Welcome to the NetApp's Third Quarter Fiscal Year 2014 Earnings Call. My name is Patrick, and I'll be your operator for today's call. (Operator Instructions) Please note that this conference is being recorded. I will now turn the call over to Kris Newton, Senior Director of Investor Relations. Kris, you may begin.

Hello and thank you for joining us on our Q3 fiscal year 2014 earnings call. With me today are CEO, Tom Georgens; and our CFO, Nick Noviello. 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, a historical supplemental data table and the 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, 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 described some of these reasons in our accompanying press release, which we have furnished to the SEC on the Form 8-K. Please to the documents we file from time to time with the SEC, specifically on our Form 10-K for fiscal year 2013, subsequent Form 10-Q quarterly reports and our current reports on Form 8-K also on file with the SEC and available on our website. During the call, we will also discuss non-GAAP financial measures. 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, prepared remarks and on our website. In a moment, Nick will walk you through some additional color on our financial results, and then Tom will walk you through his perspective on the business this quarter. I'll now turn the call over to Nick.

Thank you, Kris. Good afternoon, everyone, and thanks for joining us. NetApp executed another quarter of solid financial results, driven by our strong innovation, competitive position and operational performance. We delivered revenue within our prior guidance range and non-GAAP gross margin, operating margin and EPS all over the high end of our Q3 guidance range. Net revenues of $1.61 billion were up 4% sequentially, but down 1% year-over-year. Branded revenue of $1.5 billion grew 4% sequentially and 2% year-over-year. Branded revenue was below our expectations for the quarter, driven solely by a shortfall in US federal business. OEM revenue dollars were flat from Q2, as expected, and down 23% year-over-year. Indirect revenues through the channels and OEMs accounted for 83% of Q3 revenue. Arrow and Avnet contributed 20% and 15% of net revenue respectively. From a geographic perspective, total Americas revenue was down 5% year-over-year. Americas Commercial revenue was down 3% and US Public Sector revenue was down 13%, driven by downward pressure in federal IT spending. EMEA and Asia-Pacific revenue each grew 3% on a year-over-year basis. Non-GAAP gross margin of 63.5% was just 10 basis points below Q2 levels, but above our prior guidance range due to a combination of strong execution across our organization and lower-than-anticipated spending. Non-GAAP product gross margin of 57.1% was 4 points better than Q3 last year and down 20 basis points sequentially. We recognized the expected product gross margin pressure during the quarter from a less favorable mix of business. However that pressure was offset by further productivity and efficiency gains driven by our operations team, which we expect will be passed through to pricing over time. Non-GAAP service gross margin of 60.8% was more than 2 points better than Q3 last year and up almost 2 points sequentially, reflecting lower-than-anticipated spending…

Thanks, Nick, and good afternoon, everyone. I'm pleased with our execution again this quarter. Though we had some pressure from the dynamics in US federal IT spending, which we expect to continue, we expect ongoing market share gains driven by our strong competitive positioning and our differentiated product portfolio. Through solid operational execution and prudently managing expenses, we drove upside gross margin and delivered operating margin and EPS above the high end of our previous guidance range. Our strategy of delivering innovative best-of-breed solutions that are cloud-integrated and flash-accelerated is well in line with customers' top priorities. IT organizations are in the midst of a transition as they evaluate the role of new technologies and delivery models in their environments. Although this transition has resulted in slower decisions and elongated sales cycles, they also present opportunity. Customers are adding flash at all layers of their storage hierarchy and are shifting to an integrated mix of on-premise and off-premise IT infrastructure known as hybrid cloud. NetApp has established a market-leading position in flash and converged infrastructure and offers a differentiated approach to cloud and software-defined storage. Customers continue to adopt our latest innovations, confident in our strategy will help navigate this transition and position themselves well for the future. It is imperative that CIOs maintain control of their data in a hybrid cloud environment. As they seek to pull public cloud into the mix of their IT delivery, they have an opportunity to offload the burden of infrastructure and application management, but cannot offload the ownership and responsibility of their business data. The versatility, efficiency and ubiquity of Data ONTAP enables our customers to build solutions optimized for their specific needs. The solutions we deliver today and our innovative strategies for tomorrow directly address that CIOs need to seamlessly manage data…

(Operator Instructions) Our first question comes from Jim Suva with Citi.

