NetApp Inc (NTAP) 2008 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Network Appliance first quarter 2008 earnings conference call.

My name in Candy, and it will be my pleasure to be your coordinator for today.

At this time all participants are in a listen-only mode.

We will be conducting a question-and-answer session towards the end of this conference.

(OPERATOR INSTRUCTIONS).

As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over the Mr.

Ingemar Lanevi, Treasurer.

Please proceed sir.

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 conference call, we will make forward-looking statements and projections that involve risks and uncertainties, including statements regarding our expectations with respect to our Q2 pipeline, and bookings distribution, our operating results for fiscal Q2 2008, our expectations regarding our financial performance for fiscal quarters after Q2 2008, including cash generation, bookings, and revenue growth, and our future operating income.

Our future stock repurchases, customer demand for our product and service offerings, our hiring plans, our intention to pay down remaining debt associated with our last year's foreign cash repatriation, and the benefits of the investments that we have made in emerging products.

Actual results may differ materially from our statements, or projections.

Factors that could cause actual results to differ from our projections include but are not limited to customer demand for products and services, increased competition, and any decline in general economic conditions.

Other equally important factors are detailed in the company's 10-K and 10-Q reports filed with the SEC, and are available through our website.

All of which factors are incorporated by reference into today's discussion.

With me on today's call are Dan Warmenhoven, CEO, our President, Tom Mendoza, Steve Gomo, CFO, and Tom Georgens of EVP of Product Operations, and Rob Salmon, EVP field Operations.

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

Steve?

Thanks, Ingemar.

Good afternoon, everyone.

As we discussed on our preliminary earnings call on August 2, NetApp experienced a revenue and earnings shortfall, relative to the expectations we had set at the end of last quarter.

However, we still believe our business fundamentals remain intact.

Let me walk you through some commentary about our final results to illustrate.

Please note that all numbers are GAAP, unless stated otherwise.

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

Total revenue for the first quarter was $689.2 million, up 11% compared to Q1 last year and down 14% sequentially.

Foreign currency affects had an immaterial impact on this quarter's sequential results, but added about 1.9 percentage points on a year-over-year basis.

The combination of product revenue and software entitlements, and maintenance revenue, which we have formerly referred to as software subscriptions, was $571.3 million, up 6% year over year, but down 17% sequentially.

Add on software, and software entitlements and maintenance, accounted for 41% of total revenue this quarter.

This compares to 40% last quarter, and 42% in Q1 of last year.

Our add-on software was about 25% of total revenue, and software entitlements and maintenance, were about 16% of total revenue.

Revenue from services, which includes hardware support, professional services, and educational services, was 17% of total revenue, up 4% sequentially, and up 46% over Q1 of last year.

Service maintenance contracts increased 10% sequentially and 45% year on year.

Professional services declined 6% sequentially, and grew 49% year over year.

Non-GAAP gross margins were 61.8% of revenue this quarter, same as last quarter.

The combined non-GAAP gross margins for product and software entitlements and maintenance, was at the highest level in the past five years.

At 68% of revenue, it is up a four percentage point from last quarter, continuing to demonstrate solid competitive strength.

Non-GAAP service margins were 31.7% this quarter, which is a 1.5 percentage point improvement from last quarter.

As anticipated, service margins continue to hold in the low 30s, which is what we're expecting for all of FY '08.

Turning to non-GAAP expenses, our operating expenses totaled $351 million or 50.9% of revenue.

Expenses increased 27% year over year, but decreased 6% sequentially, as we place more emphasis on expense management given the lower revenue level.

Total head count increased by 179 people, to a total of 6,814 employees in the first quarter.

This is slightly lower than we guided to at the end of last quarter.

We will continue to hire strategically, but at a slower rate than recent quarters, until we return to our targeted business model.

GAAP operating expenses include the affect of costs related to prior mergers, by intangible amortization from acquisitions, and the affect of FAS 123R.

GAAP income -- excuse me, non-GAAP income from operations, totaled $75.3 million or 10.9% of revenue.

Non-GAAP other income, which consists primarily of interest income, was $17 million.

Non-GAAP income before taxes for the quarter, was $92.1 million or 13.4% of revenue.

Our effective non-GAAP tax rate remains at 17.5%.

Non-GAAP net income totaled $76 million, or $0.20 per share.

GAAP net income totaled $34.3 million, or $0.09 per share.

Now turning to the balance sheet and our cash flow metrics, cash and investments increased by $21 million from last quarter, and finished at a near record $1.33 billion.

Cash and investments exclude $109 million of restricted cash associated with last year's foreign cash repatriation, a debt on our balance sheet related to the repatriation is currently $69 million.

We paid down approximately $16 million of this debt during the first quarter, and we expect to pay off the remaining balance within the next nine months.

The generation of significant amounts of free cash flow, has always been an important facet of the NetApp business model.

Free cash flow is defined as cash from operations, less capital expenditures.

Over the past three years, NetApp has generated $1.5 billion of free cash flow, and the compound growth rate in free cash was 38%.

During this same period of time, free cash flow expressed as a percent of revenue, averaged 23%.

