Good day, ladies and gentlemen, and welcome to NetApp's First Quarter Fiscal Year 2016 Results Conference Call. At this time all participants are in a listen-only mode. Later we'll conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call may be recorded. I would now like to turn the conference over to Kris Newton, Vice President of Investor Relations. You may begin.

Hello and thank you for joining us on our Q1 fiscal year 2016 earnings call. With me today are CEO, George Kurian; and CFO, Nick Noviello. This call is being webcast live and will be available for replay on our 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 second quarter and full fiscal year 2016, our expectations regarding our ability to respond to changing demands of our customers, our ability to manage our portfolio to drive efficiency, profitability and growth, our expectations regarding market acceptance of Clustered Data ONTAP, our ability to drive operational and financial performance, our expectations regarding our business model in FY'16 all of which involve risk and uncertainty. Such statements reflect our best judgment based on factors currently known to us and are being made as of today. We disclaim any obligation to update our forward-looking statements and projections. Actual results may differ materially from our statements and projections for a variety of reasons. We describe some of these reasons in our accompanying press release, which we have furnished to the SEC on a Form 8-K. Please refer to the documents we file from time to time with the SEC, specifically our Form 10-K for fiscal year 2015 and our current reports on Form 8-K, all of which can be found on our website. During the call all financial measures presented will be non-GAAP unless otherwise noted. These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of our GAAP and non-GAAP results is provided in today's press release and on our website. I'll now turn the call over to George.

Thank you, Kris, and good afternoon. This is my first earnings call as NetApp's CEO and it's an honor to be here. We delivered revenue above the midpoint of our prior guidance with gross margin, operating margin and EPS all above our previous guidance ranges. We did what we said we would, but we're clear that we have a lot more work to do. We're committed to helping our customers navigate their IT transformations to improving our own execution and to enhancing value for our shareholders. We're making progress against our plan, adding new customers and expanding the adoption of our portfolio by aggressively pivoting towards modern architectures such as scale out software defined flash, converged and hybrid cloud, all while planning to return to our operating models in the second half of this fiscal year. This is my first time addressing many of you and what you'll hear from me today is the focus on portfolio management, execution and enhancing shareholder value. I want to start by sharing my views on how I think about managing our business and how we're shaping our strategy to respond to the transformation in the IT industry to increase efficiency and to deliver strong financial returns. Then I'll provide an update on our business in the quarter and hand it over to Nick to cover our financial results before we open the call for Q&A. In my first days as CEO, I spent time to ensure that we had a well articulated view of the industry transition and a clear understanding of customers, IT transformation priorities, but this alone is not enough. To maximize results from our strong portfolio of technologies we need to operate the business with a greater level of discipline and to align resources against our most important priorities. In…

Thank you, George. Good afternoon, everyone and thank you for joining us. NetApp delivered Q1 results that were generally on track and in line with our expectations. As George highlighted, the storage industry is in transition as customers drive IT transformations to take advantage of new technologies and architectures, while planning their journey to the hybrid cloud. As you know, this industry transition has impacted our business as well. We've embarked on a new chapter and we're aggressively shifting our efforts to better position ourselves for the future. We saw progress on many fronts in Q1, but we still have a lot of work ahead. For the first half of fiscal year 2016, we're raising the bar on execution across all aspects of the business. For the second half of the year, you can expect us to deliver against our plan and return to our target operating margins. Beyond fiscal 2016 we will do a much better job demonstrating our broad value proposition to customers and translating that to financial results top and bottom line and increased shareholder value. Please note that I will be referring to non-GAAP numbers in today’s presentation unless otherwise indicated. Fiscal Q1 net revenues were $1.34 billion down about 13% sequentially and down 10% year-over-year. FX headwinds had an unfavorable impact of about four points on the year-over-year comparison. We estimate that the extra week in Q1 which occurs every six years to realign fiscal and calendar months added approximately $40 million of revenue to the quarter. Product revenue was $664 million in the first quarter, down 27% sequentially and 25% year-over-year. FX headwinds had an unfavorable impact on the year-over-year product revenue comparison by about five points. The decline in product revenue due largely to the decline in ONTAP 7-Mode sales was in line…

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

Thank you. [Operator Instructions] Our first question comes from the line of Amit Daryanani of RBC Capital Markets. Your line is now open.

