Good day, ladies and gentlemen. And welcome to the NetApp second quarter fiscal year 2011 earnings conference call. My name is Katie, and I will be your coordinator for today. At this time, all participants will be in a listen-only mode. We will be conducting a question-and-answer session towards the end of this call. (Operator Instructions) I would like to now hand the call over to Ms. Tara Dhillon. Ms. Dhillon, over to you please.

Thank you. Before we began, I would like to acknowledge that approximately 3 p.m. Eastern Time today, it appears that someone improperly accessed a restricted website, a link to our financial tables, without the accompanying press release and supplemental commentary was been disseminated by someone approximately one hour prior to the press release. We are investigating how it happened and we will do our best to ensure that it does not happen again. With that, let me begin our prepared remarks. Good afternoon, everyone. Thank you for joining us. With me on today's call are our CEO, Tom Georgens and our CFO, Steve Gomo. 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. Concurrent with today's press release, the supplemental commentary we published contains many of the metrics and analysis we previously provided during our live call, in order to provide additional time for review of the data prior to the call and allow us to focus on more strategic commentary and perspective from our CEO and CFO. As a reminder, during today's call, we will make forward-looking statements and projections, including our financial outlook for Q3, our expectations regarding our future market share and our expectations regarding the benefits of our new product introductions, all of which involve risk and uncertainty. Actual results may differ materially from our statements or projections. Factors that could cause actual results to differ from our projections are detailed in our accompanying press release, which we have filed on Form 8-K with the SEC, as well as 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 in today's discussion. These factors include, among others, customer demand for our products and services, including our recently announced new product introductions, our ability to compete effectively and general economic and market conditions. All numbers mentioned today are GAAP, unless stated otherwise. To see the reconciling items between non-GAAP and GAAP, please refer to the table in our press release, on our supplemental commentary and our website. I'll now turn the call over to Steve for his thoughts. Steve?

Thanks, Tara. Good afternoon, everyone. The NetApp team delivered another quarter of outstanding financial performance in Q2, by offering customers the more flexible and efficient alternative to traditional storage, NetApp grew total revenue by 33% and product revenue by 49% year-over-year. Our total gross margins are near their high watermark and non-GAAP operating margins were the highest in over a decade at 19.8%. Non-GAAP net income jumped 56% over Q2 last year. Our cash balance increased over $460 million, sequentially, to $4.4 billion, with free cash flow contributing $321 million. Non-GAAP product gross margins were also near record high levels this quarter, improving by 4.5 percentage points from Q1 level, several favorable forces drove this improvement. First, a tiny gap between some material cost reductions and the associated price reductions added about 2 percentage points to the sequential product margin increase. Second, the mix of richly configured systems was high contributing about 1 percentage point to the sequential product margin increase. Finally, volume and all other factors drove the remaining improvement during the quarter. Non-GAAP operating expenses increased 10% sequentially from Q1. The primary drivers of this increase were the full quarter impact of the net 640 people we added in the first quarter, annual merit increases which went into effect in August and higher than expected variable and incentive compensation, associated with our strong financial performance. We added 370 new people in Q2 and expect to continue hiring primarily sales and engineering resources at similar levels next quarter. As I mentioned earlier, our cash balance increased by over $460 million in Q2. Some of the big contributors to our cash balance increase were high level of net profit, an increase in deferred revenue and a high level of stock option exercises, which added about $96 million of U.S. cash…

Thanks, Steve. And good afternoon, everyone. I’m also very proud of the NetApp team's continued strong performance. The company produced our third consecutive quarter of more than 30% total revenue growth. Our third consecutive quarter of roughly 50% product revenue growth and our second consecutive quarter of over 75% growth in system units shipped. We continue to demonstrate solid execution, as we invest aggressively in our future while simultaneously generating our highest non-GAAP operating margins in over a decade. Evidence of the impact of our investment is our announcement last week of the biggest product launch in the history of the company. This quarter, we are bringing the market new medium and large system families, our latest data on tap-A release, a new on command system and data management suite, our new disk shelves, shelves-based disk and an enterprise data center solution called FlexPod for VMware. A joint development between Cisco, NetApp and VMware that offers integrated modular and validated solutions. This launch strengthens our position as the platform of choice for the next generation IT infrastructure. IT departments today face tremendous pressure to decrease costs, while simultaneously increasing their enablement of business objectives. As a result, they are changing how they are thinking about their infrastructure, in order to achieve greater flexibility and efficiency. This involves moving away from application specific hardware silos, to a share infrastructure, enabled by server virtualization which can run many applications at once. NetApp has been a clear innovation leader in virtualized environments, producing solutions that are far more efficient, flexible, automated and secure all with far less complexity than those of our competition. The announcements we have just made to extend our capabilities in each of those dimensions. The performance and manageability of this new offerings, also enhances our competitiveness in our traditional…

