Kris Newton - IR George Kurian - CEO Ron Pasek - CFO

Jim Suva - Citi Brian White - Drexel Jason Nolan - Robert. W Baird John Long - USB Irvin Liu - RBC Capital Mark Moskowitz - Barclays Rod Hall - JPMorgan Aaron Rakers - Stifel Louis Miscioscia - CLSA Simona Jankowski - Goldman Sachs David Ryzhik - Susquehanna Steven Fox - Cross Research Sherri Scribner - Deutsche Bank Andy Nowinski - Piper Jaffray Maynard Um - Wells Fargo Tim Long - BMO Capital Eric Martinuzzi - Lake Street Capital Katy Huberty - Morgan Stanley

Good day, ladies and gentlemen and welcome to the NetApp Second Quarter Fiscal Year 2017 Financial Results Conference 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 call maybe recorded. I would now like to introduce your host for today's conference Kris Newton, Vice President of Corporate Communications and Investor Relations. You may begin.

Hello, and thank you for joining us on our Q2 fiscal year 2017 earnings call. With me today are our CEO, George Kurian and CFO, Ron Pasek. This call is being webcast live and will be available for replay on our website 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, our expectations regarding future revenue growth and improved profitability including cash flow and shareholder returns, all of which involve risk and uncertainty. 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, including the macroeconomic and IT spending environment, our ability to successfully pivot to the growth areas of the market, to gain market share, to expand our operating margin, to reduce our cost structure, and to continue our capital allocation strategy. Please also refer to the documents we file from time-to-time with the SEC, specifically our most recent Forms 10-Q, our Form 10-K for fiscal year 2016 and our current reports on Form 8-K, all of which can also be found on our website. During the call, all financial measures presented will be non-GAAP unless otherwise indicated. I’ll now turn the call over to George.

