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NetApp, Inc. (NASDAQ:NTAP)

February 25, 2013 11:45 am ET

Executives

Thomas Georgens - Chief Executive Officer, President, Principal Operating Officer and Director

Analysts

Kathryn L. Huberty - Morgan Stanley, Research Division

Kathryn L. Huberty - Morgan Stanley, Research Division

Good morning. Welcome to the conference, everyone. I'm Katy Huberty, Morgan Stanley's tech hardware analyst. I very much look forward to spending time with all of you over the next couple of days. It's my pleasure to kick of the tech hardware sessions with Tom Georgens, President and CEO of NetApp. Tom brings deep expertise in engineering, decades of experience in storage. He's in his 8th year at NetApp, fourth as CEO. Before that, he spent about a decade each at LSI and EMC.

So with that, we will jump right into it. Similar to the last session, we will take some questions at the end, so I'll make sure to leave a few minutes.

Question-and-Answer Session

Kathryn L. Huberty - Morgan Stanley, Research Division

So Cisco just teed up my first question, which is -- data centers are changing. The world is more virtual. Flash is being discussed as a performance accelerator, particularly with data. Workloads are moving to the cloud. So I want to start, Tom, by understanding how NetApp is changing its engineering, its product roadmap. How are you thinking about the products that were developed a decade-plus ago and how they fit into the world today?

Thomas Georgens

Well, I think the cloud Flash service providers, that's a lot of ground. So I think it's sort of how we think about the products. I think a number of the key value propositions that we provide -- that we've been providing over the years, still have relevance. If you look at clustered ONTAP, which is our core operating system, and while NetApp is the #2 provider of storage in the world, clustered ONTAP is actually the #1 storage operating system in the world now by far. And it brings with it a value proposition around ease of use, around storage efficiency, around multiprotocol and all of those things. And what we're bringing to it now is clustering, and that's what clustered Data ONTAP is all about. So it allows us to take that value proposition and basically deliver it now with unlimited performance, unlimited scale and nondisruptive operations. So if you think about the role of the enterprise, I think that clearly makes sense. But if you think about it in the point of view of the service providers, now the service providers are building a massively large infrastructure that's multiclient, therefore, multitenant. They need unlimited performance, unlimited scale and nondisruptive operations. So if I think about the evolution of clustered ONTAP, I think it serves us well with the service providers. The traditional service providers, IT as a Service, Software-as-a-Service, I think clearly, it's a really good fit there. I think we feel good about that. I think in terms of the role of the hyperscalers, the Amazons of the world, I think we've done some interesting things there as well. We've done a recent announcement where we've actually partnered with Amazon. NetApp private storage allows people to use NetApp storage in conjunction with the Amazon server farm. I think that's been innovative. And then, on the question of flash, yet a different -- totally different subject, I think that one of the things about Flash technology, driven by the economics and the R&D investment around mobile devices, it's been driving the cost down to Flash. So while Flash is still a lot more expensive per gigabyte than hard drives, its performance is several hundred times better. So the idea of basically taking your most performance-oriented workloads, which is usually a very, very small percentage of your total storage requirement and putting that on Flash, where the Flash is in the server itself, close to the app, whether it's on the network in an all-Flash array or whether it's in the storage system, there's many applications for Flash. And I think NetApp -- that's not a new phenomenon for NetApp. We've been doing that for 3 years. I venture to guess we've shipped probably as much Flash as anybody. Certainly, we've got a higher attach rate of Flash to our systems. And we just made a project announcement last week about all-Flash array. So I think all of those have got big impact, but I think the core value proposition that we've been delivering, now we need to deliver them at scale and we need to deliver them at high performance. And I think that's really the role of clustered ONTAP and the Flash product.

Kathryn L. Huberty - Morgan Stanley, Research Division

Okay. We're increasingly hearing from the traditional enterprise customers that similar to what they did with their server footprint and spend, they're looking to address growing storage budgets every year. So they're using more compression technology. They are using Flash so that they don't short-stroke their drives any longer. They're moving somewhere close to the cloud, and the endgame is that they can keep their storage budgets flat, hopefully reduce storage budgets over time. Is that necessarily a negative for NetApp? How does that play into your view of growth in the storage market?

