NetApp Inc (NTAP) 2006 Q3 法說會逐字稿

Good day ladies and gentlemen, thank you for standing by and welcome to the Network Appliance third quarter fiscal year 2006 conference call. [OPERATOR INSTRUCTIONS].

I would now like to turn the presentation over to your host for today's conference, Tara Calhoun, Senior Director of Investor Relations.

Good afternoon everyone and thank you for joining us today.

Before we begin, I would like to you invite you to register for our upcoming analyst day on March 14, in San Francisco.

In addition to Investor presentation providing an update on our corporate vision and direction we will host a solutions pavilion in the afternoon where you will be able to see a live demo of Data ONTAP GX , our next generation operating system, as well as several NETAPPS solutions that are driving our growth today.

Please contact the IR team for details and registration information.

Today's conference call is being webcast live and will also be available for replay on our web site at www.NETAPP.com, along with our earnings releases.

The reconciliation between GAAP and non-GAAP numbers and other financial and statistical information presented during our call.

In the course of today's call, we'll make forward-looking statements and projections that involve risks and uncertainties, including statements regarding our expectations for stock repurchases, potential declines in total shares outstanding, hiring goals, operating results for Q4, and FY '06, timing of future product introductions, growth in our SAN iSCSI business and growth rates relative to the industry.

Actual results may differ materially from our statements or projections.

Important factors that could cause actual results to differ from those in the forward-looking statements include, but are not limited to, customer demand for products and services, increased competition, a decline in general economic conditions and foreign currency exchange rate fluctuation.

Other equally important factors that could cause actual results to differ from those in the forward-looking statements are detailed in the risk factors section of our company's 10-K and 10-Q reports on file with the SEC and accessible through our web site, all of which are incorporated by reference into today's discussion.

We disclaim any obligation to update information contained in these forward-looking statements, whether as a result of new information, future events or otherwise.

With me on today's call are Dan Warmenhoven our CEO, Tom Mendoza, President, Steve Gomo our CFO and Tom Jorgen, Executive Vice President of our Enterprise Storage System Group.

Steve will review this quarter's financials and discuss our financial outlook for the fourth quarter and then Dan will share his thoughts before we wind up with everyone here for Q&A.

Steve?

Thanks, Tara.

Good afternoon, everyone.

As you can see from the results, Network Appliance had a robust third quarter, which, again, was driven by the strength of our new FAS 3000 mid-range products.

Our business was also strong across all geographies.

Now I'll walk through the details of our results to provide additional color.

Please note that all numbers comply with GAAP, unless stated otherwise.

For the third quarter, total revenue came in at $537 million, up 30% over 3Q of last year and an increase of 11% sequentially.

The foreign currency affect subtracted approximately half a percentage point on a sequential basis and 3 percentage points year-over-year.

Product revenues of $474.2 million grew 29% year-over-year, almost 12% sequentially.

Add-on software and software subscriptions accounted for 36% of total revenue this quarter.

This figures a combination of software subscriptions, which were 11% of total revenue, and add-on software products that were 25% of total revenue.

Revenue from IBM and Decru both increased, with IBM just over 1% of total revenue this quarter.

Decru finished the quarter a little under 1% of total revenue.

Revenue from services, which includes hardware support, professional services and educational services, was just under 12% of total revenue, up 8% sequentially, and up 40% over the third quarter of last year.

Service maintenance contracts increased 9% sequentially and total professional services grew 6% sequentially.

Non-GAAP gross margins were 61.6% this quarter.

Non-GAAP product gross margins returned to a more normal level of 66.3%, despite a modest increase in the mix of add-on software.

This decline in product margin was mostly due to a significant increase in the amount of low margin storage sold this quarter.

Sequentially, period expenses were also higher, as we responded to product demand that exceeded our expectations.

Non-GAAP service margins of 25.9% declined 6/10 of 1 percentage point from last quarter.

As expected, the credits we received last quarter for service parts and European VAT did not recur this quarter.

Underlying service productivity showed continued improvement and will allow us to continue to build out our professional services capabilities.

Turning to expenses, our non-GAAP operating expenses totaled $238.4 million, or 44.4% of revenue.

Expenses increased 11% from Q2, despite a hiring pattern that was back-end loaded.

Employment head count increased by 299 people this quarter, ending with 4,631 employees, not including over 75 pending starts.

With over 400 open racks in our system and our goal to hire another 300 people this quarter, we expect to achieve our annual target to hire 1200 people by the end of April.

GAAP operating expenses include the effect of intangible amortization, previous merger-related stock compensation charges, and some very minor adjustments of restructuring charges this quarter.

