NetApp Inc (NTAP) 2005 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Network Appliance first quarter of fiscal year 2005 earnings conference call. My name is Rachel, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. If at any time during the call you do require assistance, please press star followed by zero, and a coordinator will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. And I would now like to turn the presentation over to your host for today's call, Mr. Dan Warmenhoven, Chief Executive Officer. Please proceed, 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, Dave Hitz, founder and Executive Vice President of Engineering, and Steve Gomo, our Senior Vice President of Finance and Chief Financial Officer. In the course of today's conference call, we will 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 S.E.C., and 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 conference call is being webcast live over the Internet, and will be available for replay on our website at www.netapp.com. Along with our earnings release and the reconciliation between GAAP and pro forma numbers. Now I'll turn the call over to Steve Gomo for a review of this quarter's financial results. And following Steve's comments, I'll share my own comments on events during the quarter, then we'll 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.

Thanks Dan, and good afternoon, everyone. NetApp is off to a great start for our fiscal year 2005. Our strong revenue growth continues, and expenses are under control. The balance sheet highlights are strong cash balance and the improvement in some of our key asset performance metrics, and the balance sheet model again -- excuse me the business model again demonstrated its strong strong cash generation capabilities this quarter. Now I would like to provide some commentary about these results. Please note that all numbers are GAAP unless stated otherwise.

Once again this quarter, revenue growth was outstanding, with strength demonstrated across in the entire product line. At $358.4 million, organic revenue was up 38% over the first quarter of last year. Revenues increased 6.4% sequentially from the $337 million in the fourth quarter, resulting in our 11th consecutive quarter of sequential growth. Foreign currency contributed a favorable 4 points to the year-over-year growth rate, and an unfavorable 1 percentage point to the sequential growth numbers. Product revenues of $324.6 million grew 6.8 sequentially, and finished 38% higher than last year. While all product areas contributed growth, NearStore and the FAS 270 were particularly strong. Total petabytes shipped increased 15% this quarter to 21.2 petabytes.

Revenue from services, which includes hardware support, professional services, and educational services, grew 36% over quarter 1 last year, and was 9.4% of total revenue, down slightly as a percent of revenue from last quarter. Add-on software and software subscription upgrades accounted for approximately 32% of total revenue, about the same as last quarter. Keep in mind that this figure does not include software that is bundled with our systems including our data ONTAP software, the WAFL file system, Snapshot and the first protocol. Add on software products were approximately 22% of total revenue, and software subscription upgrades were approximately 10% of total revenue.

Pro forma gross margin for the quarter was 60.2%, compared to 60.5% reported last quarter and consistent with our expectations. Pro forma product margins finished the quarter at 65.1% compared to 65.7% last quarter and are 6/10 of a percentage point higher than year ago. We remain extremely pleased with the consistent performance of our product margins not for just this quarter but over the course of the last two years. Service margins were 13.5% for the quarter, an increase of 8/10 of a percentage point from the last quarter. Global services continues to an major area of investment for us, with the emphasis on building out our professional services capacity and capability.

Pro forma operating expenses totaled $157.4 million, increasing approximately $5 million from the $152.4 million reported last quarter. Expressed as a percentage of revenue, pro forma operating expenses were 43.9%, down 1.3 percentage points from last quarter. Pro forma operating profit for the quarter was up 1 point to 16.3%, compared to 15.3% reported last quarter. Pro forma other income was $3.2 million for the quarter, compared with 3.6 million reported last quarter. Pro forma pretax income for the quarter was $61.6 million, or 17.2% of revenue. The effective pro forma tax rate for the quarter was 19%. The reduction of 2 percentage points from last quarter's and our planned tax rate of 21% is due to a small but permanent shift in if our pretax income to more favorable tax jurisdictions. Going forward, we expect 19% to be our effective tax rate for the for seeable future.

Pro forma net income for the quarter was $49.9 million, or 13.9% of revenue. Pro forma net earnings per share was 13 cents based on a weighted average of approximately 373 million shares outstanding. This quarter we reported a GAAP net income of $46.9 million, or 13 cents per share. We have 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 our website www.netapp.com.

Turning our attention to the balance sheet now, cash and investments at the end of the quarter were at an all-time high of $827 million, up $19 million from the previous quarter. Cash generated from operations during the quarter was $78.1 million. Capital purchases of plant, property, and equipment were $33.3 million, which includes the $24 million RTP site purchase announced during the quarter. Depreciation during the quarter was $13.2 million. At the beginning of fiscal year 2005, we announced a new stock repurchase program allowing for the purchase of up to $200 million worth of stock. This was in addition to the $14 million we had remaining in our original authorization of $150 million that we announced in fiscal year 2004. During the first quarter, we purchased approximately 2.5 million shares of outstanding common stock at an average price of $19.41 for a total of $47.7 million.

