Here’s the entire text of the Q&A from Network Appliance’s (ticker: NTAP) fiscal Q2 2006 conference call. The prepared remarks are here.
QUESTIONS AND ANSWERS
Operator
(OPERATOR INSTRUCTIONS) Harry Blount, Lehman Brothers.
Harry Blount - Lehman Brothers - Analyst
A quick question, I guess, in terms of longer-term thought process. It seems like with the launch of SQL Server, the IBM relationship, Decru, you had some new low end products coming later this fiscal year, what is it going to take to get back to a 30% topline growth? I noted the numbers are still in the 25 to 28% range -- very healthy rates. But I know the goal is to get north of 30. What is it going to take to do that?
Dan Warmenhoven - Network Appliance, Inc. - CEO
This is Dan. It is really going to be really, I think, a question of sales productivity, shorter sales cycles, higher win rates, etc., more indirect channel contribution, all of which kind of fits into sales productivity model. And we're very focused on ways of improving our overall field effectiveness. I should point out that we are kind of hampered on a year-over-year comparison by about 2 points of currency movement. And that would be just enough to push us over that 30 bar. But I have to tell you we're very focused here on trying to get back over 30% growth year-over-year. The entire Company is committed to that kind of number.
Operator
Tom Curlin with RBC Capital Markets.
Tom Curlin - RBC Capital Markets - Analyst
Further to that topic, just given the comments on further penetration in the Fibre Channel SAN world, should we assume that some of these recent hires, both of whom are SAN industry veterans, suggest a greater focus on driving market share gains in Fibre Channel SAN environments, and perhaps even trying to evolve the culture internally towards that end?
Dan Warmenhoven - Network Appliance, Inc. - CEO
I think that is a pretty good assumption. A couple of employees pointed it out to me as well. We still have a core orientation towards NAS, and we're not walking away from that. But we have set our sights on gaining share in the SAN market. Our strategy in a nutshell is continue to lead the NAS markets, be the leader in the iSCSI market, and have a share position there that is about the same as in the NAS market, and then continue to gain share in the SAN space. The real strategy in a nutshell is the unified storage message, right. Any flavor the customer wants, he can get the best solution possible from Network Appliance. But in order to make that a reality, we've got to be a real player in the SAN space.
Operator
Keith Bachman with Banc of America.
Keith Bachman - Banc of America Securities - Analyst
I was just hoping to understand a little bit more about the services run rate. Could you talk about that? It seems to be doing fairly well. What are your expectations given the recent performance has it changed at all? Combined with any color on the gross margins of that particular organization.
Steve Gomo - Network Appliance, Inc. - CFO
I think you should expect the service topline to continue its performance that you saw this quarter. There's no reason why we expect service to slow down from a revenue growth rate standpoint. We've got lots of new service offerings. They are compelling. We have been investing in professional services, and that organization is really starting to hit stride now. As far as the gross margin is concerned, we do expect that some of the benefits that we saw this quarter, particularly the onetime credits, will not repeat next quarter. I would look for next quarter's service margins to be in the mid-20s.
Operator
Ben Reitzes with UBS.
Ben Reitzes - UBS - Analyst
With regard to the new product that you are going to launch at the high-end, Dan, what kind of contribution are you looking for this product? And could there -- how does it differ -- I know since it is higher end, you probably don't have as big a disruption risk. And can you talk about how much contribution you expect this quarter, and then to the overall growth rate from this type of high-end foray -- maybe for the rest of the year?
Dan Warmenhoven - Network Appliance, Inc. - CEO
The new high-end system will not contribute anything this quarter. We are planning as always by the Q4 of our fiscal year, not the calendar year. You won't see any regular contribution to this quarter. It will probably be coming to market, certainly on a limited basis, on our fiscal Q4. But the objective of the product is to be a complete replacement for our high-end 960 and 980 pair. You should expect two models, much like we did with the FAS 3000. And it is going to be well above the 980 in terms of performance and capacity. It is the first time we've had a 64-bit microprocessor, and it makes a big difference in terms of bus throughputs. And I think you'll find it to be quite a behemoth.
