Kris Newton - IR George Kurian - CEO and Director Nick Noviello - EVP, Finance and Operations and CFO

Jayson Noland - Robert W. Baird Jim Suva - Citigroup Lou Miscioscia - CLSA Kulbinder Garcha - Credit Suisse Sherri Scribner - Deutsche Bank Ananda Baruah - Brean Capital Amit Daryanani - RBC Capital Markets Brian White - Drexel Hamilton Maynard Um - Wells Fargo Securities Steve Milunovich - UBS Andrew Nowinski - Piper Jaffray Rod Hall - JPMorgan Brian Alexander - Raymond James Aaron Rakers - Stifel Nicolaus Joe Wittine - Longbow Research

Good day, ladies and gentlemen, and welcome to NetApp's Second Quarter Fiscal Year 2016 Results Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would like to introduce your host for today’s conference, Ms. Kris Newton, Vice President of Investor Relations. Ma’am, please begin.

Hello and thank you for joining us on our Q2 fiscal year 2016 earnings call. With me today are CEO, George Kurian and CFO, Nick Noviello. This call is being webcast live and will be available for replay on our Web site at netapp.com along with the earnings release, our financial tables and guidance, a historical supplemental data table and a non-GAAP to GAAP reconciliation. As a reminder, during today's call, we will make forward-looking statements and projections with respect to our financial outlook and future prospects, such as our guidance for the third quarter and full fiscal year 2016, our expectations regarding our ability to respond to changing demands of our customers in an increasing uncertain macroeconomic environment, our ability to manage our cost structure portfolio and processes to drive efficiency, profitability and growth, our expectations regarding market acceptance of Clustered ONTAP, our ability to drive operational and financial performance, and our expectations regarding our business model in FY16 all of which involve risk and uncertainty. Such statements reflect our best judgment based on factors currently known to us and are being made as of today. We disclaim any obligation to update our forward-looking statements and projections. Actual results may differ materially from our statements and projections for a variety of reasons. We describe some of these reasons in our accompanying press release, which we have furnished with the SEC on a Form 8-K. Please refer to the documents we file from time to time with the SEC, specifically our Form 10-K for fiscal year 2015, subsequent Form 10-Q quarterly report, and our current reports on Form 8-K, all of which can also be found on our Web site. During the call, all financial measures presented will be non-GAAP unless otherwise noted. These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of our GAAP and non-GAAP results is provided in today's press release and on our Web site. I'll now turn the call over to George.

