NetApp Inc (NTAP) 2012 Q3 法說會逐字稿

Welcome to the NetApp third-quarter fiscal-year 2012 conference call.

My name is Christine and I will be operator for today's conference.

(Operator Instructions).

Please note that this conference is being recorded.

I will now turn the call over to Ms.

Tara Dhillon.

You may begin.

Good afternoon, everyone.

Thank you for joining us.

With me on today's call are CEO Tom Georgens and our CFO, Nick Noviello.

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

As a reminder, during today's call we will make forward-looking statements and projections, including our financial outlook for Q4; expected benefits of new partnerships, alliances, and product introductions; our ability to procure sufficient inventories; and our expectations regarding future competitive positions, all of which involve risk and uncertainty.

Actual results may differ materially from our statements and projections for a variety of reasons, including general economic and market conditions, such as the flooding in Thailand, and matters specific to the Company's business, such as customer demand for and acceptance of our products and services.

We describe these factors in our accompanying press release, which we have filed on an 8-K with the SEC, as well as in our 10-K and 10-Q reports also on file with the SEC and available on our website, all of which are incorporated by reference into today's discussion.

All numbers discussed today are GAAP, unless stated otherwise.

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

In a moment, Nick will walk you through some additional color on our financial results, and then Tom will walk you through his perspective on the business this quarter.

I'll now turn the call over to Nick.

Thank you, Tara.

Good afternoon, everyone.

NetApp delivered a solid quarter with revenue and non-GAAP earnings per share at the midpoint of our guidance range.

Our Americas, European, and Asia-Pacific geographies all showed healthy growth trends, as did most of our major accounts, both on a sequential and year-over-year basis.

The only outlier was our U.S.

public sector, where the typical sequential decline in revenues we see from Q2 to Q3 was exacerbated by lower spending by customers in the defense and intelligence sectors.

Hard disk drive constraints did have a modest dampening impact on revenue in Q3, although within the bounds of what we forecasted.

We expect constraints and unpredictability of supply for certain types of drives to continue for a few more quarters, so we will maintain a conservative stance with respect to the impact of hard disk drive supply on both our revenue and gross margin forecasts for Q4.

Our total OEM revenues grew 6% sequentially, while our NetApp-branded revenues grew just under 4% sequentially from Q2.

Overall performance was on plan with our expectations, despite the dynamics around hard disk drive supply and softer U.S.

public sector performance.

Both software entitlements and maintenance revenue and services revenue resumed their typical growth patterns in the quarter.

Turning now to margins, on our earnings call last quarter we said we expected to finish Q3 with non-GAAP gross margins around 60% and non-GAAP operating margins around 17%.

Actual impact of customer mix, OEM mix, and Thailand flooding were all consistent with our forecasts.

That said, non-GAAP product margins, which reflected these factors, came in about $5 million lower than we ultimately expected, in part due to new customer acquisition-related costs.

Non-GAAP service gross margins declined 40 basis points sequentially, rather than rebounding as we had expected, primarily due to several million dollars in costs we absorbed for replacement parts associated with hardware components supplier quality issues.

Our non-GAAP operating expenses increased about 2.7% sequentially in Q3, in line with our expectations.

The Q3 non-GAAP tax rate was 17.4%, returning very close to the 17.5% rate we expect to average for FY2012.

Our balance sheet remains strong with approximately $4.9 billion in cash and investments.

Total deferred revenue increased by $107 million, almost double the net increase in deferred revenue in Q2.

Our accounts receivable days sales outstanding increased modestly to 40 days from 38 days in Q2.

Inventory improved 16.5 turns this quarter.

Cash from operations of approximately $269 million declined 24% from the same period last year, in part due to the change in DSO, but also a decrease in payables of over $30 million associated with one-time integration activities and transition from legacy E-Series contract manufacturers to our own.

Free cash flow finished the quarter at $178 million.

Our diluted share count decreased by about 2 million shares sequentially to about 374 million shares, primarily due to a lower average quarterly share price in Q3.

The accounting for the shares associated with our convertible notes and warrants had a modest impact, with about 6 million shares associated with the convertible notes included in diluted share count.

You may recall that 80% of the convertible notes are hedged.

If we were to address the share count to reflect the hedge, then non-GAAP EPS would have been about $0.01 higher.

You can find a table on our website which shows the impact on diluted share count for a range of stock prices.

Now looking forward, our target revenue range for Q4 is $1.645 billion to $1.725 billion, which, at the midpoint, implies just under 8% sequential growth and 18% year-over-year growth.

We expect consolidated non-GAAP gross margins of approximately 59% and non-GAAP operating margins of approximately 17%.

We expect our blended consolidated non-GAAP effective tax rate to be approximately 17.5%, bringing our earnings-per-share estimate to approximately $0.60 to $0.65 per share.

Diluted share count is expected to increase to about 378 million shares in Q4, based on our average stock price of $39.43 for the first 10 days of the quarter.

This will include about 8 million shares from the convertible notes.

Recall that the favorable impact of the note hedges is not included as an offset.

If we were to adjust the share count for the convertible note hedge, that would add about $0.01 to the EPS guidance.

At this point, I'll turn the call over to Tom for his thoughts.

Tom.

Thanks, Nick, and good afternoon, everyone.

As Nick described, our results were essentially as expected, despite entering the quarter with considerable uncertainty regarding the cost and availability of disk drives.

Overall, the business performed well with the only area of weakness being defense-related spending.