Ben Reitzes - UBS - Analyst
And not expecting any disruption in this quarter from it?
Dan Warmenhoven - Network Appliance, Inc. - CEO
No, in fact nothing in Q3 -- no disruption, no issues whatsoever. But in Q4 I would expect to see, especially for some of our longer-term and more performance sensitive customers, that they will start adopting the 980 pretty quick. But you know it really will be additive. I think it is going to be an accelerator for Q4 to the extent that the customers decide to adopt it right away. Don't forget there our typical sales cycle on new system is 60 days or something like that. Testers really take an eval and make sure they're comfortable with the whole thing, and not necessarily commit to it until after they have been through that level of evaluation. So even in Q4 I would expect the revenue to be somewhat diminimus. But we will see. It is going to be introduced in Q4. Like I said, the performance sensitive customers will take it. And we will just have to see what that equates to relatives to incremental revenues.
Operator
Mark Kelleher with Adams Harkness.
Mark Kelleher - Adams Harkness - Analyst
I was just wondering if you could maybe talk about IBM a little bit? The FAS 270 shipped in the quarter, and the 3000 is starting this quarter. Yet we're only looking for 1% of IBM contribution next quarter. What are sort of the touch points to look for in terms of ramping those products a little stronger at IBM?
Dan Warmenhoven - Network Appliance, Inc. - CEO
The plan was always it would take them about a year to introduce the complete product line and to roll it out across all geographies and all channels. It is a progressive type of roll out. And I think the plan has always been they will build over time in terms of revenues in our mix. We have no indication from them for this particular quarter, which is their fiscal Q4, what the volume might be on the FAS 3000. It is brand-new. And I think that is really going to be the first indicator. At the end of this next quarter we can kind of give you an indication I think as to what the volume might look like going forward. But to be very honest if you, this is a new product for IBM. And we are all proceeding fairly cautiously with respect to all the support infrastructure, manufacturing infrastructure, etc. And our expectations are that until all of that infrastructure is really smooth that you won't see a volume ramp coming through.
Operator
Richard Chu with SG Cowen.
Richard Chu - SG Cowen - Analyst
I wonder if you can give as any metrics that give us a sense of how much progress you are making towards hitting your 70% large enterprise attrition goal a few years out?
Dan Warmenhoven - Network Appliance, Inc. - CEO
I'm sorry, Richard, you dropped off at the end of that question. (multiple speakers).
Richard Chu - SG Cowen - Analyst
I believe, perhaps a year ago, you talked about -- you tried to get to a 70% enterprise penetration mix. And I wonder how much progress you're making towards that?
Dan Warmenhoven - Network Appliance, Inc. - CEO
I don't remember the 70% number. But I can tell you -- I recall the sign we put up -- and I think it was Rob Salmon put it up in the analyst meeting -- that we were really trying to go for one-third from top enterprise accounts, one-third from I guess what you consider to be the Fortune 2000, and about one-third from you consider to be down to the Fortune 10,000 or 15,000 or whenever. Our view is just roughly one-third, one-third, one-third. So maybe that is where the enterprise number got to 66 or something. This particular quarter enterprise revenues were up 10 points in a quarter over quarter comparison. I think we're making great progress. But you know our profile right now is just about 60% from enterprise accounts. And that includes the top two segments I was referring to. I should point out also that the government agencies are in their. A number of our top enterprise accounts are either in DoD or in the civilian agencies.
Richard Chu - SG Cowen - Analyst
Thank you very much.
Dan Warmenhoven - Network Appliance, Inc. - CEO
We have done extremely well on the enterprise business. And as I look at the mix, we are actually a little ahead of our plan relative to where we expected to be with adoption in the enterprises.
Operator
Laura Conigliaro with Goldman Sachs.
