NetApp Inc (NTAP) 2004 Q4 法說會逐字稿

Welcome to the Network Appliance '04 and fiscal year '04 earnings conference call. (OPERATOR INSTRUCTIONS).

As a reminder, this conference is being recorded today, May 18, 2004.

I would now like to introduce Dan Warmenhoven.

Please go ahead, sir.

Thank you.

Good afternoon, and welcome, everyone, and thank you for taking the time to join us today.

With me on today's call are Tom Mendoza, President of Network Appliance and Steve Gomo, our Senior Vice President of Finance and Chief Financial Officer.

In the course of today's call, we may make forward-looking statements and projections that involve risk and uncertainty, including statements regarding our forecasted operating results and our outlook for continuing growth.

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, customer demand for products and services and any decline in general economic conditions.

Other equally important factors are detailed in the Company's 10-K and 10-Q reports on file with the SEC and also accessible through our Website, all of which factors are incorporated by reference into today's discussion.

I would also like to remind you that today's this conference call is being Webcast live over the Internet and will also be available for replay on our Website at www.NetApp.com, along with our earnings release and the reconciliation between GAAP and the pro forma numbers.

Now I will turn the call over to Steve for a review of the quarter's financial results.

Then following Steve's comments, I will share my own comments on events during the quarter and the year, and then we will discuss our financial outlook and conclude with a question-and-answer period.

So at this point, I would like to turn the call over to Steve Gomo.

Thank you, Dan, and good afternoon, everyone.

Our press release is available, both on business wire and our Website.

I'd now like to provide some commentary about our results for the fourth quarter and full year 2004.

Please note that all numbers are GAAP unless stated otherwise.

Once again this quarter, revenue growth was outstanding.

At $337 million, organic revenue growth was up 39.5 percent over the fourth quarter of last year.

Revenues increased by 13.3 percent sequentially from the $297.3 million in the third quarter, resulting in our tenth consecutive quarter of sequential growth.

All regions and all product areas met or exceeded our expectations with respect to growth this quarter.

Favorable foreign currency impact contributed about four points to the Q4 year-over-year growth rate and half a point to the sequential growth numbers.

Revenue for the full year totaled 1.17 billion, up 31 percent from 2003.

Revenue from services, which includes hardware, support, professional services and educational services, grew 35 percent over the fourth quarter last year and was 9.8 percent of total revenue, up slightly from the 9.5 percent reported in Q3.

Service revenue for the full year was 112 million, up 25 percent from 2003.

All geographies posted significant revenue growth in the fourth quarter.

The Americas were extremely strong, contributing approximately 57 percent of total growth, up from 54 percent last quarter.

Europe contributed approximately 32 percent of total revenue versus 34 percent last quarter and Asia-Pacific contributed approximately 10 percent versus 11 percent in Q3.

This past quarter, direct business was 57 percent and our indirect business contributed approximately 43 percent of total revenue.

Add-on software and software subscription upgrades accounted for approximately 33 percent of total revenue.

Every add-on software product across the board experienced increases in revenue this quarter.

Keep in mind that this figure does not include the software that is bundled with our systems, including data ONTAP software, the WAFL file system, Snapshot and the first protocol.

Add-on software products were approximately 23 percent of total revenue and software subscription upgrades were approximately 10 percent of total revenue.

Pro forma gross margin for the quarter was 60.5 percent, similar to the 60.7 percent reported last quarter.

We are extremely pleased with the performance of our product margins.

Pro forma product margins finished the quarter at 65.7 percent, up 0.4 percent from last quarter and at their highest level in the past year, reflecting competitive strength across the entire product line.

Service margins were 12.7 percent for the quarter, a decrease of 3.6 percentage points compared to last quarter.

Mobile services continues to be a major area of investment for us as we continue to build out our service capability and capacity.

Pro forma operating expenses totaled $52.4 million, increasing almost $20 million from the $132.7 million reported last quarter.

Of this increase, almost $3 million of R&D was related to ongoing Spinnaker expense and about 14 million was a result of strong commissions and hiring in sales.

Expressed as a percent of revenue, pro forma operating expenses were up just slightly to 45.2 percent, an increase of 6/10 of a percentage point from the third quarter.

Pro forma operating profit for the quarter was 15.3 percent compared to 16 percent reported last quarter.

Removing the operational expenses associated with our acquisition of Spinnaker, pro forma operating profit would have been 16.1 percent in Q4.

Pro forma other income was $3.6 million, an increase of almost $600,000 from last quarter, primarily due to higher cash balances.

Pro forma pre-tax income for the quarter was $55.1 million or 16.4 percent of revenue.

The effective pro forma tax rate for the quarter was 21 percent.

Pro forma net income for the quarter was $43.5 million or 12.9 percent of revenue.

Pro forma net earnings per share was 12 cents based on a weighted average of approximately 375 million shares outstanding.

This quarter, we reported a GAAP net income of $36.4 million or 10 cents per share.

We provided a reconciliation between pro forma and GAAP net income in the condensed consolidated statement of income of our press release and is available on the investor section of the our Website, at www.NetApp.com.

Turning our attention now to the balance sheet, cash and investments at the end of the quarter were at an all-time high of $808 million, up $30 million from the previous quarter.

Cash generated from operations during the quarter was $133.4 million, a record high for the Company.

Capital purchases of plant, property and equipment were $13 million during the quarter while depreciation was also $13 million.

Days sales outstanding were 52 days, down seven days from the 59 days last quarter.

Inventory turns were 15.9 times, up from the 12.3 times reported in Q3.

At $278.9 million, deferred revenue increased by $42.1 million or 18 percent quarter over quarter and 60 percent from the $174.4 million reported a year ago.

At the beginning of the fiscal year, we announced the stock repurchase program, allowing for the repurchase of up to $150 million worth of stock.

During the quarter, we purchased approximately 4.2 million shares of outstanding common stock at an average price of $21.94 for a total of $91.3 million.