This quarter, although revenue growth flowed, our cash generated from operations was $200.9 million, up 22% over Q1 of last year.

Capital expenditures were $33.6 million, and free cash flow totaled $167.3 million, growing 18% over Q1 of last year.

Despite the revenue shortfall, free cash flow finished at the third highest level ever, as the improvement in accounts receivable levels, made up for softer levels of profitability and deferred revenue.

Expressed as a percent of revenue, first quarter free cash flow was 24.3%.

This past quarter we repurchased about 6.5 million shares of outstanding common stock at an average price of $30.57 per share, for a total cash outlay of $200 million.

There's approximately $200 million remaining in our previous stock repurchase authorization.

As we announced in today's press release, our board has authorized an additional $1 billion for stock repurchase purposes.

Looking forward, I would expect us to become more aggressive with our share buy back program, given the current stock price.

Our goal in Q2 would be to repurchase around $200 million, to $500 million of stock, at the current price level.

Accounts receivable day sales outstanding were 53 days, compared to 62 days last quarter, and 51 days in Q1 of last year.

Starting this fiscal year, we have reclassified all sales tax and back tax receivables, about $34 million, from our gross accounts receivable, to other current assets.

This reflects the true nature of this receivable, as it has to be remitted to a particular government, it was never recorded in revenue, and it is not cash due to NetApp.

The prior period DSO numbers I just described have also been adjusted for this impact to show a proper comparison.

The methodology change reduced DSO for this quarter by five days.

For Q4 '07 and Q1 '07, the reduction in DSOs is five days and four days, respectively.

Again, this is a reclassification within current assets and has no cash flow impact.

Inventory turns decreased to 18.2 times this quarter from 22.5 times in Q4.

I would expect inventory turns to improve in Q2.

Total deferred revenue balance increased by $46.8 million this quarter to $1.15 billion, a 4% sequential increase, and a 55% increase in the balance year over year.

Before I turn the call over to Dan for his comments, I'll discuss our operating model for the second quarter.

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

We are making forward-looking statements and projections, that involve risk, and uncertainty.

Actual results may differ materially from our statements or projections, for the reasons cited earlier.

We expect Q2 '08 revenue to be between $752 million and $768 million, which represents about a 9% to 11% sequential increase from the first quarter, and about a 15% to 18% year over year growth rate.

This will result in second quarter non-GAAP earnings of approximately $0.24 to $0.26 per share.

GAAP earnings are expected to be $0.16 to $0.18 per share.

We expect our diluted share count to be decrease by about 1% to 3% in the second quarter, depending upon the stock price and the amount of our stock repurchases.

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

Dan?

Thank you, Steve.

Since our last call on August 2, we have conducted significant analyses to better understand the dynamics of what happened in our first quarter.

As a result of that analysis, I'm even more convinced that we misread the strengths we experienced in April, as a recovery in demand, and as a result we overestimated the bookings outlook in Q1.

The revenue data for Q1 supports our earlier assertion, that a number of our top enterprise accounts, and many of our enterprise accounts, paused a meaningful portion of their spending, in our first quarter.

The number of deals over $1 million dropped 27% sequentially from the record high in Q4, attributable to many of those large accounts.

We expect them to resume their spending on NetApp in the future.

One highlight of Q1 which we mentioned on the earlier call was a 27% year over year increase in bookings.

Which demonstrates the underlying health of the business.

However, bookings during Q1 were quite back end loaded, resulting in many orders being received too late to converted to revenue, and ending up in backlog as we exited the quarter.

Consequently, we are entering our second quarter with a substantial backlog position, that is much better than we had going into Q2 of last year, and significantly better than we had going into Q1.

Additionally, we scrubbed the pipeline for Q2, from both the bottoms-up and tops-down perspective, and believe the integrity of our pipeline are much higher and healthier going into this quarter.

This gives us a high degree of confidence that the forecast we provided for Q2 can be achieved.

I and the executive team remain certain that the underlying market forces driving demand for our solutions are intact, that the solutions we offer provide the best value to customers, and they have substantial competitive differentiation.

The areas of fastest growth in the market are the areas where we are also the strongest.

We are also actively expanding our programs to develop more new accounts, deepen our penetration in more of our current enterprise accounts, and broaden our vertical coverage.

I'll now review some of the statistics we typically share with you about this quarter's performance.

What's important for you to remember is that these metrics are generally based upon revenues, unless I specify otherwise, so our healthy bookings growth will not be reflected in these metrics.

Geographically, the revenue distribution was very similar to Q1 of last year.

56% of total revenue came from the Americas this quarter, compared to 57% a year ago.

Our federal business in the U.S.

was very strong, up 39% year over year and accounting for about 12% of revenue.

While our U.S.

revenue in the commercial sector was negatively impacted by our financial and technology top enterprise accounts.

Europe was 32% of revenues this quarter versus 31% last year, up 12% year over year.

Our business in North, Central, and Eastern Europe was very strong, offset by slowness in the U.K.

and France.

Asia-Pacific was approximately 13% of revenue compared to 12% last year, up 19% year over year.

The direct channel contributed 38% of revenue this year as compared to 44% in Q1 of last year.

