NetApp Inc (NTAP) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Network Appliance third quarter 2007 earnings conference call.

My name is Jeremy, and I will be your coordinator for today. [OPERATOR INSTRUCTIONS]

I would now like to turn the call over to Ms. Tara Dillon, Senior Director of investor relations.

Please proceed, ma'am.

Good afternoon, everyone.

Thank you for joining us today.

Our conference call is being webcast live and will be available for replay on our website at www.netapp.com, along with the earnings release, the financial tables and the reconciliation between GAAP and non-GAAP numbers.

In the course of today's call, we'll make forward-looking statements and projections that involve risk and uncertainty, including: Statements regarding our expectations for operating results of fiscal Q4 and FY '07; our stock repurchases; a decrease in our effective tax rate; hiring goals; our intention to pay down our debt; the success of our emerging businesses; the impact of our Topio acquisition; and the growth of our partner EchoSystem.

Actual result may differ materially from our statements or projections.

Important factors that could cause actual results to differ include, but are not limited to: Changes in customer demand for products and services; increased competition; a decline in general economic condition; 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 10-K and 10-K reports on file with the SEC and accessible through our website, 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 the call today are: Dan Warmenhoven, CEO; our President, Tom Mendoza;

Steve Gomo, our CFO; and Tom Georgens, our EVP of product operations.

Steve will review this quarter's financials and discuss our financial outlook for the thir -- 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 our revenue growth rate, NetApp had a tremendous quarter.

The demand for products and solutions was extremely strong.

To put it in perspective, if you look at the combination of our Q3 revenue and deferred revenue growth, you would find that it grew just over 43% compared to Q3 last year, giving you a sense for the true strength out of our business.

During the quarter, given the strength of the business combined with the market opportunity we saw, we took the initiative to increase investments to fuel additional growth.

As a result this quarter marks the return to our target operating profit model range, a 15.8% to 16.4%.

At the same time, we generated a record amount of cash from operation.

I'll discuss that shortly.

As I walk through the details of our results, please note that all numbers comply with GAAP unless stated otherwise.

Total revenue for the third quarter was $729.3 million, up 36% compared to Q3 last year and up almost 12% sequentially.

Foreign currency affect added about a half a percentage point to this quarter's sequential results and three percentage points on a year-over-year basis.

Revenue from IBM accounted for almost 6% of total revenue, driven by the strength of their fiscal year end.

Due to the seasonality of their business, we expect our contribution to pull back in our fiscal Q4, but still end the year between 3% and 4% of our full fiscal-year revenue.

The [crew] contributed a little over 1% of total revenue, bringing our expectations for their contribution to total revenue to a little under 2% for the full year.

Revenue from net cash was just under 2%, down 33% sequentially and down 26% year over year.

The combination of product revenue and software subscription revenue was $635.9 million, growing 34% year over year and almost 13% sequentially.

Add-on software and software subscriptions, accounted for 37% of total revenue this quarter.

This is a combination of add-on software products that were about 25% of total revenue and software subscriptions, which were about 12% of total revenue.

Revenue from services, which includes hardware support, installation, professional services, and educational services was 13% of total revenue, up 5% sequentially, and up 49% over Q3 of last year.

Service maintenance contracts increased 6% sequentially and 48% year over year.

Professional services grew 1% sequentially and 60% year over year.

Non-GAAP growth margins were 62.0% this quarter.

The combined product and software subscription, non-GAAP gross margin was 67.2%, down slightly from last quarter, but still reflecting the impact of the strong software component in our business this quarter.

In operations, we experienced the benefit of favorable volumes, which in turn drove favorable manufacturing variances.

Non-GAAP service margins decreased to 26.5%.

As we discussed last quarter, we plan to increase our rate of hiring services in the second half.

In fact, our hiring ramp accelerated as the quarter progressed due to the level of enterprise demand we saw.

In addition, we increased our discretionary expenditures in field service enablement, including training, process development, and systems to prepare for the demands that our service and support businesses will experience in the future.

You should expect service margins to return to about 30% in the fourth quarter.

Turning to non-GAAP expenses, our operating expenses totalled $334 million or 45.8% of revenue.

Expenses increased 15% sequentially and 40% year over -year, as we adjusted our investment spending and hiring upward during the quarter in response to the strong current demand and future opportunities that we saw.

With the focus on expanding sales capacity, about three-quarters of the sequential increase in operating expenses went into sales, marketing, and global support.

For the Company, total head count increased by 516 people, ending the quarter with 6,148 employees.

To date in FY '07, a total of 1,172 people have been added and we expect to add about 400 more people in the fourth quarter.

Third quarter operating expenses also include the impact of Topio, which closed on December 7th.

GAAP operating expenses include the effect of prior merger-related costs, like intangible amortization from acquisitions, as well as the effects of FAS 123(R).

GAAP OpEx returned to more normal levels after benefiting last quarter from the one-time gain related to the sale of our net cash asset.

At $117.8 million, non-GAAP income from operations finished at 16.2% of revenue, returning to our targeted range.

Removing the impact of Topio, non-GAAP operating profit would have been 16.3%.

Non-GAAP other income, which consists primarily of interest income, was $15.3 million.

Non-GAAP income before taxes for the quarter was $133.1 million or 18% of revenue.

Our effective non-GAAP tax rate decreased in the third quarter and also includes accumulative adjustment to reduce our full-year FY '07 tax rate to 17.5%.

This reduction resulted from Congress's passage of the extension for R&D tax credits during the quarter.

Therefore, our current quarter's non-GAAP tax rate is artificially low at 16.6% to catch up for the previous FY '07 quarters.

We expect our tax rate to remain at 17.5% for the foreseeable future.

Non-GAAP net income totalled $111.1 million or $0.29 per share.

GAAP net income totalled $66.5 million or $0.17 per share.

Please refer to the table provided in our press release and on our website to see the reconciling items between GAAP and non-GAAP.