Thank you, Kris, and good afternoon everyone. Thanks for joining us today. Our Q2 fiscal year ’16 financial results were generally as expected. We’ve continued to make progress as we pivot towards growing parts of the market, scale out software-defined flash, converged and hybrid cloud. Our key investment areas of sales capacity, channel traction and acceleration of the transition of our install base to Clustered Data ONTAP continue to show early results. Our focus remained on enabling our customer success as they navigate their IT transformations to leverage modern architectures and deploy hybrid cloud solutions. Over the course of our second quarter, I’ve continued to rigorously analyze our business, I traveled around the world and participated in our Insight user conference, meeting with thousands of customers and partners. The feedback I heard was overwhelmingly positive and reaffirmed my conviction that our Data Fabric strategy resonates with and is aligned to our customer’s strategic technical direction, underpinning our confidence and the opportunity ahead. We’ve made progress but we still have more work to do to become more efficient and agile, so that we can best take advantage of our long term growth opportunity. An increasing uncertain macroeconomic environment, continued shifts in the market and an aggressive pricing environment, have slightly tempered our fiscal year 2016 outlook. By coupling the strength of our Data Fabric strategy and the benefits we deliver to customers, with a more efficient and agile business, we can generate value for customers, partners, employees, and shareholders over time. I have tremendous confidence in our opportunity for success. That said, parts of our business are working well, some parts need improvement and other parts we must manage through declines. The IT spending environment continues to be constrained and the expectation for growth for the overall storage market has decreased to low single-digits. At the same time, customers are seeking to take advantage of new applications and modern data center storage and data management architectures. Based on our analysis, this has resulted in the traditional standalone hybrid storage market declining at approximately 9%, while at the same time, the parts of the market addressed by our scale out, software-defined, flash converged and hybrid cloud solutions are growing at a rate of roughly 20%. Highly disciplined portfolio management is required to address the different growth rates of our markets. We must be more efficient in the parts of our business that aren’t growing in order to generate sufficient profits that can be returned to shareholders and leveraged for investment in areas of growth to deliver innovation ahead of the market. We have already sized our investments in OEM and ONTAP 7-Mode commensurate with the opportunity and I have recently consolidated all of our hardware platform engineering teams into a single group for further efficiency. IT spending will remain under pressure as customers evaluate cloud and modern architectures. We are growing our install base and have made investments in growth areas that are showing results, although they are not yet enough to offset the decline in our traditional business. The decline in standalone hybrid storage most notably impacts our traditional ONTAP 7-Mode business. The 7-Mode storage operating system was shipped on about 30% of FAS units in the quarter, down from roughly 65% a year ago. ONTAP 7-Mode unit shipments were down almost 60% year-over-year and Q2 marked the first time that we did not experience growth in the 7-Mode install base. At a subset of our customers, the normal hardware refresh cycle has been slowed as they plan for the move to clustered ONTAP. We continue to work to smooth this transition for our customers and in our insight user conference last month, we announced the port for ONTAP 7-Mode through 2020. Customers are also slowing investment in the capacity expansion of their traditional 7-Mode storage environment. The dynamics of our 7-Mode and OEM businesses continue to put downward pressure on product revenue, despite strong growth in other parts of our business. As a part of their IT modernization efforts, customers want scale out and software define storage functionality for efficient management of data growth and cloud service provider like flexibility, Clustered ONTAP enabled seamless data management across flash, disc and cloud footprint for enterprise applications like databases, virtualization and ecommerce. The software-defined architecture of Clustered ONTAP provides a consistent way to manage data across public and private cloud regardless of underlying hardware. Clustered ONTAP was deployed on approximately 70% of FAS systems shipped in Q2, up from 35% a year ago and unit shipments of Clustered ONTAP systems grew over 95% year-over-year demonstrating continued strong customer demand. At the beginning of the fiscal year, we created a set of Clustered ONTAP transition program to accelerate the migration of install base customers who are ready to upgrade both their systems and their software from ONTAP 7-Mode to Clustered ONTAP. These programs of customers and certified partners transition support, temporary gear and financial incentives. We saw strong uptake in Q2, almost all of which was done with the tremendous support of our channel partners, while these programs helped migration ready customers move, migrations themselves are projects that must fit within the overall IT priorities and budgets of our customers. The low growth of overall IT spending has an impact on the pace of migration. As we have stated before, we anticipate that the transition of the install base will happen over the course of year. The Clustered ONTAP install base continues to grow and now represents 17% of total install FAS system and almost 30% of installed FAS capacity. The number of customers who purchase Clustered ONTAP systems in Q2 grew by 85% from Q2 last year. And in that same period, the number of new to NetApp customers who purchased Clustered ONTAP in Q2 grew by 95%. Customers are deploying high performance flash technology to gain advantages from accelerating business transactions, processes and their supporting enterprise applications. Our all flash FAS products offer enterprise grade flash technology combining built-in data protection, multi-protocol support, scale out performance and seamless data movement from flash to disk to cloud. After introducing flash essentials, with optimized read performance, in line compression and in line zero based deduplication in Q1. We improved both the list price and form factor for our All Flash FAS by 40% as well as announced a controller upgrade program, a seven year extended warranty and a 3x performance guarantee. These enhancements garnered