This decline in the direct mix is correlated to our weakness in our enterprise accounts.

Our indirect channel accounted for 62% of revenue in Q1, versus 56% a year ago.

The total non-deferred revenue contribution from Arrow and Amnet, was 12.5% of total revenue compared to 11% last year.

IBM was up both in absolute dollars, and a percent of revenue this quarter.

Our parabytes shipped decreased for the first time in years, down 12% sequentially, to 111 petabytes but up 52% year over year.

ATA stores accounted for 57% of total petabytes this quarter, about the same as last quarter.

Total storage system units shipped were down 19% sequentially, and up 6% year over year.

The high-end FAS 6,000 series units were down, more than 30% sequentially, another indicator that reflects the slowdown in purchasing from our largest accounts.

The low-end products were down the least, aided by the channel launch of the new FAS 2,000 series, toward the end of the quarter.

Our midrange products still accounted for about half of all storage systems shipped.

The percentage of our storage bookings that included block-based protocols increased to 44%, a very strong performance.

Within this 33% of our storage business had a fiber channel SAN interface, 19% included iSCUSI, and 8% included both fiber channel SAN and iSCUSI on the same purchase order.

Our scale op operating system On Tap GX was also down sequentially, but had some solid wins behind just high performance computing this quarter, including media and communications.

Results from our emerging products were mixed.

The leader continues to be our virtual tape library, which nearly doubled sequentially in bookings.

Our new data application product, formerly Topio, is making solid progress, including closing its first deal over $1 million.

Both Topio and our SMB revenue, were up about 7% sequentially, albeit off a small base.

We continue to develop very good traction with our broader partner Ecosystem.

Microsoft and Oracle are strong advocates for combining our solutions with theirs, and SAP is now doing the same for us, particularly in Europe.

The characteristics of the endware server virtualization solution is very complementary with NetApp Solutions, and we're working together more closely and more often.

Our investments in these relationships are paying off, and should keep growing in a positive way going forward.

Overall, we believe our business fundamentals remain strong, despite our lower growth rate in revenues this past quarter.

Our cash generation is but one example of our underlying health, and combined with our bookings growth, we're optimistic about our future growth potential, which begs the question what we expect our long-term growth rate to be.

We have always been focused on maximizing our revenue growth and gaining market share, and the events of the last quarter have not changed that objective.

While we are not ready to provide guidance for the full year with any degree of specificity, with do believe our growth rates will accelerate through this fiscal year.

We do not foresee getting back to a 30% growth rate in this fiscal year.

We have also not surrendered on that objective for the longer-term.

Our expectation is that we can achieve a revenue growth rate in our fiscal Q4, of somewhere in the low to mid-20% range, and at that time to be back on our target operating model of 16% operating income.

Our internal stretch goal is to achieve our first $1billion revenue quarter in Q4, which would equate to a growth rate of approximately 25% year over year.

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

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

Operator?

Thank you, sir.

(OPERATOR INSTRUCTIONS).Your first question comes from the line of Richard Farmer with Merrill Lynch.

Please proceed, sir.

Thanks.

Dan and Steve, just wondered if you could talk about any sort of time series of the backlog as a percentage of the forward quarter revenue for the last several quarters and this one, including, if you can, the percentage of that that is non-deferred versus deferred?

Thanks.

That is very complex.

No, we can't.

Backlog is scheduled over many quarters.

There's a lot of components to it, there's professional services, there's product, there's all kind of things on the balance sheet that comes off, and flows into revenues.

Backlog is, I think, is not a quantifiable term that's easily understand.

I think you have to look at it as a relative, not as an absolute, much like bookings.

Bookings go into all different kinds of components, with what happens with the business.

The absolute number is not the key.

The relative number is the key.

Are bookings trending up or down, and how they relate to overall revenues, and backlog is the same kind of thing.

, We had a pretty good position relative to the backlog going in.

We think we got a pretty good start on the quarter, but that's about as specific as we're going

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

Please proceed.

Good afternoon, thanks.

Dan, can you just talk a little bit more about the economy, why -- anything that came out more, over the last few weeks about why the customers paused, and then why you think things will accelerate throughout the year, given some of the volatility in the financial markets and whatnot, and your exposure to financial markets?

If you could just provide more specificity, maybe just a little more details about your conversations and what the sales over the past couple of weeks, has been able to come back to you and tell you, in more specificity?

Thank you.

Let me start.

I've got both Tom Mendoza and Rob here, so I'll invite them to chime in.

One of the things that we have in our top enterprise account are executive sponsors, and we asked each executive sponsors to go back and to speak to their principals on the accounts, and find out what their intentions were, find out if these were company specific, or what were their intentions going forward.

Some of the things we picked up, a lot of projects we're involved in, you would have to consider from their discretion to be somewhat discretionary.

Things like archival.

They don't have the sense of urgency around those projects in a production sense that you might get if you were deploying a brand new application, on a fixed schedule.

A lot of them are infrastructure related, and the infrastructure can be metered out over time, as kind of the economic conditions would warrant.

They did say that they slowed down in the first half of the year, and I think most of the enterprise accounts are feeling pretty bullish on the second half.