We saw the bookings growth rate increase over last quarter, as evidenced by an increasing sequential growth rate and an increase in deferred revenue of $107 million, nearly doubling over last quarter.

Of particular importance is the second consecutive quarter of record NetApp-branded new customer acquisitions with all-time records in both storage 5000 and midsize enterprise.

Our major accounts have been a drag on revenue growth all fiscal year, but we saw a bit of a rebound this quarter as the major accounts in all geographies other than U.S.

public sector produced revenue growth in excess of fiscal year-to-date levels.

Our multi-year strategy to diversify our coverage model continues to contribute, as we generated record sales from indirect channels.

The federal slowdown also impacted Arrow and Avnet's business, but we were able to offset that with very strong growth in our volume segments with U.S.

general territory bookings up over 35% year over year and our state, local, and higher ed bookings up more than 50%.

In fact, in November, we won a Partner of the Year Award from CDW.

Similarly, our E-Series OEM business remains very robust, and after three quarters we are now at $509 million in revenue against the $600 million full-year target we communicated at the time of the acquisition.

Looking at product mix, we saw units of our 6000 series increase 2.5 times on a year-over-year basis and over 40% sequentially.

This is indicative of competitive success on several fronts.

First, it shows our strength in performance-oriented workloads, particularly in technical computing and increasingly in media and entertainment and health care.

Second, it was aided by a rebound in our major accounts and is evidence of our continued penetration deeper into the enterprise.

Last, it is indicative of a greater number of customers re-architecting their data centers to leverage virtualization.

Customers are looking to build infrastructures that are highly efficient, highly automated, and highly homogeneous that could run a wide variety of application workloads.

This is the ideal application of ONTAP as it is a single architecture that can very effectively serve the widest range of application workloads of any architecture in the industry.

For example, this quarter we had a large takeout win at a financial services firm that was a 100% EMC shop.

We prevailed over a VMAX proposal to virtualize and consolidate over two dozen separate business units.

This is an example of how our compelling value proposition is fueling our momentum in both the private and public clouds, and is only further enhanced with the industry-changing clustering capability of our latest release, ONTAP 8.1.

We refreshed our 2000 series this quarter and saw a 10% sequential increase in units shipped after three consecutive quarters of decline.

This quarter's reversal was driven partially by the major account improvement, but mostly by the strength of our volume segments.

The 3000 remains our biggest revenue contributor, and it saw units increase 3% sequentially and 22% year over year.

Our Alliance program continues to generate leverage for us as we jointly develop and sell our portfolio of tightly integrated solution offerings in partnership with other best-of-breed vendors.

FlexPod is a terrific example.

This is our modular data center solution developed in conjunction with Cisco to provide partners and customers with an integrated, standardized, and scalable infrastructure to support a variety of workflows.

Together, we offer validated designs for Citrix, VMware, SAP, Red Hat Linux, Microsoft Exchange, SQL Server, and SharePoint.

We had another outstanding quarter with FlexPod, and as a result, our relationship with Cisco and our respective channel partners continues to intensify.

NetApp greatly expanded its big data solution portfolio during Q3.

In the area of analytics, NetApp and Cloudera announced a joint solution based on E-Series to speed and harden enterprise deployments of Apache Hadoop for aggregation and analysis of big data sets.

In the area of bandwidth, NetApp announced several new solution portfolios, including a high-performance computing solution with the Lustre file system for government and higher education laboratory environments, as well as a marketing and content management solution for media and entertainment and a new seismic processing solution for upstream oil and gas exploration in the energy industries.

Q3 not only saw the introduction of the latest members of the 2000 family, but the latest release of our main operating system, ONTAP 8.1.

This is the most impactful step to date in realizing our vision of merging what is already the industry's richest data management capability in a single operating system with the architectural capabilities of clustering.

We are able to offer our industry-leading functionality at a level of scale, performance, and availability that cannot be matched in a standalone system, regardless of size.

ONTAP 8.1 is not only well suited for technical applications and cloud workloads we serve today, but it also expands our reach into large-scale analytics and content repositories, frequently called big data.

It allows us to expand deeper into mission-critical business applications as well.

The combination of compelling functionality with massive scale is unprecedented in the industry and enables NetApp to provide optimal solutions to the widest range of workloads with a common set of tools, processes, and compatible hardware.

ONTAP 8.1 represents not only the support of the new 2000 platform and the evolutionary path for tens of thousands of systems running ONTAP 8.0, it substantially increases the workloads where clustering becomes our recommended deployment option.

On the competitive front, our presence and our relevance has been substantially enhanced as NetApp has grown from $3.9 billion to over $6 billion in two years.

During this time, we've gone from number four to a clear number two market-share player in network storage.

Along the way, we have seen the consolidation of many of the smaller competitors by the major industry players.

For those businesses acquired by the large server companies, we have not seen a commensurate increase in competitive engagements.

We still see much of that volume going into the server vendors' captive customer base, channel partners, and service offerings.

Elements of these sectors are hard for us to reach, particularly on the low end, and that is why the OEM channel is essential to our strategy.

Other parts of the server vendors' installed base are well within our reach, as evidenced by the relative market-share performance over the last couple of years.

Conversely, due to our relative size and expansion of our respective portfolios, the competitive engagement with EMC has increased.

We compete in our installed base, in their installed base, and through replacing common storage of other vendors.

Their acquisitions have expanded their portfolio into few traditional NetApp spaces.

