NetApp Inc (NTAP) 2009 Q4 法說會逐字稿

Good day, ladies and gentlemen.

Welcome to the NetApp fourth quarter and fiscal year end 2009 earnings conference call.

I will be your audio coordinator for today.

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

We'll facilitate the question-and-answer session at the end of the presentation.

(Operator Instructions).

I would now like to turn your presentation over to Ms.

Tara Dhillon, Investor Relations, NetApp, please proceed.

Good afternoon, everyone, thank you for joining us today.

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

Today we are also presenting slides concurrently with our audio remarks.

They will be available for download on our Investor Relations site at the end of this call.

In the course of today's call we will make forward-looking statements and projections that involve risk and uncertainty including statements regarding our financial performance in future periods including FY '10, our expectations regarding the synergies and other anticipated benefits resulting from our proposed acquisition of Data Domain including that it will be accretive within 12 months of the transaction's close, the expected timing of when the transaction may close and our expectations regarding integrating Data Domain into our operations.

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, our ability to maintain or increase backlog and increase revenue, increased competition, our ability to successfully complete our acquisition of Data Domain and integrate its operations into our own, and the material and adverse global economic market conditions that currently exist.

Other equally important factors are detailed in our accompanying press release as well as on our 10-K and 10-Q reports on file with the SEC and also available on our website, all of which are incorporated by reference into today's discussion.

Please note that all numbers are GAAP unless stated otherwise.

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

We would also like to notify you that in accordance with SEC guidance published on August 22, 2008, NetApp will begin to disseminate material information about the Company through our corporate website within the next several fiscal quarters.

We intend to designate a separate portion of our website for purposes of these disclosures and will include a prominent link on our home page to allow visitors to locate this information, which NetApp will routinely update.

The website will supplement rather than replace NetApp's current existing channels of information distribution.

Now, with me on today's call are Dan Warmenhoven, Chairman and CEO; our President and COO, Tom Georgens; and our CFO Steve Gomo.

Dan will start with a brief discussion of today's acquisition; then Steve will review the fourth fiscal quarter financials; and Tom will discuss our operations and opportunities; Dan will wrap up with some closing comments before we open the floor to Q&A.

I will now turn the call over to Dan.

Thank you, Tara.

I'd like to start by saying how pleased we are to have the Data Domain team joining the NetApp team.

The addition of Data Domain to the NetApp family will bring a complementary product line with high growth and high synergy to our portfolio and we'll provide them with access to channels, markets and opportunities they have not yet been able to reach.

We believe the combination of NetApp and Data Domain can drive more revenue at less cost than could have been accomplished separately.

With their deduplication optimized backup solution for multi vendor storage environments Data Domain has been very successful selling to mid size and large enterprise customers.

They're in the early phase of making the investments necessary to move more broadly into international markets and expand their channel to serve more enterprise class accounts, which requires a significant amount of resources.

With 60 to 70% of our business coming from the enterprise segment along with our global distribution and customer support capabilities we bring tremendous leverage to their highly differentiated technology.

Combined with our primary, secondary and VTL capabilities we will offer an end to end storage infrastructure for any customer environment.

We see a lot of cross-sell and up-sell opportunities as well with less than 6% overlap on our existing Storage 5000 accounts, the combination of our two companies should help us increase our penetration within each of our customer bases.

We plan to operate Data Domain as a separate product line and a separate product management and development organization within product organizations.

The similar nature of their model -- they too are a software based solution wrapped in standard commodity components -- should help foster a smooth and rapid transition.

They have an outstanding record of new account acquisition and our objective will be to sustain and amplify that momentum while offering them the leverage of NetApp's global sales and service infrastructure as well as significant new opportunities within existing NetApp accounts.

On the strategic side that's about the extent of what we can share with you until the transaction closes sometime later this summer.

Steve will talk briefly about the financial aspects of this deal so at this point I'll turn the call over to him for his quarterly review.

Steve?

Thanks, Dan.

Good afternoon, everyone.

We're very excited about the opportunities today's acquisition brings but before we discuss the terms and the projected financial impact of the transaction let us walk through our fourth quarter financial results.

Non-GAAP revenue for the fourth quarter was $880 million up almost 1% sequentially and down 6% from fourth quarter last year.

GAAP revenue was $715,000 less than non-GAAP revenue due to an interest payment to the Federal government related to the GSA settlement.

Foreign currency effects decreased our sequential results by three-tenths of a percentage point and decreased our year-over-year growth by almost 4 percentage points.

Over the past two quarters we've seen a marked increase in the number of one-year renewals of both software entitlements and service maintenance contracts as many customers look to defer capital purchases and extend the life of their current systems during this economic downturn.

As a result, current period purchases of systems slowed.

With product revenue down 4% sequentially and down 20% year-over-year to $506 million.

Add-on software which is a subset of product revenue was 18% of total revenue.

However, revenue from software, maintenance and entitlements which is a deferred revenue element, was at a record high of $165 million or 19% of total revenue.

Software E&M was up 5% sequentially and 21% year-over-year.

Total software, the combination of add-on software and software E&M, was 36% of total revenue compared to 37% in Q3 and 38% in Q4 of last year.

Revenue from services was also a record $210 million and 24% of total revenue up almost 11% sequentially and up 22% over Q4 last year.

Services revenues are comprised primarily of hardware maintenance, support and professional services.

Revenue from service maintenance contracts is another deferred revenue element and was almost 60% of our services revenue category this quarter.

In Q4, it increased 9% sequentially and 25% year-over-year.

Professional services increased 13% sequentially and 14% over last year.

On a non-GAAP basis consolidated gross margins were 61.8% of revenue this quarter, up 1.1 percentage points from last quarter primarily due to higher mix of deferred elements carrying higher margins.

Compared to Q3 non-GAAP product gross margins were down eight-tenths of a point to 52.7% due in part to a lower mix of software, lower volumes and slightly higher manufacturing period expenses.

Non-GAAP service margins increased to 55% partly as a result of the higher margin contract maintenance business and also we had record high utilization in professional services.

Non-GAAP software E&M which increased in the revenue mix contributed gross margins that remained at 98.5%.

Turning to non-GAAP expenses our operating expenses totalled $426 million or 48% of non-GAAP revenue.

OpEx increased less than 1% sequentially and declined 2% year-over-year.

Operating expenses increased less than we had expected primarily due to continued emphasis on cost controls across the Company.

The restructuring that we implemented at the beginning of the fourth quarter is tracking to our expectations in terms of spending and head count reductions.

Our head count at the end of the quarter was 7,976.

A net decline of 407 people.

As we discussed in our Q3 call, the changes we made were designed to preserve our revenue-generating potential and increase our focus on key growth opportunities so we did have some targeted hirings of new skill sets in Q4.

On a GAAP basis we incurred approximately $33 million in GAAP severance and other charges associated with this restructuring.

Non-GAAP income from operations increased for the third consecutive quarter totaling $118 million or 13.4% of revenue in Q4.

Non-GAAP other income which consists primarily of interest income, was $4.4 million up slightly from Q3.