But as long as the macroeconomic conditions don't absolutely implode, and I think most are expecting them to be pretty solid at this point, that they're going to continue to move forward with their project plans, and they expect to use a fair amount of network appliance technology in those solutions.

I should point out to you, they expect us to compete aggressively for it, and that's exactly what we intend to do.

As Dan said, this is Tom.

We chatted with each of our top accounts, we split it up among the executive team, they were very happy to talk to us about it.

They made it clear there was not a NetApp specific issue on their hold on spending.

I think the macroeconomic condition has people just wondering how fast they want to unleash their budget.

We're in the midst of many, many projects that I believe we're in a very good shape on.

I didn't see a big change in their attitude, other than their own internal thoughts on how they're going to spend their money, or when they spend it, I should say.

Thanks a lot.

Your next question comes from the line of Shebly Seyrafi with Caris.

Please proceed.

Yes, thank you very much.

So, it's encouraging that you're providing optimistic guidance right now.

If we take the high end of your guidance, for the October quarter of $768 million, to get to $1 billion in fiscal Q4, which you said was your goal, would require greater than historical patterns for sequential growth in fiscal Q3 and fiscalQ4.

I'm wondering, why, perhaps, you're putting out such aggressive targets, and what's your visibility right now, as well?

Thank you.

This is Dan.

I'll start.

We built a model at the beginning of the year that had us on a higher number.

So our sales capacity, and the amount of total hiring we've done, etc., should be adequate to deliver that kind of number.

We've gone through territories, and plans, and (inaudible) global account plans, and all the rest, and we're feeling pretty confident that as the year progresses, that we can see that kind of return to growth.

I know you're looking at it sequentially.

We look at it more on a year-over-year basis, and that still puts us in the low to mid-20s.

Just to be clear.

This $1 billion target in fiscal Q4, is that a stretch goal, or is that a realistic target that you believe you will get?

I think we'll be in the low to mid-20s.

I would say it's a stretch goal from the perspective we put it out there for the company as something to go shoot for, but if it's achieved, it's only 25.

It's a high end of the range I just gave you of low to mid-20s.

Thank you.

Shebly, this is Steve Gomo here.

Remember that the order growth rate over the past couple of quarters, has been fairly strong and certainly stronger than first quarter revenue growth.

We are starting from a very low point.

And even the strong sequential growth that we're projecting for next quarter, does not take us to a very high level of revenues, type of things, relative to the order potential.

So I think that the sequentials on revenue, given the low starting point, are very reasonable.

Okay.

Thanks.

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

Just a different way of following up on the things that have already been asked about.

Since a portion of your Q2 revenues, Dan, are coming from better backlog, as you said, and since you don't seem to be indicating that you're already seeing a recovery from some of your largest customers, where does the confidence come, for going from the second quarter, into the third quarter?

Laura, this is Rob Salmon.

One of the things we laid out for you at analyst day in New York, was our strategy on go to market, where we were going to broaden our coverage and pathways to market, and win more new accounts.

We believe through our channels, and I just got back from a trip this week down in Southern California meeting with a partner for a couple of days, we believe that strategy is paying off in Network Appliance.

We've told you for a while now, that we need to broaden the customer base we go after.

We think that broadening is having an impact, and we certainly believe it's going to have an impact this quarter, as well throughout the second half of the year.

So as Dan and Steve both alluded to earlier, macroeconomic conditions aside, if we continue to execute on the strategy that we've embarked on this year, yes, we were too aggressive in Q1, in terms of what we thought we would do, but we believe we will be right back on track with our strategy going forward.

A big part of that has to do with new account acquisition, working through our partners, as well as going deeper in the big enterprises, as Dan's already talked about.

Thank you.

Your next question come there's the line of Aaron Rakers, with A.G.

Edwards.

Please proceed.

Yes.

Thanks, guys.

I guess, first of all, congratulations, or good job on the share repurchase.

I guess I want to ask about cash flow generation here, going forward.

Maybe we could start by talking a little bit, how we should expect to see deferred revenue growth continue.

It looks like you had pretty good numbers here in the July quarter, despite the shortfall.

How should we be thinking about that?

And then tailing into that, how do we think about the cash flow or free cash flow generation for the year, following up on your guidance given at the analyst day in mid-March?

Steve Gomo here.

So I would expect to see our -- as the revenue growth rate accelerates, I would expect to see the deferred revenue growth rate, also accelerate.

That's going to contribute to cash.

In addition, as our profitability increases throughout these coming quarters, that will also contribute to our ability to generate cash.

Finally, I don't know that we're going to be able to hold receivables where they are, but I hope they won't deteriorate back to where they were last fourth quarter, type of thing.

All of that put together, I would expect to see a fairly high, generation of cash, relative to revenue, as we move forward in the next few quarters.

Thank you.

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

Please proceed.

Okay, great.

Thanks.

Dan, there's been a lot of debate over whether SAN or NAS is preferable for virtualized server environments, as you know.

Knowing that you participate in both market segments, can you give us your view on this issue?

I'll turn it over to Tom Georgens.

He's spent a great deal of time with the team at VMware, and dug really deeply into the question of virtualization.

Tom?

