NetApp, Inc. (NTAP) Q3 2015 Earnings Report, Transcript and Summary

Good day ladies and gentlemen and welcome to the NetApp's Thirds Quarter Fiscal Year 2015 Financial Earnings Conference Call. At this time all participants are in a listen-only mode. Later, we will have a question-and-answer session and instructions will be given at that time. [Operator Instructions]. I would now like to turn the call over to Kris Newton, Vice President of Investor Relations. Please go ahead.

Hello, and thank you for joining us on our Q3 fiscal year 2015 earnings call. With me today are CEO, Tom Georgens; and 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, such as our guidance for the fourth quarter and full year fiscal 2015, 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 a Form 8-K. Please refer to the documents we filed from time-to-time with the SEC, specifically our Form 10-K for fiscal year 2014, 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 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 and on our website. I'll now turn the call over to Tom for his commentary on the quarter.

Thank you, Kris and good afternoon everyone. We are clearly disappointed with our top line performance in Q3 and are committed to taking the steps necessary to get back on track. Despite the soft revenue we delivered another quarter of solid operational performance with improved gross margins from Q3 a year ago, and non-GAAP operation margin at the high end of our prior guidance. We further reduced diluted share count and delivered EPS within our previous guidance range. We remain confident in the fundamentals of our business and continue to make progress against our hybrid class strategy. Top line revenue finished below the low end of our guidance, impacted by greater than anticipated FX movement in the quarter, which Nick will quantify shortly, as well as our own sales execution issues. EMEA and APAC were impacted by FX, U.S. public sector driven by strong performance in federal had the highest growth, but Americas Commercial fell sort of expectations. The Americas team bullied by the increase in enterprise large deal activity in the first half of the fiscal year was optimistic about their forecast. Deals over $1 million increased yet again in Q3, but we also saw a significant number of large deals slip out of the quarter. We have new leadership in global and Americas sales and I’m confident in the team and fully expect execution to improve. Looking ahead, we see FX headwinds impacting growth for not only NetApp but our customers as well. As companies lower their revenue expectations for the coming calendar year, there is an increase deferral of IT projects. We clearly saw that in January. Anticipated budget was no longer available as companies delivered updated spending targets for the new calendar year and deals that were pushed out may not return in the near term. We are seeing large tech refresh opportunities being replaced with one-year support renewals and indications that customers remain committed to NetApp, but do not have budget to upgrade at this time. Despite the revenue short fall we continue to make progress in key areas. As I mentioned earlier, Q3 marked our third consecutive quarter of growth in large deals, a point of validation of our enterprise strategy. In November we further delivered against our data fabric vision with the availability of NetApp private stores for IBM software, the SteelStore appliance and Cloud ONTAP for Amazon web services. We also introduced the newest version of Data ONTAP the industry’s number one storage operating system, Data ONTAP 8.3. To-date ONTAP 8.3 has had the fastest ramp of any of our Clustered ONTAP software release introductions. Shipments of Clustered nodes grew 160% from Q3 a year ago. The attached rate of Clustered ONTAP continues to increase and now stands at roughly 40% of FAS controller shift in the quarter. Total system units shipped increased 9% from Q3 last year. We saw notable strength in E-Series branded and configurations of all flash FAS. The entirety of our portfolio has been refreshed over the past year with the recent launch of the E560 and the EF560. We continue to see sustained momentum with our broad flash portfolio as flash capacity shipped grew 69% year-over-year. With FlashRay innovation injected into all flash FAS and the new EF560, we anticipate that our all FlashRay systems will soon hold two of the top spots in the industry performance benchmark. OnCommand Insight also continues to perform well with the number of deals increasing from Q3 a year ago. Overall we are confident with our portfolio and pleased with the growth of our emerging products. As we have discussed in the past both the market and the enterprise IT are undergoing a major transition. Likewise NetApp has been undergoing a transition to position ourselves for the future as we talked about at our analyst day last June. The NetApp data fabric vision, our seemliest hybrid cloud strategy is up leveling the nature of the conversations we are having with customers. We have delivered an unprecedented portfolio expansion, including new offerings in flash, object and cloud integration. We further augmented our cloud integration with the SteelStore product line acquisition. We have also highlighted the internal productivity, efficiency and supply line initiatives that have resulted in gross margin and operating margin improvements despite a very challenging growth environment. We have increased emphasis on our enterprise and cloud service provider customers while maintaining the momentum we have in midsize business. We are seeing progress with our go-to- market transformation, but it’s still a work in process and in need of ongoing improvement and investment. The increase in the breadth of the portfolio and our compelling data fabric vision are yielding positive results, but its clear in order to fully realize the value of these new capabilities, we must expand our go-to-market capacity with greater account coverage, product specialist and partner enablement. Clustered Data ONTAP currently meets the technical requirements of our largest and most demanding customers. We believe NetApp’s engagement, helping them execute the transition to Clustered ONTAP over the next year will unlock differed Tech Refresh. In prior years go-to-market capacity expansion in times of high confidence in the portfolio proved to be a growth driver, even in difficult environments. We believe we are in a similar situation today. We also understand the imperative to deliver shareholder value in a low growth environment and the resulting pressure on operating expenses. We will continue to employ the discipline of shifting resources away from lower yield activities, as well as driving productivity and efficiency through the organization to offset as much as possible the impact of high priority investments to expand capacity. Overall the growth of the emerging products, the uptake of Clustered ONTAP and the resonance of our vision with customers, as well as our operational focus have been on a positive trajectory. All of this only compounds our disappointment with our performance last quarter. External factors such as FX with clear headwinds, but our focus is on our own issues and what it takes to get back on track. We do not see any change to our strategic priorities and we’ll aggressively seek to maximize return on our product portfolio within the confines of our business model. I will now turn the call over to Nick to provide details on Q3 and our guidance for Q4 before returning with summary comments. Nick.

