NetApp Inc (NTAP) 2008 Q3 法說會逐字稿

Good day, ladies and gentlemen.

Welcome to the NetApp third quarter 2008 earnings conference call.

I'll be your operator today.

At this time, all participants are in a listen-only mode and we will facilitate the question and answer session towards the end of the presentation.

(OPERATOR INSTRUCTIONS) As a reminder ladies and gentlemen, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call Tara Dillon, Investor Relations.

Ma'am, please proceed.

Thank you for joining us today.

Our 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 will make forward-looking statements and projections that involve risks and uncertainties including statements about our expectations for future performance, our anticipated fiscal fourth quarter financial results, our plans for repaying debt, the anticipated benefits from our acquisition of Onaro and our expectations about growing our business.

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 our products and services, increased competition, any decline in general economic conditions.

Other equally important factors are detailed in our accompanying press release as well as our 10-K and 10-Q reports on file with the SEC and also available through our website.

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

With me on today's call are Dan Warmenhoven, CEO; our President and Chief Operating Officer, Tom Georgens; and our CFO, Steve Gomo Steve will review this quarter's financials and targets for the full quarter; Tom will discuss our operations; and Dan will share his thoughts; and then we will wrap up with Q&A.

At this point I'll turn the call over to Steve.

Thanks Tara.

and good afternoon, everyone.

NetApp produced excellent results this quarter as revenues, operating profits, and cash flows all exceed record levels.

Revenues finished just above the high-end of our target range and our 16.6% non-GAAP operating profit margin was above our long term target.

As I walk through the financials, note that all numbers are GAAP unless stated otherwise.

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

Total revenue for fiscal third quarter was $884 million, up almost 12% sequentially, and up more than 21% compared to Q3 last year.

Foreign currency effects aided sequential growth by 1.3 percentage points and augmented the year-over-year growth by 3.6 percentage points.

The combination of product revenue and software entitlement and maintenance revenue was $733.7 million, up 11% sequentially and up 15% year-over-year.

Revenue from add-on software and software entitlements and maintenance was 40% of total revenue this quarter.

This compares to 40% last quarter and the same in Q3 of last year.

Our add-on software was about 26% of total revenue and software entitlements and maintenance were about 14% of total revenue.

Revenue from services which includes hardware support, professional services, and educational services was 17% of total revenue, up 12% sequentially and 61% over Q3 last year.

Service maintenance contracts increased 11% sequentially and 56% year-over-year.

Professional services increased 13% sequentially and 72% year-over-year.

Non-GAAP gross margins were 62% of revenue this quarter, down 0.2% from last quarter.

At 66.3% of revenue, the combined product and software non-GAAP gross margin was down about 1 point from last quarter, within our expected range.

As anticipated, this reduction was due to a moderate increase in the IBM revenue mix as well as modest changes in pricing.

We expect product and software gross margins to remain stable in Q4.

Non-GAAP services gross margins were a record 40.6% this quarter, up substantially from the 35.5% last quarter due to slower-than-anticipated services and support hiring.

The efficiencies and utilizations also improved this quarter.

In Q4 we will host a significant services training event for our partners and employees which will cost about $3 million.

As a result, services gross margin should finish Q4 in the mid-to-high 30s.

Turning to non-GAAP expenses, our operating expenses totaled $401 million or 45.4% of revenue.

These expenses increased 9% sequentially and 20% year-over-year.

Total headcount increased by 271 people on a net basis ending the quarter was 7,123 employees.

Going forward our investments and operating expenses will continue to emphasize sales coverage hiring in order to drive additional market share gains and future growth.

GAAP operating expenses include the effect of prior merger related costs such as intangible amortization from acquisition and the effect of FAS 123-R.

Non-GAAP income from operations totaled $147 million or 16.6% of revenue.

Non-GAAP other income which consists primarily of interest income, was $12.7 million.

Non-GAAP income before taxes was $159.7 million or 18.1% of revenue.

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

Non-GAAP net income totaled $131.7 million or $0.37 per share.

GAAP net income totaled $101.8 million or $0.29 per share.

Now I would like to turn our attention to cash flow performance.

We define free cash flow as cash from operations less capital expenditures.

This quarter strong profit, a large increase in deferred revenue and strong current asset management more than offset an increase in capital purchases to produce record results.

Our cash generated from operations was a record $287 million, up 26% sequentially and up 15% from the strong Q3 of last year.

Capital expenditures were $53.7 million.

The free cash flow totaled a record of $233 million, growing 23% sequentially and 9% over Q3 of last year.

Expressed as a percent of revenue third quarter free cash flow was 26.4% compared to the 23% average of the last two fiscal years.

Moving onto the balance sheet, cash and investments increased by about $145 million from last quarter to $1.13 billion.

This balance excludes approximately $63 million of cash associated with last year's foreign cash repatriation, $307 million of restricted cash related to our secured revolving credit facility, and about $8 million of restricted cash related to security and rent deposits.