Thanks, Kris. Good afternoon, everyone. Thank you for joining us. Our focus on the disciplined execution again yielded solid results on the top and bottom-lines. Our second quarter fiscal year 2017 revenue was as the midpoint of our prior guidance range with both operating margin and earnings per share above our previous guidance. And we expanded our innovation in our industry leading flash and hybrid cloud solutions during the quarter. These results are clear evidence of our ability to execute, while we streamline the business and pivot to the growth areas of the market. As you've heard from us before we have three priorities to deliver on our commitment to return the company to revenue growth with improved profitability, cash flow and shareholder returns. First, we are executing our data fabrics strategy and delivering this strategic solutions that create the foundation for how we enabled customer success. Second, we are permanently lowering our cost structure and streamlining operations while maintaining our ability to innovate. And third, we are continuing our robust capital allocation program, which includes a mix of share buy backs, dividends and investment for the long-term growth of the business. I'll begin with an update on our first priority. Our strategic solutions are aligned to our customer's top IT imperatives and position us to lead in the new era of IT. In Q2, strategic solutions comprised 62% of net product revenue, growth was relatively flat against a tough compare in Q2 fiscal year 2016, but grew 10% sequentially, an indication that we continue to gain attraction in customer environments. Net product revenue from our mature solutions declined at 29% year-over-year. We expect that over the course of this fiscal year, the headwinds from mature solutions will lessen allowing the growth of the strategic solutions to return the company to moderated revenue growth in fiscal year 2018. As you saw in the Q3 guidance included in our press release we expect this shift to begin delivering growth in the second half of this fiscal year. Much like us, our customers need to drive efficiency in the mature parts of their businesses while adding flexibility to capture new business opportunities, out execute the competition and grow revenue. To achieve this we are transforming IT. Modernizing their datacenters so that they can lower costs, increase agility, get more value from their data and integrate cloud resources with on premises environments. As customers modernize their infrastructures they are replacing standalone silos of storage and monolithic frame arrays which scale out software defined shared storage platforms. Clustered ONTAP enables seamless enterprise data management across flash, disk and public and private cloud environments. With Clustered ONTAP, IT organizations can consolidate multiple workloads into a single repository dramatically improving the efficiency of their enterprise storage infrastructure. We continue to see strong customer demand and are gaining new customers and migrating existing customers to Clustered ONTAP. Clustered ONTAP was deployed on 86% of FAS system shipped in Q2, up from roughly 70% a year ago. Unit shipments of Clustered ONTAP systems grew 14% year-over-year. The installed base of FAS systems continues to grow and Clustered ONTAP is now running on approximately 36% of systems in that large and growing installed base. At the beginning of the fiscal year, we introduced ONTAP 9 which unifies data management across flash, disk and cloud bridging current enterprise workloads and new emerging applications. The initial customer feedback has been tremendously positive. In the first four months since its release, ONTAP 9 has had the highest adoption rate of any of our major ONTAP introductions. In Q2, we expanded the innovation of ONTAP 9 with built-in multichannel capable inscription for improve data security, support for massively scalable high performance NAS containers and greatly simplified provision in operations for enterprise applications. To gain advantage through greater speed and responsiveness from key business applications while substantially lowering total cost of ownership, customers are leveraging flash technology as part of their IT transformations. Flash is being used for a wide range of workloads and becoming the main stream choice for on premises deployments, requiring that all flash arrays deliver enterprise grade data management capabilities. NetApp is leading the industry in the transition to flash with our highly differentiated portfolio of all flash arrays which provide customers with unrivaled scales, speed and data services. Gartner recognized NetApp as a leader in its Magic Quadrant for Solid-State arrays. IDC ranks NetApp number two in the all flash array market with our growth outpacing depth of the market and our peers. We expect to gain share again this quarter. In the second quarter, our all flash array business tripled year-over-year to an annualized net revenue run rate of over $1 billion inclusive of all flash FAS, EF and SolidFire product and services. With flash moving from a point solution to a per basis technology, we refreshed our portfolio of ONTAP powered hybrid in all flash arrays in Q2. We also enhanced ONTAP Select to support flash in commodity servers. Our new hybrid array systems expand the requirements of large enterprise data centers to small enterprises and mid-size businesses offer dramatically increased speed and responsiveness compare to our previous hybrid arrays and scale up to 14 petabytes in a single system and out to a 172 petabytes in a Cluster. Our new all flash systems offer the industries best data management features with up to twice the performance of prior system at half the latency and are designed for easy setup in less than 10 minutes. Our new all flash FAS systems are included in our flash promotion which offers 3X guaranteed performance and a 4:1 guaranteed increase in storage efficiency over competitive disk arrays as well as a risk free upfront trial, free storage controller upgrade and support extension to simplify ongoing operations. The majority of our growth in the All-Flash-Array market is driven by the All-Flash FAS customers are deploying the All-Flash FAS to improve existing infrastructure and processes, lower cost and enhanced flexibility. A North American Financial Services Company choose the All-Flash FAS to create a modern alternative to their expensive legacy monolithic private channel SAN array from a competitor. Another North American Financial Services Company replaced the competitor's NAS footprint with an All-Flash FAS cluster connected to a disk-based cluster with SnapVault backup services to create a tiered cloud service model for its next generation file services platform. We’re gaining new customers and new footprint at existing customers with our All-Flash-Array's. For the first half of calendar 2016 NetApp is the fastest growing SAN vendor as measured by IDC. A clear indicator that we are moving outside of our traditional installed base and expanding our market opportunity. For enterprises and service providers who want to build a multichannel public and private clouds SolidFire delivers a web scale style architecture for next generation datacenters. Through the expanded reach of NetApp we are acquiring new customers introducing SolidFire into existing NetApp accounts and bringing NetApp solutions to SolidFire customers. A global financial services company is moving to NetApp after years of preference for a competitor. They are building a next generation datacenter environment to power their digitization of their services by deploying ONTAP as the storage infrastructure for their open-stack environment, SolidFire for their IT web dev environment and storage grid web scale for their third platform solutions and archiving. Each of these products address unique requirements in the customers environment while delivering the performance and reliability needed for a global digital enterprise. SolidFire is a key area of focused in investments for the long-term growth of NetApp and is performing to plan. Customers are also leveraging the hybrid cloud in their IT transformations to capitalize on the value of their data. Our data fabrics strategy enables data management that seamlessly connects disparate systems, software stacks, clouds and datacenters allowing customers to architect the IT environment that best meets their needs utilizing a mix of flash, disk and public and private cloud resources. All at the scale needed to accommodate the exponential data growth of the digital world. Customers can innovate faster by leveraging the scale of on demand cloud capabilities, while maintaining data visibility with the single consistent view of data and infrastructure of chorus clouds and on premises resources. Earlier this month, we announce new data fabric solutions and services that maximize control and improve the secure movement of data across the hybrid cloud, along with updated versions of AltaVault, storage grid web scale and SnapCenter technologies to help customers extract the value of their data from anywhere in the hybrid cloud. We expanded the used case for ONTAP cloud to include Microsoft Azure and announce cloud control for Microsoft Office 365, a simple way to control and protect critical data stored in Office 365 which support for data retention in cloud services such as Amazon, S3 and Azure as well as on premises storage. Additionally, we introduced NetApp private storage as a service, an OpEx based consumption model available to a growing partner delivery ecosystem. We are engaging with the broadest set of partners to help customers plan and evolve their hybrid cloud deployments to fit their changing business needs, and more and more customers and cloud service providers are choosing NetApp because we enabled their hybrid cloud strategies. While Ron will go into depth about cost savings and capital allocations, I want to reemphasis our commitment to both priorities. At the start of the third quarter we announced a reduction in force as part of our planned transformation and cost reduction efforts. This action was taken in alignment with real structural changes to make our business more streamlined and agile. We are making substantial progress against $130 million cost reduction goal net of reinvestment that the outlined on our Q3 fiscal year 2016 earnings call. We are on target and expect to achieve the remainder of savings through the normal course of business. I want to thank the NetApp team for remaining focused on execution while making difficult restructuring decisions. We are pleased with our progress but still have more work ahead of us. We are advancing our product and solutions portfolio, evolving our ecosystem of partners, streamlining our business processes and enhancing our go-to-market model. We sharpened our focus, accelerated our innovation and are funding the investments against the fastest growing parts of the market like all flash arrays, next generation data centers and hybrid clouds solutions, while accelerating our ability to deliver shareholder value in the form of improved profitability and cash flow. We are on track to return the company to long term growth and to our target operating margin range, but we must remain focused and continue our disciplined execution. Our second quarter results and third quarter guidance are evidence that our strategy is working and I am more confident than ever in the NetApp team's ability to successfully evolve the company for leadership in the data power digital era. I’ll now turn the call over to Ron to walk through our Q2 financial performance and expectations for Q3. Ron?

