NetApp Inc (NTAP) 2005 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Network Appliance second quarter fiscal year 2005 earnings release conference call. My name is Steven, and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will facilitate a question-and-answer session toward the end of the conference. If at any time during the call you require assistance, please press star, followed by 0 and a coordinator will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. Dan Warmenhoven, CEO. Please proceed, sir.

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; and Steve Gomo, the Executive 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 metrics, forecasted market share, anticipated technological and product developments, and our outlook for continuing growth. Actual results may different materially from our statements or projections. Factors that could cause actual results to differ from our projections include, but not limited to, customer demand for products and services, any decline in general economic conditions. A number of 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 way reference into today's discussion. I'd also like to remind you that today's conference call is being webcast live over the internet and will also available for replay on our website at www.netapp.com, along with the earnings release, the reconciliation between GAAP and pro forma numbers and other financial and fiscal information presented during the call. Now I'll turn the call over to Steve for a review of this quarter's financial results. And following Steve's comments, I'll share my own thoughts on events during the quarter. And then, we'll discuss our financial outlook and conclude with a question-and-answer period. At this point, I'll turn the call over to Steve.

Thank you, Dan. Good afternoon everyone. We are very pleased with the outcome of the second quarter of fiscal year 2005. In fact, we set records in many aspects of the business, starting with top line revenue. The balance sheet is as solid as it's ever been, with all time -- with an all-time cash position resulting from extremely strong cash generated from operation.

Now, I'd like to provide you with some commentary about these results. Please note that all numbers are GAAP, unless stated otherwise. Revenue for the quarter was $375.2 million, up 36% over the second quarter of last year. Revenues increased 4.7%, sequentially, resulting in our 12th consecutive quarter of sequential growth. Foreign currency contributed a favorable 2 point to the year-over-year growth rate, while the sequential impact was immaterial. Product revenues of $336.8 million grew about 4%, sequentially. And finished 35% higher than last year. While all product areas contributed growth this quarter, low-end filers showed particular strength. Revenue from services, which includes hardware support, professional services, and educational services, grew 47% over 2Q of last year and was 10.2% of total revenue, up almost 14% over last quarter. Revenue from professional services increased 58% year-over-year. Add-on software and software subscription upgrades accounted for almost 34% of total revenue.

Now 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, Snapshots and the first protocol. For example, the FlexVol functionality associated with Data ONTAP 7G product introduced yesterday is bundled with our system, while the new FlexClone software will be sold separately. Add-on software products this quarter were approximately 23% of total revenue and software subscription upgrades were approximately 11% of total revenue. Pro forma gross margin exceeded our forecast and finished at 61.8%, compared to 60.2% reported last quarter. In fact, the gross margin was at its highest level in the past 2 years. This exceptional performance was driven, mainly, by pro forma product margins, which finished the quarter at 67.1%, compared to 65.1% last quarter. Several factors contributed to this favorable performance relative to our forecast. First, a focussed operational initiative yielded 6/10ths of a point improvement in product cost of goods sold this quarter. Second, purchased part price variances were more favorable than anticipated, contributing 4/10th of a percentage point to product gross margin. Third, manufacturing overhead spending also had a favorable impact this quarter. Finally, software content increased this quarter and added about 4/10th of a percentage point more than anticipated to the gross margin.

Roughly 1/3 of the favorable effect of these factors will continue next quarter, as the rest is expected to be dissipated by pricing and operational decision. As a result, third quarter Company pro forma gross margin is projected to finish in the range of 60.5 to 60.8%. Service margins also improved this quarter to 15.9%. This was an increase of 2.4 percentage points from last quarter. Professional services continues to be an investment area and a growth driver for us, although the investment rate tends to delay the service margin increases in the short run. Pro forma operating expenses totaled $166.2 million, increasing $8.7 million from the $157.4 million reported last quarter. Of this increase, almost 2/3 was attributable to sales, in the form of commissions and staffing-related expenses. Expressed as a percentage of revenue, pro forma operating expenses were 44.3%, about the same as last quarter, and right in line with our spending plan.

Pro forma operating profit finished this quarter at 17.6%, 1.3 percentage points higher than last quarter. The quarter-to-quarter improvement was due, entirely, to our pro forma gross margin performance. Pro forma other income was $6.2 million for the quarter, compared with $3.2 million reported last quarter. This quarter's results benefited from a $1.3 million interest payment on a tax refund. In addition, a higher average cash balance and slightly higher interest rates also contributed to higher interest income this quarter. Finally, last quarter's results contained a loss associated with our balance sheet hedging program. Pro forma pre-tax income for the quarter was $72.1 million, or 19.2% of revenue. The effective pro forma tax rate for the quarter remains at 19%. Pro forma net income for the quarter was $58.4 million, or 15.6% of revenue. Pro forma net earnings per share was 16 cents, based on an average -- based on a weighted average of approximately 375 million shares outstanding. Adjusting for the interest on the tax refund, pro forma EPS would have been 15 cents per share. This quarter we reported a GAAP net income of $55.3 million, or 15 cents per share. We have provided a reconciliation between pro forma GAAP -- between pro forma and GAAP financial measures in our press release and a separate reconciliation table, both of which are posted on the investor section on our website at www.netapp.com.