positive feedback in the channel and drove rapid adoption of our All Flash FAS products with unit shipments accelerating 445% year-over-year, the sixth consecutive quarter of triple digit growth. To meet the requirements of ultra high performance, low latency application, customers opt for our ES product. Units of the ES series grew 65% from Q2 a year ago. In order to achieve the performance, availability and cost requirements of new web scale and analytic applications like Hadoop and Splunk, and the increase in the amount of data retained on line for business insight and cyber security, customers are deploying our E Series platform. For customers who are increasing their cyber security defenses with real time analysis the E Series capability to store hot and cold data under the same data management architecture substantially improved the efficiency and flexibility of their environment. We are aggressively targeting this part of the market and continue to see growth of the E Series with unit shipments up over 20% from Q2 last year. Our hybrid cloud solution comprised NetApp private storage for clouds, cloud ONTAP, StorageGRID Webscale and AltaVault. While these solutions do not contribute materially to revenue today, they are important in positioning us for leading edge hybrid cloud deployment. A large European manufacturing company chose NetApp for our cloud integration, coupled with converged and All Flash solutions and the ability to manage it all under a single framework in Clustered ONTAP. Similarly we had wins at a global law firm. A large global security vendor, a US based software management company and many others because of our ability to deliver highly competitive storage solutions and have a broader strategic discussion encompassing cloud ready integration and enablement with the world's leading cloud service providers. This is the power of the data fabric at work. For customers looking for preintegrated converged solutions NetApp offers FlexPod in conjunction with Cisco. NetApp and Cisco introduced FlexPod five years ago and have generated 5.6 billion in shared revenue delivered by more than 1,100 partners to more than 6,300 customers worldwide. In Q2 we announced a Cisco validated design for All Flash FAS FlexPod with Cisco's application centric infrastructure ACI. You will continue to see exciting innovations from our strong partnership with Cisco. Our customers are transforming themselves using digital technology, connected with pervasive broadband network and cloud computing to improve the efficiency of their businesses, build global business systems and better serve their customers. Data is at the heart of that transformation. At the same time they are scrutinizing the value that they have gained from past investments in IT, reducing IT budgets and rethinking how they consume IT. This evaluation is creating caution on traditional storage system transactional spending and is diverting spending towards transformational projects and modern architectures like scale out, software-defined, flash, converged and hybrid cloud, where our data fabric strategy gives us an advantage over the competition. NetApp is the only company that can help customers manage their data seamlessly across multiple cloud architectures, and provide the scale and modern architectures needed to accommodate the exponential data growth of the digital era. NetApp is changing to position the company for long term growth. We expect to gain share in the traditional part of the market but that alone won't be sufficient to overcome the decline of that market and drive overall growth for NetApp. We will continue our pivot towards modern architectures such as scale out, software-defined, flash, converged and hybrid cloud. The growth in this part of our business is strong and encouraging. Customer and partner feedback drives strong conviction that our industry leading portfolio and differentiated data fabric strategy will expand our opportunity and drive long term growth. However this transition will take time as the growth is coming off a smaller base than our traditional ONTAP 7-Mode footprint. We are investing to accelerate growth and are taking action on the cost structure of the business to ensure value creation for customers and shareholders through the duration of this transition. In fact we're conducting a fundamental assessment of every aspect of our business structure, portfolio and process to reduce complexity and drive the efficiency while improving our velocity and investing for long-term growth. This will require making some important decisions about topics crucial to our business from our product portfolio to our go-to-market approach and our supporting functions. We must both invest for the long-term growth of our business and preserve our current growth initiatives that are showing early results while streamlining and improving the efficiency of our business. We will lower the cost structure of the Company but will not take actions that improve our short-term results at the expense of our long-term strength. There is growth to be had in this industry and we believe we have the right strategy and technology to capture that growth in the long-term and deliver increased shareholder value overtime. NetApp has the innovation, scale, and open ecosystem needed to solve the data management challenges for the enterprise. The changes to larger players in the market create opportunity for us. NetApp is the only company able to span flash to disk to cloud and the only company delivering the ability to manage data across multiple clouds and on premises today. Many elements of our portfolio are growing strongly and we need to capitalize on them by maintaining our sales capacity, continuing our channel efforts and making it easier for our installed based to migrated Clustered ONTAP. Customer wins and partner feedback indicate that we’re on the right path. We have a portfolio of differentiated IT and a growing install base, we are delivering tremendous value to customers in their strategic IT transformation, it is critical that we build a stronger more efficient company that solves customer challenges while delivering profitability and earnings growth in a moderated IT spending and storage market. You can expect tangible results from this process over the remainder of this fiscal year and beyond. Before turning the call over to Nick, I would like to thank the entire NetApp team for their hard work and dedication as we evolve our great company for future growth and sustained success. And I would like to extend a special thank you to Rob Salmon, President, who after 22 years announced his intent to retire from NetApp at the end of the fiscal year. We appreciate all he has done for the Company and his work to ensure a smooth transition. I'll now turn it over to Nick.