We all know that the federal government and the government spending has been pressured due to the critical reasons and the sequestration and things like that. Is there a bright point where you see they have a come back and spend regardless and are they just kind of wringing in the towel out as much as possible? And do you think that this is kind of the new go-forward rate at what we're doing right here?

Time will certainly tell. But I think from our perspective, it certainly appears to be that the government is going to be in this state for a while. So I'm not in a position to say that I think they're going to bounce back in, in a week or month or a quarter or longer than that. So I think as we think about where we're going from here, I think we're basically assuming the situation that we're going to see, as there's going to be a tight spending across the board. So for us, obviously it makes next quarters compare and the Q1s compare, Q2s compare more challenging. And then assuming that has no change, that would start to normalize. But I think it would be imprudent of us to kind of bake in an expectation. I think they're going subtly snap back. I think our assumption baked into our numbers is that this is the environment we're going to see, it's going to be challenging, NetApp will win its disproportionate share, but I'm not expecting that thing to return to normal in the near term on the federal side.

Our next question comes from Joe Wittine with Longbow Research.

I wouldn't think federal is a hug impact there given just how weak the January quarter was. Is there anything else you could point to as far as what's happening in keeping this outlook?

We actually missed the front-end of your question. So I'm going to ask you, was your question around branded growth for Q3 or around the outlook for Q4?

I was asking about just the outlook for the fourth quarter here, well below seasonal and it doesn't seem to me that federal should be a significant impact on a sequential basis, given just how weak the January quarter was for federal? So what else is going on?

Well, let me first point out that last year, when we looked year-over-year for Q4, federal was down pretty substantially year-on-year. We've got to build in that overall federal environment into our thinking for Q4. And if you were to kind of look at the overall, our expectations for the branded side of the business for the quarter are probably about flattish. We also have some conservatism and pressure built on the OEM side. And we think that is appropriate, given one of our big OEM partners there is IBM and some of the dynamics going on in their business as an example, and the number of the OEM business, we're going to be dependent upon those parties, our OEM customers and the dynamics impacting them. So those are two areas where we think our level of conservatism is appropriate in terms of building that Q4 revenue guidance for you.

The one thing I'd add to that is certainly the federal story is an issue, but that's not to say that the rest of the global market is everything is fine as well. And clearly, you see the guidance of our peers and the commentary of our peers. And we certainly see that as well. So I think all these things are factored in. So clearly, we've got a tough compare with the federal side. As Nick indicated, as we go forward into next quarter, also heading into the Q1s of both IBM and Teradata, two of our big OEM partners, clearly there's a sequential impact associated with that that we'll need to absorb. So I think all those things considered that there is not a lot of bright light. Broadly certainly we've got by virtue of having number one market share in the federal. We have an exposure that some of the other guys don't have. And likewise, we have OEM seasonality that's somewhat different than our own. And that's something else you need to factor into next quarter.

Our next question comes from Bill Shope with Goldman Sachs.

So you had another quarter of surprisingly strong gross margins, and I think that's very encouraging to see that persisting. But with that said, we're still not seeing similar performance in revenues, and I understand all the factors you mentioned, particularly the federal weakness. But is there any component here we're getting some of that if you have to walk away from more aggressive deals in the quarter at a more often that normal? How should we think about the pricing dynamic and whether or not you may be getting some revenue on the pay book and the strong gross margin?

Well, I think overall, certainly we don't want to sacrifice any sales discipline here. But nonetheless, I think that it separates very competitive large deals and big accounts from the broader motion of the business. So I think in the broader motion of the business, we have a discipline about our pricing. I thin we've come a long way over the last year and training our field and our partners about the value proposition of clustered ONTAP. And if that becomes more mainstream, we see purchases there. I think the value proposition is exceptionally strong. So we feel certainly heartened by the strength of the gross margin now two quarters in a row. I don't think the rest of the industry has seen that. And I don't think that's a coincidence that that also coincides with much broader acceptance of clustered ONTAP. Now that said, I think on big transactions, which are either new accounts or complicated for any number of reasons, I don't think in this market we're walking away from those easily. So I think that we are going to pursue business. We are going to be aggressive to go after big deals. We are aggressively going after accounts. And in terms of the large opportunities, we're not walking away from too many of them on price, certainly no more than we have in the past. But I think broader discipline, better execution of the value proposition and better training of both our people and our channel partners have been a bigger contributor than that.

