In addition to historical information, this report contains 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, which are subject to the "safe harbor" created by those sections. These statements include, among other things, statements concerning our expectations regarding:

• the growth and growth rate of our operations, business, revenues, operating margins, costs and expenses;

• fluctuations in our gross margins;

• the effect of recent accounting pronouncements on our financial position, results of operations, and cash flows;

• our future stock-based compensation charges;

• our foreign exchange risk and our practices related to hedging those risks;

• our future uncertain tax positions;

• the potential impact of our storage solution on the total lifetime cost of storage for our customers;

• the increase of research and development, sales and marketing and general and administrative expenses in the future;

• our future capital expenditures, including investments in our infrastructure and in test and development equipment to support our research and development efforts;

• the availability of individuals with the specific skills required for key positions, as well as our ability to attract, hire and retain sales employees and key personnel;

• our hiring of sales and other key personnel and the impact such hiring may have on our business, growth and competitive position;

• the future yield on our investment portfolio;

• the sufficiency of our existing cash balances to meet our future capital requirements;

• the materiality of our exposure related to contractual guarantees and indemnities;

• the materiality of the exposure of our cash equivalents to changes in value and the projected value of our investment portfolio;

• future changes in competitive practices and landscape in our industry;

• our future reliance on establishing relationships with resellers and authorized service providers to sell, service and support our products in select markets;

• our continued investments in international markets and our expansion strategies in those markets;

• the contribution of international sales as a percentage of our total revenue on an annual basis;

as well as other important statements regarding our future operations, financial condition and prospects and business strategies. Forward-looking statements are based on our management's beliefs and assumptions, and on information currently available to our management, as of the date of this filing. These forward-looking statements are subject to certain risks and uncertainties that could cause our actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this report, and in particular, the risks discussed under the heading "Risk Factors" in Part II, Item 1A of this report and those discussed in other documents we file with the Securities and Exchange Commission. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

The following discussion should be read in conjunction with our financial statements and the related notes contained elsewhere in this Quarterly Report on Form 10-Q and in our other Securities and Exchange Commission, or SEC, filings, including our Annual Report on Form 10-K for the year ended March 31, 2009.

Overview

We are the leading global provider of utility storage solutions for mid-sized to large enterprises, financial services firms, cloud computing service providers, consumer-oriented Internet/Web 2.0 companies, and government entities. Utility storage provides a foundation upon which organizations are able to build highly virtualized, consolidated IT infrastructures for managing their data. We help organizations build storage infrastructures to meet the performance and high availability demands of the virtual datacenter. Our storage systems are designed to be self-managing (smart), capacity efficient (thin), and resiliently adaptable (ready). We believe our storage systems provide substantial benefits for our customers, including reducing administrative costs and provisioning complexity, improving server and storage utilization, easing power and cooling requirements, scaling efficiently to support continuous growth, and adapting rapidly to meet changing business needs.

Established by engineers with substantial experience in the high-end server and storage markets, we began operations in 1999. From our inception, our corporate and product development objectives have focused on finding ways to use physical storage resources more efficiently and effectively by reducing unused storage and power consumption. Our utility storage solutions are comprised of the 3PAR InServ Storage Servers and the 3PAR InForm Suite, which includes the 3PAR InForm Operating System and other software applications.

We have sales offices in the United States, Canada, Germany, Japan, United Kingdom and Singapore and research and development facilities in California and Northern Ireland.

We have experienced a history of net losses in each fiscal year since our inception as we have invested significantly in our product development, customer services and sales and marketing organizations to support the growth of our business. While we plan to continue focusing on constraining discretionary operating expenses in light of the current general economic downturn, we plan to continue to invest heavily into our sales, customer service, and engineering organizations, which could limit our ability to generate profitability. We believe this strategy will better position us in the market to achieve substantial, long-term growth and market share in our business.

During the three months ended September 30, 2009, we continued to experience a generally weaker demand environment as capital spending by our customers remained under pressure. While our total revenue increased sequentially from the quarter ended June 30, 2009 and on a year-over-year basis, our product revenue decreased slightly on a year-over-year basis. Continued or increased weakness in general economic conditions, a reduction in storage infrastructure spending even if general economic conditions improve, or deterioration in the financial condition of our customers and customer prospects will adversely impact our business, revenues, rates of revenue growth (if any), operating results and financial condition, including potential inventory writedowns, longer sales cycles, increases in price competition, reduced unit sales, increased number of days of sales outstanding and customer payment defaults.

The last day of our fiscal year is March 31. Our fiscal quarters end on June 30, September 30, December 31 and March 31. Our current fiscal year, which we refer to as fiscal 2010, will end on March 31, 2010.