Thank you, George, good afternoon everyone. Before we get started as a reminder I will be referring to non-GAAP numbers in today's discussion unless otherwise indicated. Overall, we are pleased with our Q2 financial results and the progress we're making related to our key investments, in sales capacity, in the channel and in accelerating the migration to Clustered ONTAP. Starting with revenues, net revenues for the second quarter were $1.45 billion, up about 8% sequentially and down 6% year-over-year. FX headwinds had an unfavorable impact on the year-over-year comparison by about 4 point. As George indicated, the overall IT spending environment is pressured, this coupled with the uncertain macroeconomic environment has affected us in different ways across our geographies. For example our U.S. public sector business declined 22% year-over-year in Q2 while at the same time excluding impacts from foreign exchange, EMEA and Asia-Pacific were up 8% and 3% year-over-year respectively. Product revenue of $815 million was up 23% sequentially in line with expectations but was down 12% year-over-year. The year-over-year decline reflects favorable Clustered ONTAP momentum which was more than offset by about 5 points of FX headwinds and declines in ONTAP 7-Mode revenue which we expected as well as OEM revenue due to the changing business dynamics of our OEM customers. The combination of software maintenance and hardware maintenance and other services revenues primarily derived from existing new and renewed service contracts was up 3% year-over-year but down 6% sequentially, reflecting the return to a 13 week quarter. As a reminder, we had an extra week in Q1 which resulted in about a $40 million increase to Q1 maintenance revenue. Indirect revenue accounted for 77% of net revenues similar to Q1. Gross margin of 62.5% was down about 2.5 point year-over-year and about a half a point below our prior guidance range. FX headwinds had an unfavorable impact of about 1 point year-over-year. Product gross margin of 51.8% was up about 0.5 of a point sequentially and was down about 6.5 points year-over-year, driven by about 2.5 points of FX and roughly equal impacts from higher discounting and unfavorable product mix. On the year-over-year basis, software maintenance gross margin was roughly flat while hardware maintenance and other services gross margin was up 2 points reflecting a favorable mix shift towards hardware maintenance as well as infrastructure cost efficiencies. Q2 operating expenses totaled $684 million and were down 8% quarter-over-quarter and 6% year-over-year. This sequential decline reflects a combination of a return to a 13 week quarter and prudent expense management. Operating margin for the second quarter of 15.2% was 7.5 points higher than last quarter and was just above our previous guidance range. Our effective tax rate for the quarter was 17% as expected. Weighted average diluted share count of 296 million shares decreased by approximately 12 million shares sequentially and 8% year-over-year due to share repurchase activity. Q2 EPS $0.61 was a penny above the high end of our prior guidance range. Now turning to cash and balance sheet metrics, we closed Q2 with $4.8 billion in cash and short-term investments, 14% of which was held by our domestic entities. Deferred and financed unearned services revenue decreased by $20 million in Q2 versus Q1 and was flat year-over-year. Inventory turns increased to 17 in line with our expectations and days sales outstanding normalized to 37 days from 30 days in Q1 reflecting the return to a 13 week quarter. Q2 cash flow from operations was approximately $145 million versus $381 million in Q2 a year ago. Free cash flow of $99 million was about 7% of net revenues, down substantially from Q2 a year ago due to lower net income and the return to normal levels of DSO and accrued compensation, net of improved inventory turns related to the 14th week in Q1. Finally, we repurchased approximately $183 million of stock and paid $53 million in cash dividends during the quarter. Consistent with our previous guidance we remain on track to complete our share repurchase program by the end of May 2018 with the first $1 billion [ph] of repurchases expected to be completed by the end of May 2016. Today we also announced our next cash dividends of $0.18 per share of the company’s stock that will be paid on January 20, 2016. Now turning to our business outlook, we remain confident in our strategy and long-term growth potential. As I discussed last quarter fiscal year 2016 is one of transition. We are realizing results from our investments in sales capacity, actions to regain traction in the channel and programs to accelerate the migration to Clustered ONTAP. Coming into the year we anticipated that top-line predictability would improve in the back half but the uncertain macroeconomic environment continued shifts in our market, and an aggressive pricing environment have resulted in continued limited visibility. While we have made progress in rebuilding our pipeline, these factors have slightly tempered our outlook. As a result, we expect revenue for fiscal 2016 to be down just over 5%. Though ultimately dependent on revenue mix, growth and our continued actions to drive down costs, given the environment we now estimate fiscal 2016 gross margin to be down 1 to 2 points from fiscal 2015 and operating margin to be down about 2 points for the year. We expect second half operating margin of approximately 18% the low end of our target operating margin range. Although off to a slow start in the first half we expect free cash flow as a percentage of revenue for the second half of the year to be in the mid-teens. Finally we expect to reduce share count in fiscal 2016 by approximately 6% and between dividends and share repurchases we will again return over 100% of free cash flow generated in the fiscal year to shareholders. As George discussed we are assessing every aspect of our business to drive efficiency and velocity. We will lower our cost structure including cost reduction actions in the second half of fiscal 2016 we will drive greater efficiency across the business and at the same time make investments in growth areas leading to increased profitability longer term growth and increased shareholder value. For Q3 we expect net revenues to range between $1.4 billion and $1.5 billion which at the midpoint implies flat revenues versus Q2 and a 7% decrease year-over-year. We expect Q3 consolidated gross margin of approximately 61.5% and operating margin of approximately 17%. Based on our share repurchases in Q2 and in the first 10 days of Q3 we expect our weighted average diluted share count for the quarter to be approximately 297 million shares and earnings per share for Q2 to range from approximately $0.66 to $0.71 per share. In summary we are confident in the opportunity ahead of us. Customer wins and feedback from partners indicate that our data fabric strategy is differentiated and well aligned with their most critical IT imperatives. We must improve our efficiency and agility to take full advantage of those opportunities and to set NetApp on a path for increased profitability, long-term growth and increased shareholder value. I will now turn the call back to Kris to open the call for Q&A. Kris?