For the full fiscal year, we purchased approximately 6.9 million shares at an average price of $19.87 for a total of $136.2 million.

Now in addition to this repurchase program, the Network Appliance Board of Directors has approved a new repurchase program in which up to $200 million of outstanding common stock may be repurchased.

Shares will be purchased on the open market at prices deemed appropriate by management.

This new repurchase program reflects continuing confidence in our ability to generate cash.

Headcount at the end of the quarter was 2,844 employees, an increase of 345 people from last quarter.

Of this increase, about 80 employees were part of the Spinnaker acquisition.

In summary, this excellent fourth quarter caps an outstanding year for Network Appliance.

This was a year of extremely strong growth, the return of profitability to expected business model levels and a further strengthening of our financial foundation.

FY '04 revenue of 1.17 billion grew 31 percent from FY '03.

All of this growth was organic.

Full year pro forma product gross margins finished at 65.2 percent and strengthened successively from the first quarter.

The strong performance of our product margins allowed us to make additional discretionary investments in our global services business while still maintaining a pro forma consolidated company margin of 60.5 percent in FY '04.

In the third quarter of FY '04, profitability returned to the level targeted by our business model.

During the fourth quarter, profits were maintained within the bounds of that model.

For the full year, pro forma operating profit percentage was 14.8 percent, an increase of 3.8 points from FY '03.

FY '04 pro forma net income finished at $146 million or 12.5 percent of revenue, and increased 74 percent from FY '03.

Full year pro forma EPS was 40 cents per share, an increase of 67 percent from the prior year.

As we exit FY '04, our financial position, as measured by our balance sheet, is also rock solid.

Our cash and short-term investments increased by $189 million during the year to finish at $808 million.

This is net of the repurchase of $136 million of stock.

Accounts Receivable DSO improved by five days from FY '03's ending levels and inventory turns, at 15.9 times, improved 35 percent from year-ago levels.

Finally, our deferred revenue position is at record levels and 60 percent ahead of where we were one year ago.

We are extremely pleased with these results.

As I stated in our call last quarter, going forward, our focus will be on topline growth and maintaining profitability within the bounds of our target model.

We have executed on that commitment and will continue to do so.

But before I talk about our targets for the next quarter and coming year, I would like to turn the conference call back over to Dan.

Thank you, Steve.

I'm extremely happy with the results this past quarter.

It truly was an outstanding quarter, in fact the term blowout comes to mind.

We saw strengthen in every region, accelerating growth in our new product lines and with the strongest organic growth rates in the industry, we're obviously taking market share.

The investments we've made in our business are paying off and our performance reinforces our belief that we should continue to aggressively invest in our business to maximize revenue growth and market share gains going forward.

Before I talk about the future, I'd like to review with you some highlights of the quarter and the year.

Our fourth-quarter performance showed tremendous progress on all the areas where we've made investments over the past few years, particularly in product development, global services, partnerships and sales.

New products such as NearStore and iSCSI contributed significant growth.

NearStore contributed 12 percent of total revenues this quarter, up 32 percent in absolute dollars over Q3 and up 97 percent over Q4 of last year.

Our key names like Edward Jones have chosen to back up their worldwide open systems data to NearStore, using both fibre channel SAN and NFS LAN protocols.

In Japan, Honda has selected NearStore as their disk-to-disk backup solution, and PDI/DreamWorks has purchased a combination of products, including our new FAS980 along with NearStore and SnapMirror so that their dual development locations in L.A. and Silicon Valley can share data and work cooperatively on the same film, in this case, Shrek II, which I understand is released tomorrow. iSCSI went from essentially zero last year to the point where about 10 percent of our bookings include iSCSI today.

Our fibre channel SAN business increased by a third over last quarter, and it has tripled in its second year of production, with over 1,000 deployments.

And while our SAN business continues to grow, at the end of its first year, iSCSI has already overtaken the fibre channel SAN business in terms of bookings, which speaks to the tremendous market opportunity for iSCSI. iSCSI is being driven primarily by customers who want a low-cost alternative to move direct attached storage to the network.

Companies like Volkswagen, who purchased our FAS250 Filers with our iSCSI protocol, to protect and replicate data between their coordination center and remote data center, and Continental Tevis AG, the tire company, wanted a FAS940 in an iSCSI environment for SAP business apps and home directories.

Our Filer business also showed excellent growth.

The number of FAS270 units shipped more than doubled over last quarter and our new FAS980 accounted for 5 percent of all filer units shipped in its first quarter of availability.

Conoco Canada is moving to NetApp as an enterprise solution, most recently purchasing our FAS980 to run their Oracle database applications.

SAS Institute also recently selected our FAS980 with SAN capabilities along with NearStore to round out their storage capabilities.

Windows contributed about 45 percent of revenue again this quarter and had over 85 percent growth year-over-year.

There are really two parts to our Windows business, our traditional mass file servers and also our SAN products for Windows applications, primarily Exchange and SQL server.

Our SAN products contributed 40 percent of the mix, and we expect our largest growth opportunities for Windows to come from block storage in the future.

As exemplified by Guidant Corporation; they recently purchased our filers with fibre channel SAN to support their Windows Exchange environment.

On the software side, revenues from SnapDrive and SnapManager, our application storage software products, grew over 85 percent on a year-over-year basis.

Our net cash products contributed 5.2 percent this quarter, up 17 percent over last year, though down somewhat from Q3.

Customers this quarter included AT&T in Tokyo, the Australian Department of Education, the U.S.

Marine Corps, Vodaphone Spain and -- this one we enjoy, the Vatican, which will be streaming the Popes' speeches all over the world.

We refer to it as the cash of God.

We've also invested significant time and resources in developing deep partnerships with our integration channel partners.

We're already seeing good traction and expect the coming year to be the year we see a visible shift in the pool for these partners into Enterprise accounts.