Thanks Tom. Good afternoon everyone and thank you for joining us. NetApp delivered strong non-GAAP gross margin and operating margin in fiscal Q3, underscoring the resiliency of our business model. We delivered non-GAAP EPS within our previous guidance range. However, as Tom indicated the impact of unfavorable foreign exchange, combined with our own sales execution challenges presented headwinds in Q3 and resulted in revenue below our expectations. Net revenues of $1.55 billion were up about 1% sequentially, but down 4% year-over-year. FX headwinds reduced the year-over-year revenue comparison by about 1 and 1.5 points, only a point of which we had anticipated when we gave revenue guidance for Q3 90 days ago. Product revenue of $930 million was down 8% year-over-year. The combination of software entitlements and maintenance and service revenues totaling $622 million was up 5% year-over-year. Branded revenue was 92% of net revenues for Q3 and at $1.43 billion was flat sequentially, but down 2% year-over-year due to a combination of unfavorable foreign exchange and execution challenges in our Americas commercial sale geography. Adjusted for FX branded revenue would have been about flat year-over-year. OEM revenue which is transacted in U.S. dollars was $124 million in Q3, up 4% sequentially, but down 21% on the year-over-year basis as expected. Indirect revenue through the channels and OEMs accounted for 81% of Q3 net revenues. Arrow and Avent contributed 22% and 16% of net revenues respectively. Non-GAAP gross margin of 64.6% was up just over 1 point from Q3 last year and just above our prior guidance range despite FX headwinds. Non-GAAP product gross margin of 57% was relatively flat year-over-year driven by unfavorable mix and FX, partially offset by continued supply chain executions. Sequentially non-GAAP product gross margin was down just over a point due to mix. Service gross margin of 64.5% was 3.7 points above Q3 of last year and 1.8 points above Q2 due to higher services revenues and lower spending. Non-GAAP operating margin for the third quarter was 18.5% at the high end of our previous guidance range. Non-GAAP operating expenses were 46% of revenue. Consistent with our expectations, our non-GAAP effective tax rate for the third quarter was 16.5%. Q3 weighted average diluted share count of 317 million shares was below our prior guidance, down 6 million shares sequentially and down 29 million shares or 8% from Q3 last year due to continued stock repurchase activity. Non-GAAP EPS of $0.75 was in line with our prior guidance range and reflects the net impact of year-over-year FX headwinds of $0.02. Our balance sheet remains healthy. We ended the quarter with approximately $5.3 billion in cash and investments, 13% of which is onshore. The sequential decrease in onshore cash was predominately due to shares repurchased and dividends paid in the quarter. Inventory turns were at 19 and day sales outstanding were 39. Deferred revenue was $3.1 billion, up 2% sequentially and up 5% year-over-year. Q3 cash from operations was $275 million and free cash flow was 16% of revenue impacted by an increase in day sales outstanding due to unfavorable linearity. In Q3 we returned $251 million to shareholders, which included $200 million in share repurchases and $51 million in cash dividends. Consistent with the guidance we provided last May, we remain on track to complete the remaining $206 million of our current share repurchase program by the end of May 2015, a year ahead of our original schedule. Over the last few years we have evolved our capital structure and delivered on our commitment to return capital to shareholders, while continuing to invest in the business. Through dividends and share repurchases we have returned a total of $3.2 billion to shareholders since May 2013. We are well positioned to move ahead with the next phase of our capital allocation strategy. I am pleased to announce that we have increased the size of our share repurchase authorization by $2.5 billion. We intend to complete this additional $2.5 billion share repurchase program by the end of May 2018, with the first $1 billion of repurchases expected to be completed by the end of May 2016. Today we also announced our next cash dividend of $0.165 per share of the company’s stock to be paid on April 23, 2015. We remain committed to increasing our dividend overtime. Enhancement to our capital allocation strategy reflects our confidence in the long-term strength of NetApp’s business as well as our ongoing commitment to increasing shareholder value. We have structured the capital allocation plan to ensure flexibility to support innovation and growth initiatives. The timing and amount of repurchased transactions under the program, as well as future dividends and dividend increases will depend on market conditions, business and financial considerations and regulatory requirements. Now to guidance, we remain confident in our strategy and competitive position. However, based on our own sales execution issues and the continued challenging IT spending environment, we are building a degree of caution into our top line expectations. We also expect FX headwinds to continue and impact the year-over-year comparisons. As a result our target revenue range for Q4 is $1.55 billion to $1.65 billion, which at the mid-point implies 3% sequential growth and a 3% decline in revenue versus Q4 last year. Based on current rates we have embedded an FX headwind of $50 million into our Q4 revenue guidance. We expect our strong value proposition to continue to resonate with customers and we will have an ongoing focus on supply chain efficiencies. With that said, we expect non-GAAP gross margins of approximately 63% to 63.5% in Q4, including about a point of FX headwinds. We expect non-GAAP operating margins of approximately 17% to 17.5% reflecting about a point of FX headwinds, as well as investments in our go-to-market capacity. Based on our repurchases in Q3 we expect Q4 diluted share count of approximately 319 million shares down 5% versus last year. We expect non-GAAP earnings per share for Q4 to range from approximately $0.70 to $0.75 per share, which reflects about $0.05 of dilution from unfavorable foreign exchange versus last year. Our full year fiscal 2015 revenue will be lower than anticipated due to currency headwinds and incremental caution entering Q4, which I reference earlier. EPS is expected to be flat from FY ’14 due to FX headwinds, revenue softness and investments in the business, offset by gross margin improvement and share repurchases. In closing, our product portfolio is as strong as it’s ever been and our discussions with customers continue to evolve to more strategic levels. Our capital allocations strategy continues to reflect confidence in our ability to generate significant free cash flow, which will enable us to invest both organically and inorganically in the business, as well as return significant capital to our shareholders through share repurchases and dividends. The investments we are making today position us to fully take advantage of the opportunity ahead and we expect to emerge from this transition with greater levels of growth and profitability. Through this evolution we remain committed to our business model and to delivering shareholder value. Now, I would like to turn the call back to Tom for summary comments. Tom.