Thanks Nick. We’ll now open the call for Q&A. Please be respectful of your peers, and limit yourself to one question, so that we can get to as many people as possible. Thanks for your cooperation, operator?

Thank you. [Operator Instructions] Our first question is from Jayson Noland of Robert Baird. Your line is open.

I wanted to ask George on the transition program. Could you provide some more detail on the economic incentives that are behind cTAP and then how are the credits accounts for on the P&L?

The credits are essentially discounts related to the product bookings that were registered as part of that program. So every transaction that is qualified for the cTAP incentives goes through a deal registration process that we administer. In terms of the program itself, the incentives and enablement that we have conducted include the availability of temporary swing gear on a loan basis to customers that need temporary capacity, some set of incentives around professional services to help them enumerate the cost of the overall migration effort. A majority of the transitions have being done through the partners and there have been strong update and good feedback from the partners in the second quarter of this year, the number of partners that participated in the Clustered ONTAP acceleration program expanded substantially from Q1 across all of the geographies in the world, as well as the number of customer transactions also expanded substantially from Q1. So we’re pleased with progress. We thank our partners for leading in with us on this important effort.

Our next question is from Jim Suva of Citi. Your line is open.

George can you give us a little bit more color on -- you had mentioned that you’re doing the strategic reviews and a lot of the efficiencies and stuff like that. Is there anything we can judge or put as milestones or look ahead and see how quickly you’re assessing these items? And then for Nick, can you talk a little bit about cash flow, whether it’d be an extra week last quarter, and not the extra week this quarter. If you sum up the two quarters in total, you kind of in my view washes out the extra week factor. And when you look at the two quarters together, the cash flow looks down significantly year-over-year. Is that kind of the new run rate we’re looking at for cash flows as a percent of revenues? Or how should we think about cash flows, because it seems like it’s directionally stepped back a little bit? Thank you.

I’ll take the first question and then hand over to Nick. I’d appreciate the next few callers to just stick with your question. In terms of the overall assessments that we have conducted, it’s really focused on both efficiency as well as velocity. And what I mean by that is efficiency around all aspects of our business, structure, portfolio, business process, so that customers find it easier to do business with us as well as partners. In terms of velocity, we feel that having accomplished the efficiency aspects of the program, we will be able to transition our business more quickly in response to changing market landscapes. We’ll just be a leaner, more efficient Company that can be more agile in response to the changing market environment. You will hear more from me over the second half of this fiscal year and over the next few quarters beyond that as we go through the program. Stay tuned it is a fundamental reassessment of all aspects of our Company.

And Jim just quickly, with respect to the cash flow, I think this is consistent with the slow start up of the year right. The first half was intended to be a rebuild, both of the pipeline and a rebuild of the business condition. You saw that in terms of even the operating margins as we grew up in the first half year. You can see it in net income. Second point would be that as we look at the second half, our view is that we’re going to be in the mid-teens in terms of cash flow as a percentage of revenue in the second half. So, that clearly washes out all of the implications of timing, 13-week versus the 14-week quarter and all of those pieces.

Our next question is from Lou Miscioscia of CLSA. Your line is open.

When you look at your operating franchise, sales, marketing, R&D, G&A, you did a good job year-over-year, and obviously quarter-over-quarter taking out the prior week. Should we expect it to more or less stay flat absolute at this level going forward? And then if you could comment where do you think it could go even more into the future into ’17 and beyond? Because it sounds like you want to continue to take a good cost out, or take cost out?

Hi Lou this is Nick, so a couple of things. I think if you back through the guidance, you will see an implied reduction quarter-over-quarter, so a sequential between Q2 and Q3 reduction in operating expenses overall. Also it’d say that 47% of revenue in Q2 is not the type of level we expect for the business, in the long-term, or in the long-term models. So, more to come, and we’ll talk more about that, George indicated that he’d spend more time talking about the portfolio and all of the things we’re looking at, but suffice it to say for purposes of the Q3 guide you can back through that and see that we expect operating expense to be down sequentially and down even as a percentage of revenue versus Q2.

Our next question is from Kulbinder Garcha of Credit Suisse. Your line is open.

And a question for both of you I guess on gross margins on the product side, and it’s under pressure this year we are seeing currently but they kind of feel almost permanent and the currencies are where they are and then on top of that pricing seems intense. There is always kind of intense in this industry and you're going through a prolonged transition which I assume opens you to more competitive attack. So would I be wise in concluding that this level of gross margin is probably all we’re going to see for some time or are there some of the drivers or initiatives that work to bring them back to historic level? Thanks.

Sure, Kulbinder let me start with that, so certainly if you look at the gross margins and specifically the product gross margins for the quarter on a year-over-year basis we have a 2.5 point impact alone from foreign exchange, we don’t expect that type of thing and in fact that will start to mitigate as we get certainly to Q4. We do have higher discounting, I made that clear. Last quarter and actually in Q4 I talked about higher discounting, it's about two points impact on a year-over-year basis to product gross margin this quarter that we have to work through, that is the aggressive pricing actions going on in the industry right now, we have to look it. That said, overtime we’ve shown that we can move margins here and in fact over a several years we did exactly that. Finally, I would say that on the services side of our business the team has done a really good job in terms of leveraging the cost base and servicing the enormous install base of customers that we have. So I think it's a combination of items certainly the aggressive pricing environment it is something that we have to be reflective of, the portfolio is something we spend a lot of time working on and thinking about and the uptake of Clustered ONTAP with customers and those actions on the hybrid cloud portfolio overtime we expect to see benefits to margins of the Company.