Non-GAAP net income before taxes was $122 million or 13.9% of revenue.

Our non-GAAP effective tax rate remains at 16%.

Non-GAAP net income totalled $103 million or $0.31 per share.

Now moving to our cash flow performance our cash from operations was $180 million down 24% sequentially and down 39% from fourth quarter of last year.

Capital expenditures were $135 million this quarter up from $51 million last quarter.

In Q4 we expended $119 million in cash to transfer two of our buildings which had previously been on synthetic leases on to our balance sheet.

This action was taken to ensure that we had ample head room to comply with all of the covenants associated with our synthetic lease agreements given the payment of the GSA contingency in Q1.

As a result of this transaction we now have more than adequate head room with respect to these requirements.

Free cash flow which we define as cash from operations less capital expenditures totaled $45 million, a decrease of 76% sequentially and down 80% from last year.

Expressed as a percent of non-GAAP revenue Q4 free cash flow was 5%.

Now adjusting for the purchase of the buildings, free cash flow as a percent of revenue would have been 19%.

As we previously disclosed in Q4 we settled a dispute with the General Services Administration.

The cash payment of $129 million including interest associated with the settlement, was paid at the beginning of the first quarter of FY '10.

Turning to the balance sheet our Q4 cash and short-term investments totalled just over $2.6 billion.

On our Q3 earnings call we also reported $2.6 billion in cash and short-term investments.

However, prior to filing our 10-Q in the third quarter, approximately $120 million related to the primary reserve fund was subsequently reclassified to long-term investments.

As a result the net increase in cash and short-term investments from Q3 to Q4 was $143 million.

At the end of Q4 our US cash balance was 48% of our cash or roughly $1.26 billion.

The total deferred revenue balance increased $86 million this quarter to $1.7 billion, a 5% sequential increase and a 14% increase in the balance year-over-year.

Turning to DSO accounts receivable, days sales outstanding were 44 days this quarter compared to 36 days last quarter and 56 days in Q4 last year.

Inventory turns were 22.1 times compared to the 16.8 times achieved in Q3 as the move of our outsource manufacturing hub has been successfully completed.

Turning to our outlook for the first quarter of 2010, our forecast is based on current business expectations and 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 previously.

Given the limited visibility that persists in the macro environment we will not provide revenue guidance for the first quarter.

What we can tell you is that we expect non-GAAP consolidated gross margins to be around 61%.

We expect our first quarter non-GAAP OpEx to increase by 10 million to $15 million from Q4 levels, reflecting the impact of a 14-week quarter offset by a shutdown week before the 4th of July.

This projection excludes the impact of Data Domain.

For the second and third quarters of FY '10, non-GAAP expense levels are expected to average approximately 405 million to $410 million.

Subject to an adjustment based upon what we see happening in the economy and our pipeline.

These estimates also exclude the potential impact of Data Domain.

With regard to the acquisition under the definitive agreement we will be purchasing Data Domain for approximately $25 per share or $1.5 billion on a diluted basis, net of cash, using a combination of cash and stock.

Data Domain shareholders will receive $11.45 in cash and $0.75 shares of NetApp common stock for each share of data domain common stock.

This totals approximately 47 million shares of NetApp common stock.

We expect to finance the cash portion of the transaction through our cash on hand.

The deal is anticipated to close in 60 to 120 days subject to customary closing conditions including regulatory approval.

I'm very pleased to report that we expect this transaction to be accretive on a non-GAAP basis within 12 months of close.

This is based upon just their projected revenue alone, with some conservative cost synergy assumptions.

In addition to the more obvious synergies related to operating philosophy, corporate culture and geographic locations, there are also expected to be longer term tax benefits as their international business grows and we incorporate Data Domain into our tax regime.

Finally, there are clearly many opportunities for revenue synergy and we intend to pursue those aggressively.

However, given the macroeconomic uncertainty that exists we chose not to include any revenue synergies for the purposes of this analysis.

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

Thanks, Steve.

I'd also like to echo my excitement about the acquisition.

Data Domain is a high growth innovation leader that is accelerating the adoption of disk as an integral and in some cases sole component of customers' backup solutions.

At our last analysts day, I spoke of four major trends in the industry where NetApp intends to capitalize.

Among them were backup redesign and storage efficiency.

Data Domain storage efficient backup and archival solutions are absolutely consistent with and contribute significantly to that strategy.

NetApp has an especially strong position in backup and archiving deals where NetApp owns the primary storage footprint.

Data Domain allows us along with our existing VTL product to actively anticipate in a much larger number of secondary storage opportunities that exist when we are not the primary storage provider.

Returning to NetApp's fourth quarter, we saw several encouraging signs in our business.

Revenues were up from Q3, our mid-range products had a resurgence, both our federal and European geographies were solid and our top enterprise accounts had a substantial sequential increase in revenue.

Storage efficiency continues to be the number one demand driver for our business during this challenging economic period as we allow customers to meet their business objectives with less physical storage, a commitment we will guarantee.

Last quarter we discussed that the portion of our business most impacted by the downturn has been our top 50 enterprise accounts which we call our TEAs.

This quarter we saw a 22% sequential increase in their contribution, accounting for 26% of our total revenue.

However, we saw a significant increase in orders from customers renewing software and service maintenance contracts rather than incurring the capital expense of a tech refresh.

In fact, there were a record number of one-year maintenance renewals this quarter.

This supports our contention that our equipment remains essential to our customers' operations and we are not being displaced by competitors.

It also may be an indication of future demand for tech refreshes once the economy recovers albeit in a time frame that is not currently predictable.

Nonetheless the current trend resulted in a relatively solid overall performance but continued softness in our product revenue.

The impact of our TEA accounts is most noticeable in the results of our direct sales force.

While direct revenue was down 15% year-over-year, it was up 6% sequentially.

Our indirect channel was 68% of the total down 1% year-over-year.

Arrow and Avnet each contributed about 10% of revenue totaling almost 21%.

Our IBM OEM business was up 22% year over year contributing 4% of revenue.

From a geographic perspective, the mix was almost identical to Q4 of last year.

EMEA revenues were down 3% from last year, and contributed 36% of the total.

Asia Pac was down 8% from last year, and was 10% of the total.

While the Americas contributed 54% with revenues down 8% from last year.

Within the Americas the federal team contributed 12% of total revenue up 2% year-over-year and up a strong 23% sequentially.

We added another 480 net new accounts this quarter with contribution from new customers at 14% of bookings down slightly from last quarter.

While business from new accounts won't fully offset the year-over-year decline in the TEAs for a while, we're progressively building a broader, more diversified account base that positions ourselves well for the future.

The maintenance renewal versus product purchase phenomenon I spoke about earlier, was also reflected in our total storage systems shipped this quarter which was down just under 5% year-over-year.

Interestingly enough the decline came from our FAS2000 entry level units also down 5% year-over-year.

Our mid-range FAS3000 series units were stronger as the recently refreshed product line gave greater acceptance.

3000 units were about flat year-over-year and up 11% sequentially.

And contributed 60% of storage systems revenue this quarter.