Thomas Georgens

I guess, if we were a 95% market share player, we'd have one opinion. But we got asked this a lot as we went through the last downturn, in 2008. We had come out with deduplication. We had come out with thin provisioning. We had a lot of storage efficiency technologies. And when business was difficult and IT budgets were compressed in some industries, very much the same today, that forces people to adopt those technologies. So we got a very heavy dose back then of, "All this storage efficiency stuff, is this bad for you?" And the fact of the matter is, we came out of that and when spending bounced back, NetApp had a 30% organic growth year. So I think that the things that we do to solve customers' problem ultimately enable us to gain share. And I think that's a really key driving force here. Now the fact of the matter is, at the end of the day, every major enterprise is going to have some combination of data that they're going to keep on premise. They have some combination of data they are going to have at external providers like traditional service providers or Software-as-a-Service companies, and they're going to have some data that fits certain workloads that's going to be in the Amazons of the world. And for NetApp, what we want to do is, rather than fighting that trend, because I think it makes sense with the right workloads in the right place, we want to support that. We want Data ONTAP and manage data on premise. We want to be able to manage data that goes through the service providers. And then, I talked about the work we did with Amazon. So if Data ONTAP can be the broker that could basically coordinate and migrate data between all of these different areas as the workloads dictate, then I think there's an enormous opportunity for NetApp to be the control point in the data management -- the data center, and that's what we really want. At the end of the day, these trends are going to have either economic value or not. And if they do, then we don't want to be fighting them, we want to be enabling them. And I think that we've done that along. The storage efficiency stuff, we have the exact same argument, that this is bad for you. "Why would you want to sell that storage?" And the answer is, if it makes Data ONTAP more pervasive -- and at that time, we were not the #1 operating system and now we are. If it makes ONTAP more pervasive, that's good for us. It allows us to sell storage, and it allows us to be the data management of choice in the enterprise.

Kathryn L. Huberty - Morgan Stanley, Research Division

Sure. So this last quarter, gigabytes shipped through 9% in '09. That growth number troughed at 20%. Is your view that the macro is worse this time around, that comps are more difficult? Are you driving more of your revenues off of non -- either low-end or software? What's driving the lower trough this cycle?

Thomas Georgens

Well, I think there's a few things at play, one of which is that if -- just if you look at capacity growth in the industry at large, and that's probably the proxy for the macro, that's probably half of what it was last year. So that's down. The other thing specific to NetApp, clearly, I think that what we're seeing is users buying smaller systems. We've seen 55% year-over-year increase in smaller systems for us, and those have got less disk drives associated with them. The other thing I'd be careful about 2009 comps is that we have an OEM business now that has a different drive mix, so I wouldn't go too far back in time to do the comps for NetApp. And I do believe that there's a category of very, very low utilization workload. In fact, we had a client this morning that I met with that talked about, right, once, "we'd never" [ph] that I think is going to the cloud. So I think there'll be some capacity component there. But for NetApp, all of those dynamics notwithstanding, our Branded business had 8% year-over-year growth last quarter, which was the highest we've had all fiscal year, and this is now our third quarter, and certainly, higher than any of our competitors in this industry. So 8% growth is certainly not a heady number. It's certainly nothing that we're looking for in terms of our historical and longer-term performance. But nonetheless, in this environment, despite all these other dynamics around capacity growth, it was actually a very, very good quarter for our Branded business.

Kathryn L. Huberty - Morgan Stanley, Research Division

So you're taking share in the downturn. You expect that growth rate to accelerate when the macro improves and you would expect to take share in that turn, also?

Thomas Georgens

Yes. I think if you look at -- if you just look at the quarters that we just put out there in terms of market share -- so that's a Branded phenomenon. NetApp was up 8%. I think EMC's product revenue was 4% or 5%. And all the server vendors were flat to down double-digits. So that's the environment that we're living in. So I'd rather be at the head of that pack than the tail of that pack, but certainly, I'd rather see more of a tailwind in this industry. And the other thing about storage is that I don't think there's anything afoot that's fundamentally reducing the demand for storage. I think every activity undertaken by mankind is generating storage demand. So I do believe that the fundamental health of this industry, certainly, the demand for bytes of storage aren't going away. But there's no doubt that storage spending is throttled by IT spending, and there's no getting away from that. Now storage may get a disproportionate amount of the IT spending over time, but until IT spending bounces back, then that will still be a cap on the storage business. And while that's happening, I think we're focused on innovating and gaining share, so when this does bounce back, just like it happened last time, we'll be back stronger than we've ever been.

Kathryn L. Huberty - Morgan Stanley, Research Division

Okay. When you think about market share gains over the course of next year -- you just refreshed your FAS6000 series. That's after refreshing the 2000, the 3000. You announced the EF540 Flash product. How do you think about your product set and the ability to maybe even accelerate share gain this year? Can it help you buck the macro trends?