Cash generation was another highlight this quarter.

Our cash generated from operations set another record at $250.3 million this quarter, up 78% over Q3 of last year.

Free cash flow, that is cash from operations less capital purchases, totalled $213.9 million this quarter, growing 99% over Q3 last year and up 15% sequentially.

Turning to the balance sheet, cash and investments totalled $1.3 billion, a decrease of about $84 million from Q2.

We repurchased about 6.2 million shares of outstanding common stock at an average price of $39.22 per share for a total cash outlay of $241 million.

In the fourth quarter, our plan is to repurchase roughly another $200 million worth of stock.

Our net cash outlay related to the Topio acquisition was $131.2 million.

Cash and investments exclude $180.2 million of restricted cash associated with our foreign cash repatriation last year.

The debt on our balance sheet related to the repatriation is currently $151 million.

We paid down approximately $42 million at this debt during the third quarter and we expect to pay off the remaining balance within 12 to 18 months.

Accounts receivable, day sales outstanding were 55 days compared to 56 days reported last quarter.

Inventory turn increased to 18.2 times this quarter.

Total deferred revenue increased $126.3 million this quarter to $944.9 million, a 15% sequential increase and up 59% year over year.

As mentioned earlier, this is another impressive indicator of the strength of our business.

Now, before I turn the call over to Dan for his comments, I'll discuss our target operating model for the fourth quarter and revised expectations for the full year.

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

We are making forward-looking statements and projections that involve risks and uncertainties.

Actual results may differ from our statements or projections.

We expect Q4 '07 sequential revenue growth to be in the range of 8% to 10% over the third quarter, which translates to about 32% to 34% year-over-year growth rate.

This takes into account the reduction in contributions from IBM and net cash in the fourth quarter.

We expect non-GAAP operating margins to remain in our target range of 15.8% to 16.4%, resulting in fourth quarter non-GAAP earnings of approximately $0.30 per share.

GAAP earnings are expected to be $0.19 to $0.20 per share.

We expect our diluted share count to decrease by about 0.5 million shares in the fourth quarter, depending on stock price.

Our expectations for the fourth quarter translate into FY '07 revenue growth of 35% to 36% over FY '06.

Non-GAAP -- non-GAAP earnings per share are expected to be approximately $1.11 to $1.12 per share.

Our forecasted GAAP EPS is estimated to be around $0.73 per share, based upon the information we have and the assumptions that we make today.

Now at this point, I'll turn the call over to Dan for his updates.

Thank you, Steve, and good afternoon, everyone.

As our revenue growth this quarter clearly demonstrates, Network Appliance continues to grow significantly faster than the markets we serve.

As our level of investment spending also indicates we believe great opportunity exists for us to capture additional market share in the future.

Let's walk through some of the quarter's highlights.

Our Enterprise Storage Systems had a stellar quarter, growing rapidly on all major axes.

At the most fundamental level, our pedabite shift increased 40% sequentially, that is 40% from last quarter to a record 104 pedabites.

ATA drives accounted for 55% of our total pedabite shift and fiber channel pedabites were also up a healthy 30% sequentially, to 45% of the total shipped.

This increase in ATA drives correlates with a strong increase in data protection and replication software revenue this quarter, which was up almost 20% sequentially.

Total storage systems shipped increased 23% sequentially, the strength across the entire product line.

Our high-end FAS6000 series increased over 50% from Q2, mid range FAS3000 were up almost 20% and our [inaudible] low-end 200 series was up a remarkable 31% in total units shipped this quarter.

The new FAS3070 is off to a good start, showing particular strength in mid-range SAN deployment.

The number of systems shipped without disks return to more normal levels this quarter.

The same competitiveness in the new FAS3070, along with the strength of our high-end 6070 SAN configured system contribute to a healthy increase in the block-base protocols component of our business.

This quarter, block-base protocols were included in 41% of our storage business.

Within this, 33% of our business had a fiber channel SAN component, 18% included iSCSI, which is increasingly being referred to in the industry as IP SAN, and there were nine percentage points of overlap for both fiber channel SAN and IP SAN were included on the same purchase order.

Revenue from our application management software family with products like Stat Manager for Oracle, Stat Manager for Exchange, and SQL server was up 20% sequentially, indicating that our primary storage business is also growing at a very strong clip.

Customers are increasingly seeing the value from our overall data management capabilities driving increase in software [inaudible].

The performance and feature sets of the 6070 and 3070 also stimulated additional sales in Data ONTAP GX clusters.

Our largest GX customer this quarter is going into production with a 20-node system.

We're seeing purchases from our targeted high performance [for] fusion environments, particularly in technology and graphics rendering.

We've also got big customers in the oil and gas space and potential customers from financial services, telecom, and internet verticals, which are currently evaluating this leading-edge technology.

Results from our emerging business were mixed this quarter.

The virtual tape library business is demonstrating very healthy growth, particularly in Europe.

Units shipped were up over 80%, all be it off a relatively be it off a small base.

The business is gaining traction, selling into a different part of the enterprise, which is really helping us to expand our footprint and learning how to penetrate new segments over the long run.

We saw a smaller contribution this quarter from our encryption products, despite win rates that remain consistently high.

The encryption business continues to be very lumpy, characterized by big deals, and we saw several large deals delayed past the end of the quarter.

So we continue to be very pleased with our overall progress as reflected in the fact that to date, over half of our top enterprise accounts have purchased our encryption products, demonstrating initial success and expanding our enterprise footprint well beyond storage.

The V series had its most successful quarter to date, aided by a new highly focussed team.

Our sales reps are getting more proficient in selling a value proposition in the competitive strong hold, when a V-series controller placed in front of a competitive storage array provides customers with all the data-on-tap manageability and functionality on their legacy system.