Thanks a lot. Good afternoon, guys. And congrats George on a nice start to the job. I guess my question really is when you think about the initiatives and the execution improvement you’re talking about, how do you think about -- is there room for cost curtailment as you go forward, because even if I take the assumptions for fiscal '16, you'll probably exit the year with low single-digit revenue growth in a good scenario. In that case do you think 45%, 50% of sales going to expenses is a reasonable target for a company to have or do you think there is room for that to lower and if so, what are the levers or what are the metrics you could do to lower that operating expense structure?

We have been and continue to be disciplined around the cost structure of the company. I think if you look into our plans for this fiscal year, there are already expense containment strategies in place that improve the target operating model of the company back to our guidance range within the second half of the year. So we have plans already in place. I continue to inspect them and I’m also rigorous that we align the resources of the company against the biggest opportunities and harvest the mature parts of our portfolio for profit. In addition both Nick and I are studying the evolution of the storage market and we’ll have a broader perspective to you about the operating structure of the company as well as the way to maximize both the return on our assets as well as shareholder value at our next earnings call.

Hey Amit it’s Nick as well, let me just get real granular for a second. If I look on a year-over-year perspective or first half to second half perspective, I would expect that the expenses of the company, the operating expenses would be down in the second half of the year. So we have operating plans and we’re operating against all of those plans across the functions to achieve just that. We also have the additional levers of gross margin that you can imagine we always look at. We always look at our spending there. We always look at our structure on that side, work for suppliers etcetera and then even to go further up the stack the value we get out of our software value proposition.

Thanks Amit. Next question.

Thank you. Our next question comes from the line of Sherri Scribner of Deutsche Bank. Your line is now open.

Hi thanks. I just wanted to get a sense from you George. On the last call we heard a lot about customers waiting to transition to Clustered ONTAP, I want to understand what change this quarter and what makes you confident in the growth for the next quarter? You're guiding to up 9%. What are you seeing that’s making you confident about that? Thank you.

The growth that we see is from both the investments in sales capacity translating to pipeline expansion and is a combination of customer acquisitions and usage of Clustered Data ONTAP for new workloads within existing customers. The pace of transitions from 7-Mode to Clustered ONTAP within our install base will be benefited from the work that we’re doing to make it easier for customers to transition but will be prioritized against their broader landscape of IT priorities. So we are by no means counting on just installed base transitions to drive growth. We’re counting on the pipeline expansion and the capacity investment that we’re making to drive that upside.

Thanks Sherri. Next question.

Thank you. Our next question comes from the line of Alex Kurtz of Sterne Agee. Your line is now open.

Yeah thanks for taking the question guys. Nick, just on the product margin in the quarter, it sounds like maybe FX had some impact here, but this is one of the lowest prints you put up in a while. Was there mix issues there or were there any component issues. And as you look at the second half statements you’re making on operating leverage so what is your expectation for product mark and recovery as we get into Q3 and Q4?

Yeah. Thanks Alex. So just to be clear so on that product gross margin for Q1 versus Q1 a year ago, yes it was a pretty significant decline in gross margin percentage. Half of that was FX all by itself okay. So you're seeing that FX really hitting the product side of the fence versus the deferred side of the fence. In addition to that, it’s a combination of volume and mix which you would expect given the rebuild of the pipeline and some discounting. So we talked about discounting last quarter. We talked about again discounting this quarter. I indicated that I would talk about that to the degree that it changes on a year-over-year basis. So you can imagine with a lower pipeline and a need to rebuild those are the types of things we have to work through. Over the course of the year in terms of product gross margin, we’re going to expect that FX certainly fades in the back half of the year. We shouldn’t have assuming there is not another dramatic change out there, we shouldn’t have the type of compares we’ve had. So we’ll back to the typical which is looking at the mix of business. We'll be looking at the combination of pricing, discounting and savings of the supply chain to really look at the gross margin there. So that’s probably the good perspective for you.

All right, thanks.

Thank you. And our next question comes from the line of Katy Huberty of Morgan Stanley. Your line is now open.

Yes, thanks as it relates to hitting the target model in the back half of the year, can you get there with the current booked maintenance and cost cuts and the gross margin acceleration that you’ve talked about already? Would you need the product revenue to grow again in the back half to hit the target? Thank you.