Let me also expand on a couple of pieces, though, because when we look at really the progression of Q2 to Q3 to Q4, there is a couple of components to overall gross margin to take a look at. Aside on the services side of the fence for a second, on the services side of the fence, gross margins went up from Q2 to Q3. Our expectations would be that they are down a bit between Q3 and Q4. But in the services side, and we've had a little bit of this conversation before, here what we're doing is we're spending to build our infrastructure in a lot of cases. So sometimes, there is and in this quarter there was certainly a timeliness spend that was a little different than our original expectations that impacted the gross margins in the quarter and helped us drive that 2 point increase sequentially from Q2 to Q3. So we expect some of that to that timing of spend to come back into the system in Q4, right, so those margins will come down. And then on the product side, I think that is where you would see the impact of big deals, the impact of the elasticity. And we had expected a decline sequentially from Q2 to Q3 on the product gross margin side of the fence in the 1.5 point to 2 point range. Some of that is always due to mix, product mix, customer mix. We saw all of the things we expected, right? We offset that with real great execution in the business and realization of a lot of value there. So we really made up the difference on the product gross margin side. But just looking at overall gross margins, you really have to get under the covers to the two pieces, because there're different drivers for the two. And that point on pricing is really more of a product situation than it is a service gross margin.

Our next question comes from Steven Fox with Cross Research.

Just going back to a couple of comments you made in the prepared remarks, you talked about some spending delays or decision processes extending out around sort of evaluating new technology and preliminary models. Can you just expand on that, how much of that was new impact relative to what you thought and whether this is something that's going to abate in the next couple of quarters, or how do you think that plays out before that becomes a non-issue?

Well, I think we see things that other people are seeing. We certainly see our IT budgets, particularly in the very large accounts under a fair amount of pressure. And the consequence of that is clearly that people are going to try and reduce their CapEx by using resources longer and higher utilization, perhaps see some of the storage efficiency features that they hadn't used in the past. The other side of it, though, I also believe that customers are looking at more technology choices like flash and they're also looking at delivery model options as well like cloud. And if you're in an investment cycle where you're looking at do I build another data center that (inaudible) regret that two years from now, I wish I had gone to the cloud and likewise and make a big investment in next version of software or something like that. So I think in the advent of cloud and FAS and new technologies, there's elongated decision cycles, because people don't want to make bets on technologies at a long term in nature that they're going to regret in a few years. So I certainly see that as people trying to figure out how to immigrate these new technologies, how do we integrate them into their work flows. While the cross-benefit they make or see (inaudible) and factor that all in. So there is no doubt that particularly in a cloud, I think it's slowing down decision cycles as people really slowed on how they can realistically deploy it in their environment. Is it any different than prior quarters? I think it's certainly a relatively new development. I would say it was dramatically different this quarter than prior quarters. But you definitely see it is that customers are somewhat reluctant to make very, very long-term commitment for rapidly changing technological environment.

Our next question comes from Lou Miscioscia with CLSA.

My question is really on the same line of that is that when you look at service side flash with your flash competitors, cloud storage companies like AWS growing at 1 petabyte to 1.5 petabyte a day, cloud storage to an object storage, hasn't the environment changed, so we all should just be thinking about very low modest, let's say, 2% to 3% kind of organic growth for your branded business just going forward, because looking at the horizon, it doesn't really like they're going to change. I'm wondering if we should just really rethink or reset them, Tom?

Well, clearly, we're in a low growth environment. I don't think we're going to basically subject ourselves to that type of questioning, because clearly the question that we have to go through is, is it different this time. And I think all of those things are factors. The kind of the things that I talked about, about elongating product lines, driving efficiencies, running at high utilization slow down decision processes, I think there is no doubt about that. But I think it's also fair to say that we also see they're somewhat close by going to the cloud. I think service side flash is much less of a factor, but I think the cloud is clearly the big disruptor in people's minds. And there's no doubt that their workloads make sense in the cloud. A lot of them tend to be temporary workloads. A lot of them tend to be proof-of-concept type workloads. And some of them are utilization workloads. But that said, when we talk to end users, I think the big question that people are facing is how do they broaden the appeal of those workloads and broaden the use of the cloud, which is a very, very complex data management issue. It isn't as simple as running in the cloud. It's how do I integrate that data to my workflow, how do I protect it. The data solution problems don't go away against the data moves. Our point of view is that we're not going to deny that data has gone to the cloud. So I believe that will depress somewhat the growth rate of the industry or some of the historical norms. They do. If I think it's 2% to 3%, I don't. I think data growth is just going to overpower that. So I still…

Our next question comes from Katy Huberty with Morgan Stanley.

