NetApp Inc (NTAP) 2002 Q4 法說會逐字稿

Good afternoon ladies and gentlemen and thank you for standing by. Welcome to the Network Appliance earning release conference call. At this time all participants are in a listen only mode. Following the formal presentation, instructions will be given for question and answer session. If anyone needs assistance at any time during the conference please press the star followed by the zero. As a remainder this conference is being recorded May 14, 2002. I would now like to turn the conference over to Dan Warmenhoven, Chief Executive Officer of Network Appliance. Please go ahead sir.

Thank you. Good afternoon and welcome to the Network Appliance earnings release conference call for the fourth quarter of fiscal year 2002. This is Dan Warmenhoven. It's my pleasure to welcome all of you and I thank you have taken time to join us today. I am particularly pleased to have you join us today as we celebrate the 10th anniversary of our Incorporation. With me today are Tom Mendoza, President of Network Appliance and Jeff Allen, our Chief Financial Officer and Executive Vice President of our Financial Operations, and also I could point out that today's conference call is being webcast over the Internet and will also be available for replay on our website at www.netapp.com. At this point, I would like to turn the call over to Jeff who will review the financial portion of the press release we issued earlier today. Following Jeff's comments, I will share my own comments on the events during the quarter and then we will move to the financial outlook and conclude with a question and answer period. Now I would like to introduce Jeff Allen.

Thank you Dan. Good afternoon ladies and gentlemen. In the course of today's conference call, we may make forward-looking statements and projections that involve risk and uncertainty. Actual results may differ materially from our statements or projections. Factors that could cause actual results to differ from our projections include but are not limited to the continuing decline in the general economic environment, customer demand for products and services, other equally important factors are detailed in the company's 10-K and 10-Q reports filed with the SEC, which are also accessible through our website. Our press release is available on the Business Wire and on our website, but I like to provide some commentary about our results for the fourth quarter and fiscal 2002.

As indicated in the press release, revenue for the quarter was 204.9 million dollars down 9.3 percent year-over-year from the 225.8 million dollars reported in Q4 last year. Revenues were up sequentially 3.3 percent from the 198.3 million reported in Q3 of this year. North America contributed approximately 59 percent of total revenue, up slightly from the 58 percent reported last quarter. Europe was 30 percent of the mix on the strength of net cash business while

was about a 11 percent of revenue, down from the 13 percent reported last quarter.

As expected, our fourth quarter seasonality delivered very strong bookings this quarter resulting in a book-to-bill well above one for the quarter. We are pleased to report the completion of our multi-quarter goal of rebuilding backlog to levels of four weeks. Pro forma operating expenses totaled a 114.7 million, up approximately nine million from the 105.8 million reported last quarter. Increased year-end commissions and marketing program spending were the major drivers of the increase. We would expect operating expenses to decline moderately in the first quarter as a result.

Gross margin for the quarter was 64 percent, up approximately 180 basis points from the prior quarter. We continue to sustain our gross margins due to favorable product and software mix and continued cost reductions. Transition to our new high-density low cost storage subsystem is complete, again helping quarter-over-quarter gross margins. Software as a percentage of revenue rose nearly two points to 23 percent contributing nearly one point of favorable gross margin. This growth is coming from both software products at 16 percent of revenue as well as software subscription upgrades at approximately 7 percent of the total revenue totaling 23 percent. Because the revenue treatment is different between software product sales, which are recognized on shipment and subscription upgrades, which are recognized over the life of the subscription, we will be providing this software mix breakdown as we go forward.

We were also able to successfully resolve some remaining material commitment issues with suppliers as compared to the historical levels of

manufacturing costs and variances. This benefit was worth approximately one-and-a-half gross margin points during the quarter. We wouldn't expect this benefit to reoccur in the first quarter of next year. Pro forma operating income for the quarter was 16.4 million or eight percent of revenue. Pro forma net income for the quarter was 14.6 million or approximately 7 percent of revenue. Pro forma earnings per share were 4 cents based on the weighted average of approximately 354 million shares outstanding. The tax rate we used in the quarter was 24 percent and we now expect to report a 28 percent tax rate for fiscal year FY03. We reported a GAAP net income of 7.8 million dollars or two cents per share this quarter. This included a net restructuring charge of approximately 4.2 million dollars related to the closure of a facility and reduction of certain engineering resources, which were consolidated into Sunnyvale. There was just over 6.4 million dollars in the amortization of the intangible assets and stock compensation expense related to past acquisitions and we have also provided reconciliation between our pro forma presentation and GAAP net income in the condensed consolidated statement of operations of our press release.

Headcount at the end of the quarter was approximately 2,280 people, up approximately 45 from last quarter, a result of selected additions in marketing, sales, and service. Cash and investments at the end of the quarter were 454 million dollars. Cash from operations, net of capital spending, generated 41 million dollars in the quarter. During the quarter, we discontinued our synthetic leasing programs by purchasing the buildings at our Sunnyvale headquarters site, the movement of approximately 250 million dollars from restricted investments to plant, property, and equipment reflects this transaction, which will have minimal income statement affect going forward. Day sales outstanding of accounts receivable were 65 days compared to 64 days reported last quarter. Going forward, we don't expect measurable DSO reduction given the mix of international business and its impact on payment cycles. Inventory turns improved for the quarter at 12.4 turns up from a 11 reported in the third quarter.

So, at this point I would like to provide few summary points for fiscal 2002. We maintained a healthy business model during a challenging year

gross margins have strengthened due to cost reductions and the growth of software products and subscription upgrades in the revenue mix. We continued to invest aggressively in sales, support, engineering, and marketing while remaining cash flow positive over the entire year. Our customer mix shift has been very successful and we are now more diversified than ever before. At this point, I would like to turn the call back over to Dan.