Similarly, we have been aggressive in targeting legacy CLARiiON, Centerra, and Solara takeouts, as you would expect.

And our 6000 strength is evidence of our competitive wins against the VMAX and other similar frame arrays.

In summary, our competitiveness remains robust as our FAS unit counts are up substantially, we have record new customer acquisitions, and the E-Series OEM business is exceeding expectations.

We feel good about our competitive posture today and we are still in the early phases of leveraging both the full innovation of ONTAP 8, as well as the branded E-Series platform.

Overall, the third quarter played out much as we forecasted.

Bookings were slightly better than expected, with revenue and EPS both on our midpoint.

The gross margin was slightly less than expected, offset by good discipline on operating expenses.

We forecasted mix and drive cost impacts on Q3 gross margins that were more or less in line.

However, we saw another half a point, about $5 million, of impact on product gross margins, partly due to the cost of successfully winning new accounts, as well as some other minor factors.

Nonetheless, there are a number of moving parts that we will be watching closely.

We entered the quarter with a great deal of uncertainty regarding disk drive pricing and availability.

We knew that it would take some time to consume the inventory and work in progress, so we did not see the whole full impact of the production loss until January.

That proved to be correct, and while the drive vendors had little forward delivery visibility, most of them shipped us drives in excess of their initial estimates.

However, not all drive types were universally available, and some spot shortages impacted revenue and will likely do so in the upcoming quarter as well.

Nonetheless, the teams at NetApp and our drive suppliers worked this aggressively all quarter, and the business impact was largely as anticipated in our Q3 guidance.

Going forward, we expect the drive situation to continue to inject uncertainty into the revenue and gross margin for the next nine months as availability, cost, and pricing settle out in the market.

In addition, we may also continue to remediate certain customer situations around our vendor component issues, as we did in Q3.

Historically, we also typically see a seasonal gross margin decline in Q4, so all of these factors combined are driving some conservativism in our gross margin estimates this quarter.

We are assuming that the macro will remain largely unchanged with no near-term recovery in the defense-related business.

However, we are encouraged by the meaningful increase in bookings growth rate in the rest of the Americas and EMEA.

In general, we are maintaining a cautious posture until we see more sustainability of the positive trends that we saw in bookings, units, and new customer acquisition this quarter.

Before I open up the call for Q&A, I'd like to congratulate the entire NetApp team for being ranked number six on Fortune's list of Great Places to Work.

The culture at NetApp is one of our keys to our success, and this recognition, our fourth consecutive year in the top 10, is evidence of our commitment to create a model company.

At this point, I will open up the call for Q&A.

As always, I'll ask that you be respectful of your peers on the call and limit yourself to one question, so we can try to address everyone in our allotted time today.

Thank you.

Operator?

(Operator Instructions).

Aaron Rakers, Stifel Nicolaus.

Thanks, guys.

I'm going to focus on the [in genie] or the E-Series business.

I know that you had given a number on the combined year-to-date, $509 million, and I can back into that math.

Can you talk a little bit about the branded side of the business, where we stand?

I think your initial target was $150 million, and just kind of what's going on there in the branded trajectory of that business?

Yes, I don't have a specific number where we are, but clearly over the course of the last two quarters we've been rolling out a number of solutions.

We started with the HPC and the full motion video solutions.

We added the Hadoop in the analytics and some of the other things that I talked about on this call.

So I think the solutions are all out.

Enthusiasm for the products are high, so in terms of the overall numbers and the overall activity levels, I think it's more or less on track.

I think from the revenue perspective, the OEM side of the E-Series is clearly ahead of what we had talked about at the time of the acquisition.

I'd say the branded is probably not on that same trajectory, but clearly certainly nothing that we're alarmed about at this point because the quoting level is high, the activity level is high, and the solutions are now in the market.

And we've actually closed some very, very large transactions.

So, so far, so good, I'd say, but still very early days.

Maynard Um, UBS.

Hi, so I was dropped off for a few minutes and I apologize if this was asked for the first one, but you talked about the rebound in your major accounts.

I'm just wondering (technical difficulty)

Maynard, we lost a good amount of what you just said.

(Technical difficulty)

Mr.

Um, please go ahead with your question.

Hi, can you guys hear me?

Okay, one last try.

Can you guys hear me?

Yes, ask the question now.

Just wondering, in terms of the rebound in your major accounts, if you have any sense of how much of that is one-time budget flush versus project-oriented spend, so I guess the question really is about how much visibility there is for the next quarter?

Yes, I think in general I would say that the last three weeks of the calendar year were actually pretty strong, so certainly the classic question we get asked, once we get past the midpoint of the year, is what do we think about the end of the year budget flush?

And in general, I'd say that that was probably stronger than I thought it was going to be.

And that drove a lot of strength in our U.S.

-- the commercial side of the U.S., and it is mostly, as you could well imagine, a large account phenomenon.

I think at this particular point, the thing about having a January quarter is that we continue after the euphoria of December with the despair of January.

And I think at this point, we just want to kind of see a little bit more into 2012 actual budget cycles.

But you know, throughout 2011 we saw all the dynamics that everybody else saw, deals got extended and all that stuff, but it closed out a little bit stronger than I thought and I think it's probably a little bit too early to have a read on 2012, but certainly I would think that the budget flush would at least be a sign of modest confidence, but that's probably as far as I'll go at this point until we get some more data points.

Maynard, this is Nick.