Laura Conigliaro - Goldman Sachs - Analyst
A question about operating margins. You mentioned that your target for the year was still 15 8 to 16 4. But yet if you use this quarter's operating margins and then basically back into the operating margins based on the targets you are giving for the next quarter, it would imply some pretty low operating margin levels for the fourth quarter. Can you give us some further observations about what you are thinking as far as operating margins, and the hiring that goes along with that? And are you being sort of very conservative just to see how it develops? In other words, is there room for operating margin upside?
Steve Gomo - Network Appliance, Inc. - CFO
This is Steve. So maybe I wasn't clear on the script part of the call. But basically our objective is for each quarter we're looking at 15.8 to 16.4. That is not to say the full year is going to be there. We already have demonstrated a pretty strong quarter here that is obviously going to have an impact on the full year. But I think that Dan made reference to it earlier. We think that that level of operating profit is the level that optimizes our ability to grow the top line, and to turn in the fastest-growing EPS that we're capable of over the long haul.
Operator Andy McCullough with Credit Suisse First Boston.
Andy McCullough - Credit Suisse First Boston - Analyst
Just to follow-up on that question, Steve, I think you are pretty clear about the balance of growth and profitability, and how you guys are managing the business. But in terms of the hiring initiative that you guys are talking about for the full year, how much of the remaining target do you plan to get done in the third quarter versus fourth quarter?
Steve Gomo - Network Appliance, Inc. - CFO
Steve again. I think you're going to see it spread pretty evenly throughout the quarters. We're looking to do about roughly 300 a quarter when we started the year. And we're going to pick up the pace a little bit here, if we are capable of doing it, but that is certainly our plan. And that is how we get the operating profit numbers we talked about.
Operator Joel Wagonfeld with First Albany.
Joel Wagonfeld - First Albany - Analyst
A follow on to those two questions. Just looking out longer term, for this year I think at the top end of your ranges you're talking about EPS growth kind of roughly in line or slightly above revenue growth. For next year should we assume that EPS would grow at or slightly below revenue growth? And if so, at what point do you get you think to a point where you start to see positive operating leverage in the model, or is it just kind of growth for the foreseeable future?
Steve Gomo - Network Appliance, Inc. - CFO
We will probably have to get back to you at our securities analyst conference in March with an answer to that question. We haven't made any kind of disclosure or announcements about what our FY '07 plans are. Right now we are concentrating on optimizing FY '06. And we're working on our plans going forward.
Dan Warmenhoven - Network Appliance, Inc. - CEO
That said, I would like to respond to the last clause you had. I think it is all about growth for the foreseeable future and trying to maximize both our revenue growth, market share, etc, over that period. I do think we are in a market which is undergoing significant structural change, market share shifts, primarily away from server vendors and towards pure play storage vendors. And I think it is incumbent upon us to ensure that we maximize the opportunity to gain share over the next several years.
Furthermore, I think our history has shown that the way to optimize the EPS growth is in fact to drive the revenue line as far as we can. And if we don't reinvest enough in revenue maximization, then ultimately it shows, in not just slowing revenue growth, but even a slowing in EPS growth. I don't see anything in the near term that would change that outlook whatsoever.
Joel Wagonfeld - First Albany - Analyst
And then could I just ask a follow-up. In terms of after this year you have talked about the services personnel a lot. Going forward with the additional services personnel would it more on the R&D side or would it be investments in the indirect channel to further expand that.
Dan Warmenhoven - Network Appliance, Inc. - CEO
We would be happy to put you back in the queue.
Operator
Rebecca Runkle with Morgan Stanley.
Rebecca Runkle - Morgan Stanley - Analyst
I love your discipline guys. Shifting gears slightly, on the buyback front you more than doubled the amount you are spending on buyback over the last couple quarters. Can you provide some more color in terms of expected levels going forward, especially given the incremental program that you announced today? And I assume that going forward you'll still manage it along the lines of buying back enough to offset the dilution, but will you just comment there as well?