The current portion of long-term debt on our balance sheet of about $29 million is related to the repatriation and is expected to be repaid in full by the end of the fourth quarter.

The debt associated with our credit facility is $250 million and is classified as entirely a long-term liability.

We continued to buyback stock this past quarter.

Repurchasing a total of 5.8 million shares at an average price of $24.88 for a total outlay of $144.3 million.

Over the course of this fiscal year, that is the first nine months of this fiscal year, NetApp has spent about $844 million to repurchase almost 30 million shares, effectively reducing total shares outstanding by almost 8%.

There is approximately $556 million remaining on our current stock repurchase authorization.

Turning to DSOs, accounts receivable days sales outstanding were 48 days.

Compared to 48 -- excuse me, compared to 49 days last quarter and 49 days in Q3 last year.

This year's Q3 DSO was recalculated -- let me try that again.

Last year's Q3 DSO was recalculated to include the reclassification of $43 million worth of sales tax from accounts receivable and other current assets.

Inventory turns were 22.5 times this quarter, up significantly over the strong 19.2 turns in reported in Q2.

Inventory turns should remain at similar levels in Q4.

The total deferred revenue balance increased $123 million this quarter to $1.34 billion, a 10% sequential increase and a 42% increase in the balance year-over-year.

Before I turn the call to Dan, I will discuss our operating model for Q4.

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 that Tara cited earlier.

We expect Q4 revenue to be between $915 million and $945 million.

This represents a 3.5% to 7% sequential increase from the third quarter and about a 14 to 18% year-over-year growth rate.

On a non-GAAP basis we are expecting gross margins to be just north of 61% as service margins recede modestly from their record high in Q3.

In addition, operating expenses will grow slightly above the rate of revenue with an emphasis on sales and marketing related activities.

As a result we are forecasting our non-GAAP operating margins to be approximately 15%.

With this guidance, our non-GAAP operating profit margin for the second half of this FY '08 will be 15.8% in line with long-term target range.

Non-GAAP earnings will be approximately $0.35 to $0.37 per share.

GAAP earnings are expected to be between $0.23 to $0.25 per share.

We expect our diluted share count to remain roughly flat to slightly down in the fourth quarter depending on stock prices.

With that, I will now turn the call over to Dan.

Thanks, Steve.

Before I comment on the quarter, I would like to take a moment to recognize Tom Mendoza and his promotion to Vice Chairman of the Company.

Tom's dedication and NetApp's success over the past 14 years has been invaluable and in his new role he will focus on partner development, customer advocacy and Corporate culture, the things he values most.

The other promotion we have focus on partner development, customer advocacy, and corporate culture for Network Appliance, the things he values most.

The other promotion we announced is that of Tom Georgens to the newly created position of President and Chief Operating Officer.

Tom has 20 plus years of experience in the storage industry and in his two years with NetApp he has demonstrated outstanding leadership.

I'm confident that consolidating product operations and field operations under Tom will result in greater execution focused and I'm sure that he will enhance the NetApp tradition of delivering the most value for customers coupled with a strong competitive focus.

As his new role as Chief Operating Officer it is appropriate to have Tom take you through the results of operations for the quarter.

Tom?

Thank you, Dan.

Today I would like to update you on both this quarter's accomplishments and our opportunities for the future.

As Steve outlined for you, NetApp posted very strong results for this quarter.

One of our objectives for the last few quarters was to diversify our revenue stream beyond our top enterprise accounts.

As evidence of our progress our indirect channel grew 13% sequentially and 32% year over year to 63% of total revenue.

Arrow and Avnet's contribution grew more than 100% since last year and totaled 17% of revenue for the quarter.

Our U.S.

commercial business outside of our top enterprise accounts also helped reduce our concentration by growing revenues 17% sequentially.

While we are still committed to expanding our top enterprise accounts, we are also focused on expanding our presence in the over 80% of the storage 5,000 accounts where we have modest or zero penetration.

We are also making strides towards becoming more balanced geographically.

Asia Pac has gained momentum, growing 37% over Q3 of `07 to contribute 13% of revenue.

Overall, Europe has been consistently strong, contributing 35% of revenue this quarter, about the same as Q3 of last year.

The Americas accounted for 52% of revenue, up 18% year over year, reflecting a seasonally lighter contribution from our federal business.

Despite the macro economic uncertainty, it's important to remember the strong market position and compelling value proposition NetApp brings to its customers.

According to Gartner NetApp is the leader in the NAS unified storage market and IDC ranks us as the leader in the iSCSI market.

We have distinguished ourselves as the thought leader in IP storage and we successfully integrated native SAN capabilities into that same architecture to become one of the fastest growing SAN vendors in the industry.

We are now consistently seeing over 40% of our business including fiber channel or iSCSI protocols.