Now, turning our attention to the balance sheet, cash and investments at the end of the quarter were a record high for the Company at $922 million, up $95 million from the previous quarter. Cash generated from operations was at $121.3 million this quarter. Capital purchases of plant, property, and equipment were $16.2 million, and depreciation during the quarter was $13.4 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 second quarter, we purchased approximately 1.6 million shares of outstanding common stock at an average price of $22.21, for a total of $35.3 million. We have approximately $130 million remaining in our buy back authorization.

Accounts receivable days out -- days sales outstanding were up slightly to 53 days, versus the 51 days reported last quarter. Inventory turns were 16.3 times, compared to 16.4 times in Q1. Compared to 1 year ago, inventory turns have improved 35%. Deferred revenue was very strong again this quarter at $339.9 million, up $30.7 million, or 10% quarter-over-quarter, and up 63% from the $209.1 million reported a year ago. Headcount at the end of the quarter was 3,255 employees, an increase of 246 people from last quarter. In summary, our market success was demonstrated by strong revenue growth again this quarter. Our growth oriented investment program for professional services and operating expenses is on track. And operating margins exceeded our forecast, as a result of strong product margin. Now, before I talk about our targets for the third quarter and full year of FY '05, I'll turn the call back over to Dan.

Thank you, Steve. As you can see from our results, NetApps had another strong, well-rounded quarter. We experienced growth in every geography and across all our product lines. Our win rates remain strong, at the same time we're engaging in more and more enterprise opportunities. The top drivers of our growth this quarter were demand for data protection solutions, strong Windows business, and customer's continued movement away from direct-attach storage. Within the data protection category, which includes disk-to-disk back up, disaster recovery, and compliant solutions, our NearStore products and related software and services grew to about 17% of our business this quarter, up 20% over first quarter levels and over 100 percent year-over-year. We have now shipped over 40 petabytes of NearStore since inception. It continues to be one of our fastest growing products. NearStore uses inexpensive ATA drives, combined with sophisticated software to make those cheap drives highly reliable. On top of that, we sell add-on software products like SnapLock and SnapVault which we developed to satisfy our customer's compliance and back up challenges.

This quarter, Airbus France purchased NearStore and SnapVault in combination with several 920, 960, and 270 clustered filers to run on both their test and production environments. The NASA Goddard Space Flight Center, which manages the Hubble Telescope Project was another NearStore customer in this quarter, archiving the complete history of all Hubble Space Telescope engineering and telemetry data. And 3 of the top insurance companies in the U.S. -- the 3 top insurance companies in the U.S. purchased NearStore as part of comprehensive regulatory compliance solutions. The Windows business was another key growth driver this quarter with our SnapManager for Microsoft Exchange software up 100% year-over-year. And SnapManager for Microsoft SQL Server up over 200% year-over-year.

Windows was also a big driver of our iSCSI business, and they are generally sold in a combination. For example, this quarter, a large U.S. petroleum company selected NetApp for build-outs of the Microsoft Exchange and Microsoft SQL Server environments. To date they've deployed several hundred terabytes of NetApp storage to run their business applications and both iSCSI and Fibre Channel. Our iSCSI and SAN business had a record quarter, with block-based storage now included in over 23% of our business. We are very pleased with the progress this business is making. We believe it is being stimulated by an increasing number of customers looking for a inexpensive way to move from direct attach to network storage, and iSCSI from NetApp is their answer. Our iSCSI growth also coincides with the increase in our indirect and Windows business, because 3/4 of our iSCSI and SAN business came in through the indirect channel on a worldwide basis. The bulk of these deployments are for Microsoft Exchange and Microsoft SQL Server deployments.

In addition to the strength of iSCSI, Fibre Channel SAN deployments also grew. Over 11% of our business included the Fibre Channel protocol this quarter. The majority of Fibre Channel SAN systems were deployed in combination with either NAS or iSCSI protocols. The trend towards unified storage continues to accelerate, as exemplified by the strong performance of our SAN and iSCSI business. Marquee customers like The General Services Administration, Baring Asset Management, the Federal Trade Commission, and TIVO are moving to NetApp for their SAN deployments. Since so many of our systems are now sold multiple connection types, we believe the market recognizes that NetApp offers infrastructure solutions which allow customers to run virtually everything on any one of our systems. We're reaping the benefit of investments we've made in R&D over the last few years to create unified storage. And this puts us in a very strong position of leverage. Our SAN business is growing and taking market share. And our NAS business continues to grow and take market share right along with it.