Our next question is from Sherri Scribner of Deutsche Bank. Your line is open.

I was hoping if you can give us a little bit of geographic detail in terms of what you saw across the world, it looks like the Asia business saw some nice uptick in the quarter just curious what that’s about? And looks like maybe the public business was maybe a bit softer, so hoping to get some more detail? Thanks.

Okay Sherri, let me just start on that for a second, so if I take the impact of currency out our EMEA business actually did really well in the quarter and that EMEA business year-over-year without currency was up 8%, Asia was up 3. The challenge obviously was in the U.S. public sector down 22, no foreign currency impact there. I think that to start and I am sure George may have a comment or two as well, I think the EMEA team has done an incredible job really over the course I am going to say no of this last year plus of taking Clustered Data ONTAP and the promise of the portfolio and the data fabric and bringing that to customers, I think it started there. And Asia, we obviously had some very strong areas, we have some that are more challenged and we have some macroeconomic implications in Asia that we’re just going to have to work through and the team there is working through it. In the U.S. public sector, there is a variety of things going on that we just have to be aware of. I would say that we are not anticipating a recovery in the U.S. public sector as we move into Q3.

Just to add some color to that, I think when I look across the geographies our large enterprise customers continue to do good business with us across all the geographies. To add some color to the Asia-Pac and public sector comments, in Asia Pac you certainly saw the impact of the slowdown of China, in the countries that were dependent on China either for investment or as suppliers to the Chinese economy. So it was while the overall business met expectations there was a wide range of different countries. I think in terms of the public sector itself. We do large amount of business through the global system integrators and their business was challenged within the public sector model. We also saw in some cases program delays or prioritization of spend towards priority such as cyber security. We feel confident of our position in the public sector business, we are the number one provider of storage and data management and we continue to win our preponderant majority of new opportunities within the public sector.

Our next question is from Ananda Baruah of Brean Capital. Your line is open.

This could be for either, George or for Nick just what I guess anecdotally is the right way to think about the levers around the R&D it certainly seemed to be just if you take a look at this quarter one of the contributors to the OpEx, the OpEx I would say kind of catalytic performance. But it just seems like this year is going to be a little bit softer than last year and in the context of I may have to give specifics now, but like looking at the overall portfolio is there anything that you can tell us now philosophically how you're looking about the -- looking at the R&D going forward given that we've already seen it come off a little bit? Thanks.

When we look at portfolio management we look at it on both products and product market as well as customer segments, geographies and all aspects of the business. As I said in my prepared remarks we run a very disciplined portfolio management process which means that for capabilities that are mature in the market we continue to reduce our investments in those parts of the business whether they are pathways, whether they are customer segments or on the product portfolio side and reinvest some of that into the faster growing emerging parts of the market. We returned some of that certainly to shareholders and some of that we reinvest to the faster growing parts of the market, so that's our portfolio management approach and we've implemented it, it's certainly part of the model that you're seeing being implemented in the Company going forward and that's what's driving discipline in the operating expense stack.

Our next question is from Amit Daryanani of RBC Capital Market, your line is open.

I guess George I just want to understand this cost containment side you talked expectation last earnings call that we would have more update this time around. So I'm curious what are you seeing and what's driving this announcement of cost optimization to be more further pushed out and then broadly as you think of your business if you have a zero to down 5% revenue trajectory what do you think the right OpEx number is, is it sort of 20% or 40% for you guys? Thank you.

We have done a thorough analysis of the business and identified a number of areas to drive fundamental transformation that fundamental transformation is both to improve the efficiency of the business and also make it easier to do business with NetApp. To do those actions will take time to achieve the full desired outcome, but it is what will help the Company both transform our operating expense stack, as well as make it easier to do business with us so that we can drive top-line velocity. The things that we have done are already showing results in the quarter so we have taken some action in the quarter and we said we will take further actions through the second half of the year and you will see more progress updates as we take those actions on. So we are not saying that we're pushing out any action to next fiscal year. We're going to start and we're going to continue to do it over multiple quarters.

Our next question is from Brian White of Drexel. Your line is open.

I'm wondering if you could give us a little color on how you're thinking about the Dell EMC deal and the opportunities that they open up or the threats that you see from this transaction. Thank you.

First of all I would say that my opening comment is that the Dell EMC transaction is yesterday's solution to tomorrow's customers' problems. It does not fundamentally address the hybrid cloud, it does not fundamentally address the data management opportunity that customers are forced to deal with. It is really about trying to build efficiency in an integrated hardware business rather than the software-defined data center of the future. I think in the near-term based on discussions with multiple customers and partners it is generating a lot of uncertainties for customers and resellers and that is clearly an opportunity for NetApp, which we intend to take advantage of. In the long-term the absence of a compelling story around the ITR section of the future will make their customer value propositions something that we can debate and capitalize on. We are taking action to improve the efficiency of our business to be able to deal with larger scale competitors and be more agile than they are. And I'll summarize at that.