At $92.5 million, non-GAAP operating profit finished at 17.2% of revenue.

Other income, which consists primarily of interest income, finished at $10.9 million.

Non-GAAP pretax operating income for the quarter was $103.3 million, or 19.2% of revenue.

Our effective non-GAAP tax rate remains at 18%.

Moving on to the balance sheet, cash and investments totaled $1.14 billion, up approximately $31 million from Q2.

We repurchased just over 5 million shares of outstanding common stock at an average price of $28.97 per share for a total cash outlay of roughly $145.6 million.

We will continue to buy back stock and expect our total shares outstanding to decrease modestly by our fiscal year end, subject primarily to fluctuations in stock price.

Cash generated from operations totaled $140.9 million.

Capital purchases were $33.5 million and depreciation and amortization was $21.4 million.

The deferred revenue balance increased $59 million this quarter, to $593.5 million, an 11% sequential increase and up 52% year-over-year.

As we said before, increases in deferred revenue are a strong indicator of continued penetration into enterprise account.

Accounts receivable day sales outstanding were 62 days compared to 61 days reported last quarter.

DSOs remained in the low 60s, due primarily to a shipping profile weighted toward the second half of the quarter.

With demand exceeding our forecast during December, coupled with some unexpected mix shifts towards storage, our supply of shelves was constrained during the middle month of our quarter.

This situation was temporary, as we both caught up and built inventory by the end of the quarter.

As a result, our turns in inventory were 12.9 times, compared to 16.4 times in Q2.

Rumors about supply chain issues and their impact on the quarter were dramatically overblown.

Before I turn the call over to Dan for his comments, I'd like to share our operating model for the fourth quarter.

Our outlook is based on current business expectations and current market conditions, and reflects our non-GAAP presentation.

I'll remind 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 FY '06, fourth quarter revenue growth to be in the range of 28 to 30% year-over-year, which reflects about an 8 to 9% sequential increase over Q3.

We expect total gross margins to fall by about 1 percentage point, as the add-on software mix moves back towards 35% level and we continue to invest in our professional services capabilities.

Our target operating margin for the fourth quarter is expected to be right around 16%, as our expense structure will increase slightly, reflecting our hiring pattern.

As noted earlier, we expect to achieve our employment targets for the full year.

Fourth quarter non-GAAP earnings are expected to be in the range of $0.22 to $0.23 per share.

GAAP earnings are expected to be $0.20 to $0.21 per share.

Our fourth quarter targets translate to full year revenue growth expectations in the range of 28 to 29% year-over-year.

Non-GAAP earnings per share are expected to be in the range of $0.80 to $0.81, with GAAP earnings of $0.73 to $0.74 per share.

We'll discuss our expectations for FY '07 at our analyst day on March 14.

At this point, I'll turn the call over to Dan for his update.

Dan?

Thank you, Steve.

The NETAPP team delivered another terrific quarter and I'm particularly pleased with our progress in penetrating and expanding our presence in enterprise data centers.

NETAPP's business with mission critical application partners like Microsoft, Oracle and SAP continues to grow.

We’re seeing business supporting data bases increase steadily in our mix to well over 40% of our business today.

In addition to going deeper within customers, our product line innovations and expansions are broadening our addressable market.

Database cloning, date in encryption and disk-to -disk data protection, to name a few.

Before I talk about our newer products, let's review the performance of our core business which drives our current growth.

Total storage system shipped were up 11% sequentially, driven, again, by the rapid adoption of our FAS 3000 product line.

With a 40% increase in units shipped, the 3000 series accounted for over 40% of all systems sold.

At our high end, the FAS 960 continued to decline, as it is slowly replaced by the 3050s, but the 980 had quite a resurgence this quarter, with a 30% sequential increase in units shipped.

Our new high end, which many of you may have heard referred to by its code name Excelsior is on track to begin shipping in Q 4 to preselected sets of large accounts who are part of our early adopter program.

This new high end, positioned well above the 980, will bring substantial increases in both performance and capacity, increasing the breadth of our product offerings in the market.

Turning to the low end, units shipped of our FAS 250 increased again this quarter, while units of the FAS 270 declined slightly.

We suspect that decline may have been a result of customers choosing to buy entry level two terabyte 3020 systems with ATA drives, as their cost per gigabyte is similar and the functionality is significantly higher.

Net cash this quarter again contributed over 3% of revenues.

Looking at our business from a geographic perspective, all three major geos turned in a very strong performance.

The Americas accounted for a little over 55% of revenue and EMEA, which is typically strong in Q3, contributed a strong 33% of revenue this quarter.

Asia-Pacific showed healthy improvement this quarter, accounting for almost 12% of revenue.