Software entitlements and maintenance line impacts growth for, I think, the first time despite decent branded product growth over the last four or five quarters. Can you just talk about what drove that deceleration?

If I look at the last 12 quarters, there's always going to be movement in those lines and essentially on that SEM line. That does come off the balance sheet, which means it is going to be dependent upon the lengths of contracts on the balance sheet, whether there's any large or lumpy contracts that are coming off over time and then what's going on. It's a combination of the two. So when I look back again over 12 quarters, sometimes it's flat, sometimes it's up dramatically. This is all timing. I would not get too much into that. But when you've got an overall business, when you have at this type of revenue rate, I appreciate the fact that you're going to look at some of those lines. But I think you've got to look at a lot of that's timing.

Did you see any change in the lengths of contracts, a residual behavior in the January quarter?

In terms of the overall contract license of what's in the balance sheet, there's no dramatic change there. These are tens and thousands of contracts, right, and you can think of it and massive Excel spreadsheet in terms of what the utilization of that looks like over time. And then during the quarter, we'll always have our fair share of. Renewal transactions of fair share is very large, multi-element transactions, all of that is in the mix.

Our next question comes from Bill Choi with Janney.

Tom, I want to continue the prior discussion you're having here on revenue versus margins. There was obviously a question about more elasticity. I want to take it to a different kind of angle to it and want to talk about reach here that you've completely refreshed your entire product line. So you might be benefiting from some upgrades, opportunities with existing partners. And yet, when we look back to last few years, you've had a lot more competition for the channel. Clearly, EMC has been a lot more aggressive and you still have all these new players like Pure, like Nimble getting some of your former partners or existing partners. So if you could kind of talk about it from that angle, reach, channel partner programs. Has anything changed materially in the last year or two that prevents you from really benefiting as the cycle comes back?

No, if anything, the broader channel reach into the general territory has actually a much higher growth in our business and into major accounts. So I feel good about how we're going down that path. And as far as the smaller companies, certainly we see them. But at the end of the day, the overwhelming competitive engagement is with the traditional companies and logic companies that we hear about everyday. So from our perspective, I don't think the competitive landscape has changed. Certainly, some of them are carrying some of the smaller players into some of the mid-sized accounts. But I don't think that that's disrupting our momentum. In fact, you see our numbers on the indirect channels being as high this quarter as they have ever been despite the OEM roll-off. So I think I feel really good about our channel program. I think one of the things that happened this past quarter, particularly in relation to our ONTAP adoption, was that we saw a big jump in the 3000s. And what that looks like to me is a lot more breadth and breadth really comes from our channel partners. The other data points is in terms of new customer acquisition, which is also primarily driven by our channel partners, our new customer acquisition year-to-date has almost doubled what it was last year. So actually I feel good about the general territory. I feel good about the channels. I think as reported by a lot of other people, the larger accounts which [ph] apply more proxy from the macro is clearly where we're seeing more slow down. But our channel momentum is actually the bright part of the story, both in terms of the commercial channels. And state, local and higher ed actually had a very, very good quarter for us again. And that is 100% channel.

Are you still growing the number of your channel partners at this point?

Probably not. I mean our number of channel partners in terms of people and the part of the program is measured in the thousands. What's more important for us is to make sure that those guys are well compensated, they're interested, they understand the value proposition. So we're not looking to add another 1,000 to a long list. We're looking to make the ones that are productive a lot more successful. And one of ours reported last quarter obviously a very, very strong quarter. So I think fewer better partners is probably a thing that we're really looking for, particularly with the clustered ONTAP transition, the expansion of our portfolio. And there's a lot of big opportunities for them to differentiate from our other partners and take us forward. Those are our top priorities.

Where are we on that transition and how long before you stabilize the number to what you think is ideal?