The key differentiator is that we offer 1 common operating system across all of our products and connection protocols. As a result, our fiber business also grew robustly this quarter, with strength in every segment of the product line, low, middle, and high. The number of FAS200 units shipped grew by over 14% over last quarter, driven by the larger FAS270, which grew 21%, sequentially. The new mid-range FAS920 more than doubled in its second quarter of production, and our high-end FAS980 ASPs increased again in its third quarter of production. Filer wins this quarter included Cannon, Constellation Energy, the GSA, Nokia, Saudi Aramco, the Times of India, United Health Group, the U.S. Air Force, Volvo, and Texas Instruments. Our NetCache products contributed over 5% of our business again this quarter. The customers this quarter included the U.S. Army and China Netcom, which purchased over 30 units of our C2100 for video-on-demand acceleration.

Looking at our business from a geographic perspective, the profile was very similar to last quarter. North America accounted for just over 58% of the business this quarter, Europe contributed 28%, and Asia-Pacific posted nearly 14% again this quarter. What did change this quarter was our channel mix, with 55% of the business coming through indirect sales and 45% through direct. Last quarter the mix was almost the reverse with 54% direct and 46% indirect. The increase in indirect business is primarily the result of a substantial increase in our Japanese business, which is all indirect, combined with a much larger percentage of our U.S. federal business coming through major systems integrators this quarter. Air on Ap Net (ph), again, contributed about 8% of our total business, growing along with us at a healthy clip. And we had terrific contributions from resellers and from systems integrators worldwide. Our investments and developing partner programs and relationships are definitely paying dividends.

Yesterday we announced NetApp's next generation software platform -- Data ONTAP 7G. 7G is our next step along the path towards the storage grade to represent the new standard of storage virtualization technology. FlexVol, one of the key, new features enables the creation of virtualized, flexible data containers, which eliminates and utilization tradeoffs. Essentially separating data management from the physical disks, the 7G would also significantly expand the capabilities of the gFiler, adding Fibre Channel SAN capabilities, which take it from being just a NAS gateway to a sophisticated storage virtualization engine. We now have the capability to virtualize the customers Hewlett-Packard, Sun, IBM, and Hitachi storage, realizing our vision of horizontal scaling capabilities. Our next step will be to integrate global name space capabilities towards the end of next year.

To recap, NetApps had another outstanding quarter, with strategic investments we continue to make in our business are proving to be the right ones. With over 36% year-over-year growth in revenue this quarter, we are clearly taking market share. With strength of the product margins, we're obviously doing well in competitive situation. And lastly, our investing for growth plans were right on target with OpEx at about 44% of revenues, which we plan to continue for the foreseeable future. At this point, I'll turn the call back over to Steve to discuss our financial targets.

Thanks, Dan. Our business outlook is based on our current business expectations 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 success in the marketplace to continue and project third quarter revenue to grow sequentially by 7 to 9%. This projection reflects year-over-year growth rates of 35 to 38%. We also expect net income to grow, and depending on revenue levels achieved, we are targeting Q3 pro forma earnings per share of 15 to 16 cents per share. GAAP earnings per share should round to 15 cents per share. Due to our increased expectations for the second half of the fiscal year, we are raising our FY '05 full-year targets revenue to 35 to 37% growth. This implies FY '05 pro forma earnings per share of 60 to 61 cents per share. Projected FY '05 GAAP earnings per share should finish in the range of 57 to 58 cents. I'll turn the call back over to Dan to wrap up.

Thanks, Steve. As you can see, NetApp is benefiting from offering great solutions in the hot growth segments of the storage market. In fact, we believe data protection, Windows, and unified SAN, NAS, and iSCSI are gaining momentum in the marketplace. We're coming out with breakthrough technology like Data ONTAP 7G to help fuel and sustain our future growth. I am very proud of the efforts across the entire Company. I'd like to compliment everyone in Network Appliance on their terrific performance, again, this quarter.

Before I open the floor, I'd like to remind you about our upcoming Analyst Day, which will be held in New York on December 1st. It is also available via webcast. We'll be providing more in-depth look at our business, talking about our growth initiatives, and our outlook for fiscal year '06. Please contact our investor relations people for details. At this point, I'll open the conference for questions. We ask that you please limit yourself to 1 question at a time, so that we may address everyone in a timely manner and also honor your request to keep the call to 1 hour. Operator?

And our first question comes from Laura Conigliaro of Goldman Sachs.

Hi. Actually, it's Brenden Smith for Laura. Guys, a few things. Obviously very solid line bottom-line performance again. But the way you got there is certainly different than what we've grown accustomed to over the last year and a half or so. Could you just walk us through a little more detail of the pause in direct sales, especially as from the U.S. this quarter? And then put that in the context of a pretty dramatic re-acceleration in growth for the next 2 quarters?