Our indirect channel business accounted for 57% of revenues in Q3, after a seasonally strong Q2 from the federal sector, our federal business decreased about 7% of revenue and the vast majority of the fed business is indirect.

The decline in federal also reduced the volume through Arrow and Avnet, which declined to a little over 9% of revenue.

One fourth of their business was from the federal sector in Q2, but they had only about one fifth of that level of contribution from federal in Q3.

On the other side, our direct business in the Americas had a terrific performance and several of our global resellers also had very strong results.

IBM continues to progress, growing, as Steve said, to just over 1% of revenue.

With just two of our product lines rolled out with them so far, we are very pleased with their progress and optimistic about the interactions and development efforts we have with them.

One of the most notable phenomenon in the quarter was the dramatic increase in total petabytes shipped.

If you recall, last quarter I mentioned that increases in our total capacity shipped may be less predictable for the next several quarters and that certainly turned out to be an understatement.

In Q3, we shipped 48 petabytes in storage, up 30% sequentially, from the 37 terabytes of last quarter.

We think there were several drivers of this surge.

The biggest single impact was the increase in units in the FAS 3000.

And then the resurgence of the 980, as well as the introduction of 320 gigabyte drives.

The unique component this quarter was a significant increase in add-on storage shelves, with units shipped increasing over 30% from Q2.

While customers don't have to buy much storage up front with the NetApp solution, given the higher utilization they get, their data volumes still grow rapidly, so we would expect to see add-on shelf purchases continue to trend up overtime.

In addition, this quarter we think this is exaggerated by a year-end buying surge, where some customers had to use their remaining budget or lose it and expansion shelves are the quickest, easiest place to spend their dollars and they know they'll need that capacity, eventually, anyway.

Customers continue to report back to us at a disk utilization rate are increasing, from industry norms around 30 to 35% utilization, to well over 50 to 60% and often even doubling, using the NetApp Flexball technology.

Customers don't have to buy as much disk storage capacity to achieve their business objectives, making our systems sold with Data ONTAP 7G, even more competitive in the marketplace.

According to our auto support tracking figures, 42% of our install base is now running 7G with Flexball. 7G continues the fastest uptake of a new operating system in our history.

These features are now standard in all new systems shipped including our coming high end.

Looking at our SAN and iSCSI contribution, there are two areas of business that contributed large components to the SAN and iSCSI mix.

Federal sector and indirect channel.

Pullback in our Federal business, as well as in our indirect business this quarter we saw a corresponding decline in the SAN and iSCSI component of our orders, with 32% of orders, including block-base connectivity.

Of this 22% of orders included SAN and 14% included iSCSI with a 4% overlap where both were present.

We believe this mix was also skewed by the amount of add-on storage sold during the quarter, since that's a higher piece of the total revenue and not attributed to either SAN, NAS or iSCSI and yet this quarter's absolute performance in SAN and iSCSI is a 75% increase over Q3 of last year.

We believe that our SAN and iSCSI business will continue to grow and be a healthy part of our business and yet will fluctuate quarter-to-quarter as part of our unified storage mix.

We have seen a correlation between increased sales and the mission critical data center environments and an increase in our mix of fiber channel drive shipped.

This held true again this quarter with fiber channel accounting for 59% of total petabytes shipped, compared to 55% last quarter.

ATA petabytes shipped increased about 17% sequentially and Near Store held its own, accounting for about 13.5% of revenues.

While the overall number of NearStore Systems shipped decreased modestly, the average capacity per system increased sequentially, further solidifying its role as a secondary storage system.

Going forward, with the launch of our near store virtual tape library solution on February 7, the concept of near storage evolving into a brand, encompassing a category of platforms, software and services optimized for data protection and retention applications.

Data protection includes disk-to-disk backup and disaster recovery solutions, and data retention includes compliance retention, archival and content storage.

NearStore VTL significantly expands our market opportunity, as we can now provide non-disruptive, disk-to-disk backup solutions to any storage environment, including EMC, HP, Hitachi, IBM and Sun.

VTL is a natural extension of our business, allowing us to go after portion of the $1.8 billion tape market, while tape is not likely to go any time soon, it makes solid business sense to store at least intermediate archives on disk for rapid recovery.

Our VTL platform interacts with customers existing backup software solutions, like Symantec, Tivoli and Legato by appearing to behave just like a tape, with all the advantages of spinning media.

We continue to be very excited about the market opportunities unfolding with the Decru.

Customers can now effectively protect their data from loss or theft with our data encryption products.

Tape encryption is certainly a strong area.