Technology partners like Microsoft, Oracle, SAP and Veritas are increasingly influencing customer wins for us.

We also just received the SAP award for innovation.

And with over 150 customers worldwide already deploying SAP on NetApp, including Hella, Coca-Cola, BMW and Mitsubishi, this heightened recognition should drive further sales into both existing and new accounts.

On a systems integration side, partners like Accenture, Fujitsu Siemens and IBM Global Services are increasingly involved in selling NetApp solutions.

IBM Global Services was the system integrator on a large deal into Arizona Public Service this quarter, who purchased our FAS960 and NearStore, our 200 secondary storage solution, for their database and layered applications, as well as backup, archiving, data protection and disaster recovery.

Our channel mix shifted towards direct this quarter, consistent with the strength in North America, which is largely a direct channel business.

One of the highlights of our North American indirect channel performance was the contribution from Hall-Mark (ph) and Avnet.

In their first nine months of doing business with us, they contributed more than 10 percent of our full year FY '04 North American bookings.

And each ranks among our top five resellers.

They are very motivated and excited to do business with us and part from the ease of doing business perspective, as well as because of the better margins on our products due to our high software component.

Overall, our partner-influenced business was increasing and should continue to have a positive impact on our business.

Our U.S. federal business continues to expand in our mix, contributing approximately 12 percent of total bookings in Q4.

Lockheed Martin, which is a major part of our federal, is now one of our top 10 resellers and growing rapidly.

This quarter, the office of naval intelligence made a NetApp Filer purchase for disaster recovery.

And the U.S.

Secretary of Defense made a major commitment to NetApp Enterprise Filers this year.

We have been able to leverage that success in other countries, as exemplified by a recent win in a large competitive deal with the Israeli army.

NetApp Storage is installed on all branches of the U.S.

Armed Forces.

And we recently won deals in two different divisions of NASA.

The federal business is ramping rapidly, and we will be investing additional people and resources to take advantage of the opportunities before us.

Another area of our business where we made strategic investments in the past few years is global services, and now we're winning business because of it, as the 60 percent year-over-year growth in our deferred revenue demonstrates.

We have great products, but in order to drive those great products deeper into the enterprise, we need to provide the best customer support in the industry.

We've put additional back office infrastructure in place and continue to hire aggressively in both customer support and professional services to handle the demand we expect in the coming quarters.

In fact, professional services headcount is up 64 percent over last year.

Recently we've seen an encouraging shift, as our professional services group increasingly engages with their customers earlier in the sales cycle, playing an active role in closing sales and penetrating further into the enterprise.

A recent example is the multi-million dollar deal at Galileo, the travel subsidiary of Cendant.

The professional services team jointly architected the high availability full-service technical solution to provide a Galileo Cendant with great confidence in our ability to design, manage, install, implement and integrate our systems with their proprietary and mission-critical business application.

This investment in service, in especially professional services is really paying off.

Another illustration of recognition, that we have a world-class customer service organization that comes from Texas Instruments.

TI recently voted NetApp vendor of the year for the second year in a row.

And perhaps our biggest success to date came just yesterday.

I am very pleased to announce that NetApp was just selected for the first time as one of the Company's on Gartner's magic quadrant for storage services.

NetApp has entered the magic quadrant, positioned as visionary, ahead of Dell, HDS, Computer Sciences, Sun, and StorageTek, and slightly behind HP and IBM.

According to Gartner, and I quote, "visionaries have a clear vision of market direction and are focused on preparing for that.

Visionaries can frequently deliver competitive advantages through their approaches to service technologies, best in class strategies and services tied to technology innovation."

NetApp's innovative use of technology to address problems before the customer sees them was key in our strong placement along the visionary access.

As we look at the future, we're seeing some structural market shifts occurring.

First of all, the old paradigm of high-end, midrange and low-end market segmentation is quickly becoming archaic, as the ability to move easily across these bands by simply purchasing additional unified storage becomes prevalent.

More accurate framework would be the three broad categories of mainframe, open systems network storage and direct attached storage.

The growth in the mainframe area was recently flat.

Direct attached is declining, but open systems network storage is increasing.

And within this category, the lines of distinction are blurring between NAS and SAN, as they are converging.

Primary and secondary stores are also converging. iSCSI and grid computing are emerging and Linux blade server farms are increasing every day.

All these translate into our strengths.

Our current products have demonstrated that we anticipate these trends and we plan to invest more resources into people and programs necessary to best capitalize on these growth opportunities.

These trends are just some of the underlying growth drivers of our business.

Our ability to innovate quickly, our strong, unified software architecture, the simplicity of our systems, and our ability to really listen and solve customer problems, are additional factors fueling our growth.

We offer the most reliable cost-effective secondary storage in the market and have the best data protection, replication, recovery and compliance solutions in the storage market today.

For example, we have sold over one petabyte of compliance storage in the last two quarters alone.

And in calendar year 2003, NetApp moved into third place on Gartner's list of top data replication software vendors.

We were in a virtual dead heat for the number two spot and have momentum to become a clear number two this year.

Not only is our growth sustainable but with continued strategic investments in people and programs, we will capitalize on the highest growth segment for the open systems network storage market both now and in the future.

Our growing enterprise relationships have enabled us to become a trusted vendor, opening the doors to deep penetration in some of the largest corporations in the world.

Our acquisition of Spinnaker provides a huge new market opportunity for us in grid computing.

We're very pleased with our progress in this quarter, and view it as a sign that we're doing many of the right things and necessary things to grow and rapidly carry and capture market share.

And now I will turn the call back over to Steve to discuss our financial targets.

Thanks, Dan.

Our business outlook is based on current business expectation and reflects our pro forma presentation.

Again, I'll remind you that we are making forward-looking statements and projections that involve risk and uncertainty.

Actual results may differ materially from our statements or projections.

We expect our momentum to continue and project first-quarter revenue to grow sequentially by 4 to 6 percent.