Yes. Brenden, this is Dan. I don't see as an acceleration. We did 36% this quarter, and I think our guidance was 35 to 38. So I don't see that as necessarily an acceleration.

Especially in terms of product revenue at 3.8%, sequentially, versus 6.8 the prior and so what -- ?

I'm not sure I understand your question. You asked about 3 questions at one time. First is relative to guidance, which I think I just answered, which is the guidance is now consistent with the growth rate we just produced. Number 2 is channel mix. And largely that indirect channel contribution is part of the strategy of really trying to get major systems integrators to partner with us. It's really paid off handsomely in federal. The other major component was the strength of our Japanese business, which was up in Asia-Pac this quarter, quite dramatically, and that is all indirect. And I think that's 2 out of the 3. I don't remember what the third question is. We'll move on.

Sure. I mean, just to paraphrase, so then, indirect --

We'll move on. You've already had 2 questions. Let's move on to somebody else.

Okay.

Operator, are there no others?

Our next question comes from Naveen Bobba of Bear Stearns.

Thank you. I guess, Dan, I guess you -- 30%-plus growth rate, you have been showing it for 2 years, now. I guess, this is the second year. In the context that you, certainly, are still fairly small in the storage market, you think you can keep up this pace of revenue growth looking beyond this year?

I certainly do. I'm going to give you more guidance at the analyst meeting on December 1. But, let's just recap real quick. In the December 1 a-year-ago analyst meeting, we guided you to 25% year-over-year for this year. As we got into this calendar year, we saw the growth rate actually accelerate. We raised our guidance to about 30%, and we're seeing continuing strength. And now we're, basically, guiding you to 35 to 38. Which, you know, at least for the next several quarters out, we think is probably, you know, pretty solid. We don't see any change in it. But we'll give you a complete update for next year on December 1.

A clarification on the product question, Dan, in terms of the direct, indirect mix. So, is that a mix expected to continue the same vein in the near term, the mix shift towards indirect?

I think you'll see variations, you know, plus or minus 5% in either category, depending what's up and what's down in the mix. For instance this quarter, typically Q3, Europe surges in our mix. This quarter was 28, next quarter, you know, is probably going to be in the low 30s. In fact, I always get the question at the end of Q3, what's wrong with North America? Happens every year. And Europe is largely a 50% indirect. And so, as they surge, you'll probably see indirect be, you know, again very strong. You know, if you look across the three geos, North America has more direct in the mix; Europe is about 50, 50; Asia-Pac is about, right now, running about 85, 15 indirect.

This is Tom. Couple of years ago we made a couple of bets, too, that we talked to you about. One was that we were going to invest in the reseller program in the United States. We have a couple of advantages over our competition. One is that we have margin and they don't. Number 2, we are under-distributors as opposed to over-distributor versus most companies. So, we're very, very attractive to major resellers. Our systems integrator business -- these are the very large companies that do deals, like IBM, Global Services, Accenture, EDS, DSC, and on and on and on. All of them are accelerating their business with NetApp. And we've taken advantage over that in the last year. So, the -- and in Europe, Fujitsu Siemens has been on fire for us, selling, specifically, SAP is one of the big areas that they've been very, very successful selling with us. So, we're taking advantage of a strategy we deployed about 2 years ago, which is, we'd like to focus our hiring on technical resource. Our sales peoples' productivity is going up, and we're getting more and more traction with the channel on a global basis. So, the percentages, as Dan said, will move a little bit either way. But we expect the channel business to become a very, very strong component on an ongoing basis of our growth.

Thank you, guys. And nice results.

Thank you.

And our next question comes from Clay Sumner of FBR.

Thank you, again. Congratulations. I just -- Steve, I was wondering if you could elaborate a little bit on some of the cost of goods initiatives that you guys benefited from this quarter in the gross margin line, and little bit more on why you don't expect that to be as favorable in the next quarters. Thanks.

Sure. The primary focus -- the operational initiative I was referring to -- was around our demo inventory program, and just becoming more efficient about how we manage that. And you can see the payoff that it had this quarter. I think that, actually, if you look at a cost -- from a cost of goods sold standpoint, that trend will continue. The reason why the gross margin should come down from their current level have to do with some opportunities that we see to be more aggressive with pricing and take our growth rates up. And that's why you see some of the decreasing growth rates, there, that we just projected.

Got it. Thank you.

And our next question comes from Dan Renouard of Robert Baird.

Hi. Thanks. Wondering if you could just talk a bit about some of where you saw the most strength in terms of verticals, particularly, if you could talk about energy and government? If you could give us more details there and then any other verticals you saw particular strength? Thanks.