Steve Gomo - Network Appliance, Inc. - CFO
This is a Steve Gomo. A couple of points of note. First, the levels we're talking about have an unspecified time frame with them, just to make sure everyone has got that on the record. The amount of cash we are talking about here is excess cash. We have been doing our analysis of what we can afford to buy back to make sure that we have enough cash for operations. And we have a significant amount of cash left in what I will call strategic reserve for any strategic initiatives that the Company may want to pursue. As we have looked at this, we set a strategy for ourselves that has -- it is kind -- two aspects to it. The first aspect of it is our intent is to try and eliminate the dilution associated with employee stock options that are granted. The second aspect of it is, is that on top of that, to the extent we have excess cash, which we do, we're going to go back and eliminate the dilution associated with acquisitions that we've made, both historically -- and then it will take several years to catch up there. But then on go forward basis, we would like to do diminimize that, or bring that to a neutral position as well. So that is the strategy behind what we are thinking about here. And again, it is based on the fact that we have excess cash. We have enough to run our operations, and a strategic reserve as well.
Dan Warmenhoven - Network Appliance, Inc. - CEO
I should point out that we have gotten the question many times -- why not just make the acquisitions with cash? And the answer is that is not necessarily our prerogative. It is normally determined by the seller. And it is really a function of tax consequences. And in general the favorable tax treatment goes away if there is more than 20% cash in the mix. So in general our sellers, if you will, prefer at least 80% of the transaction to be in stock, which they can time the ultimate capital gains transactions around.
Operator
Kevin Hunt with Thomas Weisel Partners.
Kevin Hunt - Thomas Weisel Partners - Analyst
Maybe you said this and I missed it, but did you say what the NearStore was in the quarter? And you kind of had been talking about maybe that wouldn't be as strong growth in the future?
Steve Gomo - Network Appliance, Inc. - CFO
NearStore was 15% of mix. That was down a little bit from last quarter. NearStore had been ramping up really over the last several years. I think it reached a peak of 18 to 20% in our mix, and dropped a little bit last quarter to 18. And this quarter it dropped to 15. What we have observed is that the smaller configurations that NearStore customers used to buy under the NearStore brand are now shifted to the FAS 3000 Series with ATA. So I think up to about 6 terabytes kind of flipped in a hurry. And so the consequence of the NearStore configurations are higher capacity, and they are also higher ASPs. But the low end units, as I say, just kind of bled off right into the 3000 Series. We expect it to still be a very attractive product line going forward. 15% is a pretty good contributor.
Operator Dan Renouard with Robert W. Baird.
Dan Renouard - Robert W. Baird - Analyst
I just wanted to circle back on Decru. I am just kind of wondering if you could give us a little bit more detail on what happened in going forward? It sounds like there was, maybe not so much execution issues it is just you didn't forecast very well. Was there also some turnover on the sale side, or did you lose some people? And then secondly, just on the government -- I know a fair amount of the Decru sales and probably the pipeline was tied in with the government -- the federal government. Do you expect any impact from Katrina, budget issues, etc., did that have any impact? And then just lastly, all related to Decru?
Dan Warmenhoven - Network Appliance, Inc. - CEO
The Decru sales issue is really around predicting the sales cycle. And the federal government, as I indicated, there are DoD mandates that really are fairly proscriptive around what data has to be secured, and what are the access rights associated with various personnel in various positions. And what we found in the commercial sector is it is just a lot more decisions to be made on the part of the customer as to where they want to deploy it? What day do they want to encrypt, and how they want to structure the access rights? And that has taken a longer time than certainly we would have thought. The DoD mandates obviously streamline the adoption process for the government. And there is no such framework like that in the commercial sector. So we were a little optimistic on sales cycles. But I have got to tell you, the funnel is pretty wide. And I believe it is still going to be a significant producer for us. We're not backing off of the objectives we had for next year. I think it is going to be accretive within a year.