I think that in the end, our channel program has to be measured against the opportunity and the return on investment. And that's the thing that we evaluate everyday. And I think it also varies country-by-country. I think overall, the channel program remained strong. And frankly, if our major accounts are going instead to our channel program, we'd be having a different conversation right now.

Our next question comes from Mark Moskowitz with JPMorgan.

Just want to come back to the topic around just kind of more muted revenue growth profile. Is this a function of maybe you guys are [ph] kind of bit with your success in terms of all these software advance, since now are just allowing or enabling customers to buy less? Less is more today and therefore your revenue content per deploying in for both new and legacy customers is decreasing, and could this be a continuing trend?

Actually, I'll be firm in my disagreement with that. I think I can roll the clock back to the aftermath of the financial crisis and we had just introduced deduplication. We had conversations on this call about deduplication slowing your growth rate, because clearly the growth rate has come down. And the simple fact of the matter is if we had 99% market share in the customers themselves, we might have a different point of view, but we don't. So if you can give the customer a better solution and ultimately be clear and play more of their footprint, I think that helps us. And in the aftermath of that downturn, NetApp had a 30% organic growth here with the exact same technology. And I think the goodwill that we built, the new customer acquisition that we built along the way and the market share gains even in the tough environment that we accrued, I think paid off huge for us. So I think where we are today, I do believe that there is a limit. In other words, people can extend the life of the equipment for so long and eventually they need to go back to the normal growth rates on top of that. So I think there's a one-time expansion, which could depress the market. And I think we certainly see that over the last couple of years. But at its core, I still contend that just about every activity undertaken by mankind is generating cadence. So I think the generation of data is not changing. People are modulating the copies of the data with the big amount of growth in the industry, but that's got its consequences. And people are trying to use assets longer. So yeah, the utilization of asset life will slow down the growth of the market in the interim, but eventually it'll normalize. So coming back to the idea that this is the new normal that storage is going to grow at the rate of IT, there hasn't been the case historically certainly in the delivery models, but in the long run, I still believe that storage is inherently only going to increase and I think that this market will bounce back.

Our next question comes from Kulbinder Garcha with Credit Suisse.

Tom, I just want to go back to that last comment with respect to storage outperforming IT as well as maybe utilization rising. I guess you guys have a lot of systems out there. Do you guys measure storage and utilization? I'm trying to understand how high some of your (inaudible) will be pushing that, because the one thing that is clear is storage has historically has outperformed IT, just hasn't probably in the last year, year-and-a-half. I'm wondering whether you've got any tangible evidence as opposed to anecdotes when customers just tell you where utilization might be? Just with respect to OpEx savings and cost savings, you're put in this subdued revenue environment. When that can become more aggressive on the cost base and could we have a restructuring, do you think?

I'll answer the first question in terms of the protracted nature. I mean if you look at IT, it's protracted against pretty much all categories. I do believe that there're other categories that are getting funded in this environment. Certainly security is the top of mind concern for every CIO that I speak to. So I think within a constrained environment and maybe some competing platforms that we might not have had in the past, but the other change of fact is storage is growing. It's a consumable. And I expect that storage to outgrow IT. I expect that trend to come back. In terms of metrics in the field, I hate to report the metrics that I got to get held to every time. Certainly, equipment-wise, it's extending. I think that there's no debate about that. In terms of utilization rates, we do have some data on that, but obviously that depends on a whole bunch of categories in terms of use cases, product platform, in that nature. But there's no doubt that equipment life is extending. And you see it in the form of, as Nick talked earlier, length of first-time service contracts and the number of renewals as opposed to tech refreshes (inaudible).

First of all, we're going to be and we've continued to note that we're very conscious on the spending side. I think we're also really quite proud of the work that broad organization has done whether it be in supply chain or many different pieces of the operations in ensuring we're getting the biggest returns for the dollars spent, whether that's in the channel or in the manufacturing side or across the board. I think we're really quite pleased with that. And we're going to keep that focus. And I think that is going to part of and continues to be part of the reality. Our job is to just find the areas of investments that will yield the biggest return and make those investments fair. Our job is also to look at those areas that aren't yet yielding return or where we think that the investment is outside to the return and direct accordingly. So I can't answer a question specifically on what actions we will take at any one point in time, because we take actions and make decisions everyday. But being conscious of our cost and being conscious of where our investments are directed, that's part of our day-to-day and we should continue to expect that.