Dan, this is Tom. The energy market continues to be very, very strong for us, specifically on the seismic side. But we're also seeing data stream growing also. We're starting to get into areas that we hadn't previously been in because of -- because of some partnerships that we've made in the last year, Accenture being one of those. Government business has been very, very strong for us for the last 18 months. We've made some key investments there that have paid off, and it continues to grow at a very rapid rate. I think it's 13%, now, of our sales. So, it's very, very solid. And I don't expect that to go anywhere but up. And the financial services continues to be a market that grows for us on a global basis. The last quarter, alone, we had 2 more very, very large financial institutions for approximately a have a petabyte to a petabyte each. We've also one from major compliance deals there. And that's 14% of our revenue. But it's -- if I look at Wall Street now, I think of the top-10 banks, I think 9 have over a petabyte of our storage. So it's a very different story than it was a couple years ago. We're moving into a wide array of applications in there. And it's clear that we're viewed as a trusted supplier to them.

Just to underscore what Tom just said, historically, our biggest sector has always been tech, which includes guys like Cisco, TI, Oracle, et cetera. But in second place, now, is definitely financial services. And that represents, you know, 14 to 15% of the business. And right behind that is federal, which is about 13 to 14 every quarter. And that's stayed pretty consistent over the last few quarters. Energy was up a little bit in the mix this time. They have a tendency to be a little lumpy as cost of oil goes up, their spending goes up. And we're the beneficiary.

And our next question comes from Brian Hertzog of Thomas Weisel Partners.

Great. Thanks, a lot. It's Brian Hertzog calling in for Kevin Hunt. Just a couple of question, I guess. Can you give us -- I think I may have missed the total Filer revenue for the quarter. You did highlight the low end and some of the newer, higher-end products. But what was the overall number? And then, the second question is for Steve. Not to split hairs, but what -- on the -- there's a difference of 860,000 in the product gross margin line between GAAP and pro forma. Can you just clarify the difference there?

This is Dan. Let me ask the question on the filing one first. Filer and NearStore are becoming absolutely indistinguishable, about the only product that's a true stand-alone now is, in fact, the NetCache product line. You know, for instance, NearStore is sold with mirroring technology. Half that technology gets installed on a Filer. So, it's not possible to really break it out very meaningfully. We have not given a Filer number in the past that I'm aware of. So the NearStore, as a product line, is 17. Caching's 5. You can, kind of, almost assume the rest is Filer.

Okay. Great.

Incidentally, every time we give one of those numbers, you should construct in your head a 3 by 3 matrix. 3 product lines on one axis and 3 types of revenue-producing items on the other axis -- systems, which includes all the hardware, storage, and operating system; the add-on software; and service. Right? So each product line has each of those 3 components. We've generally only given you summaries by product line and summaries by type, right, add-on software and service, in particular.

Brian, the answer to your second question, is actually provided in the press release. There is a reconciliation of non-GAAP and GAAP results on the income statement. And for cost of goods sold, you're right, it's about 858 K. And it has to do with the amortization of intangible assets, most of which were involved with the Cisco -- with the Spinnaker acquisition.

Okay. Great. And then one other question If I could, is there any differentiation between last quarter and this quarter as far as the mix on the deferred revenue line?

No, it's very similar.

Okay. Great.

And our next question comes from Tom Curlin of RBC Capital Markets.

Yes. Good afternoon. I apologize, I'm losing my voice. Can you hear me okay?

Yes. Perfect.

Just looking at the projections you gave and working through the margin scenario over the next couple of quarters. Does it feel like, roughly, 16% for the year is the right way to think about operating margin?

Well, we didn't give guidance, specifically, to the operating margin, as you'll notice. But if you'll do the math, it's around that number.

So, if I -- if I, kind of, work through the numbers over the next couple of quarters, it seems like you probably end up with a fourth quarter number that's down a bit. Is that related to some accelerated investment on the OpEx line to build out the service, or is it more related to some of the pricing actions you described?

It's related to a little bit of both. As we mentioned, we're on our spending plan. Our hiring is, basically, on track. And, you know, to the extent that we're projecting a little more revenue in the second half, we probably are, right know, looking at opportunities to leverage that growth and growing faster in the future. As far as the gross margin is concerned, I mentioned that it would be coming down a little bit. Though, I don't think that this quarter's operating margin will be representative of what we expect in either the third or the fourth quarters.

You know, we haven't changed the fundamental model of roughly 60% gross margins and roughly 44% of OpEx, which gives you 16%, basically, on the operating income line.

Okay.

You'll see some fluctuations, but that's, kind of, the target model we've got going. As you saw -- as you saw in the guidance that Steve gave, gross margins for next quarter were forecast in between 60.5 and 60.8. So, that's running a little hot. And my guess is that part of that drops through, you know, to the 16% operating income as well.