The only thing that I would add to that is we have people in many of these accounts, because they are big for us, so your question on the fourth quarter, this is our forecast and our guidance for the fourth quarter for these accounts includes a lot of bottom-up forecasting based upon our presence in those accounts and our knowledge on those accounts.

Shelby Seyrafi, FBN Securities.

Thank you very much.

The hard disk drive situation is going to go to supply/demand balance, supposedly, by mid to early H2 of this year, according to WD and others.

You're talking about nine months of -- for a difficult situation for you in disk drives.

But do you expect that whenever the situation improves that your product gross margin returns to that 63% level or so you had before the floods?

Yes, I think one of the things about the supply/demand balance is that actually doesn't make up any of the supply gap of the prior six to nine months.

So, I think how that plays out -- and the other thing about the supply/demand balance is I believe it will be different for different classes of drives.

Certainly the desktop and the mobile at least from what we hear, we're not consumers of those products, have been hit a bit harder.

And the enterprise-wide, I don't think, fulfilled 100% of demand was certainly a bit better.

You know, as far as where we're going to go back, I don't want to give anybody the impression that the disk drive situation is four points of gross margin hit.

That's not what we forecasted.

You know, the 63 points you need to go back and also adjust for the OEM business that we didn't have last year, and likewise the OEM business being bigger than we anticipated, which is a good thing.

So I think the guidance we gave, I believe, for this quarter is that -- in the vicinity of a one point margin hit as a result of the disk drives, and I think that's more or less where it is.

So we don't certainly want to overattribute anything else to that.

I think that's what we expected, that's what we saw.

But the one thing I would point out is I still think it's a little bit fluid in the market in terms of pricing and how that has translated to street pricing.

So certainly we've seeing a lot of players, ourselves included, raise list prices, but the street pricing is still somewhat more fluid.

I don't think that has settled out yet.

So I still think the next three to six months, and then nine months I still think we'll be talking about making up previous supply.

But the next three to six months we should see some settling out of the drive side and kind of know where we are going to be.

Deepak Sitaraman, Credit Suisse.

Thank you very much.

First, just a clarification from Nick.

Nick, is the $5 million impact on product gross margins that you called out due to new customer acquisitions, do you expect that to be an ongoing cost of business going forward?

And then, relative to your gross margin guidance of 59% for the April quarter, what are you assuming for product gross margins?

Can you maybe talk a little bit about the puts and takes there in terms of mix versus the hard drive impact versus the pricing environment?

Sure, Deepak.

Let me just walk you through those couple of points.

So in terms of the Q4 guidance, why don't I start there for a second?

We actually would expect to have some benefit to product gross margins from a changing mix, right?

In the third quarter, we talked about a negative on the mix side of the fence.

So you're going to have a partial offset to that in our fourth quarter.

Think of the OEM business and those types of things that have a heavier end of calendar year revenue stream.

The offset to that is in our fourth quarter generally, we see a higher discounting level, right, so they basically offset each other.

So the product gross margin that you see in the results here for Q3 is not that far off of what you should expect for Q4.

In terms of that customer-acquisition costs that were built into the Q3 actual results, again that is part of the guidance that we've put together for Q4, and if there is anything important there to call out, we will let you know that at that time.

Yes, I think if you're asking the question do we want a lot of new customer acquisition, I think the answer to that is yes.

And I think the $5 million, I think that's a factor.

We also had relatively minor, but we're talking about $5 million here, FX impact this quarter that was negative on the revenue side, which I'm sure flowed through the gross margin, and that's a few million dollars.

You know, so $5 million has a few causes, and eventually you start parsing it relatively thin, but the simple fact of the matter is we have now two quarters of very, very strong momentum in new customer acquisitions, some of it's driven by -- in response to the concentration that we saw earlier in the year.

So a fair amount of that new customer acquisition is actually in new verticals for us and that's been a big focus.

We seen media and entertainment and health care as factors there as well.

So, trying to continue to expand our customer base, and it's good to see the momentum now two quarters in a row, and if $5 million is the price we pay, then I think we'd be glad to pay it.

Brian Alexander, Raymond James.

Yes, I guess the follow-up, do you think there's a permanent change in your gross margin structure for your branded business that is being caused by a step-up in customer acquisition that could actually escalate beyond the 50 basis-point impact this quarter and become larger?

You know, if that is the reason, then I think that would be a very, very strong long-term payout for us.

When I think about gross margin, I think we've got a couple of things at play.

Clearly we have the drive saying, we have the OEM mix being higher than expected, and I think we want to get a full year of -- a full-year cycle out of that business so we understand what it means to us.

Clearly the unit mix moving to the high end is impactful.

Clearly we had a gigantic jump in the 6000 units, and then the public sector component as being smaller in the mix.

So I think there's a few moving parts here.

So I guess -- in my prepared commentary, I said that we wanted to really take a close look at this.

Some of these trends are positive for us as a Company, but they're also impacting the gross margin.

So I think we really want to get another 90 days in front of us to get one full cycle of the OEM business, another quarter of visibility to drive pricing, understand the unit mix and how stable that is, and I think from there we'll probably have more concrete commentary on gross margin.

That's kind of the way I would see it.

Jayson Noland, Robert W.

Baird.

Great, thank you.

I wanted to ask about the [HGD] price increase.

I believe that was early February.

Tom, did you see any business get pulled into FQ3 and how sticky do you think that price increase will be?

I know it's been pretty much uniform across the industry.