On January 29, the Storage Performance Council published an independently audited results comparing NetApp's SAN offering to EMCs CLARiiON.

Based on both Company's best practice configurations our FAS 3040 system demonstrated 24% better performance despite the fact that our system used Raid 6 data protection, which is typical of real-world environments instead of the performance optimized mirroring used by our competitor.

When snapshots were enabled of both systems, once again, typical of real-world environments, NetApp's performance advantage jumped to 234% over CLARiiON.

SEC also indicated that NetApp achieved these results with 68% better capacity utilization than EMC.

This lays to rest any residual doubt that NetApp has arrived as the leading SAN vendor.

These results will be a tremendous asset in our efforts to take additional share in the large SAN market.

Our recent acquisition of Onaro provides yet another way to penetrate competitive SAN environments.

Onaro enables customers with large heterogenous storage infrastructures to manage capacity, performance, recoverability, and change.

Onaro has now expanded its offering to include functionality for NAS and VMWare environments, most recently being awarded best of VM World by an independent industry group.

As a result of adding this technology to our portfolio, our sales force is excited about the opportunity to engage even more strategically with large accounts.

Some product highlights this quarter include the FAS 2020 system, our new entry level platform being named Storage Magazine's product of the year.

With the extension of the product line and our emphasis on expanding the indirect channel, our lower-end systems accounted for almost half of our units shipped.

Despite the growth in the entry segment, our fastest-growing products this quarter were our high end systems both in terms of units and dollars, now contributing almost 30% of systems revenue.

With mid-range systems still contributing a little over 50% of revenue the portfolio is very balanced.

We continue to diversify our product portfolio by investing in emerging products, some of which produced record results this quarter.

Revenue from our V-series virtualization appliance was at an all- time high.

The V-series provides customers with a superior NetApp data management functionality in front of arrays from other vendors.

Customers get more efficient storage management and NetApp gets a foot in the door in entrenched legacy environments.

Our VTL solution showed dramatic growth over Q2 and had a record revenue quarter while our storage security business posted its strongest quarter in almost two years.

(Inaudible) has doubled its number of customers in the last two quarters and has a strong pipeline of financial services, oil and gas, and telecom accounts.

We continue to advance our storage manageability software portfolio and yesterday we announced several new software products and services to improve storage efficiency in virtualized environments.

Server virtualization and VMWare in particular are top of mind among CIOs today.

NetApp's value proposition around reducing risk and complexity, while drive improved power and asset efficiency, allows customers to maximize the benefits of virtualizing their server infrastructure.

In addition, our powerful replication technology allows us to uniquely solve the desk recovery and backup issues which are particularly complex in a virtualized environment, thereby helping our customers to more quickly move beyond the test phase to full production deployment.

Our total petabyte shifts this quarter grew 26% sequentially to 173 petabytes of storage.

A large contributor to our growth in petabytes shipped is the huge proliferation of storage for backup, disaster recovery, and archival purposes.

The various copies of the data can outnumber the original by as much as 30 to 1.

To address this problem, NetApp offers the widest range of storage efficiency features including safe provisioning, flexible cloning, and deduplication.

In fact we are the only vendor to offer deduplication functionality across all copies of the data, including the original.

Uptake of our dedupe software has been tremendous with over 1,000 licenses installed in Q3 alone.

The last area of focus I would like to discuss briefly is our partner ecosystem.

We spent a lot of time with the teams at Microsoft, Oracle, SAP, and VMWare, and these relationships are stimulating more business for us every day.

These four environments constitute the majority of business critical data and are essential to the operation of most enterprises.

We have developed a set of software and storage solutions that uniquely enable superior performance and reliability for each of these mission-critical applications.

In addition, our IBM relationship also continues to deepen as IBM was up in our mix this quarter to nearly 5% of total revenue.

To summarize, NetApp has become one of the top storage vendors in the industry with a value proposition that affords us a long runway of share gain opportunity.

We are focusing on investing and expending our product portfolio, expanding to markets we cover, and diversifying our revenue streams to fuel our growth over the coming quarters and years.

We get more leverage every day from our indirect channel, our international business, and our partners.

I am excited about our prospects and I look forward to meeting many of you over the coming months to talk further about opportunities.

At this point I will turn the call back over to Dan for his closing markets.

Thank you.

Tom did an excellent job outlining why we are confident in the opportunities we have to grow our business significantly faster than the market as a whole.

We think that our value propositions with SAN and (inaudible) and iSCSI and secondary storage, virtual tape and data security are quite compelling.

We just finished a great quarter and although the economic environment remains uncertain, we believe we have the value proposition to allow us to continue to grow faster than the aggregate growth rate of the markets we serve and to increase our share of those markets.

In the last economic downturn in 2001 and 2002, the difficult economic environment provided us with an opportunity to gain entry in many new accounts.