Thank you Jeff. We made significant progress in our drive into the enterprise during the fourth quarter. Key customer wins included Bear Stearns, Boeing Satellite Systems, Lockheed Martin, NIMA, Petrobas, Shandong Telecom, and Verizon. Enterprise business from our six target verticals, which include energy, financial services, life sciences, major manufacturers, and telecommunications plus federal government is up quarter-over-quarter at approximately 53 percent of total revenue. We continued it up to focus on building partnerships during the quarter. EYT, formerly known as Ernst and Young Technologies, will offer storage-on-demand solutions designed around NetApp filers. We began a global service and support partnership with IBM Lotus for deploying Lotus Notes for NetApp filers and expanding our existing relationship with SAP and became one of the first storage companies to be included in the mySAP advanced infrastructure program. These partnerships to extend our ability of fit into the existing customer environment enable us to provide complete solutions for our customers and further enhance our position in the enterprise. Database related bookings represented over one-third of filer product bookings for the quarter and the mix continues to broaden across multiple database solutions including Oracle, Microsoft's Sequel Server, IBM DB2, and Sybase. Over one-third of the systems eligible, we shipped in clustered configurations typically to support high availability business applications such as databases. These metrics along with our progress in the six target vertical markets are indicative of our success in supporting enterprise business application infrastructure.

During the quarter, we introduced our first DAFS product with integration of the Sybase, IBM DB2, and Oracle database environments. As part of the launch, we announced the record breaking TPC-C benchmark with a real

configuration including products from Emulex Corporation, Fujitsu Siemens Computers, and Sybase Incorporated. The benchmark result delivered a record-setting price performance for our UNIX-based system, the best per-processor performance for a SPARC-based system and a best performance per CPU megahertz on SPARC ever achieved. These results demonstrate that NetApp can easily support the high performance database architectures our customers are deploying and our great validation of the capabilities of the DAFS technology.

The NearStore R100 was formally introduced during the quarter. We saw very promising customer acceptance. Partners who participated in also included Computer Associates, Connected Software, Enigma Data Systems, IXOS Software, Legato Systems, Quantum, Spectra Logic, StorageTek, and Veritas. NearStore customers during the quarter include

Hospital, Broadcom, DreamWorks, EarthLink,

, and

. NearStore Solutions are key component of the successful business continuation strategy and information retrieval architecture for these companies. During the past quarter, we completed a biannual customer satisfaction survey with Burke Customer Satisfaction Associates. The Burke secured customer index represents the percentage of customers who are very satisfied with Network Appliance, definitely will recommend Network Appliance to others and definitely will repurchase from Network Appliance. The secured customer index for our filer business ranked in the top one percent of all computer hardware and computer services companies surveyed by Burke. These results reflect our progress over the past year to more effectively support our enterprise customers.

We made significant progress at a number of strategic initiatives during fiscal year 2002. Although we were and continued to be tested by the slowing IT spending environment, we are particularly pleased with our increased penetration to the enterprise. Over 50 percent of our business now comes from the six target verticals reflecting a significant shift in our customer mix. We have demonstrated that our product or item

benefits for storage consolidation, reduced the cost associated with data center operations, simplified business continuous architectures, and managed distributed enterprise data. The strategy diversify our customer base has been extremely successful and positions us for success although spending environment does improve.

We made significant progress during the fiscal year in strengthening our partner relationships with database and business application companies including Oracle, Microsoft, SAP, Sybase, and several units within IBM including Lotus and DB2. As I mentioned earlier, database-related bookings improved every quarter during the fiscal year to over one-third of filer product bookings. Windows bookings also grew year-over-year as a percentage of filer bookings from just over 20 percent in fiscal year 2001 to approximately 25 percent in fiscal year 2002. Service partners such as Accenture, Computer Sciences Corporation, and IBM Global Services allow us to better service our customers by broadening our service offerings as well as leveraging existing service and support relationships our customers already have in place. Technology and Solution partners allow us to integrate seamlessly into our customers' existing environments resulting in lower costs and more rapid deployment. This partner list includes Brocade, Cisco, Computer Associates, Legato, Quantum ATL, StorageTek, Spectra Logic, and Veritas. Each of our partner plays an important strategic role

success and contributes towards our leading position in the marketplace. During fiscal year 2002, we launched more products than in any year in the history of the company. We introduced a number of new systems including the F87 and F810 low-end systems and the F880 and 880c high-end systems plus the NearStore R100, which defined a new category of storage solution. We captured the number one market share position in content caching according to IDC and we enhanced every single software product in our portfolio. We launched new products, some significantly improved data management capabilities, provide new solutions on the area backup and recovery and enable new business continue its functionality. We announced new products that better integrate NetApp filers in the Microsoft Exchange, Microsoft's Sequel Server, and Oracle database environments. All of these new products have been well received in the marketplace and it strengthens NetApp's industry leadership in our network storage and content delivery markets.

We would like to thank our customers, partners, suppliers, and especially our employees for their support over the past fiscal year. Our first decade has been very successful and we look forward to the next. I will now turn the call back to Jeff.

Thanks Dan. I would like to take a moment to talk about our business outlook. This outlook is based on current business expectation and reflects our pro forma presentation. Again I will remind you that we are making forward-looking statements and projections that involve risk and uncertainty. We continue to be pleased with our ability to execute well in a tough economic environment. We now expect revenue for Q1 to be in a range of 205 to 215 million dollars with a book-to-bill of about one to one, thus keeping our backlog levels steady with this quarter. Gross margin should continue at around 60 percent and as previously mentioned, our operating expenses should decline moderately in the first quarter. We would expect the first quarter pro forma earnings to be in a range of 4 to 5 cents per share depending on the revenue level achieved.