Thomas Georgens

Well, the macro is the same for everybody. So I think -- certainly, we have no patience internally for that as an excuse. So if I look at the portfolio, so clustered ONTAP, which has been a long-term journey for us as a company, it's good to see the momentum around that. We've got 2,000 systems now, roughly a quarter of our high end systems are now running clustered ONTAP. The ramp of that is steeper than we imagined. It is up 70% sequentially and 100% sequentially the quarter before. But it's still in the early days. So I think it's real and I think it's got momentum, but I think it's early on. We just did an announcement last week of our Flash products, one of which has already won a major benchmark and has already sold 100 systems last quarter. Another one, more forward-looking, but it will be beta this summer. We've got the E-Series technology. That's really nascent. So if I look at the portfolio, independent of the macro, I see a bunch of technologies that are very exciting, that I think are very innovative, that I think are -- that are far from having played out in the market, that I think we're just bringing on board. So our expectation and certainly, the expectation that I'm conveying to the group is, I can't predict the macro and we can debate that all day. But I think that there are stimulants for NetApp that I think it will allow us to overpower the macro. And yes, we'd rather have a tailwind than a headwind, but I think that we can -- if we bring these to market successfully, then we're going to position ourselves really well.

Kathryn L. Huberty - Morgan Stanley, Research Division

Sure. You brought us clustered ONTAP a couple of times. A couple of years ago, there was a lot of talk about Isilon coming in and displacing some of your accounts with [ph] high win rates, pricing aggressively. How do you feel NetApp is now positioned with clustered ONTAP 8.1, 8.2? The iterations that will come out over the course of the next year or 2? And where do you expect to gain the most share with that product?

Thomas Georgens

Well, I think in the Isilon case, Isilon came in the market with a clustered product really designed at large sequential read operations, and we certainly saw movement of that product in media. We saw movement of that product in relatively less performance-intensive workloads because of ease of management of clustering. And certainly, that product really established a place in the market, no doubt about that. So when we come out with clustering technology, it clearly allows us to compete very, very effectively against those. And then, the E-Series on the media side is actually far more compelling from a performance perspective. But the -- one thing I'd point out is that ONTAP is not an overlap product with Isilon. That is only one segment of the ONTAP use case. The other ONTAP use case is much broader business applications, like virtualization where we don't see Isilon like, where we want to take ONTAP in the future. So I think, clearly, scale-out NAS and content repositories and that type of technology, from a -- that's been a core part of NetApp for a long time, and Isilon has made some inroads there in a couple of low utilization workloads. But NetApp made a big bet around virtualization, to establish technology leadership there. And with the extension of clustered ONTAP, it allows us to build a much more robust storage infrastructure and enabled the virtualization of even more apps. But we also want to take this infrastructure deeper in the data center and actually go after applications. Now that we've got unlimited performance and capacity and nondisruptive operation, go after applications that have previously not been part of the NetApp domain, aggressively after databases, aggressively after data warehousing. So the Isilon overlap, yes, is a factor and clearly, we want to take that on and we certainly don't want to see any erosion of our customer base. But that's only a small portion of the ONTAP value proposition. So we clearly see Isilon as a competitor, but to use EMC as an example, we also see VNX and VMAX as competitors where we also believe that we've got superiority.

Kathryn L. Huberty - Morgan Stanley, Research Division

Right. Shifting focus to the Flash discussion. There are a number of different flavors of Flash in the market: Flash as primary storage, Flash as a cache, Flash as a server, Flash in storage, Flash as standalone array. What's NetApp's view of how Flash is best put to work in the data center?