Our next question is from Maynard Um of Wells Fargo. Your line is open.

George you talk about portfolio management but it sounds more like you're looking for areas that de-emphasis in declining products. You obviously have a pretty strong customer install base even in large enterprises, so I'm curious why you wouldn't look to more aggressively broaden out your portfolio to cross sell more products into your existing install base and then across your broad channel. And I know you've done acquisitions like buying Riverbed's SteelStore product but why not have a more aggressive product acquisition strategy maybe even larger to increase your revenue per customer rather than returning the cash to shareholders and I guess the question really boils down to NetApp being either a growth versus value company and which one you think is right for the Company long-term? Thanks.

I would tell you that we are in a changing market landscape where some parts of the market are declining and some parts of the market are growing quickly. I would say that it is important for us from a management perspective to apply discipline and maturely harvest the categories of the market that are declining. We do believe that we can continue to gain share even in those declining markets. At the same time we balance every dollar that we have incremental in terms of investing in new market opportunities or returning it to shareholders and that's a careful balance that we continue to have. In terms of our emerging portfolio of products as I said on the call, we are very pleased with the progress in terms of the growth rates of the emerging portfolio the all-flash arrays, the E series portfolio, the hybrid cloud solutions we're very pleased with the progress both in terms of the growth rates as well as the number of channel partners selling it, as well as the number of customers that are adopting multiple products from NetApp to the point you just made. So we will continue to stay disciplined. We have a disciplined market and strategic evaluation process that looks at our portfolio and compares it to the market trends and it's an ongoing evolution in a changing market, so thanks.

Our next question is from Steve Milunovich of UBS. Your line is open.

You talked about the Company in two pieces standalone storage and on the other side scale out software-defined in cloud, what percentage of the Company is in each bucket today and what do you expect maybe exiting the year in a couple of quarters?

Obviously, when we talked about traditional standalone storage systems we were talking about our 7-Mode operating system and the OEM business. I think when you look at the used cases for the E series through the branded channel there are a large number of third platform used cases that are built around the data center of the future. The Clustered ONTAP operating system is also part of the datacenter of the future combining scale out, software-defined and all-flash architectures to enable customers to operate their environments like cloud service providers. So traditional storage we were referring to were particularly around 7-Mode and OEM.

Our next question is from Andrew Nowinski of Piper Jaffray. Your line is open.

So I just like to ask about linearity in the quarter, I know you said product revenue was down 12% year-over-year, product gross margin was down I think impart due to higher discounting, but then your DSO was also spiked up which seems to imply the quarter maybe have been a little backend loaded and your guidance for the January quarter was a bit lower than street was expecting, so I guess when you look at both your metrics together it seems like you may have pulled in revenue into October quarter, so just wondering if you could provide any color on that dynamic and whether the sales pipeline for the January quarter is up on a year-over-year basis?

Andrew it's Nick. Let me get you started on that part of the first half activity as we talked about it back in May and then again in August on our calls was to rebuild pipeline, and the team has been doing a really important effort around just that, putting sales capacity and rebuilding channel partner relationship et cetera. So I think the work continues to go on there, that's not something that's going end, it's going to be something that continues. In terms of linearity in the quarter, the second quarter is a quarter that encompasses both the federal year-end in September and then our quarter end in October. When I look at our position at the end of the quarter, end of the quarter versus the sort of the end of the quarter a year ago is not much different there. So the linearity, I think is pretty normal in terms of overall what has happened year-on-year, I realize the pieces there is anomalies, I should say there are anomalies in this 14 week quarter from Q1 which we see every six years. So, hopefully, we will not have that type of thing talk about for another six years, but other than that the linearity is really consistent with what we expected and our position going into Q3 consistent with what we had going into Q3 even last year.

Our next question is from Rod Hall of JPMorgan. Your line is open.

George I guess I wanted to ask about the penetration CDOT you said it was 17% I think in this quarter, that's a little bit of a slowdown in penetration rate from the last quarter, so wanted to just get you to comment on that, you're talking about a pretty high transaction rate there so just trying to proposal of two things? And then also on that same line you said 30% of capacity is penetrated, can you guys give us the last two quarters of that number so we can compare that capacity penetration rate? Thanks.

So let me just say that our prior quarter was at 15% and the current quarter is at 17%. So we're not -- we don't see this as a slowdown, we see this as a constant sort of trajectory of customer environments transitioning from 7 to CDOT as well as new shipments getting deployed in our install base. When a new shipment gets sold by NetApp to the customer, it usually takes a little while before it actually shows up in our install based measuring system because of the time it takes for the customer to get it ready and deploy it. So sometimes the quarter boundary is not the perfect answer and so we see this as part of our ongoing trajectory. In terms of capacity deployed and capacity managed, we don't breakout those numbers they are essentially a measurement of the valuable of Clustered Data ONTAP in terms of being able to consolidate multiple systems and provide for large-scale data management in a very efficient fashion for customers, so we are pleased with that statistic as well.