Thank you Jeff. That concludes our remarks for today. So, at this point, I would like to open the conference for questions. I would like to ask each of you limit yourself to one question so that we can address everyone on a timely manner and keep the call to an hour or less. Thank you.

Thank you sir. Ladies and gentlemen. At this time, we will begin the question and answer session. If you have a question, please press the 'star' followed by the one on your push button phone. If you would like to decline from the polling process, press the star followed by the two. You will hear a three-tone prompt acknowledging your selection. Your questions will be polled in the order they are received. If you are using speaker equipment, you will need to lift the handset before pressing the numbers. One moment please for the first question. Our first question comes from the line of Don Young. Please state your company name followed by your question.

Yes, thank you. It's Don Young with UBS Warburg. Hai guys. Congratulations on another good quarter in turning this around. The question is about the expenses. I was wondering if you could explain what the impact of the synthetic lease will have on your going forward expense structure? And then, I wonder if you could to explain what was in some of the marketing programs that seem to drive up the expenses higher than expected in the just reported quarter?

what the running or the ongoing run rate is for the expense structure? Thank you.

Yes. Don. This is Jeff. The synthetic lease change really won't have any impact on our P&L, basically trading the spreads on interest or depreciation. So, with minimal impact as I mentioned in the script. As far as marketing programs, we went to more tradeshows, initiated more market program related activities in our vertical market initiatives. But, the biggest factor is really increased commissions at year-end, where we have experienced both the accelerator for certain people as well as the paying on the bookings that stayed in our backlog this quarter.

Does that answer your question, Mr. Young.

Yes. Thank you.

Thank you. Our next question comes from the line of Kimberly Alexy. Please state your company name followed by your question.

Yes. Thanks.

Prudential Securities. Just a clarification of that question. Jeff, if you said and I missed it, could you just go over the cashing as a percent of revenues? And then, a question, I guess

for you Dan was just I think on the

the other day and really through to conference from last week, you were talking about outlook that tend to be a little bit more longer term in nature in terms of fiscal 2003 and maybe giving some numbers about industry growth etc. Could you just sort of clarify what was said and what your expectation is when you look out sort of into fiscal 2003 for either NetApp topline growth or industry would have been? Just give us a sense of color on and it will be great.

Kimberly. This is Jeff. I will take the first one. Cashing was about 12 percent of revenue this quarter driven by the Deutsche Telekom order that we got last quarter and shipped.

Great.

Kimberly. This is Dan. Let me talk a little bit about growth rates. So, I will replay for you the remarks I made last week. I started with, we expect an overall IT spending and my expectation is going to be an aggregate relatively flat. I think that has been

out by three or four other surveys, I think, conducted recently that is from 2001 through 2002. You see some sectors are down, maybe financial services example have been decreasing budget, but others like manufacturers have been increasing overall. I

it to be about equal year over year. Within that, however, we think the customers are committing more or larger percentage more dollars to storage solutions because of the leverage they get back in terms of reducing operating costs, storage consolidation plus server consolidation and therefore we expect the storage industry to grow, probably at single-digit rates, 4 to 5 percent. But, the next layer down from that is the growth should occur primarily in networked storage solutions.

we expect direct

to continue to decline further rapidly and network

to increase. The IDC numbers have that segment increasing at 25 percent. I think that is probably a little aggressive, but the bottom line as I expected grow at whatever that industry rate is and at a minimum, not to lose share potential when to gain share. So, whatever you think as network storage growth rate, that should be I think the base line for growth rate. If you assume 20 percent, which I think is where most of the analysts are right now, that would put us in 950 or 960 million range in revenue. If you assume 25 percent, that would put us on a roughly billion mark. I would certainly like to be back at a billion where we were in the prior fiscal year in 2001. But, that's driven largely by spending patterns and growth rates throughout the industry. My guess is your crystal ball is better than my in that regard.

There is nothing that you are seeing currently that gives you more optimism to that billion number vs. say that the 950?

No, not at all. No, it is just a question of whether you expect spending to pick up as we go through the year.

Great. Thank you so much.

Thank you. Our next question comes from the line of Mark Kelleher. Please state your company name followed by your question.

With First Albany. Hello gentlemen. I was wondering if you could talk to the jump in deferred revenue. What was driving that? And with that jump up, first your book-to-bill coming in so strong, why is your outlook for the next quarter basically flat to slightly up for a sequential growth in revenue?

Deferred revenue is recognized over the subscription life and you have seen both the deferred revenue in one-year column called current assets or current liabilities grow as well as in the three-year column. So, we will pro rata recognize that revenue. One of the elements that we broke out in this call was the software subscription upgrades that we sell and we recognized those randomly over the subscription period. So, I think that those are just the strength of the software mix as one element driving that and our serving mix driving it as well. What was the second part of the question?

And so, the book-to-bill comes in strong and your deferred revenue was strong, yet your guidance is for sequentially minimal growth? What's different from how you ended your quarter with your projections going into the next quarter?

Well. We have always expected some level of seasonality in the first quarter. Dan has always expressed the challenges we face in the first quarter of the fiscal year and that is really the reflection of our guidance at this point in time as we built the backlog where we wanted it. We don't want to give it back and we are expecting some level of seasonality in the quarter. I will have Dan

.

Yah Mark. Just to amplify on Jeff's remarks. We are about 80 percent of our revenue comes from the direct sales force. The characteristics of direct sales force is we have a strong push to the finish and consequently, we start the New Year with less in the sales

. We scramble obviously to get it rebuilt in our

by the normal 90 day sales cycle and say that we are going to be challenged to get it rebuilt and don't forget that the third month of the fiscal quarter is July. So, we have seen that every year, the first quarter will be a very challenging quarter. As Jeff said on that, natural seasonality pattern that we expect to continue.