Accounts receivable day sales outstanding were 51 days, reflecting a very linear shipment pattern during the quarter. DSO improved one day from last quarter, and three days from a year ago. Inventory turns were 16.4 times, up from the 15.9 times in the fourth quarter. Compared to one year ago, inventory turns have improved 55%. At $309.2 million, deferred revenue increased by $30.2 million or 11% sequentially and 63% from the 189.3 million reported a year ago. Head count at the end of the quarter was 3,009 people, an increase of 165 employees from last quarter. Once again this quarter I'm extremely pleased with these results. Now, before I talk about our targets for the second quarter, I'll turn the call back over to Dan.

Thank you, Steve. As you can see from our results, Network Appliance had another superlative quarter. The business is very healthy which is exemplified by our balance sheet. Our team demonstrated strong consistent execution, and though we saw several companies stumble recently, we believe the strategic components of our business, our targeted areas in market are growing at a significant pace, and we expect to see continued strong demand for storage in many areas including mission critical tier one environments, distributed enterprise, disk to disk backup, compliance, disaster recovery, and unified SAN and MAS solutions.

Now, at a more strategic level we're seeing a consistent theme emerging in customer behavior. Customers are are increasingly moving towards storage solutions that support multiple applications. Our customers are adopting our technology to build storage infrastructures that support all tiers of data. Creating a multipurpose storage utility, similar in concept to the network utility, which is independent of the applications it supports and therefore much more flexible. This was a key differentiator for Network Appliance because we offer unified storage with one common architecture that customers can use for multiple purposes.

The good news is that we see this as the primary driver of our growth, but the by-product is it's much more difficult to categorize our product sales by business applications going forward. The majority of our systems are now purchased along with multiple protocols and multiple interfaces to support a variety of application with a variety of access types and data structures. Consequently going forward we will continue to break out our business by product line, by geography, and by channel, but not by application any longer. Rather, we will look more broadly at the business drivers are I just mentioned.

Let me take a few minutes to describe the success we've had in these areas. NearStore, our secondary storage solution, contributed over 14% of our business this quarter, up 25% from the prior quarter. Functionally NearStore is identical to our filer products, but uses inexpensive ATA drives. Customers frequently purchase NearStore and the appropriate snap software in combination with our filers to backup data that will reside on their tire one production filers, providing them with a complete and seamless intermission life cycle solution. In some cases, NearStore is also purchased to backup data which adds in storage solutions from other vendors. which is fairly additive to our business and a terrific way for for us to get a foot in the door in competitive domains. Our ease of use can make a dramatic impact in those cases, sowing the seeds for future purchases.

GE Health Care is a great example. They recently chose NearStore to be their archive and data recovery vehicle for digital images such as MRIs and X-rays. They will use NetApp filers with snap shot software for frequent, automatic copies of primary system data and SnapMirror to replicate that data hourly to their NearStore systems at their disaster recovery site. NetApp has helped GE Healthcare reduce the total cost of ownership of its infrastructure, ensure scalability for high data growth, and deliver even better performance and availability at the hospitals around the country. Conoco Phillips, TELSTRA and Yahoo were some other large NearStore customers this quarter.

Our filer business also grew this quarter with strength in every segment of the product line, low, middle, and high. The number of FAS 200 units shipped grew by approximately 9% over Q4 driven by the larger FAS 270 which grew by 25%. The new mid range FAS 920 got off to a fast start in its first quarter of production, and our new high end FAS 980 increased 22% from last quarter, accounting for 6% of all filer units shipped in Q1, which is its only second quarter of production. Qualcomm did a multi million dollar transaction with NetApp this quarter for a large chip development project, purchasing our high end FAS 960 C filers along with NearStore and snap vault. NetApp was selected for its ease of use and the compatibility between our filers and NearStore products. ING BHF Bank in the UK purchased several FAS 270 systems using the iSCSI protocol with netware servers to mirror critical bank data offsite for disaster recovery purposes and had planned to add additional Windows servers. NetApp was chosen over competing fiber channel SAN solutions because our solution both met ING's stringent requirements for disaster recovery, and was also substantially less expensive.

Our NetCash products contributed 5.4% of revenue this quarter up just slightly from Q4. Customers this quarter include MTL, the U.K.'s largest cable company, ROCKATON, a highly successful Internet venture in Japan, and China Everbright Bank, which has over 350 branches. We are seeing an interesting phenomena occuring in our growing SAN business, which contributed over 17% of business this quarter. More and more, customers are using both IP SAN and fiber channel SAN together in the systems they purchased. In Q1, nearly 25% of our SAN bookings contained both fibre channel and iSCSI, including companies like Hertz Corporation, which was using their Oracle database using both protocols on several FAS systems. The trends in our SANs business are a great example of the unification trends in the marketplace.