Thomas Georgens

Well, so before I get to the incarnations, I think that -- what are we trying to solve with Flash? So Flash, from a pure capacity perspective, is still substantially more expensive than rotating media. But if you think about Flash from a I/Os per second or transactions that it can do, it's actually much higher performance than rotating medium. People -- you've mentioned short-stroking before, the ability to minimize how far you have to move the heads on a disk drive to get more performance out of them and throw the capacity away. So Flash is really optimized for that data that's got a very, very high random I/O workload which, in general, in a data center is a very, very, very small percentage of the total capacity. So in terms of Flash undermining total capacity shipments in the industry or capacity of hard drives, I really don't think it's going to have that big of an impact. On the other hand, Flash deployed against these very, very important, high-performance workloads, I think is very, very important. Even if it is only 1%, it's still a big number. And I think as such, people will look at how they deploy Flash. So they might put flash in the server, closest to the application. But that's got implications for sharing and asset lifecycle and disaster recovery. They might put Flash as an all-Flash array so it can be a shared resource. And they might put flash in the storage systems so that you can get rid of enterprise, clusterize and basically improve the price performance. So Flash is really a journey on application acceleration and really, about optimizing price performance of the data center. So the fact is, which of those models are going to prevail? The simple fact of the matter is, they all will. There will be Flash in the host. There will be all-Flash arrays. There'll be Flash in storage systems. There'll be Flash in disk drives, and NetApp wants to manage all of that. So -- because the data that you want to accelerate today might not be the data you want to accelerate tomorrow. And the last thing you can afford to do is have inactive data on the Flash, because now you've got something that's very, very expensive that's not doing anything. So the management of that, over time, and the migration of that data to the appropriate level is what NetApp wants to do. So we've got Flash Accel, that we can work with Flash in the host and basically, back up to NetApp storage behind it. We've just announced all-Flash arrays, and we've got Flash in our systems. So NetApp has shipped 36 petabytes of Flash. I don't think anybody has got as pervasive a Flash portfolio as we have, and so I feel really good about where we are and the things that we've got imminent.

Kathryn L. Huberty - Morgan Stanley, Research Division

How do you feel that NetApp's view of Flash differs from EMC? Because they were vocal several years ago, quite early, on this topic.

Thomas Georgens

Well, I think early on -- not to just [ph] put EMC in perspective, I think there was a sense of if you just took hard drives out and put Flash drives in, that that had value. And the answer to that is without some changes to the software, I don't believe that that has value. Because that would mean that you know where the most active data is at any point in time. It doesn't change over time. And we also went through all this activity to virtualize away all the physical disk, and now you need to recreate all that and know where the data is physically located. And we didn't believe that that was worth any effort of our time. Certainly, solid-state drives in the systems, that's -- there is a user use case for that but it's small. Our view is that Flash deployed as a cache. That way, it's always dynamic. It's always adaptive. It's always got the most important data. It was a much, much more effective way to do Flash in storage arrays. And that's what we did. And now in our high end family, the 6000, Flash is in every unit item. In the 3000, it's close to being at every unit item. And we found that 1% or 2% of Flash in the system dramatically improves the performance of the product. And now we've got several exobytes of storage behind the Flash that we have at the front end. So our belief is that over time, just purely replacing hard drives with solid-state drives without fundamentally changing the software is not an important technology and is nothing more than a niche market. But deployed as a cache, it can be very influential, and that's what's really driven up. And I would venture to guess that not only our capacity, but certainly, our footprints of cache are higher than anybody's in this industry.

Kathryn L. Huberty - Morgan Stanley, Research Division

And does -- you mentioned that EMC incorporated SSDs without a software change. As you use Flash as a cache, is there a software change that's required in the NetApp software?

Thomas Georgens

Well, originally, because we had caching, we made that bigger. So we've also innovated there with things like Flash Pools that allows us to use solid-state disks as a cache, but use the form factor of a solid-state disk to get more Flash into the system. And not to misrepresent [ph] EMC and not to defend them either is, they've also made changes to their software beyond their initial rudimentary utilization. But at end of the day, I think that the pervasiveness of our technology -- of Flash in our technology throughout all of our products at all of the levels, I think, is far more pervasive than anybody in the industry.

Kathryn L. Huberty - Morgan Stanley, Research Division

Recently, IDC published that in 2012, the amount of storage shipped to service providers was greater than the amount of storage shipped to enterprise. And at the beginning of the discussion, you talked about a number of partnerships that NetApp has. But the concern that, I think, investors have when they hear about Amazon and the large buyers purchasing large amounts of technology equipment is that they don't want to pay full price. And there's a risk around margins. There's a risk around whether they would go around the branded companies to a cheaper solution. How do you think about why NetApp technology is best suited for that market?