Prospects were forced to consider alternatives to their high cost environments and try NetApp's alternative solutions because we helped them to reduce cost and manage their data more efficiently.

We were also at that time an established $1 billion business that could offer them global professional services and support and so we were a viable low-risk alternative.

We believe similar opportunities exist for new account acquisition and expansion today so we re not going to slow down our increase in sales capacity.

We are going to keep investing and expanding our coverage and new account focus to drive top line growth and capture share.

Please join us at our Analyst Day in New York on Tuesday, March 11, to get a more in depth look at our plans, our opportunities, and our perspectives on the market and our business.

You can contact our investor relations team for details.

I'm proud of the NetApp team for our accomplishments this past quarter.

It reinforces my confidence in our ability to grow at more than double the industry growth rates.

At this point I would like the open the floor to questions.

Please limit yourself to one question at a time and then if you have a second question, please return to the queue so we may address everyone in the allotted time.

Operator?

(OPERATOR INSTRUCTIONS) Our first question comes from the line of David Bailey with Goldman Sachs.

Thank you very much.

Last quarter you commented about your top 22 commercial accounts and said the revenue was down 4% year-over-year.

Can you comment on how that group did this quarter and have you see the weakness spread to a broader set of customers or geography?

David, this is Dan.

We have not tallied it up this quarter.

Last quarter we made that analysis to understand why we were a little short.

We did not want to do that math this quarter.

If you look at it, the performance for the various verticals has not changed appreciably quarter over quarter.

Financial services is lower than is traditional representation or mix.

Financial services in this past quarter was about 13%, typically it's closer to 17%, 18% so we have not seen any material change.

Financial services, which a lot of those large 22 accounts, are in that sector, I should point out, a third are in that sector.

So it's consistent although I cannot answer your question with a quantitative answer.

Okay, thank you.

Next question comes from Paul Mansky with Citigroup.

Great.

I was hoping you could update us a little bit on the pricing dynamic.

Looks like you took some action during the quarter to bundle some more software specifically with your SAN products.

NAS looks like it could be priced be at a premium.

Notice that EMC just reported their lowest platform software attach rate we've seen in quite awhile.

Do you believe you are still leading the pricing dynamic down into that SME segment particularly on the SAN side or have you seen some increased competition there?

Just any color you can provide would be helpful.

Paul, on the last call we indicated that we were going to try and move aggressively towards, with the introduction of our new low end products to move aggressively and expand those channels.

I think we did some of that.

More broadly I think our attach rates have all looked good.

Unit growth has actually looked pretty good.

I actually don't really see anything different in pricing.

I don't want to send a message that pricing is benign or any of those words.

I think it has been competitive for a long time.

But I don't think I saw anything last quarter that was dramatically different than the quarters prior.

Yes, the pricing initiatives that we talked about last quarter, we implemented and reported on, a lot of those were in the channel.

Some of those, as I think I mentioned last time, would never see their way to the Street, some of those took the form performance milestones that earned a partner-funded head count to do business development on behalf of Network Appliance and things like that.

Those programs were very, very successful, according to our channel people.

Thank you very much.

The next question comes from the line of Aaron Rakers with Wachovia.

Please proceed.

Thank you, thanks for taking the question.

I want to dive into the head count growth here, the comments you are really not going to drop any additional leverage down to the bottom line going forward.

Looks like you missed your target of 300 to 350 net new adds this last quarter, why might that be and what should we expect in terms of net head count additions here as we roll into the next quarter?

We didn't execute against our plan.

We were a little sluggish, if you will.

Probably erring on the side of cautiousness.

That said, it's a lost opportunity in some sense because the people we didn't hire won't be generating revenues for us in the future.

So looking forward, we are going to try and make up for a little bit of that this quarter as we catch up and really focus our investments here on sales and marketing activities that basically allow us to reach out further into the market and grow faster.

This is Dan.

I want to add one comment on top of Steve's.

We have some fairly unusual events this quarter as well with respect to convention of contractors and a few other things.

For instance, one of the operations in India was a bill to buy.

The numbers we'll give you on head count are regular, full-time employees, and the contractors and other forms of temporary employment is not included.

Next quarter we will see at least 100 or so increase in head count that does not have any associated increase in expense because of those unusual conversions.

Thank you.

Our next question comes from the line of Ben Reitzes with UBS.

Your line is open.

Hi, I'm here.

Just wanted to talk a little bit more about the guidance -- I mean, take the midpoint of 5 to 6% or so, sequentially, that's the lowest sequential growth rate for the April quarter since '03.

I just wonder if you could dive a little deeper into why you feel that's prudent at this time, maybe if the linearity of the quarter had something to do with it or bookings or any more color -- I mean, we are all on pins and needles here.

Hey, this is Dan.

Hey, Dan.

My guess is this is probably the lowest GDP growth rate we have seen in that same five-year period.

It's really just that easy.

It's not a function of anything we can put our finger on.