The high-end FAS6000 systems were flat sequentially both in units and revenue although down 30% year-over-year in units shipped which seems typical of other high end storage systems in this environment.

From a protocol perspective, our NAS business has been particularly impacted by the drop-off in business from our TEAs.

A NAS protocol was included in 56% of our booking this quarter compared to 67% in Q4 of last year.

The biggest contributor of our NAS protocols is CIFS for Windows environments, which was down slightly in units both sequentially and year-over-year.

The bigger impact to our NAS business came from a decline in the traditional NFS component which is predominant in our oldest and largest accounts.

While our relevance remains intact the lack of new equipment procurements in those environments resulted in our considerable NAS decline.

Partially offsetting this trend is the recent rapid increase in the deployment of NFS in VMware environments.

NetApp NAS now supports about 25% of our VMware deployments and this segment of the business has doubled over last year.

Orders with a fiber channel SAN or an iSCSI component, totaled 45% of our bookings this quarter with 32% including fiber channel and 19% including iSCSI.

6% of those orders had overlap including both protocols.

Fiber channel SAN continues to be the most commonly deployed protocol in first time sales to new accounts and we also saw good growth in SAN from our enterprise accounts and with our larger systems.

Our SANscreen product continues to exceed our expectations achieving over 140% of its bookings goal in its first full year as part of the NetApp product family.

Our V-Series platform had its fourth record quarter in a row as our sales force increasingly uses it to break into new accounts.

Customers deploy this solution in front of their existing conventional EMC, HP and Hitachi infrastructures to achieve functionality and efficiencies not available from those legacy architectures.

There's a remarkable 71% dedupe attach rate to our V-Series products as customers can instantly recoup their investments in a V-Series through storage reclamation.

In today's environments customers are still willing to invest in IT if they can achieve a return on investment in a relatively short time frame.

Typically less than 12 months.

This is why server virtualization continues to grow in a down economy and NetApp remains a direct beneficiary of this trend.

Our storage efficiency technologies, such as deduplication with over 37,000 licenses downloaded as well as thin provisioning and virtual cloning, all dramatically reduce the cost of storage.

The increased deployment of NFS in these environments further strengthens this uniquely NetApp value proposition our competitors cannot manage.

VMware remains one of the primary application environments we enter when we win new accounts.

We're also seeing the next phase in the deployment of server virtualization as people are using it to create next generation data centers and outsource services.

These have many names such as virtual data center, dynamic data center and internal and external clouds.

In all of these environments the NetApp value proposition around virtualization is especially relevant and represents some of our most successful customer engagements.

In looking beyond the rhetoric to actual customer deployments I would match our progress against anybody else in the industry.

We feel confident about our competitive position and our win rates are similar to previous quarters.

That said, visibility remains cloudy around overall IT spending.

We, therefore, took serious steps in Q4 to increase our efficiency.

And as Steve mentioned, the NetApp team continues to be frugal relative to operating expenses.

We're hiring in strategic areas in a limited basis while keeping a watchful eye on expense controls.

Our goal is to optimize our resource allocation to support our strategic initiatives and protect our sales capacity for future growth.

With that I'll turn the call over to Dan.

Thanks, Tom.

Looking back on our fiscal year 2009 NetApp ended up faring well in light of the economic environment.

We achieved record levels of new customer accounts this year.

Customers are increasingly turning to NetApp for the answer to their intractable problem of growing data and shrinking budgets.

We offer them lower cost, easier manageability and a smaller hardware footprint and our software intensive solution preserves our gross margins even in challenging economic times.

With non-GAAP annual revenues up 7%, we were below what we had hoped to achieve this year but relative to the industry I feel good about our accomplishments.

We've also expanded our operating margins three quarters in a row demonstrating our commitment to controlling expenses, although it was unfortunate that we had to implement the restructuring plan we announced early in the fourth quarter, given the challenging business environment it was the prudent thing to do.

It gave us the flexibility to implement changes intended to optimize our resource allocation, improve our efficiency and bolster our growth potential while at the same time reducing costs.

Our goal in any economic environment will continue to be the expansion of our long-term market share, and we believe the actions we've taken will help us achieve that.

Looking now to Q1, there are a number of variables which will affect our bookings and revenues in this quarter.

Our fiscal Q1 tends to be seasonally down from Q4, this Q1 is a 14-week quarter as we realign our fiscal year to the calendar.

We also plan to shut down our headquarters and development locations for the week prior to the 4th of July.

Customers' budgets seem to have solidified somewhat albeit at lower levels than last year.

Some are choosing to extend the life of their existing systems and extending support contracts, rather than refreshing those systems with the purchase of new ones.

Given the uncertainty around customer sales cycles that persist, especially concerning close rates in this economic environment, it remains impossible to predict Q1 revenues with any degree of accuracy.

Hence, our decision not to give quantitative revenue guidance again this quarter.

As I mentioned earlier, the acquisition of Data Domain is expected to close sometime in the summer.

Given our desire to focus on the successful completion of this transaction and the fact that there's only so much we can say until the transaction closes, we have decided to postpone our upcoming analyst day until the latter part of September.

At that time I believe we'll also have a somewhat better indication of how the economy is doing and the resultant impact on our business going forward should be clearer.

We'll also be able to talk more in-depth about the integration of Data Domain and include Frank Slootman CEO of Data Domain on the event.

We expect to confirm a new date in the next few weeks and at that time our IR team will provide you with more specific information.

Depending upon the timing of the close we may also slide our August earnings date out by a week.

We'll update you on this early in August.

In closing, I'd like to thank the NetApp team for their passion and commitment and ask them all to extend a warm welcome to the Data Domain team.

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

As always, please keep it to one question per person and then return to the queue for any follow-ups.

Thank you.

Operator?

Thank you.

(Operator Instructions).

Your first question comes from the line of Keith Bachman with Bank of Montreal, please proceed.

My question, Dan, is for you.

In the past, you've commented that deduplication was a feature, not a product.

And I'm just wondering how your changing has evolved due obviously to the pending acquisition of Data Domain?

This is Dan.

Actually my view has not changed.

I mean, deduplication is to me in fact a technology that has got multiple variants, we've got deduplication of primary that is based on block alignment, we've got deduplication for our VTL product that has got a different model.

Data Domain's instream, realtime, variable window is a different style, Riverbed, as you know has a different style.

So I do think it's a technology that has got multiple variants.

I think the key here is not that they have deduplication.

I think the key here is they have taken that and put it into a product line which is extraordinarily well suited as an appliance to slip easily into customers' backup environments in a broad way.

It's easy to use, easy to deploy, very efficient, et cetera.

So to me the deduplication is an enabler for a product solution which they have done a particularly good job at implementing across a very broad front.

If you look at the accounts they target which is basically the input I got from their team, they really think they have more value ahead in non-NetApp accounts than they do NetApp accounts.

The reason is in the non-NetApp accounts in general the customers haven't done anything to reduce the use of tape, don't have a solution for dedupe et cetera.

In the NetApp accounts many of our customers have already deployed NetApp secondary storage, they have done the deduplication on primary, et cetera, they've reduced the utilization of tape and so on.