Ok. Thanks.

Thank you. Our next question comes from the line of Dane Lewis. Please state your company name followed by your question.

It's Robertson Stephens. Thank you. Congratulations guys on a nice job. I had a question about gross margin performance. Could you just expand on the drivers of that? I know you mentioned software, maybe if you could talk about is it a tax rate or bigger ASPs that's driving that? And then, in your guidance Jeff, you mentioned 60 percent gross margin. Did you mean an absolute 60 percent number and if it is, is that just conservatism or is there some reason why we would expect gross margins to go down?

Dane. You know I am not good at predicting gross margins. So, I will do the best I can. The software mix is really all around the extended applications and they can include

manager for exchange and

server, multiprotocol software,

. All of these are applications that we have seen growth as part of our mix in the penetration rates over the year and we have had a pickup in the number of customers who are signing up with us for long-term subscription upgrades in these products as well. So, both of those factors have helped. This quarter, the mix of the new high density lower cost storage sub-system was virtually 100 percent and that helped margins as well and I think, we have now concluded the issues that we

as the downturn happened related to commitments to suppliers and as I mentioned that has affected our margins favorably by about 1.5 points this quarter.

Thank you guys.

Thank you. Our next question comes from the line of Clint Vaughan. Please state your company name followed by your question.

Thank you. It's Salomon Smith Barney. In the past, you have talked about backlog in the form of how many weeks you have and where you are trying to build it to. I was hoping if you could give us some update on that and some clarifications as far as where you are and where you intend to go. And then also, could you talk a little bit about units and ASPs for the quarter and any trends you are seeing there? Thank you very much.

Yah. We said in the script and the call that we achieved our four-week backlog level that we had set as a goal. So, we are

working on backlog and it will grow as our revenue grows going forward. So, I think that goal has been achieved and we are at a place where we are very pleased with the progress we have made and the balance between having some visibility in satisfying customers. As far as the mix, I don't have specific unit volume at this point.

The unit volume, Clint, was very very consistent with the last few quarters. We have been running about between 2,100 and 2,200 units per quarter over the entire fiscal year. So, this quarter was right in there up just a few units from last quarter. Net cash units where the growth was

were virtually flat up just a few.

ASP trends?

ASPs have again been fairly consistent. We see ASPs move around by plus or minus about four to five percent just based on slight fluctuations in mix. But, ASPs has been right around 80,000 dollars per quarter, plus or minus 3,000 or 4,000 dollars every quarter.

Ok. Great. And just one clarification if I could Jeff. When you were talking about the backlog being full relative to your comments that you mentioned on a seasonally weak first fiscal quarter, could you just kind of sink those a little bit? Does that mean that you intend to work through back or eat into some of that backlog in the fiscal first quarter in the fiscal first quarter as your guidance is actually that you are going to keep that backlog fully stock?

This is Dan. This process basically is that we see just like any other company with direct sales force, we see a surge in bookings at the end of every fiscal period without the

of the quarter. So, fundamentally what one has in hand when you start the quarter is four weeks for the backlog as the first fiscal month. You see a nonlinear performance in bookings, which means you have got, as you ship linearly you then replace that with new bookings coming in near the end of the month that sees the factors in the next month and so on. What Jeff said in the call was we would expect that, although revenue levels are up, we will not eat into backlog that is our backlog at exit of the quarter will be the same as exit this quarter as it is a four-week target.

Great. Thank you very much Dan. Thank you Jeff.

Thank you. Our next question comes from the line of Robert Montague. Please state your company name followed by your question.

With RBC Capital Markets. Few little questions. Could you give us last quarter as you are beginning to break out the software category to where it was last quarter in terms of products and subscriptions and also the cash numbers last quarter? Then, also is the NearStore revenue large enough to be a percent of revenue and what was it? And then, if you could give us any update on your Exchange relationship with Microsoft and

?

The software mix of 23 percent on the product side, it was up about a point and a half and on the subscription side, the remaining. So, it is basically healthy on both sides of that equation. NearStore was a few percent of revenue, good start to the quarter. We were pretty enthusiastic about the sales activity and the sales

. So, we are very encouraged about the breadth of customer engagements across different vertical markets and applications as well.

One more

of that question.

Well actually, what was cash in that quarter and then the Exchange relationship you announced in that quarter?

Cash as an

not balance sheet cash but product line net cash?

Yes.

The cashing as a percent of revenue last quarter was just slightly under 10 percent and this quarter, this quarter it is right around 12 and then it has fluctuated through the year between 10 and 14. The relationship with Microsoft has continued to improve. There were several updates that they posted on their web site and publicized throughout their sales organizations,

to support for our SnapManager for Exchange 2000 product. They made an attempt to clarify, I think just about three months ago in February around the time of our conference call. Customers started to be still ambiguous. So, they updated again. I think there are actually two updates, as I recall during the quarter, which makes it very explicit at block services over Ethernet as a

configuration. That's exactly the technology we have within the SnapManager for Exchange 2000 product. They are also communicating that to their field organization. So, I think the relationships there have improved dramatically.

Thank you. Our next question comes from the line of Bill Lewis. Please state your company name followed by your question.

Thanks. JP Morgan H&Q. Could you provide a breakdown of direct versus indirect in the quarter? And then, talk about what initiatives you have in place to broaden the channels, maybe what you currently have in place and where you think that

business may go over the course of next fiscal year?