In fact, so many of our systems are sold for multiple purposes we believe the market is beginning to recognize that we offer an infrastructure which allows the customer to run almost anything on any of our systems. That puts us in an enviable position with our SAN business growing and taking market share, and our NAS business growing and taking market share, and as a result of this flexibility, it has become increasingly difficult to break out the UNIX, LINIX, and Windows contributions to our business, because most systems now have multiple access types and multiple applications running on them. The investments we've made in R&D over the last few years to create unified storage are clearly paying off. It is NetApp unified architecture based on one operating system with complete interoperability across all of our product lines which drives demand from customers for our solutions across all of their tiers of storage.

A few years ago, we were purely a NAS company, much of our business came from tier 2 and 3 environments. With our product innovations over the last few years, we have emerged as the new best choice for tier one storage as well. Our SAN solutions and high end systems such as the FAS 980 compare favorably to the biggest systems our competitors offer based on price, performance, scalability, and availability. Marquee customers like Qualcomm, SAP, Southwest Airlines, ZILINKS, and several of the large financial institutions on Wall Street trust NetApp filers with their tier one mission critical applications. Our mid-range FAS 920 and FAS 940 are well suited for tier two storage environments, and the FAS 200 series products are an outstanding solution for tier three, distributed enterprise and departmental leads. And of course our NearStore products round out the tiered offering by providing the most cost effective disk to disk backup and archival solution for tier four needs.

Looking at our business from a geographic perspective, North America accounted for 58% of business this quarter, about the same as last quarter. Europe came in with 28%, down about 4% from last quarter, and Asia Pacific posted a strong 14% contribution, up 4% from last quarter. Interestingly, only the first quarter of the last year had a very similar geographic profile, so we believe we are starting to see some signs of seasonality beginning to emerge. This is also reflected in the channel contribution this quarter, with 54% of the business coming through direct sales and 46% coming through indirect channels. Last quarter the mix it was 57 direct and 43% indirect, so it's a 3-point shift. The increase in indirect business is primarily the result of Asia Pac's increase in the mix, plus strength in our U.S. federal business, which is also largely indirect.

Our U.S. federal business continues to grow, contributing nearly 12% of total bookings in Q1. We had several substantial wins, including a multi million dollar transaction with the U.S. Army's National Ground Intelligence Center. We are are particularly proud that the Internal Revenue Service chose NearStore and SnapLock to securely store and access10 years' worth of tax returns from all tax exempt organizations in the country. The top contributors to our indirect business continue to be [INAUDIBLE] Net, who produced a combined 8% of business this quarter, followed by Fujitsu Siemens, IBM Global Services, TOSHOO in Japan, and Lockheed Martin and Computer Sciences Corp primarily on the federal business side.

To recap, Network Appliance had another terrific quarter. The strategic investments we continue to make in our business are proving to be the right ones. Our product lines are effectively targeted at some of the strongest growth areas of the market, and both customer and industry feedback tells us we're doing the right thing. Gartner Group has added Network Appliance to the leader quadrant of their mid-range storage magic quadrant. Gartner defines leaders as companies that execute well today and are positioned well for tomorrow. We view this as a particularly strong endorsement of our strategic decisions and the adoption of our solutions in the marketplace. With over 38% year-over-year growth in revenue this quarter, we again are clearly taking market share, we will continue to invest in the people, processes, and systems necessary to reach our growth targets. Now I'll turn the call back over to Steve to discuss our financial targets going forward.

Thanks, Dan. Our business outlook is based on current business expectations, and reflects our pro forma presentation. Again I'll remind you that we're 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 in the marketplace to continue and project second quarter revenue to grow sequentially by 4 to 6%. This projection reflects year-over-year growth rates of 35 to 38%. Pro forma gross margin should finish at roughly the same level as Q1. As mentioned earlier, we're using a 19% pro forma tax rate going forward. We also expect net income to grow, and depending on revenue levels achieved, we are estimating Q2 pro forma earnings of 13 to 14 cents per share. GAAP earnings per share should also round to 13 to 14 cents per share. Now I'll turn the call back over to Dan to wrap up.

Thank you, Steve. I would like to thank Network Appliance team for their terrific performance this quarter and for our investors for their continued support. We'd also like to ask you to mark your calendars for our upcoming analyst day, which will be held in New York on December 1st. You'll be receiving additional information shortly, or you may contact our Investor Relations people for details. At this point, I'll open the conference for questions. We again ask, and I please ask you to abide by this, please limit yourself to one question each so we may address everyone in a timely manner. I also honor your request to keep the call to one hour. Operator, we'll now open the call for questions.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Dan Renouard of Robert W. Baird. Please proceed, sir.

Thank you. I was wondering if you could give us some insights into verticals where you saw either specific strength outside of government where you saw strength, and maybe where you saw any softening if any, given what has happened to the economy in the last month or two. Thanks.