Thanks Nick. We remain confident in our business, but continue to operate in a challenging environment. We face ongoing macroeconomic uncertainties and FX headwinds. Our industry is in transition as enterprises manage their existing infrastructure to meet the current and growing demands of the business, while adopting new technologies and delivery options. Our solutions and technology vision are well suited to help customers meet both of these requirements. Cloud will play a key role in creating value for enterprise customers and we want to accelerate their ability to realize that value. Enterprise will deploy a hybrid model with both cloud based and on premise resources in their IT environments. Our NetApp data fabric vision provides customers with the only consistent way to manage, secure and protect their data regardless of where they choose to store it. The NetApp data fabric weaves together disparate data elements of the hybrid cloud into a single integrated architecture, giving customers control and choice with the flexibility, elasticity and ubiquity of cloud resources. Data ONTAP is the foundation of the NetApp data fabric. Clustered Data ONTAP delivers true software-defined functionality with a set of enterprise-wide data management capabilities independent of the underlying hardware. Clustered ONTAP enables customers to grow incrementally and non-disruptively with the flexibility of a wide range of deployment options; from converged and integrated systems to third-party arrays, as well as software only and cloud options. We are confident in our ability to help customers take advantage of the evolving IT landscape. Our data fabric vision and portfolio of data management solutions offer differentiated approach that improves the economics and flexibility of customers existing infrastructure, while giving on path to a hybrid cloud future. Our best of breed solutions are compelling for existing requirements and are integrated into a broader vision for the hybrid cloud that only NetApp can deliver. The investments we are making in our go-to-market capacity and then accelerating the migration to Clustered ONTAP demonstrate the strength of our conviction in our technology and our strategy. During this transition we remain committed to our business model and delivering shareholder value. Our expanded repurchase authorization exemplifies this commitment. We expect to come through the transition in a stronger position with a high level of growth and profitability. Before moving to Q&A, I would like to thank the entire NetApp team for their continued commitment. Despite the challenging environment we are making the right choices and remain focused on innovation and execution, which enable us to deliver value to our customers and yield solid operational returns. We will now open up the call for Q&A. Please be respectful of your peers and limit yourself to one question, so we can address as many people as possible. Thank you. Operator.

[Operator Instructions]. Our first question comes from the line of Sherri Scribner with Deutsche Bank. Your line is now open please proceed with your question.

Hi, thanks. Nike I was trying to get a sense of how the FX split out between your different segments. Thank you for the detail on the impact this quarter; but was a lot of that in product or was it also in the software and services segment. It seemed like the product revenue was down a lot year-over-year? Thanks.

Yes, Sherri in terms of Q3 in terms of product revenue for Q3 it was all there, so its about two point on product revenue from the FX side of the fence. You have to remember that the SEM line and the services line are substantially coming in off the balance sheet. So the FX is really pointed at the product side of fence.

Thank you.

Thank you. Our next question comes from the line of Maynard Um with Wells Fargo. Your line is now open please proceed with your question.

A little bit about the execution issues. I guess to start, what gives you confidence that it is execution issues rather than competitive or secular and I guess what, can you go into the issues a little bit more in particular on how you do intent to fix that going forward? Thanks.