So the remaining set of customer issues is not as severe as it is in non-NetApp primary storage environments.

And that's really where this thing is aimed.

What I would add to that, Keith, is you can argue whether dedupe is a feature or product.

But I think what is unmistakable, is that archiving and disk-to-disk backup are clearly market and customer problems that need to be solved.

So Data Domain also has deduplication as a key component.

But they also have IP replication and a whole other set of features that enable to be competitive in those markets.

So this is not just about deduplication, it is about the whole product technology and the whole product solution targeted at markets that are clearly high growth that are adjacent to markets that we currently serve.

I'll jump back into the queue.

Thank you, guys.

Your next question comes from the line of Wamsi Mohan with Merrill Lynch, please proceed.

Can you give us some sense of what percent of your customers in your opinion that are due for a hardware refresh are actually renewing their maintenance contracts?

And on the expense side, what is causing the OpEx to go up from current level assuming you had already contemplated the extra week when you spoke about fiscal 1Q OpEx levels last quarter?

The question about the refresh is what percentage, I think that's a hard thing to tell.

I think clearly the number of one-year agreements tells me that people are looking to extend the life of their equipment in this environment.

But those are two-year agreements and three-year agreements, and will they when that one year is up renew them again for another year?

I don't think we know the answer to that question.

I think it is going to be a function of spending, it's going to be a function of the economic recovery.

So the short answer is I probably couldn't quantify that for you, just to say it is clearly a trend we have seen this quarter, actually beginning last quarter and continuing into this quarter.

Wamsi, this is Dan, I'm happy to answer the question on expenses or have Steve answer it on the next tour through the queue.

Your next question comes from Aaron Rakers with Stifel Nicolaus.

Please proceed.

Yes, thanks for taking the question.

I guess I want to understand, clearly you guys put up some very solid numbers on a relative basis in the software entitlement as well as in the services line.

As you see that kind of roll off your balance sheet.

Clearly we've seen over the last few quarters some deceleration in the year-over-year absolute change in your deferred revenue.

I would like to understand do we continue to see some deceleration in the growth rates of those two what are increasingly important line items for you.

If you can give any color on how we should think about deferred revenue rolling into the P&L, that would be very helpful?

This is Steve here.

So we track this very carefully, what should be called our deferred revenue waterfall.

Basically I would anticipate that you're going to see a continued, over time here deceleration of the deferred elements reported as revenue.

It is a simple matter of our business has flattened over the past multiple quarters and as that has happened we are not adding deferreds to the balance sheet as fast as we once were.

And the old stuff is coming off relatively at a pretty high rate.

That said, the point that Tom made about all the renewals we're seeing this past quarter and the large service contracts at the point of sale, keep postponing that deceleration a little bit, so I would expect to see just slight deceleration over the next couple of quarters, but it's -- the mix in terms of total revenue, it's going to be roughly where it is today.

Thank you.

Your next question comes from the line of Amit Daryanani with RBC Capital Markets, please proceed.

Thanks a lot.

Guys can you just help me understand why do we expect gross margins to be down sequentially in July?

Does that just reflect you expect sales to some degree follow historical seasonality and be down as well or is it something in the mix or pricing that's driving that?

I think we expect to see gross margins north of 60%, I think we said approximately 61%.

That would be down from this quarter.

It just depends on what happens with our product mix there and our product business.

It's just a placeholder if you will.

There is a little bit of a range around that.

Volume will also play a big factor there.

Thanks.

Your next question comes from the line of Mark Moskowitz of JPMorgan.

Please proceed.

Yes, thank you, good afternoon.

Dan, I wonder if you could talk a little more about the inspiration for data dedupe in terms of this acquisition and your confidence it can be integrated cleanly.

It is a bigger type of transaction than you had done previously and you've had some deals in the past where you really weren't able to achieve your goals with respect to Spinnaker and Decru in terms of achieving greater technology capabilities.

I wonder if you could talk a little bit more about that?

Yes, this is Dan.

Certainly this was a little different than both Spinnaker and Decru.

Spinnaker was completely an integration.

We were trying to fuse together two separate technologies, that was a much harder problem than I think we anticipated going in.

Decru had a little different outcome.

While I agree with you it was not the fulfillment of our expectations I think because we saw that market shift much faster than we thought.

Security moved from data at rest to data on the laptop really quick and budget shifted and so the growth slowed.

Here I think the situation is such that first of all we understand in our sales organization how to identify these opportunities, how to position to the customer it is an appliance styled product, it's still a storage product, not too dissimilar from the kind we already offer.

It goes into a slightly different application environment, but it's fundamentally outside of that very similar to what we've already been doing.

Another way it actually looks architecturally like our products as well.

It is an industry-standard kind of platform.

It uses Xyratex shelves and it has got a very unique operating system on top.

And I got to tell you, the NetApp sales team really understands that model and how to sell high value software wrapped in inexpensive hardware.

So it has got all of the attributes we think for one of the -- a easy integration, even operationally, I mentioned the same shelves, but it's very similar architecturally from a support model.

A lot of the business strategies that they pursued were very similar to NetApp's, things like auto support, and so on.

And we think it is going to be very straightforward.

They're in largely the same facilities as well.

The headquarters is right down the street from us in Santa Clara, and they have a facility that has all the support center and Research Triangle Park, within about a five iron shot from our office.

The employees -- we are co-located around the globe in almost all the same places.

We think it is going to be fairly easy to put it all together.

Five iron.

Dan's a big hitter.

I would say -- I would be reluctant to compare the different transactions.

Certainly we did the Onaro transaction at the beginning of last year, and that has been an unquestioned success.

And Spinnaker was primarily a merging of operating systems, so there was a lot of technical complexity associated with, and we still intend to reap the benefits of that deal, albeit probably a little bit later than we had hoped.

But I think the key dynamic here in all of these deals at the end is the market opportunities, and I think what's different is that Data Domain has already proven that there's a market opportunity and they've already built an organization to exploit it.

So I think the business has a lot more momentum and I think there is a lot less investment required on behalf of NetApp to make a market.

I think they already have momentum, they already have business, they already have growth and I think we're in a position to add to that as opposed to building it like we had to do in other situations.

So I wouldn't draw an analogy between other transactions and this one.

I think all the points Dan said, the affinity of the products, the affinity of the sales force, the adjacency of the market segment, all those things lend themselves to a fair amount of optimism.

On top of that obviously their existing business success already speaks for itself.

Your next question comes from the line of Brian Freed with Morgan Keegan.

Please proceed.

Thanks for taking my call.

If you look at the historic execution in your sales force in Q4 which has always been phenomenal, how much of the stability you're seeing out there do you attribute to the macro environment versus the sales execution at your team?

Brian, this is Dan.

We had that discussion internally in extremes.

It is very difficult we conclude to separate the year-end effect of our fiscal Q4 and the sales incentives and attainment of goals and so on from the underlying macroeconomic environment.

You are correct that historically our sales team does a blow-out job in Q4.

This quarter it turns out that it showed up in the way of booking of service extensions.