We're also seeing demand increasing for other encryption products, including a large deployment for iSCSI security.

This quarter enterprise revenue from Decru exceeded the government sector, closing business with several large institutions and a broad set of verticals, including financial services, insurance, healthcare, life sciences, manufacturing, publishing.

Marquise customers include Ameritrade, Amgen, Guardian Life, Iron Mountain and Mizuho Bank in Japan.

In fact, Iron Mountain is a Decru customer, but they have gone on record publicly recommending that all tapes with sensitive data be encrypted before they are transferred.

The development of our next generation operating system is also progressing well.

We will release the first version of ONTAP GX as an option in the FAS 3000 in the very near future.

Initially, be targeted at high performance computing environments.

ONTAP GX is the first operating system to support a true storage grid architecture, built using modular storage devices that can scale to hundreds of systems when the single global name space.

As Tara mentioned, you'll have an opportunity to see a live demo of ONTAP GX in the solutions pavilion at our analyst day next month.

To summarize it, feels great to post a 30% growth quarter again.

Our strategy is working.

We have many reasons to be optimistic about our future, in addition to strong performance of our core business, with new high end products coming, new markets opening up with VTL, Decru and our other emerging business segments and more contribution to look forward to from IBM, we expect to continue delivering the highest growth rates in the industry.

With that, I'll open the floor to questions.

Again, I'll ask that you limit yourself to one question each.

If you have a follow-up, please return to the queue so that we may address everyone in a timely manner.

Thank you.

Operator?

Thank you, sir. [OPERATOR INSTRUCTIONS] Sir, our first question is from the line of Andy McCullough with Credit Suisse.

Thanks, guys.

Can you dig in a little bit more as to what drove the strength in the add-on software mix and then looking ahead, why do you think that add-on software, the add-on software mix goes down, particularly when you got a high-end product cycle coming online this quarter?

Andy, Steve Gomo here.

There's no single driver behind the add-on software mix.

Several categories of software picked up during the quarter slightly and matched the contribution to the increase.

We think, and we still are modeling here, a target of 35% add-on software as we go forward.

We think there is a absolute penetration level that our software can reach and we think at 35% we pretty much reached that.

That said, think there will be quarters when you could see a point, maybe even a 2-point uptick in that level, but you could also see a point or two-point level down tick, so I think that targeting 35% is safe and representative of what you'll see over the longer haul.

This is Dan.

We also find on a new high-end systems that the percent of their total value that's associated with add-on software declines initially.

And so as the new systems come out, I think you'll see they carry less than 35% going out the door than you'll see add-on software for the systems pick up later.

And, sir, our next question is from the line of Ben Righteous with UBS.

This is Jeff Brickman for Ben.

I was wondering if you could give a little more detail on inventory, obviously, understand what happened in the middle of the quarter, but clearly there was a pretty large uptick here and when are you expecting DSO's could possibly go down and maybe if you could give a little more color on how you see things ending the quarter.

This is Steve Gomo here.

You'll notice, again, we had the, we had the superior growth this quarter and indeed, December was a challenging month for us, as orders significantly outstripped our expectations.

So obviously we had to build some inventory to catch up.

We also have seen, DSO deteriorate now for two quarters and we've decided that it would be prudent to have a little bit more inventory on hand, given the robust demand we're seeing across the board.

So we're going to start the new quarter in a better inventory position, hopefully to avoid any kind of challenges this next quarter.

Two other things in that inventory number, inventory supplies that are essentially consigned to IBM, who now does their own manufacturing through Jabil, and that's a significant component as they start ramping up.

And we have a significant amount of material in there for the new high-end systems and they won't convert to revenue until, if at all, until the very end of this quarter.

And, sir, our next question is from the line of Tom Curlin with RBC Capital Markets.

Thank you.

Can you comment on Decru revenue contribution?

I think everything else was pretty clear, but that piece.

This is Dan.

I think in Steve's script he had it just under 1% of revenue.

Okay.

Thank you.

And, sir, our next question is from the line of Brian Freed with Morgan Keegan.

Hi, guys, great quarter.

Could you comment a little bit more about the IBM relationship you just mentioned, how that's going to be manufactured by IBM, maybe give a little bit more detail about the stable relationship you mentioned.

You broke up on that.

Could you repeat?

Could you give a little more clarity on the IBM manufacturing?

You just mentioned, I think you said they are going to manufacture through Jabil.

Yes, JVIL is our contract manufacturer, IBM also uses Jabil, so the arrangement we have is that JVIL will manufacture the IBM logo and branded equipment and pull essentially raw material stock for that, and we get the invoiced or whatever as, or they get invoiced from us automatically, I should say, as they pull a kit.