By penetrating heterogeneous environments in this way, we get our foot in the door with accounts where we previously had little leverage followed by the opportunity to grow in those accounts, as customers get a sense for how more -- how much more they can accomplish with Network Appliance.

The number of reps actually selling these series is still very small today, but you should expect to see a concerted effort to increase this very effective penetration tool over the next year and a commensurate increase in our penetration to competitors' accounts.

Our acquisition of Topio in December will also help us to expand heterogeneously.

Topio software allows customers to mirror any incumbent primary storage to NetApp storage and get all the data management benefits that come with the NetApp functionality.

At the same time, they can reduce the amount storage required to support their infrastructure.

Progress on our small and medium StoreVault business has been very slow, but we received very positive external reviews on the product, including a small business computing excellence award for the best storage product.

We've made good progress in our VAR recruitment and will be supporting and watching this business closely as its sales bandwidth increases.

This quarter the bulk of the revenue from net cash came in the form of deferred revenue, but we also had some customers extend their service contracts, resulting in slightly higher than expected revenue for this legacy business.

At a little under 2% of total revenue, it's still down 33% from last year and will continue to decline, as future revenue will consist almost entirely of deferred revenue coming off the balance sheet related to the support of existing net cash terms contracts.

Our indirect channel was up over 13% sequentially, again accounting for 60% of revenue.

Contributions from [Aero] and [Abnet] was down slightly after a record second quarter, generating a little under 11% of total revenue.

And as Steve mentioned, IBM more than offset that decline with a surge consistent with their fiscal fourth quarter.

We're very happy with the progress of our IBM relationship, but they do have a seasonally lighter first quarter, so we're forecasting that their contribution will return to about 3% of our business in our fourth fiscal quarter.

Our partner EchoSystem is one of the keys to our growth, and our team continues to cultivate strong relationships with the major application vendors.

This quarter, the joint Microsoft exchange road shows got underway and was a particularly strong generation machine for Network Appliance.

We were recently certified for Oracle Enterprise LINUX and joint development continues on our upcoming SAT manager for SAP products.

Geographically, just under 54% of total revenue came from the Americas.

As we mentioned previously, the federal sector is very cyclical.

Historically the same seasonal strength from federal in our fiscal second and fourth quarters, but a pull back in our first and third.

Correspondingly, the fed contributed 9% to total revenue, down from 13% last quarter, which is reflected on a roughly flat Americas GO performance and in a somewhat lower contribution from our aero distribution partner.

EMEA had a tremendous quarter, contribution 35% of total revenue, and Asia-Pac grew to 11.5% of total revenue.

In summary, we believe that Network Appliance has its strongest arsenal ever of highly competitive solutions, and we're becoming more and more effective at selling them.

We're also investing to increase the aves to which we sell because we see tremendous opportunity to capture additional market share ahead of us.

The hiring we did last year is contributing to today's success, and the hiring we're doing today will help to fuel our future growth.

To wrap up, I'd like to emphasize how proud I am of the consistent effort from the entire Network Appliance team, who collaborate so well together to create value for our customers and to drive hard for our success.

I encourage the investment community to registered for our upcoming analyst day to learn more about NetApp and our plans for future growth.

It'll be held in New York City on the 13th of March.

Pease contact either Tara or Billy in investor relations for additional information.

At this point, I'll open the floor to questions.

I request that you limit yourself to one, and if you have a second, to return to the queue so we may address everyone in the allotted time.

Jeremy, will you now open the floor for questions?

[OPERATOR INSTRUCTIONS] And your first question is from the line of Richard Farmer with Merrill Lynch.

Please proceed.

Thank you.

I would like to ask a question about the services margin and the factors that are affecting margins more generally.

If you look at your results, at least relative to our model, all of the revenue up side was in products.

Services were a little bit light, at least relative to our model.

It would seem to imply maybe some price impact in the services margin.

Is that a fair read or is all of the services margin pressure from the hiring and the cost impact?

And then just more generally, would you mind just clarifying your comments on the other factors?

I think you said mix was less favorable with less head than last quarter, is that right?

And how was pricing as an effect in the products, as well?

Okay.

That's one long question.

All right, Steve Gomo here.

So in the service margin, the biggest factor in the service margin was the fact that we added more people than we had originally planned as I mentioned.

And secondly, and by far the most important thing,was a number of discretionary investments that we made. ,I talked about the service field enablement, that we're building a lot of processes and systems, particularly around the professional services organization that's going to serve us well into the future, but we're incurring a lot of those costs now.

As far as the revenue line is concerned on services, if you look at the growth of professional services, that has been growing around 70% year-over-year, 75%.

This quarter, you'll note, it grew 60%.

It was a little light relative to prior quarters.

What happened there is in our growing professional services business, we're seeing larger statements of work, larger projects if you will.

They take a little longer to complete, so we didn't complete them this quarter, we don't recognize the revenue.

But you don't particularly see price pressure in services contract?

No.

The services revenue line to the extent that it's support contracts, that's coming off the balance sheet.

And that's -- that's business that we booked years ago.

You're right.

On the professional services side we're not seeing any particular price pressure whatsoever.

And professional services we're not seeing it, no.

Thank you.

You're welcome.

Question on the upgrades.

Last quarter we had a unusually high amount of controller-only upgrades that were sold basically as diskless systems to upgrade systems already in the field.

That was non-recurring.

Those carry a very high margin because in our particular mix, the disks have lower gross margin than do the controllers which carry all of the software.

And your next question comes from the line of Keith Bachman with BanC of America.

Please proceed.

Hi, guys.

One to Steve, I think this is for you is just talk a little bit about the deferred revenue.

I think you highlighted some of it on the past question. but it was up fairly substantially this quarter relative to certainly our expectations in past quarters.

What was the key driver there?

I think some of it was certainly the support side of those contracts you just mentioned, but if you could add some color to that?

And with all that deferred revenue and cash, I know you identified how the buy back was going to go this quarter, but how should we be thinking about that -- all that cash that's sitting on the balance sheet on a longer term basis?