Still early in the year for most of our customers some of them haven't finalized their spending plans for this year, as I'm sure all of you guys know.

Just looking at the macro economic conditions I would have to argue that this quarter doesn't feel as robust as the last one.

Nothing specific to point to.

I don't think it is going to be the high end of our growth range.

Relative to prior years that is.

I think 2003 was a great comparison point.

Anything particular by geography?

You thought it was across the board?

It doesn't feel as robust.

Just across the board.

Asia is still doing really well.

Australia is doing well, Japan is doing well.

Countries in Europe are doing well, some are a little slower.

As we mentioned last quarter, the UK continues to be a little sluggish.

North America is actually rebounding a little bit, especially in the East.

I was very pleased to see the Eastern area which was dominated by -- that's where the headquarters for financial services are.

The East did very well so, again, it's not something that's global, it's not something that's across all verticals, either, and so it's really hard to pick.

The question for all of you -- and I think most of you look at the macroeconomic picture pretty closely -- do you expect the GDP growth rate to be up or down this coming quarter.

I haven't heard anybody say it is going to be up.

Okay, thanks a lot.

The next question comes from Tom Curlin with RBC Capital Markets.

Please proceed.

I think sticking with the bookings theme, you are entering an easier compare with respect to year-over-year bookings growth, the April quarter of last year being the first tougher quarter for you on year-over-year bookings so you would think that may offset what you're seeing in the macro environment.

Is that the case and related to that how would you describe your targets on backlog coverage f you will, for the end of the April quarter this year versus a year ago?

Are you taking extra measures to try to have coverage just given concerns about visibility relative to macro?

First, relative to the bookings, in Q4 of last year we had a very strong revenue quarter so the revenue growth was actually quite robust.

Books were 26% year-over-year, if I recall, the response from the July quarter.

Yes, but if effectively what we are doing is a compare year-over-year is on the revenue number not the bookings number.

As far as backlog, I think at this point I don't think we are going to give any more color into the backlog situation.

The bottom line, as we look forward, I think there's a lot more uncertainty than where we were a year ago, and I think that we are just trying to be cautious and trying to prudent here about what we focus on.

With that said, one point I would like to not lose sight of is that we've been working very hard on diversifying our revenue stream.

We talked about that on prior calls.

I made the comment that a substantial amount of the large storage buyers in this world are not yet our customers, and that's a key part of our focus.

I do believe there's opportunity for us to gain share and to grow our business, despite the macro environment but nonetheless to forecast independent the macro overhang I think would be a bit reckless at this point.

Just on the backlog coverage scenario, do you feel like you're taking extra measures on coverage given the macro environment versus a year ago?

Tom, this is Dan.

Coming into this quarter, our backlog profile looks like it did at the entry of Q4 last year so roughly the same composite backlog to work with and we would expect to have a normal backlog going into Q1 as a result of the bookings estimates we have and the revenue forecast we just shared with you.

So we've done a normal profile if everything came together as we'd hoped.

All right, thank you.

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

Please proceed.

Thank you.

I'm curious whether your guidance which is below your typical near double-digit sequential growth guidance, is mostly because of concerns about the macro noise, U.S.

and Europe or more specifically related to your backlog and your pipeline and things like that.

For example, do you have upside to double-digit growth in your opinion and relate to that, do you think that the July quarter -- I know that's two quarters out -- could be up like it has in the past, or?

The Street has it down sequentially.

I just mentioned the backlog was roughly the same going into Q4.

We expect to see at the normal levels as we head to Q1.

Is there an upside?

I'm an optimist.

You got to be an optimist in this business.

There's always the potential for double-digit growth.

Our guidance is what it is, right, it's exactly what we think is going to happen.

There's lots of puts and takes to this, right, there's lots of softness in the economy.

It also happens to be our fiscal fourth quarter where you have got the maximum sentence going for the sales team.

All boiled up that's how we came to the number we shared with you and that's where I would encourage you to land on your forecast.

Relative to Q1, I think you should assume Q1 is going down.

If you recall at the analyst meeting last year Steve showed what the normal seasonality is.

We have seen an increased sawtooth that has a drop from Q4 to Q1 over the last few years so you should expect to see that in Q1 of next year.

This is Steve.

I want to make sure we are very clear on this point.

The issue with the guidance we gave you, our backlog is in a normal position, our pipeline looks normal.

The question is, in this environment, are you going to close all that pipeline?

The question is, in this environment, how much aggregate demand is there going to be out there and frankly demand is down from some expectations because we are worried about the outlook.

You should also understand we are dealing primarily in a customer community with people who are at the senior director level.

They think they have funded programs for particular undertakings and if they are facing a budget cut, they don't know it until they get to the final sign-off where all of a sudden some things are decided to be cut from the plan others are stretched out in time.

We don't know how to forecast that.

Here's the interesting thing.