But nonetheless they did a great job.

We really can't see through that to see what the underlying demand picture is.

Okay.

Your next question comes from the line of Mark Kelleher with Brigantine Advisors.

Or Brigantine Advisors.

Thanks guys.

Just wanted to go back to the gross margins, particularly on the product margins.

You're down five quarters in a row there.

Can you just talk about the trends that are driving that, the factors underneath that and maybe tie that into the competitive environment to the extent that that's affecting product margins?

Thanks.

Mark, this is Steve here.

So let's go back to a year ago where we made a reporting change as we entered this fiscal year.

And basically what we did was we changed the way we reported our warranty expense.

We previously, including the fourth quarter of last year, had warranty expense included in service, and starting with the first quarter of this year, we moved those charges up to product cost of goods sold.

That increased -- that decreased the product gross margins by about 1.4 percentage points and added about 4.5 percentage points of service.

Didn't change the total gross margin for the Company.

Throughout this year, as you know, we've struggled with the currency head wind.

In fact, this quarter you can see that compared to a year ago we're down 4 percentage points.

It doesn't take much to calculate to figure out how much of that would be products and how much of that impacted the products.

So a large -- a substantial portion of the reduction, probably on the order of about 2 percentage points is due to currency.

This year we've also seen a dramatic shift in mix to the low end of the product line, and we chronicled that in these calls over time here.

So that is a surprise to nobody.

We've talked about how the software attach rate is different at the low end than it is at the high end, so software attach rate basically goes with that.

So those are the primary drivers.

In addition, in our manufacturing operation which is primarily outsourced, we still have a number of fixed expenses, if you think about our departmental expenses, some of our fixed logistical expenses.

Those are fixed in time and as volume drops they pop up in terms of cost of goods sold and they reduce the margin as well.

So those are the big drivers of the margin performance in products.

Thanks, very helpful.

Next question comes from the line of Katy Huberty with Morgan Stanley.

Thanks, good afternoon.

I understand there is probably a wide range of outcomes for the July quarter, but given you've now seen two quarters of well below normal seasonality, you're starting to see firming of budgets, good, recent new account wins.

Is there a potential that at least the high end of that range of outcomes could include a scenario where July seasonality is better than normal, the decline is less than normal?

I think that any scenario is certainly possible.

I think, as I said in my comments, we would expect this quarter to be down in a sequential sense.

And I'm not seeing anything that would cause us to forecast anything that would be a blowout, that is for sure.

We're typically down, I think last year it was about 6% sequentially, 7%, something like that, and I -- I would think that we're, we're looking at the same kind of range.

I don't see anything that would make that different this year.

Got it.

We talked earlier about -- about the fourth quarter effect on our sales force, the consequent action of that is there is a first quarter effect on our sales force as well and it is typically our weakest booking quarter, so the combination of the normal seasonality of performance of our sales force in this quarter combined with the uncertainty in the market makes it really difficult.

I don't necessarily believe that there's any reason there to be any more certain about our guidance than we were a quarter ago and that's why we aren't giving any.

Your next question comes from the line of Bill Shope with Credit Suisse, please proceed.

Thanks, guys.

Question on the margin line, as well.

Your services margins are obviously far higher than we've seen in the past.

Can you comment on what you would characterize at this point as sustainable levels longer term.

And when would do we start to see that trend down to sustainable margins and what would be the drivers there?

You broke up in the last 10 words of that question.

Can you restate the last piece of it?

Sure.

I was saying, what would be the drivers towards pushing it down to more sustainable levels longer term?

If you're talking about the deferred elements in our P&L which are the software entitlement and maintenance, obviously that is not going to change.

The services gross margins popped up this quarter primarily -- two things.

The short-term phenomenas will probably wane here, is the fact that our professional services utilization hit an all-time high.

I would not expect to see the professional services utilization stay at that level and thus that will cause the services margin to drop slightly.

On the other hand, the customer support business, as the volume grows et cetera, we're really spreading a lot of the fixed costs that are associated with that business over a larger and larger volume build, so I actually expect to see for the next several quarters to see the contribution of gross margin from the support business actually increase.

Those two will have a somewhat offsetting effect, but the professional services decline and utilization will offset it and drive the margin down a little bit.

Okay.

Just to clarify if I could.

Historically we've seen them in the 30% range, 40% range and now we're in the 50% range.

I mean, where in those categories would you characterize as normal margins for the segment?

I think that over the course of the foreseeable future it's going to hover around a number that starts with a 5.

Okay.

Perfect.

Thanks, guys.

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

You indicated that you expect the Data Domain deal to be accretive after one year using their internal forecasts.

Can you share with us what those forecasts are and given that you don't have visibility to give guidance for July, what gives you confidence that those numbers are realistic?

Thanks.

This is Dan.

We have the same problem forecasting revenue for them that we do for us.

Although, you take a look at various items such as sales capacity, things like that, and you kind of get to a range.

And I will say that all of the statements that Steve made had no assumptions in there about revenue synergy, or any operational cost synergies in the sense of opportunities associated with consolidation of supply chains -- for instance I mentioned the Xyratex opportunity -- or support centers et cetera, logistics and parts and third-party maintenance.

It was a very, very conservative assessment of expenses that would be saved primarily in the G&A functions, and that is really it.

So we didn't make any further assumptions.

Even with that little bit, it becomes accretive in four quarters.

Your next question comes from Ben Reitzes with Barclays Capital, please proceed.

Could you elaborate a little bit more on the quarter in terms of what you saw?

You said that budgets seemed to have stabilized.

Obviously it still seemed like product revenue was a little below expectations and there was a little better than expected on all the other lines obviously as you said.

Just in terms could you just give us a little more detail about linearity to the quarter on the product line and then why you say budgets stabilized and then just a little more color maybe by geo as well, Europe versus the US, if you don't mind?

Yes, this is Dan.

The budget issue I think is one where if you remember last quarter's conference call, it occurred in February and a lot of customers are still going through a budget churn.

I knew this wasn't any resolution yet as to what the capital spending plans were.

Now that situation has been pretty much reconciled.

I think we understand their intentions, in general.

Although it is at a much lower level than -- than sort of last year's spend was.

I think you've seen this reflected in every single vendor who's reported results.

My recollection is IBM was down about 20% in storage, EMC was down 20%, HP was down 22% yesterday.

So I think you're seeing less capital spending in general.

And I think what happened in our case is that customers decided that that equipment they had which typically they amortized over three years, they could use for one more and that is how you saw the shift move to -- or away from capital spending and into renewals of one-year duration.

Linearity was pretty good throughout the quarter and looked like any other typical Q4.

The race to the finish line in Q4, is kind of a NetApp experience.

So this one was one, too.

Do you think you're seeing a mix shift to your products an advantage, because you tend to have a lower price for first (multiple speakers)

I'd be happy to have you get in the queue and I'll do that one later.

Okay.

Your next question comes from the line of Rajesh Ghai ThinkEquity, please proceed.

Good afternoon.

You mentioned that your top 50 accounts witness a sequential increase with respect to Q3, can you give us some color on the increase in demand in the product mix and what sense you have for enterprise spending going forward?

