good quarter and it was very broad-based among all verticals including financial services.

[Brent Bracelin:]

Okay. Again, the new customer, would you attribute that success there to stronger sales force? Would you attribute it to kind of the new product starting to accelerate some share gains? How should we kind of think about that up-tick in what has historically been a slightly more difficult quarter across the industry?

[David Scott:]

I think we have been reporting consistently that we’ve been delighted by our new customer win rate. We do have the impact that there can be fluctuations and when revenue from those new customers is recognized. But I believe the rate of uptake is more clearly associated with evidence back from these customers that they have to do more with less. Improved utilization efficiency through technologies like thin provisioning, virtual copy snapshot technologies, our Fast RAID 5 implementations are becoming a very important element in customers’ ability to handle growing data growth rates in a very controlled IT budgetary environment.

[Brent Bracelin:]

Okay, thank you. That’s helpful and then my last question really is around hiring. I know that early in the year you talked about it being a little bit more challenging environment from a sales hiring standpoint. Has that burden eased up a little bit? Or is it still challenging? And how should we kind of generally think about new sales hire given the momentum you continue to see there?

[David Scott:]

I think sales hiring remains a challenge and I can’t foresee an environment where it won’t but in terms of additions to our sales force I think we’re making steady progress and I don’t think we yet see a signal of an environment where we cannot achieve the growth targets that we’ve projected.

[Brent Bracelin:]

Okay, great. Thank you.

[Operator:]

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

[Aaron Rakers:]

Thanks, guys and congratulations as well. A couple questions from me. I guess first building on Tom’s question earlier on the competitive front, just – can you help us understand to what extent maybe you’ve seen the XIV platform in the market from IBM because I think that competitively that has a somewhat similar architecture as what you guys offer?

[David Scott:]

We’ve seen extremely little of it. There have been a couple of our customers mainly in financial services who’ve been kind of looking at evaluation units in their R&D organization but we haven’t seen any of that move to kind of purchases for a production basis. So at the moment our experience base on actually meeting them in the field is extremely limited.

[Aaron Rakers:]

Okay and then obviously you had a pretty solid new customer number this quarter but your existing customer revenue looks like it was down 5% or 6% sequentially. Was there something in that with relation to the product cycle or anything to take away from that in terms of just being down sequentially this last quarter?

[David Scott:]

Not really. I think what you should remember is that last quarter we reported that we had to accelerate $2.2 million worth of ratable revenue part of which would have come in this quarter as well as I think we reported one of our large internet companies accelerated revenue that was planned for this quarter so they’re part of our existing customer base. So I think that had a substantial distortion effect on what you see in this quarter from a repeat business perspective.

[Aaron Rakers:]

Perfect and a couple other questions, can you talk about your guidance going forward and what you are assuming with regard to the additions to productive account executives? And are you being a little bit more cautious with regard to the current environment and productivity or bookings from those account executives going forward?

[Adriel Lares:]

I’d say that the sort of widening of the guidance that we had from a revenue standpoint was only associated with the general macroeconomic conditions. We’re trying to be as prudent as we can and Aaron, you’ve known how prudent we’ve been in the past and we’re just trying to sort of take that into account. As it relates to the productive account executive growth, in general we fit into the path of a tough hiring environment but we still believe that we should be able to still continue to grow the productive AEs to the point where we can still achieve our operating target model by the end of fiscal year ‘11. So far, given all that we see right now, we see sort of the long-term aspects of reaching our model still okay, but we’re just trying to be a little bit more prudent given the macroeconomic environment.

[Aaron Rakers:]

Fair enough and then final question for me, can you help us understand how much of your existing customer base, or your installed base, our currently license your thin provisioning capability?

[David Scott:]

Again, we don’t tend to break down the percentages but what I can tell you directionally is that the level of thin provisioning licensing, has gone up substantially from a trend perspective over the last year.

[Aaron Rakers:]

Fair enough. Thanks, guys.

[Operator:]

Your next question comes from the line Aron Honig, from Canaccord Adams. Please proceed.

[Aron Honig:]

Hi, guys. Nice quarter.