And the inventories will be on whose balance sheet?

They are on ours until they actually pull one to go to fab, they are on ours.

Sir, our next question is from the line of Aaron Rakers with A. G. Edwards.

Hi, guys.

Thanks a lot.

Nice quarter as well.

Maybe you can talk a little bit about the high end business.

I see that the 980 was pretty strong in the quarter ahead of a product cycle, forthcoming.

Maybe you can help us understand what type of ramp we expect with the new high-end product coming on board, any type of revenue expectations, contributions for the current quarter from that new high-end solution?

Yes, high end solution, you know, is kind of on the cusp for this quarter.

We're putting in basically beta systems.

They are not revenue.

They are still on our inventory, et cetera, although they are in customer hands.

My guess is if we do anything at all it, will be very close to the end of the quarter in terms of revenue recognition.

It may not be in the quarter at all.

Relative to 980, the new Excelsior System is well above the 980, as I made in my comment.

I expect the 980 to stay as a very healthy contributor in the product portfolio for quite sometime.

We're talking like 2 X of differential between them.

There's plenty of room between a 980 and Excelsior.

Sir, our next question is from the line of Harry Blount with Lehman Brothers.

Hi, guys.

Quick question, Dan, you mentioned that part of the contribution to the significant growth in petabytes is you saw an uptick to add-on shelves.

Can you give us a sense of where that's at?

You thought that might grow as a percentage of revenue.

I think the surge in the add-on stuff was $3 or $4 million.

The way we have it quantified, add-on shelves was up 30%, but that really means $3 or 4 million in the mix.

Like I said, I really believe that was customer who is took it at the end of the year because they had money to spend, they'll probable set it aside and install it when they need it.

I should also clarify a misstatement I made in the, in my remarks on the introduction.

I misstated a number.

I had said that total systems shipped were up 40%.

That number is actually 47%.

And, sir, our next question is from the line of Laura Conigliaro with Goldman Sachs.

We had two quarters in a row where you've taken your strong revenue growth and allowed for some large earnings upside, is this indicative of a slight change or attitude toward rewarding in investors with upside or is it more of an operation to give you strong revenue growth, misstep in July, and it seems like you've been strong higher expectations, higher revenue outlook would suggest that your margins can move higher.

I don't think that's the case.

We're still operating through a target operating model of somewhere between 15.8 and 16.4% on the operating income, and if we see a surge in revenue, it's got to fall to the bottom line because you just don't have time to spend it.

But nominally what were trying to plan to is 15.8 to 16.4.

Our next question, sir, is from the line of Paul Mansky with Citigroup.

Can you hear me?

Yes, sir.

Oh, great.

Thank you.

Just wanted to touch base on Decru again.

You indicated it was about 1% of revenue, suggests 5, $6 million roughly.

I think that may be tracking now for the second quarter slightly behind expectations.

Can you give us some guidance as it relates to what you expect ultimately that revenue run rate to look like over the next couple of quarters?

It's really very lumpy.

I think that's part of the challenge.

In fact, we don't normally disclose bookings, but Decru's bookings in this quarter were about 3 X their revenue contribution because some large deals close at the end of the quarter and they didn't get converted.

As a start-up business, selling into large enterprises with lumpy deals, it's very difficult to predict what the linearity is going to look like.

I'm much more interested in looking at the deal slow and sales cycles and so we were pleased this quarter that the enterprise business exceeded the federal business.

Think we're starting to get a handle on those sales cycles, but I, I would be reticent to predict any particular number for this quarter, and hopefully we'll give you better guidance for next year, in March, at the analyst day.

And, sir, our next question is from the line of Kaushik Roy with Susquehanna.

Congratulations on a great quarter there.

There has been some talk about the delay if the integration of the [spinerest] can you comment on the time line and what impact it may have on revenues?

That new operating system, we call ONTAP GX is in the hands of at least five or six customers as we speak in a beta condition and we know they use it because they filed bug reports, so I think it's right on track.

It's-- yes, again, you'll see it in the March 14 analyst day, and we'll be right on the cusp of, of making that a generally available release, or available to any customer who wants, I should say.

GA is a different term, but FCS release, right at the end of this fiscal quarter.

You should-- you'll not see any revenue impact, though.

Realize it's on the same 3000 systems that you buy data ONTAP today.

And, sir, our next question is from the line of Dan Renouard with Robert W Baird.

Thanks.

Going back to the high end product for this quarter, you kind of indicated you'll be in beta or maybe heavy beta mode for the April quarter.

Does that imply that we'll be in full, be shipping to everybody for the July quarter so you'll be at a sort of normalized run rate, or would you expect that to be a ramp for the next couple of quarters?