Thanks.

So the elements that are deferred at Network Appliance are both the service contracts and the software subscription.

And we've actually seen a increasing ratio in terms of our total mix of business in both of those categories.

You'll note that over the past eight quarters if you go back and look at the transcript, the information we provided you, look at the increase in software subscriptions as a percent of revenue.

That's historical and that's coming off the balance sheet, but nonetheless it shows that that's been growing.

And today, both software subscription and service contracts are growing slightly faster than the rest of our business.

And you see that in a variety of instances if you look at the revenue information correctly.

The second part of the question was --?

What are you going to do with all that cash?

Oh, what are we going to do with all that cash?

So basically we look at our cash, we have our cash -- we have cash that's domestic and cash that's international, and you typically can't mix those two things.

Basically what we do is we first make sure that we have enough cash to run the business.

Then we make sure that we have enough strategic reserve to give us the flexibility if we see something out there that can help us fill a gap or whatever the case from an M&A standpoint.

And finally if there's excess cash above and beyond those two categories, that's the cash we use for the buy back of the stock.

And that's how we think about it.

Next question?

Your next question's from the line of Harry Blount with Lehman Brothers.

Hi, guys.

You guys obviously continue to put up good top-line growth rates.

Question really relates to the sustainability of that as we look forward here.

Essentially as I look at the network storage piece of the business, it looks like that gradually will slow a little bit, which suggests you guys will need to continue to take share maybe at a higher rate going forward.

And obviously you're obviously coming up against a bigger base.

So I'm just trying to -- would like you to comment, if you will, on terms of the sustainability on top-line growth rates that have at least a 30% type number?

Hello, Harry, this is Dan.

We've obviously provided guidance for Q4.

So in the near term, certainly growth rates are up in the 30s, and for anything beyond that, you'll have to come to the analyst day on March 13th, where we'll provide you guidance for our next fiscal year.

All right.

Any other factors that you would point to that are more qualitative that you can help us with there that as we look at things like the encryption and the Topio, et cetera, in terms of what you think addressable opportunities are?

If you really look at the market pam in storage -- and by pam I mean everything thrown in, right?

Everything south of the server, including services and all [inaudible], it's in the order of about $75 billion.

So we think we've got a lot of opportunities as we pick up adjacent segments to continue to grow at a very healthy rate.

But the quantification that's going to have to wait for a about a month.

Fair enough.

Thanks.

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

Hi.

To what extent have you actually changed your hiring policy and now hiring more in advance than you had been, so setting yourselves up for a more extended period of higher future growth?

And to what extent was some of that, at least, reflected in this quarter's numbers?

This is Dan.

We actually did a catchup this quarter.

We put in some more professional services heads than we had originally forecasted at the beginning of the year, but other than that this was really a catch up.

Last quarter we felt as though we fell behind.

If you recall at the beginning of the year, we said we wanted to hire about 100 a month or 300 a quarter.

I think we were behind by 100 as we exited the first half and we just really did a catch-up.

Was there a second part to that?

It was really more that -- even on a go-forward basis, are you now hiring more in advance than you had been?

Where you seemed to have been hiring really for the next quarter, are you now putting people in place for your new fiscal such that you can really get them trained and on the ground running?

No, although we probably -- we did have more last year in fiscal Q4 than we are planning for this year.

We've got -- this is a much more linear progression as you go through the year and our forecast for hiring this quarter is somewhere in the range of about 400 people.

There'll be a sizable percentage of those that goes into sales, but it's not going to be disproportionately weighted in that regard at all.

So no, this is more of a just ongoing continuation of execution of the plan that has been in place.

Laura, I'll just add on top of Dan's comments, I don't think there's been any philosophical change here.

We've always been trying to balance current quarter needs and future needs also.

Professional services was something that typically doesn't pay off for us for two to three quarters out type of thing.

Sales reps, depending on whether they're -- how much experience they have, they can come up to speed anywhere in four months to nine months, depending on the person, the [pats] they're given, et cetera.

I don't think you're seeing any change at all in terms of our philosophy about whether we're investing for the current quarter or the future quarters.

And your next question comes from the line of Ben Reitzes, UBS.

Yes, good afternoon.

Along the lines of some of these costs, when I look at the model, the bottom line is blowout revenue, but you -- your SG&A was up with it.

And I know you talked about hiring and what not as being one of the factors in there.

It seems like SG&A would be the reason that you don't let the up side flow through to the next quarter.

And can you just clarify and then can you just talk about on the SG&A side just, I guess, even more detail just in terms of how we should think of that line?

It's quite impressive revenue.

I'd love to flow it through, I'm just wondering what your thinking is in holding it back I assume with that line?

This is Dan.

Yes.

You shouldn't assume anything's going to flow through.

I've been, I think, incredibly consistent to the point of being boring that we think our optimum range to maximize growth in revenues and EPS is when we're running in an operating income level between 15.8% and 16.4%.

That SG&A line expansion is really reflected in sales expansion, sales capacity.

It's investing in not like people, but channel programs, et cetera to -- and channel marketing, et cetera to really drive our sales performance in the future.

You should not be disappointed.

I have told you in the past and I said it last quarter, we were disappointed last quarter when we got to 18 point something that we lost an opportunity to invest in our future growth.

And I try to make it just as clear as I possibly could that this quarter that we were going to be back in the target operating model, and we are.

As revenue growth takes place in the future, you'll see it proportionately flow to the bottom line.

But last quarter was the one where the big surprise occurred, where we didn't spend enough, and we corrected that situation this quarter.

Got it.

Well, with the revenue up side you're seeing, I was wondering if you thought maybe, though, you were being conservative with the $0.30 and your assumptions even for --

Nice try.

-- and assumptions for that?

But that is my try. [LAUGHTER] Thanks a lot, Dan.

No comment.