(Operator Instructions) And your first question comes from the line of Maynard Um from UBS

Hi, thank you. Just a question, I guess more philosophically on how you think about your OpEx and how you manage that. And obviously at some point you may start to see more seasonal effects on revenue, can you talk about how you manage the OpEx relative to the revenue, how much of OpEx is perhaps variable? And how you smooth some of those impacts out? And then secondly just an update on competitive landscape given the acquisition of Isilon by EMC? Thanks.

I'm sorry to interrupt. We had some technical difficulties on our end and lost most of the question. I apologize, can you repeat the question for us.

Sure. The first question, the question is on OpEx and how you manage that OpEx, obviously at some point you start to see more of the seasonal effect on revenue, I am just curious how you think about, your OpEx, do you continue to spend to continue to drive that growth on an annualize basis, or is there some variable amount there, that can help to smooth out those effects? And then any commentary on the acquisition or the landscape, compatible landscape given the acquisition of Isilon by EMC? Thanks.

Though on the OpEx side, it’s kind of conundrum that we facet there is that business is good but the headlines are bad. And the question is how we make this trade off going forward. And the message that I've given to the team is that, as long as we are winning in the market, as long as we are growing, then we intend to invest accordingly. We don't want to be in a position, where three years from now we look back and say that NetApp was exceptionally well positioned and we were cautious, because we were looking at the headlines every day, as opposed to the tape of the business. So right now our stance is, as long as we are winning, as long as we are growing, we are going to invest commensurately. And, clearly the seasonality issues we need to work through, just like we need to work through every year. So I think the high ordered bid here is that we are continuing to invest aggressively, we are hiring – we hired a thousand people in the first half of the year. So we still see opportunity ahead and we certainly see market shares ahead, net market share gains ahead. And that's what we are going to go after. Right now, we have been investing at a high rate although that high rate of investment has been less than the growth in revenue. And we have been generating, extending operating margins and, so we see some material negative impact for the business. I intend to just continue to invest aggressively. Now, the seasonality point well taken. We certainly need to work through that, but right now our stance is that we are winning and we are going to continue to invest in the future and the question of Isilon, just a couple of points on that. I think my first response is not a whole lot different than our response to the 3PAR acquisition between Dell and HP. And that is, if you go back to our two year compare, basically most of the players in this industry, outside of individual acquisitions that they did, are basically flat to down. So I think in search of growth, after an internal plan to growth is the desire to basically acquire technologies. So I think first and foremost, the deal is as much about the target or as much about the acquirer than it is about the target. And, as far as Isilon as we see them in the market, they staked out well from certain niches that and in some cases we overlap with and take in the hands of EMC, will probably see them a bit more. And the message to the team is we just need to compete and win against them every day, just like we are doing today.

Next question, please.

(Operator Instructions) Your next question comes from the line of Aaron Rakers from Stifel Nicolaus.

Yeah. Thanks, guys. One question and one follow up. First on the question, looks like DSO was up a little bit. I'm curious of what you guys are seeing from a month-by-month basis in the quarter, obviously Cisco a little bit more tempered in their call a week ago. So I'm just curious on a demand perspective, can you help us understand what the monthly patterns look like through the course of the October quarter and then one follow-up, please.

Yeah. This is Steve here. With respect to DSO, not a lot different, I think we hit kind of an unsustainable level last quarter. So if your reference point is 30 days, we had last quarter that's the best we’ve ever done. At 34 days we are actually quite complete, not quite pleased. The difference between the two numbers probably has more to do with a slight shift in seasonality towards the middle month, than anything else. So we are going to take the 34 days, we are actually quite pleased with.

Let me ask differently. Can you characterize, how would you characterize the demand environment, in particular in the month of October relative to what you guys saw in September.

I would not imply anymore science to the month-to-month data than actually exists. Yeah, I would say that, October was not a whole lot different than September and the month before. The one dynamic that we pulled in out in the middle of the quarter was the end of the federal fiscal year and clearly that generated a flurry of activity in September. And this is clearly that strong quarter. So, to the extent to try and underneath that, trying to glean the trend outside of federal I think is probably overstated. So I would say that, certainly, there was nothing so dramatic in the number that we would recognize anything different in October than we didn’t see in the prior months.