Yes, I think the -- I don't know whether it's just us, but price increases are not something that we do very often.

And there's a lot of complexity, but let's not lose our grip of what we've done.

We basically raised list prices, right?

And that's what we've done.

In terms of how that translates, we certainly have customers with contracts who have contractual price takedowns.

We have OEM agreements that have pricing in them.

The price increases that we give to our channel partners have got a 30-day effectivity date.

We have got quotes outstanding that it's up to us whether we choose if we want to honor them or not.

So, simply raising the price doesn't mean the street price goes up; otherwise, we'd have all raised 10 years ago.

So I think the flowthrough of the street price also is a function of burning off and remedying some of these other situations.

So, the list price, I think that most of the industry has raised prices but I think the street price is still very volatile yet.

Any pullforward into FQ3?

Okay, I've been cutting the follow-on questions, but you know that is a hard thing to say.

Since we were honoring quotes, I would say most likely not.

Ben Reitzes, Barclays Capital.

Tom, you spoke a lot about public, but can you talk a little more about Europe?

I think that probably exceeded most people's expectations, at least ours, and it seemed like it got back to some pretty good growth and obviously that's the area everyone is worried about.

And I think it was a little light as quarter.

So what changed there and what are you seeing into the next?

Yes, I think our -- one of the things we've had in the past, although it's been pretty constant this quarter, was since we didn't ship all the revenue that we had, sometimes there's a little revenue distortion, but the bottom line if you go back to pure bookings, the bookings growth rate across all of NetApp was up this quarter from last quarter, in Europe as well.

And clearly the German economy still appears to be robust.

It still appears to be strong.

As far as southern Europe goes, it's not a large market-share place for us, so my response usually is when you don't have any market share, the macro is not that important.

But overall, I think the European business in the major geos has held up for us reasonably well, and currency was kind of a headwind that they also had to contend with.

So I think we're all pretty much pleased with the EMEA performance and, frankly, outside of defense-related activities, the U.S.

performance bookings as well.

Amit Daryanani, RBC Capital Markets.

Thanks a lot.

Just actually have a question, I guess, on the comp [theater] front.

It appears you and EMC are going up more and more against each other as you both seem to be expanding your product offerings.

I am curious, do you worry in the long term and do you sense that pricing may just have to get more aggressive due to this, and that's -- at least when you look at your new customer additions you've had, I'm curious if you could talk about what percent of those wins you think have come from EMC displacements versus several OEM displacements.

You know, I think -- I mean, we could talk about pricing theory, where the pricing becomes more destructive when there are a lot of players or when there are two major players.

You know, EMC is relatively disciplined, and so are we, I think for the most part.

So I wouldn't expect anything really dramatic, although I do believe that there is some unsettling of pricing in the market right now, which I think will be temporary.

I think going forward, clearly as our products become more mature and we go deeper into the data center, clearly that is their stronghold.

Clearly they've done acquisitions where they compete with us more.

So, I think we knew this battle was coming, and frankly as we see the industry, I think that there are really two players.

You look at the market-share growth over time, and really they've been share gainer, primarily inorganic.

NetApp's been a shared gainer as well, primarily organic, although clearly we added to that this year, and I think over time they and us clearly are going to have the ability to continue to invest and to continue to innovate.

So I think as time goes on, ultimately I think the two of us are going to be the share gainers and are going to be the key players in this industry, and I think we should only expect to see that more and more.

I'm sorry, could you just talk about the new wins that you had, how much of it do you think is coming from EMC displacement versus the server windows getting displaced, possibly?

I'd say it's -- in some cases, it doesn't matter because usually when we're competing to displace the server vendors, EMC is the alternative that we're competing with.

But we certainly have -- clearly, I'd say, three, four years ago most of it was us and them competing for server vendors business.

But at this point in time, I think a lot more direct competition between us and them and our respective installed bases.

Clearly, them competing on the [nas] side and us competing on the SAN side deeper in the enterprise.

So, I don't really know the answer to your question, but it's increasingly EMC, but in any case we typically compete with them either way.

Congrats on the quarter.

Rajesh Ghai, ThinkEquity.

So if I look at your growth rate over the past two quarters for the core business, excluding [in genia m], it's been in the 7% to 9% range.

And if you look at your guidance and take the high end of the range, looking at a growth rate of 8% for the core business, assuming $180 million for the ingenia business.

So my question is that, looking ahead, is this the kind of growth rate we should expect for ONTAP, which is very close to the market-growth rate?

And if not, what gets it higher?

Yes, I'd say probably that estimate for the OEM business is probably a little high, simply because I'm guessing the quarter we just passed will probably be the high water mark.

And you know, one of the other things that we tried to put out in the prepared text is when we look at our bookings growth rate, clearly it translates into revenue growth rate, but the other thing it does is it also translates into an increase in a deferred revenue balance on the balance sheet.

So depending on the nature of the deals and contracts and ELAs and things of that nature, the revenue growth rate clearly is, as you quote, but we also had remarkably strong growth in our deferred revenue balance on our balance sheet, and I think that -- it's the combination of those two is probably indicative of where our bookings actually look like.

So in terms of new wins and our actual booking growth rate, it's still at a multiple to the market-growth rate, and over time, clearly the deferred revenue will flow back through and the bookings and the revenue will normalize.

But right now, we're seeing a spread between the revenue growth rate and the deferred revenue growth rate.

In fact, deferred revenue growth rate, I think, has been up 20%-plus every quarter this year, and last year I think it averaged 15%.