This projection reflects year-over-year growth rates of 35 to 37 percent.

We do not expect revenue from the Spinnaker products to be recognized in Q1 so our projections reflect totally organic growth.

We are targeting Q1 pro forma earnings of 12 to 13 cents per share.

GAAP earnings should come in modestly below these levels.

For fiscal year 2005, we are increasing our target for revenue growth.

We expect year-over-year revenues to grow by 30 to 32 percent.

As we mentioned on last quarter's call, we reached our target business model one quarter early.

I would like to reiterate our intention to adhere to that model, meaning that even as revenue growth increases, we will continue to invest aggressively back in the business for future growth and market share gains.

In FY '05, consolidated gross margins should finish right around 60 percent.

And we should -- and we expect to -- maintain operating margins between 15 and 16 percent for full year of FY '05.

Therefore, we expect pro forma EPS to be between 52 and 54 cents.

I will now turn the call the over to Dan to wrap up.

Thank, Steve.

Before we open the floor to questions, I'd like to quickly review our business priorities and target business model.

Our primary objective is to gain market share, reflected in revenue growth that exceeds the market growth rates and the growth rates for our competitors.

This quarter, we achieved 39 percent year-over-year revenue growth, resulting in 31 percent growth for fiscal year 2004 over FY 2003.

We believe we have the potential to grow revenues, as Steve just said, from 30 to 32 percent through next year, as reflected in the revenue growth targets that Steve shared with you.

This growth is a result of fairly aggressive investments in sales capacity and channel expansion, global services and customer support and engineering for new product development.

During Q4, we added 345 employees.

And even after adjusting for the Spinnaker acquisition, the net add is still over 260 people or more than 10 percent increase in employment.

We plan to hire another 200 people each quarter for the next four quarters through FY '05.

To recap our target business model again, in FY '05, we expect to grow revenues from 30 to 32 percent, with gross margins of approximately 60 percent.

Our operating expense structure will range approximately 44 to 45 percent of revenue each quarter and our operating income will range from 15 to 16 percent of revenue each quarter, resulting in net income between 13 and 13.5 percent of revenue each quarter during FY 2005.

I want to stress that we fully intend to execute to our investment plan and the 15 to 16 percent operating margin targets we've laid out for you today.

We are really excited about our growth prospects and we believe we have the opportunity to take additional market share.

So we believe the way to maximize shareholder value is to invest now to maximize future growth and forego any potential short-term expansion of operating margins.

At this point, I would like to thank the Network Appliance team for their stellar performance this quarter and our investors for their continued support.

I would also like to ask you to mark your calendars for our 2005 analyst day, which will be held in New York on December 1.

You will be receiving additional information later this quarter or you're welcome to contact our Investor Relations people for details.

At this point, I would like to open the conference for questions.

We ask that you limit yourself to one question so that we may address everyone in a timely manner and also honor your request to keep the call to one hour.

Operator?

(OPERATOR INSTRUCTIONS).

Laura Conigliaro, Goldman Sachs.

Actually it's Brendan Smith in for Laura.

Hi, guys.

Quickly on the headcount adds, you had 295 or so out of this quarter, I guess 200 or so excluding Spinnaker, and it's the most you've added in a long time.

You know, showing, given the revenue leverage there.

But as we kind of go through the back part of fiscal '05, are you going to start at least reevaluating how you're trying to scale the business once we kind of close that portion out?

Or is it really just set in stone at this point that we are going to be adding that many heads per quarter going forward?

Brendan, just to clarify, we added 345 full-time employees in the quarter. 345 was the number.

Approximately 80 of those came from Spinnaker.

So about 265 were net adds in the base Network Appliance organization.

You know, we do obviously plan for the year, which is what we share with you and then we do dynamic adjustments on that as we see conditions change.

So you used the term cast in stone.

I don't think of the future as cast in stone.

So we are going to adjust that as we go.

Okay, Fair enough.

I have got a related question on the services side, as well.

I mean you know the long-term deferred balance started ticking up pretty quickly about this time last year.

You know, some users have talked about potentially having a year grace period on some of their maintenance revenues.

I mean, A, would you care to comment on that?

And B, should that mean that we should expect to see the services revenue start to tick up a little bit in terms of growth rate, once we get into fiscal '05?

This is Steve Gomo here.

Just so the record is straight, our fourth-quarter service revenue increased about 35 percent over the same quarter a year ago.

So we've already saying it start to tick up.

I would anticipate from the size of the increase in the deferred accounts that we'll see at least that kind of continued growth rate going forward.

Although it could vary each quarter because some of the revenue that's reported on the service line is a period charge if you will or a period revenue, i.e. the installation.

On your comment about grace periods, that is certainly not a policy.

If you can give me the source, I'll go check on the behavior of the individual sales rep.

But I go to tell you, that would be an exception, not the common, normal condition.

Fair enough.

Nice quarter, guys.

Harry Blount, Lehman Bros.

On the SG&A, I'm trying to parse through what we should kind of expect as a normalized level of SG&A going forward.

As you indicated, I think there was some commissions in there and I suspect some year-end bonuses and some maybe accruals-related issues?

Can you maybe segment that a little bit better for us in terms of what we should expect going forward?

Harry, this is Steve Gomo.

Yes, I think that the fourth quarter was unusually heavy, obviously with commissions.

As you know, every incentive that we have is basically turned on in the fourth quarter and the sales guys are obviously responding to that.

Going forward, you know, I would expect to see SG&A basically pretty much stay where it was on a full-year basis, maybe improve just slightly.

I think that the sales area, sales expense area, should probably come down a little bit, certainly from its fourth-quarter level and a little bit from its full-year level.

Admin will probably stay right about where it is.

And marketing will probably stay where it is to go up just a little bit.

So the net of all that is I would expect to see a slight decrease year-over-year in those expense categories as a percent of revenue.

Great.