Hi, Dan, it's Tom Mendoza. Particular strength is financial services, and that was driven both by our direct and indirect strategy. We had some major wins in Wall Street and in London through our integrators this quarter which is a trend that's been happening. Also, I think we saw a little softening potentially in some -- I would say manufacturing in certain parts of the world, but overall, it wasn't a big trend, it was just -- I would say some of the orders slipped into next quarter, so actually it makes us feel even better about where it's headed. But tech sector was solid, Internet sector was solid, and I think the energy sector continues to an thriving market for NetApp. So I didn't see any big differences from what we've seen in the past, except for some upticks specifically in financial services.

That's my one question.

Your next question come from the line of Laura Conigliaro of Goldman Sachs.

Yes, thank you. You had very strong revenue growth, especially on the product side. Why shouldn't your revenue growth targets perhaps be even a little higher, particularly given how strong your product revenue growth was in presumably your hardest quarter. Now you're going into a somewhat easier quarter, you say you've got momentum, and of course you also built a large services backlog so to speak in your deferred rev category.

We feel -- this is Steve Gomo. We feel very comfortable with the guidance we've just given you. You know, we -- we're very conscious of all that's happening in the market. However, we also realize that we're taking share, and our business happens to be growing a little fast right now, so I think you see all of those forces combined as we do our analysis of what we can do. We would like to grow a little faster, but right now we think this guidance is very appropriate.

Thank you, ma'am. Your next question comes from the line of Mark Kelleher of Adams Harkness.

Thanks. Nice quarter, guys. Can you give us an update on the Spinaker integration, how that's going, expectations for product rollout?

This is Dan. We did in fact complete stage one, which is adding the Network Appliance -- excuse me, the disk packaging subsystem to the Spinaker 4100 platform, and we will be recognizing revenue for that in this quarter, Q2 . It was not reported in the quarter we just completed, but that integration is on-track, and we are -- we're marching right along the path that we had originally outlined in merging the two operating systems,sticking basically the WAFL file system underneath the SPIN OS operating system as the next step, that that should be near the end of next year.

Okay. Thanks.

Thank you, sir. Your next question comes from the line of Harry Blount of Lehman Brothers.

Hi, guys, question related to margins. Both margin related. Essentially on the services side, saw very little uptick in gross margins. I know you are not focused on that as a goal per se, much more focused on building out the infrastructure, but nevertheless,you have been investing in that for several quarters, we should see some uplift in that, and also saw that your margins on the operating line were slightly above target, so I was wondering if you could give us more flavor on thoughts of drivers of margins going forward?

This is Dan, I'll answer the one on the operating profit. We failed to hire to our plan. We were short by about 35 people. I think we forecasted we would hire 200. Actual is 165. And if you do the math real quick, you'll find that the cost of 35 people for a prorated piece of the quarter was roughly $1 million, or .3 tenths on the profit line. We fell behind on hiring. We would expect to make that up in this quarter and going forward.

On the service gross margin, the answer is actually on the revenue line. Turns out that just with the mix of business that we saw, the large service component of the orders came in in the -- oh, I would say the second half of the quarter so we didn't recognize as much revenue, because those orders are -- those contracts are recognized ratably over their lifetime, so we got off to kind of a slow start during the quarter revenue recognition for the ongoing or the current quarter's orders, but that will catch up next quarter when we have a full quarter to recognize all of that.

Thanks

Thank you. Your next question comes from the line of Bill Shope of JP Morgan.

Great. Thanks. Could you comment on how demand from the federal sector is shaping up so far in the October quarter, and maybe give us a rough idea of what percentage of your revenues come from the federal sector in the October quarter?

That's really hard to forecast the percent of revenue. We would expect them to be strong this quarter. This is the end of the fiscal year for the government, so we always see an end of year flush, but that's always very difficult to predict. You don't see it coming until you're right into the middle of September. Federal business demand looks very, very good. Right across the board, both on the civilian agencies, the -- the intelligence community, including military intelligence, as well as basic military operations. Right across the board, we look very good. So we're feeling pretty good about our ability to continue to expand our federal business going forward.

Just a clarification, do you tend to to see any positive or negative impact as a result of the election?

I'll keep my political comments out of it.

Okay. Great. Thanks.

Thank you. Your next question comes from the line of Keith Bachman of Banc of America.

Thanks very much. Was wondering if you could update us on your hiring goals for not only this quarter -- you mentioned 35 catch up, but for the balance of the year. Could you help us understand -- make sure we understand what your hiring objectives are?

Our plan for the year was roughly 200 per quarter. In Q1 we hired 165, so we're about 35 short. We would like to catch up on that and hire 235 this quarter and 200 in each subsequent quarter.

And just to follow up if I could, will that kind of headcount ramp continue into calendar '05.