Well, I think from the question about whether it will be secular or competitive, and effectively what we are talking about here, what we saw pushed out were actually deals in the committed pipeline. So whether the question of we didn’t have pipeline and we didn’t have deals that we are pursuing, these are deals that the sales force had committed, that reflected in our forecast, reflected in our guidance and reflected in our planning as the quarter proceeded, and so not surprisingly Monday the quarter ended, I was ahead of Americas sales and went through, what happened to these deals? They went through a relatively long list of deals two pages worth of deals that were committed that we expect to count that didn’t come in and all of them have a story of which competitive and loss deals was a trivially small amount of that. So from a competitive perspective I’d say first and foremost the competitive wasn’t the key components. Some of it clearly was closable deals that we didn’t get done and that’s entirely on us, some of it was changes in customer behavior with the change of the calendar year and companies looking at their own financial forecast, their own FX impact. We certainly saw the fall of deals that we thought were there. The other thing is, in order for the deals to be in the committed pipeline there are deals for which substantially we have won the technical recommendation, so the competitive phase of a lot of these transactions was effectively over. So it’s really about either customers changing budgets, requiring more scrutiny in their approval process or fundamentally thinking about their new budgets in line with the new calendar year. I think going forward clearly we need to watch this a lot more closely. We certainly saw elongated sale cycles earlier in the quarter, but the forecast has remained unchanged and the team is still relatively bullish about pulling it out. So I think that, we need to look at some of the data points along the way. Certainly we need to inspect a lot closer and you can argue that the other side of this and the message to the team is that there is uncertainty about closing deals, you need more deals, so what are we going to do to enhance the pipeline. So clearly we are going to be watching this closely as we look at our productivity, whether it be pipeline generation per rep and even despite the quarter in terms of actually bookings per rep, the numbers are actually quite high, relatively high in our history. So the sales force productivity is actually still pretty high, yet we didn’t get these deals closed. But the feeling is it isn’t like the sales force can’t sell and productivity is down. That will be more of an indicator of a product problem or there is no opportunity out there. So our feeling is as long as productivity is high that people are generating pipeline at peak levels historically, that if we could put more feet on the street and get more people out there selling the product, we can drive some more business. So that of course has a lead-time associated with in terms of hiring and bringing it up to speed. But at the end of the day we wouldn’t have these deals in the committed pipeline, we wouldn’t have the pipeline productivity we had unless we felt strongly about the portfolio and the portfolio was resonating. So I think where we are now, you know I don’t think product is our issue. I think capacity is our issue and that’s the bet we are making and that’s what you are going to see from us going forward.

Great, thank you.

Thank you. Our next question comes from the line of Keith Bachman with Bank of Montreal. Your line is now open please proceed with your question.

Hi Tom. I want to follow on Maynard’s question. Clearly every enterprise company is suffering from FX and so let’s remove that from the conversation, but we haven’t heard many or very, very few companies talk about elongated sales cycles in the current macro with the recent string a companies that have reported, including Cisco tonight. So just wanted to try to understand what’s your thoughts on why NetApp in particular seems to be seeing some issues on deferrals or pipeline not coming through. Is it something related to the storage side in particular, but just want to get some more thoughts about why you think NetApp in particular is seeing some of those elongated sales cycles.

Well, I think a few things. I think some of those I’ll say; I don’t think we quite know. I think we need more data. All we really understand is our own point of view here. So certainly we see the FX that’s a purely mathematical exercise, we get that. Likewise we see FX not only in our industry but we also see FX impact on our customers and that’s got to lead through into the decisions that they make. So I don’t really know the answer to your question, until we see actually more companies that are reporting January quarters. So our assumption if FX is purely mathematically and everything else is our responsibility to get on to and fix. And like I said, if you look at these individual accounts, there is no doubt that we had closeable deals that we didn’t get done in time and that’s pure execution and those will fall into Q4, but we’ve also seen elongated approval cycles and we’ve also seen people re-evaluating what their plans are for the year now that the calendar year has changed. People thought they had budget when we put this in the pipeline, they don’t now and I think the return on those transactions is as yet unknown. So I think from our perspective we just clearly need to do better on that. I’m certainly not ready to say that there is a broader trend until I see some more data points, but for our point of view is that we are going to focus on our deals and our pipeline and we are going to do a better job executing this quarter.

Tom was everything on track the first two months and the wheels kind of came off the last months for the quarter?

Well certainly the forecast hadn’t deteriorated materially at the beginning, so we were. Obviously this is a quarter where you’ve got kind of the end of the quarter push and you got the end of the calendar year push, which is a little bit different than other quarters. But from our point of view is certainly we saw bullishness going into the end of the year and then still we have expectation of a relatively strong normal quarter end in January, and a fair amount of that business didn’t come through the way we would have thought. So I think we did see the budget flush. Maybe we can debate whether is this robust as we would have thought, but certainly close enough, but we certainly had a lot of January business that was a normal part of our final month of the quarter that we see being back end loaded that didn’t come. And like I said, every deal has a story, but when you go through 40 deals and only one or two are competitive and the rest of them are deals specific, I don’t think the competition is really the issue. And on top of that, the feedback from the field was optimistic the whole quarter. We still did a record number of million or increased number of million dollar deals. So it wasn’t like they were searching for business. They have business that they have, that it was winding up and they thought they were going to close and they didn’t.

Okay, I will cede the floor then, thank you.

Thanks.

Thank you. Our next question comes from the line of Kulbinder Garcha with Credit Suisse. Your line is now open please proceed with your question.

Thank you for the question. For Tom, with respect to the deferral of spending you're talking about, I guess this comes after a period of time where there's already been a prolonged period of deferral. So I guess at some point your customers in your installed base just need to spend to much data growth, and despite all the efficiencies out there, why isn't that helping your visibility at some point? I'm just kind of curious, we've had a period of kind of sluggish growth in storage in the industry frankly, not just with your numbers. And so I'm curious as to how you would think about that dynamic going through last year and then now having this added issue? And then the other clarification is despite this deferral of spending that you talk about, you're not really assuming any that goes back in the near term just to be clear, just to be conservative. Is that correct?