Fair enough. And then the follow up, with the….

Okay. That's three questions. That’s three questions.

Okay, guys.

Your next question comes from line of Ittai Kidron from Oppenheimer.

Congrats, guys on good numbers. Steve, wanted to dig in a little bit into your gross margin outlook for the next quarter, just playing with the numbers, I'm getting to about a 3 points decline in gross margin and looking back in history, that's pretty much the biggest drop that we've seen seasonally, going into the January quarter. So, I'm trying to understand with the mix issues and passing along the cost reductions to the clients, why it is that you need to do that in such magnitude and in such speed, especially if you claim and certainly believe that your product is so much superior than anyone else's? Why couldn't that be a much slower selected in case of specific beats and specific needs rather than, it sounds like more of a kind of a broad cost reduction to all of our list pricing.

Okay. So, if you look back basically to the second quarter of last year and the third quarter of last year, you will see that the drop in the consolidated gross margin was about 3.3 percentage points, so. And typically, quarter two is our – typically, pretty good quarter for us coming off strong quarter ones, because then we can do backlog and things like that. And I think you are going to see similar pattern as you go back in time. That said, I think if you look forward now from the second quarter, most – you are absolutely right, we are looking at roughly a 3%, a little less than that, in fact it was less than it was last year, reduction in gross margin. And most of that is due to the cost pricing issue. So what happens is this, basically, we anticipate certain costs to decline throughout the quarters, right? And most of those costs are associated with materials and most material is disk drive. So we typically try to match our price reductions with these cost reductions and sometimes there is a timing difference that occurs. This was a very favorable timing difference in the sense that we had a massive drop in cost and there was a lag in the price decrease, because the cost decline came a little sooner than we were expecting. The reason why we passed this along is because our customers are very valuable to us. There is a reason why our customers value us, they want to keep us around and they continue to buy from us, we have tremendous loyalty. Because they know we are passing these costs long-term. We don't want to make money of disk drives. Okay? So that's the idea we try to provide value to our software and all the other costs, we try to pass back to the customers.

Very good. And the follow up, regarding our share count and I understand the dynamics here, but within the last four or five quarters, your overall share count has increased by about 20%, which is a pretty aggressive number. Are there any thoughts here with regards to buybacks or doing something to mitigate this continuous increase in share count?

Again, as you look at the share count increase as I indicated in my script, some of the share count that you see that has a very large portion of it is actually hedged. It’s just that we don't report it that way. The economics of some of that share count, either hedged portion or the convert, is that it will never see the light of day. We have a call option on it. So the share account is lusery [ph] and that it's over stating the true economic effect. But with respect to the rest of it, when we consider repurchasing shares offset that, absolutely, we will consider that going forward. We are making no commitment at this point, with respect to any share buybacks in any timing of that.

Very good. Good luck.

Thank you.

And your next question comes from the line of Keith Bachman from Bank of Montreal. Please proceed.

Thank you. Steve, could you talk a little bit about mix in the context of guidance, products versus add-on software and services, the services growth, the products growth was great this quarter and services were little bit slower, than I was thinking. So just hoping to get a little context, please on the guidance?

I think, Keith, you are going to see another quarter of sequentially slower deferred element growth. It deferred elements, being the software entitlements.

Right.

And the service contracts. So, I would expect that to be relatively slow, low single digit for the next couple of quarter. I think that starts to turn around, around the first quarter of next year. I think I talked about that. Probably, not going back to the growth rate that we used to see in the go-go days back in 05, 06, 07, type of things but certainly a little better than it is today. That's just the nature of the game. I think most of the growth on the topline is going to come from the sale of products going forward, as we recognize the revenue in the current period.

Okay.

Keith, we effectively have to age off the low growth quarters from a couple of years ago and replace them with higher growth quarters as we go forward.

Yes. Fair enough.

One of the key components of the NetApp story is, we are still growing at 30 something percent and roughly, a third of our revenue is not growing at all. And we are just overpowering it with product growth. So, in a lot of ways our market share performance is actually even better than our financial performance.

Got it.

And then in the long run, just one final thought and that is, everything we do here attaches to products. So product sales are really good.

Okay. Steven, my follow up if I could? Just on – the cash flow was very strong this quarter and as you mentioned 27%, free cash flow yield, related to revenues. Is the longer term targets, still the upper bound of that longer term targets still 22. Or, can we think about – it might be a better number as we look out over the next periods of time?