We are on our target business model. 16% operating is where we would like to zero in on, and as long as that's the case, the answer is going to be yes. Most of those heads will go into sales to expand our sales capacity which drives the top line, and to a professional services organization which we believe is a facilitator for those sales, and in engineering. So, yeah, I expect it to continue to ramp. I don't think it will be 200 flat. It will probably increase. It will look more like proportional to revenue growth.

Okay. Many thanks.

Thank you. Your next question comes from Shebly Seyrafi of Merrill Lynch.

Hi, nice quarter. Can you tell us how the quarter flowed? There were comments by some of your competitors that there was weakness in late June. Did you notice any weakness at any point throughout the quarter and maybe you can talk about how business has tracked over the last month? Thank you.

This is Dan. This was a typical Q1. We always get off to a slow start in May, we have our sales kick off. That's when we change territory assignments in the sales force. We always get a slow start, but we saw accelerating business demand through June and July. July was really strong finish, and it was again typical of our fiscal Q1. But we saw no slowdown at any point during the quarter. In fact, I would say it continued ramp fairly linear through the quarter.

It was very clear us to in June that we were not seeing any of the attributes other people were talking about. Our business is accelerating rapidly throughout June, and it continued through July for a very strong quarter, and that was on a global basis. There was no area that carried us. We saw strength in all three geos.

Thank you. Your next question comes from the line of Kaushik Roy of Susquehanna.

Congratulations. On the services margin, how much do you expect the services margin to be for fiscal '05? I mean, in the past, it has been in the 20s. So could we expect it to get close to 20?

Yes, this -- cash effect, she is Steve Gomo here. As we said, we would expect to finish this year at or slightly above 20 for the full year. Now, having said that, understand that that is not a goal of this organization. Our goal to put the right kind of capacity and capability in price in both the services organization and as well as in the professional services organization, so that we can serve these big enterprise customers. That's what's driving our growth, that's taking incumbrances out of the way, it's a sales type of thing, and we're going to continue to invest there. So if we have an opportunity to grow faster and that means investing in service to do it, we will do that.

Now, I want to reiterate that point.

On the professional side, can you break down the services between professional services and hardware support?

No, this is Dan. I would like to reiterate what Steve said, just to make sure this is perfectly clear to everyone. The gross margin number is not a business objective for this year for our services organization. Our objective was to remove inhibitors to our customers and prospects acquiring and utilizing with the utmost efficiency our product solutions. Increasingly these solutions are going into complex environments: mirroring environments disaster recovery environments, consolidated SAN mass environments and so on, and I got to say that requires professional services for them to be successful and for them to consume more product. The investments we're making in our services organization should primarily be tied to our success in product revenues, and I just want everyone everybody to keep that in mind. We do not have the service organization this year on a profit metric.

Congratulations again. Thanks.

Thank you.

Thank you. Your next question comes from the line of Andy McCullough of Credit Suisse First Boston.

Thanks, guys, just a quick questions for Steve. I want to follow up on the topic of hiring. I was curious to hear how you guys are generally compensating new hires in terms of cash and equity mix. I guess what I'm trying to get at is trying to better understand what the potential impact on your share count might be a couple of quarters down the road when all of this hiring is complete.

Okay, Andy. As a rule of thumb, and this isn't the same in every single function, but as a rule of thumb, the average new hire at Network Appliance receives about 5,000 shares when they join. And so you can count that into -- you can calculate that into your formula. In terms of cash compensation, there's really two components, a component that's not at risk, which is your base salary, and we're pretty much at the mid point of the competitive ranges and we compare ourselves with companies like ourselves, and larger firms as well, and always show up somewhere in the mid-point of the range. And finally there is an at risk portion of everybody's salary we call the incentive comp program, and that can run -- well, that varies depending on your level in the organization, but everybody has probably somewhere on average around in the 15 to 20% of their salary at risk.

On the share count number, the rough forecast, this is an approximation, is that we'll issue roughly about 10 million new shares of options this year, and on the $200 million buyback, assuming roughly the current market prices we will retire about 10 million shares, is they should roughly about balance.

Got it. Thanks.

Thank you, sir. Your next question comes from the line of Glenn Hanus with Needham and Company.

I was wondering if you guys had any thoughts along the lines of moving slightly beyond storage given what EMC and Barretts have done, and tie that into your comments, or Dave's comments on R&D road map.

We're pretty happy in the segment we're in, and actually we think that the strategy pursued by some of our competitors from Hockington really the wrong strategy. We think the partnering strategy is a much better one, and I'll have Tom make comments about the Veritas relationship, but we think that it actually -- a very significant strategic partnership not just for this year, but in our long term. Dave, do you want to comment as well on road maps?