Bill. This is Jeff. The channel mix was not substantially changed. Last quarter, about 78 percent of the business was direct and this quarter about 77. So, the channel business is up a bit over the quarter. I guess, our long-term expectation is that we hope and expect to develop channel partnerships, which should drive the indirect part of our business somewhat faster than our direct business.

Hai. This is Tom and those are

comment. In Asia, of course, we are completely channel-based, and we found that our channels are actually very stronger. We have the same channels over the last few years and they have matured. They have invested dramatically higher in the last, I would 12 to 18 months. They saw the opportunity for

expand and we are seeing markets such as China and India become more relevant to

. But, the channel business is very healthy. In Europe, it's more of a 50-50 mix and the channels tend to be large partners who help us drive into the enterprise more than just a

type channel and I think, we are very very healthy, especially in the major three

and also Scandinavia, which is all channel-driven. In the US, we have active programs in two areas to increase our channel penetration. One is with our global partners

before like IBM Global Services, CSB, and

and people like that and then the second level is those companies that can help give us a broader penetration as we continue to take advantage of our success in the enterprise by focusing our sales force

. We have many people

and expand and broaden our presence. So, I think you will see, specifically in domestic in the United States, moving more resources towards the channel in the future.

Thanks. Any targets? Anything specific we can measure again?

I don't think that we need to do that because

I certainly don't want to do is say okay we are going to pick a number and then just move things there just to move them. All

that we are focused on as a company. Clearly, our business model is holding up better than others. We feel very confident that it's going to go forward. And to now, we have to do is to raise the topline as fast as possible to make everybody on this conference call extremely happy. And, the way to do that, I think, is to get more people pushing our product along with our sales force and so, we are not trying to do it to just display like some companies do. I will say that it used to be the case that we want to be part of the people either global or geographic

pushing that partnerships and almost all cases would say, people have established

as a clear differentiated lead in

storage and they wanted to be on our side. So, we are just trying to make sure that we have the structure in place to support that type of

. We are

of business and then to scale up.

Thanks.

Thank you. Our next question comes from the line of Peter Labe. Please state your company name followed by your question.

Hai. Nutmeg Securities. Following from the gross margins, you probably answered to this, but is it fair to assume that the price climate has been fairly benign this quarter and could you bring us up to date regarding patterns of developments, if any?

Well. This is Tom again. What has been consistent over the last few quarters is that although

a year ago or 18 months ago, everyone said that what we do is irrelevant, if we talk about from a competitive point of view. The network-attached storage was irrelevant and then they all came out with network-attached storage and basically told people what it couldn't do. It can't do database, it can't do this and it can't do that. It was

for two reasons. One is that if NetApp has won the deal, it would be

against us typically at a monster discount or two, it would be to say, we have

. The reason I bring that up, I continue to state that unless people lead with that product before they at their other products we are not going to see price pressure because if it is indeed brought in at the very end and it is only brought in because they have lost it is not a compelling sales opportunity. Secondarily, I think we are taking advantage of the confusion in the market that Compaq has experienced and HP has experienced and we certainly are having tremendous success in the NT consolidation field at their

and secondarily, I think there is some confusion at Sun too given what's going on there. So, the market seems to be in

. Most of our competitors are battling their own business model and I think they are able to focus on a very simple statement, which has raised the topline. So, I don't think the direct answer is the discounting has not changed from our perspective and we are able to keep a relatively smooth discount level and continue to make high margins.

There is another metric, I will give you. Round numbers last quarter, we shipped about 3

of storage last quarter and this quarter, we shipped about 3.8. So, our revenues increased by a small percentage. If I did the math right, the storage component is up, in terms of bytes by over 25 percent, that would imply that cost per

continues to decline about that rate.

Well, ok. Thanks.

Thank you. Our next question comes from the line of Shebly Seyrafi. State your company name followed by your question.

Yah. A.G. Edwards. Thank you very much. It looks like cashing grew more than filers sequentially this quarter. What about in fiscal first quarter? Do you see more of the same? And secondly, how much of cashing revenue was due to Deutsche Telekom?

What was the second half of the question, Shebly?

How much of the cashing revenue was due to Deutsche Telekom?

I don't know specifically and if I did, I am not sure I will be interested in disclosing it. But, it is

certainly the world's largest cashing network as we indicated in the press release. Cashing, as I indicated, was up a little bit this quarter, but I think that was in the range of about 5 million dollars of total revenues.

What about in the following quarter Q1?

Q1. I don't have a specific forecast and guess is it will decline somewhat and we have estimated it to be around 10 percent of revenues. It has been as low in the quarter as about 9.5 and as high as 14. As we said in the past, it is very lumpy and it is very difficult to predict exactly what is going to be in the mix.

Can you also talk about the verticals? What was the Internet vertical this quarter and what were your strongest verticals in an order?

The Internet vertical was about 5 percent of the total business. Actually, we saw some rebound in the tech sector mostly driven by large tech companies, you know, some of our long-term

like Texas Instruments and Cisco. The largest single vertical in terms of percent of revenue was Tech. Telco began very strong. Financial services were very strong. Each of those three was over 10 percent of revenue. Significant growth in Federal partially as a result of

win that we mentioned. So, there was pretty good performance. Significant growth also in major manufacturers.

Finally, if I can. Can you talk generally about your outlook for DAFS? How much of a drive do you think will be this year?

You know, that's again very difficult to forecast. You know, DAFS is going to be, I think a facilitator for customers in transaction-processing intensive environments. So, I have always personally believed that those are small percentage of the total number of databases. It is very straightforward to put a database on a file or on a basic math architecture. I think it is just reflected by one-thirdof our business this quarter from database are just pretty straightforward. I don't think DAFS is going to move our percentage significantly. I think it has just got to change the attachment type somewhat within that overall mix.