Keith, as I stated in our Analyst Day – the last Analyst Day we had. I provided that table and I showed you that, as the net – excuse me, the operating income increases above 15% to 17%, 17 to 18 and so on type of thing. As the operating income increases, you should expect a higher level. So, right now I would probably set a slightly higher target, given the fact that we just guided to 18.5%, type of operating income, I probably set the target probably around – somewhere around 26% of the upper end.

Okay. Thanks very much.

Yeah.

Before we continue in the Q&A, I would like to ask if you have a follow-up question that it's related otherwise, we are not – it's not fair to the other callers. We are not going to be able to get through of all the questions today. Thanks.

Your next question comes from the line of Alex Kurtz from Merrimack Capital.

Yeah, Merriman Capital. Thanks for taking the questions. Tom, did you talk about where you are going to be putting new sales bodies in North America and Europe, what segments and what verticals do you think need the most coverage right now?

Well, if you look at it, first of all, the first thing I want to do is that not all the sales bodies are direct selling people, we are actually investing in our channel. I think diversification of our channels is one of probably the lesser understood components of NetApp’s growth rate. We are going to continue to invest in and enabling our channel partners. Now, with that said, we will add continue to add direct sales in certain key areas. This past year the telcos and service providers have been a big investment area for us. We are building a vertical practice around healthcare now. So, historically the company is not been very vertically focused except when those verticals happen to be geographically centered, like financials in New York, Media & Entertainment or Oil and Gas in Houston. So, telco and service provider has been a big investment for us this past year and I think we see healthcare as another one. As far as geographically, I think one of the challenges we always have is how do we balance mature market investments with emerging market investments? And that's one of the things we are also going to need to balance. It is pretty safe to assume the best near-term return on incremental dollar spent will be in our mature markets. We’ve been only achieved number market share in places like Germany and Federal. The market share numbers are still well below the majority. So the short-term gains there are obviously there to invest. So we need to invest for the future and that’s going to be our balance. So, I think it will be a combination of the two. We need to maintain discipline, not just focus on the near term, but also the long-term. In terms of vertical markets, I’d say the service providers will continue to get investment, because we clearly believe that more and customers will be looking them to provide I.T. as a service and likewise, we need to get in emerging market component as well.

On a related quick note, is the service provider vertical, is that over 10% of revenue at this point for you guys?

I would have to look at my chart. Yes, we kind of put that telco and service provider. I’d said probably in that vicinity, but I don't know if the topline had actually and try a little bit lower than that.

Thank you.

Your next question comes from the line of Chris Whitmore from Deutsche Bank. Please proceed.

Thanks very much. I was interested to get some more color on the product announcement, maybe even more specifically. Was this product announcement well anticipated by our customer base and did you see any kind of pullback or slowdown in front of its announcement?

That's always one of the complexities. And, I think it is tribute to the sales team. First of all there are no secrets in this business, so I’m sure that – certainly, our biggest customers were hinted at this and certainly the ones that have access to our roadmap, rather NDA had seen this coming. So, I think, as a tribute to discipline of the sales force and production, we were able to manage despite having the biggest tech refresh or the biggest technology refresh of our platforms in the history of the company. We still manage not disrupt our financial performance in the prior quarter with 33% growth. So, I think we’ve been very discipline and very structured about that. Very clear about the deliveries and probably a big component of that that's probably understated is belief in the predictability of our billions of levels of customers can plan accordingly, when they don't have confidence then all sorts of odd behavior happens. They will order in advance and things like that. So I don't believe it will have an impact on last quarter's business. Clearly, we are going to enhance our competitiveness, some customers will adopt this technology right away. Other customers will evaluate it over time. So I don't expect it to be a sharp message cutover for the old products and new products. So I think certain segments will grow the new products pretty aggressively.

Your next question comes from the line of Kevin Hunt from Hapoalim Securities. Please proceed.

Hi. Thank you. Yeah, I just had a question about the direct-indirect, it seems like you had a much stronger growth on the direct side, sorry in the indirect side and wondering if that's – I know you have been pushing that for a while, but is that something where you are trying to push more and more through the channels or how should we think about that mix going forward?

We have been steadily increasing. I probably, if I had to disrupt it to – suggest one distinction here is that a lot of our indirect business is aided by our direct people. So, particularly in U.S. Public Sector our people are involved with all the customers that we fulfill and direct. So I wouldn’t equate indirect business with, either low touch or zero touch from that perspective. Certainly, a fair amount of our Arrow NetApp business and a fair amount of CDW business and other resellers or volume businesses that we don't have a lot of touch in, but the indirect business in our big accounts, particularly in the Federal space, have a lot of net up involvement. So the relative growth rates between the two, I would not equate with relatively success of large customers versus small customers. I don’t see it playing out that way. So, all in all I think the indirect business is a measure of our leverage and the more that we can help them to be successful with the high touch model, the more they are willing to invest and generate low touch sales for us as well.