[David Scott:]

Thanks to you.

[Aron Honig:]

Can you talk a little bit about the service provider vertical? Was that stronger than expected in the quarter?

[David Scott:]

It was strong and it was also at the – towards the higher end of the 30% to 40% range that we’ve talked about in the past.

[Aron Honig:]

Okay and then as budgets sort of come in, I think you guys said on the last quarter call that 3PAR’s usually between 5% to 10% of a normal IT budget. Has that gone up as your product has become stronger in the market?

[David Scott:]

I think we made the point in the past that that figure depends very heavily on which segment we’re talking about. The figure of 5% to 10% has really been in the global 500 customer base because in other segments, for instance the business to business service provider or the business to consumer web and internet 2.0 environments, we often may be the standard platform throughout the organization and our growth rates there are associated with the growth rates of those businesses. But in the global 500 type environment clearly, once we’re installed and have a footprint, we have this massive opportunity to grow market share within each of those enterprises.

[Aron Honig:]

Okay, thanks.

[Operator:]

Your next question comes from the line of Doug Whitman from Whitman Capital. Please proceed.

[Doug Whitman:]

Congratulations on the strong quarter, guys. Had a quick question about the foreign exchange. I missed the number that you said that you had a foreign currency exchange loss.

[Adriel Lares:]

Yes, the actual amount was around $425,000.

[Doug Whitman:]

And also the R&D spending, you spent very aggressively for your future growth but was there any additional large mass kit expenses in the quarter, any one-time items?

[Adriel Lares:]

There are some in there but basically, it’s with respect to obviously ongoing and new products and that will occur from time to time.

[Doug Whitman:]

And you talked about gaining market share and talk a little bit about in particular where you’re thinking you’re gaining share both as far as from companies and also is there particular verticals where you’re seeing any opportunities that you hadn’t seen before?

[David Scott:]

Well, I think now the quarter’s been reported out and I’ve seen reporting that suggests E&P storage business year-over-year was growing about 11%, Hitachi storage solutions was growing around 12% and I think in US currencies and IBM year-over-year about 1%. So those are our high-end competitors and our growth rate as we’ve just reported was about 62%. So you have effectively, a four, five times the growth rate that we’re demonstrating, admittedly off of a much lower number but that clearly allows us to consistently take market share. I believe it’s pretty broad based but our strength in the business to business service provider segment is clearly one where we keep adding new business to business service provider, managed hosters, people involved in software as a service, et cetera and we feel very good about our momentum there. We believe that cloud computing and the purveyors of cloud computing based enterprise services are going to become the dominant form of deploying enterprise IT over the next 10 to 15 years and securing our position there is very important to us.

[Adriel Lares:]

Dave?

[Doug Whitman:]

Congratulations again. In the new T-class, do you have any different kind of characteristics in terms of its sales cycle? The type of customers you’re trying to take? Can you just talk about, and I know you’re doing a road show on that one too, how customers, their thoughts that they’ve said to you on it so far on the road show?

[David Scott:]

Yes, I can tell you that the sale cycles are very similar to the S-class. There is probably absolutely no change. The platform is consistent, it’s part of the same architecture it’s just a new generation with a new, our new Gen3 ASIC. We have road shows that are going on. I think there have been three in Europe. I think six in the US They’ve been extremely well-attended, a mixture of our customers as well as prospects and they’re a powerful tool for building our future pipeline activity.

[Doug Whitman:]

Thank you, guys.

[David Scott:]

Thank you.

[Operator:]

Your next question comes from the line of Mark Boulter [ph] from Bluefin; please proceed.

[Mark Boulter:]

Thanks, David, Adriel. Dave, it looks to me like the S-class has been mostly banished from your website. I’m curious in terms of inter-operatability, if there really is any and the pricing differences between T and S classes?

[David Scott:]

Sure. The S-class has certainly not been banished. We continue to sell it. There are many of our customers who continue to be purchasing S-class associated with their own kind of change management strategies and consistency of infrastructure and we expect to be selling that platform on into next year. As far as the second part of your question, could you just repeat it again, I’m sorry.