Thank you.

Thank you. Our next question comes from the line of Doug van Dorsten. Please state your company name followed by your question.

Thomas Weisel Partners. Thank you. Just two details Jeff. Could you give us some color on the software, the terms of the subscription agreements, are they three-year terms or are they less than that? And, could you give us some color on the trend on G&A? It is running pretty stable and decline at a fair amount and what in the fourth quarter of the year?

Hai Doug. Most of the agreements are one-year agreements. There are some three-year agreements and that's reflected on the balance sheet between near-term and longer-term deferred revenue. And what was the second question?

The trend in the G&A line Jeff.

G&A was down quarter over quarter. We, basically, did not make any reserves for any bad debts because basically our customer mix has continued to improve and it's a focus from vertical market perspective

enterprise. We also have been frugal about spending money on outside services and other things like that. So, I think it probably moves up over time moderately, but we are pretty happy with kind of how we are controlling the G&A line.

So, you would say that that's the kind of real baseline. There are no other artifacts in there. Right?

No.

Great. Thank you.

Thank you. Our next question comes from the line of Will Slaughter. Please state your company name followed by your question.

Sure, it's Will Slaughter calling from Robert W. Baird. Two questions, what was the CAPEX and D&A in the quarter? Just looking at all the aggressive product introductions during the past year, what should we be looking forward to over the next 12 months in terms of important product announcements, in particular, maybe some of the block level-based products?

This is Dan. Let me start with the second half of that question. First, you just hit it on the head. The biggest product announcement that we have this year, I think, is going to be in fact our SAN product, both for fiber channel and

. We are very excited about the opportunities that open up. We lead the market the conversions of

and SAN and provide our customers with alternative styles of attachment. That's part of the single largest

. Obviously every year, we continue to enhance our software capabilities. As I said, this year we upgraded every single product in our software portfolio. We will continue to do that again next year. You'll see more extensive management services next year, focused very much on enterprise features. You will also see new platform as indicated, we have updated a number of platforms this year. We will continue to do that on a regular basis. Just recently, we started shipping synchronous mirrors, and for example, you will see extension in that area for more sophisticated solutions.

This is Tom. I don't want to go by NearStore as it came in now. We have done with it. NearStore, I think, is the most exciting product we've announced in the last few years in the sense that you have to take a look of what the year is

we are. Different way that we have been talking about. One is in data consolidation that's unique to your database. Second is in data recovery for backup and recovery. And thirdly

recovery. Our products, NearStores fitting into those seamlessly is something the same stores understands immediately and the value of which is seen by our current customer base as well as our prospects in an extraordinary fashion. The real challenge is on the recovery basis. The window is getting too short to the amount of data and coming back from disk is the efficiently we are doing it. The software that has gone with that is contributing and will continue to contribute to our margins I think. More importantly it gives us the tremendous amount of room to add benefits to our customer base. So, there is a lot of excitement in our base about what we will do with that

.

We don't make specific forecast related to capital spending but in the quarter the capital spending was about 10 million dollars. It's

, it's mostly equipment or either people or test labs and periodically as we are expanding and outfitting buildings, we might have improvements in the building that we would capitalize as well.

and the depreciation...?

I don't have that specific number right now.

Thank you our next question comes from line of David Bailey. Please state your company name followed by your question.

Yes, it's Gerard Klauer Mattison. Just a quick question. I was wondering if you tell us the

in the quarter and how that varied from past four quarters?

Is it booking or revenue?

Revenue.

Linearity was just fine.

I think, you now, we are going to do clear victory on our program to get back to linear and build the backlog. So, we would expect that you know our patterns are back to much more historical levels at this point.

OK, thank you.

This is Tom. I don't think the comment at this strengths was in any one area. This was the strength in the entire all three

which are North America, Europe as well as intercontinental operations. All three have met a very strong

in the quarter.

Thank you, our next question comes from the line of Glenn Hanus. Please state your company name followed by your question.

Needham & Co. Tom, maybe you can just give us a little more color on the kind of the environment you are seeing out there. Maybe relative to say 6-8 weeks ago. The environment improved, the same, or do you see more cautiousness than where people stand with their budgets and the process of actually cutting

? Thank you very much.

Thank you. I think it 's improved. I have done a lot of travel in less than seven weeks. I have been on a road

. I think Dan has about the same. I can tell you from the field

a lot of enthusiasm though they

particular site because. We are hearing on exactly to write topic. Our customers feeling like they have a budget that they can proceed with. One other thing people continue to measure what can happen with IT spending. As relevant, will they spend it throughout the year, or will it be very very lumpy and will they stay cautious the entire year. I don't think it is happening that way. I feel completely differently of what I at this time last year and throughout this quarter as we pursued different revenue opportunities, I found it was

. They did make a decision or

were high and that's why we ended up with the results that we ended up with. So, we start to continue to see how they will spend throughout the year but I do feel. My personal belief is that CIOs now have a budget. They have their priorities in line. I think we understand them. There are

data consolidation, data recovery, debt recovery and also taking advantage of any opportunities which

of remote offices. Because those who got data centers three years ago as for as data but they don't have the IT. So, we

our strategy along those four colors if we will. I think customers are going to move forward in a pretty straightforward fashion. I don't feel it's anywhere near as up in the year as I did two to three months ago.

Thanks.

Thank you. Our next question comes the line of Shaw Wu. Please state your company name followed by your question.

Yes, Banc of America Securities. Just one question on DAFS. How is DAFS sold? Is it sold as a separate product line or as it kind of a add-on feature? What software/hardware changes further made?