All right. Thank you, very much.

And our next question comes from Harry Blount of Lehman Brothers.

Hey guys. Question on -- Dan, you have cited 3 drivers as the part of the principle growth that you're seeing, the strength of the growth you're seeing on data products, Windows, and this switch to desk and network storage. As it relates to Windows, specifically, I know you have NT coming into light -- NT 4.0 Exchange 5.5 coming into light. Can you, maybe, give us a little bit more flavor, in terms of the addressable market, how far along you guys are in hitting that potential addressable market, and how long that will continue to be the principal source of growth, those 2 products, specifically?

You know, I -- it's really hard to forecast, Harry. My sense is that there is a number of customers who are not making the conversion off of 5.5, just because it's got end of support as the end of December. I mean, clearly, that's a driver. But there's awful lot of migrations left to go. And many of the customers are in the position of, if it works, don't fix it. You know, I mean, the conversion of -- off of 5.5 can be a fairly disruptive one. It's got, basically, a different connection architecture to go with it, right? LDAF and the rest of that kind of stuff wasn't mandatory in the 5.5 world. So it's a bigger and more expensive change than just swapping out or upgrading your Windows Exchange server. I think customers are going to take it pretty methodically. I think we're probably less than halfway through the conversion.

And then on the 4.0 side of the equation?

You know, that one, I think, is a lot easier for customers to go through. But, you know, we don't see that as a primary driver. We really see it as the application upgrade, right, Exchange or SQL or whatever.

Fair enough.

And we have a follow-up from Clay Sumner of FBR.

Thanks. I was wondering if you could give your tax rate expectations for the forward quarters and also an update on the Spinnaker integration?

This is Steve Gomo here, I'll give you the tax rate expectations. You should be modeling the same 19% that you saw this quarter. That's what we're modeling as we look forward, both for the balance of this year and into next.

On the Spinnaker integration, we're continuing to sell the Spinnaker version that we acquired. When we just did our launch yesterday, all the flexible volume stuff that you saw is really the foundation that's required for the Spinnaker technology to come in. That's the virtualization underpinnings required for all of the Spinnaker components. What you're going to see is, over the next year, we're going to come out with more converged stuff. But we expect a fairly long transition cycle for our customers. We're actually going to be managing this as 2 choices for them to make. And we'll give them a very orderly opportunity to go over, so that we're never in a position of driving customers out of their comfort zone.

And you guys said you would have Spinnaker revenue this quarter, I believe. Can you say what it was?

No. It looks like a filing.

Thank you.

And our next question comes from Aaron Rakers of A.G. Edwards.

Yes. Thanks, guys. Nice quarter. 2 quick things. If you can, I think in the past, you've given some kind of terabyte or petabyte shipment growth. If you can update us on what that was in the quarter? I think you did 21.2 petabytes last year. And also talk a little bit about the linearity you saw in the October quarter. Did we see increased momentum as we exit the quarter, or a pretty linear quarter? Thanks.

This is Dan. On the booking side, I -- you know, we had a traditional, kind of, Q2. August was very slow. You know, we always call for pretty good finish at the end of our Q1 in July, and then our own sales force takes their family vacation. So, August is always a very slow month for us. And then, we had a great September and October, which is pretty traditional. I don't think you can look at our quarter and say we gained momentum, because we always have a big September and October. But they were pretty strong. And linearity from a, you know, a manufacturing view point, was pretty good. So, you know, that's what showed up. You know, the DSOs are about same as they were the prior quarter. That's the easiest metric there. I think the petabyte shipped was up about 3%, sequential.

Okay. Thanks, guys.

And our next question comes from Brent Bracelin of Pacific Crest Securities.

Thank you. Most of my questions have been answered on the quarter. What I wanted to do is take a step back and look at the competitive environment. How much would you attribute, kind of, the growth, here, near term to the unique capabilities you have, kind of, on the iSCSI side, the unified storage platform, and is that resonating with customers? And what are you seeing from a response from some of the competitors? And when do you expect a more significant response from competitors in regards to, kind of, IP SANs?