Tom Mendoza - Network Appliance, Inc. - President
Let me add to that. It is Tom Mendoza. First of all when we acquired Decru their primary salesforce was into the federal government. They had just started to expand out of that. The interest level outside of that is intense. I personally just finished a five-week trip all around the world. All around the world people have come to a couple of realizations. One, the FBI put out a report in the last 60 days that 50% of all data theft comes from inside the firewall. Everyone agrees they haven't protected that well.
Secondarily, Gartner Group put out a report advising all enterprises they should be encrypting their tape. Decru, because it is an appliance, and you can do it at wire speed without changing a wrap -- everywhere I go they are considered the leading force to do this. So we are in many, many, many accounts that are non NetApp accounts. We have a lot of partners working with us to sell Decru into non NetApp accounts. I think the entire field is so open that it is creating a lot of excitement. We're very, very focused on maximizing this opportunity, but I don't think federal will necessarily the big play over time. I think financial services is going to be huge. And I think it is more of a broad application then the original Decru emphasis was. And we're going to take advantage of that.
Dan Warmenhoven - Network Appliance, Inc. - CEO
This is Dan. The other part of your question was about salesforce attrition. We didn't lose anybody that we were interested in keeping. And in fact, employee turnover at Decru in general has been very low, almost nil. That said, I will point out that Dan Avida, the former CEO, has decided to move on. And that that was not unexpected. It was a little earlier than we had thought, but not by much. And he has been replaced with somebody I think most of you know well, Suresh Vasudevan, who used to run all the core systems of product management, is now the General Manager of Decru. One other point I will make, to give you some sense in terms of numbers. Decru is actually less than .5% of revenue this quarter. We expect that to double next quarter to the 1% range. And probably go up to 1.5% the subsequent quarter. So it is on a pretty good growth clip. We were just a little more aggressive at the original outset than we think was warranted at this point.
Tom Mendoza - Network Appliance, Inc. - President
The other thing I would tell you is a lot of the trials we're doing the vast majority are on very, very, very high profile accounts -large accounts. And what they're going to do is they're going to test it. They're going to deploy some of it. And then they going to deploy a lot of it. It is kind of like the early days of the pilot. But the interest little in all the major accounts that I have called on -- literally all are interested in what Decru is doing. And specifically because they are owned by NetApp. Because almost all of the encryption companies that are out there are very small companies, and people are concerned about that. So I think that we gave them a validation and a comfort feeling that they can do this because NetApp is behind them.
Operator
Clay Sumner with Friedman Billings Ramsey.
Clay Sumner - Friedman Billings Ramsey - Analyst
Congratulations on great results. Can you go back a little bit to the issue of shipping more filer (ph) heads than disks this quarter. Why well that return to a point where balanced level in the future? Just kind of what factors at work there?
Dan Warmenhoven - Network Appliance, Inc. - CEO
This is Dan, and thank you for the congratulations. I want you guys to remember that we are proof positive that there is such a thing in Wall Street as a one quarter problem. That said -- I was waiting for the congratulations from somebody, just so I could use that line. The phenomena of the head upgrade I think is what drove that particular mix. We saw a significant number of system units shipped without disks, which are primarily intended for one of two purposes. Either field upgrades of existing systems like 940s, or alternatively the addition of a second head to an existing system for purposes of clustering. And that is the kind of thing that happens fairly quickly in an installed base. It was pretty fast. And I would expect that mix to shift back to a more normal mix next quarter.
Clay Sumner - Friedman Billings Ramsey - Analyst
So people were clustering 960s. I'm still not quite understanding you, Dan.
Dan Warmenhoven - Network Appliance, Inc. - CEO
Yes, many stand-alone configurations, they were clustering -- let's say 940's with a stand-alone configuration. They would upgrade that not just to a single stand-alone 3020 or 3050, but to a dual.
Operator
Glenn Hanus with the NIM Associates.
Glenn Hanus - NIM Associates - Analyst
Any update on the competitive front with -- EMC have been -- had some fairly aggressive tactics of bundling software and services. Any life of out of the HP? Just kind of wondering anything in incremental that you have been seeing out there are over the last three, three to four months?