The one thing I'd add on that subject is in clearly a tough environment that we're particularly pleased with is we did restructuring last year and it was painful and it should be. And it's not something that we're happy about doing. But in parallel with that, we took a very, very serious effort about the rest of the cost structure on the cost side and things of that nature. And I think tha the improvement in gross margin is the culmination from very, very important activities that we did there. So in a very tough environment, we see NetApp gross margins go up, and I don't think that's been the trend of either our competitors or more broadly in the IT industry. And NetApp is the company that also generated expansion of operating margin in a very, very difficult environment as well. So I think our execution intensity is way up. I think we're committed to make the decisions that are necessary to generate shareholder return and the long-term health of the company. But I should also add that I do expect this industry to come back, that we're not going to sacrifice investment that we believe is going to create competitive advantage for us, that's going to sacrifice our position going forward. The market share numbers are really strong. And while the topline numbers aren't great, I mean it's four consecutive quarters of increasing market share gain in the IDC numbers, and that's a sign of winning. And the confidence is high. And we don't want to let that go just because of going through a tough period that we think will ultimately lapse. So I think we made some hard decisions, we made some painful decisions. The execution tends to be as high. But we're not going to sacrifice the investments that we think are going to enhance our competitive position going forward and jeopardize our ability to capture the return in this market.

Our next question comes from Ananda Baruah with Brean Capital.

Just really more of a clarification on your gross margin comments in the prepared remarks. I think guys mentioned, Nick, you would eventually pass the efficiency gain through product margins to pricing over time. And just want some context on that. Should we expect gross margins to begin to decrease now? There's some of that that's sort of implied in your April 2 guidance.

First of all, when I gave guidance 90 days ago, we talked about the product gross margins in Q2 and some of the savings and our expectation that those would pass through in Q3 and in fact they did, right. So that is something we're going to be doing. There's always a bit of timing lapse that we have to work through, but we recognize savings in Q2 will pass some of those savings through in Q3. We recognized even more savings in Q3. We're going to pass through some of those in Q4. It's just timing and I think it goes back to the really, really strong efforts around execution and operational excellence that are going on here. So yes, the guidance that we gave on gross margin would imply a lower product gross margin in Q4 than in Q3. That is a result of some of the pass-through. If I go look over time between Q3 and Q4 over some years, there is a reasonable sort of downtick in product gross margin. So none of that should be unexpected.

Yeah, overall, I think using some gross margin and generating some growth, attracting some strategic accounts, that's a trade-off we make frankly. I think more broadly if I look at our channel business and our general territory business in the transactions, I think we're doing well there from both the gross margin perspective. So I wouldn't basically give that up. But nonetheless, there's no choice of ugly deals to pursue, particularly if we're making into new accounts and those are of keen interest to us. And we've doing that we're doing that all along despite the gross margin rise. But if saw opportunities around competitive take-out opportunities or opening up new accounts that had high growth potential for us, we're certainly willing to use gross margin to make that happen.

Is there are a normalized gross margin that you think is reasonable?

I think we kind of gave our long-term model in terms of gross margin, and we're certainly at the high end of that. But I think we need to move on to next question.

Our next question comes from Nehal Chokshi with Technology Insights.

So on the US Commercial, that was down 3% year-over-year, and I understand that federal came in below expectation and that OEM has also been in pressure. But compared to prior two quarters, Commercial is up 8%. So I'm trying to figure out why isn't the (inaudible) reversal and the year-over-year growth trajectory for that segment there?

Yeah, I agree. I think I said that earlier. I think if I look at this quarter and the delta from a new point of guidance, I think we can put that in the context of central business both in terms of barely grew as fast as (inaudible) of the other territories or the nominal 10% of our total revenue, it's in the 9% like they were this year, 10% last year. Both of those explain all of the difference. But going forward, I think that the more general IT trends that you see reported from other people, we're not immune to that either and we're seeing that in all the geographies. So I don't want to say that the difference between normal seasonality and where we're guiding is all about federal. Certainly federal isn't helping and we don't expect it to come back. The OEM is a factor. And I think that's on the trajectory. But I think that the rest of the major markets are still challenging. And I don't seem them improving. I mean we had some bright spots in some of our emerging markets. China was especially strong for us, but it's just not enough to offset the major market. So if I look at the numbers, US Commercial down 3%, that's clearly a downtick from where we were last quarter. That's factored into where we are going forward. I don't believe that and certainly nobody in NetApp believes that that's a competitive dynamic. I think we're seeing what other people see. That in fact our numbers are going to affect our guidance. I think that's a conservatism that we don't give. Federal is clearly a factor, but I think we can see some downtick broadly in the major markets as well.