Yes. This is Tom. I'd say 2 things. One is, I travelled 10 of the 12 weeks of this quarter and, literally, covered the globe looking at opportunities and talking with customers, prospects, and sales teams. Since I've been with NetApp, I've never seen this much momentum on a global basis at one time. That's been true for almost 4 quarters, that everybody -- ever area of the world has made its goal, that's kind of interesting in its own right. But we're not dependent on any one area pushing us forward. That's number 1. Number 2, the iSAN business grew faster than we expected, I think, this quarter. And we're seeing a very, very big uptick of iSCSI. I think it was about 3 quarters ago on our own internal projections, we were bigger than the IDC forecast of the market. The IOPS that we measure inside are about 10 times what was projected by us, even a year ago. It's our finding in a distributed world, number 1 our SAN product is getting old. Number 2, people like all that kind of stuff, the unified storage, because they don't have to worry about what they're doing on either side, the interface or the backend. And then, number 3, iSCSI is becoming very popular because it's being pushed by many other big people like Microsoft and Cisco. So our story is resonating and it's -- you know, people -- TCO is misused by everybody. Everybody's got a lower TCO. The fact of the matter is, by having 1 file system at the lowest end to the highest end, failing over to NearStore, which has the same file system. You know, our largest customer, now, has more than 7 petabytes, and haven't added an administrator in the last 3 petabytes. I don't think our competitors can say things like that. So, the simplicity message which NetApp has always believed, if you're going to lower cost, you're going to have to make things simpler is resonating in a big, big way. Now it's really about execution. You know, if somebody asked me the other day if our win rates are going up. Our win rates are staying the same. We're just in a lot more stuff on a global basis. And it has to do with our own end-user sales force and the strategic account issues that we went after about a year ago that we talked to you about, and our channels bringing us into many, many more opportunities.

You know, are you seeing any, you know, change in the competitive environment at all? Or, you know, when would you expect to see more competitors, kind of, on the IP SAN side?

This is Dave Hitz. From a competitive perspective, I certainly do expect to see more people introducing iSCSI, in particular. I mean, that's something that's starting to catch hold. To me, the big advantage that we have in that space is we're just viewed as a strong player in storage over IP. And we connect into companies from that perspective. The place that I don't expect to see strong competition coming in anytime soon is on the unified front, where you see Fibre Channel, SAN, iSCSI, and NAS all in 1 solution. And the reason for that, is that all of our competitors have entered this business by doing acquisitions that give them the starting point of fundamentally different OSs, whereas, we've got an OS that supports these capabilities. So, just architecturally, they're in a very tough place to compete there. So, iSCSI, yes, I think they'll come full unified. I don't expect anything soon.

Perfect. Thank you, very much.

80% of the systems we ship with iSCSI or Fibre Channel also have a NAS interface on them. 80%. That's a big number.

And our next question comes from Brian Freed of Morgan Keegan.

Hi, there. Good quarter. I wanted to delve into the mix between direct and indirect a little more. This was the first quarter I'd seen direct down in some time. Could you talk about your strategy there? Is it really, you know, a shift and focus more to IBM and Fujitsu and other SI partners?

You know, one thing at this time I want to point out, we don't have a strategy which says we want X-amount to be direct or X-amount to be indirect. What we're trying to do is move the top-line revenue as hard and fast as we can. We've made it very, very clear that over the last couple years that we were going to invest in, primarily, technical resources to support either channel. And how they deliver it really doesn't matter to us. I think that we're becoming very, very attractive to the large, large integrators because the alternatives are vendors who are very much over-distributed or, in EMC's case, they have Dell taking away the value at the last end, and that's starting to get the channel a little hairy. So I think we have real opportunities because we have a situation where we have the margin to give them. We can work together. Our sales force is compensated the same either way. So we have a very synergistic program working. So if I can get the channel to help us grow faster, I think that's fantastic. I'm personally spending a lot of time on channel stuff. And our sales force isn't out there saying, gee, how can we sell it direct or indirect. They want to sell more, fast.

Okay. Thanks.

And we have a follow-up from Dan Renouard.

Hi, thanks. Can you give us an update -- and if I missed this, I apologize -- on the headcount, how many you were successful in hiring this quarter, and what your thoughts or plans are for the next couple?

Yes. We're at 3,255. I think we added a net of 246. And we're going to stay on the 200 per quarter rate, going forward. Maybe pick it up a little bit as the growth rates we just gave you, kind of, went up. We'll pile more of that back in the head. But it's 200-plus.

And if I can just ask, is the hiring environment as the economy picks up a little bit, is the hiring environment getting better, worse, staying the same?

You know, I think our success has driven the -- our ability to track really quality people. I am not sure I can comment on the overall hiring environment, but we have been really fortunate, I think, in being able to add some really, really talented people. You know, one of the highest growth areas in the company is professional services, distributed around the globe. And we've been able to really put together -- just from my view point -- a Cracker Jack, world-class team. We continue to hire in engineering. Here and Sunnydale, as well as Research Triangle Park, where we are expanding the facility. In Pittsburgh and Bangalore, and we've been able to really attract some very talented people there, too. So, you know, around the globe, I just think it has more to do with our success. People want to be part of a winner. I mean, right now, would you rather be on the Philadelphia Eagles or 49ers? Terrell Owens cast his vote, right? I mean --

How about the Steelers?

All right. The Steelers. There you go. How about them Steelers?