Yes Katy, let me start on that and if George has a perspective he can weigh in as well. Remember the first half of this year was about pipeline rebuild. We’re talking about pipeline rebuilds from a perspective of rebuilding sales capacity, of channel investments, of C-DOT transition programs and we’re seeing the beginning of those things. So in terms of the back half of the year, what we expected to happen and what we’re seeing the early -- the green shoots on if you will, those metrics are coming in and they’re starting to build and we expect to monetize some of that in the second half. Is it a dramatic shift of product revenue from the second quarter, let’s say to the third or the fourth, I wouldn’t call it a dramatic shift. Certainly the first quarter was impaired and we knew that coming into the first quarter. The maintenance streams of the company, we can look at those year-over-year, quarter-over-quarter and that's reflective of that installed base. The installed base as we indicated continues to grow. It’s a combination of new renewal and that and we see that -- sometimes we see that in short terms. Sometimes we see that in longer term thesis. So is there a dramatic shift from the second quarter to the second half of the year, I wouldn’t say it’s a dramatic shift. Obviously we expect some uptick in terms of product revenue. We will no longer hopefully have the FX pressure on product revenue, but certainly Q1 was a low point and Q1 was reflective of what happened to the pipeline and Q1 is really the area where we’re going to be the lowest.

Thank you.

Thank you. Our next question comes from the line of Brian Alexander of Raymond James. Your line is now open.

Yes just following on to that, the revenue guidance up 5% to 12% sequentially Nick is the most growth you’ve guided to for a July quarter in many years. So can you just talk about your confidence level and the key drivers of what appears to be an above seasonal growth outlook and specifically how should we think about on a sequential basis, the product revenue versus software and services? Thanks.

Well if you’re talking about a sequential basis from Q1 to Q2 obviously there is going to be an uptick we expect on the product revenue side. That is a granular build up we do of pipeline and a granular build-up we do of our expectations for the quarter. Obviously the -- what comes in off the balance sheet on the software and hardware components, we know very, very well. So there is a sequential increase on the product revenue side of a sense in Q2 that's reflective of some of that pipeline that started to build up, started to build in the metrics there. It is a pretty significant increase quarter-over-quarter sequentially. So a year from now I will be reminding you of that but that is built on our bottom up projection of the business.

Do you still expect software and service revenue to grow double-digits on a year-over-year basis in the October quarter?

I would not. Okay. They come in off the balance sheet I would…

All right. Thank you, Brian.

Thank you.

Thank you. Our next question comes from the line of Jayson Noland of Robert Baird. Your line is now open. Again Jayson Noland of Robert Baird. Your line is now open.

All right. Let’s move on to the next caller.

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

Thank you. Could you talk a bit more about the transition to ONTAP 8 from 7? You gave us some percentages that you haven't given before. It sounds like there is a pretty significant shift toward 8, but you didn’t give us any kind of sequential percentages? So was that really accelerating at this point and anyway now it seems to have accelerated obviously the total number has gone down and I guess that plays to your comment about just people transactionally holding back right now.

I think at the highest level when we talked about percentages, we talked about the percentages of FAS shipments and we said that the 7-Mode systems were down to 20% to 35% of FAS shipments from 75% year ago and the clustered ONTAP 8 version are up to 65% of FAS shipments from 35% -- from 25% a year ago. So there is a dramatic growth in clustered ONTAP systems as a percentage of our total mix as well as just year-on-year and it represents the value propositions of Clustered ONTAP. Those include shipments being made to new customers, new workloads within existing customers and as we mentioned some early benefit from the transition programs that are under installed base. I would say that on the last bucket meaning the transitions were still very early in that program it seems some good momentum and confidence building within our customers, but hasn’t materially translated into results yet.

Thanks.

Thanks Steve.

Thank you. And our next question comes from the line of Louis Miscioscia of CLSA. Your line is now open.

Okay, great. May be I'll go back to Brian’s question, it looks like most of the etcetera week fell into software entitlement and also services. So how much would we expect those to be down on a quarter-to-quarter basis or do you expect them to be flat, which will help us think about how we should also then model in the product revenue? Thank you.

Yes Lou, I’m not going to get into a granular level of specific there, but really the $40 million of the 14th week was in software and was in the service revenue lines. So it's all there and in fact you can see it on the deferred revenue side of the fence. So deferred revenue was down pretty substantially in Q1 on a year-over-year basis and we haven’t seen that kind of decline really in quite some time. If you take $40 million out of that, which is a deferred component, you get back to a number of that, we’re not thrilled about, but that's a lot closer to those types of sequential decline we’ve seen before. So what we expect to happen is obviously that 14th week doesn’t occur again in Q2. We go back to a 13th week. We won’t talk about 14th week again for six more years from now. So we’re going to look at those pieces. It obviously means that the amount of revenue of $40 million was shared between software and hardware and the share was 18 and 25 respectively that's not going to occur again in Q2.

All right. Thanks Lou.