Revenue, Cost of Revenue and Operating Expense

Revenue

We derive our revenue from sales of our InServ Storage Servers, licenses of our InForm Suite and other software applications and related support. Prior to March 2007, we typically sold our products with a three-year basic hardware warranty and software warranty, which was limited to bug fixes for any non-conforming software products. Commencing in March 2007, in anticipation of evolving customer requirements for software support, we changed from a software warranty model to a software support model. Under the software support model, the customer receives, in addition to bug fixes, unspecified software upgrades and enhancements, on a when-and-if available basis, over the term of the support period. Support revenue also includes our extended and premium hardware warranties. Our premium hardware warranty offers faster service response time than our basic hardware warranty.

As a result of the implementation of our software support model in March 2007, we expect our support revenue to increase in future periods.

Cost of Revenue

Cost of product revenue consists primarily of raw materials, manufacturing cost for our products, shipping and logistics cost, expenses for inventory obsolescence and warranty obligations. Cost of premium and extended warranty obligations are included in cost of support revenue. We utilize third parties to manufacture subcomponents of our products, which are then shipped to our Fremont, California operations facility for final assembly and testing prior to customer shipment. We outsource onsite support to third-party support vendors.

Cost of support revenue consists of personnel cost and outside vendor cost to support premium and extended warranty services for all periods presented. Beginning March 2007, cost of support revenue also includes costs associated with providing software support. As a result of the implementation of our software support model in March 2007, we expect cost of support revenue to increase in future periods.

Gross Margin

Gross profit is the difference between revenue and cost of revenue, and gross margin is gross profit expressed as a percentage of revenue. Product mix and system configurations affect our gross margin because our software and support margins are higher than our hardware margins. Larger systems tend to have greater software and support components and thereby result in a higher margin. Our gross margin tends to be higher for direct sales than for indirect sales because we generally sell our products to resellers at a discount. Our gross margin has fluctuated significantly in the past, and we expect it will continue to fluctuate in the future primarily as a result of product mix and order size.

Operating Expense

Operating expense consists of research and development, sales and marketing, and general and administrative expense. The largest component of our operating expense in each case is personnel cost. Personnel cost consists of salaries, benefits and incentive compensation for our employees. We grew from 451 employees at March 31, 2008 to 591 employees at March 31, 2009 and to 619 at September 30, 2009. While our personnel costs generally have increased from period to period, in light of the general economic downturn, we implemented tighter cost control measures over other discretionary expenses during fiscal 2009, which we continued to impose during the first half of fiscal 2010.

Research and Development Expense

Research and development expense consists primarily of personnel cost, prototype expense, consulting services and facilities cost associated with personnel. Consulting services generally consist of contracted engineering consulting for specific projects. We expense research and development expense as incurred. We expect to continue to devote substantial resources to the development of our products. We believe that these investments are necessary to maintain and improve our competitive position.

Sales and Marketing Expense

Sales and marketing expense consists primarily of personnel cost, sales commission, marketing programs and facilities cost associated with sales and marketing and certain customer service and support activities not associated with cost of revenue. We plan to continue to increase the number of direct sales personnel we employ. Our sales personnel are not immediately productive and therefore the increase in sales and marketing expense we incur when we add new sales representatives is not immediately offset by increased revenue and may never result in increased revenue. The timing of our hiring of new sales personnel and the rate at which they generate incremental revenue could therefore affect our future period-to-period financial performance.

General and Administrative Expense

General and administrative expense consists primarily of personnel and facilities costs related to our executive, finance, human resources, information technology and legal organizations, as well as fees for professional services. Professional services consist of fees for outside legal, audit, compliance with the Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley, and information technology consulting. We expect to continue to incur significant accounting and legal costs related to compliance with rules and regulations implemented by the SEC, as well as insurance, investor relations and other costs associated with being a public company.

Other Income (Expense), Net

Other income, net includes interest income on cash balances and short-term investments, interest expense on our outstanding debt and borrowings under our revolving line of credit, and losses or gains on our hedging activities and remeasurement of non-United States dollar transactions into United States dollars. If we are successful in growing our international sales we may be subject to increased currency conversion risks because a larger portion of our sales could be denominated in foreign currencies. We have historically invested our available cash balances in money market funds, short-term United States Government and agency obligations, municipal bonds, corporate debt securities and commercial paper.

Income Tax Provision

The Company's tax provision relates primarily to state income taxes and provisions for income tax related to the Company's international subsidiaries.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States, or GAAP. These accounting principles require us to make estimates and judgments that can affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements as well as the reported amounts of revenue and expense during the periods presented. We believe that the estimates and judgments upon which we rely are reasonable based upon information available to us at the time that we make these estimates and judgments. To the extent there are material differences between these estimates and actual results, our consolidated financial statements will be affected. The accounting policies that reflect our more significant estimates and judgments and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results are revenue recognition, stock-based compensation, inventory valuation, warranty provision, allowances for doubtful accounts and income taxes.