Just that the road map is consistent with what Dan just said. We are very focused from an engineering perspective on how to work closely with the partners that we have, especially when you look at the data and system management front, partnering with companies like Veritas, HP, Openview, IBM, on the management and backup side, it's -- it's clear that there's some pieces of that we have to do ourselves, and it's appropriate for our systems to do, but is in terms of meeting the customer's overall requirement, we want to plug into this big frame works.

I would just comment that I had a very interesting talk with a CIO of a very large company, bought a ton of storages from our us, 450 terrabytes, and he said the interesting thing about NetApp is you are the only company with the same storage this year that you had two years ago. Everybody else, typically when you're doing real well, you don't try to find a new market. Everybody else has had to find a new market and then sell you guys on that it's a good idea. So our story is that we're doing what we have done all along, and fleshing it out, and people are buy more every quarter. It's an easy one to execute. I'll tell you that continue and some companies are at position where people know what they want and don't want it. Our situation is that people in general if they why our products, they like it. They've heard a lot about it, they think they should look at it more, but most of the world is still finding out who we are. When they find out, they find it intriguing, and they're a great prospect for it so we're very focused on distribution channels, partnerships that make us more visible like Oracle, Veritas. I was the keynote speaker for Oracle in three different parts of the world this year. Dan did a lot of stuff like that. So I think that we can address a much more sizable market, and we're about to do that.

Thank you.

Thank you. Your next question comes from the line of Chris Russ of Wachovia Securities.

Yeah, thank you. With the October quarter guidance of 35 to 38 percent year-over-year revenue growth, does this imply that you are raising your previous full year 2005 guidance.

We wondered how long -- how deep we would get into this call before someone asked that question. The answer is no. We'll give you a full year update after the end Q2. It's a little early to forecast the full year.

So no change to the full year guidance?

That's right. No change.

Okay. Thank you.

Thank you. Your next question comes from the line of Joel Wagonfeld of First Albany.

Thanks very much. There has been a number of anecdotal data points suggesting that EMC has been getting more aggressive in terms of trying to win stand alone NAS implementations as well as at the gateway level. Just seems like you guys aren't seeing any impact from that at all. Is that accurate? Are you seeing them out there more and are you able to essentially respond without having to adjust any of your tactics, or are you just not seeing them.

That doesn't show up on the numbers. Our win rates some stayed very good. I think our frequency of encounter had probably gone up. You hear anecdotal kinds of things about EMC trying to incent the channel to be more aggressive in their behalf, things of that nature, but it hasn't shown up in any material way. I do believe, however, they have probably decided that we are their number one challenger. That's the roll we aspire to, and I think we have now been recognized for it.

And for the last few quarters, I walked into accounts. They order for -- the price of their NAS stuff was free, you get what you pay for and the fact is you can't be too much more aggressive than that. And I can't think of very many cases if any where they actually displaced us because of that. So at the end of the day, we try to make sure that we deliver on the promises and commitments we make to our customers, move our road map forward. It says something when an incumbent, the number one company in the market has to offer things for free and pay people extra incentives to go forward in the market. If they had the right product strategy, I would put forward, they wouldn't have to do that.

Great, thanks.

Thank you. Your next question will come from the line of Bill Fearnley of FTN Midwest Research

Thank you. Could you guys comment on the direct indirect sales mix you saw a 3% shift this quarter. What would your mix expectations be for the upcoming quarter and the remainder of the year.

It's difficult to forecast exactly how the federal business is going to flow. Lot of that goes through systems integrators, which gets classified to the indirect category, it it's often difficult to determine,000ny government will actually decide to make the procurement. However, the points -- the three points you saw this time was directly tied to strength in Asia Pacific, riding up 4 points in the mix, and with the exception of Australia, 100% our business in Asia Pac is through indirect channels, so as it goes up on the mix, indirect goes up. And we did have some additional strength through both Lockheed Martin and Computer Sciences Corp. Again, that's difficult to predict in advance. Which vehicle or which procurement contract the government chooses to use is often the last decision made.

Thank you.

Thank you. And we'll take our next question from the line of Brian Freed of Morgan Keegan.

Thanks, guys. Great quarter. Could you guys comment on price per terrabyte trends in the quarter, and also average system price in the quarter

This is Steve Gomo here. Basically the price per megabyte trends pretty much continued, the disk costs generally continue to fall. We don't see a lot different -- we don't see things much different from any off our competitors in that regard. We pass those savings along to our customer, and they're out in the market.

Product revenue was up by 7% roughly sequentially, and storage was up by roughly 15, so you can kind of get a feeling for what the decline in the cost per meg and cost per gig is. Part of that was driven by increased mix in NearStore. It's a much lower cost per meg. But that's why Steve put it in the script at 21.2 petabytes. You can do the math pretty quick.

Thank you. Your next question comes from the line of Brent Bracelin of Pacific Crest Securities

Thank you. I wanted to circle back on kind of NearStore products which obviously were surprisingly strong in the quarter.

Surprisingly? We weren't surprised.