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

Yes thanks for taking the question. Just on clear and will go back to Brian’s question and I think the prior question as well, at what point does the decline in deferred catch up with the software entitlement maintenance and if you do expect that to decline or not grow the double-digit rate it seems to imply a fairly high teens if not 20% sequential growth in product revenue after the first quarter. So I’m just curious of how we should expect the deferred revenue trends? Should we expect that to grow going forward and what that implies for the product revenue in the first quarter?

Okay. So if I think about deferred the software entitlements and service revenue, on a year-over-year basis in Q2, I would expect those things to go up and not going to go up dramatically, they are not going to be reflective of 14th week because there will be no such things. Okay. On the product revenue side and I think the real question is what's going to happen with product revenue? On a sequential basis, we expected a pretty reasonable increase in product revenue. Why is that? That is because at the time we came to the end of Q4 we did not have a pipeline on the product revenue side and we had to rebuild that pipeline. What we're seeing and what we're doing as we build up the guidance for Q2 is that we're going to see some return on the product revenue side and that's reflected in the guidance that we pulled out there.

Thank you.

Hey, Aaron as you know, we don't guide below the overall revenue line third quarter.

All right. Thanks.

Thank you. Our next question comes from the line of Brent Bracelin of Pacific Crest Securities. Your line is now open.

Thank you. George wanted to go back to kind of the decision here to kind of pivot to these modern data architectures. The question is how quickly can you pivot and will that include divestitures or acquisitions and the reason why I ask obviously C-DOT has been years in the making. So help us understand your appetite, how quickly can you pivot here and will that include divestitures or acquisitions?

First of all, I think we have a strong portfolio of technologies that are relevant to the modern architectures within our customers. In some cases it is developing core technology. In other cases it is qualifying our technology for emerging used cases within our customers because solutions development. I think that is all well underway and we feel good about the portfolio we have. We're also constantly looking at the evolution of our customers perspective on the IT landscape, their requirements for data management and we'll always be on the lookout for M&A tuck-ins where they make sense have strategic fit, have the right financial criteria associated with them and we have a disciplined way of scanning the landscape and discussing with our customers their choices ahead of them and for us.

All right. Thanks Brent. Next question.

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

Yes, hi guys. Thanks for taking my question. I just had one, which is could you give us -- you gave us all the year-over-year trajectory on Clustered ONTAP, but would you be able to give us the proportion of the install base that has adopted it just to give us some idea where we are, where we're tracking?

We're as a percentage of our install base, we're about 15% of the total install base and remember the install base is growing and last quarter we were at 11% of the install base. So pretty good sequential growth.

Great. Okay. Thank you, George.

Thanks Rod.

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

Hi thanks. Nick you talked about next quarter being based on a bottoms-up basis. Can you just talk about how much of that is based on fiscal year government spending or what your expectation is there? And then George if you could just talk about -- you talked about making sure to understand customer mindsets and if they're changing. Wondering if you are seeing any changes within your customer mindsets since you bring that up, thanks?

Okay. So Maynard, why don't I just get started. So second quarter is when we generally see the Government, the U.S. Government I should tick in. So our bottom up includes our expectations from the U.S. Fed. It includes our view of contracts that are taking shorter, longer or sideways in terms of the time to land them. As you know we have a very strong presence there and a very good business condition overall and value proposition for them. So the second quarter will include U.S. public sector element to it, a federal fiscal yearend element to it. We plan on all of those. We look at risks or opportunities to those as we build that bottom-up guidance.

I think to answer your question in terms of the discussions we have with our customers, I've actually had several meetings with customers from all different parts of the world and I am just headed out to Asia Pacific as well. I think the things that encourage me are the breadth of discussions we have and the adoption of multiple products in our portfolio by the enterprise customers that we work with. I think they are expanding the range of things they're doing with us and we're excited and encouraged. Strong growth in terms of the number of customers, enterprises buying multiple products from us for broad set of used cases.

Thanks Maynard.

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

Thank you. What has been the capsulate of new workload across to market with Clustered ONTAP over the past year. It seems like it’s been depressed and I think you've talked about being refill that pipeline? Is that a fair way of looking at that?

I would say that if you were to look at two dimensions of new workloads being captured, I think the first one is new to NetApp customer where clustered Data ONTAP has given us a footprint that we didn’t have before. And as we said in our commentary that has seen strong growth up triple-digits 225%, and so that’s a measure of competitiveness of Clustered ONTAP in net new to NetApp environments. Within existing NetApp customers, the preponderant majority of Clustered ONTAP sales have been to new footprints. As we mentioned the percentage of our installed base that has migrated from their legacy 7-Mode environments to Clustered ONTAP has been small.