Dan Warmenhoven - Network Appliance, Inc. - CEO
No, nothing of that level of drama and intrigue. In terms of frequency of competition, Hewlett-Packard was up in the mix this quarter. Our win rate stayed very consistent against both EMC and HP. So, yes, there wasn't really anything dramatic in the change. I think the most notable statistical difference had to do with the frequency of engagement versus Hewlett-Packard.
Tom Mendoza - Network Appliance, Inc. - President
I also think that -- and we said this before, but I can't tell you how many customers have said that they now believe it is a two horse race. It is NetApp and EMC. They are the two companies innovating. And many, many of the wins we had this quarter into new accounts simply were customers turning to us and saying, using our technology, how would you accomplish my business problem? We have have reached a role of many of our customers. We are no longer just talking about gigabyte prices and things like that. They are allowing us to use our creativity. And that goes back to Dan's point, why the petabytes were down. We are using our new technology, showing them -- giving them higher utilization rates. And that has given us major wins. I would say that the competitive landscape hasn't changed, except we're starting to tilt it in certain ways because of product.
Dan Warmenhoven - Network Appliance, Inc. - CEO
An interesting to phenomena that is going to occur in the metrics is that you are going to see I think a flattening of the cost per gig, because the customers can achieve their business objective with fewer gigabytes. And so even though we can come in under in terms of the dollar value of a deal, it is with less starch because of the utilization rates being higher. So it is going to be an interesting transition over the next few quarters.
Operator
Les Santiago with Piper Jaffray. Les Santiago - Piper Jaffray - Analyst
Could you give us a more color on the overall spending environment in the enterprise and SMB markets for storage? How much of this trend this quarter was pent-up demand due to the product transition versus maybe share gains, or maybe some kind of a seasonable seasonal uplift in demand that you are seeing out there?
Dan Warmenhoven - Network Appliance, Inc. - CEO
This was a typical Q3 from my viewpoint. So seasonality was such that August was very weak, and we saw a pretty good strength in September and October, particularly at our federal, which always surges in the end of the fiscal year for the federal government. So September -- that trickles into October from our viewpoint because the lag time through the system integrators. But you saw the federal business really surge in the mix. I didn't see anything relative to pent-up demand, other than the end of the year buying rush in federal. It seemed like a very normal kind of model.
Tom Mendoza - Network Appliance, Inc. - President
I would say that on our federal team too, it was a spectacular execution by that team. A quarter ago after we didn't do well, (indiscernible) came here and said there was some very specific issue where things had shifted. And by God, they went and got them this quarter, and they did it.
Another thing I would point out to you is I really think what we're taking real advantage of some of our key partnerships. I had the great opportunity to speak in front of about 14,000 people at Oracle World last quarter. That paid off for with a lot of deals this quarter, where people were not looking at NetApp. Dan is doing a lot of speaking at major events at companies like Symantec, SAP. Microsoft just did a cross country tour with us over the last two quarters.
Those type of things really are giving NetApp a whole different visibility and profile in the market. And I think that has helped us. Again, again as long as we get to engage in more deals, given our win rates, things are going to go better -- continue to do well at the rate we're looking at.
Dan Warmenhoven - Network Appliance, Inc. - CEO
Getting back to the essence of your question, I think most of this is share gain. And I think federal, as Tom was pointing to, is a pretty good example. Our federal business is outgrowing the market by a lot. And if you look at this particular quarter as compared to one year ago, roughly 30% of the booking this quarter came from civilian agencies, whereas last year it was a very small percentage. So as we have continued to expand our focus on different segments of the market, we have continued to gain share. I think is just that simple.
Operator
Bill Shope with JPMorgan.
Bill Shop - JPMorgan - Analyst
Looking at the other verticals do you see any surprising strength in particular verticals, other than the federal government?