At the end of the day, people are attracted -- for career opportunities they look for growth. They look for companies that are growing. And if you look at our segment and you look at technology, there are not many companies growing at the rate we're growing.

Thank you.

And our next question comes from Paul Mansky of Smith Barney.

Dallas Cowboys fan myself. But I guess I'm part of contrarian. So, a lot of my questions have been answered. I did want to come back to some of the discussion around the iSCSI market. And, Dave, I guess this is specifically for you. I know, historically, you talked about implementation being primarily software oriented. Have you seen any trends there with respect to any hardware assist on the I/O front?

Boy, to be honest, I don't know what the numbers are. The reason that we see such a high driver on the software side is simply this -- when you look at the applications where iSCSI is really targeted, it tends to be in lower-end kinds of applications like Exchange and SQL Server. Generally, you've got CPU to spare, right? They're running on really high performance Pentium systems. You've got CPU to spare and the underlying limitation is I/O, not CPU. And so, doing it in software costs less money, and doesn't hurt overall performance.

Do you see any specific event on the horizon that will pull through a larger incidence of hardware, hardware-enabled iSCSI products.

I think, as you see the stuff move higher end in the market, you'll start to see more of that. But I don't have a particular time frame in mind. You know, if you look out a few years, I think you'll start to see more penetration in high-end unit kinds of environments. And in that kind of space, then I think the hardware will definitely make sense. And we do see, even now, Fibre Channel has a performance advantage over iSCSI in CPU-intensive applications. And so those applications will drive some amount hardware attached. So I don't think it's an either-or, but I do see software being predominant for a while.

The only piece I'd add to that is watch the adoption rate of 10-Gig ethernet. At 10-Gig, you pretty much got to have some kind of hardware assist to utilize it.

Okay. Great. Thank you, very much.

It's been answered. Thank you.

You have one more?

And we have a follow-up from Clay Sumner.

Wow, 3 questions. Thank you, very much. Can you guys just talk a little bit about what you're seeing in Asia, Japan, China, and India, specifically? So, like, in Japan, do you think we're on the -- or nearing a significant market-wide move to open systems? And in China, do you think your hardware-bundled approach to selling software gives you some kind of natural defense against piracy?

Yes, on China -- this is Dan -- I think the answer is yes. I mean, this is essentially the same type of structure you find inside a router or some other kind of fixed-function device, right? It's not -- it's not software we ship to run on a PC platform or something like that, right, a Windows-based or UNIX-based operating system. So, yes. I think there is a natural protection built in. I got a very close friend at Adobe who said their China business is booming, but the problem is they only get paid for about 2% of the licenses.

Right.

I don't think we've got that risk. The licenses also are tied to a system serial number, the way it's enabled. So they're non-transportable. So even if you copy the software, and try to install it somewhere else, it will not boot. So that we've done some other defense mechanisms. In Japan, I'm going to let Tom carry that one. I don't see a fundamental shift in their thinking on open systems. I just think -- I just think it's just generally more robust. Tom?

Yes. Obviously, Japan has more mainframes than most countries as a percentage. However, it is very, very clear -- you know, we've been in Japan a long time. TTC has been our reseller now for almost 11 years, given the length of our Company, that's pretty big. But Fujitsu is a very big reseller for us. Every single one of our Japanese resellers saw their business expand dramatically this year. And primarily, that's because about a year ago, they finally found the wind behind the sails in network-attached storage. The Japanese end users get it. They want to save money. So network-attached storage had not really taken off in Japan, except by push. Now, we're getting a lot more pull. Secondarily, they have all invested significantly behind NetApp because it's the 1 vendor that allows them to make profit. I hear that consistently. They can't make money with the other guy. So we're seeing our business grow there very, very dramatically. India, I think we have, as a percentage of the market, it's either first, second, or third for us in the world, as far as our percentage of the total market for open systems. So we're doing extremely well in those 3 markets -- in India. China's more of an investment market for us right now. But both Japan and India have the Company excited.

Could you -- could you speculate on what percentage of your mix, Asia, might be a year from now?

Yes. We think it's going to go up continually. I mean, this quarter it was about 14. You know, we forecast out a couple years from now, being FY '07 they could be as high 17% in the mix. And most of the 3-point shift will probably come out of North America. The other market we're trying to open up right now is eastern Europe. You know, so, I think -- I think Europe has got more territory expansion to go, as well.

Great. Thank you, very much.

Okay. Ladies and gentlemen, I think we ought to adjourn. I want to thank you, again, for joining us today. And, again, I want to remind you of the analyst meeting in New York on December 1st. We'd love to see you all there. If, in fact, you cannot make it, however, you can join us on the website that day. For more information, please contact our investor relations people. Again, thank you, very much for joining us. And have a great day.

Thank you for your participation in today's conference. This concludes the presentation. You may disconnect. Have a good day.