Let me just clarify one thing because apparently I caused confusion and then I'll turn it over to Tom for the answer.

There are two separate categories of accounts.

One is what we call our top enterprise accounts which are those which we think deserve special treatment.

And the top enterprise accounts is an account management program.

There is roughly about 40 or so accounts on that list -- sorry, the top 50 accounts is the historical order pattern.

So last quarter when I referenced the top 50 from a year ago I literally meant those who have, in a rank order sense were our largest order customers in our that quarter.

That is not necessarily the TEAs, and I'm sorry I created that confusion.

Tom, you want to answer the TEA question?

Yes, as far as the TEA is concerned, we had great sequential performance from the TEAs, up 22%.

But what I don't want to imply is that somehow they were in a distribution that was somehow clustered between 20 and 25.

We have some that were (inaudible - background noise) huge and some that were up huge and they netted out in a net positive around 22%.

At this point it is good to see the momentum, it's good to see some business come back.

Lot of it is in form of renewals as opposed to product refreshes just now but it all counts.

But I think at this point given how uneven they are, it is hard to basically declare a victory and assess if that's some kind of a trend.

Basically we had a very, very wide range of performance and in the net, the gainers outnumbered the losers.

But I think until we see more consistent performance across the board I think we'd be reluctant to say that anything has dramatically changed in the spending environment.

Okay.

Thanks.

Your next question comes from the line of David Bailey with Goldman Sachs.

Please proceed.

Just following up on the increase in one-year maintenance renewals that you had in Q4.

Have you seen any pickup in add-on storage sales this quarter and what impact does that have on margins?

That's a great question.

I expected it but it didn't happen.

I really did think, and this is Dan, I really did think that we would see the same pattern that we had seen at the last downturn in 2002 that as customers delayed orders of new systems or upgrades and refreshes that we would see additional add-on storage and that did not happen in the mix.

We think it may be that more customers are turning on our primary storage deduplication capability and reclaiming storage, but that is a speculation only.

Yes, I think I share those answers.

I think we've been wrestling with that a little bit ourselves.

One theory that is out there is, since we shipped a bunch of low end systems over the last year and a half, in a lot of cases instead of upgrading just storage only, it is just as easy to buy a full system.

So perhaps we will see a little bit less of that.

This past quarter we also saw a fair amount of increase in our mid-range business.

So if anything, maybe in prior quarters percentage of add-on storage and maybe some of those machines have reached their limit and now they're actually upgrading.

So the good news is we saw a fair amount more FAS3000 platforms this quarter.

I do believe that the storage efficiency component is also in play.

I think people are up against their budget limits and we have a bunch of features and I think it gives them a very, very strong incentive to actually deploy them before actually making the transition to buy new hardware.

Thank you.

Your next question comes from the line of Brian Marshall with Broadpoint AmTech.

Good execution in the challenging environment.

Question with regards to the Data Domain transaction.

From a contribution analysis perspective it looks like 25% of the newco is going to Data Domain despite the fact they had about an incremental 10% of revenue in EPS.

Can you talk about anticipated cost in revenues and synergies from the transaction and how that results to getting to accretion within four quarters?

This is Steve here.

First off, in anything we've discussed so far we've not included any revenue synergies in our projections with respect to accretion and dilution.

We said that we expect the transaction to be accretive within a 12-month period, and there's basically a category of things that we have quantified for that analysis and they are the base level things, Board fees, audit fees, legal expenses, accounts -- excuse me, IR, facilities is huge, as Dan mentioned, there's a lot of savings in facilities because of where we co-locate, IT costs.

Things like that.

So we were able to identify that -- we're not pinning hopes, yet on any cost of goods sold synergy that Dan referred to in the supply chain.

We haven't quantified any impact of any benefits in our support business from leveraging their logistics costs with ours, et cetera, which looks to be very positive.

Also in the out years, beyond that first 12 months, looks like there might be an opportunity for us to leverage our tax regime as their international business expands.

That is how we came about these numbers.

The one area I would add that is important here is the area that we're not seeking synergy.

Outside of infrastructure and overhead, we're not looking to achieve synergy on the engineering side in terms of development capacity, and likewise we're not looking for synergy on the sales side in terms of sales capacity.

Certainly facilities, infrastructure tools, all of those things are areas that we're going to look at more closely, but we've got no plans here to basically reduce the development capacity of that organization or the sales capacity of that organization as part of our analysis.

Thanks, guys.

Nice quarter.

Question comes from the line of Bill Fearnley with FTN Equity Capital.

My question had to do with pipeline as you measure it by outstanding quotes and proposals.

What are you guys seeing on the direct side and when you're having planning discussions with the channel as you enter the new fiscal year on the pipeline side?

Software service and hardware color if you have any would be helpful as well.

I can't break it down for you by category.

We look at it in volume, by geo.

We do have very good visibility of the channel.

Because most of the channel guys get some degree of support from us in terms of quotes and configurations.

Pipeline looks really good, it looks great.

If this was a normal period you would see us being a lot more bullish on the results on the breadth of the pipeline.

The only problem is the conversion rates are very slow.

So need is high, customer engagements are high, the ability to convert those to revenue is where the challenge is and like we indicated this quarter, some of the original deals that have turned into renewals for software support -- software subscription and maintenance support, started off as refresh deals.

And so it's really hard to predict how this is all going to come out.

That is probably the unsettled nature of the period we're in.

But raw breadth of the pipeline looks very good.

Thanks.

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

Actually I had a follow-up question around the top 50, top enterprise accounts.

It sounds like you're seeing some signs of life there based on the rebound you mentioned.

I'm a little surprised we didn't see a corresponding increase in the FAS6000.

My question is, are you seeing a shift in buyer preference to lower cost, mid-range platforms, or is there some sort of product transition here that's perhaps impacting the FAS6000 orders?

And then as you think about if it is correct you are seeing some signs of life in the top 50, how sustainable do you think that is?

Well, as I indicated before, it's very uneven.

So I think some of the top 50 have returned to health and I think, have a sustainable growth opportunity.

I think other ones are still struggling and I think there are some that are in between that reached their period at which they absolutely have to do some type of upgrade and add more capacity and they may buy now but they may be quiet next quarter or down next quarter.

So I think that in the net they've moved in the right direct, but I believe that it's still too uneven to basically say that there is a clear pronounced trend that we can exploit there.

As far as the 6000 is concerned, 6000 is roughly flat.

I think it was exactly flat sequentially.

I wouldn't necessarily connect that to the top enterprise accounts.

I think certainly there is a fair number of them in those places, but in general I wouldn't say that those things are linked explicitly to each other.

Brent, this is Dan.

One thing I would add is that there doesn't seem to be a pattern by geo, or whatever.

The biggest patterns, the biggest correlators of strength and weakness are on verticals.

But even there there's account-specific discussions.

We said government was good but one of our largest government customers was way down year-over-year and way down sequentially.

They just got to the end of a build cycle.

So there's some account specific issues that cloud the data as well.

Exceptions to every rule.

Exceptions to every rule, right.