And then just -- would you comment a little bit also on your AR, even with the big revenue increase, the AR was actually flat sequentially.

So can you talk a little bit about the implications around that and linearity?

Yes.

We -- you know, I'm actually quite proud of that.

We've spent a lot of time focusing on improving our performance in this area and I think that our efforts here are starting to pay off.

And I give the team full credit for that.

You know, there's a lot of forces at work.

There's a lot of things you have to manage in doing this.

But we have a full (indiscernible) on all of them right now.

And obviously from the results, we're making good progress.

In terms of where this goes long haul, I think we're kind of in a zone right now.

I think that there is a potential we could see some improvement going forward, but I'd be pleased if we could keep it right around this level or 50 days going forward.

Great, thanks.

Dan Renouard, R. W. Baird.

A question related to your buyback and maybe partly related to compensation just in general.

Can you talk about your policy on options going forward in terms of you know you have been a little bit more aggressive maybe than the average bear, maybe not for storage but just in general.

Maybe you can just talk about how -- your plans going forward in terms of -- you plan to try to fully offset option creep with your buyback program or what the plan might be for the buyback?

This is Dan Warmenhoven.

I would have to disagree that we've been more aggressive.

In fact, I would say that the numbers, in terms of percentage of overhang, are maybe a little higher than some of our peer group only because we never did a regrant.

And so there's a lot of shares in that number that are way out of the money on the bubble period.

Those are still counted in the overhang percent.

That said, I think we have been actually fairly conservative, we -- here recently.

You know, we didn't ask for any shares last year as I recall.

And this year, we will probably ask for a number that is significantly below what we did in prior years.

You know, our historical norm is around 5 percent and we are thinking probably closer to 3.

We've had to really reduce the number of shares per employee.

I must say it is very, very challenging to try to add basically in a five-quarter period, about 1,000 people, new-hire grants being the most sizable of the utilization components, given kind of the reduction overall.

But our stock is just going to be a less significant component.

And you'll see that I think when the proxy comes out later this year, we are far more conservative than we were in the past.

And I guess just as a comment, thank you for not re-pricing your options.

You are very welcome.

We thought most investors would feel that way.

Glenn Hanus, Needham & Co.

Good afternoon.

Nice job.

Maybe you could talk about -- maybe you could sort of rank here the growth drivers and things that are really helping you gain market share, recently.

And then, sort of rank the growth drivers over the next couple of quarters, either -- maybe it's certain applications, maybe it's certain vertical markets.

Could you take a stab at that?

This is Tom Mendoza.

Let me take a shot at that.

I think a number of investments that we've made have really paid off.

Number one, as Dan mentioned, the investment in sales capacity, but not only sales capacity; we focused that sales capacity you know on what you would normally look at as Enterprise accounts.

So the majority of our sales force have three or fewer accounts now.

So they're going very deep.

Along with that, about three years ago, we invested seriously in channels and partnerships, both on a global partner type level, as IBM, Accenture and those guys, Landmark, but also just in -- with resellers around the globe.

You know we have one advantage over our competitors in that we still make a lot of money and we still have good margin in our products and we're not over-distributed.

So we seem to be very, very attractive as a partner, and that has really paid off.

The last year or two, our partner programs have exploded, which has really helped again, give us mass coverage while we're going deeper into the enterprise.

Secondarily, I mentioned partnerships.

The partnerships that I would highlight are the partnerships with Veritas.

I was just the keynote speaker at their Vision event in Las Vegas, and there was about 1,000 CIOs in the audience.

And Oracle, where Dan and I have been keynotes three times in the last six months now around the globe.

So the two of those companies being very, very upfront about NetApp as one of their primary infrastructure providers and partners, has helped us tremendously gain visibility in the market.

And then the third thing I would say is the support capabilities that Dan referenced are paying off very big in repeat business and our ability to bring on more enterprise-oriented apps within our current customer base, which is happening at a rapid rate.

And the last thing I would say, our product line has never been stronger.

And I've said this on many conference calls in the past.

The fact that we have one file system top to bottom and the ability to fail-over to the SaveFile system HCA on our strategy, is really gaining a hold with people as they realize that they want to take cost out, they have to simplify the problem.

And NetApp has now proven that.

It's not a concept any more.

And with the strong partnerships in place to get us in front of the right customers, I'm finding larger sales coming in shorter amount of time on a global basis.

Dan pointed out that this quarter, we gained share in every part of the world.

Every part of the world exceeded our objective for them.

So typically, you have one very strong area, maybe one that's not so strong.

We feel like we're gaining momentum in all the important markets that we're in.

So that's one of the reasons we're looking to keep on thinking of ways that we can put the peddle to the metal.

Doing outbound, I would tell you that we're going to continue investing in the services piece because it's clearly paying off on the topline.

And the second area you're going to see is additional focus on marketing in areas like branding, in areas like getting our name known, in areas we're not.

I think where we are today is most people who buy our products like us a lot.

Most people who hear our conversation or our sales pitch say, gee, that's a lot better than I expected.

The next big step is not to let our competitors define us to the rest of the market.

It's clear that we have a better message than our competitors, and we've got to make sure it gets out there in the way we want it to, and we plan on doing that.

So we'll be making investments in that area in the future.

Thank you.

Tom Curlin, RBC Capital Markets.

Hi, good afternoon.

I wonder if you could expand upon the Veritas relationship specifically in terms of lead generation, but also architecturally, how you are deciding and working with Veritas on which NetApp software versus which Veritas software sold into particular deals, especially on the availability side?

Let me make a quick comment on that.

Gary Bloom was nice enough to come and address our sales kick off.

I'm the only outsider, I believe addressing their sales kickoff in July.

So that gives you an idea that things are working well.

Our two executive teams have spent time together to really think through how we can accelerate the momentum in the market with the ecosystem, which you'll be hearing more about.

But we're doing quite a bit of thinking together at a high-level strategic value.