One of my directors told me in 2001 -- your sales guys are always the last to know because the customer they are talking to thinks he has a got a budget and that's the issue we are dealing with.

We don't know how to forecast that very well.

I would encourage you all to take a very conservative posture on your expectations for Q4.

And the next question comes from Katie Huberty with Morgan Stanley.

Good evening.

Just switching topics back to the business with the new server virtualization group in place, do you have any metrics you can share around the percentage of new installations that ar driven by or incorporated into virtualized server environment?

Probably no metrics that we are prepared to share at this point but if you look at field activity, you look at field engagement and you look at the new opportunities flowing into our pipeline, in fact, even our internal analysis about which of the primary opportunities do we use to renew accounts, it's very heavily skewed towards VM World so I have no doubt just by the empirical data that our penetration in VMWare the percentage of the total market, we are probably doing better in the VMware environment than we are doing overall.

So I'm still very excited.

I think that our focus and the team we put together is building the right capabilities so all-in-all I'm pleased with that.

There's nothing I'm specifically willing to share at this point but I think that we are doing better than our competition and I think our market share in that segment is greater than it is in the market overall so I feel good about that.

And the next question comes from Keith Bachman with the Bank of Montreal.

Please proceed.

Thank you very much.

I wanted to see if you could add some color either qualitatively or quantitatively on how we should be thinking about the different growth levers particularly between products, which came in at roughly 10% and the other categories of software and services.

How should we be thinking about that going forward particularly since sequentially, at least, the bookings on the balance sheet grew slower than the revenue rate?

So I just wondered if you could help us think about how we should think about the different revenue levers going forward?

Thanks.

I am going to let Tom answer the corporate question.

But the bookings on the balance sheet, what are you referring to?

I'm sorry, excuse me, Dan, deferred revs.

Excuse me.

Deferred revenues grew faster than revenues.

Not sequentially.

On a year-over-year basis they did, not sequentially.

I'm sorry.

Okay.

Okay, maybe I will start off.

I think Keith, what you're referring to is the fact that our products and software grew, the nonsubscription software--.

Correct.

Grew roughly at 10%.

Correct.

Just a couple of points.

You have to remember you're comparing back to periods when you had our CDBU.

Remember our caching business was included so you would have to add 1.5 points more of growth if you backed out CDBUs performance last -- year ago quarter.

Yes.

More importantly I think what we look at very closely is how fast our units grow and if you look at unit growth, again, sans CDBU, we're looking at 20% growth.

That's a lot of sockets out there for network appliance to build on and to attach secondary storage to and provide secondary solutions around.

So that's the number that we are looking at.

This whole shift that you've seen compared to a year ago to the lower end of the product line, the acceptance of the FAS 2000 series and the rapid ramp there is providing a lot of those sockets for us and that's what we think is really exciting.

Yes, just a little more color on the unit growth -- units have actually grown roughly 15% sequentially each of the last two quarters.

As Steve indicated, those are the things that we attach professional services, future software to.

So in terms of the metric that we're driving, clearly we want to keep driving the unit growth because that opens up opportunities to follow-on sales and includes the gross margins that go with it which remain robust.

Tom, does that suggest when you anniversary that mix issue that your revenue from products would increase?

There's a lot of complexity that goes into that in terms of discounting and deferred revenue and all those other types of things.

The underlying fundamentals is that we drive units we are basically opening up sockets.

I think we are doing well on both of those dimensions.

The typical system shift does not reach its full configuration in terms of things being added to it for at least two years so every system you ship, you essentially have a two-year annuity coming forward.

The other thing that's baked into those numbers is hardware upgrades, too, so you're seeing equipment sales which are different than unit sales also have to do with upgrade.

So upgrade activity will move that number around up and down.

As (inaudible) selling units the proxy for new footprint, it's also a door opener for future business so the revenue number isn't the entire story.

Okay, thank you.

And the next question comes from Bill Shope with JPMorgan.

Thanks.

Last quarter on the margin guidance you commented that part of the decline would be from the increased contributions from IBM on a seasonal basis.

I think you said it was going to be about one-third of the margin decline.

Was that actually how it played out in the quarter?

Looking at the April quarter, obviously IBM's seasonally weaker.

Is that going to be a tail wind for the April quarter margins and what does that say about how you expect pricing to trend?

So yes, pretty much played out like we anticipated.

IBM ended up roughly 5% of our business, it was up from the prior quarter, and it was indeed about 0.4 of a point.

We thought it would be up to 0.5 point.

Going forward IBM should moderate a little bit in terms of mix this quarter if history holds here.

If that's the case we should pick up roughly 0.1 of a point or so maybe 0.2 of a point in product margin.

Thank you.

Yes.

Next question comes from the line of (inaudible) with Pacific Growth Equities.

Thank you.

Can you comment on the impact of the Onaro acquisition on the bottom line?

And then are you seeing Dell being more aggressive on storage with their Equilogic acquisition?