But what's the reason for that downtick in the major markets?

I think it's all the other dynamics. You watch the IT spending numbers estimates come down and down and down. And I think we see that. One thing about storage is we can talk about the snap back and storage and storage and consumable and we're generating a lot of storage. But storage spending is still up the umbrella of IT spending. And we don't sit around this Board table and say, boy, I wish we could spend money on R&D, but we can't, because I can't buy more storage. Those conversations don't happen. Basically there's an IT budget that's set. Storage I think will over time get a disproportion amount of it, but doesn't change the fact that storage is still very, very highly pricey with overall IT spend. As IT spend comes down, it comes down with it.

Our next question comes from Eric Martinuzzi with Lake Street.

Given that we did $787 million last fiscal year and I'm tracking to a little under $600 million this year, are we in that zone where we can say it does start to flatten out? Or given the declines, it's still too soon to tell?

I think the IBM story, I mean it's roughly flat last two quarters. And I think that we've been guiding towards flattening out. IBM is a big mover in that storage, certainly over the last two years. The IBM component of that, I think we've been very upfront with that. And I would say that IBM is kind of gliding into the range that we expected of them. But although we don't have a direct knowledge, certainly there's a lot of decisions going on in IBM that could either help us or hurt us. So I think there's some uncertainty around that might not have six months ago. But I think that the trajectory thereon is very much in line of what we guided to. And I do see that kind of settling in. And the other partners of that community have all been good. And that's that. So if I look at branded E-Series both the all-flash EF and non-EF E-Series on the branded side, it's actually growing even faster. And I said on the prior call and I stand by that we're looking for aggregate E-Series, both branded plus OEM to be a growth business for us next year. So we're actually excited about that combination.

But kind of in this minus-20% to minus-25%, and that seems like it's tied to the Q4 guidance. Is that roughly accurate?

If you're talking about the OEM for Q4, what we mentioned earlier is that our Q4 is the Q1 for the OEM. That's going to put pressure on that business. If you look at last year between Q3 and Q4, the sequential down was 18%. So the type of math you're doing could absolutely be there. We've got be aware of that dynamic. So certainly, we're being conservative in what we expect from OEM.

Our next question comes from Rajesh Ghai with Macquarie.

Given that the move to the hybrid is inevitable for enterprise IT and you seem to be finding some success going into the hybrid cloud as well the public cloud or service model verticals, I was just wondering does your model change over time and how long would that be? Do you see a potential for gross margin to increase or you are not going to see any benefit out of that? And also related to that, I was wondering if you could begin sharing some specific revenue metrics so that we can gauge your progress in these new verticals?

Yeah, I think over time, clearly we've had a service provider vertical for a while. And over the past year, US Commercial market has been our best performer. So I think we continue to do that. More broadly, within the hyperscale, there is a likelihood that hyperscale is finding a standard product and deploying it. I think it's probably remote. I think certainly we'll pursue IT discussions with them that may or may not yield anything. But in the end, where we are right now, I need to see us ranking number one in capacity of storage in the public cloud. So I think our service provider program is working quite well for us. I think in the end game, it's a move that and make that more mainstream and make it integrated into the key flow of key business applications for customers. And these are the seamless integration of on-prem and off-prem computing. And if you think about it, in order to use the service providers, also the hyperscalers, if data could be managed and protected and backed up and organized and archived all with one data management tool, that would be really compelling. And really that is the push that we're on to the next level. And that is rather than fighting the cloud and debating the relevance of a cloud, I think similar to our deduplication conversation of five years ago, and that is if we embrace the cloud and make it possible for customers to use it, the likelihood of a greater standardization deployment of our data management across the enterprise goes up. And if we're writing more data and controlling more data with our data management and the opportunity to add more value through software, it also goes up. So from our perspective, I do…