We know that we have the best infrastructure to reduce the cost to the end-users and they know that they bring a lot of complementary software that customers need on top of what we have.

So the number one thing that we agree on as the executive teams is that rather than focus on who gets the most out of which transaction, we've got to make the pie a lot bigger.

We believe by working together, we can drive much larger transactions.

At the end of the day, I think customers really like the whole concept of open ILM as long as the partners really are partners and if there's a problem, it's not their problem.

So Veritas and NetApp currently have engineering under way.

They add value in the disk/disk backup, and all kinds of high availability and recovery schemes.

Secondarily, you'll see more and more product coming over time, where we talk about the care and feeding of data both from our systems as well as other peoples' systems coming into our NearStore product line.

So we have teams on both sides dedicated to saying, where do we think they can add the most value, where can we add the most value.

And you'll see product coming out of the two companies that are complementary over the next six months.

But I think the top thing that's happened is at the highest levels of both companies, we're saying if we did what together, if we spoke at which events together, if we put an ecosystem together, with which partners, where we accelerate the topline for both companies -- and we're very, very comfortable in saying that we have a very high priority to them and they have a very high priority to us, more than we've ever had in the history of both companies.

And I think our customers are going to be the key beneficiaries of that.

Tom, this is Dan.

Only, I think the analyst community is really concerned about where the product overlap might exist.

We've had a number of meetings with the Veritas sales and marketing organization putting together guidelines.

I've got to tell you, neither one of us is concerned about the overlap here is.

In fact, they're actually fairly small.

And we haven't seen a case yet where on a deal-by-deal customer-specific basis, we've had a significant conflict, so.

And I think both companies you know, at the risk of speaking on behalf of Veritas, are very comfortable that when you are faced with a customer situation, it's pretty easy to figure out what solution he needs and what is the optimum fit of all the technology building blocks to address the customer's problem.

So it's just, from our viewpoint, a non-issue.

Thanks, very much.

Another question just on market share shifts.

And as you look at the competitive environment, if feels like EMC and IBM in the midrange or if you prefer the modular side of the market, have done reasonably well.

You guys are clearly doing well.

Maybe HP is languishing.

Do you think that's fair?

Are you finding HP environments to be an easier penetration?

Thanks and that's my final question.

I think if you look at the -- I haven't seen, obviously, HP's results today.

But certainly, from the prior quarter, their growth rates were significantly less than I think the market as a whole.

And yes, we have -- three of the -- there's three market share leaders ahead of us.

With the way we rank things right now, HP is in the number two position.

And we've said in the past, we think we have an opportunity to gain share against them.

Thank you.

Andy McCullough, CSFB.

Thanks, guys.

Two quick questions.

One, if you could just clarify what capacity shipments look -- total capacity shipments look like quarter-on-quarter?

And then secondarily on the NearStore side, as NearStore continues to get bigger and bigger, I'd be curious to see if you're starting to come into more head to head activity with the EMC Centera product.

And if so, how these deals get decided on the serial ATA side?

Thanks.

This is Tom.

We've been in contact with them for a long time, and we feel extraordinarily good about the ability to compete with that.

I think that the fair way of looking at it is they came up with a story on the compliant (ph) side before they had it, as an aside, but at least they had a story, and they got people to move out of fear about a year ago, year and a half ago.

That's what customers say to me.

The biggest advantage we have with our strategizing (technical difficulty) was that we have software that allows you to lockdown a volume or a file.

You don't have to buy a specific system for that.

And secondarily, you can though, we can buy our NearStore product line or you can put on your existing.

We have some product development and some thinking going on with Veritas about how really to bring value to that market.

But I would say this, the NearStore is the fastest-growing part of our business.

It drives a lot of the other business, data recovery is huge for us.

And I think at EMC, in (indiscernible) accounts where they just don't look outside, then EMC does fine.

But when we get in head-to-head competitions with them, I think we do extraordinarily well.

I don't think we've ever done better against them than we're doing right now.

So I don't know how they're doing -- they can talk to themselves -- but our sales force around the globe relishes the competition on any part of their product line.

The Centera, definitely, we like to compete with.

Andy, would you ask the question again about storage?

Yes, just total capacity shipments quarter on quarter.

I don't know what last quarter was.

This quarter was over 18 petabytes.

As I recall, last quarter was around oh, roughly around 12 or 13.

Okay.

I think we gave you that number last quarter but I don't happen to have it handy.

Thanks.

Omar Al-Midani, Schwab.

Yes, thank you.

As you're providing your fiscal year '05 revenue guidance, can you comment on how much of the growth you expect will be achieved through existing customers maybe driving deeper into the larger Enterprise customers and how much of that growth do you think will come just from new customer adds?

And I wouldn't count an additional department within one customer as a new add.

And then I have a quick follow-on, if you don't mind.

I think the growth will scale equally.

You've seen our channel partners are bringing in a lot of new accounts, so it's kind of hard a little bit to track exactly how many because they are coming through channel.

The primary growth drivers are our sales team tends to be into new divisions of the major accounts that we're already in, and some new big targets that we've taken down.

But I think you're going to see it scale equally.

Omar, what was the second half of that?

Just a quick follow-on to that maybe is, maybe it has to do with your direct sales force.

It's done surprisingly well this quarter.

Not surprisingly well, they -- in fact, their normal historical performance.

I was wondering if within your fiscal year '05 margin estimate if you've factored in -- or what kind of direct to indirect mix you factor in basically?

I think looking forward, as Tom said, we see them scaling about equally.

If anything, we will be a small uptick in indirect, mostly as a reflection of the contribution from large systems integrators.

You know, I think the Accenture business, IBM Global Services, some of the federal business, which is much more through system integrators etc., will grow faster than our direct business, but that's by design.

And I don't think you'll see it be a significant mix shift.

Incidentally, in those deals, we have direct salespeople involved.