Shaw it's Dan. DAFS is a software feature. It's a different type of link, upstream link to few other attached to systems. It's also a client attach kit because there it has the driver that install and few other application server side of the connection. But it's basically a piece of software that runs over a gigabit Ethernet link.

Do you lead with that or how that sold by the sales force?

I certainly hope to lead with it. We simply our customers. That's data manager's problem. Provided our platform we can consolidate all other storage solutions in a much simpler way and save all money and it's probably maths. We have taken into a variety of different solutions including how we consolidate file storage, how we can simplify database environment, how we can simply the exchange server environment. Then we get down to trail further to just database.

talking about different types there in. DAFS was one of those alternatives, manually we can pick from. If you think about it, DAFS was created to allow file transfer memory-memory machine between systems. It has some specific markets. You are going to get early adapters. Those markets are going to include people with very files like

, like different types of database environment and the application vendors who announce with us very early when we announced DAFS in a consortium are clearly working to take advantages of some of the new application work. So, I think another

question. We are working close with a group of application vendors, who believe there is a real advantage to them of utilizing DAFS. They are in the target verticals we are in. We are going to take advantage of joint selling with them to make sure that the customers they are only customers give us good indication of whether real home

or we will push them.

Thank you. Our next question comes from the line of John Roy. Please state your company name followed by your question.

It's actually John Roy from Merrill Lynch. Hi! guys. On the capacity issue, I know you used to run about 50-60 percent capacity on your systems. Can you give any color or any kind of update on that.

You can have more background to your question John. You mean in terms of ship size or...?

In terms of how much utilization, what people are running out of their capacity? Say having one terabyte system they are running at or 20 percent of that...

I have not looked at the data personally recently but I know what is trending up. Most of our customers are running close to, depending on how you account them now, but 70-75 percent. There are from a vast storage to use

. There are two reserves taken. One is free space.

and is about 10 percent. The other area is the snap shot space, which is optional. But if you turn to snap shot now, we are going to recommended of about 10 percent. So of the gross to the net available was about 80 percent. We find customers utilizing that in excess typically of 70-75 percent.

John, the ability to add at

system is so simple. If customers buy what they need and so about 15 percent of our business on an ongoing basis is the expansion of storage in the existing customer environment.

Generally as additions of one shelf at a time which these days is one terabyte.

Great quarter guys.

Thank you.

Thank you. Our next question comes from the line of Andrew Neff. Please state your company name followed by your question.

Bear Stearns. A lot of controversy over option accounting and things like that. Could just give the sense of what the numbers will look like with or without be with or without option accounting? What impact they would have on your reported results projected results or anything like that.

You know, I am not that smart.

Because I don't want what method do you want to use. But my view is we report that every quarter in the diluted earnings per share calculation. So, I can take this off line and try to understand what methodology you want me to use.

Just trying to get a sense of what the magnitude? So, you are saying given the diluted numbers would be around 2 cents. Can you give a range of what you thought it will be on the reported numbers or...?

Not really. I think the methodology we have is the one that is subscribed to has got a basic calculation and then you have got diluted with included the treasury method of repurchasing all your options. So, I think, at this point that might be my best answer.

Thank very much.

If the number we have reported was on a fully diluted calculation...

Just given the controversy over inclusion of having reflect options as compensation expenses

proposals going around...

I think, that's the problem. There are a lot of different proposals going around.

Alright. I will talk with your off line. Thanks.

Thank you. Our next question comes from the line of Harry Blount. Please state your company name followed by your question.

Hi! Lehman Brothers. Two questions, one with regard to the Federal government. You guys have continue to express some optimism that Federal government will play a big role on what it sounds like it continues to go nicely for this quarter. Given the long-term budget cycles required by the Federal government? What are your expectations at this point for 2003. And then Jeff just a point clarification on the backlog. Did the backlog exclude the revenue impact that you are expecting from software subscription and services.

Let me talk about the Federal government first. This is Tom. We

in the Federal government now for the past six years. We have increased the investment

at about 18 months ago. One of our largest customers, I don't know where they rank, but certainly top 10 of the intelligence community, could be top 5 and has been for a long time. Our technology is extremely well part of their and prevalent. So, this past year, it was the single

going part

. A lot of investments we have made are paid off like a lot of our different type of new technologies. So, even as the challenging business year happened, we increased our investment in a couple of areas with Federal being a queue. So, it was our fastest growing business last year. We expected to grow again at a good rate this year and we are going to pay more attention to it, if anything. So, you right about the cycle time, but we have a lot of buying vehicles in place. We have a lot of good partners in place. We are very very happy customer that's one of the most

in the entire government in defense.

what's going on in the intelligence community today. I think, it's a real opportunity for our company.

And just within the Federal government, other than the intelligence vertical, any commentary on the other verticals that make sense and also any commentary on state from local?

We have won a number of different mapping organizations. We have, actually in the DoD, in general has had very good success in the past year. To defense, the intelligence community just won with it. Has really a lot of first

products. But we have done well across and naturally we have increased the investment.

intelligence community, it's got a broader group. On state and local, I think, there is a real opportunity for partnerships there. We have to start to take a real advantage of that. That's not something I want to home grow because it is mostly relationship built. So, we are now in the process of linking if you are with a number of partners that you have in state or in local

with some success.

On the backlog, the vast majority of the backlog is product. There is some software subscriptions upgrade backlog. It's basically a portion of the next quarter. So, I would say the vast majority is factory loading of parts and then some portion of what's been defined in our balance sheet under the 7 percent I mentioned.

So, if we were to take that 7 percent number and annualize it that would essentially represent the software component of the backlog in the balance of the equipment?