Well, clearly -- Well, step number one is we could participate either way.

We've got SAN offerings, we've got NFS offerings, we've see them both out there in the market, and we see customers being successful with both of them.

I think from an NFS perspective, I think that has not gotten a lot of emphasis, but we're actually seeing some momentum.

In fact, on our own webcast, where we've done webcast around VMware, which in fact have been our largest attended webcast, the interest in VMware with NFS has been very, very high for a lot of reasons you should expect in terms of ease of management, and ease of migration, and the ability to support the mobility model that VMware wants to put out there.

So clearly I think that we're going to be positioning not only NFS, but also iSCUSI as a very, very key technology as customer's re-architect, and move towards a VM virtualization model.

There's those customers that do have a preference for SAN, and certainly we're not afraid to support that, and will support that, but whether it'll be iSCUSI for SAN and then the same ethernet connection for NFS, it's a much more simple environment, much, much more lower cost, and a lot more flexible.

So, certainly we see more momentum in NFS, than probably the rest of the industry, and that's clearly a solution we're going to continue to promote.

The bottom line is, we'll go with the customer preference, but we do have a recommendation, and we do have a preference for both iSCUSI, for SAN, and ethernet for NFS.

This is Dan.

The SAN attachments scheme was the one that VMware first emphasized, and that's got probably the widest install base, but we're saying, as Tom said, a lot of that interest going forward, rolling over the ethernet, as opposed to fiber channel, and ethernet supports both NAS and iSCUSI.

And that seems to be the convergence point.

Convergence of wire first, and then you configure out what kind of access type you want.

Okay, great.

Thanks.

Your next question comes from the line of Kevin Hunt with Thomas Weisel Partners.

Please proceed.

Thanks, guys.

I wanted to ask another technology question that you didn't mention, and that's the GX operating system.

Can you give some kind of an update in terms of what you're seeing there in terms of adoption?

Well, as far as GX is concerned, we talked about our initial release of GX.

Dan gave some color about the momentum.

I won't do all that.

The original target markets for GX were high-performance computing, to basically leverage the scalability of the offering, and go from there.

We see an expansion of that, away from pure technical computing, into some of the animation houses and the movie houses and the people that are doing high performance computing around entertainment.

And the other thing that we see, is deep archiving.

The ability to have an infinitely large name space, that we can continue to dump more, and more, and more data into, without having the capacity limitations of different types of file systems.

So for us, I think there's an ease of use component, and ease of management on deep storage, and we're seeing more and more of that for GX, but still the primarily target market for that today is high performance computing, and I should also make it clear that GX is not an end game product.

GX will ultimately be converged with everything else that we do, and we're going to bring clustering to our broader product offering.

And that remains our objective with that product.

Today it's about high performance computing, media entertainment, deep storage, but ultimately we're going to combine that with our rest of our value proposition, our replication and data management, and basically bring clustering to our entire installed base, and our entire customer target market.

This is Rob.

I would agree with what Tom just said.

I spent some time this week talking to a customer about their recent acquisition of our GX technology, and what they liked, is the entire NetApp value proposition, and the road map we allowed them to buy into, as they build up the solution and needs for today, but also want to build on it tomorrow.

I think also, this is an area, where an awful lot of prospects and customers kick the tires on some of the other technologies and solutions in the marketplace, and wind up looking an awful lot, but coming back to Network Appliance, because they believe in the road map that we have, and the total value proposition with the road map that Tom talked about.

Thanks, guys.

Your next question comes from the line of Harry Blount, with Lehman Brothers.

Please proceed.

Hi, guys.

Dan, you mentioned the strength in federal.

I know that seems to be a little bit ahead of their normal fiscal year end.

I guess the question really is, is you guys went back through and scrubbed the backlog, and looked at this vertical by vertical.

Could you maybe give us a sense of, what your current mix is by vertical, and any particular areas where you might have seen strength or weakness in those verticals?

Thanks.

The strongest vertical is federal, like you said, and is likely the result of really, programs we started getting involved in two, three years ago.

We have a long gestation period kind of things, that finally culminated.

It wasn't around end of year buy, it was really new wins and very long term sales engagements.

In terms of the vertical mix, Steve do you have it there?

I know the financial and technology sector were pretty soft.

Let's see, the vertical mix running from top to bottom, tech was still about 20%, but was down in a dollar sense.

Financial services was around 18%, a little up in the mix -- I'm sorry, excuse me, pardon me.

Tom just pointed me to the other, I'm reading the wrong column.

16% for high-tech, about 12% or 13% for the financial services, Teleco at about 7%, and it kind of drops off from there, so a mixed bag.

But if you notice, those numbers are shifting down from where they were in some prior quarters.

Great.

Thanks.

Your next question comes from the line of Clay Sumner, with FBR Investments.

Please proceed.

Thanks very much.

Dan, as you said, you had strong bookings growth in the July quarter, and you built substantial factory backlog heading into the October quarter.

It seems that either your October quarter revenue guidance is actually still pretty conservative, or that you're expecting bookings to slow in October way down, from the strong 27% growth you had in July.

Given the commentary on the year, it sounds like strong bookings growth is coming later in the year.