The fulfillment goes through a system integrator, but we're actually doing demand generation with our direct sales team.

And do you have double comp going on or --?

Well, we comp our sales reps and then we have relationships that have structured discounts to our resellers, but it's not exactly double comp.

Thank you.

Naveen Bobba, Bear Stearns.

Thank you.

Nice results.

Two questions, first, can you give us the --

Naveen, we can barely hear you.

Can you speak up?

Better now, Dan?

Yes.

Nice results, again.

Two questions.

Can you give us the petabytes shipped for NearStore?

And second, Dan, can you talk about the pricing environment, how that's being (indiscernible) and what you're expecting there going forward?

On the second part of the question -- this is Tom -- on the pricing, we have -- you know, our pricing has declined at the same rate over the last I would say three or four years, and we are going to continue to drive price down through the natural evolution of our products and our ability to bring bigger disks to market and the economies of scale we get.

So we are not changing our strategy at all.

We don't feel any additional price pressure.

Every call, we get asked about different competitive offerings and how it makes the environment shift from pricing.

But we're not noticing that.

I think the main reason for that is that people tend to buy our products looking at the total cost of ownership both at the low end and the high-end and the fail-over capabilities.

And so we're not competing on a point (technical difficulty) how much per gigabyte is that.

So again, our pricing discounting is not really being driven -- or our street level pricing is not being driven by need to match competitor pricing as much as it is (technical difficulty) decrease the pricing that we bring to market at least every half a year, usually every quarterly basis; and we have for at least four or five years.

Naveen, this is Dan.

We had over 275 NearStore systems shipped of all varieties, meaning R100's, R150's, R200's, etc., and it accounted for just a little over six petabytes.

Great, thank you.

Brent Bracelin, Pacific Crest Securities.

Thank you.

Two quick questions on margins.

First question, on service margins, would you consider Q4 service gross margins kind of the low point here?

Or as you continue to invest, do you expect that to continue to trend down?

Second question on margin would be on product margins.

Was there any sort of benefit in the quarter from mix shift or component cost, reductions in disk drives?

Can you talk a little bit about kind of drivers of the product margin expansion in the quarter?

Thank you.

Let's start out with the product margin expansion in the quarter.

Basically, as you know, we mentioned that the add-on software and subscription software upgrades accounted for about 33 percent of total revenue.

Sure.

That explains a portion of it.

Generally speaking, you know I -- there is a whole bunch of other minor forces going on, but that's probably the biggest single force I'd mention.

If you look forward and why we're guiding to a 60 percent margin going forward, you know, we expect to see some decline in margin as a result of perhaps a service business that's growing, you know -- a chance it could grow a little faster than revenue particularly in spurts during the year.

And in that case because service margins, although they could improve from where they are, you know, they'll still be significantly lower than product margins.

So that's why we're guiding that down.

Okay, great.

Thank you.

Keith Bachman, Banc of America Securities.

Hey, guys.

This is actually Nunda Baruah (ph) for Keith.

Just piggybacking off your services comment, I think on the last call or at some point in the past, you talked about services margin maybe getting back to 20 percent at sometime in fiscal year '05.

Given sort of where they're at this quarter, do you think that's still feasible?

This is Dan.

I think so.

The real question on the services margin is almost on the demand-side, right.

How much do we have to add in terms of professional services staff to respond to customer demand?

But obviously as you see on the deferred revenue category, that's kind of matched to the revenue.

The only question is what period it shows up in.

Right, the COGs show up right now.

And some of the fulfillment, right, occurs over time, so.

But my belief is that those two will probably blend together to be in the 20 percent range in a couple of quarters.

Okay, okay.

So we can sustain sort of mid-30s type of year-over-year revenue growth in services, (indiscernible) gets back to 20 percent?

I think so.

I think that's a reasonable forecast, yes.

This is Steve Gomo.

Again, our focus here is on two to three years out, making sure we have the right kind capacity and capability that our customers are going to require you know then.

And so if we have to spend a little more to get ahead of that curve so that we're ready for them, we will go ahead and do it if we have the opportunity to do so.

But right now, our anticipation is if we look at what we've just guided you to, we would expect to see improvement in our service margins to something in the low 20's, yes.

Okay, great, thanks.

And just one more quick follow-up.

I believe last quarter, you spoke of excuse me -- AddNet (ph), Arrow (ph) combined being 15 percent of quarterly revenue.

Can you just talk about the progress that was made there and the continued momentum was good and maybe where they turned out for this quarter?

Thanks.

They are in our top five, as I mentioned, for the year. mentioned I think if you add the two together for the whole year, they are around 8 percent, you know, which is really pretty good.

So I'm feeling pretty good about where we are at with those guys right now.

I don't have a quantifiable number for the quarter.

I really don't intend to go through it quarter by quarter.

Okay great.

Thanks.

Kaushik Roy, Susquehanna International.

Thank you.

Of the services revenue, can you break down how much was hardware support and then how much was professional educational services?

And I have another follow-up.

No, we don't break it down that way.

Okay.

And it seems like NearStore grew 24 percent, software grew 21 percent, but Filers grew only 11 percent.

So it seems like Filers are cannibalizing -- NearStore is cannibalizing your Filers.

So how does that impact your margins?

I mean is NearStore better margin than Filers or vice versa?

They're about the same roughly.

Incidentally, most -- a lot of NearStores get deployed as "Filers."

I mean so you call it cannibalization I call it market expansion.

I mean you know it's only the flip side of the coin.

I don't worry about what that mix is.

And customers used to do an awful lot of mirroring, for instance, from our 900 family to other 900's.

Now we have a more cost effective mirroring solution, by sticking NearStore on the other end.

So I guess if you want you could put a negative spin on it and say it's cannibalization.

My way, it's a much more cost-effective solution for the customer and provides a lower cost of ownership.

But yes, the product mix does change.

You know, you got to look at it in the aggregate product gross margins.