Your next question comes from the line of Brian Marshall from Gleacher.

Hi. Thanks. Question was regards to guidance, clearly enterprise storage is a secular gross market and I think NetApp gaining share and that’s pretty clear. But if you look back over last ten years, I think your average sequential growth for the January quarter has been about 8%, so given the guidance of 3% to 7% sequentially, I was wondering if you could help us kind of fill the disconnect there and then just if you give a quick confirmation, if you include the hedge on the convert that your earnings per share guidance for January would actually be $0.50 to $0.52 cents. Thanks.

Thanks, Brian. So, a couple of things. With respect to the sequential guidance, again, if you go back over ten years, you are absolutely right. The difference is the company was a lot smaller. The install base was different than it is today et cetera. The bottom line is kind of the same answer that I gave to Keith. Look at the size of the deferred elements in our revenue today and look at how fast they are growing. Tom made a point that they are actually impediment to rapid growth and that is indeed the case. Sequentially, they are growing in the very low single-digit at the low end of the range that we gave you. So the things that's really carrying the growth here is the products. The deferred that you are comparing to – that's when the deferreds were also growing at about the same rate as the products, i.e. in the 30%, year-over-year. So I think you have to adjust for the size of the company today, how the revenue mix has changed. And the way the deferreds are coming off the balance sheet. With respect to the guidance on earnings per share, you're correct. It's about $0.2 adjustment if you look at it on an economic basis.

Yeah. I think relative to the market share and the guidance, I think Steve is right. We have a third of our revenue that flows through the balance sheet over a 30 plus month period, so clearly we need to age off the lousy quarters and replace them with better some quarters and that will take time. But nonetheless, the guidance that we give going forward from a product growth perspective is still a high 30s, 40% number, year-over-year growth. And I think from a market share perspective, I don't anticipate any of our competitors will be close to that.

Yeah. I would almost say that if you went back over that ten year period and you’ll look…

I’ll bet our products are growing faster over the past three quarters than they have over that same period of ten years ago.

Your next question comes from the line of Richard Gardner from Citigroup.

Yeah. Thanks. I wanted to ask about professional services which looked like it was up a little bit less than the normal seasonal amount in the quarter. I know it's a small piece of the business, but I was just wondering if there is story there, is this just a situation where you continue to slough off some of the lower value added professional services to your partners or was there another story there. Thanks.

Slough off; those are our customers we are talking about.

Maybe not the best term, I am sorry about that.

I think first and foremost, I think you are right, I think as a company we built a strategy that we have always firmly believed that professional services is a essential component of success with our products and other products like it. We do not believe that it’s a necessity for us to actually build our professional services business ourselves. We’ve got partners who would be more than happy to do it. In a lot of way is that a lot of time that’s their profit opportunity in these accounts and for us to compete with them for their profit opportunity, it was problematic for us. So, I still remain convinced that professional services are essential to customer success and we continue to invest as a company around projects that customers insist on we do or projects that only we can do. But after that, I am not looking to grow the business on professional services, we are a product company and if we’ve got partners that are willing to make investments and learning about technology and being capable of doing this and delivering services to their customers then I would rather enable them to build a big – low margin infrastructure of our own to provide similar services.

Thanks, Tom.

Your next question comes from the line of Mark Moskowitz from JP Morgan.

Yes. Thank you. Good afternoon. Tom, I want to see that you could talk a little bit more about the government’s business just in terms of the outside performance you saw this past quarter, how should we think about the trend line going forward? Can you still stay above the mid teen as percentage of revenue? And then Steve if you can just way talk quickly about your OpEx profile, can R&D kind of peel off now that you have a major product launch this past week?