Is there something about the October quarter that you're expecting bookings to slow, or are you being very conservative on the forecast?

You'll have to make your own interpretation.

We just picked ourselves up off our back.

This is one we're going to make.

You'll have to make your own interpretation.

The guidance is, what the guidance is.

That's what we put in black and white out there.

You'll have to put the color on it yourself.

Understood.

Thanks.

Your next question comes from the line of Paul Mansky, with Citigroup.

Please go ahead.

I wanted to follow up a little bit, on that last question.

Dan, you provided some comments around pipeline scrub.

It sounds like revenue could be considered a bit of base case here, at least over the near-term.

Given that reduced head count growth, I wanted to get a better grasp on the op margin line.

It sounds like three quarters is a fairly long time to get back to 16%, versus your historical MO.

Is that a function of quota resets, maybe some expected softening in gross margin?

Conservatism?

A combination of all three, or any other color around that would be most helpful.

This is Steve Gomo.

The question is, could we get back faster, all things being equal?

The answer is yes, if we froze hiring, we could certainly manage expenses in a way that would get us back faster.

Let me be very clear, that is not our intent here.

Our intent here, is to make smart and prudent trade-offs so we make sure that we can grow in the future, and so we are investing, as we go.

So what you see here is a plan, that balances future growth, with current profitability.

That's why it takes us the time it does, to get back to the operating margin in the fourth quarter.

Be very clear, we are still investing, we're still hiring people, albeit not at the rates we did last year, but we're still investing for the future as we go.

This is Tom.

You mentioned our past track record and one of the things about NetApp, is that we've always focused on what are we going to do to grow.

Anytime, where we have an issue like we did last quarter, we take a step back and say, okay, since we just went through extraordinary growth for three years, are we investing in all the areas that are the right areas, because you invest in a lot of things rapidly, and we're more tuning our investment strategy, and figuring out where we're going to make our big bets.

One thing that we did right the first time we had an issue back in nearly 2000, we said, we're going to grow our way out of this, we're not going to cut our way out of it.

And I think that's what Steve's talking about.

We're very, very focused on how we're going to grow our way, back to where we want to be.

This is Rob.

Let me just add on.

You asked about replan for sills.

In some cases, we will absolutely give new targets out, and that's not across the globe, but in areas where we were too aggressive in our thoughts for Q1 in the year, we will go ahead and replan for those folks, to get their objectives far more in-line, with what we want to do, within the guidance of our business model, and where we're going to invest.

So we're clearly working on that right now.

Great.

Thank you all for that color.

Your next question comes from the line of Kathy Herahty, with Morgan Stanley.

Please proceed.

Thanks.

Good afternoon.

Steve, what are the drivers behind lower inventory turns this quarter?

And is it just a matter of shipping what you have in backlog, in order to get back to normalized levels in October?

Hi, Kathy.

Steve here.

Where I came from, 18 times was a pretty good turn, but the reason why it declined from previous quarters, and why we expect it to go forward, at the end of this quarter, as Dan mentioned, we received a lot of orders very late.

We were actually doing a number of with a we call pre-builds in advance of those orders.

So this is where we know the configuration is coming in, and we build it in advance.

The problem is that the order got here too late to get through the test chamber, or whatever the case and get out the door.

So we were left with a number of pre-builds that didn't get out the door.

The good news is as we speak today, those are all shipped.

Great.

Thanks.

Your next question comes from the line of Dan Renouard, with Robert W.

Baird.

Please proceed.

Hi, thanks.

My question is I think a quick one.

Steve, your product revenue was down slightly, software, maintenance, and service was up pretty sharply year on year.

Is that purely a function of the shipping product, versus what's coming in off deferred, or is there anything else going on?

You hit it on the head, Dan.

That is the issue.

Remember those-- what we used to call the subscriptions, the software entitlement and maintenance basically is coming off the balance sheet.

That's pretty automatic every quarter, we know that's going to grow.

The problem was the non-deferred piece, which is a lot of the product hardware, that ended up in backlog, and as we built that substantial backlog, we didn't ship.

That's the force at work.

Got it.

Thanks.

Your next question comes from the line of Tom Curlin, with World Bank of Canada.

Please proceed.

Hey.

Can you guys hear me?

Yes, we can hear you fine.

The -- if you look at your comments on bookings growth from last quarter, or I guess from the preannounced call, and talking about getting back to 30% plus year over year, there was some comments about the sequential trend being aggressive, but when I look at the guidance or the discussion about mid 20% by Q4, it seems to me you're assuming you operate at a higher level of backlog, relative to revenue, than you have been and do that all fiscal year.

Is that the approach you're taking, just to be sure that you're covered, in terms of the macro issues out there?

I wouldn't say based on macro issues.

I would say due to operational efficiencies.

We can't run a company efficiently when we're trying to ship everything that comes in at the end of the quarter.

We were always in a pattern where those last few days of shipments didn't have to be rushed through the factory and converted to revenue.

In fact, it's inappropriate to do so, and very difficult to do so in many cases, because in Europe in particular, our customers traditionally require delivery for recognition of revenue, as opposed to shipment.

And so it's just a -- it's not a very good way to run a company, right.