So overall, I think the bookings remain robust, the translation to revenue in the near term clearly has not been quite as high, but you should also see the deferred revenue as a proxy for our winning rate.

Katy Huberty, Morgan Stanley.

Thanks.

The chatter among your customers and reseller partners is that there is significant interest in the FAS 2000 new products, but not a ton of availability in the January quarter.

Is that a fair characterization?

And where are you in ramping volumes for those products?

And do you expect to see a full benefit from that line in the April quarter?

No, I wouldn't want there to be any -- that we've signaled in any way that we were supply constrained on that product, because I don't think we were.

So I wouldn't concur with that.

Clearly, we've seen a very, very substantial uptick in demand for that product in the first quarter of its availability.

I believe that at this point, bookings of the new product have surpassed the bookings of the product it's replacing.

So I think the momentum is good, but I don't believe that we've had an availability issue.

Maybe there's different words around that, but I think from the factory, the product has been available on our normal lead time.

So I don't think that that has been an issue.

In terms of where the demand is coming from, one of the demand areas for the small products or the 2000 family, interestingly enough, has actually been on the DOD side.

And their slowdown has impacted the volumes in that area all year long.

So in terms of where the uptick in demand is coming from, it's almost all coming from the general territory area.

So it's mostly gone through our channel partners.

But you know, I'll take that as feedback, as a perception of availability, but certainly from our perspective those things have been our normal lead times and have been available.

Brent Bracelin, Pacific Crest Securities.

Thank you.

Tom, really just trying to get a better grasp on the rebound of the business.

Clearly DOD had a drag this quarter, but U.S.

commercial up 11% sequentially, EMEA up 23% sequentially.

I think that's the highest sequential growth in Europe in a little over a year.

How much of the rebound you're seeing, outside of DOD, would you attribute to just seasonal budget flush versus some of the share gains that you have, or frankly just some of the major accounts coming back?

Again, trying to gauge the rebound we saw and really how sustainable it is going forward.

You know, in my prepared commentary I tried to go after that as well, and said we clearly saw some positive things and not just a rebound to the big accounts.

We saw obviously an explosion in units of all types.

It wasn't like one cannibalized another, but 2000, 3000, 6000 all up sequentially in a meaningful way, particularly the 6000 and the 2000.

We certainly saw improvement in the major accounts, but we also saw new customer acquisition very, very strong as well.

So, all things considered, I think that there are a number of positive data points this quarter, but obviously one point doesn't make a trend.

Now, new customer acquisition has been strong now two quarters in a row, and that's good.

I think clearly we'd love to convince ourselves that while the macro is different today than it was a few years back, but a few years back was our biggest new customer acquisition years, and that basically was a very, very strong precursor to future growth.

So at this point, I'm certainly not going to go out on a limb and predict it.

I'm just saying is that the new customer acquisition and our efforts to diversify our customer base, particularly into some new verticals, appears to be paying off.

And I think [ScottPark] we're excited about and we'd love to see that continue.

Mark Moskowitz, JPMorgan.

Yes, thank you.

Good afternoon.

Nick, I wanted to see if you could help us out in terms of understanding some of these new acquisition costs around the customer momentum, also the Smart Decisions initiative that's been undertaken recently.

How should we think about the OpEx or the shape of the OpEx growth trajectory for the next couple of quarters?

Will there be any sort of spike there?

Hi, Mark.

Yes, no, I don't think you should think about that on the OpEx side of the fence.

I think what we built in was on the margin side some new customer acquisition costs that is built into the gross margins.

Frankly, in terms of the guidance and the ranges, we've got some, frankly, conservatism built in so that we could cover some of that.

On the OpEx side of the fence, we've given you, again, a specific guidance range here that you could back into that's not inconsistent with the prior quarters.

So I would not expect to see a big kick up in OpEx at this point time for those types of things.

Also, we're rolling into our Q1, which is obviously the most challenging quarter we have, and that usually isn't a quarter that allows for a wide range of OpEx envelope.

In terms of the new customer acquisition, a couple of things about that.

Usually -- although we are seeing bigger first-time ever transactions with customers, and I think part of that we're seeing in the 6000, usually first-time transactions with customers usually involve knocking out an incumbent and they tend not to be large deals.

And that's why the new customer acquisition is costly.

It's not so much costly from an OpEx perspective so much as it's costly from a gross margin perspective.

In terms of the launch, that was really around the 2000 and really getting the channel ready, getting all the training programs out there, getting all the pricing out there.

So I think that the bulk of that spending occurred earlier in the quarter and the end of the prior quarter, as opposed to this quarter.

So you'll see the normal things at the end of the year.

You'll see the commissions tick up and all the other things that happen in a typical Q4, but I would expect us to, as we enter Q1, to not be that aggressive on the OpEx side.

Andrew Nowinski, Piper Jaffray.

Great.

Congratulations on the quarter.

Just had a question on 8.1.

Is it fair to assume that the early adopters of 8.1 will be your major accounts since the larger NetApp deployments would stand to benefit the most from cluster mode?

And then, is there a professional services revenue opportunity if those customers migrate from non-cluster mode to cluster mode?

You know, in the cluster mode, interestingly enough, it's not always new customers.

I'm sorry, it's not always existing customers.

It's a balance of the two.

But there's no doubt that our existing customers have been hearing this story for a long time and they've been testing with 8.0 and into 8.1.