[Mark Boulter:]

Just curious in terms of the pricing and interoperability of the – if you’re populating a cabinet, do you have to populate with S-class components and drives and chassis and controllers?

[David Scott:]

Thank you for reminding me. The T-class is priced at a slightly higher incremental level than the S-class, probably around a 5% to 10% difference. As far as interoperability, we have a very strong message in that space. First of all, our management consoles and GUIs can manage both S and T classes as well as in fact our L, O, and E class systems from a single unit. So they could be mixed and matched. There’s complete interoperability between the S, T and E classes as far as our remote replication technology is concerned so people can have different systems located in remote data centers and provide disaster recovery solutions between them. Also all of the software that runs both on the S and the T classes kind of identical versions so there are no core differences. And then finally we provide data in place upgrades so that existing customers with S-classes that want to upgrade to the T-class can do so without having to disrupt their data or migrate it from one system to another.

[Mark Boulter:]

Great, thank you. My other question, did you mention cash flow or if you used any of the buyback?

[David Scott:]

We hadn’t mentioned that.

[Adriel Lares:]

We hadn’t mentioned it. We actually did not use any of the $10 million amount of the board-authorized buyback program last quarter. As you may recall after the call the stock price sort of rose significantly and during that period of time we did not purchase at that time and when the stock price did come down a bit that was already during our close window. Now that we’re obviously through coming up on another open window, we’ll certainly reconsider it and sort of see where we are once obviously we’ve come back after a couple of days of the earnings being out there.

[David Scott:]

But we’re also cognizant of the major changes that occurred in that period of time in the general economic conditions and so we’ll use careful management judgment as to how we pursue this.

[Mark Boulter:]

I think I teased you about not being able to buy it at $8 a share last quarter so my face is red and cash from operations? Did you mention?

[Adriel Lares:]

Cash from operations, actually on a net cash basis we generated about $600,000 but on a cash on operations we had about $3.9 million in operating cash flow.

[Mark Boulter:]

Great, thank you.

[David Scott:]

Thanks.

[Operator:]

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

[Alex Kurtz:]

Congratulations on another good quarter.

[David Scott:]

Hey, thanks, Alex.

[Alex Kurtz:]

So just looking at your guidance and thinking that you have a fiscal year-end that ends in March and I think a lot of the concern out there in the market is a lot of the storage companies are going to do well in December or moderately well because that’s budget year flushes for IT budgets but you’re going to see a drop-off in March. That’s your fiscal year-end; you probably have some accelerators for sales reps. How should we think about that offset to your fiscal year-end?

[David Scott:]

I think the assessment of our guidance range and the winding of our guidance range is really associated with the fact that we haven’t seen significant impact to our business trajectory right up until this earnings call. As you can imagine I do very detailed – I’ve had very detailed discussions with my field organization, I speak with our customers et cetera and try to assess whether there’s any information that gives me a sense that their demand for storage is dropping and may impact our business model. I can tell you that from our field’s perspective we feel the pipeline is strengthening but given that current position we’re also cognizant that things can change very rapidly. And if they do change, as you can imagine, it’s prudent for us to do, we wanted to make sure that our guidance reflected that outside possibility of the change and we will fundamentally restructure our business to address it if it happens. But we’ll hit – we’ll cross that bridge when it comes to it.

[Alex Kurtz:]

But you feel that with March being your fiscal year-end that’s probably your strongest quarter of the year that should more than offset what may be a decline in overall IT budgets as it goes into 2009.

[David Scott:]

The problem with your question, Alex, is that those who are knowledgeable commentators point out the fact that everything can drop off a cliff almost instantaneously so we as the management team are positioned where we can’t forecast accurately if such a change could happen. We do believe that we have favorable elements like the acceleration that occurs as our sales forces goes into commissions and accelerators and has incentive to continue to push forward but the other half of it is do customers have a budget to buy?

[Alex Kurtz:]

Right. Okay, thank you and then back on the financial segment, I know you haven’t disclosed really in detail in the past but can you give us a broad range of what the financial services represented as a percent of sales?