Then when would it be a reasonable timeframe, and I know it's hard to predict, but just some sort of goal post around when IBM, you might expect IBM to qualify in that OEM product.

You would have to ask IBM on that one, but the last one they took was roughly a three-month separation and obviously both parties are looking to try to improve that.

I think on the, on the new high-end, I know, I'm not encouraging to you include any revenue in your model for this particular quarter.

We'll be in a ramp quarter in our fiscal Q1.

Generally the high end, as it comes out has a tendency to have a fairly quick takeup and, but I would think it would be kind of in its steady state in the mix, probably during our Q2.

And, sir, our next question is from the line of Andrew Ness with Bear Stearns.

Hello?

Hi.

I know that you wanted to save some of this for your upcoming analyst meeting, but are there factors that you see they are going to slow down your growth as you go into fiscal '07, or do you see same sort of-- that will effect your margins as you look out at '07?

At this point we're not forecasting any change in our normal business model.

And our next question is from the line of Clay Sumner with FBR.

Thanks, and my congratulations, too, on the quarter.

Can you guys say what percentage of the 3000 series or of the total product line shipments shipped with dual controllers this quarter?

Yes, if I could find the data.

I generally understand that the trend has been markedly up in the last couple of quarters.

I don’t know the answer to the number, but I do recall that the volume was up 12% sequentially.

Volume of dual?

Yes, of clusters, right.

Of clusters.

As I recall, it's approaching over 70%.

Okay.

Great.

Thank you very much.

And, sir, our next question is from the line of Brent Bracelin with Pacific Crest security.

Thank you.

Two-part clarification on IBM, if I may.

Obviously we're in early days here, but what was the order linearity, from IBM in the quarter?

Was it anything different than what you saw with your kind of reseller base?

Then secondly, Dan, you did mention that IBM is only shipping two products from NetApp today.

Can you talk a little bit about what other products you anticipate IBM taking on over the next one to three-year period?

Yes, I certainly expect them to continue to take most of our primary storage systems, so they will pick up Excelsior, is my guess.

In fact I'm pretty sure that's going happen.

But I think that will kind of the conclusion for them and they will track with us relative to refreshes.

When we refresh the low end, I'm sure they will introduce that as well.

Did you have a second-- piece of that?

Oh, the linearity in the quarter.

Pardon me.

So IBM's fiscal year ended in December.

So we saw a surge in both bookings and shipments during that month.

It was a very atypical relative to the rest of our channels, so we had a really strong December from IBM.

Other than the IBM surge right there, which is only 1% of revenue, our booking profile this quarter looked virtually identical to last year.

We were stronger through December, a little weakest at the beginning of January, then a pretty strong finish.

IBM was actually part of the December challenge relative to materials selling.

And, sir, we a question from the line of Glenn Hanus with Needham & Company.

Could you maybe give some color around how you'll be offering the GX pricing it, how you'll be upgrading people, sort of the basic marketing tactics around that?

I'm not going to say anything about pricing, but let's think about new shipments first.

The customer who chooses a 3000 or one of the new high end systems will have their choice as to which operating system they want installed when it's shipped, and customers who have current 3000 systems have the opportunity to upgrade those if they so choose.

That upgrade process requires that they have Flexball enabled on their current ONTAP environment, and from that point it, should be a fairly straight forward process.

Thank you.

And, sir, our next question is from the line of Caroly [Con] with Cowen.

Yes, good afternoon.

Could you give a little bit more detail on your [inaudible] hiring plans, specifically how you're going to allocate new hires, whether it's more toward R&D or field direct sales, given it looks like you might be able to harvest some of the fruits of our R&D efforts.

Steve Gomo there.

Basically there's been no change in our hiring profile or planned hiring profile.

Roughly we plan to hire roughly 300 people next quarter, about 100 in sales, 100 in the services area, predominantly professional services, and about 100 in engineering.

And, sir, our next question is from the line of Bill Fearnley with FTN Midwest Securities.

Thanks.

Quick question regarding availability for you.

There was a lot of questions on third quarter, certainly, but for the fourth quarter, is it fair to say that you guys are out of the woods in regard to availability?

You mentioned the inventory build in your introductory remarks.

Thanks.

We were never in the woods.

We did not-- we were never in any kind of difficulty whatsoever.

I think we lose the fact that we had a surge in the number of add-on shelves, which stressed the supply chain.

IBM had a really good December, which was concurrent with that.

Many of our customers gave us orders which were conditional upon receipt of the product by the end of the calendar year, and so we were in a churn of rescheduling to give them priority.