Thomas Georgens

Well, I think we need to break the service providers down into a number of categories. So the Googles and the Amazons, you kind of put them in the hyperscaler category, and I'll come back to them. But as far as the traditional service providers and IT as a Service players, for the most part, those guys are providing enterprise class services, and they're doing it with enterprise class gear. So in a lot of ways, the service providers -- our belief early on was that as the service providers grew, they would be consolidating a lot of demand of end users in one place. And if we could win the service providers, then we could satisfy a lot of end-user demand that we might not have been able to win on individual oneoffs. So service providers was a big bet that we made, and we created a service provider business unit, telco service provider business unit. And we work with them, and it's not just selling stuff to the service provider. It's enabling them to create products that they can sell to their end-users. So in a lot of ways, there's like an OEM feel to it because there's design wins and then there's sell-through activity. And certainly, over this fiscal year, that group, the telco service providers, has been the best-performing part of our business. So clearly, we recognized this early on. We built a business around it. And if you think about the value proposition we're bringing with ONTAP, it's a commercial product. It's a proven product. And now with clustering capability, we can deliver that with multi-tenancy at a very, very large-scale. So I think from that perspective, it's the right product at the right time. And I think we feel good about that, and some of the most zealous supporters, in fact, today are service providers. A lot of people are doing public speaking and references and things like that for us [ph] R&D service providers. As far as the hyperscalers are concerned, I think we can take a lot of attitudes against them. We can basically say we hate them, and we're going to have to compete against them. And I think there are some workloads where they're not a good fit and some where they are. And I think where they are the right choice for the customer, it would be pointless for us to fight that. So in that scenario, we could sell them something and make them a customer, and I don't -- I -- to your point, I don't believe they're going to buy standard product from us, but there's intellectual property engagement that we can engage in. But the other one is if they're going to build, and they're going to spend billions of dollars building an infrastructure, then how do we leverage that to our advantage? And that was the rationale of the NetApp private storage. And that is how do we enable customers to have access to EC2 server farm and NetApp storage and use that in a very, very effective way? So they can basically use Amazon for things that are very, very good, for temporary, for proof of concepts, for test-and-dev, and still stay integrated within the NetApp storage framework. So we could sell software. One of the analogies that I use is that we don't sell disks for a living and so we don't necessarily have to sell storage for a living. But if we sold software that can help customers use Amazon and migrate data into Amazon, use the server farm, migrate it out and then integrate it with their environment, then that can be very innovative. So I think the hyperscale players, in some cases they are competitive -- I'm not going to deny that. There's some workloads that are going to move to them. Now that's maybe on NetApp or EMC or whomever today, but they're also a target for us that we'd love to sell to. And the last one is, they're going to build this infrastructure and it would make a big investment and the question is, how do we leverage that? And I think we've done a number of interesting things and you should expect to see more of that as time goes on. So in some cases, they're going to be an alliance partner to us and not necessarily purely a competitor and not purely a customer.

Kathryn L. Huberty - Morgan Stanley, Research Division

Okay. I don't think anybody believes that all workloads, all data will move to the cloud. Where do you think the ceiling lies today? What workloads are moving to the cloud? What do you think companies will stay away from over the next couple of years?

Thomas Georgens

Well, I think the things like backup, things like lower utilization workloads, I think those will clearly go to kind of IT as a Service type things. I think there are a lot of peripheral activities and a lot of peripheral programs, whether it be marketing programs or whatever, that will move towards a Software-as-a-Service model. I think the Software-as-a-Service model is real, and I think a lot of companies, NetApp included for noncore applications, will look to that first. But I also believe there's a whole other set of applications which are either security-intensive, performance-intensive, integration-intensive that are differentiating, that are going to stay on trend [ph], at least, for big companies. And at the end of the day, there will be a combination of all of those. There'll be some combination of SaaS, some combination of on-premise, some combination of traditional service providers and some combination of the hyperscalers. And I think that coordinating all of that and making sure the right data is in the right place, and it's safe and it has the right performance -- and then, the other wrinkle is integration. And that is a lot of these applications are only valuable if they're integrated to each other. They have access to each other's data and single sign-on and all of that stuff. And I think that's going to be a challenge out there as well. But as far as NetApp is, we would love to be in a situation is that whether data is in the cloud, whether it's on a service provider, whether it's on-prem, that it's basically managed by Data ONTAP, whether we're actually storing the physical bits or not.

Kathryn L. Huberty - Morgan Stanley, Research Division

And that's a good segue into talking about the partnership ecosystem, because that's ultimately how you get involved in all those buckets. When we compare and contrast NetApp to other storage companies, it is the big differentiator. Over -- well over half your business goes through partners like Arrow and Avnet. Cisco was up here talking about a great relationship with NetApp. You have OEM relationships with IBM and others. We talked about some of the cloud providers. How core is that to your strategy, and do you think you're gaining even more momentum in the channel? Are there opportunities -- or with partners -- are there opportunities to bring on additional technology partnerships in the next year or 2?