Well, arguably, there's some more competitors in the space, so the first question is how do you see the competitive landscape now, and what would you attribute your success to in that space, were there are a couple of large deals that sort of artificially impacted revenue this quarter, or are you guys really dominating that market?

The answer to the last one is definitely not a couple of deals. There's strength across the board, across the world. The reason that NearStore is so attractive to people is that since our filer family as one file system, and NearStore shares the exact same file system, you can implement a sale over solution of primary storage to secondary storage very simply, very simply, and the management of that is very cost effective, so there's a very high percentage of our systems use that for near for. They don't sale over to their own stuff that much because it's too expensive. So the simplicity of managing the same file system across wide areas geographically is very enticing to most companies. Numb her two, many of our partners, all of the backup type guys, are pushing people with us to go disk to disk, and then NearStore is a very good target.

What would you say the mix is between kind of fail over and kind of the disk to disk backup right now?

Those are really hard to separate.

Okay.

But let me separate it out didn't for you, and that is reference archival, which is not intended to a DR, but is just kind of a large volume reference store. That represents somewhere between -- anywhere from one quarter to one third of the total. The DR and data recovery in general, right, disaster continuation, business continuation and so on back up, or kind of merged together in most customer's architecture by the time they deploy this, so it's really hard to separate those two.

I just wanted to make a comment about what you said on the competition. There's a lot of folks coming out and saying hey we can throw some really cheap disk drives together. We've taken a very specific focus with NearStore to try and improve the reliability of ATA drives in ways nobody else is, and we've just introduced the double parity rate that allows any two drives to fail instead of any one drive, and so our long-term goal is to take this technology straight into the heart of enterprise storage for high-end tier 1 applications. We're not there today, although we do have a handful of customers starting to run Oracle on near storage, just a handful, and they're doing crazy stuff, but just want to give you a sense of where we're taking this.

Your next question comes from the line of Omar Al-Midani of SoundView.

Yes, thank you. New store growth has historically been a good indicator or indicator of your software growth. This time around, your new store increased substantially, but not your software mix. Can you comment to whether this was just a one quarter event, and maybe there's some reasons why the software mix did not increase, or how should we think about software going forward?

I think you should think about it has being in the low 30s. I think it for at least the near term pretty much tapped out in terms of growth. We hit 32 last quarter, I think it's going to stay plus or mine us a point or two right around that zone. NearStore was up year-over-year, and that's part of what drove that growth last year, but mostly what it grove were thinks like SnapMirror, and some other things that had been here to fore deployed on filers. So I don't think you're going to see a big shift. In the NearStore, the as a percent of revenue looks very much like it does on the filer business.

Could Spinaker give you that uptick in software?

No, I think that Spinaker is a new OS, a new core platform, but the software services on top would be largely identical to what you see today.

Thank you. Your nest question comes from the line of Tom Curlin of RBC Capital Markets

Hi, good afternoon. Given the shift in tax rate, and I know someone asked about guidance earlier, I do think it's fair to come back to the previous guidance on the EPS line for the year was 52 to 54 cents, if I don't bring my OpEx assumptions. Again, it's going to going to be hard to get to that range. So are you -- I've already got some pretty aggressive stuff in here. Are you go guys going tobe -- can you really hire that fast on the OpEx side, or is it gross margin?

Well, as Dan mentioned early western we're not going to be forecasting our target, you know, guidance for the full year at this point in time. We're watching things very closely, and if things stay out and we stay on this trajectory we'll update you at our analysts day and may have some new numbers for you. The interest rate could add a penny know, to what we've seen so far, but we pretty much are South by what we've said for now, and we'll update you in December.

And on the hiring front, I do belive we can catch up in the quarter before we hired well over 200, and we seem no to slow down summer.

Thank you. Your next question come glimpse line of Kevin Hunt of Thomas Weisel Partners.

I want to follow up on that competitive environment question from earlier. It seems to me there's sense in the investment community that the storage market has been weak overall, and obviously your results would not indicate that, you're up almost 40%, EMC is up almost 30% on their year, I wonder if you could comment what you're seeing on the overall storage market. Is all your success share gains, or is it partly because the storage market is better than people think, and if it is all share gains, could you give who you are actually gaining market share from, since it is not obviously coming all from EMC, since they were obviously doing pretty well.

We have have predicted for some time that both EMC and ourselves would do very well. We hope to out grow them and gain share against them, but both of us are offering we believe very differentiated solutions from those you see from server vendors. If you look at what the server vendors look at to as their attach rates they have been in decline for some time. Their typical model was to sell storage as a expense of these are as a peripheral, and we believe the customers are looking at this as a new utility infrastructure. They want to put an infrastructure in place that will support all kinds of server environments all kinds of application environments and so on that gives them incredible flexibility. We have more some time believed that's ultimate share gains will come at the expense of the server vendors, and you have seen some here recently, and that the pure play horizontal focus of storage providers will continue to do well as they continue to offer the customer community a very broad range, high function and flexible solution.