Dan Warmenhoven - Network Appliance, Inc. - CEO
Yes, financial services continues to be pretty good. And actually the energy sector this quarter -- it is really going to be in this quarter. Somebody asked about Katrina, we shipped an awful lot of equipment to our customers in the oil sector in the wake of Katrina and all the rest of the storms. But that didn't show up materially in last quarter's revenues. I think it may have a spillover effect into this quarter's. The oil sector continues to do well. The financial services sector continues to do well. We're continuing to do very well in automotive. And it is -- there are not many weak sectors right now. I think based on the numbers I saw the tech sector is still 18% of mix. And they are continuing to buy and doing well. So it is pretty strong across the board.
Bill Shop - JPMorgan - Analyst
What percentage of the business is energy this quarter?
Dan Warmenhoven - Network Appliance, Inc. - CEO
I don't know -- it is roughly about 5%, 5 or 6%.
Operator
Aaron Rakers with A.G. Edwards.
Aaron Rakers - A.G. Edwards - Analyst
A real quick question. You guys had talked about FAS 3000 Series ramping, and the fact that is driving some increased software -- add-on software rates. You have now seen three quarters either at or above 35% contribution. Should we think about that contribution continually expanding as you continue to ramp the 3000 Series, as well as new high-end solutions going forward?
Dan Warmenhoven - Network Appliance, Inc. - CEO
I don't think so. The advice I would give you is to model about 35. There is probably an error bar around that of plus or minus 1 or 2%. I think we're getting to a zone where you are going to see some oscillations just based on normal fluctuations. But I really don't think there's a lot of upside over the 35%. Steve?
Steve Gomo - Network Appliance, Inc. - CFO
I agree with Dan. In our model that we have in front of us right here, we are modeling 35.
Operator
Kaushik Roy with Susquehanna.
Kaushik Roy - Susquehanna - Analyst
Let me be the second person to congratulate you on the nice quarter end, guys. The product margins have jumped almost 100 basis points to 67.5. What are your expectations for the product margins going forward? And how does it change as IBM contribution increases?
Steve Gomo - Network Appliance, Inc. - CFO
This is Steve Gomo. If I look going forward, here is kind of my anticipation. We're looking for, as I mentioned, next quarter our margins in total for the Company to come down more to the 61% level. I think there's several forces at work here.
First, I think that service is going to back off from its current level, as I mentioned. We're not going to have the benefits that we saw this quarter. I think software, as we just talked about, we're modeling 35%. And I think that based on our analyses we could see some fluctuations around that number. So to go above 35% is to, I think, take a risky profile with the model, because it could end up just slightly below 35%. If you take the software back to the 35% level that is half a point based on what we did this quarter.
And finally, I think if you look at the ratio of our system heads to our disk capacity, if you will, while it may be a little bit more favorable than it has in the past, it is not going to as favorable as we saw this quarter due to the onetime events that Dan was alluding to earlier. Those are other half a point. I think it is pretty reasonable to assume that we get back to about a 51% Companywide gross margin for the next couple of quarters.
Kaushik Roy - Susquehanna - Analyst
How does it change as IBM ramps up? Obviously they're going to put a downward pressure on your product margin.
Steve Gomo - Network Appliance, Inc. - CFO
Yes, we have that figured into that mix.
Operator
Paul Mansky with Citigroup.
Paul Mansky - Citigroup - Analyst
Actually, just a clarification. In the prepared remarks I believe you indicated that petabytes shipments grew. But I believe Tom suggested they actually declined in the Q&A a minute ago. I just want to make sure I'm not crossing wires in my model here. Which one was it?
Dan Warmenhoven - Network Appliance, Inc. - CEO
Petabytes grew by about 2 petabytes. We saw more efficiency -- that is the amount of storage a customer has to buy for a particular business purpose declined somewhat. Yes, average configuration sizes went down a little bit year-on-year. But what you see is the utilization rates go up. So the growth rate is going to slow in terms of petabytes. I think this quarter it was 8% sequential, whereas in most quarters it has been running around 15 to 20, even higher. And it is just because of higher utilization rates.