So let me grant you your hypothesis for a moment and then point you back to the gross margins increasing this quarter over last quarter. (multiple speakers)

One more if I may.

You mentioned you're gaining market share.

EMC says they're gaining market share with their NS700 and their Getaway.

So can you comment who actually is losing share?

Just look at the growth numbers of both companies and you guys figure it out.

I mean I get -- for years they used to double count and Nasan (ph) family (ph) would equal 140 percent and people would be okay with that.

We're growing a lot faster than they are growing.

So if they are gaining share in our part, they must be losing it in other parts.

So it's added up to 100 percent somehow.

There's just literally no doubt.

I mean look at the growth numbers we just posted and then look at their growth numbers and try and figure out who's gaining share.

You know, and go back to the other question for a second, I had a customer recently who talked to me, they had 500 terabytes in the semiconductor business that they bought from NetApp over 10 years.

They're buying 500 terabytes this year from us.

And I said to him, how is that working?

It's working because they are going to 64-bit processors, they're moving from UNIX to Linux, and the ability to tier our storage allowed them to double their capacity and do things they could never have done before.

Same thing's happened to our financial services on the analytics side.

So we're getting pushed into -- we're going to much more business-oriented solutions, far more storage, but it's a complete solution.

That's what's going on.

It's not which product point are we trying to push.

You know, by having NearStore there and having the extended enterprise go to the appliance, back up to central using our Snap products, use gateways to get more out of what they've got, and then lower the total cost of ownership.

By the way, that 500 terabytes was the same cost.

He was able to double the capacity at the same cost, so he didn't have to increase his budget.

That's what's going on, and the ability to manage it with far fewer people is why we're winning.

Fair enough.

Great quarter, congratulations.

Let me follow up on the market share thing for just one second.

As Tom said, look at the relative growth rates of the various participants in this sector.

We've argued for sometime that customers have increasing levels of sophistication in their requirements.

Mirroring, compliance, all the rest of those things.

And that increasingly, they will not find the breadth of solutions that they need from their server vendor and hence will choose a pure-play storage vendor.

As I do the quick ranking of growth rates in my own head, I've put NetApp way out in front, more than twice the growth rate of anybody else.

I think, as I recall, EMC's was kind of in the midteens if you take out their software acquisitions of Document and Legato.

And there's nobody else even close to that.

Most of the server vendors actually are posting negative share in the most recent periods.

And so you're seeing the shift away from storage purchase from server vendors and customers moving to pure-play horizontals.

And I have argued for sometime that both EMC and ourselves will do well because of that shift.

And I believe if you look at the relative growth rates, ours is much higher; theirs is larger than the overall market growth rate.

Chris Russ, Wachovia Securities.

Yes, hi guys.

Windows, the Windows platform is growing as a percentage of your overall business, I guess 45 percent of total revenue, up 85 percent year-over-year, and I think that's up from 40 percent last quarter.

Do you anticipate that Windows will comprise over half your business in the near-term?

And also, are you seeing much in the way of Linux-related deployments currently?

This is Dan.

I think you're going to see the mix oscillate around as more a function of what the customers prioritize in their projects.

You know, the federal stuff, for instance, has the tendency to actually be very Windows-centric.

I think that's what drove it up.

Most of our federal deployments are a lot of exchange and things like that.

When we move back towards guys like DreamWorks with Shrek, right, that's all UNIX, in particular, Linux.

I mean so it's going to oscillate all over based on the lumpiness of the deals and so on.

I think we're kind of at a normal run rate.

You know, this is almost back to where we were a few years ago when we had only SIFS only and NFS multi-protocol, and kind of when it bobbed around plus or minus 5 percent in the mix for three years.

And I think Windows versus UNIX or Linux is probably going to be in that same kind of state; it's going to go up and down.

But you cannot determine a trend I think in a given quarter.

I think we are in a steady-state.

I think it's going to be about 40 to 45 percent Windows.

And you know I foresee it being the case for great sometime.

If anything, the iSCSI pieces are being adopted more quickly on the Windows side; it could drive it up in the near-term.

But I also expect iSCSI to be extremely popular on the Linux side so it should come back on the balance pretty quick.

Okay.

Yes, that was sort of my next related question with iSCSI.

I think, Dan, you mentioned 10 percent of bookings included iSCSI.

And I'm just wondering, is there a comparable metric for last quarter?

Because I think in the past, you used to talk about the percentage of Filers that shipped with the iSCSI module enabled, and I think that number was like in the mid-20s.

Yes, no, in fact, at that point it was more of a freebie, right.

I mean, you order a Filer and you get free iSCSI interface because we didn't have any hardware to put in it so, and there was 20 percent or 20-something percent of the customers that took advantage of that.

Okay -- (multiple speakers) 10 percent of bookings this quarter, can you give us an idea of where that stood at like a year ago?

Was it you know --?

It was zero.

I mean it was really zero.

We introduced our iSCSI product within the last year.

Okay.

And do you think that 10 percent will grow a lot faster than for instance NearStore as a percentage of bookings?

Don't forget NearStore is in that number.

We're talk when interface (multiple speakers) that.

So I mean don't forget, everybody tries to slice and dice this thing among different dimensions and gets all confused.

I can count at least four or five or six different dimensions of our business, geography, channel, product line, interface type, and I can go right through the list.

And there's all kinds of you know software versus systems versus service.

I mean you'll get all confused if you try to take one particular dimension and figure out what it looks like on a particular second dimension.

Okay, all right, great.

Thank you.

Gentlemen, we have no further comments.

Please continue with your closing comments.

I would like to thank you, all, again, for joining us today.

We think we had a terrific Q4 and fiscal year '04.

And we look forward to seeing you roughly this time in three months, as well as on December 1 in New York at our analyst meeting.

Thank you all for joining us.

Ladies and gentlemen, this concludes the Network Appliance Q4 and fiscal year '04 earnings conference call.

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