Okay. So you think the actual sort of intent to purchase storage in a general sense is about the same, or --

I think the reasons why customers purchase it is different. It's not just adding capacity. We see a lot of demand coming from re-engineering of backup and data recovery environments. We see a lot of demand coming from compliance solutions. I think this quarter we got close to petabyte of compliance based storage. We see an awful lot of demand coming from business continues requirements. All of those have an intrinsic requirement for new kinds of storage infrastructure, and so it's not that the total storage market is growing, but the types of storage the customers are purchasing, and the reasons, the business problems they're trying to. So with those purchases are in fact quite different. And you don't mind any of those solutions being offered by through I vendor at all.

One of the other area that we see expansion and we have for the last year and a major financial institution entire are price. We just had a major financial institution -- in -- some, they had 10 site ace round Asia, they were backing them all up locally. What they did was rather than bring the day to to the people, they decided to bring the people to the data. They lowered their cost by almost 80%. So the distributor enterprise throughout the world, people are saying our remote offices have too much data, and we can put in where they don't have to snap to a near store, cost competitive wonderful operating system, one file system.

Thank as a lot, guy.

Thank you. And your next question is a follow up question from the line of Chris Russ.

Yeah, hi. I just wanted to know about the Windows mix. I know Dan you had mentioned you're not going to comment about specific platforms, think last quarter was 45%, in the prior quarter 40%. Is the directional change up or down this quarter, and are the drivers still in the essentially server, or are you starting to see larger deployments of Windows sever three.

It's logical hard to tell and the data became less significant the more we dug into it because of the variety of configurations. I will see this it is it is clear at on 75% of the systems we shipped had some support capability. Another probably 15 to 20% were candidates, but you can't validate it. So if you think about Windows as one of the supported server types, it's somewhere between 75 and 80% of the systems we ship. But beyond that, I don't know how to count it up. I mean, it's actually -- if you look at commentarial stuff, it's about 20 different categories of combinations that you can see in the purchase orders that are probably Windows, but it's just really hard to segment it done. Anecdotally Windows is up. We've seen some big deals. Sequel server continues to be very strong in the mix. ISCUZI is going primarily into windows environments. Listen, continues to be a big braver in certain -- it's prior pearl right now I would say it's prior pearl entertainment, post production, semiconductor and her oil and it was in their big ones that we, saw see, but it's also getting a fair amount of deployment financial services sector. Mostly for what we call the miracle -- natural six, but it's not brokerage and trading, more analytical in nature, but we're starting to see listen, dough provided in a number of environments around in the globe.

Okay. Great. Thank you.

And your next question is another follow blow up from the line of Harry Blount of Lehman Brothers.

Hi, guys. Just on the driver side of the equation, we have microsoftware with service back two, and then the end of life of 4.0. I was just wondering if you -- and then also the XP broad apply defined. If you can maybe talk to some of the drivers that we're looking at, and how much of an impact in that you're seeing on your business currently as opposed to where you expect to see it.

I think the pig issue is on the NT4 sides, and actually the tie in there is in the elimination of support from I think it's exchange 5.5, and so customers forced to go to exchange 2000, and so on, and that's causing them to look at to infrastructure that goes with it. That's probably what's is causing a lot of these customers to go to delimit considerations so it's very hard to have a direct tie in. Most of it I think is on the exchange side, though.

Great, thanks.

Okay. And we do have one more follow up from the line of Joel Wagonfeld.

Thanks. Just wanted to follow up on services margins. I know that you said that in the 20 percent range wasn't a key goal, but in order to even get to that range, it seems like the services hiring would have to be pretty front end loaded in the year, or your services revenue would have to be ramp pretty dramatically. I'm wondering, it sounds like it more in the latter are that you haven't seen the services revenue layer in as much as you will over the rest of the course of I year. Is that accurate?

Yeah, this is Steve Gomo here. Yeah, we expect to see the growth rate and the service pick up a little from what you saw last quarterer. Service grew last quarter, but it didn't grow at to rate of the in the company, I would not be in the following quarter, and then stay with the rate of the company going forward.

Are the services hirings, though, pretty linear?

No, I net income it's fair to say they're a little front end loaded. Before we can effectively sell services from a professional services engineer, we have to have that person on board fully trained, typical the customer wants to meet the individual before they'll trust the individual to execute it on their behalf.

Great thanks.

And at this time we have no further questions.

Well, thank you very much, again, for joining us, ladies and gentlemen, we look forward to seeing you at the analysts day on December 1st in New York, and we'll be talking to you around the same time in November. So everybody have a good day, and again thank you for joining us.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the presentation, and you may now disconnect. Have a great day.