[David Scott:]

We’ve said in the past that financial services is one of our top three segments and it was a strong performance across the board.

[Alex Kurtz:]

And Dave, did you see strength this quarter in the investment banking world or is it in commercial banks and other?

[David Scott:]

We’re very broad based in financial services but I would clearly tell you that we also saw strength in the investment banking world.

[Alex Kurtz:]

Thanks and then Adriel, just to go through the OpEx question again, it may have been asked, was there one specific line item either R&D or sales and marketing that saw greater than usual growth this quarter and that maybe should decline going into December?

[Adriel Lares:]

No, there wasn’t one particular here and there. I mean the one-timers I sort of mentioned which was the bad debt reserve that we took sort of precautionary tone there and obviously the stock-based compensation expenses that sort of rose a bit there. But there wasn’t anything specifically that made it rise other than those items.

[Alex Kurtz:]

So just to – looking at it from a modeling perspective, that 64% to 66% range is sort of how to get to the number?

[Adriel Lares:]

Yes, I did say on the call that we thought we’d be more on the higher end of that range.

[Alex Kurtz:]

And that’s a non-GAAP range, right, Adriel?

[Adriel Lares:]

No that’s actually a GAAP range.

[Alex Kurtz:]

GAAP range, okay, thank you very much.

[Operator:]

Your next question comes from the line of Rajesh Ghai from ThinkPanmure, please proceed.

[Rajesh Ghai:]

Hello there, congratulations on the quarter.

[Adriel Lares:]

Thanks, Rajesh.

[Rajesh Ghai:]

If I’m correct, then I believe you had a lot more transactions this quarter and the average revenue for transaction was down. Can you see a trend over there? Or is that something that was just one-off?

[David Scott:]

Rajesh, I think the advantage of our architecture is becoming clear. In an environment where maybe IT budgets are facing some constraints, our clustered architecture and its very granular approach allows people to buy just in time and that kind of encourages more transactions that may be of a relatively smaller size as they buy when they absolutely need it. And that’s very different from some of our competitors approaches where – someone mentioned XIV earlier. I think you have to buy 180 terabytes of storage at once every time you want to buy more capacity and that doesn’t sound like a good approach in this kind of economic climate.

[Rajesh Ghai:]

Okay and Adriel, you mentioned that you’ve taken – you’ve kind of taken a higher back-end reserve. Are you seeing any impact with the credit crunch out there that makes you do that? Or is that just precautionary?

[Adriel Lares:]

Nothing broad based, we’ve had an instance here or there of where there has been some push out or some concern, but I think again, it’s been just sort of us looking at our back-end reserve, looking at our accounts receivable and obviously keeping in mind the general macro economic climate, and just being prudent.

[Rajesh Ghai:]

Okay, and the T Class, was that more popular with your existing customer base? Or do you see some new customers who haven’t bought the technology in past decide to jump in because of the T Class?

[David Scott:]

We saw very strong adoption amongst new customers as well with the T Class.

[Rajesh Ghai:]

Okay, and in terms of close rates, you mentioned that your funnel was much bigger at this point in time in the quarter. Are you seeing those close rates decline or close rates as high as what you saw last quarter?

[David Scott:]

I don’t think there’s been any significant change in our close rates that I can point to.

[Rajesh Ghai:]

Okay, and have you seen any traction from the Cloud storage vendors in terms of new business or is that –?

[David Scott:]

We would view ourselves as the leading Cloud storage vendor. Can you outline who you would –?

[Rajesh Ghai:]

The likes of Paracale or Nirvanix or Vembu, the pure play guys –.

[David Scott:]

I’m afraid we’ve never seen them.

[Rajesh Ghai:]

Okay. Well thank you, I’ll talk later.

[David Scott:]

Thanks very much.

[Operator:]

Your next question comes from the line of Clay Sumner from FBR, please proceed.

[Clay Sumner:]

Thanks and congratulations guys on a strong quarter.

[David Scott:]

Thanks, Clay.