Thanks George and good afternoon everyone. As a remainder, we will be referring to non-GAAP numbers today. As you heard from George, we continue to make significant progress toward growth areas of the market while at the same time transforming the company. Q2 marks another quarter of solid execution albeit against a difficult year-over-year compare. Net revenues were at the midpoint of our guidance at $1.34 billion, this was an increase of approximately 3.5% sequentially and a decline of about 7% on a year-over-year basis. Product revenue of $710 million increased 7.5% sequentially and decline 13% year-over-year. As we have discussed, we expect the growth of strategic solutions to improve our product revenue growth trajectory over the course of fiscal 2017. The combination of software maintenance and hardware maintenance and other services revenue of $630 million, was relatively flat sequentially and year-over-year. Gross margin was 62.7% and within our guidance range. Product gross margin of 48.2% decreased about 3.5 points year-over-year and increase 1.5 points sequentially. Software maintenance gross margin was relatively flat sequentially and year-over-year while hardware maintenance and other services gross margin increased just over 3 points year-over-year. Operating expenses of $636 million decreased 7% year-over-year and 2% sequentially, reflecting the benefit of our ongoing transformation efforts. Operating margin of 15.2% was above our guidance range evidenced of the progress we’re making towards the operating margin range that we guided for the year. Aligning our cost structure with the opportunities ahead remains my top priority. As I said on our last earnings call part of the plan transformation efforts would include additional steps to permanently lower our cost structure including headcount reductions. As such on November 3rd we initiated a reduction of approximately 6% of our worldwide headcount which will results in a onetime charge of $50 million to $60 million, primarily in Q3 fiscal 2017. This action will yield an annual run rate savings of approximately $130 million. As a reminder we are driving to permanently reduce our cost structure across both cost of sales and OpEx. In Q3 ’16, we announced our plans to reduce our cost structure by $400 million annualized by the end of fiscal 2017. We said some of those savings will be reinvested into strategic opportunities such as SolidFire and will yield a net run rate savings annually of roughly $130 million by the end of fiscal 2017. We have made meaningful progress against this plan by implementing tighter cost controls over indirect spending, improving supply chain efficiency, streamlining our product portfolio, evolving business processes and reducing headcount. Given the progress we’ve made today, we remain confident in our ability to achieve our goal on schedule. Our effective tax rate for the quarter was 17.3%. Weighted average diluted shares outstanding were 284 million. EPS of $0.60 was $0.04 over the high-end of our guidance range, reflecting improved gross margin, lower operating expense, and the benefit of our share repurchases. Our cash and balance sheet metrics remain healthy. We closed Q2 with $4.4 billion in cash in short-term investments with approximately 10% held by our domestic entities. We remain committed to completing by the end of May 2018, the remaining balance of our share repurchase program announced in February 2015. In Q2, we repurchased $117 million of our stock, and paid approximately $52 million in cash dividends. Today we also announced our next cash dividend of $0.19 per share, which will be paid on January 25, 2017 to shareholders of record as of the close of business on January 6, 2017. Deferred and finance unearned services revenue was up 5% year-over-year and down 3% sequentially. Q2 cash flow from operations was $158 million up 9% year-over-year. We generated free cash flow of $102 million, an increase of about 3% year-over-year. We are aggressively managing our working capital metrics DSO, DPO and days of the inventory outstanding. DSO were flat year-over-year while DPO increased by eight days and days of inventory outstanding improved by three days. As a result our cash conversion cycle was nine days which was an improvement of 12 days year-over-year, but three days longer sequentially due to the seasonal increase in DSO. Now, onto guidance, as outlined today, our transformation efforts are resulting in stronger more focused and agile company. We were committed to driving productivity, while at the same time continuing to shift our investment and focus towards the growth areas of the market. We're increasingly encouraged by the early signs of progress that we're seeing. While we still have work to do we remain confident in our ability to continue to execute against the plans we outlined for fiscal 2017 on our Q1 earnings call. For Q3 we expect net revenues to range between $1.325 billion to $1.475 billion which at the midpoint implies a sequential increase of approximately 4% and a 1% increase year-over-year. We expect Q3 gross margin in the range of 61.5% to 62.5% and operating margin between 18% and 18.5%. And finally we expect earnings per share for the third quarter to range from approximately $0.72 to $0.77 per share. With that I'll hand it back to Kris to open to open the call for Q&A. Kris?