Your next question comes from the line of [Katie Huberty] with Morgan Stanley.

Good afternoon, guys.

Just quickly on geo mix.

Is the improvement in the EMEA growth rate macro related or do you feel like you're gaining traction in that region?

Europe had a particularly strong quarter, but if you look historically they surge every Q3 in the mix.

I think last year, as a matter of fact, I think they were right at 35%, and then you'll see them drop off in Q4.

I get this series of questions every year.

What happened to the Americas in Q3?

Why was Europe so strong?

And then I'll get it in the inverse next quarter.

The Americas will blow it out and Europe will flatten off.

It's a compliment that -- this is Tom.

It's very, very clear that our European team is executing at an extremely high level.

Germany and UK have been a power house for a while -- for a long time, actually and they're really executing at superb levels, taking both enterprise business, their channel businesses extremely strong.

On top of that, though, our French organization has responded extremely well.

We had new leadership come in about nine months ago and it's executed tremendously well.

Italy's taken off.

Our emerging market business, which we invested in a year ago, has actually done very, very well, so --

One our higher market shares, I think, is in Ethiopia. [LAUGHTER]

Well, that wasn't what I was going to comment on, but we actually have built a very big business in a number of places you wouldn't expect.

Nigeria's been very good with the oil and banks.

Israel continues to be a shining star.

But the fact of the matter is, if the top two keep going at such a great level and the other guys kick in above goal, which they did, that makes a big impact.

I don't think it's macro for everybody else, I think it's execution on our side.

Great, thanks.

Your next question comes from the line of Bill Shope with JPMorgan.

Please proceed.

Okay.

Great.

Thanks.

Can you give us a read on the linearity on the quarter?

Was it similar to prior years or is IBM starting to throw it off a bit?

No, Bill, it was very similar to prior years.

Our pattern through the fourth quarter is a very strong November-December, and then things go swack in the early part of January, because a lot of the customers just don't have their budgets put together.

And then it picks up again in the last couple of weeks, and that's exactly what we saw this quarter.

It didn't move materially.

IBM did surge, obviously, at the end of their fiscal year, but it wasn't so much that it significantly altered the distribution for the quarter.

Okay.

Thanks.

And your next question's from the line of Paul Mansky with Citigroup.

Yes, great.

Thank you.

You touched on it a little bit a moment ago, but I wanted to maybe go into a little more detail.

As we look forward to that Q1 guidance, are you indeed expecting a resurgence in business here domestically versus the international markets?

And how is the federal vertical wind up shaping up thus far in the quarter?

You mean, Q4, I hope -- you said Q1.

Oh, excuse me.

Sorry.

I was calendarizing, sorry.

That's all right.

The upcoming -- I thought that's what you meant.

The upcoming quarter my guess is you'll see America surge again.

The U.S. always comes on really strong in our fiscal Q4.

Europe will probably flatten off and therefore decline in a percentage sense.

Federal normally has a really good finish to the fiscal year.

If for some reason their -- the fed buying pattern obviously associated with the end of the year, September.

Right that's the end of the federal fiscal years, so that's why our fiscal Q2 we see the big surge in federal spending.

But we see another one in our Q4.

Something about the March-April period, in particular, that the feds unleash a lot of money.

We think the federal government business is coming back in a stronger in a mix than it was this quarter.

Great.

And Steve on the software mix, I know that we've targeted 35% as the sustainable level historically.

Obviously we've been pushing that and pushing north of that here for the past -- for the past few quarters.

Should we be thinking about a recalibration upward from here?

I wouldn't at this point.

I would still encourage you to use around 35%.

We're looking at that.

There will be fluctuations around that number and I'll give you update on that at the analyst day in a couple of -- in a month.

Almost all that increase, two points, has come from software subscriptions.

Basic percent of revenue each quarter coming from new licenses has held pretty constant.

Right.

Thank you.

Your next question's from the line of Dan Renouard of Robert Baird.

Hi, thanks.

My question is on the security market, and I guess just backing up, obviously Decru® is pretty lumpy.

But if you just back up closed, EMC/RSA® closed and a lot more noise around the security market.

Has that acquisition in any way validated the market for you and have you seen your pipeline or level of engagement increase in the last three to six months as a result of EMC/RSA®?

Thanks.

Actually, yes, it has.

In fact, I believe RSA® will turn out to be a great partner for us.

Our solutions are fairly complementary.

It may seem a little strange to have EMC and NetApp partner, but this is one area where partnering actually makes a lot of sense.

The -- the Decru® market this quarter, I think, is -- the pipeline's actually pretty good, but the issue has been the expectation that in the not too distant future the number of vendors will have LTO4 tape drives with embedded encryption.

Customers I think have withheld purchases until they can evaluate the various alternatives, of which that is one.

So instead of committing a particular architectural solution, they're waiting until they can make that evaluation.

So pipeline's good, we haven't lost any deals, but they're hard to close right now.

Thanks.

Next question's from the line of Bill Fearnley, RTN Midwest.

Yes, good afternoon.

I had a question on the competitive environment and how you're seeing deal flow.

To ask it another way, are you getting more chances to quote and are you seeing any changes in your win rate in either geographies or versus specific competitors?

Thanks.

This is Tom.

I don't think there's any doubt that we're getting a chance to quote a lot more.

Our channel -- let me be a little more granular.

Our channel in North America has really, really performed.

It's close to 50% of our business.

Now put that in context, we were $1 billion in 2000 and it was 25%.

So as we've ascended the scale, they've ascended with us.

They're investing heavily, and that has really taken off the arrow and Avnet's situation is extremely strong for us..

When you look in Europe, the channel has been strong, but the thing that I'm -- that's striking me as the size of transactions that we're getting -- in some cases in a fairly rapid fashion -- has grown dramatically.

I put that to leading with services.

The teams that have really built out the services -- and they're usually in the largest markets in the enterprise -- are bringing down very large transactions, not just number of transactions, it's the size of those transactions.