We'd rather see this thing kind of smooth out a little bit.

Is it a higher level of backlog, it's actually lower in a percentage sense of a quarter's revenue, than it was a couple years ago.

Okay.

But higher than this past fiscal year?

Yes, I think so.

That's fair.

Okay.

And then also, in the past, maybe you provided an update and I missed it, but what is the status of the new entry level program and is that ramping, or roughly what's the timing?

Well, on prior calls we indicated that we'd be taking revenue on that in Q1.

In fact, that was the case.

So we did a launch into our channel partners, and we actually shipped units.

Dan talked about the combined low end shipments, and we'll be doing a formal announce with our partners in the quarter.

So, the product did come out last quarter, we did take revenue on it, it is in our channel, and then we'll do a broader release in about a month or so.

So you'll essentially be, we'll call it, fully released by the end of this quarter?

Absolutely.

Okay.

Great.

Thank you.

Your next question comes from the line of Bill Fearnley, with FTN Midwest.

Please proceed.

Good afternoon.

Dan, you guys have mentioned your competitive win rates were about the same, but you also mentioned decision cycles being stretched out by a month, and talked about clients being more conservative.

What do you see -- is there anything you see different in the decision cycle trend for the balance of the year after you did your survey of the top 40 accounts you mentioned in the last call, and how much of the stretch of the sales cycle is due to the number of new players, and at least their success, potentially, getting into the consideration cycle here in the enterprise storage space?

I'll start and turn it over the Tom and Rob.

Tom has spent a lot of time with the customer community, that's for sure, to understand what's going on.

My sense is that it's not a function of more players, it's a function of a reduced sense of urgency.

A lot of our business has been in the secondary storage space, and a lot of that has to do with finding efficiencies in their infrastructure, more investment in things like archival business continuity, etc.

Those are not production-oriented deployments.

I think a lot of the customer community has just decided, look, if they've got to slow down something, that's the piece they'll slow down.

They don't affect, if you will, their customers, in an obvious way.

And that's the easiest way to stretch things out.

And they were very clear.

They've been stretching out spending.

I want you to understand.

We were in a situation, where in many cases we were told we had one deal, but could not secure the order.

And that's when you kind of go, what the hell's going on?

It's not a competitive situation, it really is a spend rate.

Yes.

Just a follow-up on your question about the newcomers, we don't see the newcomers quite so much in the big enterprise accounts.

They're specifically in verticals, and not saying it's going to minimize them, but in terms of the specific dialogues here on top enterprise accounts, traditionally the competition is the big competitors we see every day, we've been seeing the past couple years.

Any change in sentiment in midrange then, with the smaller players?

I'm just going to add on to what Tom said on the big accounts, I would agree with Tom, we're not seeing a change in the landscape with the big accounts, but this one area that we're very focused on, that does take awhile, that's new account acquisition.

New account acquisition typically takes a little bit longer than going through the same-store sale, because they have to understand your value of proposition, you have to find an area where you can provide a solution to a problem they have at that time, and then you have to prove yourself.

We've been very clear to all of you that we are going to broaden our install base, and that was by new account acquisition.

Those sale cycles take a little longer and we are in a lot of those sales cycles.

We are winning new accounts, not winning an awful lot of new accounts, but as we embark on that, one of the things we are trying to help fulfill it with is greater awareness of the success we're already having.

It's really a two prong strategy.

(Inaudible) to more new accounts, but also get far greater awareness of Network Appliance in the marketplace.

And how we're already providing solutions to many big enterprise customers.

No real change in dynamics.

With big enterprises we already call on, we already talked about some of the delays we've had in terms of sales cycles there.

It's really a lot of new account acquisitions, where we're spending emphasis with our partners, and our enterprise sales force, going after those takes a little bit longer.

Your next question comes from the line of Chris Whitmore, with Deutsche Bank.

Please proceed.

Just a follow-up on that last question.

I was hoping to get some color as to where you expect the growth to come from, what's your outlook for the large enterprise versus the channels, versus the new accounts?

Particularly in terms of accelerating the growth rate back to 25%?

Thanks.

I don't we want to get that specific about where it comes from.

That just tells our competition where they should go focus to try to slow it down?

Are you anticipating any recovery at all in your large enterprise accounts?

Are you seeing any indications that spending there will pick up?

Yes, absolutely.

In fact, the ones we had communications with, virtually everyone indicated, that they expect to see the second half spending be pretty strong.

They really expect to spend through the rest of their budgets for the year and there's a lot of different factors that went into springtime, that I think now, are largely behind us.

I think the level of confidence there is higher.

Have you seen an acceleration in orders over the past three to four weeks from large accounts?

Tell you all about it in the middle of November.

Your next question comes from the line of Kaushik Roy, with Pacific Growth.

Please proceed.

Can you comment on the pricing environment in the midrange and the entry level, and then this is probably for Tom Georgens, data domain now has a market cap of $1.4 billion.

Can you comment on the dedup market and your efforts in that segment?

Thanks.

The second question first.

As far as dedup goes, it's really a two-pronged strategy.