[Clay Sumner:]

Especially on the new customer acquisition, the revenue kick back level that you talked about. Was that traceable to large deals or numbers or large number of customers?

[David Scott:]

It was a large number of customers. I think in past quarters, and Clay, I think we had a discussion about this. We remain delighted by our new customer win rate. Our numbers on new business can fluctuate just because of when companies decide to accept product when they have power Cloud floor space available, et cetera and so there’s some natural fluctuations there which will make that line item change with some level of volatility. But you know it’s broad based. We’re adding customers at a rate that I’m very happy with right now.

[Clay Sumner:]

Okay thanks and can you talk about maybe what you’re seeing or hearing from your service provider customer segment in terms of – in this macro economic environment, are they seeing a shift towards more outsourcing? Or are they seeing maybe customers flow some of their outsourcing initiatives.

[David Scott:]

You know it’s strange. Because when you talk about outsourcers, you have to be very careful to distinguish their different lines of business. In some cases they have both co-location, they have dedicated managed hosting as well as kind of utility infrastructure kind of hosting. What I’d say is that the Utility Infrastructure Hosting business, for almost all of them seems to be growing at a very strong pace. I think it’s a better economic model for customers when their IT budgets are constrained and that leads them to be more successful. Some of the other lines of business, it’s more difficult. Kind of dedicated managed hosting, I suspect would get – we’re hearing feedback that there’s longer cycle times involved with that business and I’m not sure that we’re close enough to the Co-lo business to comment on it.

[Clay Sumner:]

Okay, and then, Adriel, in terms of inventory, it seemed to rise a little bit. Was that related to the T series product?

[Adriel Lares:]

Yes, that was the S to T transition.

[Clay Sumner:]

Okay, and then lastly for me, David, I guess you mentioned earlier customers buying more just in time with your product. Can you talk about industry wide, your products or others? Are you seeing customers start to shift toward paying for shorter term maintenance contracts? Maybe paying a year at a time instead of three, even if they have to pay up for that?

[David Scott:]

You know I have to say I haven’t seen that trend at all. Competitively, it’s been pushing the other way. There’ve been a number of companies pushing fourth year, fifth year maintenance bumbled into up front deals and I haven’t seen signs of those trends. You know fifth year is very, very rare, but I haven’t seen people move the other direction towards just requesting one year.

[Clay Sumner:]

Right, thank you very much.

[Adriel Lares:]

Thanks, Clay.

[Operator:]

The next question comes from the line of (inaudible). I’m sorry, please proceed.

[Unidentified Analyst:]

How are you doing, David? In the last few weeks, a number of Wickibond users have reported to us that their leasing and financing strategies are changing and may be getting more complicated. And basically what they’ve said is that money is a less fungible commodity in this market. So the way they find money and value money has changed in the last several weeks. Who has it to lend? And what are the terms? And the treasurers are putting more constraints on them. One even said GE Capital wouldn’t lease to them. So I know you guys have a deal with Key Equipment. I have two questions, is leasing a major component of your deal flow? And two, is there any change with the relationship with Key Equipment and are you seeing anything on this front?

[Adriel Lares:]

So leasing hasn’t been a huge component of our deals and our revenue and in terms of our relationship with Key, we’ve been in relationship with Key for a while and I think the general conflict is that where they’re going to grow with us over time. Part of it is that many times the customers are so focused on the actual technology aspect of it that typically when they make the decision to go with 3PAR, they often just hand it on to their own finance areas and then they lease it on the back end for themselves. So there may be some leasing on the back end that we just don’t see, but at least from the front end deal aspect, I find it a huge component of our revenue today.

[Unidentified Analyst:]

Okay, thanks.

[Operator:]

At this time, I’m showing you have no further questions. I’d like to now turn the call back over to management for closing remarks.

[David Scott:]

All right, well, thank you again. We’re delighted with our quarter’s performance and look forward to speaking with many of you over the course of the next few weeks.

[Adriel Lares:]

Thanks very much.

[Operator:]

Ladies and gentlemen, thank you for your participation in today’s conference call, you may now disconnect. Have a wonderful day.