The third thing I would say, we're seeing a lot of markets that previously we hadn't really paid much attention to -- southeast, some parts of the northwest, some countries I've already mentioned -- are starting to really kick in and start to make an impact because of execution.

I think the Company's getting better recognized.

I think Dan would agree that the speaking engagements through and around the world are having bigger and bigger audiences and bigger impacts and the deal flow from those is growing, so I think NetApp is getting branded in a lot better way.

And part of that also is the partnership we do at Microsoft to be in the technology centers is bringing a lot of people through.

Oracle and their data center is getting a lot of flow through.

SAP has been much more active with NetApp over last year, both in North America and we've been strong in Europe.

And our relationship Symantec was both for shows and speaking engagements.

So from -- I've just been traveling quite a bit, as is Dan, as had to Rob Salmon.

And as we sat down and talked to each other, it's very, very clear we have increased momentum first quarter, second quarter, third quarter everywhere in the world.

We're feeling very, very strongly that our teams are executing at a high level.

We've had very low turnover.

We don't talk about culture much on these calls, but being in the best places to work five years in a row is attracting a lot of people to our cus -- to our business and a lot of people are staying and have been in place four or five years and now we're seeing results of that.

Excellent.

Thank you.

And next from the line of Chris Whitmore with Deutsche Bank.

Thanks.

Good afternoon.

Hoping to get some color on mix between new products and older generation products.

In particular, if you can provide any --any quantification of the contribution of the 6000 line and the 3070 in the quarter, that would be great?

I wouldn't consider the other ones you didn't mention old.

Still pretty new.

Let's see, the 6000 series I think I mentioned that it wa -- in the prepared comments was up about 80% sequentially, something like that.

Do you believe that?

Yes.

It was really quite strong.

Most of the growth, actually, was in the 6030, which is up more than 100 units quarter over quarter.

So I mean it's quite substantial.

And the ASPs in those systems are also really quite large.

The 6030s and 6070s go for somewhere around $200,000 a piece, so when they go up by 80%, you see a significant increase in the revenue.

The 3070, which is kind of half the price, where is about $100,000 configuration, that in its first quarter of shipment got off to a really good start.

I know we were really pleased with it.

But in any first quarter you look at the numbers 100 units being a lot, so that's the kind of number you would see.

How big is the 6000 as a percentage of total revenue, both the 6030, the 6070?

So it's not a --

Historically we've had a third, a third, a third.

The 6000 series is a little lower because it's such a high-end system that customers are still gaining confidence.

I think ultimately it'll be a third of our revenues.

It's growing to that kind of revenue.

Is there any way to provide some quantification in GX ramp in terms of percentage of systems shipped with GX or pedabites with GX shipped?

Any idea?

I don't think we have any specific quantification there.

I think that we've had a number of customers testimonials -- customer valuations, many of which closed with the introduction of our [TracFile] system in November.

So the GX basically has the clustering capability, the TracFile system capability, and we're seeing a lot of demand and a lot of evals and a lot of evals closing. .

As far as quantifying it, I'm not quite sure we quantify it that at that particular level.

In terms of penetration of the target market, we're definitely seeing the customer value proposition as we expected.

It continues to be largely single-digit number nodes, but it turns out to be, on average, well over $1 million for each single system installed, so they're near very high-end.

And your next question from the line of Brent Bracelin with Pacific Crest Securities.

Thank you.

Dan, I actually I had a follow-up question on kind of margins.

It's clear here you're reinvesting to maximize growth and share gains.

You've talked about the 16% operating margin goal here for the last three years.

But with IBM ramping, with the software mix increasing, the software subscriptions increasing, why can't you expand the margins and maximize the growth rate, perhaps at a higher level, given the increasing contribution from software and IBM?

Our goal would be to drive the growth rate even higher, and that requires even additional investment in sales capacity, in particular, and we think that yields the best long-term result.

Could I drop it?

Yes, but I think we would give up the opportunity to add a couple points of growth rate to the top line.

Name another company that's in the fortune 1,000, other than Google, that's grown at over 30% per year.

I certainly can't.

I don't know of either and I don't know of one in particular that sees its increasing.

Our growth rate went up this quarter.

If I could -- just remember that we have a couple of market opportunities, We have the mid market that has really got a big opportunity for NetApp.

That takes channel experience and we've been doing that aggressively.

And then you go into the enterprise and you're leading with services and you're taking down big numbers.

We see that if we do more of the same, we're going to take bigger deals globally, so this is -- you know, we're still an emerging Company, I would say, that has a big market opportunity and we are taking share.

To Harry's earlier question, said you guys have to keep taking share.

Well, guess what?

We're only 8% of the market.

We've got a lot of share to take yet.

And if we have that opportunity, we've always believed we should grab it now, get the units out there that we can attach software to and this will all work out well in the end.

You know -- this is Steve here.

If you back net cash out of the comparable period and this quarter, you'd find that revenue was up about 39%.

So --

And if you had to defer to it, which I actually think is a representation of the strength of the business.

It's a bookings growth rate, right?

You're up in the 40s.

This is -- this is a model where we think we can invest to cover more markets, more segments, more verticals, more channels and more partners and that takes -- that takes investment.

Right.

And I think that the investment that we've made over the past year have enabled this quarter.

And frankly, the investments we're making now are going to be the most help in the future quarters.

I just reiterate.

The one I felt bad about was last quarter, because we really felt like we left the growth opportunity on the table.

That makes sense.

Thank you.

Your next question's from the line of Shebly Seyrafi of Caris.

Yes, thank you very much.

So you're clearly now investing for growth.

You have great opportunities, your revenue growth is over 30%, and you're talking about capping your operating margin at 16.4%.

I'm wondering as we project in our models if you think your revenue growth is going to decelerate below 30% year to year, do you expect to expand your operating margin target above 16.4% to maybe 17% or 18%?