Thank you.

Next question comes from the line of Jayson Noland with [Robert Baird].

Please proceed.

I believe there's a number of NetApp alums at Data Domain and I guess, is that a benefit when you start to look at integration and would there be any potential for long-term technology integration between the two product lines?

We're not looking to have technology integration at the software level.

Certainly we may converge some of the hardware platforms.

They already use the same Xyratex shells we do.

There's no reason for redundancy there.

One of the nice attributes of this particular combination is because there are so many NetApp alums over there, and because Frank Slootman, the CEO really tried to design the company after NetApp, the NetApp culture pervades over there.

I think it is going to be a very easy cultural integration.

And, they already certainly understand us a lot.

I think that's going to simplify the problem a great deal.

So no, there is really no attempt to smash the two together.

As Tom said, we're going to try to run them as independently as possible from the viewpoint of both the technology development, which they have done a terrific job at.

And we're going to retain all of the sales capacity.

At the same time we'll probably link the organizations and where we can, share some of the more basic kinds of services and components such as disks.

I think as a practical matter as time goes on, the fact that people from here have gone over there and been successful says that our sales force can be trained to sell that product.

And the flip side is that there are people over there that used to work over here which means they know how to sell our product.

So, the simple fact of the matter is, is that these are two very, very adjacent technologies and two very, very adjacent markets with a very similar customer set.

I think the opportunities for leverage are very very large.

I think that is why people have gone there and been successful and that is why I think that both sales organizations should be able to get sales leverage out of this transaction.

Thanks, guys.

Question comes from the line of Kaushik Roy with Wedbush Morgan.

Congratulations on a nice quarter.

My question is on IBM.

Seems IBM came down a little bit.

Was it because of poor execution of IBM or are you seeing your XIV product cannibalizing the ancillaries a little bit or is it something else?

Actually just the opposite.

You look at IBM's results last quarter I think their storage was down 20%.

The N series grew in that quarter and it was up to a new high this quarter.

So, no, we're not feeling any pressure from the XIV.

IBM continues to perform very well for us.

They're a growth component for us.

And we think that is going to continue into the foreseeable future.

And I can't speak to the specific momentum of the XIV.

All I know is that our numbers clearly dramatically outperform IBM at large so clearly our value proposition is standing firm.

If you look across the board about what is the appeal of our product line and their lineup, clearly NAS is one of them which the XIV nor any of their other platforms have.

The other one is the storage efficiency features which are also not present on the other platforms.

And that applies whether it be NAS or SAN.

So when I think about XIV, I actually think that the overlap is much greater with the rest of their portfolio than it is with ours.

As a result we were up 22% in a quarter where IBM storage was down a fair amount.

So I think we're more than holding our own sharewise and if anything we're clearly gaining if you look at the numbers.

They had the diligent products.

What is the probability that they would OEM the dedupe product as well?

I think that is a second question, Kaushik.

Next question comes from the line of [Andrew Nowisky] with Piper Jaffray, please proceed.

Good afternoon, thanks for taking my question.

I think you guys said that NAS revenues are impacted by a drop-off in new system purchases within your top enterprise accounts.

So just wondering, do you expect NAS demand to rebound once the spending environment within these accounts improves?

Or is block level date growth simply outpacing file level data?

No.

I expect the NAS business to bounce back, clearly in our top enterprise accounts or accounts that we culture over -- cultivate over a long period of time, and as a result they go back to the early days of NetApp and they tend to be more NAS centric than our overall business.

Clearly at the top enterprise accounts slowed down it disproportionately impacts NAS.

I expect that business to come back, tough enterprise accounts to get healthy again, I expect them to resume.

We made the point earlier that that if we thought that a slow-down of top enterprise accounts is because we had our products replaced, then I don't think they would pay service contracts to renew maintenance on them.

I think that our presence there is just as significant as it ever was.

I think clearly the market has slowed down and the fact that we're concentrating on our business up in that space says that when they rebound I expect our NAS to rebound.

I don't consider our current NAS position to be something I would expect to see once the economy recovers to some degree.

It's a historical notion.

File's gone NAS and database has gone standard and block goes on -- or structure data goes on SAN.

You really got to get over that.

I mean, you look at almost any of the major environments today, Oracle, SAP, VMware, et cetera the customer has the choice to run those either NAS or SAN.

It is strictly a question of what is most convenient for them and what are they the most comfortable with.

You can't read anything into that at all.

Furthermore, if you look back the last 20 years, the mix between structured and unstructured has been relatively the same in terms of proportion of the two.

Neither one -- speculation is, oh, unstructured is growing faster or whatever?

That isn't true.

For 20 years they have been almost the same mix in the market.

The other thing is the NAS acceleration and VMware environments and ultimately virtualization in general, is probably a new dynamic in that space as well.

In that regard I'd expect to see a fair amount of life in the NFS business going forward.

Your next question comes from the line of Alex Kurtz.

Thanks for taking the question.

So looking at this Oracle Sun acquisition, can you give us a sense of how that impacts your business, Oracle and Sun we're talking about the Sun 7000 series adding about 800 customers over the last five months.

Obviously Oracle being an important partner over the years.

How does that impact your business as you look over the next couple of quarters?

It has not had any effect to date and I think if anything, if you go back in the future would be really speculative until Oracle sorts out what they're going to do and where they're going to go.

Great question to track during the next quarter and maybe at the end of next quarter we can give you a better answer.

Thank you.

Question comes from the line of [Rob Tiara] with Caris & Company, please proceed.

Just curious if any updates or anything new on the road map for data on TAP 8?

Thanks.

Not particularly.

We're still on track.

We expect to have it in the marketplace certainly before the end of the summer which I'll point out is end of number.

That's Q1.

Late into September.

What did I say?

Sorry.

September.

End of the summer.

And, we're still on track for that.

And it's come along well.

I don't think we want to preannounce it but I would say there has been no development change to the situation that we said in the past.

Schedule is still intact.

Great.

Thanks.

Your next question comes from the line of Glenn Hanus with Needham, please proceed.

Thank you.

Maybe at least qualitatively on the revenue synergies that are possible, maybe you could just lay out how you would step through capturing some revenue synergies?

You mentioned international and helping them scale more into the enterprise, maybe just talk about priorities there to go capture them and what might be sort of the biggest opportunities?

I'll start and I'll give it to Tom.

From my perspective, it is really a three primary components.

The first which you mentioned is international.

More than 50% of our revenues come from outside of the US.

For them it is 21.

They've got a very immature undeveloped distribution fabric, especially in Asia.

Where they're just getting started.

I think we can cat put that up in a hurry.

That is one.

And, there a lot of channels we have done over the last several years.

The second one is in a place what we call storage 5,000, account by account.

The first pass numbers were there and 300 we're in about 1600 and the overlap is about 100.

So there is roughly 1500 storage 5,000 accounts, that we already have a presence with, where this is the potential item to add to the list of proposals.

And they have been really good at the entering new storage 5,000 accounts.

When you look at -- this is the third one, when you think about accounts we are not in, we don't have any primary storage at all, I believe going forward this will be the easiest way to enter those accounts.