Our next question is from Brian Alexander of Raymond James. Your line is open.

Just going back to the geographic performance why do you suppose Europe has been so strong in the last couple of quarters, I think you said up 8% in constant currency, the macro backdrop at Europe obviously isn’t all that favorable. So what’s different about your business or your competitive position there that’s allowing you to have a pretty strong growth in constant currency versus the performance in the Americas?

I would say there is two or three factors. The first is I want to thank our European sales leadership team. We have a deep experienced, well executing sales leadership team and a group of loyal channel partnerships who we have enabled with our technology sets and that has driven consistency in terms of the execution of the European organization. It is also translating our investments in the channel as well as the capacity investments we have made in the field into results. The second is we have introduced capabilities that were specific to the European market. So for example Clustered Data ONTAP there is a high availability configuration of it called Metro Cluster that is built for European, with European datacenters in mind and that gives us a far superior solution for Europe than any other competitor in the market. So it’s both technology as well as great execution on the ground.

Our next question is from Aaron Rakers of Stifel. Your line is open.

I wanted to go and discuss the free cash flow guidance I believe last quarter you had talked about 15% free cash flow relative to revenue, I know that you’ve tampered slightly your revenue outlook for this fiscal year but now you are talking about 15% for the back half of the year which by my math would adjust a deepened decline in the full year free cash flow contribution. I am just kind of wondering what necessarily has changed so significantly in the free cash flow expectation relative to the slight write-down on the income statement.

Yes, Aaron, actually if you go back to some of the discussion that actually happened in May we are talking about a cash from ops for the year that was going to be coming in, in let’s say the high 100 million range if you backed through the math and then redeploying to shareholders over 1 billion so over 100% redeployed to shareholders. When I look at our forecast today they are moderately south of that but we are not talking about material numbers. So it is mid-teens is the expectation for the second half of the year. There has obviously been some pressure here in the first half, there has been some noise in terms of Q1 versus Q2 but overall for the year we should be generating a cash from ops range in the $800 million to $900 million range and that is not that significantly different from what we even talked about back in May.

Thank you. Our last question is from Joe Wittine of Longbow Research. Your line is open.

George I think I want to appreciate the pragmatic view on market growth splitting out kind of the traditional on prem areas that are shrinking, I think you said 9% of the growth the portions converged all-flash et cetera are growing 20%. Give us a sense of what is NetApp’s current breakdown I think it just helps in believe the story it helps kind of helps us to do the math as far as when top-line growth could return? Thanks.

I would say that first of all it’s hard for us to breakout specific segments because essentially our all-flash arrays are part of our core Clustered Data ONTAP business. I would point you in terms of the places where the business is declining to 7-Mode and our OEM business as we said the 7-Mode business is down to 30% of new shipments down from a much, much larger number a year before, Clustered Data ONTAP is 70% of new shipments and so you can draw your conclusions in terms of when that transition will happen. The majority of our business has already transitioned to the go forward platform. I will leave you with that. The majority of our business has already transitioned to the go forward platforms in the E series branded versus OEM in the ONTAP and FAS business Clustered ONTAP versus 7-Mode.

Thanks Joe. I’ll give it back to George for a couple of summary comments.

Thank you for joining us today. I would like to conclude by saying we continue to make progress as we pivot towards growing parts of the market. Scale out, software-defined, flash, converged and hybrid could. Our key investment areas is sales capacity, channel traction and the acceleration of the transition of our install base to Clustered ONTAP are showing early results. Clustered ONTAP, flash and other emerging pieces of our portfolio are growing strongly although not yet to enough to offset the decline in our ONTAP 7-Mode business. Our customers are transforming themselves using digital technology connected with pervasive broadband networks and cloud computing to improve the efficiency of their business, their global business systems and better serve their customers. Data is at the heart of that transformation and where NetApp has a unique and valuable role to play. Feedback from customers and partners is overwhelmingly positive and reaffirms my strong conviction that our data fabric strategy is aligned to our customers’ strategic technical direction for IT. NetApp is the only Company that can help enterprises manage their data seamlessly across multiple cloud architectures with the scale and modern system architectures needed to accommodate the exponential data growth of the digital era. NetApp is changing to position the Company for long-term growth. We are conducting a fundamental assessment of every aspect of our business, structure, portfolio and process, to reduce complexity and drive efficiency, while improving our overall velocity. We will build a stronger more efficient Company that solves customer challenges, while delivering profitability and earnings growth in a moderated IT spending and storage market. Thanks for joining us and I’ll speak with you again next quarter.

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program. You may now disconnect. Everyone, have a great day.