First of all, I'm not going to comment on what the future growth rates could be or speculate on it.

But no, we think, somewhere between 25% and 35% growth rates probably to sustain that level, given the size of our base business, is going to require that level of investment going forward.

I think you have to look the -- Shebly, in light of the market opportunity that we're trying to address.

Yes, we may have a quarter where growth rates slow down a little bit or growth rates pick up, but the opportunity in front of us is absolutely signif -- it's astounding, and we have the ability to capture that.

And the thing that we're missing today to capture that is sales capacity.

Sales capacity in terms of salesmen, channel programs, all the marketing programs we need and building up a support infrastructure when we're going to need to be able to support those customers, and that's what we're investing in.

So this investment isn't for this quarter or next quarter, it's for down the road, and there's a long game to play here.

Okay.

Thanks.

And next is from the line of Glenn Hanus of Needham and Company.

Maybe just a little more detail on how you're feeling about IBM from the standpoint of being incremental in the U.S.

Do you feel that's -- I assume over -- abroad it's pretty much all incremental for you.

And in the U.S., do you feel like a portion of that is coming out of other channel partners or maybe you could characterize that for me?

This is Dan, I really think that IBM is very much focussed on what we jointly refer to as white space.

That is area that we don't have covered.

An example is state and local governments.

We're just not there and they are really focussed on it.

Another example is retail.

We have never targeted retail as a target vertical.

You'll notice the growth in the low-end systems this quarter was largely associated with purchases by retailers, store base systems in particular.

So no, I think it's largely incremental.

They've done an excellent job of trying to manage the conflict by focusing on areas where we're not, and I think that's true around the globe.

And if I sneak one more in, what really surprised you guys on the up side this quarter from a product or geo standpoint?

A lot of good statistics you provided, can you summarize it into one or two or is it really just across the board?

It really was across the board.

I'll give you a couple and Tom give you a couple, as well.

I was surprised that we crossed over the 100 pedabite mark and that we saw sequential growth of storage of, I think it was 40% from Q2.

And that was really driven by a large number of customer projects and deployments associated with secondary storage, that is stuff that's not in production.

It's there for data replication protection, et cetera, and largely is alternative of tape, some for business continuity, et cetera.

But the asymmetric mirroring, where we can mirror from a NetApp primary that running fiber channel drives, to an ATA-base system is a very attractive price solution.

So yes, a lot of demand for secondary storage was really high in the mix and large deal size.

Tom?

We had a specific deal that came in that was very, very large.

It wasn't even forecasted.

It wasn't forecasted because it was a take out of a major competitor.

It seemed like they had every advantage in the world, and I happened to visit with that customer about a year ago and they wanted to -- they basically said how would you do this and they told us how it was architected.

So I said we could do this with fax machines if you don't want us to think, but perhaps we could come in here and look at your business problem and come back and say if you use NetApp the best way as possible, here would be the advantage.

This is how we've won many, many big deals.

Well, the net of it was they ended up using iSCSI and fiber channel and eventually from that took 30% out of their equation and handed us a very, very large order and the guy told me he was surprised we won.

We were like one of those add-on RFPs.

And I'm seeing all over the world people now instead of saying NetApp bid it the way the other guy does it, they're starting to realize we have a very different way of thinking about the problem.

And by utilizing all of the protocols or the right one for the right job, failing over to ATA drives, which are re -- dual-re protected so you can take a double-disk bay without going down, which makes it so you really can use it as opposed to what other people do with ATA.

And we're seeing massive footprints on -- even on initial implementation.

That happened more this quarter and last quarter, I would say, than we've seen before, and that's the work of leading with services, architeching it for it, delivering it, testing it, and proving it.

So, we -- they weren't a real surprise except for the fact that we executed almost everywhere at a very, very high levels.

The entire quarter looked good from right at the beginning.

Wasn't like we said, wow what a save.

It was like boy, this is looking good.

We had almost 100 deals this quarter of value of $1 million or more.

Our deal size is definitely going up.

Thank you.

Your next question's from the line of Tom Curlin with RBC Capital Markets.

Good afternoon.

On the V-filer and the FAS6000 series, are you seeing a higher attach rate in SAN environments for those two products versus the broader product set, and is that by design just given your, if you will, penetration strategy in the SAN market and how those might play in?

No, I wouldn't say the mix is especially strong there.

I think we're seeing strength across the board.

Certainly our entry mid-range products are being very.

In IP SAN and iSCSI we're certainly seeing a tremendous amount of growth there.

But the 6070 we're seeing across the board, We're seeing it in high performance computing, we're seeing it in server consolidation on the NAS side.

And we're certainly seeing it in big SAN deployments, fiber channel and iSCSI.

A lot of these big machines are also driving large, what we call secondary storage for either data projection, data retention, disk-to-disk backup, archive and compliance.

So we're also seeing the high drive count capabilities of the 6000 driving very, very large machines with very, very drive counts that basically leverage our replication technology into these other solution areas.

So Dan talked about that segment of our business earlier and what we're seeing with particularly the 6000 that has drives that scale up to 1,000 drives per unit, that these very, very high drive count applications, and primarily the secondary storage area are a big part of our growth.

As far as V-series, V-series has been all over the map.

One of the standard applications of V-series is just the NAS gateway and that will continue to be a significant part of our business.

However, we also see V-series as a way to introduce the NetApp value proposition around data on tap and our replication and management and total quest of ownership value to an infrastructure the customer's already invested in from a competitor.

So it's our way of basically bringing [inaudible] provision in, bringing flexible clones, bringing replication, bringing disaster recovery to an investment that the customers already made.

In the long run that could stay as purely a V-series sale or the customer may move that over to a full system sale from Network Appliance and ultimately sweep the floor with our product.

How does the support model work?

For example, we've heard that you have V-filer working in front of the MC storage in some of the accounts.