Okay – and really two questions. One of them is clearly the federal business has a fair amount of seasonality to it. We just come off the glamour quarter for them and Q4 will be strong again, but not quite as strong in Q1 and Q3 kind of the bounce back quarters, so in terms of the mid-teens aggregate for the full year, in that vicinity, maybe not as high as 15% for the full year, probably a little bit lower than that on a full year basis, but it remains an important part of our business, I think that we as a storage provider and the number one share in that sector, we continue to be robust and continue to invest. But clearly this is the end of the government buying season, so this is always a quarter where they have got the biggest impact on our business. And as far as R&D is concerned, we’ve always got ten more things to do than we’ve got money to do it with. So yeah we just did a significant product release. We got asked about DSO, one of the things we should mention is that despite a very, very, very large hardware release, we actually had higher inventory returns than the prior quarter. And that the execution by the operations team is notable. I don’t necessarily see any slacking off, I mean, the vast majority of our R&D investment is actually in software and not in hardware platforms and that continues in full force. So, I think we are a technology company as long as business is robust. I think we want to take the opportunity to invest and create competitive advantages for ourselves.

Your next question comes from the line of Paul Mansky from Canaccord Capital. Please proceed.

Thank you. And I would like to echo the solid quarter, congratulations. Going back to some of the earlier comments, particularly pertaining to the software ENM velocity over the next couple of quarters, if I recall, it was a year ago that you introduced the low end refresh and while the revenue mix might not have changed, certainly there was a lot of volume of velocity there at the low end, if I also recall, you gave away or you bundled in, if I maybe it’s a better choice of words, a lot more software that product did affectively at the same price, so the question is why shouldn’t we be thinking about the ENM business accelerating as you come back in around when your anniversary starts hitting those installations for that 20% maintenance renewal?

Steve here, Paul. Paul, the SNM business or the software entitlement maintenance business – it’s a long-term business, Paul. These contracts on average are three years long. So you’re actually looking back in to a period of time on average, a couple of averages but on average, 18 months. So lot of things happened over this period of time. Remember it’s driven by the mix of deferred, versus the mix of non-deferred, it’s driven by the rate at which the business is growing and then it’s driven by the individual contracts and how the contracts shift over time with renewals which tend to be shorter length and point of sale contract which tend to be longer length. It’s a very complex equation that yields a bleed-off, if you will, from the balance sheet in to revenue. So basically, you are not going to see – nothing is going to change these deferred performance on the revenue line in any short order. It is something that’s more evolutionary, it takes time and you have to make a whole bunch of assumptions going forward about the mix, between deferreds and non-deferreds the rates that’s got all the things I just went through. So suffice to say, that we have a lot of information here about what the current deferred revenues looks like today. From that we can model what it’s going to look like pretty much going forward and as we go out further and further we got to be more dependent on assumptions we make about what the forward orders look like. Nevertheless, I can tell you that for the next couple of quarters we are not going to see a significant change in the sequential growth rate of those elements.

Thank you for that color. And just quickly, can you touch on for us, obviously there is a press release earlier in the quarter, relative to the drops in mutual suits around ZFS, I know terms can’t be discussed, but can you kind of talk to us a bit about philosophically how we should we be thinking about that action and then maybe in context of Zyrotec [ph] specifically a key partner of yours recently purchasing Luster which obviously had a big ZFS focus?

I think as far as the lawsuit has got, a lot of factors to it, there is a lot of things that go in to calculus of pursuing a lawsuit versus not pursuing a lawsuit. And clearly dynamics changed when the counterparty of the deal moved from Sun to Oracle. There is more Oracle is a long time partner and at the end of the day without getting in to any details I think it’s safe to assume that an opportunity to collaborate more effectively with them has an economic value that doesn’t exist as we position against Sun. So, I think we took a look about the behavior that we thought was potentially risky and potentially damaging to us, evaluated that against the economic opportunity associated with a better and continued strong collaboration with Oracle. And at the end of the day we decided to do what we did. So, it really had nothing to do with the trajectory is the law, it had more to do with the overall – all the factors involved in relationship. In fact Oracle is going to be a key mover in the industry. From our perspective, we had a long-term partnership with them and likewise the things that were particularly irritating about the prior relationship with the prior owner – we felt a lower risk to the scenario. So at the end of the day we just decided it was a better thing to do. Basically there is no restriction on either of us, we can go back in there and reach for hostile attempt but I don’t anticipate that happening. In fact I am actually optimistic about continuing collaboration.

Your next question comes from the line of Jayson Noland from Robert W. Baird. Please proceed.

Great. Thanks for the question and just a couple on FlexPod. We’ve heard good things specifically regarding virtual desktop, Tom, how big of a deal is FlexPod, how does it compare to C-Box [ph].