Okay. Thank you.

Thanks Nehal.

Thank you. Our next question comes from Jim Suva of Citigroup. Your line is now open.

Thank you very much and congratulations both George and Nick. First I've a question for George and a easy clarification for Nick. George you talked about stay tuned to many things you’re looking at for the next quarter, can you help us understand these many things? Are they more operational focused? Are they more capital allocation deployment focused that we might ask is I’m sure you are aware of where your stock price is and your strength of your company? And so one could beg hey why not even buyback more stock, but one could also say maybe we’d spend that more for strategic acquisitions or maybe some different go to market strategy or something like that. So if you can help us understand what’s exactly you're looking for stay tuned. And then for Nick, can you just help us understand you guided for I think was 3 or 3 million in shares, does that include the share count today than what you buyback so far this month or does that also include your estimated stock buyback that you will do after today’s call?

So let me answer first the perspective I’m taking is a broad perspective looking at all aspects of the business, both the operating model of the company as well as the opportunity to optimize our capital structure to maximize returns to shareholders.

Okay. And then my quick clarification on the 303, this is what we’ve done based on the first 10 days of the quarter. So we have not in the past and don't in the future plan to project out what we'll by over the quarter is really based upon first 10 days what happened last quarter and how that falls and depend really just the first 10 days of volume.

Thank you, Jim.

Thanks so much.

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

Thanks. I was hoping you could comment on the international aspects of your business just as you’ve re-built the pipeline exiting Q1 pockets of strength in the international EMEA APAC rest of the world if you could comment that I’ll appreciate it?

We’ve had a strong start to the year in the European theater with all of our parts of Europe doing very well year-on-year both especially with FX being accounted for. So that’s a reflection of both the Leadership Team in Europe as well as the value proposition for Clustered ONTAP. Some of the key features that our European customers were waiting for were made available to them in 8.3 and that is now translating into results from the capacity investments as well as the product readiness. Within APAC, we continue to monitor the situation in China. Of course our China business is a small business and hasn’t been affected by the changes in China, but we’re evaluating the impact of the Chinese economy for the rest of the Asia Pacific Theater.

Thanks Eric.

Thank you. Our next question comes from Andrew Nowinski of Piper Jaffray. Your line is now open.

All right. Thanks you mentioned pretty strong growth out of your genuine pipeline this quarter, just curious of your thoughts regarding the acquisition stock here last night, you're normally competing against one of your largest suppliers DA?

The focus for our E series business is on the branded customer business and it is about building pathways to market through our more traditional routes to market resellers, system integrators and service providers. I think we feel good about the progress we’ve made. We think we feel good about the relationships that we have with enterprise and service provider customers who look to buy directly from us or through our reseller model and so we feel that the acquisition does not materially affect that business.

Thanks Andy.

Thank you. And our last question comes from the line of Srini Nandury of Summit Research. Your line is now open.

All right. Thank you for taking my call. Congratulations on a good quarter. I had a question on the Clustered ONTAP adoption within your install base. Are they -- when you sell into your install base, are they going to the net new workloads or are they going to your existing workloads? Or in another words are people replacing the old 7-Mode and putting the new boxes in?

When we look at that right, so there is sort of two or three sets of used cases within our existing customers. One is competitive displacement or new workload growth. We're certainly seeing a strong set of trajectory around that. The second is replacing 7-Mode for a workload that could have run on 7-Mode, where they choose to go to a new architecture. That certainly happens as part of footprint and then the percentage of those where you have a workload that is running on an old 7-Mode system that now gets essentially upgraded and converted to a Clustered ONTAP system, the last one is a small percentage of the total.

Thanks Srini.

All right. Thank you.

Thank you. And I'll hand the call back over to NetApp for any further remarks.

Thank you. I would like to conclude by saying I am excited and honored to lead NetApp through the industry transition. I want to extend my thanks to the entire NetApp team for your hard work and for your support as we create opportunity for NetApp during this transition. We're taking action to better address the trends in the storage market and will manage our portfolio of solutions to target the requirements created by those trends. Our strategy resonates with partners, enterprises and service providers and we're making investments to ensure we're engaging in more customer conversations an opportunities. Those investments are yielding results that position us for a successful future, but we have more work ahead of us. We're committed to enhancing shareholder value and plan to return to our target operating model in the second half of this fiscal year. Our focus on cost structure, stock buyback program and dividends are important demonstrations to this commitment and to our confidence in our future. Thank you all for joining us and I'll talk with you again on our next earnings call with a further update on how we're evolving the business to deliver greater value to customers and shareholders.