I'm sure there's some other vendors already that you've qualified, as well.

Well, this all started with -- well, we have agreement with Hitachi some time ago.

I think that was 2002, probably five years ago.

And yes, it's been expanded to include other systems, as well.

Our view is we ought to be able to put it in front of any vendors' equipment.

The industry's changing quite a bit, right?

You've got to think of this a little bit as a switch, right?

It's between the server and the storage infrastructure that's got the disks, and then some value-added functions, very similar to Decru®.

Do you take over the -- essentially the support of that -- let's say it's an EMC system behind.

Does EMC continue to offer any support for that box or do you have to if you will take that over for the cust --

No, the agreements we have with all these vendors is inner-operability certification and mutual support.

No, we're not trying to build expertise in every vendor's storage array.

It's a joint support agreement.

Is there an agreement with EMC in that regard?

I can't comment on that one.

We do have some supported customers.

Okay.

Thank you.

Your next question's from the line of Clay Sumner with FBR.

Thanks very much and congratulations on a strong quarter.

Just looking for an update on your plans for SAS-based storage.

It seemed the industry's kind of underestimated the difficulty of the integration there and just looking for an update there and maybe with your plans with ?

Yes, as far as our plans there, they're no different from the last call.

We talked about our reluctance to introduce new products in Q4, so you should expect to see some activity on that front in Q1.

But I would add in Dan's prepared remarks he talked about the strength of all of our product lines, including the FAS200, so I would share your concern that the complexity of that technology probably proved to be more than most of us anticipated.

On the other hand I don't think we're feeling any particular strain to rush that product to market any sooner than it's going to be ready.

The FAS200 was very strong.

We had a record shipment quarter this quarter on top of a record shipment quarter last quarter.

We still have a fair amount of momentum there.

When technology's ready, we'll ship it, but I don't feel like we have a high vulnerability there and we're not going to rush it.

I would like to underscore that one.

There's no reason to take the 200 series out of the product line and inject any risk.

Don't forget, a lot of these, as I indicated, also goes through IBM to retailers.

It's really hard to go make a service call in a store.

And we want to make sure this is absolutely rugged before we start pushing that into remote location.

Very well, thank you.

And your final question is a follow-up from Harry Blount.

Thanks.

Glad to get in under the wire.

Dan or Tom, this is probably more of a strategic question regarding -- seems like there's some broader changes going on in the structure of the competitive environment for the storage business in general.

Sun openly talking about partnering with different people.

HP's restructured the storage business.

Dell's cut kind of an interesting deal with Microsoft.

You even saw some things on the Intel front.

So was wondering if perhaps you could maybe comment in terms of just a few new structures that we might likely see, you guys even partnering in some ways with EMC and RSA®.

Some of the new structures and new competitive dynamics that we might see going forward and how business is going to be won against some of these players?

I'll tell you my personal view on it.

I really do believe and I've said this in the past that the server vendors become more channels than manufacturers.

I think you'll see an increase in OEM arrangements, much like ours with IBM or some of the ones you mentioned, Dell with EMC, whatever.

I think you'll see that -- if you look at markets shares by as manufactured, you're really down to four market leaders that stand out right now, at least take out mainframe, right, because you've got a different class there.

But in the open system space, it's EMC, Network Appliance, Hitachi and Hewlett-Packard.

And the Hewlett-Packard seems to be struggling in the EVA family, which is the non-OEM portion.

And I believe that continues to decline.

And you see [Engeneo] as a pretty strong player there as a part of [inaudible] logic on the OEM-base model.

It's definitely going horizontal.

Now you see market shares can be very misleading, because it doesn't show as manufactured.

You've got to make the adjustments for product line.

As such I think what you're going to find is the market leaders -- namely EMC, Hitachi and ourselves -- are obligated to cooperate more even though we compete.

EMC is a channel for Decru®.

RSA® is going to be a channel for Decru®.

And I think you'll see other forms of partnering like that.

Our V series in front of Hitachi and other vendors.

I just think that's inevitable.

As you concentrate all the technology, if you will intellectual property, into three or four different vendors, the customer community is going to demand that those vendors partner and cooperate.

There is one thing if I could add it, Tom, is that the biggest advantage we have -- and I hear customers telling me this all the time, we are a very, very focussed company.

We know exactly what our business is, if -- you've listened to our message for years.

It has not changed that much.

It's fleshed out, it's broader, but the fact of the matter is, it's pretty consistent over five -- I've had customers say you're the only vendor that sits here year in and year out, and you're in the same business.

So I really do think the fact that we are an extraordinarily focussed company.

When we do alliances, it doesn't distract us.

Other people kind of whip-saw all over the place.

I can -- almost everybody you named has started strategies and gone a different direction two years later where you wonder what happened to that strategy.

We're pretty much -- I have had more customers and even our own people say the reason they like it is that you know exactly what we're going to do when we wake up in the morning, they know how we're attacking and they know the set of products we're going to push.

That's easier to manage than some of our competitors.

So I think that you'll see us do some things and people approach us.

Almost everybody wants to partner with us at this point.

But the ones that we do won't distract us and we're all about growth.

If we do what, can we grow faster?

And we tell everybody who want's to partner, you've got to speed us up or we're not interested.

I think that's our situation.

I think you're also going to find more emphasis on [hetrogen 80], multi-vendor environments.

That's where the V series plays, that's what was behind our Topio acquisition.

I think you'll see a lot more emphasis on inner-operabilities going forward as well.

Thanks.

Ladies and gentlemen, before we sign off, I see no one in the queue at the moment and our time is up.

I want to remind you once again about the analyst day in New York City March 13th, and I look forward to seeing you all there.

Thank you for joining us today.

Have a wonderful Valentine's Day.

Thank you for your participation in today's conference, ladies and gentlemen.

This does conclude the presentation, and you may now disconnect.

Have a wonderful day.