But none of those were severe, nor did any impact our performance during the quarter.

So we got plenty of supply, got plenty of material and I should point out that if you look back at [Sirectecs] reports in January, you can see we had a very, very strong performance through the end of the calendar year, correlated with their results.

So I mean Steve said, I think the comment he made was that the rumors concerning our supply chain issues were greatly exaggerated, so, again, I stand by my opening comment.

We were never in the woods.

And, sir, our next question is from the line of [ Omamba Barrura] with Bank of America.

Hey, guys.

Thanks for taking the call.

Services business had another really strong quarter.

Just wondering if you guys sort of have a goal there for, you know, I guess-- as a percentage of total revenue and I mean how long here should we expect you to continue to sort of outgrow the rest of the business?

You know, I think it goes on for quite a while.

I can foresee the day when services represents 20% of our business or more.

So I expect that to keep growing faster than the product business and I think that's very appropriate.

I mean the service set is used to accelerate customer acceptance of the product and there's a strong demand for it.

Yes, in fact, to add on to Dan's point, think, or to emphasize his point, professional services is the fastest growing piece or fastest growing category of our business today and so while it's small in terms of its absolute size, it's going to continue to grow quickly, particularly as we continue to add resources to pull our technology and to-- into customer accounts.

This is Tom.

One of the big requirements, we had a very strong enterprise quarter, as you've heard.

One of the big requirements there is consistent service offering globally and they are willing to fund that.

So when you get into bigger and bigger enterprises, spreading major applications onto our products, they want to have professional services involved at each end and that could be on every continent in some cases.

We're in front of that.

Rather than trying to be reactive to it, we're being proactive and hiring and-- the whole strategy is to provide the customer what is they need by more of our products.

Obviously the margin structure is good.

We don't have to find the new business, just make sure this one works well.

We want to be on the front end so we're not reacting.

I think that's what you're seeing here.

And, sir, our next question is from the line of Shebly Seyrafi with Coffman Brothers.

Yes, thank you very much.

Looking at your geographic trends, your enter continental revenue grew quite nicely for the first time, I would say, in a fiscal Q3 for several years.

Maybe you can talk about the geographic trends and whether or not you expect broad-based geographic growth in the fourth quarter.

Shelby, we had actually forecast sometime ago that Asia-Pac would outgrow the rest of the world and they really struggled during Q2, so they kind of rebounded in Q3 was the way I viewed it.

I expect to see the fastest growing region still be Asia-Pac-- next several years, and probably Europe in second place.

I would expect to see a few points of our mix shift towards Asia-Pac from the U.S.

I should point out that the currency issues in Europe created interesting challenges, especially as compares year-over-year.

As Steve mentioned in his remarks, that basically, that took three points off our growth rate on a year-over-year comparison.

Without the currency issues, we would have been at 33% year-over-year.

I'll give you just a pattern on Europe in the mix for those of you who are wondering why it was up.

If you look at fiscal, or Q3 '04, fiscal year '04, Europe was 34%.

Q3 fiscal year '05, Europe was at 34%, and this year they are at 33%.

So they always have those Q3 spike.

It would have been higher, as I said, if it wouldn't have been for the currency.

Sir, our next question is from the line of Kevin Hunt with Thomas Weisel Partners.

Thanks.

I think I missed when you said earlier, did you say what the net cash number was for the quarter?

Yes, it was about 3% of revenue.

Okay, thanks, guys.

[OPERATOR INSTRUCTIONS] Sir, our next question is from the line of Clay Sumner.

Thanks.

You know, now that you guys are going-- when you launch the new DX operating system, you'll have two OS's as you said to choose from-- I assume so, but can you just confirm its a full family of other add-ons software products will be fully compatible with both OSs?

No, not initially especially.

As GX comes to market as a subset of the total ONTAP capabilities, it would be adding additional features to it over time.

Over a period of a couple years.

The interoperability will be preserved, but it will actually be different code, you know what I mean?

And, sir, our next question is from the line of Kaushik Roy.

Can you comment, what are your expectations from IBM this quarter?

Could it be 4, 5% or 6, 7%?

I doubt it. 1% last quarter.

I don't think we should model more than 2, certainly and probably 1.5 might be more appropriate.

And, sir, our next question is from the line of Shebly Seyrah.

Yes, your product sales were quite strong this quarter, up 12% sequentially, yet Hewlett Packard arrested also reported this evening and their storage results were down 9% sequentially.

So did you notice an easier time winning against them and separately, they are supposed to have an iSCSI announcement next week.

Do you think that will change the playing field?

No.

I think we've gotten some visibility to their upcoming announcements and I would-- I think that's just a mid life kicker.