So there's clearly a lot more activity there, but we actually have some brand-new, new to NetApp, accounts that are jumping into the story with 8.1.

So in terms of professional services on the migration, I would say yes, but I -- we don't think it's going to be meaningful to our overall numbers.

And the reason being is, if they're existing customers and they're migrating, clearly we want to enable them to make this migration and enable them to make this migration successful.

And to basically try and turn that into a revenue opportunity for ourselves probably is not in the spirit of the partnership.

So we probably will do some activity.

We certainly aren't going to do work for free, but on the other hand, I wouldn't consider that a revenue generator.

We want to see people successfully deployed.

We'll give them the help that they need, but we're not going to try and extract a price for it.

Jason Ader, William Blair.

Thank you.

Tom, do you guys have a view on server-side Flash, a la what EMC is doing and others?

Do you guys have a plan there and what's your overall view on the potential uptake in the market for that type of solution?

Thanks, and what I appreciate is after a year of being asked about SSDs, now we're back on the subject that really matters, which is Flash.

You know, first of all, Flash is going to be pervasive.

I think you're going to see it everywhere on the infrastructure, simply because of the economics compared to alternatives and the payback that it has.

But when I think about this odyssey over the last couple of years, you know, we sat there with the competition crowing about just replacing hard drives with solid-state drives and not impacting the software at all.

And we were very, very clear that while that's an interesting niche market, that's not really where this technology would be optimally deployed.

And our position all along has been that Flash as a [cache] is where it has the most impact, and I would say that we've actually seen probably more pervasive deployment of Flash in our systems than anybody else in the industry, and I think it's been a big part of our growth, and in the 6000, which is exploding, it's in every unit item.

The other thing we said about Flash is that we saw systems in the long run that just be Flash and ATA, that the need for enterprise drives, and hence tiering software and all of those things, would ultimately go away as well.

And effectively from an IOs per second performance, the difference between Flash and a rotating drive is so great that trying to [match] two different drives, rotating drives, doesn't really make any sense.

And now we see the competition talking primarily about Flash as a cache, and talking about one drive type.

So I think all along, our view is I don't think we kind of conformed to the conventional wisdom on this.

I think we've been an outlier all along.

We've been asked about this on a lot of calls, but in the end I think I've been pretty clear with the strategy that we went on and our execution.

So to your question on Flash on the host, I think that's a sure thing.

For all the reasons that we're putting Flash in the disk array, I think people are going to put Flash on their host for performance enhancement.

But from NetApp's perspective, I don't think the opportunity is simply selling cards into the host, and we may do that, but our real goal here is that we want to bring the data that's stored in Flash on the host into our data management methodology, put backup and replication and de-duplication in all of those things, and that's our focus.

So you'll hear more from us on that dimension, but it isn't a simple we're going to make a PCI Flash card.

The software component and bringing that into our broader data management capability is really what our focus is here.

Ananda Baruah, Breen Murray.

Hi, good afternoon.

Thanks for taking the question.

Tom, just interested to get your thoughts on kind of demand as we go through this year and into calendar 2013.

The drive companies have been pretty publicly talked about their belief that a good portion of the capacity demanded will not be met this year, and there will be a good backlog going into next year.

Just wanted to get your thoughts on -- and I guess what impact that might have on seasonality as we get into the second half of the year?

Thanks.

I would be careful about parsing that statement one step further, and that is I think meeting demand differs by drive category.

And I think that the mobile and the desktop are in a little bit different category than enterprise drives and high-end ATA drives.

While I'm certainly not an expert on that segment, I think that the amount of aggregate demand in the enterprise space that was met last quarter was probably higher than where it was in the other spaces.

So, while it's still tight and I don't think that all of the demand in our sector has been satisfied, and certainly we did leave revenue behind last quarter, as we said we would and we probably will again next quarter, I wouldn't factor into your plans that there's some 20% or 30% unsatisfied demand that's going to come crashing down in the second half.

That may be true of other sectors, but I don't think it's necessarily true of this one.

And as Tom indicated last quarter when we gave guidance, that we expected not only have a cost implication (multiple speakers) came true as expected, but we expected some revenue softness from it, which was also pretty much (multiple speakers) in our guidance range.

We have built that similar type of both cost and topline challenge and dynamic into our Q4.

Brian Marshall, ISI Group.

Thanks, guys.

Obviously there's been some concerns on share loss from some of the new mid-range platforms out there, namely [BNX].

The company had a couple difficult quarters, but it seems as though things are kind of on the rebound here.

Can you talk a little bit about how much these results in guidance is kind of indicative of perhaps the eval period for some of these newer competitive platforms being over, and those orders are now finally coming back home to NetApp?

Thanks.

You know what, I'm not quite sure that that's the dynamic.

You know, I think -- frankly, if you look at our business all year long, their major accounts have been pretty much with this conversation has come back to the last two quarters.

Beyond that, the general territory, the broader geographies, the rest of the business has all been very, very, very strong.

And so, for us, I think it's been a little bit more of a major account story, financial services in the first quarter, and clearly we've got Department of Defense now, but once you carve those out, the business is substantially different from where we want to be.

So I think the major accounts have been more of a swinger than any individual competitive dynamic, and I think one of the overlays that we've had, particularly after the first quarter, was a desire to diversify our base a bit, and I think that the new customer acquisition is important.

So if I look at the NetApp story, the major accounts have rebounded, but they're still hardly robust.