Thomas Georgens

Well, I think that starts, actually, with almost a fundamental strategy point. And that is -- well, NetApp is #2 on storage. If you look at the other companies on that list, IBM and HP and Oracle and Dell and EMC and Hitachi, they're all a lot bigger than us. And NetApp is under no illusion that at our core, we're a technology company and that NetApp has to have compelling customer-relevant technology at all times. And if we don't have that, no amount of rest of the strategy is going to compensate. But we also recognize that that's not enough, and the challenge is how do we project the scale that can compete against all those other companies on that chart? And we've done that. We've achieved #2 market share position. But how do we achieve a scale, yet simultaneously recognizing that we need to preserve our investments in R&D to continue to differentiate and innovate? And the only real answer to that question, to really do that at true scale is through a partnership. And I think NetApp recognized that early and made that an integral part of our DNA. So some of the partnerships are go-to-market like distribution partners and resellers and things like that. Some of it is OEM. These are classic customers that will only buy from a single source, and we need to work on that. But the big thing that I think that has really come into play in the last couple of years is actually the leverage of the alliance partners, other like-minded best-of-breed players in the industry that we can align with to create solutions. It started with VMware. That was a big turning point for us, and then, Cisco turned out to be huge. And I think in the Cisco case, and this is true with some of the other partners as well, is I think what works with us with Cisco is first, I think we have a common view of the role of Ethernet in the future of storage, whether it be block or file. I think we also have a very common go-to-market model, which is very much indirect. And I think the last one, which is really important is I think we have a strategic domain that, at least for the foreseeable future, is not overlapping. So I think that there's legs to this relationship and that is we can continue to pursue our interests, we can continue to grow our company without having to compete with each other. And I don't think that's true of a lot of other partnerships. And there's certainly several players in the industry that have got aspirations of expanding, that are becoming more and more threatening. So what I see is an opportunity for NetApp, with other like-minded best-of-breed players, to create very, very tightly integrated, very supportable solutions. So when we compete against the server vendors, we can say, "We've got something every bit as integrated as anything that an HP or IBM can offer, but is made of best-of-breed components and here's the value that we provide." So focus on that. But likewise, I think there's the opportunity of basically bringing our channels together to promote these joint solutions. And what we're seeing is not only is that working for us -- and Cisco is now 2,100 customers, 500 customers added last quarter alone, really true momentum -- is that we're starting to see the software vendors wanting to be connected to this as well. So the work we do with Cisco is called FlexPod. But now there's Microsoft for FlexPod. There's SAP for FlexPod. There's even Oracle for FlexPod. There's Citrix for FlexPod, and more and more people want to be part of that. But I think the integration story does matter, and -- but I think that while -- but integration alone is not enough. People aren't willing to trade off a lot of innovation to get integration, otherwise, the server vendors would be gaining share when, in fact, they're all losing share. But if you can bring integration and innovation together with a bunch of like-minded players that have not overlapping objectives, then you can build a long-standing relationship that could have a lot of momentum. And I -- that's why we're really excited about Cisco, because I don't see us on a collision course strategically. I think that the evolution of our product offering and them trying to gain share on the data center is very aligned. We have great channel relationships, and I think that we're bringing a lot of other people towards that. And I think what we'd like to do is create an ecosystem of like-minded people that's getting bigger and bigger and bigger, to basically ward off some of the more threatening elements in the ecosystem that might not be good long-term partners for anybody.

Kathryn L. Huberty - Morgan Stanley, Research Division

On that front, just shifting to competition. There's a view in the market that EMC is doing a better job competing in the channel which, for a long time, has been a big driver of NetApp's growth. Is that a fair view? Or are EMC and NetApp really competing with the server vendors who sell a lot of servers and storage to the channel?

Thomas Georgens

Well, I think there's a few things at play, one of which is clearly, as the EMC relationship with Dell unwound, EMC needed to compete for that business. And the only way they were realistically going to do that was with the channel. So I think they had the opportunity to bring a pretty broad customer list, a pretty big install base to the channel and move that along. And the question is, has that all played out? I mean, clearly, as I think EMC has caught back a fair amount of that business. You can see it in the relative growth rates of the companies. Clearly, as EMC sells EMC products instead of Dell selling the Dell-branded EMC products, it's helped EMC from a market share perspective, because it's been a re-class away from Dell towards EMC. But the question is, has that played out now, right? That transition is over and I think now we are going to play. I think simply put, EMC clearly has invested more in the channel for that reason, but I think what NetApp has done over the years is we've demonstrated staying power. I think the strategy that I articulated about our need for leverage and our need for scale, given our size, I think that resonates with the partners. They understand that if they were in my shoes, they'd be doing the exact same thing in trying to partner. So I think they understand partnering is in our DNA. I think we've been a lot more consistent. And I think they're a little bit more skeptical of other players that may have only found the religion recently. So I think for us, I think the longevity, the strategic importance of it, has been a key factor. And even Arrow and Avnet had good growth quarters for us this past quarter as well. So those continue to get stronger.