Steve Gomo - Network Appliance, Inc. - CFO
I misspoke, sorry.
Paul Mansky - Citigroup - Analyst
No, I just want to make sure I wasn't modeling anything wrong.
Operator
Kevin Hunt with Thomas Weisel Partners.
Kevin Hunt - Thomas Weisel Partners - Analyst
I just had one question on the tax rate. It was a little bit lower than it was. And what should we expect on that going forward? And maybe what are the reasons why it is lower?
Steve Gomo - Network Appliance, Inc. - CFO
This is Steve Gomo. The non-GAAP tax rate did not change. It is still 18%, and we're projecting 18% going forward. And you should be using 18% for your model. They actually GAAP tax rate, particularly with the new accounting conventions, will tend to be a little bit more variable, as basically we have to take discrete items in the period that we recognize them. In the non-GAAP tax rate we are spreading those items over an annual period so they have less of an impact. On a GAAP basis now we are required to take them as we discover them. This particular quarter we had a -- we completed a R&D tax credit study, and indeed confirmed that we're going to get everything that we thought. So we took an adjustment against our tax reserve as a result. And then there was a transfer pricing analysis that was also done that caused another minor adjustment. That's what drove the GAAP tax rate down this quarter.
Operator
Harry Blount with Lehman Brothers.
Harry Blount - Lehman Brothers - Analyst
One of the questions that I know will come from customers is you guys had indicated, based on the timing of beta units, that there might be some spillover effect from last quarter into this quarter. Can you maybe help quantify that a bit?
Dan Warmenhoven - Network Appliance, Inc. - CEO
See, I really think there was much spillover. The backlog coming into this quarter was very similar to what we had seen in the exit of prior Q1s. I understand that speculation. I read a lot about it. I've got to tell you, it was not true. It was not well founded. So there was no spillover affect whatsoever.
Operator
Richard Chu with SG Cowen.
Richard Chu - SG Cowen - Analyst
I wonder whether you could expand on the decision to not do the R210? And perhaps comment a little bit more on the Spinnaker delay?
Dan Warmenhoven - Network Appliance, Inc. - CEO
The R210 was intended to be kind of a low end of the NearStore family. And obviously the low end of that was the addressed adequately by the 3020 with ATA drives. So it really became kind of a redundant product. They would have overlapped too much in terms of the marketplace, probably created some confusion in customers minds. So we just said we've got that space adequately addressed with a 3000 Series, and there is no reason to have a separate product in the portfolio.
On the delay on the Spinnaker thing we continue to make good progression, and I'm very pleased with the progress. However, this is an enormous undertaking to create a new version of our operating system. It is the integration of millions of lines of code into a single base. You have two separate code bases kind of being merged together. And so we have found that the time required to finish the project is about three months longer than we had originally forecast, which on a 24 month plan strikes me as not too bad.
Operator
And with that this concludes the question-and-answer session of today's conference. Back over to the group for any concluding remarks.
Dan Warmenhoven - Network Appliance, Inc. - CEO
Again, I would like to thank you all for joining us in this conference call. Before we end, I would like to really extend my thanks and appreciation to the people at Network Appliance. At the end of last quarter I kind of sent out some messages saying we have got to pick up our game. And I would like to thank them for increasing their focus this quarter. I think you see it in the results, and I surely am appreciative of the way they reacted. We will look forward to seeing some of you maybe at the NASDAQ opening on the 21st, our tenth anniversary of our IPO. And certainly I look forward to seeing you with us next February 15 for the results of our fiscal Q3. And at the analysts meeting, I would like to mark your calendar for March 14 in San Francisco. So again, ladies and gentlemen, thank you very much, and have a great day.
Related:
- The prepared remarks from this call are here.
- Source: NTAP web site.
- A list of full conference call transcripts available on the Seeking Alpha Network.
- The complete list of hardware stocks (and links to articles about them) covered by The Hardware Stock Blog.
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