We'll now open the call for Q&A. [Operator Instructions] Operator?

Thank you. [Operator Instructions] Our first question comes from the line of Jim Suva with Citi. Your line is now open.

George you mentioned the workforce realignment or change, I believe, like in early November of this year. Can you just clarify -- earlier this month, can you just clarify was that incremental to prior rounds of restructuring and if so, are we at the point where you have now made all your announcements and done all your realignments or is this kind of like phase two or three and still more to come because your OpEx as really been quite impressive, you’re just this kind of measure where you’re at along that phase of thought there?

We announced a program to reduce the cost structure of the company permanently as part of our Q3 fiscal year '16 earnings call; and we're making substantial progress against that. We took an action as you can recall in Q4 of fiscal '16 to accelerate the pace of transformation and we've taken a second action in November in alignment with the prior transformation efforts. We took these actions in two steps, to allow the business to make the structural changes necessary so that we can sustain the cost savings going forward. At this point we have accomplished a substantial portion of the cost savings activity and we think we can accomplish the remainder of the savings through the ongoing course of our business operations.

Our next question comes from the line of Brian White with Drexel. Your line is now open.

I'm wondering if you can talk about a little bit about how the Del EMC combination has offered opportunities thus far kind of what are you seeing out in the field right now. Thank you.

Del and EMC continue to be a formidable competitor and we compete with them in the broadest range as both customer and the reseller opportunities as I communicated on the call we are taking core customers from EMC, but because of the strength of our technology both in solid-state as well as next generation datacenters and increasingly because of the relationships that we have with the hyper scale cloud providers. We continue to compete, they continue to compete aggressively, there are a formidable competitors and we need stay focus but we do feel that in this transaction of this combination we do see opportunities both in terms of the recruiting new channel partners as well as willing customer footprints that are net new to NetApp.

Our next question comes from the line of Simon Leopold from Raymond James. Your line is now open.

This is Victor in for Simon. I wanted to drill in on your All-Flash products just a little bit. Some of the discussions that we've had with our checking distributors suggested that the success of some of your competitors early on with All-Flash was more attributed to timing and the positive reception that you’re seeing to NetApp solutions more recently implies that those customers may have preferred NetApp's offering all along if it have been available at that time. So can you just comment to the degree that it’s consistent with? What you are seeing and kind of what that means the headroom in terms of improvements in the share gains?

First of all the market as we've said before has transitioned from an early adopter market to a mainstream replacement of performance drives with solid state arrays. In that transition customers are looking for consistency in their business processes, risk management, as well as the maturity of the technology solutions and our solid-state portfolio we feel is the best positioned in the market without question. Because we combine state of art technology efficiency and scale out architectures with the world's best data management features for enterprise datacenters with all flash FAS and for web scale datacenters with SolidFire. We have gained share in solid-state and we continue to feel confident about our prospects going forward.

Our next question comes from the line of Jason Nolan with Robert. W Baird. Your line is now open.

I wanted to ask George on MD&A and cross point and how important are these new technologies what's the timing look like and how are you positioned data phase so strong reasonably I'm wondering what this holds for us in ’17 and in ’18?