The description of our critical accounting policies that involve significant management judgment appears in our 2009 Annual Report on Form 10-K under "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates."

Results of Operations for the Three and Six Months Ended September 30, 2009 and 2008

Revenue

The following tables present period over period comparisons of our revenue by
revenue source for the three and six months ended September 30, 2009 and 2008
(dollars in thousands):



                                       Three Months Ended                                  Six Months Ended
                                          September 30,              Change in              September 30,              Change in
                                       2009           2008           $          %         2009          2008           $          %
Types of Revenue:
Product                              $  39,693      $ 41,427      $ (1,734 )    -4 %    $ 78,495      $ 81,351      $ (2,856 )    -4 %
As % of total revenue                     86.2 %        91.8 %                              86.7 %        92.3 %
Support                                  6,362         3,720         2,642      71 %      12,029         6,749         5,280      78 %
As % of total revenue                     13.8 %         8.2 %                              13.3 %         7.7 %

Total revenue                        $  46,055      $ 45,147      $    908       2 %    $ 90,524      $ 88,100      $  2,424       3 %


                                       Three Months Ended                                  Six Months Ended
                                          September 30,              Change in              September 30,              Change in
                                       2009           2008           $          %         2009          2008           $          %
Revenue by geography:
United States                        $  38,383      $ 37,871      $    512       1 %    $ 73,902      $ 77,252      $ (3,350 )    -4 %
As % of total revenue                     83.3 %        83.9 %                              81.6 %        87.7 %
International                            7,672         7,276           396       5 %    $ 16,622      $ 10,848         5,774      53 %
As % of total revenue                     16.7 %        16.1 %                              18.4 %        12.3 %

Total revenue                        $  46,055      $ 45,147      $    908       2 %    $ 90,524      $ 88,100      $  2,424       3 %

                                    Three Months Ended                                   Six Months Ended
                                       September 30,               Change in              September 30,               Change in
                                    2009           2008           $           %         2009          2008            $           %
Revenue by Sales Channel:
Direct                            $  28,943      $ 33,094      $ (4,151 )    -13 %    $ 56,118      $ 69,444      $ (13,326 )    -19 %
As % of total revenue                  62.8 %        73.3 %                               62.0 %        78.8 %
Indirect                             17,112        12,053         5,059       42 %      34,406        18,656         15,750       84 %
As % of total revenue                  37.2 %        26.7 %                               38.0 %        21.2 %

Total revenue                     $  46,055      $ 45,147      $    908        2 %    $ 90,524      $ 88,100      $   2,424        3 %

Our total revenue increased by $908,000, or 2%, to $46.1 million in the three months ended September 30, 2009 from $45.1 million in the three months ended September 30, 2008, and by $2.4 million, or 3%, to $90.5 million in the six months ended September 30, 2009 from $88.1 million in the six months ended September 30, 2008.

Product revenue decreased by $1.7 million, or 4%, to $39.7 million in the three months ended September 30, 2009 from $41.4 million in the three months ended September 30, 2008 and by $2.9 million, or 4%, to $78.5 million in the six months ended September 30, 2009 from $81.4 million in the six months ended September 30, 2008. The decrease in product revenue during the three and six months ended September 30, 2009 related primarily to decreased sales to our existing customers of software and hardware products that expand the capacity of their previously purchased storage systems. We believe this decrease was due to the general economic downturn and information technology spending constraints. Additionally, the six months ended September 30, 2008 benefited from the recognition of $2.8 million of deferred revenue associated with certain March 2007 transactions that we were previously recognizing on a ratable basis. Product revenue from our existing customers accounted for 70% and 71% of total revenue in the three and six months ended September 30, 2009, respectively, compared to 71% and 76% in the three and six months ended September 30, 2008, respectively.

Support revenue increased by $2.6 million, or 71%, to $6.4 million in the three months ended September 30, 2009 from $3.7 million in the three months ended September 30, 2008 and by $5.3 million, or 78%, to $12.0 million in the six months ended September 30, 2009 from $6.7 million in the six months ended September 30, 2008. The increase in support revenue in the three and six months ended September 30, 2009 compared to the same periods in the prior year is primarily attributable to the growth in the installed base of our storage solutions, which resulted in a higher support revenue from post-contract customer support as well as extended and premium warranty contracts.

International revenue represented $7.7 million, or 17% of our total revenue, compared to $7.3 million, or 16% of our total revenue, in the three months ended September 30, 2009 and 2008, respectively, and $16.6 million, or 18% of our total revenue, compared to $10.8 million, or 12% of our total revenue, in the six months ended September 30, 2009 and 2008, respectively. The increase in international revenue in the three and six months ended September 30, 2009 in absolute dollars and as a percent of our total revenue is the result of our efforts to expand our international presence and customer base.