It's a little early to comment on Dell/Equilogic.

That deal hasn't been closed for that long.

I don't think we've really seen any fundamental change in dynamics.

I think they are probably actively substituting product for one of our competitors and they see some impact of that.

In terms of marked dynamics, I don't think I have seen anything dramatically differ just yet.

It's still early.

In terms of the impact of Onaro and our bottom line, it's absolutely immaterial.

It's a rounding error next quarter and even next year it barely rounds to $0.01 in a worst-case scenario.

Okay, thank you.

Next question come from the line of Bill Fearnley with FTN Midwest Research.

Please proceed.

Thanks.

When you take a look at the competitive dynamics, is there additional color you folks can give regarding decision cycles, whether you saw your hardest competition from your larger competitors or your smaller competitors this quarter?

You talked about that in past.

From my viewpoint the competition is the market leader.

That's the one we encounter most frequently and that's the one we really focus most of our energy around.

The smaller guys, we think we have done an excellent job in response to the ones that we thought represented a challenge.

There's several in that category and we feel as though we have done very, very well.

Our win rates in all categories for the ones we have identified as ones we should respond to have increased significantly.

How about decision cycles, Dan?

Decision cycles I think they are really hard to judge right now.

Q3 is the worst.

I'll tell you why, because you have got some customers who face a use-it-or-lose-it situation at the end of the calendar year.

That effects decision cycles.

Then you get into January, which is always actually the toughest month for us of any month in the calendar because a lot of customer do not have firm budgets in place.

The first two or three weeks of January we can close the booking desk because there's nothing coming in.

You see them waiting for guys to nail down the budgets in mid January and hopefully things flow.

I can't read anything out of the January cadence.

It felt like a normal December/January, a big rush at the end of the year, dry period for the first few weeks of January and I just don't know.

Thanks.

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

Please proceed.

I actually had a follow-up question on your top enterprise customers -- I know you don't have specific numbers to give us but as you think about those set of customers and as you think about the opportunity there, are you fully penetrated with those customers, is there still share gain opportunities or do you think the trends with those top customers are solely attributed to kind of of the sensitivity around economic changes here?

This is Dan.

I think in the U.S.

of the 22 or so commercial top accounts, there is significant growth opportunity for a number of those.

But the real growth opportunity is reaching beyond us.

So let me give you a few stats real quick.

We have done this piece of work called Storage 5000 trying to identify the 5,000 organizations that spend the most on storage in the world.

Right now the Storage 5000 accounts are roughly three-quarters of our total business and only about, right now, one-third of those are, in fact, current customers.

There are at least 1,000, where we are less than 15% of their spending on storage.

This is 1,000 of the largest buyers of storage in the world who have a relationship with NetApp and we are very low in terms of their total mix.

Their percent of share.

That's where the opportunity is, from my viewpoint.

1,000 accounts that know us and hopefully that we can expand in.

Many of those, because they are so large, I think we can drive them into the top accounts program over the next couple of years.

Yes, I would share that.

If you look at the top enterprise accounts there are no doubts there are some where we have got the overwhelming majority of their wallet and we are going to grow at their rate but that's not the most common case.

There are some that we're doing well and as Dan indicated, a substantial amount.

That doesn't get to the two-thirds of that list where we have no presence at all.

So if you look at it, if you look at the investment levels and the decisions that dan and Steve spoke about, that's why expanding our sales capacity and expanding our awareness is so important to us.

We believe there's a substantial amount of customers out there that look just like customers that we have that buying products we already have that if we could just reach them, and get in front of them, we can grow our business.

That's helpful.

Thank you.

Next question comes from the line of Chris Whitmore with Deutsche Bank.

Steve, I was hoping you could update us on cash available for buyback, how much is in the U.S., how much is outside, and any thoughts or updates around buying back more stock given the depressed stock price?

You bet.

So we have right now we have crossed over the line in the fence where the bulk of our cash is now overseas.

And remember, that a good portion of our U.S.

cash -- in fact, over $300 million -- is now in the form of restricted cash, which is not available for buybacks either.

So as a result this quarter, what we plan to be in the market and repurchasing shares it will probably be a more modest amount than you've seen over the past several quarters, obviously.

And the next question comes from [Jason Nolan] with Robert W.

Baird.

Please proceed.

Thanks a lot.

I'm sure there's going to be a fair amount of speculation regarding your March 11, analyst day, any preview or additional color there would be--.

It is going to be great.

You should be there.

Yes.

We look forward to seeing you there.

Nothing you can say regarding road map or long-term operating model or anything along those lines?

You're certainly invited.

No, I'm not going to say anything.

Thanks.

You can join us on the web if you can't make it in person.

I'll be there.

And the next question comes from the line of Clay Sumner with FBR Research.

Please proceed.

Sure, thank you.