Yes, I think certainly you don’t and with the surprise that we had where committed deals didn’t closed and that assumed they were all just going to come back that simply. I think clearly we need to derate some of the feedback that we get, and I think we need to embed some caution into this and likewise frankly I think we need to see what other companies are reporting at January close and see if this is common or not. So I think that there is just a natural sense of conservatism, both in terms of the forecast we receive and likewise. Our own judging of those forecasts as a result of this. I mean simply put, we came out of the last quarter relatively bullish. When I lay out the delay of the land we were pushing the cloud story, we came out of Insight with a lot of momentum, the feedback on the cloud and the hybrid cloud from customers and partners has been tremendous. We did a dramatic expansion of the portfolio with refreshes E-Series introduction of the storage with Webscale, we acquired the SteelSore product the release of 8.3. So very strong about the portfolio. I felt very strong about the forecast and I think we came out this last call actually relatively excited about where we are heading. So that’s why we are really doubly disappointed about all of this. In the end if suddenly there was a competitive disjoint or some type of quality issue or some type of product issue, but there is really none of that. So things were pretty much normal as far as we look at the quarter as it played out until we got to the end.

Thank you our next question comes from the line of Rod Hall with JP Morgan. Your line is now open. Please proceed with your question.

Hi guys, thanks for taking my question. I guess I want to circle back around this January commentary and see if you guys could – those 40 deals, I guess Tom that you are talking about, is there any regional pattern that you spotted? I mean did you see particular regions worsening in January and others not? Did you see just sort of across the board in January things not coming through as you had expected? And then I also, just as a follow-up to that, wanted to see if you could comment. Do you think that, have you had any direct feedback from people suggesting that maybe budgets got reset and they come back to the table in January and they can't do the deal because there's some sort of a trend in terms of enterprise budgets? Thank.

Yes, I mean the budget reset is exactly what I’m saying. So I think that that’s clearly the case. I think in terms of markets in general, certainly energy was one that kind of jumped out of people being very, very cautious obviously with the movement of the price of oil and I think certainly on the oil and gas it has a negative impact. Presumably it will help the rest of the industry, but I think that’s a lot more diffused and I think it will take more time to flow through. So I’d say probably the only segment that I’d say that we can clearly identify with relatively urge and caution would be oil and gas, but I’d say mostly the rest of the business is spread around. I mean other sectors were very robust. I mean one of the things that we talked about in prior calls is our belief that we are going to see solid growth on the federal side, the second half of the year, over easier compares last year that entirely came through. So if I think about the road map that we went into this year, we communicated at analyst day, we talked about our rebound in federal in terms of growth in the second half of the year and we certainly saw that. We talked about focus on the enterprise and we certainly saw record $1 million deals, we certainly saw that. We saw certainly growth in $1 million deals and I think overall it seems like a number of those things were on track and that’s what we kind of left last quarter with, in terms of how we felt about the second half of the year. So I think some of the things came together and but the other ones didn’t. I think we sense that FX was clearly an issue that was certainly a comment that we had last quarter. I think that’s proven to be a bigger issue than we originally thought and they quantify that and likewise it’s not just an issue for us or our competitors, that’s also an issue for our customers, which has impact on their buying.

Great. Okay, thank you.

Thank you our next question comes from the line of Steve Milunovich with UBS. Your line is now open. Please proceed with your question.

Thank you. Tom, did you say that there was a change in sales management? Could you talk a bit more about it? If that's true, who is in place now? And you also talked about investments in go-to-markets. Could you talk a bit about what those investments are? And Nick, are we going to see kind of a pickup in the SG&A to revenue ratio in the fourth quarter?

Yes I don’t think its any secret that certainly we hired a new Head of Global Sales and we also have new leadership in the Americas commercial business. I should point out that the leader of that business is the person who led our federal business to number one market share in the federal space. So it’s a person that has very strong track record, somebody we have a lot of confidence in. So could it be some measure of them not being familiar with their guys and judging the forecast, I think certainly that’s a factor, but I think in general these are people that were pleased with the work that Randy doing, certainly Mark’s has a great history and so we are still confident in the team. So I wouldn’t want to signal any of this message that there is a change in the team. Perhaps there is some change in process, perhaps that impacted the forecasting; I’m guessing that that’s a factor, but we are talking about two people who practice really deep inspection. Like I said on the Monday the quarter was over, I had a very, very detailed report on what happed in the quarter before in terms of deals that happened, deals that didn’t happened, why they didn’t happened and what we should expect going forward.

Steve, its Nick. Let me just add to that comment or answer your question around SG&A revenue. When we look at operating expenses, what Tom mentioned in his comments, this is also going to be an environment where we are going to position our investments for highest return activity. So to the degree we are investing in certain areas and pushing investments in some, we are going to be holding investment in others and I think that’s really important from the perspective of the business model and running the business go forward. So I don’t see a material change in Q4 as an example of SG&A to revenue. Certainly and we’ll give guidance in May for next year and we’ll talk about Q1, we’ll go a quarter at a time and give you a perspective a quarter at a time. Always a lot of times Q1 looks a little disjointed, why? Because top line there is a substantial sequential decline in top line from Q4 to Q1, so we’ll go through all of that now. But to your specific question of Q4, I don’t see a substantial or a material change in the SG&A or the operating expense to revenue ratios here.

Thank you.

Thank you. Our next question comes from the line of Katy Huberty with Morgan Stanley. Your line is now open. Please proceed with your question.

Yes, thank you. How do we reconcile the comments on the weak January and delayed deals with DSOs that were up 6 days at the end of the quarter? And then also does the limited recovery in branded growth after refreshing the product portfolio change you are thinking on acquisitions as it relates to just broadening out the product portfolio? Thanks.