I didn't attach any particular significance to what I saw.

No, I don't think it will impact the iSCSI field at all.

We actually did not see a change in competition or a change in win rate with Hewlett Packard, although I must say we cannot track that very well through the channels, so there may have been-- we really saw the increase in competitive engagements with EMC and I think that was largely at our initiative.

We're really going after them, as Tom said in the enterprise.

HP was flat in that mix.

One of the overriding themes I would leave you with is that many customers are now concluding that they should have two storage vendors.

There's a large number in the enterprise that have relied on one and we are becoming the logical second.

I mean Hitachi and EMC compete with a similar architecture and you can decide which does it better, but if you're looking for a true different company that's innovating, most people have concluded that we're the other innovator and we are getting that shot.

Over the last year, I would say it's been building and building and building, but over the last two quarters, it's been very obvious.

The number engagements and size of the engagements have increased dramatically.

That's another reason for the professional services piece.

If you get larger opportunities, you got to be prepared to meet a certain need.

That's exciting.

This is where we've been heading for a long time.

The last thing I would say is the unified storage message and the ability to enhance their infrastructure in different way with things like our D filer, and then when you combined with the ability to not only consolidate information, but cover that information, but secure it with Decru, the whole message is resonating very well with the large accounts.

Sir, your next question is from the line of Dan Renouard.

Hi, just a housekeeping question.

Can you give us a rough sense of what the option, stock option expense would be for the April quarter?

There won't be any in the April quarter.

Yes, we don't-- this is Steve Gomo here.

We don't start reporting-- we don't implement FAS 123R until our first quarter.

Fiscal quarter.

First fiscal quarter, so we continue to footnote it in our Q and K.

And Steve's going have a section in his presentation at the analyst meeting to cover what the forecast is on options expensing.

And, sir, our next question is from the line of Aaron Rakers.

Yes, thanks, guys.

I guess kind of along those same lines, you guys continue to make some meaningful investments in terms of head count.

Maybe you can talk about the environment you're seeing in terms of making those hires.

Is it becoming increasingly challenging for you on a hiring front, and then maybe on the same lines, if you can talk about maybe it's a little bit early, but maybe talk about Steve, what your approach is in terms of options expensing, in terms of possibly seeing that decline at some point going forward.

This is Dan.

On the hiring, we haven't seen any significant change in profile.

This past quarter obviously we were again included in the, as Number 27 on the Fortune List of the Top 100 Great Places to Work.

We've got a lot of assets that attract very talented people and we've had no difficulty whatsoever with finding and having the right people join us.

And it shows in the numbers, so we've been able to, I think, keep very, very high quality level as we go about hiring several hundred people a quarter.

What was the second question?

The question on option expensing, I would like to table that whole thing until March 14th so we can treat it in its entirety.

And, sir, our next question is from the line of Glen Hanus.

Just a follow-up on the increase in low margin storage.

Are we going to continue to see that become an increasing portion and how should we think about how that translates to product margin, possible product margin declines, sort of sequentially over the next year or so.

I'm not sure we have enough of a, a vision to be able to give you any guidance on that one.

I think it's going to fluctuate in the mix a fair amount.

We saw in this quarter that a lot of customers chose to just buy add-on shelves.

My guess is that does not recur next quarter, but our product architecture is moving to the point where our systems can grow than incredibly large.

You'll notice even on the R 200 when we brought that out, it's configurable from 8 terabytes, to 96 terabytes in increments of 8 terabytes, 8 terabytes is a shelf, so customers start small and add-on I think you're going to see that trend continue and we're going to encourage our customers to buy what they need and then buy the expansion later because it's probably going to be at a lower price as the rate, drive prices come down.

So it's hard to predict how all those things are going to fluctuate in the mix.

We've seen it trend up maybe a point every, every other quarter or so, half a point a quarter in the mix.

This time it surged a little bit.

My guess is goes back down.

I don't think it's going to be material.

If you think about it, it's about 2 to 4/10 of a point of gross margin was the result of the-- gross margin decline quarter- over-quarter sequentially, was the result of the increase in the stand-alone storage.

And with that, ladies and gentlemen, this concludes the question and answer session of today's program.

I will now turn the call back over to Dan Warmenhoven for any closing remarks.

Thank you all for joining us today.

Again, we want to remind that we're looking forward to seeing you at our analyst day on March 14, in San Francisco and also on sharing our Q4 results with you on May 24th.

So, again, thank you all for your interest and look forward to seeing you on March 14.

Take care.

Ladies and gentlemen, we thank you for your participation in today's conference.

This concludes your presentation and you may now disconnect.