I think, first and foremost, the target of this particular offering is against the integrated system vendors, HPs, IBMs, as we look at solutions and really that’s the strength of their offering is affectively integration, they all come from one place and they are all integrated and fastened together. A weakness of the offering is the individual components of the stack and it’s our belief that – providers that customers would prefer to see best of breed solution to their data centers and imperative upon companies like us is to lower the integration barrier of them being able to deploy these. So I think there are some components which are different, I mean, this is a channel focus type of video solutions that’s really aimed to enable our channel, I think it’s a bit more flexible. Having this last about whether we have that VBlock that doesn’t have and it’s more about how do we at Cisco, together go after HP and IBM and really what we are trying to do is undermine what advantage they have which is an equation.

Your next question comes from the line of Jason Maynard from Wells Fargo.

I have a question about server virtualization and just how it might impact your business going forward. VMO talks about server virtualization being 25%, 30 % penetrated on existing workloads. And they are starting to penetrate more tier one, tier two workloads and I was wondering do you think the next leg in virtualization is harder or the same in terms of the process using – getting the sales made and what impact does that have on you given that some of your growth obviously is being driven by our position in that market?

Well, I think there is really two components of this. I think what you are saying is true, I think from a NetApp perspective we might look at it a little bit differently. When I look at virtualization, I would say the initial wave of virtualization was really simply about server utilization and that is I can now run multiple apps on a single server when I used to have dedicated servers and therefore I can reduce my server count or run more apps from my existing server and it’s a pretty compelling economic argument. And clearly it propelled and did quite well with it. And it’s a perfectly legitimate argument, but what really happened which I think is just as dramatic is that what this technology affectively did was decouple the application from the server really for the first time. And it would allow people to think differently around their infrastructure instead of having servers around individual applications, now that the applications are independent and they can redesign the entire server infrastructure. They could be homogenous, they could be cost efficient, they could be automated they can be very flexible. The implication of that is that they want to same thing for storage. They want to have a homogenous, automated, easy to manage, cost efficient infrastructure. And if you look at NetApp’s unified storage. We are primary a back (inaudible) archiving all of one set of tools and one architecture, it’s pretty compelling in that model. So the penetration of virtualization relative to physical systems is one measure, but the thing that’s really driving our business is really customers that are actually leveraging this technology to build out the next generation data center whether it was on a private cloud or a dynamic data center or whatever brand name you want to attach to it, I would say that that is really in the early stages. I would contend if you look at our performance over time when most of our competitors are flat over an extended period of time and NetApp is growing, I would say that NetApp’s growth isn’t necessarily coming from us winning incremental storage demand around legacy apps. I think NetApp has been particularly affective winning next generation data centers as people now use this opportunity leveraged by the capabilities of virtualization to rethink about how to build a much more flexible I.T. infrastructure. And I think that is where we are winning and I have a disproportionate share this. That’s I think what’s driving a partner relationships, particularly the big partners is that we are really about the future designs and less about incremental demand around legacy apps.

Your next question comes from the line of Brent Bracelin from Pacific Crest. Please proceed.

Thank you. Steve, question for you around the model and growth rate, clearly you have two-thirds of business tied to products revenue, when it’s on fire you are clearly taking share, a third of the business tied to deferred to revenue elements, you talked about the lag there, 18 months lag, pretty clearly, my question is looking out at beyond January quarter, end of the April timeframe where you really have the fist tough competitors this kind of revenue side. That in to the April time frame where you have the first tough compare on product revenue side, it was up by 50% year over year tied partially to some unfulfilled orders that got filled that quarter, is it reasonable to expect a normalized product growth rate in the high teens six months from now or do you think it’s actually possible for the new products that you just introduced continued to share gains to kind of overpower some of the tougher compares and sustain product growth in this 30% kind of growth range?

That’s a tough question to answer because a lot of it has to do with the environment that we are selling throughout six months from now. That said, I got to believe that irrespective of the fact that the comparer gets tougher, these new products that we launched, I think, are going to be – are going to help us to be even more competitive than we were yesterday type of thing. So I am expecting that we are going to be able to maintain a fairly high level of product growth, it may not be at the 50% level, that’s kind of an outlier, but I do think we are going to be substantially better than the market we serve and I think substantially better than what we are going to see from the competition.

I think looking out, I made the commentary about limited visibility and it’s the same that it’s been for a while. The kind of the way we answer this question internally is, that’s why I was focused on market their growth. And good market or bad market, the point of market share gain is a point of market share gain and things slow down, but if we continue gain share then we are going to emerge stronger than ever. That’s really our focus. So internally one of our top three objectives as a firm is to grow shares and that remains our top priority. And then we look at the overall envelope around the business why does the Metro look like and what translates that into international dollar growth and will basically modulate our expenses accordingly. That’s kind of how we are looking at it, but share gain is basically the point of the arrow. And as we are gaining share and I think life is improving. For us no matter what the macros is doing. will translate that in to dollar growth and – that’s how we are looking it a. Share gain is basically the point of the arrow, as we are gaining share life is improving no matter what the macro is doing.