No I think the DSO is a function of the timing of shipments and invoicing more than anything else. While there are elongated sales cycles, we still were backend loaded even through we didn’t take all this business at the end. But that said, I don’t think there is really anything more to the DOS story. The other question about – oh! Acquisitions. I think acquisitions, I don’t think this changes our opinion on acquisitions. I think we will continue to move ahead with tuck-in acquisitions that expand our portfolio. We did two this past quarter. The SteelStore one is the one that got more headlines and I think we will continue to do that and that should be the normal course of business. I wouldn’t expect that to neither accelerate nor decline. I think on the question of larger deals, those tend to be very, very asynchronous and hard to predict. So I think from our point of view if I look at transactions that we’ve done, E-Series branded had a very, very strong quarter, up 100% again. I look at OnCommand Insight, which is also an acquired technology. That also had a very, very good quarter. So I think the success of our acquired business has been very good. So from my point of view I think we’ll continue to do tuck-in acquisitions. In terms of larger deals, we don’t get to predict when they are going to be available, when they are going to come about. But certainly our recent track record has been pretty good and for the right transactions, the right price when that’s executable, we’ll certainly move ahead with that. But I wouldn’t want to predict any rate or any either increased desire or decreased desire to pursue those.

And maybe just a comment to really take that DSO comment Katy and take it up one level with overall cash. I mean I think that cash and cash conversion as a percentage of revenue in Q3 was perhaps a little bit lighter than we typically do. However we will have a strong quarter in front of us here as well. So when I look at the overall statistics and the overall expectations in terms of cash generation this year, I don’t see any change there at all. And I see us landing right inside the types of metrics we’ve talked about and modeled for the three-year period of time certainly, that we talked about in our last financial analyst day.

Thank you.

Thank you. Our next question comes from the line of James Kisner with Jefferies. Your line is now open. Please proceed with your question. James Kisner – Jefferies: Okay, just want to verify something, like was there any particular product lines at all that sort of saw more details slip-outs and I guess just regionally I’m looking at the year-over-year rates in both Europe and Asia, they are both down a lot sequentially here on a year-over-year basis. But Asia has a tough compare. Was there any kind of regional differences in terms of the activity you are seeing.

I would say, one thin to bear in mind with the year-over-year comparison of Asia and especially EMEA, you got the currency component of that. There is some currency component, you got the Canada, South American, and the U.S. number as well or the Americas number, but not that big. So I’d say certainly the FX one. There is really two questions I think in play. One of them is the relative performance and the other one is deals that we actually had in the pipeline that we are expecting to close. So I think we are looking at both of those differently. Overall in terms of our international business, the EMEA team is dealing with FX, obviously the Russia situation, even the French situation late in the quarter were all factors and I think overall from a booking perspective they did quite well. So I’m actually – well, the numbers don’t show, but I’m actually quite pleased with the EMEA team. Asia Pac is not a unified region. All the different geographies perform differently, but I think overall they did pretty well. We saw growth in China again. Certainly the China headlights haven’t been great, but I think the team there continues to make progress and so I think the biggest surprise relative to where we thought we were going be is in the American and particularly the America is non-federal. James Kisner – Jefferies: Any particular product lines to follow up that under performed or had more slip outs I should say.

Not in terms of slip deals. I think that the category on slip deals is really a function of size rather than product. James Kisner – Jefferies: Thank you.

Thank you. Our next question comes from the line of Amit Daryanani with RBC Capital Markets. Your line is now open. Please proceed with your question.

Thanks. Tom I guess this is a question for you. You talked a fair bit about I think adding more boots to the ground, adding more product specialists. I’m just trying to get a sense, I mean how much headcount increase do you anticipate doing or what’s the timeline to doing that? Is it one quarter or two or three quarters and what sort of payback do you expect in terms of – in my head I guess branded growth accelerating. Maybe just walk through you know what kind of headcount additions you want to do and how do you think that pans out on the other side in terms of branded growth?

Well, I think at this point we are not ready to quantify that. I think that’s a model that we are working through on our own. But obviously it will be something that we think is going to move the needle and something that we want to move the needle this coming fiscal year. So its not that its going to move the needle in the immediate term. I don’t think that we’re going to hire people and they are going to be all still coordinated in a very, very short period of time. There will be a sliding scale in terms of how they ultimately ramp up. So the real impact to that will probably be towards the middle or the end of next year, but the vessel will be front ended and as Nick indicated, as we think about our full year business model, its our full attention to operate within the bounds of the business model that we have previously communicated. But if I look at it, it’s independent of the individual issues of the end of last quarter. If I look at our ratios and I look at our investments, we’ve done a substantial expansion of the portfolio. Within that portfolio has been carve outs for specialists to drive things like E-Series and OnCommand. I think that’s paid off quite nicely for us. As we think about adding new products to the portfolio whether it be StorageGRID or SteelStore, we’re going to have to do some of that. So I expect all of those investments to come in, while in the meantime we still need to be cultivating new accounts and new opportunities for Clustered ONTAP. And the other one is I think that our partners are a key part of this. I think invested in the partners so they come up to speed on the new products, so they are pitching. Its accepting and successfully be self sufficient in pursuing these opportunities and likewise helping our customers with the migration to Clustered ONTAP as they are all go to market activities that I think have immediate impact or relatively near term impact on the business. But the simple fact of the matter is if sales force productivity was the issue and they were not anywhere near quota and they were sub-optimal, because we didn’t have competitive products and we didn’t have competitive technology, then I think we make it an entirely different investment choice. But the feeling is that the portfolio is strong and we just don’t have enough people out there promoting and selling it and serving customers and that’s the investment that we want to make within the confines of the business model that we talked about.