One of them is we're introducing deduplication technology and we're showing that to our customers today in the context of the VTL, which allows to us bring deduplication and VTL technology together, and that will position ourselves quite well, against the duplication technology for backup that Data domain has.

But more broadly, we did a relatively larger announcement, about compression technology, deduplication asis applies to all of our environments, that's part of our core products.

Rather than specialty products around backup and archiving, we're actually bringing deduplication to home directories, we're bringing deduplication to VMware images, we're bringing deduplication to mainstream applications.

I think that's a more compelling technology, and the takeup and interest of customers around that technology, has been very, very high.

So, the bottom line year, I think deduplication is a feature of a product that will emerge and not necessarily a product or a symbol or a company.

So I think that you're going to see D duplication in all sorts of products, at all sorts of levels, and that will be integrated in the products just like many of the features are today.

Okay.

And then pricing?

I thought we were doing one question each.

What was the pricing?

What are you seeing in the price environment in the midrange, as well as in the entry level?

Our gross margins haven't changed, our list prices haven't changed, our discounts haven't changed.

So is it fair to assume that pricing is stable, more or less?

[ laughter ].

You have to reach your own conclusion, but the math would say nothing's changed.

Okay.

Fair enough.

Thanks.

Your next question comes from the line of Brent Bracelin, with Pacific Crest Securities.

Please proceed.

Dan, don't want read too much into Q1 stats here, but it does look like there's a slowdown in FAS 6,000 and NAS was a little more pronounced than the slowdown in FAS 3,000 and SAN.

Was that solely due to kind of large enterprise, and the commercial slowdown?

As you talk to customers, is there any other factor we should also consider?

And as we look at the pre-builds, was there a higher mix of FAS 6,000 and NAS in the pre-builds that didn't get shipped out the door.

Not going to comment on the mix of the pre-builds, but your assertion at the beginning is correct.

Largely, our 6,000 series goes through the direct channel to the largest customers.

And that's largely where we saw the slowdown, and that's why the 6,000 units were off.

The SAN business was very strong.

I don't necessarily have much -- the NAS decline, wasn't really a decline, it just didn't grow as fast.

Not particularly concerned about.

Not any areas for caution there.

I will say, that a lot of the archiving solutions that we're talking about, are largely 6,000s and they are largely NAS deployments.

They kind of R200 near-store style having been replaced by the 6,000s, and those would be NAS deployed solutions in general.

That's helpful.

Thank you.

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

Please proceed.

I know you're o not going to speculate much on fiscal '09, but just maybe philosophically, your 16% model, is there any change in philosophy that's, that's sort of the right place to be for the foreseeable future as an optimal number to continue your growth strategy, or might that be under evaluation?

I am clueless about '09.

I will be very candid, I don't have a clue.

Our goal is to go find a sustainable growth model that delivers the highest sustainable growth rates, with basically a fixed operating income envelope.

Over the past few years, that's been about a 15 to 16.4 operating income envelope, and yielded a roughly 30% year over year growth rate.

We're going to try to find that balance point again.

I don't know what the numbers look like, I can't give you any guidance for '09, I can't even really give you any guidance for third quarter this year.

As you evaluate that, are there a lot of analytics and metrics that you do to come up with that level, or is it more your management experience over the years and sort a gut instinct?

It's done both top-down and bottom-up.

There's a ton of models to do with sales productivity rates, and a variety of other productivity issues, and overall employee productivity as well as what we think market opportunity, and win rates, etc.

There's a combination of different things that go into it.

Ultimately, you ask the sales team, is this a goal you think you can achieve, and they say yes or no, and you know you're kind of in the right zone.

Thank you.

Your next question is a follow-up question from the line of Harry Blount, with Lehman Brothers.

Please proceed.

Hi, guys.

Just wanted to come back to Rob, the account coverage that you guys had laid out.

As you look at the opportunity set, of your addressable market, where do you feel, both on the direct and indirect side, you guys still have probably the biggest opportunity if you would, over the next, call it, 12 months?

Harry, with our market share, I think we've got a big opportunity across all the markets that we're playing in right now.

One of the things we try to be very clear on, we believe we have an opportunity to go deeper and broader in our existing enterprise accounts.

We told you on analyst day in New York, that in general on average, we have about less than 20% total tam in those accounts.

We think we can go far deeper.

Our enterprise customers tell us that.

I also think this notion of going broader in the marketplace, going to more customers, is a real big opportunity for Network Appliance.

In the enterprise, as well as in the midsized enterprise market.

I think there's a big opportunity in both of those, so as we look at growth, we believe in all those areas, there's a big opportunity for us, and to the point that Steve and Dan have both made, we need to prioritize where we think we can get the best return on investment, for the business model that we have if place, prioritize those investments, to give us the greatest return, in terms of getting to the growth that we want to achieve.

Thanks.

At this time, this concludes our Q&A session for today.

I would now like to turn the call back over to Mr.

Warmenhoven for closing remarks.

I would like to thank you all for joining us today, this afternoon, and we look forward to with communicating with you again, in no less than 13 weeks from now.

Thank you all very much, and have a wonderful day.

Thank you for attending today's conference.

This concludes the presentation.

You may all disconnect, and have a great day.