I think there are lots of elevations to come in the solid-state storage market the two that you referenced are certainly things that we have in our technology portfolio and we will as I said make those offerings available with when they are mature and ready for mainstream customers just like we have done with All-Flash storage solutions. There is a long roadmap of success ahead on 3D NAND technology, then there is evolutions to that. And what I’ll tell you is that even with with 3D XPoint and NDME, the same values that we have brought to some enterprise all flash array market will continue to have value for customers. Proven software, mature enterprise systems technology and the track record and experience of large successful storage and data Management Company.

Our next question comes from the line of Steve Milunovich from USB. Your line is now open.

It's John Long in for Steve. Wanted to get the question, are you kind of saying that the competitive environment has allowed product gross margins to essentially reach a bottom here at around 48%, is that we kind of think going forward?

It's difficult to tell, the environment changes constantly. I would like to think it's bottom, that would be good. We are doing some work to improve product gross margin, it will take some time for that to pay off. But at this point I think, I would like to think it is the bottom.

Our next question comes from the line of Amit Daryanani from RBC Capital. Your line is now open.

Thanks guys, this is Irvin Liu calling in for Amit, first of all congrats on a great quarter. And I just want to ask you about your mature product revenues, they declined by about 29% year-over-year, and I was wondering if there is a sort of maintain level run rate for the mature business going forward and if so how close are we to reaching those levels?

So just to set context, the mature bucket includes the OEM business both E and N-series, the ONTAP 7 mode business and the add-on storage components of the mature buckets, we see that the predominant declines are behind us and we’re reaching a point where the forward looking declines should be less material than they have been in the past. As you can see even this past quarter, the rate of decline sequentially continues to moderate relative to what we saw in '16. Add-on storage which is a large percentage of the mature bucket is not going to decline at anything like the rates of 7 mode or OEM and so we feel that going forward we should see some degree of stability in the mature business.

Our next question comes from the line of Mark Moskowitz from Barclays. Your line is now open.

I wanted to see if we could better understand the trend line through the underlying business. Strategic revenue growth fell to 1% versus 24% in July and 16%, and then storage system revenue declined nearly 13% after almost flat in last quarter. I guess I'm concerned we're seeing some major decelerations by developing good strides you made in both revenue and also OpEx by containment.

Yes, so Mark, I think part of the challenger last year was Q2 was our single highest quarter. So it's really difficult compare. So you saw -- last quarter we actually had product revenue roughly flat and we guided for Q2, we knew that it would be a difficult compare, we knew it was going to be down double digits. If you include the guidance we gave going forward that starts to get better as we move forward to Q3 and Q4.

Our next question comes from the line of Rod Hall with JPMorgan. Your line is now open.

Just came off the Cisco call and commentary there has written -- relates to a little bit of underlying weakness in enterprise, obviously the forward looking, more service provider. But a lot of the numbers suggest weak enterprise spending particularly in the midsize business environment, so I wonder if you guys could comment on what you're seeing from that point of view? And then I guess I also would ask you to comment a little bit on the cash return policy. Obviously we're looking at potentially lower tax rates now and some changes with the administration coming up with Trump presidency, so could you just talk a little bit about how that might affect your thinking with regards to cash return?

Okay, let me take the economic environment, as we've said on the call, it remains uncertain macroeconomic environment, I think spending decisions are not materially different than they were in the prior quarter, but you have to compete every opportunity and we've done that through the course of this quarter and we intend to do that successfully through the course of next quarter. I would say that the geographic mix of our business reflects the economic environment across the globe. It's a diverse landscape and we have strengthened some parts of the work where the economic environment is stronger and our executions has been better and it's been mixed in other parts of the world. I'll let Ron talk a little bit about our cash return policy.

There's couple of things being discussed. We would prefer fundamental corporate tax reform as opposed to one-time holiday. We'll wait and see what that looks like and decide what the best return policy is based on that. And I think doing a holiday is beneficial and it might be advantage to take -- for us to take advantage of that, but to fix the permanent disadvantages U.S. companies have in the world will require a fundamental corporate tax reform.

[Multiple Speakers] It's a little early for us to comment. We're going to wait to see what the new administration defines to be its policies both on trade and tax and then we'll communicate our plans soon thereafter.

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

I wanted to talk a little bit differently about the competitive landscape. I know Cisco was mentioned in a prior question. Cisco's obviously got a strategy of trying to push their HyperFlex product. We now see Nutanix out in the market as a public entity. I'm curious to how you guys are currently seeing the hyperconverged market, where you see that competitively showing up and, if not, why that wouldn't be.