Thank you. Our next question comes from the line of Jim Suva with Citigroup. Your line is now open. Please proceed with your question.

Hey, thanks very much. Its Jim Suva here from Citi. NetApp has been going through a little bit of shifting with its sales people you know over the past 12 to 24 months out of certain areas in the focus of other areas and then today on the conference call you mentioned a need to really get the kind of feet going and the right people at the right place, but you have the expense area to be within the relatively normal of what you expect. So can you help me explain what’s different? Meaning, you’ve kind of been shifting around a little bit in the past 12 to 24 months and you’re saying your still looking around. So what’s different and how should we think about what your truly doing different to adjust these needs, especially if the expenses are not going higher.

Well, I think that there is really two questions here. One of them is the shifting of the resources within an envelope and the other one is the total envelope. So I think clearly we’ve been doing shifting of resources within the envelope. I think across the entire company we worked very hard at that and I think that manifests itself in terms of the engineering choice that we made and the products that we’re bringing to market. We were able to do that by de-emphasizing other products and fast moving out of certain spaces. We have certainly seen it in terms of carving out part of the sales resource to focus on some of these newer products. I talked about E-Series and OnCommand and that has worked out well for us and I also talked – in fact we spoke at the Analyst Day around the enterprise strategy and getting our partners more self sufficient in the mid-sized business, so we can migrate some of our resources against the bigger opportunities in the enterprise and we’ve seen that million dollar deals. So if we look at that data and that is more specialists around the new products generate sales. If we look at moving more resource towards the enterprise we’d generate more million dollar deals. If we can continue to make our partner self sufficient and continue that and widen the total number of people engaged in that, I think we’re hard pressed off to conclude that there is an opportunity for growth in that and that’s the nob that we want to turn. So only Clustered ONTAP has been a big investment. 8.3 is a culminating release for that. We absolutely needed to get that done. We need to get customers migrated to it. We certainly have the finished investments that we’re making and other key technologies around all-flash FAS and flash in general, but I think we are ready to shift that transition towards field going activities now that the product arsenal is ready.

And Jim, I guess I might just add in the context of it and operating expense envelop of just under $3 billion on an annual basis, we believe we have the opportunity to shift investment for highest return activities.

All right. Thank you very much.

Our next question comes from the line of Srini Nandury with W.R. Hambrecht and Summit Research. Your line is now open. Please proceed with your question.

All right, thank you for taking my call up. The question I have is that regarding your flash, FlashRay. I don’t know whether you commented on FlashRay during the quarter. I must have missed my earlier part of the call. The question is that you have a single controller device and its limiting your adoption in the market. As you look at the FlashRay opportunity out there, what does it take NetApp to become a dominant FlashRay provider; perhaps second in the market at 20% to 25%.

Well, you are just talking about one product in the portfolio. We actually have the EF product which is doing quite well, we’ve got the FlashRay product and we also have the all-flash FAS and then we’ve got the hybrid rays that also have flash. We certainly talked at the analyst day and our view of this is that flash is a compelling technology. Its got a compelling set of deployments and they are all different form factors. There is flash in the host, there is all-flash arrays, there is hybrid arrays and all those are going to be important. The key component for us ultimately is not any of the individual products or any of the individual categories. Its about total flash under management which was up huge year-over-year. So from our perspective I think we’re absolutely in the flash game. I think FlashRay has been a key driver of innovation for us. We’ve seen not only FlashRay in its own incarnation, but FlashRay technology integrated and introduced in the form of all-flash FAS and in EF as well, but all-flash FAS clearly has a product that the team is familiar with. It actually had a very, very big growth quarter and overall I think that the idea of an all-flash FAS instead of a stand along point product, to actually be a node of a cluster that’s compatible with all of our other data movers and all of our storage efficiency and all of our scale-on capability is a compelling value proposition. So I think FlashRay is going to serve a segment of the market. We continue to invest it in some customers’ hands and we’re getting feedback around the key efficiency and performance and ease of use components, but that’s not the totality of the flash portfolio. In fact the overall majority of our flash is in the other products and in fact the all-flash FAS, which was only introduced about a quarter and a half ago is actually the one that’s actually ramping the hardest of all of those and we’re actually pretty pleased with the use cases and what you’ll see from that is in fact from a number of our products are compelling performance benchmarks that we’re going to publish in the very, very near future. So I think from a performance perspective certainly all-flash FAS has a feature set far beyond any other flash array and compelling performance and compelling efficiency. I think you’ll see a lot more of that product in the near future as well while we continue to evolve and develop FlashRay to serve the segments that its targeted at.

All right, thank you.

Thank you. Our next question comes from the line of Joe Wittine with Longbow Research. Your line is now open. Please proceed with your question.

Hi, thanks. On the headcount your adding, I think your saying you need more product specialists. So what exactly are you referring to? Is it more resources for the ramping flash business or maybe the service provider business or certain market verticals. I think just a little bit more clarity would be helpful. Thanks.

Yes, I don’t want to leave a misperception there. I think first and foremost we’re adding people that are carrying numbers. Whose job it is to close business and bring business in. So product specialists, I talked about them in the category of the product specialists have been successful, but within the fixed size envelop they’ve comes at the expense of generalists that are selling the standard product and pursuing new accounts and those types of things. I think we want to be able to do both of these at the same time. So I think we have invested in an overlay. I’d say the increment from here will not be nearly as significant percentage wise. What we’re really looking to do is getting more people out there, getting in front of new customers, new customer acquisitions and deeper into our largest biggest customers. So I say that, the reason why I brought the product specialty is within a fixed envelope the more product specialists you have, the less generalists you have and our new is that we need more generalists out there pushing the ONTAP based products pursuant to our enterprise strategy. We are proving that we can get big deals if we move in that direction and now we want to get more people out there cultivating new accounts, deeper in existing accounts and bringing in more big deals.