We derived 63% and 73% of our total revenue from direct sales to customers in the three months ended September 30, 2009 and 2008, respectively, while the indirect sales represented 37% and 27% of total revenue during the same periods, respectively. In the six months ended September 30, 2009 and 2008, we derived 62% and 79% from direct sales to customers, respectively, while the indirect sales represented 38% and 21% of total revenue, respectively. The increase in indirect sales as a percentage of revenue in the three and six months ended September 30, 2009 compared to the same periods in the prior year is mainly related to increased sales to the United States government agencies as well as in non-English speaking markets where the sale of our products is conducted primarily through our resellers and channel partners.

Cost of Revenue and Gross Margin

The following table presents period over period comparisons of our cost of
revenue by cost source for the three months and six months ended September 30,
2009 and 2008 (dollars in thousands):



                                      Three Months Ended                                Six Months Ended
                                         September 30,             Change in             September 30,              Change in
                                      2009           2008          $         %         2009          2008           $         %
Cost of product revenue             $  13,903      $ 14,551      $ (648 )    -4 %    $ 27,617      $ 28,572      $  (955 )    -3 %
As % of product revenue                  35.0 %        35.1 %                            35.2 %        35.1 %
Cost of support revenue                 1,897         1,157         740      64 %    $  3,627         2,163        1,464      68 %
As % of support revenue                  29.8 %        31.1 %                            30.2 %        32.0 %

Total cost of revenue                  15,800        15,708          92       1 %      31,244        30,735          509       2 %

Gross profit                        $  30,255      $ 29,439      $  816       3 %    $ 59,280      $ 57,365      $ 1,915       3 %
Gross margin                             65.7 %        65.2 %                            65.5 %        65.1 %

Cost of revenue increased by $92,000, or 1%, to $15.8 million in the three months ended September 30, 2009 from $15.7 million in the three months ended September 30, 2008 and by $509,000, or 2%, to $31.2 million from $30.7 million in the six months ended September 30, 2008 primarily due to increased cost to provide customer support due to an increase in our installed base.

Cost of product revenue decreased $648,000, or 4%, to $13.9 million, which is consistent with the 4% decrease in our product revenue during the three months ended September 30, 2009. The slight decrease in product margin in the six months ended September 30, 2009 compared to the same period in the prior year is mainly related to an increase in inventory write-downs for excess and obsolescence related to certain product transitions.

Cost of support revenue increased by $740,000, or 64%, to $1.9 million in the three months ended September 30, 2009 from $1.2 million in the three months ended September 30, 2008 and $1.5 million, or 68%, to $3.6 million in the six months ended September 30, 2009 from $2.2 million in the six months ended September 30, 2008. The increases in cost of support revenue in the fiscal 2010 periods are primarily due to increased personnel and infrastructure costs required to support the growth in our installed base partially offset by our efforts to contain overall costs, which enabled us to improve our support revenue margin in the three and six months ended September 30, 2009 compared to the same periods in the prior year.

Research and Development

The following table presents period over period comparisons of our research and development expense for the three months and six months ended September 30, 2009 and 2008 (dollars in thousands):

Three Months Ended Six Months Ended September 30, Change in September 30, Change in 2009 2008 $ % 2009 2008 $ % Research and development $ 11,359 $ 12,034 $ (675 ) -6 % $ 22,991 $ 22,191 $ 800 4 % As % of total revenue 25 % 27 % 25 % 25 %

Our research and development expense decreased by $675,000, or 6%, to $11.4 million in the three months ended September 30, 2009 from $12.0 million in the three months ended September 30, 2008. The research and development expense increased by $800,000, or 4%, to $23.0 million in the six months ended September 30, 2009 from $22.2 million in the six months ended September 30, 2008. Research and development personnel compensation and related benefits expense was $285,000 and $1.2 million higher in the three and six months ended September 30, 2009, respectively, compared to the same periods in prior year due to increase in research and development personnel to 209 employees at September 30, 2009 from 189 employees at September 30, 2008. The higher compensation expense was offset by a $1.4 million and $1.7 million decrease in engineering prototype equipment expense in the three and six months ended September 30, 2009, respectively, when compared to the same periods in the prior year.

As a percentage of our total revenue, research and development expense decreased to 25% in the three months ended September 30, 2009 from 27% in the three months ended September 30, 2008 and stayed constant at 25% in the six months ended September 30, 2009 and 2008. The percentage decrease in the three months ended September 30, 2009 is attributable principally to our efforts to contain overall research and development costs.

Sales and Marketing

The following table presents period over period comparisons of our sales and marketing expense for the three months and six months ended September 30, 2009 and 2008 (dollars in thousands):

Three Months Ended Six Months Ended . . .