First of all, our relationship with Cisco has been strong, the All-Flash FAS has driven a really strong business together with FlexPod and is allowing us to compete in parts of the data center with FlexPod that we couldn't before. The second is as we said hyper conversions has a value to customers who require rapid time to provisioning or a very simplified configuration for departmental and small office workloads. We have two approaches to compete with hyper converged solutions, one is a set of innovations that we brought to the FlexPod family called FlexPod Automation and the second is with SolidFire which provides a zero touch storage provisioning solutions. The release of SolidFire that we introduced in the summer of this year called Fluorine allows us to compete very well with Hyper converge solutions and VMware environments and we have been seeing wins. So we realize there is value to customers from Hyper converged offerings and we have solutions to respond to those customer needs.

Our next question comes from the line of Louis Miscioscia with CLSA. Your line is now open.

Can you maybe help us out with the guidance both on the high-end and the low-end? In essence the high-end if we were actually able to do it, if I’m doing my math right would suggest a quarter-to-quarter product revenue number given that software entitlement services have pretty steady numbers of a 127 million quarter-to-quarter and absence dollars and going back over the six or seven years now really got about close to anything like that, usually going into the quarter usually doing about somewhere between let’s say 50 million or 55 million. So how did you ever get through high-end number and then alternatively maybe if you could comment on why there would be a possibility of product revenue down 22 million quarter-to-quarter from an absolute numbers standpoint?

We were taking a broader range. We look back and there are quarters where we were up sequentially, probably not as high as what you are quoting on product revenue, but we wanted to give a wide berth both ways and it's just really being conservative. You saw in Q2, we gave that same for rest of the 150 million we hit it spot on so. I think there -- it is a difficult environment its unpredictable and we’ll try to make sure we’re in the range somewhere close to that point.

Maybe just following on the past question, do you -- some are not predicting your budget plus as they finish the year are you getting any visibility to that one way or another realized your quarter into January?

Difficult to tell as different customers in different markets, in different geographies. Certainly sometime certain customers have December as their yearend not all customers obviously and then as we said our quarter ends in January.

Okay, great. Thank you.

Our next question comes from the line of Simona Jankowski with Goldman Sachs. Your line is now open.

I just had a follow-up first or a clarification on the improvement in product gross margin. Can you just unpack for us what drove that, to the extent some of that was from the perhaps slightly more benign pricing environment versus the cost reductions you've been implementing versus mix because I'm just trying to get to the go forward and how many of those drivers might be permanent. And then I just wanted to follow up on the comment you made about better exposure or greater exposure to hyper scale customers. Could you quantify for us roughly what percent of your revenue now goes into those kinds of customers? Thank you.

Look, Simona. I think if you look, we do have -- tender to have a seasonal bump up in product gross margin from Q1 to Q2. You can call it customer mix if you’d like, so that's what, what you saw to a largest that, but part of that will continue in Q3, but not to the same extent also in Q3 what we have is higher products revenue which puts a little pressure on the overall margin rate.

I think in aggregate Simona what we are doing in that to address gross margins is both continued to drive transformation into our services business which has allowed us to improve the gross margins of that business over the last few quarters. And on the product side being delivered about the use of promotions as well as improving the pricing and discounting approaches in our transactions. So we will -- we’re generally focused in gross margin in aggregate and we have enough leverage to keep the gross margin within the ranges that we shared with you. In terms of the hyper scale question, what I was referring to was the fact that we are building hybrid IT solutions that combined on premises data centers with the data enter and IT architectures of the hyper scale providers. This includes solutions like NetApp private storage for secure cloud storage. It includes solutions like the AltaVault solution and it includes the use of our software as part of hyper scale market places. And what they are doing is, while that part of our business is not material, they are allowing us to win on premises transactions because of a compelling forward looking hybrid IT roadmap that customers can buy into.

Our next question comes from the line of Mehdi Hosseini of Susquehanna. Your line is open.

This is David Ryzhik for Mehdi Hosseini, thanks so much for taking the question. What percent of cDOT shipments in the quarter were all flash FAS? And regarding ONTAP 9, how much of a factors is that in your migration from 7 mode to cDOT? And do you think there was some customer cause ahead of ONTAP 9 and should ONTAP 9 catalyze additional migration? Thanks so much.

I would say that in terms of the all flash FAS solutions, all of the all flash FAS solutions are based on clustered ONTAP as an operating system. And so they count towards our aggregate clustered ONTAP numbers, they are a growing percentage of the clustered ONTAP business, not yet the majority. So we have room to go. In terms of the installed base, there are a variety of reasons why customers choose to migrate from 7 mode to clustered ONTAP and flash is certainly an important part of that transition. The fact that we have a very compelling all flash FAS solution is encouraging customers to move in some cases their upgrade schedules up.