In the fall you guys were talking about building up backlog higher than normal after your July `07 quarter, higher than you typically carried in the past and with the economy deteriorating since the fall I would assume you would have tried to continue that trend.

Can you talk about book to bill was it -- I would assume book to bill would be better than 1 this quarter?

It sounds like you're actually saying the opposite.

Clay, we have talked before.

We are not a semiconductor company.

Book to bill is not a metric that is very meaningful for us.

Orders measure value, and revenue is subject to accounting regulations and accounting recognition rules.

So suffice it to say that our backlog is healthy and everything we know has been factored into guidance.

The most concern we have about the future has to do with the uncertainty that's out there in the marketplace.

As Dan says, GDP were growing at what it was a year ago type thing, I guarantee you we would be projecting faster growth rate.

The commentary here on the bookings and backlog, is that our backlog going into Q4 looks exactly identical to the profile we had going the last Q4.

It's now a function of what does the booking profile look like?

So we are sitting in a normal position relative to our backlog and entry to Q4.

In terms of percentages of all the kind of numbers we gave you.

Dan do you mind just reminding us what -- I remember you used to say I think high 205s of your product revenues with normal in a Q4?

You must have a very long memory because we have not done anything like that in a long time.

The backlog had to many complex components including professional services, VSOF deferrals that come off the balance sheet.

Other forms are reserves or sections.

It's a very complex problem.

That's why I say it has got the right profile.

In the older days back in the late `90s, early 2000 era, backlog was predominantly dominated by product backlog which would get billed and shipped.

That's now kind of a days gone by.

And the next question comes from the line of Scott Craig with Banc of America.

Thanks, good afternoon.

With regards to increasing the investments in the channel last quarter, when do those investments star to peak out so to speak?

Secondly, when looking at one of the GAAP measures to stock compensation expense it looked like it declined significantly as a percentage of sales.

Was there any strategy behind that?

Or did it just happen to be a lower share price with the same number of shares changing going forward?

Thanks.

Isn't that amazing accounting really provides the incentive for us to drop the share price?

That is, in fact, one of the by-products of how the numbers are calculated.

It was not a strategy to drive the price down.

As far as the channel goes, I don't know if I would use the word "peaked" that being an area of continued investment we want to leverage the channel to get us some of those Storage 5000 customers as well so whether it be the midsized enterprise or the Storage 5000 we intend to continue to push the channel.

I wouldn't want to convey a message that was somehow a one-time investment that has already passed.

Yes, I will am going to follow up on Dan's point to show you how -- well, just to follow-up on Dan's point.

We actually issued more shares for compensation last quarter both in the form of options and certain shares than we did the prior quarter.

But because of the stock price and because of the effect of the price, predominantly, you saw a reduction in the amount of stock compensation charge.

So that's just the nature of the game.

By the way we are on plan for our commitment that we gave all our investors at the beginning of the year, and we are right on the plan to achieve exactly what we committed to in our proxy review.

Okay, thanks.

Yes.

Our next question comes from Aaron Rakers with Wachovia.

Please proceed.

Yes, I would -- thanks for taking the follow-up question.

I guess my question is around the IBM relationship, understanding that it grew on a sequential basis.

When we look at the year over year growth it's really implying only about 3% growth.

Can you help us understand what's going on there and when we should maybe expect that to really start to materialize in terms of the year-over-year growth rates?

Aaron, last year's Q3 numbers were I would not say inflated but driven by a very large compare by a major sale to one major U.S.

retailer.

It was a great big, lumpy deal that showed up in that one quarter and I mean millions and millions of dollars in one quarter on that one account so it made for a very tough compare.

Then if I could ask a quick follow-up as well, free cash flow I know was above the historical average as a percentage of revenue, do you see that reverting back to that level this next quarter or should we think about these current trends continuing?

I think that you will probably see, again, if historical trends continue, if you go back to the last three or four fourth quarters you will probably see an extension or an expansion of our DSO and all things (inaudible) I would think that it would probably return to more of the historical compare.

Thanks for the follow-ups.

You bet.

The next question comes from the line of Tom Curlin with RBC.

Please proceed.

You have been giving quarterly guidance for several quarters now.

Do you plan to come back to an annual guidance policy or do you plan to stick with quarterly guidance?

At our analyst day on March 11, we will give you our full-year FY '09 guidance.

Every quarter we will just update you with the next quarter.

Once a year we give the annual guidance and this has been our practice for years.

Then every quarter we update the next quarter.

Okay, thank you.

You bet.

This concludes the question and answer session.

I would like to turn it back to Mr.

Warmenhoven for closing remarks.

I would like to, again, thank you all for joining us today and remind you that our much-anticipated analyst day is scheduled for March 11, in New York.

For details please contact our investor relations staff.

We'll look forward to seeing you there.

Again, thank you for your time today.

Ladies and gentlemen, this does concludes the presentation.

You may now disconnect.

Thank you very, very much.