It is the least disruptive, customer has a change to his application environments or whatever, just slips right in.

And it is low risk.

If the backup fails it's a bad problem.

But guess what, it is not the same as if your enterprise app fails.

So I think it's going to be a primary focus for a new account acquisition.

So those are the three.

I would add one more and that is channel programs.

We have garnered many awards on channel for -- channel supports and variety of other things like that.

And there are channel programs I would classify as fairly immature, development stage.

Well advanced for a company their age.

Not nearly as mature as ours.

That will give some lift to that one as well.

Next question comes from the line of Bill Choi with Jefferies & Company, please proceed.

It is pretty well known out there among your customers that you have the new OS coming out.

I'm just curious what kind of feedback you're getting about that impact to current purchasing behavior.

Do you think that had an impact on the NAS weakness in any way, and related to the strengths and the maintenance contract renewals here, obviously the new OS becomes available to anyone on maintenance.

Did that help it and how do you ultimately look at, getting impact of OS on current behavior?

Thanks.

I actually don't believe that customers are changing their behavior or holding things up waiting for the data on Tap 8.

If it is happening, it is happening on the margin.

It is not significant in terms of the data that we see.

As you indicated the operating system runs on the same hardware as the current operating system.

Customers that already have this software are entitled to it.

So I think people are moving ahead and we see more changes in buyer behavior around hardware releases than we do around software releases.

So I don't believe that that is a factor either slowing us down now nor something that is going to precipitate a rapid uptick in demand when it gets released.

I should point out also that the new release truly is a fusion of the two and that at install customers can continue to run either what we today call 7 mode, or the new scale-out mode.

And 7 mode they get significant new features and benefits.

I think there is going to be a strong desire for them to upgrade.

Even if they decide not to turn on the scale-out feature soon.

The scale-out feature seems to be really incremental.

Once you have the OS but do you anticipate that's really when they start buying the additional hardware?

I don't see a correlation.

I don't necessarily think so.

I think you will see people deploying on their existing hardware because for the existing customers to lay down data on Tap 8 on top of what they have, it will look no different except they have a whole bunch of new features they can choose to deploy or not deploy.

So I think the initial rollout the data on Tap 8 will be on existing hardware and then customers will step into the new functionality as they see fit.

So I do not believe that it's a pressing demand now, nor is it going to suddenly stimulate demand when it comes out.

Okay.

Thanks.

Your next question is a follow-up question from the line of Wamsi Mohan with Merrill Lynch.

Welcome back.

Let me guess.

You want expenses?

Yes, that would be good to get answered, thanks.

So I thought we were pretty clear that when we talked about the 405 to 410 range we were talking about quarters two and three and outside the bank.

Quarter one we always said that we were going to have the extra week.

That extra week is about $15 million of expense.

There's nothing we can do about that.

That's just the fact of having an extra week of expenses in the plan.

In addition, in the first quarter we have our summer intern program which we're going to honor this year again.

And we have, just under a -- roughly 50 to 70 summer interns coming in and so that's going to be an expense that we're going to incur.

And finally, we mentioned that we're redirecting some resources to focus on growth areas and streamline our operations and we're making some investments there and there is roughly about $1 million of that as well.

So that is what causes the first quarter to go up from the current run rate.

After that, though, we expect that second quarter to be down in that 405 to 410 range we talked about, along with the third quarter.

All right.

Thanks a lot.

Your next question is a follow-up question from he line of Keith Bachman with Bank of Montreal.

Please proceed.

Hi, guys, Dan, once again back in the queue.

Well done, thank you.

Steve, I wanted to push you back a little bit on something.

At the operating margin level for dedupe, why wouldn't it be accretive in the very near-term?

Well, it's very Keith.

I said it is accretive within 12 months.

It is on the margin all the way out.

It is marginally dilutive in the short run.

Marginally dilutive at the EPS I assume but at the operating margin, operating dollar level, wouldn't it be neutral to accretive straight away?

Depends on the transition costs.

There are transition costs that come into play here now.

Fair enough.

That's it for me, thank you .

You're welcome.

Your next follow-up question comes from the line of Aaron Rakers with Stifel Nicolaus.

Please proceed.

Actually that was pretty much my question but I guess I will ask, I guess just with regard to Data Domain, can you give us a feeling for, why now, because it does appear to be a pretty bold move by you guys.

Was there anybody else involve or were you concerned that Data Domain wouldn't be available at some point in the future?

I guess I'm just trying to understand why now?

Don't read too much into the timing.

Like I said, they're very local.

We've known these guys for several years.

I've had an ongoing dialog with Frank Slootman, who I think is a terrific guy.

I think the concept evolved over a long period of time.

It is pretty clear, you get this from Data Domain that Frank is frustrated by his ability to build his sales capacity fast enough to attack the market opportunity as he sees it.

I think he feels accretion like they're underperforming against the market potential because they just don't have the distribution capacity to hit the -- and, I think that the notion that everything that's out there should be theirs is kind of what is driving the deal.

And I don't think it is any more complex than that.

It is a terrific addition to our portfolio, and it is a terrific company and terrific technology.

It is just a nice win-win for both companies.

Fair enough.

Thank you.

Your next question is a follow-up question from the line of BIll Fearnley, with FTN Equity Capital

Thanks guys.

I came in again as well, with the one question rule.

Competitive win rates, you had mentioned that they -- that your win rates were the same but two follow-up questions to that.

Are you getting more pitches and proposals to hit, and was there any change in win rates versus specific competitors during the quarter?

Or what you see here in the near-term as well from a competitive standpoint?

I would say that there is probably not enough trend information to make things dramatically different than the way they were.

I think the nature of this business that makes a little bit complicated is that one of the big players out there that we're competing against is no decision.

We talked about pipelines and I'm sure there are other people saying the same things about how great their pipelines are and a lot of stuff is going into the pipeline but the inability to get deals done is basically just causing them to well up.

So in our scenario I think the volatility and the uncertainty is less about our competitive positioning than it is in our predictability about what customers are actually going to make decisions.

I think the pipeline looks robust.

I think our win rates are substantially the same as the way we were.

However, I think what is different is our inability to predict when customers are actually going to make a decision.

That's where most of our vulnerability is coming from.

We saw deals last quarter from customers and deals that we had long ago given up on and likewise there were deals that we thought we had high confidence in that got hung up in the last second.

Thanks.

Ladies and gentlemen, due to time constraints this concludes our Q&A session.

I would like to turn the call over to Dan Warmenhoven for closing remarks.

Thank you all for joining us today.

As we indicated, we'll be postponing our analyst meeting from June 4, to sometime in late September.

I want to remind you one more time this transaction with Data Domain is expected to close somewhere in the window of 60 to 120 days from now.

Depending on the time of that close we may also choose to delay next quarter's conference call by a short amount if it is advantageous to do so.

With that I want to thank you all again for joining us today.

I hope you all have a wonderful evening.

Thank you, everybody.

Thank you for your participation in today's conference.

This concludes our presentation.

You may now disconnect, and have a good day.