Kathryn L. Huberty - Morgan Stanley, Research Division

There's been a lot of press over the past year around some of the server vendors. HP has had management changes, strategy changes. Dell's now in the press, looking to go private. Is that helping your business? Is that helping relationships, momentum, conversations with customers?

Thomas Georgens

Well, I think it's clearly creating uncertainty. There's no doubt about that. And so in this is -- I don't think there's any ambiguity about, is HP still going to be here 5 years from now? I think it's pretty safe to say that they will. But the question is, how much investment are they going to make in this technology? It's one of the things about the server vendors, is that they've acquired a lot of technology, but over the last -- pick any horizon, they've all been net share losers. And I think the primary reason for that is their inability to sustain the level of investment it takes to innovate in this space. And I think that's been the challenge. So acquisitions notwithstanding, and there's certainly been a lot of acquisitions by all the server vendors, but still, none of them are share gainers. And I think that's one of the challenges that are out there. I think more broadly, in terms of NetApp versus the storage products, I think this is where the partnership and the alliances that we do with Cisco and some of the other server vendors, even IBM for that matter, which is an OEM partner of ours, is helpful. Because I think that they'll foresee it as either stable or up-and-comers or whatever in the midst of the turbulence that Dell and HP are going to go through. So I don't know what the outcome of any of those are going to be. I think it does create uncertainty in the eyes of the customer. And I think from that perspective, certainly, it opens up opportunities that perhaps would not have happened had circumstances been different.

Kathryn L. Huberty - Morgan Stanley, Research Division

Okay. I'm going to ask another question or 2 and then, I'll open it up to the audience. I just want to end on M&A. Last year, we talked a little bit about NetApp's strategy and one of your comments was that NetApp would focus more on smaller technology acquisitions. There was a bit of a fear to bid on a developed business for fear of other companies with larger balance sheets. Is that still the strategy, to stay away from a larger acquisition?

Thomas Georgens

Well, I think that's not only true of NetApp. I mean, that's true of -- I mean, we've seen it. I mean, look at the 3PAR bidding, right? I think that everybody wants to stay away from those situations, even companies with bigger balance sheets. So I think that's forcing people to buy companies earlier -- taking a little bit more risk and buying companies earlier in their business cycle. Because once proven, there are more buyers than there are sellers and you end up with very complex situations. And I think that's true not just for NetApp but the other guys as well. So I think for us, I think simply put, we're getting bigger. I think you should expect to see tuck-ins. We just announced one a couple of weeks ago. We announced one last quarter. So as we get bigger, then I think you will see a commensurate increase in some of these smaller tuck-in acquisitions that we do. As far as larger ones, they're going to be entirely asynchronous. It'll be a function of, is it the right technology? Is it available? Is it the right price? Is it executable? And we could go a long period of time without doing one, or we could do a couple of them in close proximity. We did Engenio not that long ago, and that was the biggest transaction. It fit those criteria. But we could go a long time without doing another one or we could do a couple of them close in, it all depends. But I think that the tuck-ins you'll see on a more regular cadence, and the other ones will be very, very asynchronous and very opportunistic.

Kathryn L. Huberty - Morgan Stanley, Research Division

Okay. And on the other end, investors recognize -- the market recognizes your operating system leadership, the ecosystem that you've created with partners, install base, very aggressive and successful sales force, and wonders why NetApp isn't part of a larger technology company that wants to move more into storage. Does that make sense to you? Is NetApp better on its own because of the partnership ecosystem?

Thomas Georgens

I certainly can't speak to the motivations and what other companies would see. I think, certainly, they would bring scale. On the other hand, the ability to sustain investment in these technologies has been unproven. So I can't speak of that scenario. What I do know is that if you look at NetApp's history and you look at NetApp as a share gainer, if you assume whatever IDC's long-term growth rate is in this industry, NetApp as a share gainer is a double-digit grower. And I think a double-digit grower will generate a lot of return for our shareholders. So what I think about the storage industry, will it get back to the IDC numbers? I think it will. I don't think there's anything broken about it. I think the demand for storage is unchanged. We're not in some technology that's being obsoleted. On the other side of it, can NetApp gain share in these environments? I think we have a lot of untapped technology that we probably couldn't talk about 2 years ago or 3 years ago, that I think is in the market or about to be in the market or it certainly is not fully utilized. So I think with some rebound in this market and NetApp's innovation and gaining share, NetApp as a double-digit grower, I think, frankly, is a better investment than any company that could potentially buy NetApp.