Thank you.

Your next question comes from the line of Katy Huberty from Morgan Stanley.

Thanks Steve. Just a follow-up on the January quarter revenue guidance, what are you expecting as it relates to U.S. growth rate versus the growth rate in international markets. And particularly, can you comment on whether you think the sequential uptick from the typical year end enterprise commercial spending will be enough to offset the sequential decline we should see in the public sector spending in the U.S.?

So we didn’t give any specific guidance with respect to the geographic distribution of growth next quarter. I would expect it to look somewhat similar to what we saw this quarter if you particularly you lump the U.S. and the USPS, or U.S. Public Systems business together. I think that Europe is going to continue to be a challenge because of the economic situation over there. Asia looks to be strong and I don’t see any reason why that wouldn’t continue and the rest would be the U.S. So I think that’s kind of going to be the distribution going forward. What was the second part of your question, Katy?

That’s it. You covered it.

Okay.

Your next question comes from the line of Kaushik Roy from Wedbush. Please proceed.

Congratulations Tom on the nice quarter. So your operating margins for the last three quarters have been higher than your long-term target of 17.5 to 18% level. So you are guiding 18.5% for January, so how should we model for next year, are you going to tap operating margin around 18% or it could go much higher? Thanks?

Okay. Thanks to Steve too for the quarter. His feelings were hurt. Whatever it is, he does. So, as far as going forward I think it starts 16% and the thing that’s been keeping above that is really for a sustained period – our gross margins were much higher then they everybody did over time and the overall growth rate has been very robust. So barring any major reversal on either of those two line items which I don’t see in the very near term, then I would think that our operating margin will remain well above the 16% and I would think we kind of hover around where we have been for the last few quarters. Going on to next year, you know frankly I don’t want to give really any guidance there, simply put, is the macro environment is going to have a big impact. So, once again my standard answer once we get beyond the current quarters it’s about market share and that will then adjust the model as we get closer.

Okay. Thanks.

Your next question comes from the line of Ben Reitzes from Barclays Capital.

Yeah. Thanks a lot. Can we just talk a little bit more about the public business and I’m sorry, but U.S. public is 20% and it looks like if you add the rest of the world, maybe it’s 25 to 30 and I was just wondering if you could just even talk in more detail than you did already about how that business was looking in October and how the dynamics of state versus local impacted you sequentially into the next year? Obviously, everybody is focused on it with Cisco and whether you really are going to see the slowdown. It seems like your guidance says, no I just would like at more details as to why.

I think first of all, our public sector penetration outside the U.S. is probably not as high as it is in the U.S. So I think public sector business tends to be more U.S. centric, certainly do public service overseas but quite to the level of proficiency we do it here. You know, I think go forward, obviously there has been election, new regime we’ll see what ultimately – what happens in terms of the spending and you can look at it (inaudible) I’ve certainly seen arguments that, that spending will get cut back I have seen other arguments that people will seek efficiency in IT spending, will actually be a component of their ability to modernize and drive efficiency of the government. My sense is that going to be any dramatic change in the behavior of IT spending by the government. That’s my gut feel these things tend not to change quickly. Probably one other thing about the NetApp business is U.S. public sector is not only our Federal business but it’s also a state and local business. And for us, we really only – we really only started to have a focus on state and local, we actually built a team around it probably a year and a half ago, maybe a little more, but certainly in that time frame. And so there has been a lot of speculation that the state and local would be lot worse off in the Federal in terms of its ability to spend. So for us, I see a rapidly growing part of the business, or it’s actually quite small. It's our belief that the state and local opportunities roughly the size of the Federal opportunity total market share, but relative to size of the businesses are dramatically different. So I am probably more inclined to believe that there will be some slowdown in state and local spending than federal spending. But for us, I would say that the mix between those two is probably a lot lower on the state local side than our competition.

Thanks a lot for that.

Due to time constraints, I would now like to turn the call back over to management for closing remarks.

Thank you, operator. We would like to remind everyone that we will be hosting our 2011 Analyst Day on March 22nd, in New York. Registration will open in late January. I appreciate your time. Thanks.

Ladies and gentlemen, thank you very much for your participation in today’s conference call. You may now disconnect, have a wonderful day.