Great thanks. And regarding ONTAP 9, have you seen that drive any incremental interest from 7 mode customers?

ONTAP 9 continues to provide compelling technology for customer of both traditional NetApp customers as well as net new to NetApp customers. The combination of scalable mass containers, volume granular inscription on parallel storage efficiency and performance together with the new platform that we recently announced, all give customers more reason to upgrade from 7 mode to cDOT or for competitors to come to us. So we feel very good about the progress we have made.

Our next question comes from the line of Steven Fox of Cross Research. Your lien is now open.

Just on the topline outlook for the quarter, you’ve accelerated the return of year-over-year growth by that a quarter versus what you said on the prior call. So I was just curious what was the main two or three drivers in sort of pulling in that return of year-over-year growth into this current quarter? Thanks.

We have always said that we -- our plan was to return the company to growth in aggregate in fiscal '18 and that we would -- our plan was to return product revenue to growth in the second half of this year; we're on plans for that and we feel even more confident than we were a few quarters ago both because the mature products are stabilizing in terms of their go forward as well as the strength of our strategic solutions.

So, there's not one or two things you would say, probably bigger drivers, as obviously I think most people are thinking that was going to happen in the fourth quarter so. I'm just curious if there's something that you would say has increase our confidence more than other things.

I would just say our aggregate execution against the plan and the fact that we've been consistently meeting expectations. So I think that's the real basis for where we are and as I said the mature products are less material a part of our business and the majority of the declines are behind us and the strategic solutions continue to perform well. So, we got to keep our head down and execute the plan. And I would just tell you that's my focus right now.

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

I was hoping you could provide us with some additional detail on the SolidFire business, how much did that grow in the quarter and do you expect that to continue to be significant growth driver?

SolidFire is as we've outlined an important part of the focus and investment for us because it allows our customers to build architectures for their next generation data centers with us that they can't with anyone else. As we laid out at the time of the acquisition of SolidFire, SolidFire would contribute about 2% to our revenue for this year and would offset the OpEx operating margin by roughly 2% and I would tell you that we're on track to those plans. We've been gaining new customers to NetApp using SolidFire, we've been introducing NetApp customers to SolidFire and we're executing according to plan that we laid out. So, this is all about where we are with SolidFire.

Our next question comes from the line of Andy Nowinski with Piper Jaffray. Your line is now open.

It looks like the only region or vertically you had year-over-year growth in this quarter was the U.S. public sector; just wondering if you could give us any more color on that growth whether the budget for us was larger this year than last year or whether you gained share in the space?

Public sectors procurement cycle was according to what we had thought and according to -- was in alignment with plan, we didn't see any unusual activity upward or downward in the public sector market, we have continued to execute well to capture the share of opportunities that are out there and so I would just say it is the budget flush that we saw in public sector was normal.

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

Can you clarify whether there was any product gross margin benefit from the shift in marketing that you talked about last year and it seems like you see scope for more improvement in product cost going forward partially from marketing shift, also from restructuring, can you just talk about how you prioritize gross margin improvement versus market share gain, I heard you mention that you're hopeful this is the bottom in product gross margin. I guess I'm asking the opposite question as we look forward in our modeling, should we be looking at product gross margins going up, going forward mix aside or will you sort of trade that for revenue market share gain? Thanks.

We would just in aggregate we operate to the gross margin guidance that we have laid out and it's a combination of improvements in service and product gross margins I would say right now what we’re focused on is capturing footprint with our All-Flash-Array's as well as converting customers and facilitating the conversion of customers from 7-Mode to Clustered ONTAP. We’ve said that we have put in place promotions that facilitate both of those objectives that are strategic to the company in the market and we constantly monitor the value of those promotions and their impact in terms of achieving our strategic objectives. The product innovations that we have made over the last year and a half continue to provide us with a really solid platform for differentiations and so any point in time we reserve the right to continue those promotions or to remove them from the marketplace and we constantly trade off the benefits of those with the benefits to improvements in gross margin.

Just to be little clear, on the services side is where are you seen most of the improvements we've made that will be a transformation. So that to some extent helps with the gross margin overall in the last couple of quarters.

Our next question comes from the line of Tim Long with BMO Capital. Your line is now open.