Before I give you an answer I want to make I understand the question. I think that the 7 percent of this quarter's mix and some portion what

differed that's recognizable over the next quarter as in the backlog. It's basically in the sense of not only that's here. Yet, we get orders in the coming quarter, which is somewhat less than the 7 percent of revenue.

Have we answered the question Harry.

I think so. I will

back offline and make sure I got it.

Keep in mind that there are two types of software revenues. One is product, which is shipped from the factory and recognized at the point of shipment and the other is the subscription upgrade business, which is the 7 percent what the Jeff was referring to.

Right.

Not all of that 7 percent is

in a quarter. It comes during the quarter as well. Somewhat less than that number is actually not thought about it that way, but to bring up a point part of the backlog. The vast majority of the number is sitting in backlog for product.

Hardware and software product.

Ok, thank you.

Thank you. Our next question comes from the line of Bill Lewis. Please state your company name followed by your question.

JP Morgan H&Q. Thanks for the followup. I wanted to ask a little bit more about the forward guidance. What I am trying to do is reconcile the near term slow growth with your longer term goal of 20 percent for the coming 12 months or even higher

market going forward. What's the disconnect there? Is it just the seasonality of the fiscal first quarter or there is some other issue going on there? Another way of going at it is the backlog if it grew in 1 to 1 1/2 weeks, booking is probably grew, say 20-25 million dollars and now we are telling it's growing by 5-10 million dollars or 0-5 percent growth. How do you reconcile these two things? Thanks.

Bill, it's all about seasonality and the fact that we are not going to use our backlog in Q1 given the guidance I gave you. We are going to hold it steady.

If you look at the prior couple of years, in general book-to-bill is below 1 in our fiscal Q1. Historically we have built backlog and then as recommended in Q1. Generally revenue is exceeding bookings, as we experience a soft Q1 bookings.

What does that imply about growth in fiscal second quarter?

I don't know you are trying to

. We are still optimistic that we will grow at a rate at or above the rate of the industry.

Thank you. Our next question comes from line of Amit Chopra. Please state your company name followed by your question.

Thanks, CSFB. Couple of questions. You talked about as Bill was suggesting a sort of growth rate, the topline growth rate for the year that you could possibly achieve. Can you talk abou the sort of the operating margin growth goals you are looking for the year. Tom, quickly on NearStore any signs of EMC adding in that market at all? I know it's little early. Thanks.

Well, our goal would be to improve operating margin each quarter. We are going to keep a good balance between investing in the business especially things that drive the top line. So, we would expect to make progress over the year, but make sure that we are investing in gross opportunities going forward.

As far as in EMC, I am happy they announced something. In general, I would like to have other people jump in

the market. The big advantage, I think, we have right now is that people are coming to understand the total cost of ownership really total cost and not vendor cost if you will. So, they really want to understand is what you are doing really

v the money. That's been the biggest advantage for us on competitors and certainly and most importantly

. So, one of the things that we have had is an advantage. We can sell our

top to bottom at a consisting cost and then with the new store product, it's the same technology. You know many thousand reasons to all and they are very confident that

data centers. They will give if they want. Secondarily, what they are very confident was net assets. This is in their plan. That's is the key to the whole strategy because where their devices are going, they don't usually have IT where it is a desire to recover your applications recovery. That's something most people don't associate with EMC with as simplicity in appliance like. So, it' still data center and I am guessing at EMC customers. I find that as people talk to me about it. They very quickly look at what we are laughing as unique and their plans being the key

to it.

Thank you.

Thank you. Our next question comes from the line of Naveen

. Please state your question followed by your company name.

. Even adjusting for the software subscription, your gross margins are still well above 60 percent. Why can't you drive more elasticity into the market and be more aggressive on pricing? Or is that no elasticity at all in the market right now?

Most of the time our customers are not aware of our list prices. We again had a discussion about proposal on

. We've quoted net prices. We will allow those net prices to go

to win the business. Our discounts have actually trended up over the year and that's fine. Right customers are getting more for less, but elasticity assumes you have a fixed price and the customer is aware of it. That does not allow the pricing market. This is not a retail distribution kind of model. I don't think that there is an elasticity component associated with

our pricing. We have tested at several times with low end products and bundles and a variety of other things, but hasn't seen the show up. I think it's because of the largely direct sales model. We are quoting a net price to the customer.

issue on the gross margin. We just got a very low cost business model. It is a software-intensive model with low cogs, efficient packaging, low overheads, and high software content on the head-on business. That's really was driving our margins. I will think it's just price per gig. Like I will argue, data abstains as we are one of the price leaders in terms of price per giga

on a sole basis.

You know there is a second component

business. So that you will

time, I know that. We are having this conversation 18 months ago. It would have been primarily that

in the tech/Internet space and that is clearly not true any longer. I think the fact that people no longer at the same money they had to spend before and they have acquirements

and then especially since 09/11/01 has caused everyone to rethink how they are going to store information. So, the significant turn

over the last 6-9 months is we are now installed in many many large accounts that we wanted before and they have got used to the plans, concepts, and liked it. We have a lot of thinking going on to say. If we did what using our profitability as a weapon, could we expand faster. That has to do a channel development, which we commented on before it has to do a different ways of packaging our products, and different way of partnering that we are clearly going to try and take advantage. All meeting that we had

right now and

more aggressive and attack using these weapons. I think your question is very valid in that way. If we find a way

, we will take it and secondarily, I think, it's buying rebounds in the Fortune 500. You are going to see a lot more

presence than you saw that last time, a year ago.

Thank you.

there are no further questions at this time. Please continue.

Ladies and gentlemen, I would like to thank you again for joining us this afternoon and I will look forward to see you at this time next quarter. Thank you again very much.