Kathryn L. Huberty - Morgan Stanley, Research Division

Great. So I'm going to stop there and see if there are questions in the audience. There's one down here in the front, if we can get a mic. Right here.

Unknown Analyst

Two questions, just quick ones. On ONTAP 8.1, what percentage of the functionality do you think you've integrated into the product to address the new enterprise commercial workloads that you're pursuing in terms of management, scalability, security, all of these nuances? Maybe you could address that? And then the second one is, I believe in the last call that you mentioned you were having some difficulty with the OEM side. Was that specifically the E-Series, or is there another component? Was it IBM weakness? Was that related the E-Series? Or can you just shed a little more light on where that softness lies specifically?

Thomas Georgens

So on the OEM business. The OEM business is both the E-Series, but there was also an OEM business with NetApp traditional solutions as well prior to that deal, and those are both [ph] together. So in the category of the OEM business, in fact, they were both down, so it wasn't just an E-Series phenomenon, to be direct. As far as color on individual customers, in the OEM business, that's a little bit difficult, because it's disclosing things about their business that they've not made public. So I think that the way the OEM business works is that in the near-term, in the very, very near term, we're subject to their ability to sell through, and clearly, it's been a challenging industry across the board. Some of them have been successful, some of them, less so. I think in the longer-term, clearly, it's about getting more design wins, keeping up the innovation pressure on the customers that would like to do some of these technologies themselves and ultimately, having them move the make-buy [ph] decision more in the NetApp direction. So that's clearly our focus. So it's not something that we're just letting wander down. It's something that -- in the near-term, it's going to be a function of their sell-through, but in the long-term, it's something that we want to aggressively add new partners and also continue to win at the partners that we have. So I think it will be a lumpier business simply because it will go up and down with design wins, and I think that's kind of what the state of play is there. As far as ONTAP more generally, I think that -- a story that I like to tell, kind of a classic enterprise story is, we had a major client in one time, and this is probably 1.5 years ago, and we were just talking about the functionality, and we were talking about putting NetAPP to run their database deployment. So this is a very, very big financial services firm that everybody's heard of. And we're having a -- kind of a difficult set of conversations, and we weren't making any progress and finally, I said, "Look, you don't want to do it. I get it. But then, why are we having this conversation?" And his comment in return was, "Because I run NetApp elsewhere in my environment and it has a set of features that I know that I will never see in this environment, which is traditional frame arrays. I will never see that functionality. My people love it. It's a lot less expensive. It's easier to manage, and I wish I could do that." So now along comes clustered ONTAP. So what was his holdback? His holdback was basically scale and performance. That was his concern. Whether real or not, that was the concern he had at the time. And now we're going to come at that solution with a clustered solution. So we can build a level of performance and a level of scale that can't be emulated with any individual box. And we can do it with nondisruptive operations, so it doesn't have any disruptive operations associated with downtime when you have to move assets. You can migrate the data off of assets, reel other ones in, put the data back. It fundamentally changes how he operates. So that was the classic case of the value proposition. The NetApp functionality was clearly superior to anything he was currently running, but he was concerned about performance and stability in a long-term environment. And now we're able to come with a solution that's architecturally superior to what he currently has. And now that customer's actually deploying us for some of those apps today as he proves out all we were able to deliver on this message. But if we can, it's very disruptive to the standalone box approach that, no matter how big they are, it'll never be as big as a cluster can be built. So from our perspective, I think that the core value around storage efficiency, application integration, multiprotocol, I think all of that resonates, and now we can do that at a scale, performance in nondisruptive operation that's architecturally superior to the alternatives. And that's why it's such a big play, because there are a lot of people that held his perception, whether it's true or not -- and I won't debate that here. There are a lot of people that held that -- his perspective, and now we're giving him a whole nother [ph] thing to think about. And demonstrating and delivering on that promise fundamentally changes the way he's going to think about how his data center's designed in the future. We've won some of those customers over. We've clearly won some service providers that basically are starting from scratch off this technology and bet their whole business on it. But likewise, in these big enterprise accounts, now is the time for us to make that move. Because now there's substantial feature parity between the clustered mode as a technology than what they previously had seen, except it's now got all the capabilities of clustering.

Kathryn L. Huberty - Morgan Stanley, Research Division

Okay. Great. We are out of time. Tom, thank you so much. Great discussion.

Thomas Georgens

Thank you. I appreciate it. And thank you for your interest in NetApp.

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