The rest of the business has actually been pretty strong, and I think we're setting the stage for the future with relatively strong new customer acquisition, but I would say that the ebb and flow of the major counts has probably been the biggest difference between this quarter and last quarter, rather than any type of competitive activity.

Keith Bachman, Bank of Montreal.

Hi, Tom.

Thanks.

I wanted to ask you a question, if I could, going back to 8.1.

Is there a notion of an upgrade cycle here where you see customers use 8.1 in, say, mixed environments or is it going to be new workloads that they deploy?

And what I'm really trying to ask is how should investors think about 8.1 on the impact of product growth rates?

Well, 8.x is basically the platform of the next decade of innovation, so to kind of put it in the context of quarter-to-quarter impact, I want to be careful of that.

What 8.1 represents is -- we're going to be recommending 8.1 for more and more, and the clustering capability of 8.1, for more and more and more workloads as we go forward.

So, I think that there are some customer workloads that tend to be enormously performance intensive that will move to the clustering capability when they think it can support their environments.

I would say that for most of the rest of them that I would expect to see cluster mode actually go out in new greenfield opportunities and new applications, as opposed to clustering what they already have in place, unless they have a very, very [cue] performance issue like some of our scientific and technical customers and movie making and things of that nature.

So, how that translates into units, you know, I'm not really sure.

I also think that this is not a trivial technology.

This isn't just one more feature.

This is a fundamentally different way of dealing with this issue.

So, you know, we had a major bank in here not that long ago, and there are a large number of frame arrays.

And the frame arrays there are all well and good until you span one, until you have a need that's bigger than one and you have to migrate data.

But it's pretty clear that the discussion that clustering is a far superior solution to that problem because it basically scales indefinitely.

And that's a really, really powerful story.

You know, I can think of another story with another bank, as it turns out, and we were having a long discussion about their concerns about moving in this direction, not necessarily 8.1, but just moving away from what they have.

And I said, you know, it's clear that you don't want to do this, so why -- what's driving this conversation?

And his answer was that when I look at the capabilities that you guys have, the de-duplication, the application integration, the ease of use, the data movement, the data migration, the thin provisioning, all of that stuff, I don't have that in my frame array and I'm never going to get it.

And that's why this stuff is so interesting.

So if you can resolve the performance and the scalability issues and deliver me all that functionality, I'd be very, very interested.

Those decisions aren't going to get made overnight, Keith.

When they get made and when we have momentum and when we have the proof cases of all of that type of stuff, this is a fundamentally different array of doing storage for the enterprise, and I think it's going to be massively impactful.

So whether it pays off in this quarter or next quarter, this really is fundamentally different.

Nobody's going to be able to merge this level of functionality with this level of scale, and that's what the 8.0 journey is all about.

And 8.1 represents a case where clustering is now available for a very, very large amount -- combined with a very, very large amount the rest of our functionality, and we'll be recommending it for more and more workloads.

Glenn Hanus, Needham & Company.

Hi, maybe could you comment a little on the potential for operating margin expansion as we -- for the fiscal 2013 year in light of perhaps the product gross margins might be a little bit lighter for a couple of quarters?

How are you thinking about scaling the OpEx next year and the potential for operating margin expansion for fiscal 2013?

I think for the next six months, the operating margin story is going to be the gross margin story.

And the decision was that while we're in the midst of perhaps some temporary disruption in pricing as a result of the drives, that we were not going to whipsaw operating expense in search of some model (multiple speakers) until that [settled] out.

So, when we have a full cycle of OEM mix, now we've got a major what appears to be change in the mix of our units, so we need to figure out whether that is sustainable or a one quarter or a six-month phenomenon.

So over the next six months, I think we're going to be cautious from OpEx because clearly the operating margin has come down and we're heading into Q1.

But I would say for the next six months that we're not going to turn the OpEx knob very hard to try and meet a target if the gross margin is going to be volatile due to one-time events.

I think in the second half of the year, after we get through the next three to six months, we're going to have more visibility and we're going to have a stronger opinion on that.

There's time for one last question.

Chris Whitmore, Deutsche Bank.

Thanks for squeezing me in.

I wanted to follow up on Keith's question around the potential for an upgrade cycle, but coming at this from the 10 GB networking space.

A lot of the networking vendors are pretty optimistic about a spending cycle being driven in part by Romley and increasing adoption of 10 GB in a lot of data centers.

Do you see that as a driver for your business as we move forward?

We have been 10 GB capable for a while, and sometimes within the data center you get to see, obviously, much more of these high-bandwidth links than you see more generally within the enterprise.

So, you know, if basically this is going to be part of a re-architecting of the data center to take advantage of virtualization, I mean, clearly that's the trend that we see is that the virtualization trend was key.

We get asked a lot about how far that's along.

I think the real trend is how many people have really redesigned their data center to take advantage of what virtualization is and build a big shared infrastructure capable of running many apps that's highly automated, highly efficient.

What people would call -- what we call a shared virtual infrastructure or the private cloud.

I think those are all factors.

One thing that 10 GB does that I think plays to our strength is that it will enhance NFS performance, and when we first pursued the VMware business, our business there was 90% SAN.

Now what we see in VMware is it's roughly 50-50, so clearly more and more customers are seeing the capabilities of NFS.

And if that's going to enhance NFS performance not only in the data center but even more broadly, then clearly that would play to our strength.

Thank you, ladies and gentlemen.

This concludes today's conference.

Thank you for participating.

You may all disconnect.