George, you mentioned the geographic performance tracking with what we're seeing from a macro standpoint. Could you talk a little bit about EMEA and APAC? It looks like the last few quarters they probably lagged the performance in North America, the Americas, at least on a year-over-year basis. Anything to that from your product standpoint or execution standpoint? And how should we think about those starting to catch up? Thank you.

I would say that in EMEA and APAC they are vastly different geographies with different macroeconomic situations. I think that we have seen strength in certain parts of EMEA and APAC where the economic landscape has stayed relatively benign and we have gained share in those environments. In others where there is more uncertainty, you see that impacting transactions and so we've had to compete to maintain share and we have done a good job doing that. I would say that we're going to wait to see what the economic outlook looks for those companies and we have built a fairly conservative outlook into our guidance. And so we continue to focus on gaining share wherever we can gain share, but do so with an outlook that builds into the forecast that the macroeconomic situation in those countries. Emerging markets is the same which falls into our Americas geography. The preponderant part of the Latin American geographies are in our Americas business.

Our next question comes from the line of Eric Martinuzzi with Lake Street Capital. Your line is now open.

Yes, just curious in working with your channel partners, there was -- some of your channel partners have been representing maybe competitive All-Flash-Arrays out in the markets. What incentives or what steps are you taking so -- maybe for an account that isn’t kind of a NetApp installed base where an [technical difficulty] from NetApp would be a layup, kind of a Greenfield opportunity. What are you doing to get it -- make that a NetApp install as oppose to a competitive product install with your channel partners?

I think its starts with the customer, it starts with making sure customers understand the value of NetApp technology and I think we’ve made substantial progress there. Analyst commentary customer references the portfolio of products from NetApp and our intense focus on raising our profile in the All-Flash-Array markets, as well as candidly the success and momentum that we’ve demonstrated substantially outpacing the market as well as our peers gives us access to more customer conversations than we’ve ever had before. Some of that also is reaching those customers through new low cost innovative digital marketing channels which our Chief Marketing Officer is an expert that doing. And then the third is enabling the channel so that they focus their attention on NetApp portfolio. I think we’re using all of those levers, and we feel good about the progress, this is an unending -- I would just tell you this is an ongoing game, right. So as I’ve said on my call, we are very pleased with the momentum, but we’re going to keep our heads down and we’ve got more work to do and we’re doing that every single day, staying focus on execution.

Our next question comes from the line of Katy Huberty with Morgan Stanley. Your line is now open.

Question about support attached to the strategic business versus mature. Curious whether there is a different dynamic or attach rate, because hardware maintenance is down year-on-year and differed revenue declined more than seasonal this quarter despite the fact that install base is growing. So just trying to understand that implications for the maintenance business? Thanks.

There is no difference in the attach rate between a strategic and mature. We are still, as you said, seeing a growth in installed base, although it is a little bit slow. What we have is very, very good growth in obviously the new cDOT products. But as you recognized product revenues for the last couple of quarters have declined, that puts a little pressure on that install base, but it is growing. Deferred is growing significantly year-over-year, there were some seasonal things that happened quarter-to-quarter, remember renewals -- it's must be renewals, and those happened to a large extend in the second half of the year. So that leaves a little bit of a trough in the first half.

And our last question comes from the line of James Kisner of Jefferies. Your line is now open.

Hi, this is [indiscernible] on for James Kisner. George, you mentioned 3D NAND roadmap and your flash business is doing really well, but are you seeing any negative impact from NAND shortage this year, and I don’t know what's your visibility into NAND pricing, are you signing a long term contracts?

We are able to secure what we need for NAND, it is a tight supply. No one is signing long term contracts right now. So I think we’re able to get what we need and prices are tight.

I think and just to add to Ron's comments, I think ensuring supply is the combination of both technological as well as commercial relationships with the NAND suppliers and we have excellent relationships with multiple of them. So we feel good about where we're at but it is constrained market.

I would now like to turn the call back over to Kris Newton for any closing remarks.

And I'll hand it over to George.

I wanted to just summarize the comments that I made at the start. I'm pleased with the progress that we've made both in the top line and the strategic portfolio of products that align with our customers priorities as well as with the productivity and efficiency of our business. We are increasingly confident to bring additional innovation to customers, add new customers, working with the hyperscale ecosystem that drives the next generation of IT as well as transforming to be a more agile, focused and faster moving company. We have achieved an enormous amount of progress and I want to thank the NetApp team and are closer to returning the company to growth than we have been in a longtime. We have more work to do to bring excellence to all facets of our business and we're going to stay focused and deliver yet another quarter of meeting our commitments to our shareholders. Thank you and we'll see you on the next call.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude your program. You may all disconnect. Everyone have a wonderful day.