Helpful thanks.

Thank you. Our next question comes from the line of Nehal Chokshi with Maxim Group. Your line is now open please proceed with your question.

Thank you. The large deals that have been pushed out in favor of extending service agreements, is there any correlation to cloud ONTAP having become generally available? Is this potentially creating any further evaluation? Do you expect this to become a material part of these large deals? And can you give any metrics around cloud ONTAP at this point in time as well?

Well, I don’t think that cloud ONTAP is changing that. I don’t think cloud ONTAP is the substitute necessarily for the types of systems that we are selling with Clustered ONTAP on-premise. I think cloud ONTAP is completion of a story, its an option for a tested development and backup and flexibility and DR, but I don’t think its changing the dynamic of do I buy an on-premise system of do I buy that. Now there’s actually been a fair amount of activity around cloud ONTAP. The numbers of hours is in the 40,000 range. So those are people kicking the tires playing with it, some people are actually using it in production. But really when I see cloud ONTAP it’s a completion of our end-to-end seamless data management story with the cloud. So I can run cloud ONTAP on extreme, I can run on-premise, then our private storage which has actually seen a lot of acceleration, its actually one of my favorite use cases. But overall I don’t think that that’s really disrupting it. I think the cloud ONTAP is basically at this point its symbolic, and emblematic of NetApp's end to end seamless cloud strategy and proving that its real. But I don’t think its intercepting near term business, that’s actually not a concern of mine.

Okay. Thanks.

Thank you. Our next question comes from the line of Benjamin Reitzes with Barclays Capital. Your line is open. Please proceed with your question.

Yes, thank you for taking the question. My questions are on gross margin. What is the implied FX hit sequentially to the gross margin versus the pricing hit and mix? And to that end, do you feel you got to get more price aggressive is sort of the premise of the question as well, and versus some of the upstart competition? Thanks.

Ben if your talking about Q4 gross margin guidance there is about a point of FX in there, so I think you need to consider that. I wouldn’t suggest that in there is any additional pricing aggressiveness. I think that pricing has been, has really been at this rate for some time, right. So there is dynamics in pricing and from time to time we did deeply discount. There are all of those types of things that we manage as part of managing the business. So there is not an incremental built into out gross margin guidance. We also inside our structure, inside our cog structure drive a set of efficiencies. And frankly over the last several years has been driving an increasing set of efficiencies. So I think all of that levels out in the end and I think the think to remember is there is appoint of FX in that year over year impact of that FX in that Q4 guidance.

What's the sequential impact of FX?

I can’t have that off the top of my head here Ben.

Okay, hey, thanks a lot.

Thank you and our final question comes from the line of Mark Heller with D.A. Davidson. Your line is now open. Please proceed with your question. Mark Heller - D.A. Davidson & Co. : All right. Most of my questions have been asked by now. But let me just ask about SteelStore. Where does that fit into your expectations going forward, particularly on the cost side, but also on the top line for the next few quarters?

Yes, I think what SteelStore effectively is, is a backup appliance that’s integrated with the cloud and clearly from our point of view and for those of you who had insight at certainly the analyst day we talked about the economics of the cloud and cloud being a resting place for very low utilization data like backup and archive. So it’s a way to seamlessly extend traditional backup all the way to the cloud and its something that we felt very, very strongly about as an opportunity and that was really the motivation for pursuing SteelStore. So I’d say that post transaction I think a couple of things came out, one of which was – this is a product with a fair amount of visibility within Amazon and the Amazon relationship is developing quite nicely around cloud ONTAP around NetApp private storage and this one has become a third leg of the stool in that relationship. In fact they’ve actually gave us some reference accounts to pursue with this. So I think at this point its not material to the number that Nick just gave. It will be certainly not 05. Its already been on zero. I think its ahead of our initial forecast, but certainly we’re on the very, very front end of that curve. So I think so far so good, no regrets, but I think it’s a little bit too early to tell. But the real goal there ultimately is how do we enable the next generation of back up that successfully integrates the cloud, but is compatible with all the back up methodologies that people currently deploy on premise. Mark Heller - D.A. Davidson & Co. : Okay. Thanks.

Okay. So first of all, thank you all for joining us today. As I think about the quarter that we just completed and I think about where we were last quarter, the evolution of the roadmap, we introduced more new technology in the last six months, whether it be a Clustered ONTAP, 8.3, the acquisition of SteelStore, StorageGRID, OnCommand, Insight, E-Series, FlashRay or Flash FAS and the momentum that we saw, both in terms of last quarter, the forecast for this quarter, I think we feel very, very good about the business. So as I talked in the prepared text, clearly disappointed with the set back that we had. Probably a little bit more than disappointed, probably I’m downright angry, because I felt like we’re in very, very good shape and we need to do better than that. So as I think when we go forward I think my belief in its as good a shape as we are with the portfolio is unshaken. The execution issues we will fix and we are going to make key investments within the bounds of our business model to fully exploit the full potential of this portfolio and drive growth for this company and that’s our commitment. So once again, thank you for your time and I’ll see you all next quarter.